Segment 1 Of 2     Next Hearing Segment(2)

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House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.

    The committee met, pursuant to call, at 10:10 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding.

    Present: Chairman Leach, Representatives Roukema, Baker, Lazio, Bachus, Lucas, Metcalf, Ney, Barr, Fox, Kelly, Weldon, Ryun, Cook, Snowbarger, Riley, Hill, Manzullo, Foley, LaFalce, Vento, Flake, Barrett, Bentsen, Jackson, Hooley, Maloney of Connecticut and Kilpatrick.

    Chairman LEACH. The hearing will come to order.

    The issue of bank modernization has come before the full committee today, almost 2 years to the day since our committee reported out legislation on this matter in the 104th Congress. Regrettably, we were unable to complete action on bank legislation last year, but the public and private party dialogue that has occurred has laid the basis for action this year.

    As we meet today, it appears there is general consensus among committee Members to move forward this session with financial modernization legislation which would allow affiliations of banking with insurance and securities firms. Differences still remain, however, on how best to regulate this new financial structure and whether the affiliation rights of banks should be expanded to include industrial interests.
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    It is my hope that all of the critical issues will be fully explored during this set of hearings which begin today, during which we will hear from bankers, securities dealers, and insurance agency companies, State regulators, and other experts in the financial sector of the economy. I would have preferred to have begun these hearings with the Secretary of the Treasury, but we have received a request that Treasury's testimony be delayed until June 3rd. We will honor that request, but Members should be advised that it remains my intention to move to the committee markup in early June and to take a bill to the floor this summer.

    Markup will be preceded by meetings of Members and meetings at the staff level to meld a committee print from the various proposals on the table. These meetings have started at the staff level on a bipartisan basis.

    In preparation for these hearings, I have had a number of discussions with interested parties, as I am sure many Members of the committee have had. It appears to this Member that there is movement within the affected industrial groupings in favor of enactment of legislation this year, and in the interest of fairness to the affected parties, the need for timely Congressional action is compelling.

    Some have come to this position because they believe a greater competition will bring more financial products to more consumers at lower costs. Some have come to this position because they feel our international competitive standing is endangered or will be endangered shortly if we do not act on modernization legislation.

    Some have come to this position because they feel that Government regulators have gone too far in one direction or another. Some have come to this position because they believe that failure to act would leave in place a status quo which may jeopardize the viability of their industry or company, and perhaps in the long run, the safety and soundness of elements of the financial system. Some have come to this position because they feel it is appropriate to act during a non-crisis time.
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    As Members of Congress our chief responsibility is, of course, to the public and not to particular elements of the financial community. To my mind, the public case for legislation to increase competition in the financial services marketplace is powerful. The public interest, however, in going beyond financial services modernization to integrating commerce and banking has not, in my view, been credibly established. I realize other Members on this committee disagree, and the committee, of course, will work its will on this issue. But, I would caution against too big a step which could have more consequences for consolidation of ownership assets in America than may fit our society and our times.

    Before turning to the distinguished Ranking Member present, I would note that we have today a housing bill on the floor again, which is the primary jurisdiction of this committee. So, a number of Members are occupied with that legislation. You may see Members from time to time take to the floor because of that fact.

    Mr. LaFalce.

    Mr. LAFALCE. Thank you very much, Mr. Chairman, and I thank you for your leadership on this important issue and for bringing it before our committee early this session.

    There is a real opportunity to pass financial modernization legislation this Congress if we work cooperatively on a bipartisan basis. I look forward to working closely with you in such an effort, and it remains my hope that the Administration will be actively engaged.
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    Having said that, I do believe that any legislation, if it is to be of substantive merit and politically viable, has a very high standard to meet. It is true that our current statutes do not reflect the realities of today's market, and our financial structure has evolved on an ad hoc piecemeal basis. The result is an unjustified level of inefficiency and cost for financial institutions and inadequate service for consumers.

    But while the evolution has been piecemeal, it has taken the system in the right direction. We must rationalize our existing financial services system so that all financial services providers can compete equally to offer a full array of services to consumers. In attempting to do that, our committee can move in one of two directions. We can either move all institutions progressively forward into a modern framework, or we can move some backward or freeze them in place to achieve some static leveling for its own sake. If we are to move backward or stand still, it might well be better that we not move at all.

    It is possible to give all financial institutions new opportunities within a more efficient and safer framework, but it will take a broad and progressive bill to do so. I will only support such a bill. I would not be able to support legislation that puts inappropriate new limits on any viable and sound financial institution in the name of competitive equality. Nor will I support a bill that is simply trying to replicate in statute the anomalies of our current system through a system of caveats and exceptions. The bill must create a framework for our future, or there is no point in doing it.

    I firmly believe there is a bill that can do that on which we can achieve bipartisan consensus. I look forward to working with my colleagues very closely on that, and I welcome today's witnesses. I thank the Chair very much.
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    Chairman LEACH. Thank you, Mr. LaFalce.

    Mrs. Roukema.

    Mrs. ROUKEMA. Thank you, Mr. Chairman. And I would ask unanimous consent in the interest of time that the full text of my introductory remarks be included in the record, but I would simply like to make a couple of short observations.

    Certainly, Mr. Chairman, I want to thank you and congratulate you for extending these hearings to the full committee. We had subcommittee hearings back in February and March, and there has been some progress since then in the development of the full debate, and it is appropriate that we are holding these hearings today. New questions have undoubtedly arisen in the interim.

    I also express appreciation to you, Mr. Chairman, for your leadership in making an explicit commitment for this committee to deal with the issue in an expedited manner and have a timeframe in which we can take action. And I say that specifically because of what has happened here with respect to regulators taking action in the absence of Congressional statutory action.

    I am, of course, referring to what is well-known here with respect—by ''here,'' I mean with committee Members and certainly with the financial institutions that are represented here today—the action of the Federal Reserve Board in approving the merger of Bankers Trust and Alex Brown. Certainly, it was yet again another example of ad hoc and piecemeal regulatory action.
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    But the action that most concerned me, and I think the industry, was the action of the OCC in terms of NationsBank in establishing an operating subsidiary to engage in real estate development and now is poised to consider whether national banks may engage in underwriting of municipal bonds. This is a significant development. And, of course, I think it is indisputable evidence, certainly to me, and I have been rather outspoken on this subject, that the Congress would be abrogating its statutory responsibility and Constitutional responsibility, really, if we fail to take action in the short term to fashion a financial modernization bill and repeal Glass-Steagall and bring it up into modern times.

    I think it is well-known that the legislation that I have introduced has very interesting provisions, including the one that is probably the most controversial, which is the 25 percent basket for commerce. And that is an issue that we will have to continue to examine here, whether it be incremental development or more narrowly defined, which is what I am looking at, a more narrowly defined definition of the commercial basket.

    Certainly as we get into this, we find that everyone likes to talk about the safety and soundness, firewalls and regulatory reform, but we have to get down to the specifics of what we mean by regulatory reform and how we deal with an umbrella regulator and functional regulation. That will be, I hope, the focus of these hearings that are being initiated today.

    In any case, I think we are making progress. I continue to be upbeat about the ability, and I certainly endorse what you and the Ranking Member have said about the importance of being explicit in making this progress without compromising or giving up on our fundamental principles. But I believe that we can do this, and, again, I will fashion my questions around those open issues that we are trying to modify in my own legislation that deal in explicit terms with functional regulation and umbrella supervision. I thank you, Mr. Chairman.
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    Chairman LEACH. I thank Mrs. Roukema and would indicate, of course, the importance of her strong input in this process.

    Mr. Vento.

    Mr. VENTO. Well, Mr. Chairman, I welcome these further hearings on the issue of modernization and hope that there would be a spirit of bipartisanship and a spirit of compromise with regard to the major issues which impact and decisions made with regard to modernization.

    Mr. Chairman, I would suggest that some of the events of the last few months have indicated more polarization with regard to issues that I think are fundamental, really are at the benchmarks which modernization has to take place. There are misunderstandings and misgivings about that foundation, which, frankly, are rooted in facts of the marketplace and the circumstance of regulation and court decisions upon which the various participants look for their current—or to their current positions.

    Mr. Chairman, I am speaking principally of the polarization around the issue of commerce and banking; the polarization with regard to the criticism that has been leveled at the Comptroller; and the continued questions of size and merger, and other questions which, frankly, while important questions, I think really do not look at the marketplace the way that it is functioning today.

    The reason that we are here to a large extent is because of the difficulty and the blurring of lines between the financial institutions of insurance, of commercial banking, and of securities and securitization, and, of course, to some extent even the blurring of lines between financial activities and what takes place in commerce. The fact is that as we move, and if there is further polarization and a lack of cooperation, I think that the effort of Congress to have a seat at the table and a voice in modernization, I think, is going to be hampered in that process.
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    I think we all have common objectives in terms of bringing our laws and policies in sync with the marketplace today, making these banks and other institutions in the financial sector as viable as possible. We look abroad and see banks exercising our institutions here, the same banks exercising some of those powers; American banks, that is to say, and/or insurance or brokerage activities abroad, exercising powers. And we look in terms of the regulatory activities, and while in one instance we are concerned about the Administration not having a definitive position, I don't think anyone could say that the Comptroller has been absent from the scene in terms of speaking to the issues of the day. In fact, I think he has been at the cutting edge, and obviously that produces some heat for him and for us in terms of raising questions and responding. But I think if nothing else, he has kept the banks a viable and an able group in terms of providing services.

    So, Mr. Chairman, as we look to the hearings, I would just suggest, I certainly am open. We have obviously tried to look to build on the cooperation of those in terms of the alliance bill that Congresswoman Roukema and myself introduced and look to working with others on the committee and in the community, but I think we need to understand clearly that there has to be an acceptance of what reality is in terms of the regulatory and court decisions and an effort, a good faith effort, in terms of trying to move ahead and solve some of the problems rather than building walls which are going to mean that this legislation is going to fall prey to the same problems that have occurred in the past, and Congress will not have a voice at table and in the future policy path in this session of Congress unless we are able to do that.

    So, I want to have that voice, Mr. Chairman. I am certain that you want to have that voice, and I hope that we can be participants in this process rather than those that break it down. Thank you, Mr. Chairman.
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    Chairman LEACH. Well, let me just say to the gentleman that the advice of the gentleman is always appreciated. He is a wellspring of knowledge and good judgment on these and other issues.

    As for the Administration, I urged the Administration last year to come forward with detailed recommendations. I have been urging them at a number of stages this year and would hope that they would come forward in as detailed a way as possible, and would stress that there is also statutory obligation to come forth with detailed language on thrift conversion. We await that language.

    Mr. VENTO. Well, I share the Chairman's enthusiasm for the Administration's further participation, Mr. Chairman.

    Chairman LEACH. OK. Thank you.

    Mr. Baker, would you like to make a statement?

    Mrs. Kelly.

    Mrs. KELLY. Thank you, Mr. Chairman.

    To paraphrase President Reagan, ''Well, here we go again.'' With this hearing we begin the first hearing in a series of three full committee hearings on the consideration of financial services modernization legislation. This will be the fourth financial service modernization hearing that I have had the pleasure of participating in this year. While the issues appear very similar, the laws and support for them have changed, and hence the committee will pass different legislation this year.
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    I would like to go on record at this point to let everyone on the committee know that I look forward to moving forward with them on this legislation, and it is my intent to keep an open mind on many of the issues before us. And I will always have a minute to discuss these issues with anyone who may have legitimate concerns.

    Today we have the distinct honor to be joined by witnesses, many of whom have taken time out of their busy schedules to share their views with us, and I am especially pleased to note that on the second panel that America's Community Bankers are well represented here today by Paul Schosberg, the President and CEO of America's Community Bankers. Not only has Paul headed up the Community Bankers since its formation in 1992 and achieved a long and strong record of service to the New York financial services industry, he has also worked here on Capitol Hill as Chief of Staff for two New York Congressmen.

    Now if this is not enough to command our respect, Paul and his wife Jane hail from my hometown of Katonah, New York. So, with that in mind, I ask that all Members of the committee pay special attention to Paul's testimony since he knows where I live, and if we do not pay attention to him—and not that I am accusing anyone, but I could get my mailbox knocked down again.

    So, with that in mind, I would like to again thank everyone for joining us here today, let you know that I look forward to working with you to address your concerns. Thank you.

    Chairman LEACH. Well, Mrs. Kelly, thank you, and I hope that it isn't an implicit threat for other Members as well.
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    Mr. Flake.

    Mr. FLAKE. Thank you very much, Mr. Chairman. In this my 11th year on the committee, I suppose I have done enough opening statements that we could go back in the record and see what kind of positions I have held over all of this time, believing at each point that we would have concluded this matter by now. And so it is my sincere hope that as we start again, that this time we will bring to closure the matter of financial modernization. And this time we don't have anyone to give a gift to, as we thought we did when Mr. Proxmire was retiring from the Senate. And I have not heard that you were retiring, so maybe we can hold together this time and come up with something that everybody can agree to and finally get this matter in a way that most people appreciate.

    My colleague who just finished speaking, she said she was going to be objective, but the way she talked about Paul Schosberg, for whom we have a lot of respect, I am not sure that he would allow it.

    So, with that, I yield back the balance of my time.

    Chairman LEACH. Well, I thank the gentleman for his thoughtful comments, and my wife would certainly love his implicit advice.

    Dr. Weldon.

    Would anyone else like to comment?
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    Mr. Bachus.

    Mr. BACHUS. Mr. Chairman, one concern that I want to express—and I want to introduce a written statement for the record—involves charter conversion and the right of the thrifts to continue to be involved in some of the businesses that they are presently concerned with, presently carrying on, such as real estate activities.

    I think it would be a mistake for this committee to limit the thrifts from carrying on any business activities which their present charters allow them to do, so I am somewhat concerned about the grandfather provisions. I think it would be a mistake for this committee to limit them to activities—not allow them to carry on some activities which they are at this time.

    With that, I will, with unanimous consent, introduce a statement to that effect in the record.

    Chairman LEACH. Without objection, so ordered.

    Does anyone else on the Minority side care to be heard? On the Majority side?

    If not, then we will turn to our first witness, who represents the General Accounting Office, James Bothwell, and who I might introduce additionally with the observation that Jim has been a long-time professional at the GAO, has an extraordinary specialization in banking issues, and has produced a number of reports over a number of years that have been extraordinarily helpful to this committee.
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    And, Mr. Bothwell, would you like to introduce your colleagues, please?


    Mr. BOTHWELL. Yes, I would, Mr. Chairman. Thank you for those very kind remarks.

    On my right, I have Tom McCool with me, who is an Associate Director in our banking group at GAO; and, on my left, I have Scott Smith, who is an Assistant Director at GAO in my office.

    Chairman LEACH. You are both welcome.

    Mr. BOTHWELL. Mr. Chairman, I have a written statement I would like to introduce for the record.

    Chairman LEACH. Without objection, it will be fully in the record.

    Mr. BOTHWELL. Thank you.

    Mr. Chairman and Members of the committee, we are pleased to be here today to assist your continuing efforts to modernize our financial services regulatory system.
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    As you are well aware, both the laws governing the financial services industry and the regulatory structure that oversees it were developed for an industry that was compartmentalized into commercial banking, investment banking and insurance. However, since that structure was established more than 60 years ago, these activities have now converged to the point where many of the financial products and services offered by banks, securities firms and insurance companies are more alike than different.

    Some of the most notable examples include: first, competition by money market and mutual funds that has been so successful that the value of such funds, nearly $3 trillion, I believe, many of which permit check writing, now exceeds the value of insured bank deposits.

    The second example is the issuance of guaranteed investment contracts by insurance companies that compete directly with both mutual funds and bank certificates of deposit.

    The third is the securitization of over $2 trillion in mortgages and other loans that a few years ago would have been held in portfolio by insured depository institutions.

    The fourth example is the increasing involvement of commercial banks in the sale of insurance products, in mutual funds and in securities underwriting through Section 20 holding company affiliates.

    And the fifth example, if you need any more, is the increasing involvement of securities firms and insurance companies in making and syndicating commercial loans in competition with banks.
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    Mr. Chairman, the basic point is that we truly have today one national financial services marketplace.

    Mr. Chairman, as I testified before this committee 2 years ago, our various financial regulators have been attempting to adapt to the dramatic and rapid changes taking place in the financial marketplace on an incremental and ad hoc basis. As a result, as our work over the past few years has shown, our existing financial regulatory system has significant overlaps, anomalies and even some gaps in it. Thus, Congress, by updating and modernizing our banking laws, could substantially improve the functioning of our regulatory system; and we commend the committee's efforts to do so.

    However, the goal of financial modernization should not be achieved at the expense of other important goals, such as maintaining the safety and soundness of the financial system and the deposit insurance funds, preventing undue concentrations of economic power and protecting consumers from potential conflicts of interest.

    Toward this end, our work suggests that the following specific safeguards should be included in any modernization legislation:

    First and perhaps foremost among these is that financial services holding companies should be regulated on a consolidated, comprehensive basis, with appropriate firewall provisions to protect both consumers and taxpayers against potential conflicts of interest and to prevent the spread of the Federal safety net provided to banks and any associated subsidy to non-banking activities.
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    Our work on past financial institution failures has shown the importance of having an umbrella supervisory authority to assess how risks to insured institutions may be affected by risks in the other components of a holding company structure. While firewall provisions can be extremely important safeguards in preventing potential conflicts of interest and protecting insured deposits, the simple fact is that firewalls may not hold up under stress or if managers are determined to breach them.

    Moreover, consolidated supervision is consistent with the way that most, if not all, large bank holding companies are managed today—on a consolidated basis with the risks and returns of various affiliates being used to offset or enhance one another.

    Consolidated supervision is also compatible with a functional approach to financial regulation. For example, the SEC could be the regulator for a securities affiliate of a financial services holding company, the OCC the regulator for a nationally chartered bank affiliate, with either of these two agencies or the Federal Reserve being responsible and accountable as the umbrella regulator for the operations of the holding company in its entirety.

    This basic approach of having consolidated supervision of the banking organizations with coordinated functional regulation of its individual components is also consistent with the approach taken by five other major industrialized countries that we recently studied. In each of these five countries—which were Canada, the United Kingdom, Germany, France and Japan—if securities, insurance or other nontraditional banking activities were permissible in bank subsidiaries, functional regulation was provided by the appropriate authority.

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    While bank regulators generally relied on those functional regulators for information, they remained responsible and accountable for ascertaining the safety and soundness of the consolidated banking organization as a whole.

    As a second safeguard, we believe that capital standards for both insured banks and financial services holding companies should exist that adequately reflect all the major risks, including market and operations risk which are becoming very important, particularly in our large money center banks, as well as the traditional credit risk. Because our work on failed banks has shown that capital can be quickly eroded in times of stress and can be a lagging indicator of an institution's true financial condition, we believe regulators should be required to conduct periodic assessments of risk management systems for all the major components of a financial services holding company, as well as for the holding company itself.

    And I would like to acknowledge here that at least the OCC and the Federal Reserve have taken steps to concentrate their examinations on assessments of risk management systems, and we really encourage those efforts.

    While the FDIC Improvement Act of 1991 requires bank regulators to take prompt corrective action against troubled institutions before their capital is completely eroded, our recent review showed that the implementation of these provisions may not be as effective in preventing deposit insurance losses as Congress originally intended.

    As a third safeguard, clear rulemaking and supervisory authority should be established that results in a consistent set of rules that are consistently applied for similar financial activities and minimizes regulatory burden. This is particularly important for critical matters such as consolidated capital requirements, firewalls and permissible activities and can be accomplished in a number of ways. Having the Federal Reserve serve this function, which is the approach taken in H.R. 10, is one obvious alternative, at least for the largest financial services holding companies. Still another approach would be to have a special interagency rulemaking board or committee.
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    We found that each of the five major countries that we recently reviewed had unique ways to ensure that their banking institutions that were conducting similar lines of business were generally subject to a single set of rules, standards or guidelines. The important point is to have some mechanism to achieve consistent, effective oversight and rules and to limit unnecessary overlaps and regulatory burden on our financial institutions. And, in particular, I don't think we want to get into a situation, as Mrs. Roukema alluded to, where we have different Federal regulators seeking to attract banks by offering differing powers or activities for the institutions under their jurisdictions.

    Mr. Chairman, as you and other Members of the committee are well aware, the number of banks have declined substantially over the past 5 years. We have essentially gone from a situation where we had 12,000 banks in 1991 to 9,500 in 1996, a 20 percent decline; and there has also been a considerable consolidation among our largest banking organizations in particular.

    Because these trends could be accelerated by financial modernization, we believe it is also important, through effective enforcement of our antitrust and banking laws, to prevent any monopolistic exercise of market power if it develops and to assure that entry into the financial services marketplace is not restricted unnecessarily. For without having competitive markets, the benefits of financial modernization are unlikely to be passed on to small businesses and consumers in this country.

    Mr. Chairman, while our work shows that the case for modernizing our banking laws is clear, we would urge that Congress proceed cautiously if it decides to relax the current separation of banking and commerce. Our recent review of the existing economics literature found that the potential benefits of eliminating the current separation generally lacked any empirical support and that most such benefits could be realized through other means.
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    Furthermore, the available literature, as well as our own extensive work on the causes of past financial institution failures, indicated that eliminating the current separation could pose a variety of risks to the safety and soundness of the financial system, to the deposit insurance funds and to consumers and taxpayers.

    While the exact magnitudes of such risks are uncertain and would depend, of course, in large part on the effectiveness of what legislative and regulatory safeguards are put into place, we believe that a compelling argument for the unbridled mixing of banking and commerce has simply not yet been made.

    Mr. Chairman, this concludes my prepared statement. My colleagues and I would be happy to respond to any questions that you or other Members of the committee may have.

    Chairman LEACH. In your full statement, you mentioned in a little more detailed way some of your concerns about the possible mixing of commerce and banking. As I understand it, you argue that it poses a risk to the safety and soundness of the financial system and thus to taxpayers.

    You point out, further, that it may cause conflicts of interest and that this is one of the historical reasons that many people have objected to this precept.

    You also point out that the potential benefits from a survey of economic literature are nonexistent.

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    Is that a valid summary of your position and would you like to amplify it further?

    Mr. BOTHWELL. I would say that we surveyed the economics literature and found little if any empirical support for the potential benefits of mixing banking and commerce; and our own work on some of the past failures that we have had in this country of financial institutions has shown that mixing banking and commerce could lead to risk both to the deposit insurance funds, as well as to the stability of the banking system.

    I would call attention to an article that just appeared in the Wall Street Journal today, which I would like to submit for the record.

    Chairman LEACH. Without objection, that article will be submitted.

    Mr. BOTHWELL.The article discusses the pretty substantial banking problems in a lot of countries around the world.

    One of the points that this article makes is that a lot of these problems are due to what is called ''connected lending and borrowing,'' where loans are being made, not on an arm's-length basis with an objective evaluation of the creditworthiness of borrowers, but they are being made because there are connections between the borrowers, the commercial activities of the borrowers, and the banks' owners and managers.

    So, one of the risks that you have through these affiliations, and one of the ones that you really need a very thick firewall to prevent, is the potential to have extensions of bank credit or other resources being made to the affiliates of banks, or to the customers of bank affiliates, that are not on the arm's-length basis, that are on preferential terms; and I think that is one of the very key risks that we have here.
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    Several years ago, we looked at the failure of a pretty sizable insurance company, Monarch Life Insurance Company, in 1990. It was domiciled in Massachusetts, had a license to do business in all 50 States and DC.; and was an insurance company where the holding company got involved with some real estate activities, got into problems with this real estate activity, took resources from the insurance company to try and solve those problems; and it did not work.

    Because the State regulator couldn't go into the holding company, the regulator just went into the insurance company and did an examination in January of 1990. But because it was not, in essence, an umbrella regulator with the authority to go into the holding company, the State regulator didn't see the problems that were at the holding company level; and these problems continued to develop, and the insurer ultimately failed, and the holding company finally admitted that it couldn't repay those loans or replace the resources that were taken from the insurer. So, that is an example that really underscores the need to have consolidated supervision of the entire organization.

    Chairman LEACH. An umbrella regulator.

    Just one final question. Are there any examples around the world where those companies that mix commerce and banking seem to have helped their economy by it, or are most of the examples ones in which the taxpayers have been jeopardized?

    Mr. BOTHWELL. I would say, of the five countries that we looked at, Mr. Chairman, that the one that is most analogous is Canada, our neighbor to the North; and they have not allowed the mixing of banking and commerce; and, yes, they have repealed their Glass-Steagall separations. For many years, Canada had the same separations that we have through Glass-Steagall. Because their banking laws have to be reauthorized every 5 years, they periodically take a look at their basic banking statutes and see whether they need to modernize them or update them.
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    In 1987, they allowed banks to get into the securities business. In 1993, the last time they looked at their banking laws, they allowed banks to get into the insurance business. And all of that has seemed to go very well, but they have kept the same banking and commerce restrictions as we have here. Essentially, Canadian banks can only own 5 percent of a corporation's stock, but cannot own a controlling interest in the firm. So, they managed to modernize their banking laws in Canada, and break down their Glass-Steagall walls, without having to breach the separation between banking and commerce.

    Now several of the European countries that we looked at have what they call ''universal'' banking systems, and their banks can own substantial and controlling interests in commercial industrial firms. The experience over the past few years has shown that some of those banks—Deutsche Bank in particular, in 1994, got into trouble because it had a very substantial ownership stake and controlling stake in a big German metals firm that got into substantial difficulties and incurred over a billion dollars in losses in copper futures trades. And so Deutsche Bank had to inject a substantial amount of capital into that commercial firm.

    In addition, among the French banks, Credit Lyonnais has a great deal of problem loans; and, again, a lot of these problem loans are associated with loans to commercial enterprises that they have ownership interests in.

    Chairman LEACH. Thank you very much.

    Mr. LaFalce.

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    Mr. LAFALCE. Thank you very much, Mr. Bothwell. I have come, over the years, to have very high regard for the work of the GAO. But in the field of banking I have heard and read much criticism of the perspective that GAO takes, and it goes somewhat like this, and I will ask to you comment on it:

    ''GAO doesn't really understand financial services. They don't understand the fundamental difference between the management of risk and the avoidance of risk and whenever they are confronted with a hands-on application they almost invariably, or invariably, will make a decision that tends toward avoidance of risk rather than management of risk.''

    I have heard it expressed another way, too, that ''GAO understands that ships in harbor are safe. They don't understand that that is not what ships are built for.''

    I think it is only fair that you be asked to comment on this.

    Mr. BOTHWELL. Sure. Sure. It is not a criticism that I haven't heard before from people in the banking industry. But I would say that I think we are quite aware that banks are in the business of taking on and managing risk. I mean, that is the principal reason why you have a banking system.

    But I think, perhaps where this criticism comes from is that as Congressional auditors, as well as the auditors of the Bank Insurance Fund, that perhaps we are a bit more attuned to extensions of risk, or extensions of activities, that could place our deposit insurance funds into jeopardy. And I think it is one of the responsibilities that we have, as Congress' auditor, to alert Congress to those potentials.
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    Mr. LAFALCE. I understand. I understand that. Of course, a good auditor must exercise judgment. There is a lot of criticism that in the aftermath of FIRREA, perhaps because of the Congress at its hearings, that we put the fear of God into the regulators and the examiners so that they no longer exercised prudent judgment.

    They said, you know, ''When in doubt whether there should be a $10,000 reserve or a $10 million reserve, make it $100 million. Nobody will ever criticize us for being unbelievably strict. We will only be criticized if we use a prudent judgment and we err on the side of leniency.'' And that is what I am trying to get at with respect to GAO.

    Mr. BOTHWELL. I think one of the other issues here is that, as you may know, we have access to examination reports of banks. And after every bank fails, there is sort of a postmortem done by the regulators to determine why it failed.

    And in one of our major efforts a few years ago we were asked to look at failed banks and these post-failure reports done by the regulators, to try to pinpoint the particular causes of the failures. We looked at all the bank failures that occurred, I believe, in 1990 or 1991. Something like 268 banks failed in those 2 years. And if you look to those reports, as we looked through all of those 268 reports, we were just amazed that in about 70 percent of these failures one of the contributing causes was insider activities; conflicts of interests between bank managers, bank owners and their outside commercial activities; fraud.

    So, I think it is from that history, where we are actually looking at the failures of financial institutions and the causes of those failures, that makes us perhaps more attuned to situations where banks could be incurring more risks than is prudent.
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    Mr. LAFALCE. Why do you—well, the regulators look at those same—those same facts, too, don't they?

    Mr. BOTHWELL. The regulators produce the reports, yes.

    Mr. LAFALCE. Yes. All right. Thank you.

    Chairman LEACH. Mrs. Roukema.

    Mrs. ROUKEMA. Yes. Thank you.

    Mr. Bothwell, you heard my introduction, my renewed look in the legislation at the regulatory structure, and I think it reflects very much what you have said here in terms of an umbrella regulator and the function of regulation, and I think we can deal with that very effectively.

    But I am concerned about your look at the commercial component of this, and I might say that I have no intention of permitting unbridled mixing of banking and commerce, as was referenced on your last page.

    So, with that as the understanding here, let me ask you, perhaps from your experience, with a little more specificity, about how we build those firewalls that both you and Chairman Greenspan have described? And I would admit that under stress, firewalls tend to melt. How, from your experience, can we improve the firewall structure?
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    And then I want to go on to the definition of ''commerce,'' as we are looking at it.

    Mr. BOTHWELL. Sure. Tom is our real expert on the firewall issues. I would just say that I think you want to make sure that you—in whatever bill the committee produces—keep the same basic statutory firewalls that are already in existence, that would prevent the extensions of credit or other resources from a bank to a bank affiliate or a customer of a bank affiliate on preferential terms. You want to make sure that those transactions are arm's-length, and you want to make sure that there are no basic conflicts of interest, say between a bank's lending—or its trust operations in particular—and its securities affiliates.

    Mrs. ROUKEMA. And you feel confident we can do that with the proper regulatory structure?

    Mr. BOTHWELL. Yes, ma'am.

    Tom, do you want to add to that?

    Mrs. ROUKEMA. Yes, Mr. McCool.

    Mr. MCCOOL. I don't have anything to add in terms of specific firewalls. I think the Federal Reserve has a proposal out to roll back certain of their firewalls because they believe that the combination of statutory provision and their own supervision will allow them, through the examination process, to do a lot of the same things.
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    And I guess that is a question that, again, Congress needs to decide.

    Mrs. ROUKEMA. Yes.

    Mr. MCCOOL.——To whether they want to allow that kind of discretion to the regulator.

    Mrs. ROUKEMA. You wouldn't recommend that, however? You are not endorsing that?

    Mr. MCCOOL. No, we are not endorsing that at all.

    Mrs. ROUKEMA. No, you are not.

    Mr. MCCOOL. All I am saying is that is what the Federal Reserve has put into place and the question comes up as to how much discretion you want the regulator to have versus how much you want to put in some sort of rules that they could not drastically change and have to enforce. And I think that is up to you folks to decide.

    Mrs. ROUKEMA. All right. Thank you.

    Mr. Bothwell, let me go on to this question of banking and commerce. As you know in the legislation that I am advancing we have a 25 percent basket. That basket has to be further defined. From what I hear, the Administration is toying with the idea of having a 25 percent basket, but eliminating the thousand most profitable or largest commercial firms from that basket. But there are other alternatives that we are looking at, like how you measure the basket? Should it be based on gross revenues or capital reserves or net revenues?
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    Have you looked at that definition of the commercial basket in any way? And could you give us the benefit of your observations? Would you like to comment on either one of those definitions?

    Mr. BOTHWELL. I might just say that it is traditional in our banking regulation, in most cases, to put limits on a particular activity, like loans to insiders to a bank; that most of those limits are placed in terms of percentages of capital, because capital is the cushion that protects the banks against potential losses. Such limits are usually not placed in terms of revenues or any other measure like that. They are usually placed in terms of a percent of capital.

    With regard to defining the activity, that is obviously a very difficult and key issue that you are grappling with. I think there is a need for Congress to lead in this area, to try and set those limits and try to make those definitions that I have alluded to. I don't think you want to have any sort of regulatory competition here along that particular line. I think Congress——

    Mrs. ROUKEMA. You think it has to be defined, whether it is gross revenues or net reserves? Or would you have any observation or reaction to the rumored proposal of the Treasury regarding the 1,000 business commercial entities?

    Mr. BOTHWELL. No, ma'am, I have no information on that other than what has been rumored and I would like not to comment on rumors.

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    Mrs. ROUKEMA. But we can deal with——

    Mr. BOTHWELL. But if there is a thousand firm cutoff, that is a very arbitrary type of cutoff and I think it raises questions about that 1,001 firm that may become the 900th firm next year. So, I think it raises a lot of implementation issues.

    Mrs. ROUKEMA. All right. Thank you. But I am encouraged by your observations on the firewalls. Thank you very much.

    Chairman LEACH. Mr. Vento.

    Mr. VENTO. Thank you, Mr. Chairman.

    Mr. Bothwell, you referred to a Wall Street Journal today. Is this the article that said, ''Waiting to Explode''?

    Mr. BOTHWELL. Yes, sir.

    Mr. VENTO. I just got through looking through the article very quickly, and I think probably it is an issue that is worth further evaluation, but you really haven't put this particular article or these subjects through the rigor of the GAO analysis.

    So, as I looked at it, it sounded as though it—I didn't think it made a case for bank—I didn't see the—I thought maybe you were making a point that this made the case for banking and commerce association risks. But, I mean, as I looked at it, I dealt, Mr. Chairman, with former Communist countries and China and a lot of it is devoted to that particular problem. It did talk about developing countries and their problems constituting sometimes 10 percent of their GDP, while the United States only had 3 percent of our GDP in the S&L industry. But, of course, 3 percent of our GDP amounts to a little more—probably more than all the other countries combined.
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    Mr. BOTHWELL. Oh, yes. My point of referring to this article was to talk about the importance of firewalls to prevent these types of conflicts of interest. You don't want to get into the same situation that apparently exists in many of these countries.

    Mr. VENTO. OK. Well, I am sure there exist firewalls. One of these things, for instance, is this whole discussion about banking and commerce and, obviously, I think many of us tried to keep some of the powers separate on the financial side and couldn't do it, and now we are dealing with this commerce issue.

    I think the predicate, too, here is that there is a way to deal with, in terms of a two-way street, in terms of financial institutions and still completely exclude, or essentially exclude, commerce-type of equity ownership on the part of institutions.

    Did you analyze that at all? I mean, because we have obviously investment banking that has additional public offerings. They have equity assets. We have insurance companies looking at the complexion of where we are at today, and if we want to offer a two-way street in terms of exercising commercial banking powers to insurance owners is there a way to do that?

    I mean, wouldn't that require a substantial change in the portfolio of business that insurance and investment banking now has?

    Mr. BOTHWELL. Well, I think you raise a good point, Congressman. Obviously, if you want to break down the separation between commercial banking and investment banking, part of investment banking, a key part of investment banking, is taking ownership positions in commercial firms, perhaps entire ownership positions in commercial firms, and then restructuring those firms and selling them eventually.
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    Mr. VENTO. Right. So, I mean, part of——

    Mr. BOTHWELL. So, you need to make allowances——

    Mr. VENTO. Have firewalls.

    Mr. BOTHWELL.——For that particular type of involvement.

    Mr. VENTO. I think that is what the bill is, H.R. 268, and I think to a lesser extent the Chairman recognizes that in his bill, although, you know, he has a great sensitivity, as we all do, to the commerce issue.

    The other, I have thought about banks and, I mean, I am very concerned about banks, but banks frequently are taking a large position in terms of mergers in various firms that are, of course, of commerce today, aren't they? They take enormous loans.

    For instance, I read where the great merger firms, law firms are—in fact, taking big positions in terms of mergers. They are playing an active role in this area. And doesn't that potentially—I mean, when does a loan become an equity position?

    I thought when I was working on the S&L crisis, Mr. Chairman, Mr. Bothwell, that sometimes I would look at what the S&Ls had done and, in essence, the distinction is a very gray area.
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    Mr. BOTHWELL. Yes. Well, it certainly can be in certain situations, but I think you can also make distinctions. I mean, you refer to the S&L situation. As you well know, a number of the S&L losses were attributed to the fact that the S&Ls got into direct real estate development activities, some outside even their home territories.

    Mr. VENTO. But I think the issue is the problems for many of them were simply the regular home loans and others that they made in markets——

    Mr. BOTHWELL. That was the general problem.

    Mr. VENTO.——Where there was an economic shock, and there were other problems that occurred.

    Mr. BOTHWELL. Yes.

    Mr. VENTO. So, we have to fix that with appraisals, which we seem to be walking away from right now in some instances, and proper diligence and proper regulation and, of course, we get back to that issue.

    One thing, Mr. Bothwell, I wanted to address in your comments is the financial holding company or the bank holding company model and umbrella regulator. Are there any inherent safeguards that exist in, for instance, a financial holding company structure or a bank holding company structure that do not, or could not, exist with regard to a subsidiary?

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    Are there any inherent differences? In other words, can you regulate from the standpoint—if you have a regulator doing their job as a bank holding company, or doing their job as a subsidiary, is there any inherent problem with, in fact, having either of those types of structures?

    Mr. BOTHWELL. I don't think that there is any inherent problem in the subsidiary approach. I would say that if you had the holding company approach and if you had an umbrella regulator that also had the authority to set consolidated capital requirements for the whole operation, in essence, you might have an extra measure of protection.

    Mr. VENTO. Or a committee—in other words, you referred to the committee as being——

    Mr. BOTHWELL. Yes.

    Mr. VENTO.——Setting the rules up so you have a commonality. But there is no inherent problem if, in fact, the regulators have the proper powers or are doing their job; is that correct?

    Mr. BOTHWELL. I would say that is basically correct, although, again, I don't think you want to have a situation where you have different regulators granting different powers.

    Mr. VENTO. Well, we have that today, as a matter of fact, Mr. Chairman.
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    Well, I appreciate the extra time, Mr. Chairman. Thank you.

    Chairman LEACH. OK.

    Mr. Baker.

    Mr. BAKER. Thank you, Mr. Chairman.

    Mr. Bothwell, I join with others in saying that I have enjoyed a good working relationship with the GAO and certainly you specifically, and find the work of the agency to be very professional.

    Today is not one of those days. I take deep differences with the findings and conclusions. It appears the report was written in late 1980 in South Louisiana after looking at three thrifts, a position which I could understand. It does not, however, go back, from an academic perspective, and look at the experience of the late 19th Century, where there were very large commercial banks that engaged in specific public purpose policies, the Atchafalaya Railroad and Banking Corporation, for example, and there were many.

    It does not take into consideration academic surveys of the Glass-Steagall era when the Congress responded to the Great Depression and enacted prohibitions based on the conclusion that diversified financial institutions, in fact, had a lower loss rate than those that had a single line of business. Congress concluded from that information that we should prohibit that diversified source of activity.
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    It does not look at the history of commercial and financial activities in this country up until the early 1970's when it was that the first real prohibition that was enacted nationally. Rather, we reached the conclusion that there is some inherent untoward evil in allowing diversified business practices principally centered on the concept that the public safety net would inherently flow through to the commercial enterprise; thereby, giving it an artificial advantage in the marketplace and perhaps placing taxpayers in an unreasonable position of risk.

    I would point to the fact today there is a bank owned by an institution which is engaged in garbage collecting and recycling in Oregon; one that is engaged in manufacturing of wood and paper products in Texas; one that is engaged in a convenience store chain operation in Iowa; one that is engaged in cellular phone operations in Virginia.

    As a matter of fact, I could go on. If we are looking for empirical evidence, I have 107 listings of what are known in the trade as ''unitary thrifts'' which, in my judgment, have demonstrated a quite successful history, without untoward risk to taxpayers, blending virtually all sorts of commercial activities with financial enterprises.

    I am troubled by the comment that we do not believe the Federal Reserve to be an adequate financial regulator in that—the conclusion I would reach from the comments—that by allowing up to 25 percent equity position in a commercial entity—which, by the way, is unlimited in its nature of conduct of business. It is also unlimited in asset or revenue size. The only limit is that the acquiring interest only be 24.9 percent or less of the equity position which the bank holds. It could be a very small bank buying an interest in a very large company; a very big bank buying a small interest in a small company. So, there are no apparent restrictions on this relationship.
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    I find the Federal Reserve's position to be, frankly, encouraging because it has, in fact, restated what I believe to be the economic theory of this country, that commerce and finance have not only not been prohibited, there are distinct advantages in allowing it.

    The Office of Thrift Supervision now has pending an application for an Iowa insurance company to acquire a unitary charter, which indicates, according to printed reports, that they wish to diversify their economic activities. There is a rumor that State Farm may be moving quickly after the principal group has made its acquisition, if it is allowed.

    Would you, Mr. Bothwell, recommend, or recommend disapproval, of that particular application, because it would be an unreasonable risk for the taxpayer?

    Mr. BOTHWELL. Well, it is not my job to be recommending approval or not recommending approval.

    Mr. BAKER. But as to policy. If I understand your paper, it says there is no empirical evidence as to the blending of commerce and finance. Is there any empirical evidence that would indicate that it is bad?

    Mr. BOTHWELL. This is sort of like looking at a glass that has a little bit of water in it like this one and saying, ''Is it half full or half empty?'' We are not saying that it is impossible not to manage or control the risks.

    Mr. BAKER. In fact, it has happened?
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    Mr. BOTHWELL. Yes, in a very narrow and pretty isolated sector. I mean, there are——

    Mr. BAKER. There are several thousands of cases.

    Mr. BOTHWELL.——Several large institutions, as you well know. We are not saying that it is impossible to do that.

    Mr. BAKER. But you want a regulated approach if you do it?

    Mr. BOTHWELL. We think it is important for some regulatory authority to have the ability to look at the whole organization, just like it would have been better if the Massachusetts Department of Insurance had the ability to go into the holding company and look at those real estate activities. It would have known sooner what the situation was with those activities.

    Mr. BAKER. Is there any commercial activity, in your opinion, that is more risky than making loans?

    Mr. BOTHWELL. Gold mining in Borneo, maybe.

    Mr. BAKER. Some would say not.

    Mr. BOTHWELL. I don't mean to be flippant. But when we looked at the literature, we were struck by the lack of any significant empirical evidence of any benefits.
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    Mr. BAKER. Well, the only benefit that could have possibly accrued, in my judgment, is that in a time of economic downturn, if we are trying to insulate taxpayers from future losses, would be to allow capital to flow from commerce into banking. That is my principal view is that there are great resources in the commercial marketplace that could be properly utilized, if properly regulated, in the banking enterprise.

    Everything I have seen to date suggests—for example, one revenue limit, where you have a bank that makes a million dollars. In a bad year, it is going to make $100,000. Under the revenue limit, we would then say, ''You can only get $25,000 from a commercial partner at a time when you really need it.'' That doesn't make sense. Or to say that a bank can only acquire an entity which is four times smaller than it.

    If you are going to go into business, I would think you would want a guy who is big and healthy, not small and somewhat limited.

    So, all of the approaches to date have constrained value of this relationship, which is to allow financial resource to flow into the financial entities so they can make loans and serve their customers. That is the reason for doing it. I think people are searching for an answer as to why. That is the obvious reason.

    Mr. BOTHWELL. I hope that situation isn't widespread. It has always been my firm belief that the United States has the most liquid and efficient capital markets in the world, and that there are many sources of capital for firms to tap; not just relying on bank loans. Most large firms don't even have bank loans at all. They go directly to the commercial paper market, to the capital markets.
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    Mr. BAKER. I have used my time and I apologize.

    Again, I just, on this one issue, have firm, deep differences, obviously, but do appreciate your willingness to appear. Thank you very much.

    Mr. BOTHWELL. Sure. I am perfectly willing to continue the discussion.

    Mr. BAKER. Oh, you will hear from me. Thank you.

    Chairman LEACH. Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    I am sure you will hear from my colleague from Louisiana again.

    Mr. Bothwell, you—in talking with Mr. Vento, you talked briefly about the regulatory side of a holding company structure versus an operating subsidiary. Let me take that a step further, and your comments don't really address this, but I would—I am sure you have thought about this at some point.

    Do you see any real difference in your studies between having a holding company structure with an affiliate for a securities firm, for instance, and going to an operating subsidiary structure within the bank? Do you think that we are capable of establishing sufficient firewalls through an operating subsidiary structure that would provide the same safety that we would seek in a holding company structure?
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    Mr. BOTHWELL. I think it is possible to have either type of structure. Again, our general principle is that you should have consistent rules and consistent powers, whether operating in an operating subsidiary or an affiliate of a holding company, as long as you have some umbrella authority over those operations, some supervisor with the ability to go in and oversee and examine.

    As I said, I can conceptualize of structures where you might have an extra cushion of safety if it was in a holding company structure, an affiliate of a holding company, because you could have the capital cushion in the bank set by the bank regulator and you could have the additional capital cushion set by the umbrella regulator for the holding company.

    But you can certainly conceive of a situation where you can construct firewalls that are sufficiently effective and thick to prevent risks to the same degree in either structure.

    Mr. BENTSEN. Couldn't you—would you be able to construct firewalls where you limit capital from the parent bank to the operating subsidiary or transfers of capital where you establish uniform rules between either structure as to the capital—how you capitalize a subsidiary? And let's just again take, for instance, a securities subsidiary, whether it is an affiliate or a subsidiary, that it has the same broker-dealer requirements applied to it in either case.

    Mr. BOTHWELL. Tom, do you have anything on that?

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    I would say the broker-dealer capital requirements that are put on by the SEC——

    Mr. BENTSEN. Right.

    Mr. BOTHWELL.——Are more geared toward customer protections. So, if there is a failure of the broker-dealer there are sufficient funds to pay off and to make customers whole.

    The capital requirements set by bank regulators are more with regard to having a cushion to protect the bank against losses. So, it is a little bit different in the reasons for those capital rules that are set by the SEC versus the bank regulators.

    Mr. BENTSEN. Have you found anywhere in your research over the years on this issue that there would be greater risk in having an operating subsidiary structure?

    Mr. BOTHWELL. In our work?

    Mr. BENTSEN. Right.

    Mr. BOTHWELL. No, we haven't looked at that particular issue in our work. As you know, it is only recently that the Comptroller has come up with his operating subsidiary proposal and there are a few applications in, but we have no functioning experience.

    Mr. BENTSEN. I understand on the Senate side that Senator D'Amato has introduced a bill that would—and this is just what I read—but would provide in the area of insurance sales some sort of carve-out to protect State consumer regulation. I know we have talked in the past about the research that you have done with regard to mutual funds and that bill would also provide strict SEC regulation of mutual fund sales in a bank.
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    Do you have an opinion of either of those issues, State regulation of insurance sales for consumer purposes and SEC regulation of mutual fund sales, both within a bank?

    Mr. BOTHWELL. Well, again, I think you want to keep in mind to try and minimize the burden on our financial institutions that are every day facing more and more competition globally. So, I don't think you want to get into a situation where you have overlapping regulations, where there are two sets of regulators, be it at the Federal level, or Federal and State, coming in with two different perhaps inconsistent rules and regulations. I think you really want to try and keep it streamlined.

    I think it has been the sense of Congress, as is embodied in the McCarren-Ferguson Act, that insurance is an activity best regulated by the States, and the national banks in particular are into sales of insurance products; there has to be some compatibility there with the regulatory approaches that are taken in the rules.

    Mr. BENTSEN. Although you have found—and I know my time is up—but, you have found with mutual funds, I think, that there have been some problems at the OCC level with national bank sales of mutual funds, right?

    Mr. BOTHWELL. Yes. Again, as you said, it is a very similar situation. There were some overlaps and even some gaps there in regulation of the bank's mutual fund activities.

    But I believe, Tom, that both the OCC and the SEC have been working together to do joint exams——
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    Mr. MCCOOL. Right.

    Mr. BOTHWELL. ——And to try to minimize that potential overlap and duplication.

    Mr. BENTSEN. Thank you.

    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Mr. Bentsen.

    Mr. Bachus.

    Mr. BACHUS. Thank you. Mr. Bothwell, I want to commend the GAO and their good work in general. You have encouraged us to pass financial modernization. And in your testimony, I think you are correct in saying that the market forces and the regulators have already, on an ad hoc basis, modernized our banking institutions. And had that not been done, I don't think they would be competitive today.

    And a lot of what we are seeing is just the market forces at work. And you have talked about financial modernization, but then you caution us against mixing commerce and banking. But would you concede that the market forces, the regulators, have, in fact, allowed a good bit of mixing already?

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    Mr. BOTHWELL. Mr. Bachus, I have cautioned the Congress against the unconstrained mixing of commerce and banking. Obviously, as we have discussed, if you are going to allow commercial banking to become affiliated with investment banking, there has to be some commercial activity permitted and allowed.

    Mr. BACHUS. Sure.

    Mr. BOTHWELL. And so you are going to get to an issue where you are talking about what is the allowable size of the basket for commercial activities, and what constraints do you put on it.

    Mr. BACHUS. Right.

    Mr. BOTHWELL. But I don't believe that the markets have illustrated that there are any great advantages for an industrial firm, like a big oil company or a big automobile producer, to be gained by owning a big bank. Up until——

    Mr. BACHUS. I understand. I don't think the banks are asking for that sort of a mix. You know, I guess what my concern is—I have talked to other Congressmen who are not on this committee, and even some—and we do, we tend to talk about whether we are for or against mixing commerce and banking, when, in fact, there is a certain amount of mix there now. I mean, we talked about the thrifts and all the activities that they are engaged in, real estate development.

    I mean, we are talking about should banking institutions engage in real estate development when, in fact, they have been for years. The thrifts are engaged in insurance activities now, security sales. Yet when the public talks about mixing commerce and banking, I think they get the perception of General Motors owning a bank. And I have even—and independent bankers, their representative will testify in a minute, and I have even gotten a letter from an independent banker who wrote me—and I guess as a result of somewhat viewing their correspondence—and said, ''Please don't allow a mix of commerce and banking,'' when, in fact, his institution probably is engaged in some commercial activities now.
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    And I think when the ABA—when the American Bankers Association, says that there needs to be some mix, I think they are talking about these traditional areas where we already have that experience.

    Mr. BOTHWELL. Yes. I think that is right. But under at least one of these proposals you would be able to have General Motors buy Chase Manhattan Bank, so, you are right. It is an issue of degree.

    Mr. BACHUS. I mean, I think that is maybe one of them. But I don't think that is what the majority of this committee is looking at.

    Let me ask you this: What about a—and I think the ABA, I read some testimony where they talked about a bank which wanted to sell on-line bill paying software to their customers, or supply that. You know, that is a strictly commercial enterprise, but it is very much a logical fit with banking.

    Mr. BOTHWELL. Yes.

    Mr. BACHUS. How do we address those type of things?

    Mr. BOTHWELL. I believe that the bank holding company structure, as regulated by the Federal Reserve, has the ability to allow banks to get into that type of activity, that is incidental to banking and/or bank-related.

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    Mr. BACHUS. Of course, you know, regulators could say, ''no.''

    Mr. BOTHWELL. And this structure has allowed banks to get into data processing and those types of closely related functions.

    Mr. BACHUS. Let me—and I know my time is getting very close. How about Section 20 of the Federal Reserve Act? Do you foresee any problem with repealing that section?

    Mr. BOTHWELL. Well, as has been dramatically demonstrated a month ago with Bankers Trust acquiring Alex Brown in Baltimore, the regulator, in this case the Federal Reserve, has pretty much substantially relaxed the restrictions.

    Mr. BACHUS. Basically allowed it?

    Mr. BOTHWELL. Yes. So, you can have a bank buy a good-sized securities firm.

    Mr. BACHUS. Now that we have that, we have one instance where Section 20 has gone by the board. On fairness, you know, if it goes by the board for one institution, it ought to go by the board for others.

    Mr. BOTHWELL. Yes. I think you want to keep a level playing field there.

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    Mr. BACHUS. OK. Thank you.

    Let me—one quick—this will only take a second. How about the activities of the insurance, the real estate and the securities activities that the thrifts are presently engaged in? Can you foresee us saying to any of those institutions, ''You have got to divest yourself of that activity, or you have got to restructure it substantially.'' I mean, when it hasn't been broken, it has been working?

    Mr. BOTHWELL. Well, I would say that history shows, when the Bank Holding Company Act was passed, that people were required to divest. TransAmerica had to split off its insurance from its banking activity.

    Mr. BACHUS. But why would we want to do that? What if it is a sound operation, you know, it is economically—it is viable, it is profitable, why would this Congress—why wouldn't we just grandfather all of those activities?

    Mr. BOTHWELL. Well, my other point was going to be that in other cases, operations that have been like that have been grandfathered in.

    Mr. BACHUS. And just say we are going to grandfather all of those activities. I mean, if there exists——

    Mr. BOTHWELL. That is one of the key decisions for the committee to make.

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    Mr. BACHUS. All right. Thank you.

    Chairman LEACH. Thank you, Mr. Bachus.

    Mr. Ney.

    Mr. NEY. I will pass, Mr. Chairman.

    Chairman LEACH. Thank you.

    Mr. Riley.

    Mr. RILEY. Nothing.

    Chairman LEACH. Mr. Hill.

    Mr. HILL. Nothing.

    Chairman LEACH. I am sorry, Mr. Cook. I did not realize Ms. Hooley has come in. I didn't see that there was another Democrat present.

    Ms. HOOLEY. I am fine.

    Chairman LEACH. You are fine. Mr. Cook, please.

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    Mr. COOK. Yes. In your testimony, Mr. Bothwell, you talked about the banking laws, regulations and structures of a number of other countries. Particularly with respect to Canada, I think you indicated that Canada reauthorizes its banking laws every 5 years?

    Mr. BOTHWELL. Yes, sir.

    Mr. COOK. And given the situation that has developed in this country, where Congress hasn't really done a lot of reauthorizing—well, new law related to banking in probably 60 years—I, and I am sure, many Members of Congress, have been very concerned about the usurping of what should be under the powers of Congress by regulators, even by the courts.

    Wouldn't this be a good idea in this country, maybe, to reauthorize banking legislation every 5 years, or do you have a feeling on that?

    Mr. BOTHWELL. Well, I certainly think that there is a need, in an industry that is undergoing such dramatic and rapid changes, for Congress to be holding oversight hearings periodically. I don't know that you have to set up your laws where they have to be reauthorized periodically, like Canada has done. But I think there certainly is value in having periodic in-depth oversight hearings for a sector such as this, where movements and changes are so major and are occurring so quickly.

    Mr. COOK. Well, even with respect to the question of mixing of banking and commerce, if we had a time period where it was obvious that—or where it was clear, I should say—clear that things would be reauthorized, wouldn't that make the questions more manageable? In other words, I think we are operating under the assumption that if we change laws related to banking and commerce, that those will be the laws that are with us for 60 years, because Glass-Steagall, for instance, has been with us for 60 years.
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    And I mean, you know, we shouldn't be under the assumption that if we do something and it doesn't work perfectly that we can't get back in and change it. I mean, you know, Congress needs to start exercising its proper authority in that regard. I am asking trying to—I am searching for anything else that you might think would help Congress gain its proper Constitutional role in this.

    Mr. BOTHWELL. And to your credit, you have passed major legislation in the banking area in the past; for example, the Interstate Banking Law which goes fully into effect in a few weeks; the FDIC Improvement Act of 1991 that corrected a lot of problems with bank supervision that we had found and pointed out in our work, and, of course, the FIRREA legislation to correct the problems of the S&L industry.

    I think this certainly has been a very active committee in Congress in addressing some of these problems and that the next logical step is to deal with these issues about the blurring of the lines and the traditional separations between banking, securities and insurance.

    Mr. COOK. OK. Thank you.

    Chairman LEACH. Thank you. Ms. Hooley, you still didn't wish to ask any questions?

    Ms. HOOLEY. Not at this time, no.

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    Chairman LEACH. Thank you.

    Mr. Ney.

    Mr. NEY. Thank you, Mr. Chairman.

    What about the fact of applying the McCarian-Ferguson type of theory? States regulate, they have insurance and people say. ''Well, banks are different.'' But, there is a lot of money out there in the insurance industry that transcends State lines. States have a remarkable way, through their partnerships, whether it is NAIC or NCSL, the State legislators, to be able to correspond and have reciprocity. What about applying McCarian-Ferguson type of thinking as these markets blend and merge, to banks also, regulation versus reduction of Fed role?

    Mr. BOTHWELL. Well, I certainly think that there is a difference there.

    The banking system is special—banks are special and they are special because they are the lifeblood of our real economy. Without credit no manufacturing firm would be able to produce; you wouldn't have employment. And because of the possibility for systemic risk, that makes it an essential Federal responsibility. Banks are very large and highly leveraged institutions, and they rely on the confidence of the people that their money is safe.

    Certainly, our history in the past, the past financial panics have shown that, in the absence of Federal deposit insurance, you can have bank runs that have dire consequences on the real economy, which was the whole reason for instituting deposit insurance in the 1930's. And once you have Federal deposit insurance with the full faith and credit of the United States Government behind it, then you are going to have to have a Federal role there in oversight and supervision of our banking institutions.
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    So, I think it is quite proper to have a Federal role and a major Federal role. I also think that one of the keys to the vitality of our system is its dual nature, that you will also have the States involved with the ability to charter their institutions and to regulate their institutions. So, I think the structure that we have, which is something pretty unique in the world, actually, we have a dual type of structure, has worked very well. So, I wouldn't recommend tinkering very much with it.

    Mr. NEY. Mr. Chairman, just one quick follow-up on that. Given the hypothetical of an increased insurance-type of role by financial institutions, at some point does the State let go some of that oversight in insurance—in the insurance arena of banks participating in that? Does it increase in the Fed to oversee the insurance end, or does insurance stay with the States, when you look at a bank doing business in that direction in the future?

    Mr. BOTHWELL. Well, again, as Congressman Bentsen was referring to, it is going to be very similar to the situation you have with the banks more and more involved with mutual funds, where the SEC is the regulator of investment companies in this country, and yet, if banks are involved with selling mutual funds, then the bank regulator has a responsibility as well. So, you have both regulators involved.

    You just want to make sure that if you have that situation that the regulators are coordinating and cooperating and not setting inconsistent standards or rules or being unnecessarily burdensome in what they are placing on the financial institutions.

    Mr. NEY. Thank you, Mr. Chairman.
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    Chairman LEACH. Thank you, Mr. Ney.

    Mr. Manzullo, did you wish to be recognized?

    Mr. MANZULLO. Yes.

    Chairman LEACH. Please.

    Mr. MANZULLO. Thank you, Mr. Chairman.

    I guess you are really on the hot seat. You know, when I look at conflicts of interest I think about the ambulance service that was connected to the funeral parlor, and you really wonder—you know, the State of Illinois got rid of that combination a long time ago. And then there were the furniture stores, there were the furniture stores that were also the funeral parlors. But then at times, it would also be the coroner. And you wondered what life safety was happening, and then some laws came about in the State of Illinois that greatly enhanced the requirements for people running ambulance services that divorced that commercial activity from the funeral parlor.

    And as I read this document, I don't see anything in here, unless I am missing it, that talks about any advantages that could incur to the consumer as a result of the mixing of financial services in other areas, other commercial areas.

    In fact, I read somewhere, I underlined it, yes, on page 6, ''A recent review of the existing economics literature found that the potential benefits of eliminating the current separation generally lacked empirical support and that most benefits could be realized through other means.''
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    And if you take this statement and apply it across the board in our capitalist society, this would seem to indicate that any business with more than five employees has a potential danger that there could be some type of antitrust—in fact, on page 16 it talks about other theoretical arguments. And I just wonder if you did studies saying well, let's assume that we allow the—we take as a model the three bills that have been introduced on the mixing of commercial activity and banking and do an empirical data as to how the consumer could end up being the beneficiary?

    Could you go that far? Do you have the resources to do that? Are there existing studies on that, Mr. Bothwell?

    Mr. BOTHWELL. Well, Scott can talk to the details of the studies that we looked at, but we essentially tried to look at all the major studies that had been done, analyzing to what extent there could be economic benefits realized by unconstrained mixing of banking and commerce. These potential benefits are things like increased economies of scale, so that the cost of the operation would become less; benefits through greater diversification, which might reduce the riskiness of the operation.

    And we found—and we looked at something on the order of 28 studies, and some of these studies were surveys of other studies, so the total number of studies we are talking about is larger than that—that there was very little evidence, if any, that any benefits would be realized by the organization. And actually, up until the Bank Holding Company Act was passed in 1956, industrial firms could own banks. But the history is that very few ever did, which sort of underscores this market test that perhaps there are no significant benefits there.
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    Mr. MANZULLO. Outside of this hearing, what we are seeing, for example, back home you will take a prime piece of real estate on a nice intersection and McDonald's will set up an operation there along with a gas station. I mean, you are seeing these combinations that are taking place. You see McDonald's and Wal-Marts. And what I am understanding, or trying to understand from here is, you know, sometimes sharing a common air conditioning system or a common roof or a common parking lot—I mean, the reason you have shopping centers is to pool the parking lots and roofs and common maintenance, and some of the arguments that I have heard, and although, you know, it is functionally different with regard to banking and commercial activities, is that there is the ability to utilize talent from the different sectors, maintain the firewalls, have protection for the consumer and yet come out with an end product that may be cheaper.

    Perhaps that is what this whole debate is about and why we are having these hearings, but I am really anxious to see more studies on that.

    Mr. BOTHWELL. Well, I don't doubt that there could be some cases where that is true, but if you look at the record, at some of the commercial industrial firms that have owned financial institutions in the past—for example, you had Sears owning Dean Witter and the Discover Card—it didn't quite work out to their expectations. They ended up divesting Dean Witter and Discover.

    You had Ford Motor Company own Nationwide, one of the largest thrifts in this country. Again, it didn't work out to their expectations and they did divest.

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    Mr. MANZULLO. But the market determined the quality of the investment, and the consumer was not put at adverse risk—would that be correct?—in those situations.

    Mr. BOTHWELL. Right, and the market test was that the benefits weren't there. The synergies——

    Mr. MANZULLO. So, that would be a decision that is made by market economics and not by regulation?

    Mr. BOTHWELL. Yes, and it was made by the market, yes.

    Mr. MANZULLO. Thank you.

    Chairman LEACH. Does anyone else wish to be heard? If not, we thank you very much, Mr. Bothwell, Mr. Smith and Mr. McCool.

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

    Chairman LEACH. Thank you.

    Our next panel is composed of a representative of the American Bankers Association, Mr. William T. McConnell, who is Chairman and CEO of Park National Corporation; a representative of the Independent Bankers Association of America, Mr. Bill Sones, who is President and CEO of the State Bank and Trust Company; a representative of America's Community Bankers, Mr. Paul Schosberg; and the Executive Director and General Counsel of the Institute of International Bankers, Mr. Lawrence R. Uhlick.
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    Let me say, without objection, all of your full statements will be placed in the record. Why don't we go in the order of the seating and begin with Mr. McConnell.


    Mr. MCCONNELL. Thank you, Mr. Chairman.

    Mr. Chairman, you and the Members of this committee deserve great praise for your dedication and hard work in trying to build a consensus for financial modernization. Modernization is a very high priority for the banking industry. We are prepared to work with this committee to create a more flexible financial system that will allow all financial firms to provide high quality, convenient and competitive products to our customers.

    There are several critical issues that should be a part of financial modernization. First, there should be a broad definition of financial activities. Financial markets are evolving so rapidly that a broad definition is needed to assure that banks can adjust to changing market demands.

    Second, banking institutions should have the freedom to choose the most efficient organizational structure. This is the best way to assure customers of low cost, high quality products and services.

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    In particular, we believe the operating subsidiary is an appropriate option for banks and any financial modernization legislation should preserve that option.

    We are very pleased, Mr. Chairman, that H.R. 10 incorporates an operating subsidiary option for many activities. We urge that H.R. 10 be amended to also permit insurance underwriting in an operating subsidiary, as does H.R. 268.

    Third, there should be a workable resolution implementing functional regulation, particularly in the areas of insurance and securities. There are other key issues that must be resolved, including banking and commerce, the type of umbrella regulatory structure, the merging of the bank and thrift charters. I would like to briefly comment on each of these.

    On the issue of banking and commerce, we see a coming together around the concept of a limited basket. The ABA supports this approach. We believe a limited basket makes good business sense. Such an approach should meet the practical concerns of most non-banks and unitary thrifts without raising worries about commercial ownership of banks.

    We commend subcommittee Chairwoman Roukema and Representative Vento for introducing this concept in the public debate as part of H.R. 268, and we commend you, Chairman Leach, for pointing out problems that need to be addressed in connection with any basket.

    We generally agree with the concerns you have raised. We believe a basket should not; one, be so broad or vague as to permit commercial firms to own banks; two, it should not be subject to manipulation or evasion; and, three, it should not have the effect of skewing economic decisions to either meet or evade the basket's requirements.
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    On the issue of an umbrella regulator, there seems to be a growing consensus that holding company regulation should be minimal and the primary focus of regulation should be on the individual subsidiaries of the holding company and not on the holding company itself. The ABA supports this approach.

    Who that regulator should be remains controversial. In talking to bankers in recent months we have found general support for maintaining a role for the Federal Reserve in holding company regulation. However, ABA strenuously objects to differential holding company regulation.

    For example, one recent idea is to have the holding companies of the largest 25 banks subject to special Federal Reserve regulation, regulation that is not applied to any other firms. This approach would plainly and obviously be discriminatory and would put these banking institutions at a competitive disadvantage, one that will grow over time.

    The last issue I would like to highlight is the merger of the bank and thrift charters. Given current marketplace trends, a merger of the bank and thrift industry seems inevitable. Any such merger, however, should result from a new and expanded charter. If this means chartering up, many grandfathering issues will become moot. Those that do remain must be dealt with fairly, with a view to minimizing any negative impacts.

    In conclusion, Mr. Chairman, we believe that this Congress has a real opportunity to enact historic legislation. While bankers have important concerns, as detailed in my written statement, we are committed to working with the committee to resolve these issues. Properly structured, a modernization bill provides great opportunities for all of us in the financial services business and in particular for the customers we serve.
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    Thank you.

    Chairman LEACH. Thank you, Mr. McConnell.

    Mr. Sones.


    Mr. SONES. Thank you, Mr. Chairman.

    First, I would like to say that the IBAA represents approximately 5,500 community banks in all 50 States, and we really appreciate this opportunity to testify on this proposed legislation.

    A little about myself. I work for the State Bank and Trust Company in Brookhaven, Mississippi. We are a $115 million bank with 57 employees, and we are located in a small town of about 10,000 people.

    Mr. Chairman, I would like to express my appreciation to you for your strong leadership in the last Congress on issues that were vitally important to our industry, especially for your sensitivity to the concerns of rural areas.

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    The critical issue, as we see it, before this committee is whether the financial services reform should include not only the securities industry and the insurance industry but also commercial and industrial companies. We appreciate your role, Mr. Chairman, in opposition to proposals that would significantly undermine the firewalls that separate banking and commerce; and we hope the committee will heed your concerns as well as the concerns of consumer groups, labor, small business and agriculture.

    Each of the financial restructuring bills introduced in the House permit the common ownership of banks, securities firms and insurance underwriters. We seriously question the need for such expanded powers. If Congress does elect to proceed down this course, we believe that they must do so carefully and with appropriate firewalls protecting the banks.

    In addition, Mr. Chairman, as you know, we are in the midst of an unprecedented consolidation of our industry, totally changing the landscape of banking in our country. Also, this year full interstate branching begins. We do not know the ramifications of this enormous initiative.

    I would ask, is this really the time to throw banking modernization into this mix? This would add even more volatility to the situation. Therefore, I urge this committee and the Congress to go slowly when considering more change to the banking industry.

    Federal Reserve Governor Meyer, speaking for the board, stated on January 24th that, ''The Board would prefer to proceed with the expansion of financial services and defer any discussion of commercial activities.'' Above all, banking and commerce should not be allowed to mix.
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    The United States has the strongest, safest and most diversified banking system in the world. I am puzzled at the sense of urgency to fix this great financial product delivery system that is not broken.

    In the United States, we can deliver banking services and products to even the most rural areas. Foreign banking systems such as Japan and Germany, who have embraced banking and commerce, are pulling away now and looking at our system as a model. Why, then, would we want to make our banking future look like their failed past?

    Mr. Chairman, I want to relate a story to you. In 1983, three men came into my office with an idea. They wanted to buy a telephone switch and sell long distance service in south Mississippi. Well, as you can imagine, a small bank like ours didn't have much expertise in a telephone long distance business; but we did have confidence in the three men and their character and their business ability; so we decided to make the loan.

    Now, some 14 years later, this company is the fourth largest long distance carrier in the United States. They have over 7,000 employees in several States. In fact, they just recently completed a $14.2 billion merger.

    In a world of banking and commerce, would Bank A, who might own its own telecommunications company, be willing to make such a loan for a new competitor? Or would telecommunications company B's bank that it happens to own be willing to make the loan? I hope we never have to find out.

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    Former Chairman Volcker has testified that this distortion of lending decisions would occur with the mixing of banking and commerce. It would be anticompetitive and threaten the safety and soundness of the banking system.

    Separating banking and commerce insures that credit is allocated impartially and without conflicts of interest. Another great fear is the further economic and financial concentration factor that will undermine CRA. That is why we can be strongly aligned with consumer groups in opposing this effort.

    Mr. Chairman, financial restructuring that would allow the common ownership of banks, insurance firms and securities firms will not help the community banks meet the economic and competitive challenges that are arising. If you want true financial modernization you must give community banks the tools that they will need to operate in the future.

    The most critical issue facing community banks is access to stable, long-term equity. I know banks such as mine, who historically have had 65 to 70 percent loan-deposit ratios, we are now seeing that creep up to 80 and 85 percent, even though our deposits are growing. So, we need new funding sources in order to help the communities that we exist in.

    Broadening the membership and collateral criteria for the Federal Home Loan Banks will allow community banks greater access to advances and will help ensure that they can continue to meet the needs of their communities.

    My written testimony will expand on these ideas, Mr. Chairman; but I did want to just say to you that there is a saying in the South. It says. ''Don't shoot the horse you rode in on.'' And I would say that one of our horses that our Nation's economy has ridden in on is our strong, safe and diversified financial delivery system.
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    Once again, I urge you to move slowly with financial restructuring and be careful not to damage our great banking system that is the envy of the world.

    Thank you again for the opportunity to testify.

    Chairman LEACH. Well, thank you very much, Mr. Sones. There is a message about not shooting the messenger which might be appropriate here.

    Let me say that there is a vote on the floor. Given the time and that we want to be precise and fair to everyone, let me say that this is a time that some people might want to get a snack. So, why don't we recess until 12:40? That way, if anyone in the room wants to get a snack, you can do so. Members are so advised as well.

    So, we will recess, pending the vote, to 12:40.

    [Whereupon, at 12:00 Noon, the hearing recessed, to reconvene at 12:40 p.m., the same day.]

    Chairman LEACH. The hearing will reconvene. Our next witness has been introduced earlier.

    Mr. SCHOSBERG. Effusively.

    Chairman LEACH. Effusively. And we welcome you Paul, Mr. Schosberg.
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    Mr. SCHOSBERG. Thank you, Mr. Chairman.

    I am Paul Schosberg, President and CEO of America's Community Bankers; and we greatly appreciate this opportunity to share with the committee our views on the need for financial modernization and on the various proposals to achieve that objective. We serve an industry with 2,000 savings and community financial institutions, with more than $1 trillion in assets and 250,000 employees and 15,000 offices.

    I want to express our gratitude to the Chairman for continuing to push all of us in the direction of financial modernization, despite the many frustrations that this committee and your colleagues have experienced. It is, in our judgment, both a social and economic imperative; and we hope that a sound bill can be enacted in this Congress.

    In addition to being an officer and Director of ACB, I am also a Director of the organization known as Social Compact, an umbrella organization of groups dedicated to housing, finance and community development. Because of today's hearing, Social Compact postponed a Congressional roundtable at which a number of committee Members would have participated; and I want to thank Chairman Leach, not only for the encouragement that he has given Social Compact, but for the offer that he made to reschedule that session for later this year.

    I mentioned Social Compact because a number of financial institutions and the community groups with whom they partnered were honored this week at an awards ceremony here in Washington. The diversity of these institutions and the creativity with which they pursued the goals of housing, finance and community development argue strongly for enhancing the diversity and flexibility of our financial system as it faces the new century.
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    That goal, in our view, becomes more urgent because of the changing role, size and scope of our Federal Government. No matter how one feels about the President's assertion that the era of big Government is over, or the lasting effects of the balanced budget agreement, there seems to be a consensus that we can no longer look to Government at any level for the magnitude of economic stimulus we have experienced over the past 60 years.

    At the same time, all of us remain committed to a strong, vibrant economy which creates jobs and opportunity. Can we achieve that without a sound, competitive financial system, one positioned to deal with global forces and the impact of rapid technological change?

    I think the answer is obvious; and that is why America's Community Bankers are committed to working with the Congress, the Administration and other industry groups on financial and charter modernization. It is why we were a founding member of the Alliance for Financial Modernization, which has demonstrated that, despite long-standing differences, a broad cross-section of financial services groups can achieve consensus on the need for reforms and on a framework for timely, constructive change.

    That is why ACB and our members come to you on behalf of the entire banking industry pointing to the strengths of our charter and to the ways in which its authorities can move our financial system forward.

    This Congress should build on this record of success as it crafts its financial modernization bill. Unfortunately, some proposals would strip savings institutions of important powers and authorities, while increasing other institutions' powers. While ACB supports financial modernization, a charter-down approach is not modernization. Congress should do no harm to an industry that is serving its customers and community safely and soundly. We could not support legislation that fails to build on the strengths of our current system.
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    ACB has taken this stance for one simple reason: legislation that strips institutions of existing authority or needlessly eliminates future business options would have direct consequences to those companies and the people and businesses they serve. The harm would be clear and tangible.

    Let me mention just one example. Both H.R. 10 and H.R. 268 would require savings associations to divest their real estate development activities unless those become conforming activities under the Comptroller's still-untested Part 5 process. That would mean, for instance, that an Illinois savings association, Financial Federal of Orland Park, would have to cease a business that renews middle-income housing in mature Midwestern communities.

    The restrictive grandfathering provisions of H.R. 10 and H.R. 268 would substantially decrease the value of savings institutions owned by a number of companies. In many instances, those companies acquired those institutions in supervisory transactions, injecting large amounts of capital and saving the taxpayers substantial amounts.

    On pages 5 and 6 of our written testimony we set forth what we believe are the elements of a modern charter, and we hope the committee and our colleagues in the industry groups will give those full and serious consideration as this process proceeds.

    Congress has an historic opportunity to truly modernize the financial system. The entire banking sector realizes that we cannot service either our consumer or business customers in the years ahead with the products and limitations from years ago. We feel the process should result in an advance, not a retreat; and we urge Congress to seize this opportunity, resisting efforts to turn back the clock.
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    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you very much, Mr. Schosberg.

    Mr. Uhlick, are you back from your call from Bern?

    Mr. UHLICK. I am, sir.

    Chairman LEACH. Mr. Uhlick.


    Mr. UHLICK. Good afternoon, Mr. Chairman and Members of the committee. I am Lawrence Uhlick, Executive Director and General Counsel of the Institute of International Bankers, an association representing over 230 banking organizations headquartered in over 50 other countries.

    Our members' U.S. banking operations include branches, agency offices and subsidiary banks. Like their American counterparts, our members are actively engaged in securities activities, particularly through Section 20 subsidiaries.

    Mr. Chairman, thank you for asking us to testify on H.R. 10. We appreciate the opportunity to express our support for this important legislation that affects all banking organizations operating in this country, including our member institutions.
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    The Institute strongly supports efforts to modernize the legislative framework for financial services in the United States. Modernizing U.S. financial laws will make financial services markets more efficient and thereby greatly benefit financial institutions, their customers and the U.S. economy generally. We commend you Mr. Chairman, Congressman Vento, Congresswoman Roukema and other committee Members, for your leadership in furthering the process of financial services reform.

    H.R. 10 represents an important step forward for the U.S. financial system. In particular, the bill would allow banks to be affiliated with full-service securities firms in the United States, without the artificial revenue limitations that currently restrict the securities activities of Section 20 subsidiaries.

    The Institute strongly supported the Federal Reserve Board's recent increase of the revenue limits. But that limit continues to impose significant constraints on the development of Section 20 companies of international banks and U.S. regional bank holding companies that do not have the necessary volume of permissible Government securities. By eliminating these artificial limits, H.R. 10 will greatly enhance U.S. markets, ensuring their preeminent position in the future.

    We also strongly support the provisions of the bill that would expand the types of activities permitted for financial services holding companies to include insurance and other activities of a financial nature.

    Elsewhere in the world financial institutions are generally permitted to engage in a broad range of financial activities, including insurance. H.R. 10 will provide the flexibility required to compete in the increasingly interrelated global market for financial services and allow U.S. regulation to keep up with future market developments.
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    The financial modernization proposed in H.R. 10 is also consistent with the international marketplace. International experience has demonstrated the strong synergies between banking and securities services. Outside the United States, international and U.S. banks alike have for many years engaged successfully in underwriting and dealing in corporate debt and equity securities. In every major financial center outside the United States, banks are able to conduct full-scale securities activities either directly or through affiliates.

    We have attached to our testimony tables summarizing the ability of banking organizations to conduct securities activities in more than 45 other countries around the world. Moreover, as these tables also show, other major countries have not found it necessary to separate banking and securities operations with U.S.-type firewalls, with the exception of Japan, which has some transitional nonstatutory restrictions.

    Perhaps of even greater significance, the United States does not impose any firewalls on American banking organizations with respect to their banking and securities operations abroad, even though such offshore affiliates are extensively engaged in underwriting and trading corporate securities.

    The Institute strongly supports firewall reductions. As the Federal Reserve Board concluded in proposing to eliminate most of the Section 20 firewalls, those firewalls have prevented bank holding companies from reaping synergy gains from the operation of investment banking. The Board has also recognized that legal and regulatory developments have rendered many of the original justifications for firewalls obsolete.

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    H.R. 10, as currently proposed, like the Federal Reserve's firewall proposal, represents a positive trend toward eliminating unnecessary restrictions on affiliations with securities companies. Whatever firewalls are ultimately imposed in financial modernization legislation, the Institute believes that regulators should be given the greatest flexibility to adopt and modify these as needed. This will permit regulators to respond to different circumstances and to react to changes in the marketplace.

    Finally, the Institute greatly appreciates your efforts to ensure that H.R. 10 furthers the long-standing U.S. policy of national treatment for international banks operating in this crucial market. The Institute is especially pleased that international banks with only uninsured wholesale operations will be eligible to be treated as investment bank holding companies, the new holding company structure created for owners of wholesale financial institutions, or ''woofies'' as they are often called.

    This treatment recognizes that the U.S. operations of such an international bank are, in fact, comparable to those of a ''woofie''. We hope that if any changes are made to the bill's provisions regarding the regulation of investment bank holding companies, international banks will continue to receive comparable treatment.

    As you know, the U.S. policy of national treatment has not only furthered U.S. interests abroad but has also created tangible economic benefits here at home. National treatment has provided significant economic benefits to the United States by allowing international banks to actively participate in U.S. lending markets with their domestic counterparts.

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    Similarly, we believe H.R. 10 will benefit the U.S. capital markets by increasing their depth, breadth and liquidity through the expanded participation of both domestic and international institutions.

    In conclusion, I repeat our strong support for financial modernization in the United States. H.R. 10 will provide tremendous benefits to financial institutions, their customers and the United States financial system as a whole. In addition, passage of such legislation will align U.S. financial services laws with the international marketplace and enhance U.S. leadership in ongoing efforts to improve the functioning of the global financial system.

    We look forward to working with you, Mr. Chairman, as well as other Members of Congress as such legislation moves forward. Thank you.

    Chairman LEACH. Well, thank you very much.

    I would say that the totality of the testimony is very impressive. It is not exactly in consonance, but it is generally so. I think with the exception of Mr. Schosberg virtually everybody supports modernization. Mr. Scholberg, you do support modernization with greater caveats, is that right?

    Mr. SCHOSBERG. I think there may be some subtle differences in vision and perhaps timing and emphasis.

    But, as I pointed out, Mr. Chairman, we were an original member of the Alliance for Financial Modernization, which I think demonstrated a broad consensus that has hopefully put a little bit of steam behind the process you are guiding now.
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    I think perhaps we are starting from a different vantage point, having had experience with the universe of unitary thrift holding companies; and that gives us a different perspective.

    Chairman LEACH. Let me say, with regard to that universe, that it was one aspect of the legislation of last year. As we all know, we didn't quite come to terms with modernization in a consensus way, but we did proceed through with the BIF/SAIF reform. And many on the traditional banking side of the financial services industry felt that they took a disproportionate burden with the allocation of FICO bonds being placed in commercial banking where it had not been before. They are wondering why it is that, in a charter sense, they took on the burden of an industry that they didn't cause and then are left in the circumstance where another industrial grouping has a preferential charter.

    And we all know there are terms of art, chartering up and chartering down. My personal view is that I am leaning a little on the chartering up side. But I think each point has to be looked at very carefully. It is not enough to glibly say charter up. It matters what one means by each point of chartering up.

    But the notion of maintaining a differential charter seems to me to be very uncompelling. That is, it strikes me that in a broad charter sense there ought to be commonality. To the degree that commonality may not fit exactly into the current circumstance and someone is disadvantaged, then maybe one has to take into account certain grandfather possibilities. But I see very little case for one part of the financial services industry having an advantageous charter over another.
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    Now, would you care to comment on that?

    Mr. SCHOSBERG. Absolutely. If our position was that we got what we wanted out of the BIF/SAIF legislation and now we are going to go home and just hang out, I think that criticism would be warranted. But from June or July of 1995, when the Alliance was formed, we have been a full participant in that effort. And the starting point, the basic premise of our involvement was to, if you will, offer the crown jewels of the thrift and the unitary holding company franchise for all depositories.

    We have not tried to circle the wagons around those aspects of our charter. We have actually said, let's do an Operation Bootstraps on behalf of the entire banking system. Why? Because the banking system, as we know it, has been losing market share at a rapid rate to non-bank but bank-like competitors, and that threatens a disequilibrium in our entire financial system.

    I hope that clarifies our stance, it is one of the reasons we are here today.

    Chairman LEACH. No, no, I think it is a good clarification. It wasn't one that surprises me. But it was a good clarification.

    Mr. Sones, would you comment on this issue?

    Mr. SONES. Well, I guess community banks have a different idea of bank modernization in that we want to really center in on retail services that we can offer at the grass-roots level; and we see the issue I guess a little differently than our competitors who had the unitary thrifts through the years. You know, there are only really about 60, 65 unitary thrifts that are really actively using the powers that they have in the world today; and it shows me that there is not a lot of appeal out there for commercial banks in these activities.
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    Chairman LEACH. Mr. McConnell, would you care to comment?

    Mr. MCCONNELL. The American Bankers Association has been in conversations, extensive conversations, with America's Community Bankers on the issue of the charter; and we are both enthusiastic about chartering up. But you have indicated that can mean different things to different people, perhaps.

    In many areas of the possibility of merging the charters of thrifts and savings banks and commercial banks we are in complete agreement. We finally differ chiefly in the area of commerce, which really relates to the unitary thrift holding company.

    We can well understand that the thrift industry does not want to take a step backward, which they perceive this to be, to have anything less than what amounts to full commerce. But our membership has reservations, as I indicated; and we are for the—what has been described as a limited basket.

    We feel rather strongly that if we are going to have one insurance fund—the deal we made with Congress was that we would have one charter, and we would be very much opposed to what you have described of having a charter for someone else that was better than our own. On the other hand, we wouldn't expect to have a better charter than is offered to the thrifts.

    Chairman LEACH. I understand where you are coming from. I also would say that, in the abstract sense, when you have two people or two industries that have slightly different circumstances, and that if Congress were to tilt, logically you would probably want to give the benefit of the doubt to the industry that accepted an obligation. After all, you took about a $6 billion obligation from the thrift industry.
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    My own strong feeling is that, at the end of the game, there ought to be a commonality of charter. I think the committee might have subtle variations on this issue. Further, probably in the amendment process, the committee will have to work its will on just where one wants that charter to come down. But I have a hard time thinking one wants to be left with two different charters.

    Mr. MCCONNELL. That is right.

    Chairman LEACH. What I thought we would do is go in regular order. Because my time has expired, and I have several more questions for Mr. Uhlick—or at least one. However, I would rather go in regular order and then maybe do another round, if that is all right.

    Ms. Kilpatrick, you are the Ranking Democrat present. Would you care to inquire?

    Ms. KILPATRICK. Thank you, Mr. Chairman, for the opportunity and to apologize to those in the room. As a new Member of Congress, it is difficult for me to be in 10 places at one time. I see that many Members are still sane, and they do that.

    Although I missed much of the testimony, I am happy to be a part of the committee and listening to all the ideas on modernization, as we discussed this morning and in some of Mrs. Roukema's hearings.

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    One of the things that baffled me—on the one hand, I hear everyone wants bank modernization; and then I hear people that don't want to merge and see the similarity to merge commerce and banking and financial services—firewalls, the blurring of the lines, all of that. As I look at it, it seems that Glass-Steagall has to have some comprehensive overhaul; but I don't see the banking community coming together as a unit yet to this Congress to really let us know what you would like to see.

    And nobody gets, in the legislative process, exactly what they want. That is the art of politics. But, at the same time, what I want to see come out of this—and I thank Chairman Leach and Mrs. Roukema for having these hearings—is that the industry, though you may not like all pieces of the puzzle, that you would present the best foot forward for this Congress so that we can act in the best interest of our constituents.

    I appreciate Mr. McConnell and the American Bankers Association and all of you and the previous panel for coming before us. But many times as I sit here, you say yes, you want it, and then with all the blurring going on, in the next breath I hear from some people that the commerce should not be merged.

    Mr. Chairman, I am a bit baffled, but, again, it is a learning process and I am happy to be a part of the committee. Thank you.

    Chairman LEACH. Well, thank you Ms. Kilpatrick.

    Did anyone want to take that on?

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    Let me say real briefly, Ms. Kilpatrick, that there are two fundamental sets of issues with respect to bank modernization. One issue is whether we should combine commercial banking with investment banking and with insurance. On this issue, I think there is pretty good consensus among these witnesses and most Members. Then, there is a separable, although interrelated issue which is whether we should allow banks to enter into industrial or commercial ventures. This issue is more conjectural, and I would guess it is going to be a close vote on the committee. However, I am just speculating. Perhaps the committee will vote overwhelmingly for it. Some of us have skepticism, and others are more committed in that direction. But that is the distinction that you are hearing, with Mr. Sones being very skeptical, Mr. McConnell being somewhat of a plus, and Mr. Schosberg being a very big plus. And so those are the distinctions that you are hearing, I think.

    Ms. KILPATRICK. Thank you, sir.

    Chairman LEACH. Mr. Riley.

    Mr. RILEY. Thank you, Mr. Chairman.

    Chairman LEACH. Excuse me, you have been here longer, Mr. Riley. Go ahead.

    Mr. RILEY. Mr. Chairman, being new to this committee, it has been an interesting learning process.

    I represent a rural district in Alabama that has many independent bankers. One of the things that has struck me among that group of independent bankers is the divergence of opinion.
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    Mr. Sones, you say here that mixing banking and commerce will hurt business and is not good for the economy. I guess I would like for to you elaborate—I apologize because I wasn't here for your full testimony; I had to leave—but if you could elaborate a little on what that means. And try to explain to me why there is such a divergence of opinion among independent bankers in my own area as far as mixing banking and commerce.

    Mr. SONES. Well, I think probably community bankers have a harder time educating themselves to the issues than maybe some of our larger counterparts just because we are in rural areas and maybe we don't get together often enough. But I think you will see as time goes on, probably as legislation moves forward, you will probably see there being a little more cohesiveness with community bankers as the issues really hit the table.

    Now, as to why we would be opposed to banking and commerce, first, there is very little in the mixing of banking and commerce that we feel is good for the community bank. A 25 percent basket approach even wouldn't offer us many opportunities. But I guess the primary reason is that we think right now that we can be totally objective when we make credit decisions.

    Let's say in the mixing of banking and commerce that I bought the funeral home next door, which would be probably the largest business that I could buy. I don't know how willing I would be to lend money to start a new funeral home on the next block to the one my bank owns. And I would say that right now we have the mixing of banking and commerce in that I am a banker, but I could own a funeral home too, if I wanted to. But the difference is putting the bank's capital at risk, which we think poses some very significant risk to the fund and to our economy.
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    Mr. RILEY. One of the things that also strikes me is, there seems to be—when I listened to the testimony today, there seems to be a certain almost inevitability that we are going to eventually merge banking and commerce.

    I think it was Congressman Bachus this morning that gave an illustration of someone who had developed a software program who wanted to sell it but it was owned by the bank. How do you deal with a problem like that?

    Mr. SONES. Well, I guess you would have to have your eyes closed and not be listening very well to say that there is not some merging of banking and commerce going on right now. I think where there is the will, there is the way in the American economy, and I think that some are willing to be mixing banking and commerce activities. So, I think you cannot really slow down inertia sometimes.

    But anyway, the bottom line for us is that we represent community banks and we just don't see much in the mixing of banking and commerce for us.

    Mr. RILEY. Well, if there is an inevitability and if we continue down this path where we allow insurance and other commodities to be merged with banking, doesn't it strike you that we should, in this committee, set up some structure so, as it does develop, there is some kind of structure that we can work within?

    Mr. SONES. I think—and of course I appreciate that you were not here during my testimony, but during my testimony I think our major message that we got across was, just be careful and go slow and be very deliberate in the changes that need to be made, because we have had a mass consolidation in our industry, there are many fewer banks than there were just a short time ago, and even in midyear this year we are going into full-scale interstate branching, which is going to be a totally new change.
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    So, there are just a lot of changes taking place in banking in the United States right now, and we need to be careful of the timing and the forethought that is put into these changes as they occur.

    Mr. RILEY. Well, my independent bankers were not hesitant to tell us to go slow. And I think that is good advice for this committee to take into consideration, all of the major effects that it will have on community banks and larger banks throughout this country.

    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Mr. Riley.

    Mr. Hill.

    Mr. HILL. Thank you, Mr. Chairman.

    I can only echo the comments of Mr. Riley with regard to being a new Member of this committee and trying to weave through the complexity of this issue. And as I read testimony and then as I talk with people, sometimes the dynamics change rather quickly, it seems.

    I want to talk a little bit about this issue of commerce and banking, because that is obviously one of the issues where this whole thing hangs up. And perhaps I don't understand this fully, but it seems that we have an example of commerce and banking in the unitary thrift charter situation.
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    I guess I would ask the representative from the ABA and from the Independent Bankers, is there evil embedded in that charter? Is there great disservice being committed to the economy of the United States? Are the customers of those institutions being ill-served that that is such a poor model for us to go forward with?

    Mr. MCCONNELL. I think I would answer no to every one of those questions and the direction of them. I cannot offer any evidence of where there have been substantial abuses because of the unitary thrift charter.

    The American Bankers Association represents more banks than any other association, and they are all sizes, and it is a diverse group. Several of you alluded to the fact at the beginning—Ms. Kilpatrick—that we have four bankers but the three of us are representing different—we all have different views on this. And that has been what has been terrible for the banking business. If we could agree on these things, why, I think we would get further, and, as a matter of fact, I think that is the motivation for the ACB and the ABA talking together. We felt that we could come together on an agreement, and, in fact, we have on many things.

    But you take all the membership of the ABA, and what we do as an association is try to reflect the views of our membership, and, honestly, the views represent one end of the spectrum to the other, represent on the one hand no mixing of banking and commerce—pretty much Mr. Sones' position, I believe—to the other, which would be represented by the unitary bank thrift holding company, Mr. Baker's argument.

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    However, the vast majority of our membership is uncomfortable at either one of these end positions and seem much more comfortable with the idea of a limited basket which would provide banks with flexibility that would help them going forward in trying to be competitive, but would allay the concerns of those who have a great concern about the economic concentrations that conceivably could come from full commerce.

    Mr. HILL. I guess my question is really, are these perceived risks or are they real risks? I mean, we have a model out there. And I am not an advocate; I am just trying to sort through this. But we have a model out there that is functioning. And are those risks that you seem so concerned about and your members are so concerned about—I am not suggesting they are not a valid risk, but is there anything occurring out there in the marketplace or in the economy that would say that these are more than just perceived risks?

    Mr. MCCONNELL. I don't profess expertise in some of this. I understand there have been examples where maybe in some other countries, perhaps Japan, where you have industrial and commercial things combined.

    Mr. HILL. That has a lot to do with the lending practices between the two countries.

    Mr. MCCONNELL. It may be.

    Mr. SONES. As to unitary thrifts, I would not say that we are necessarily opposed to unitary thrifts. In fact, IBAA policy says that we would favor grandfathering the current unitary thrifts; however, we would prefer it as a new charter. As we pull our charter together with an S&L charter to make one charter, we would prefer something that is a little less than that.
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    As to the risks involved, we too, I guess, would point at other countries who maybe tried the mixing of banking and commerce and are now having problems and are looking at our system. The bottom line for us is that we have the best banking system in the world. I don't know why we want to model one after Japan and Germany who have tried to mix banking and commerce.

    Mr. HILL. But it does include the unitary thrift charter?

    Mr. SONES. It does. But I would defer to my friend and colleague as to the actual numbers. But the number that I hear is that there are about 170 unitary thrifts in the country and there are only probably 60 to 70 that are actively exercising those powers, so the numbers are not real large. I know in Mississippi there is one unitary thrift. So, there are not a lot of those out there to really look at as models.

    Mr. SCHOSBERG. Well, there are certainly enough of them out there to look at, and they have been around long enough. And as much as I respect the work of the General Accounting Office, I was absolutely struck that their study omitted any reference to unitary thrift holding companies, when the centerpiece of their analysis was the issue of banking and commerce, and here you have a laboratory experiment right in front of you.

    The Office of Thrift Supervision has done such a study and concluded that while there have been instances where unitary thrift holding companies and the depository institution ran afoul of rules and regulations, there are no instances whatever of any systemic risks because of that corporate structure.

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    I think what we find compelling about this unitary holding company model is; A, it has been tested over time, and; B, our financial system and the environment in which it is being reshaped are so fluid that, why should any reasonable option which has a tested track record be denied? Who has the clarity of vision to say that there is only one way of doing financial business in this country as we approach the next century?

    If we have learned anything—and as Bill McConnell and Bill Sones both pointed out, the strength of our banking system is in its diversity. We are a diverse Nation in terms of its needs and its people and its communities, and we should have a framework of law and regulation that encourages diversity, not stifles it.

    I am not sure that a one-size-fits-all approach to banking will keep our financial system competitive and viable; it may instead continue us down the slope to where our banking system loses market share to all the hybrids that are out there.

    Mr. HILL. Thank you.

    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman.

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    Mr. McConnell, in your testimony you all seem to favor a dual structure approach of either the affiliation or an operating subsidiary structure, so you all feel fairly comfortable with that. You also state that the ABA opposes any legislative provisions that would impose statutory firewalls on bank securities activities that are greater than Sections 23(A) and 23(B).

    Would that mean that the ABA, if we went to an operating subsidiary structure or provided that, that the ABA would then oppose any firewalls that would apply to capitalization or the ability to move funds between the parent and the subsidiary, other than giving that authority to the regulators?

    Mr. MCCONNELL. No, I don't mean to imply that. We would like the flexibility to make a business judgment as to whether in a particular bank an operating subsidiary of the bank works better than an affiliate company of the holding company. But we would assume that there need to be firewalls or restrictions that limit the amount of capital that is at risk.

    And what I understand to be one suggestion is that you would net the capital of the operating subsidiary or the other affiliate against the capital of the bank, which would limit how much capital you put in, certainly, and there would be limits on the amount of borrowing.

    It occurs to us that if there are limits on what the bank can provide either through lending or capital infusion to the subsidiary, then it is possible to protect the bank sufficiently, so that if the subsidiary fails, the bank is not in danger.
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    Mr. BENTSEN. I am not an attorney, but it would seem to me that it would be necessary to have at least some statutory limits for liability purposes in the event that the subsidiary got into trouble where its liability exceeded its capital, that you would want to have some statutory firewall to fall back on so you could not upstream that liability into the parent company and then affect—and then get into a safety and soundness question.

    Mr. MCCONNELL. I am not an attorney either, but I fully agree with you on that.

    Mr. BENTSEN. You also state that you would prefer the repeal of the artificial quantitative limit on bank ineligible securities and move them—also move ineligible securities into an operating subsidiary, as the Comptroller is now proposing with the Section 5 operating subsidiaries.

    If we went—hypothetically, let's say we had a Glass-Steagall reform bill that passed and was signed into law. If we were going to get that far and set up a dual structure of either an affiliate or an operating subsidiary, why not move all securities into either an operating subsidiary or an affiliate?

    And I am not necessarily advocating that, but I am curious why you wouldn't do it? Is it because you want to retain some securities function within the parent for trust operations or for your own funding operations? Why not just—if you are going to set up an affiliate, why not just move them all over?

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    Mr. MCCONNELL. More specifically, the securities that you are talking about may be Government or agency bonds or municipal revenue obligations. The authority to do that within the bank goes back a long way, and maybe to the Civil War, and that has worked very well. Banks are very comfortable with it.

    If we had to make that change, it would come at some cost to the bank. It is the sort of thing that is working very well in the situation that we have, and we would like to not have to artificially put those kinds of securities powers into either a subsidiary or an affiliate.

    Mr. BENTSEN. But I am just curious, is there—I mean, there would also seem to be some inefficiency in having a Government desk both within the bank and within your operating subsidiary.

    Now, I would understand if you were a bank that was not going to set up a broker/dealer, or was not going to get into the securities business, you would want to retain the ability, but if you are a bank that is going to get into that type of business, why wouldn't you just move everything over to one area so you could have it under one profit center and one manager, in effect?

    Mr. MCCONNELL. I would hope that the banks would have that option. In other words, fundamental to our view of this is that we believe that we should have as much flexibility as possible. In doing that, we ought to then, therefore, make the kinds of decisions that make the most economic sense, and the ones that you just described perhaps would be one of those. But if that happens, then there are benefits to our customers. Costs should be down, and prices should go down, and all the things that flow from that.
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    So, I don't know that there wouldn't be banks that would choose to follow the model that you have, sort of, outlined, which makes lots of sense, but we would like to have the option and not be forced. Especially as you have described it, a bank that doesn't have any intention of doing any other securities business anyway, should not be forced into moving something out of the banking or an affiliate or an operating subsidiary.

    Mr. BENTSEN. Thank you.

    Mr. Chairman, I have another question if we have another round, but my time is up.

    Chairman LEACH. Mr. Baker.

    Mr. BAKER. Thank you, Mr. Chairman. I regret that I have been absent for some portion of the hearing. We had some business on the floor that required attending.

    Mr. McConnell, I am interested in understanding your view of the basket approach. Can you describe for me the way that basket looks? Does it have a handle? Is it pink? Does it have a ribbon on it? How is it made up?

    Mr. MCCONNELL. I cannot be very specific. What we believe is appropriate is a limitation on commercial activities that a basket approach implies. We think in order to determine, say, the size of the basket in terms of the percentage of activity, it would first—we should carefully look at the base, whether it is going to be capital, as I believe Chairman Leach has suggested, or revenues.
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    Mr. BAKER. Tell me some of those points. I think I understand the criteria that are under consideration. If a bank at the close of business today has extensive derivative holdings and has 8 percent capital standard, if you took a real risk analysis of that bank's portfolio, you may well determine they need 12 percent. On the other hand, you could look at a bank, perhaps Mr. Sones' bank, Brookhaven—well run, well capitalized, good return on equity—and you could say they are at 6 percent and he is overcapitalized.

    I don't take great comfort in capital positions, given the technology that we have and the ability to shift great portions of investment portfolios in day from day. The other is to limit the asset size of the entity that is required so that the bank is three times the size of its partner. To what extent—I don't know whether that is an automobile dealer and you are a bank and you want to get some of his business financing his customers. I don't know why they would do that unless it is really a great rate of return.

    On the other hand, someone suggested revenue limits so that the bank can only get X percent of revenue from its commercial affiliate. What that does is, in a time of financial duress for the institution, you limit the amount of money you can get from your partner when it is most needed. That, to me, seems to be a bit ironic.

    However, the Fed seems to have an approach where up to 24.9 equity position in a commercial entity, regardless of who it is, how it operates, what it does, and how much money you make off of that, the only criteria is the question of control by the bank over that investing entity's operations. As long as the Fed looks as though they believe you are not controlling the practices or business judgments of that company, that is OK.
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    Is that something that makes sense to you?

    Mr. MCCONNELL. As we looked at this question, I think that we have come to some of the conclusions that you have, that you look at revenues and you say——

    Mr. BAKER. Why?

    Mr. MCCONNELL. Right. What if there are no revenues this year? And what does that imply? And what if they have a wonderful year? We should perhaps be able to spell out for you, with great specificity, exactly how a basket would work and what size it would be. Rather, I would say to you that our membership believes that we need something less than full commerce, and the basket approach seems to do that.

    Mr. BAKER. On that point of less than full commerce, I am still trying to grab what that means. Whether it is the basket approach, even to the extent of the Chairman's mark, which has a limited commercial interest through a wholesale financial entity, and that is financial in nature only. Everybody else is talking about unbridled commerce and finance in this sense: that we do not tell bank ''A'' which commercial entity ''B'' can it affiliate with; that is unbridled in that sense.

    The only limit that I am hearing, and I am asking for clarification, possibly some revenue asset size or other constraint on that entity that then makes it, quote, ''Not full blown commerce and industry.'' Is that about where we are, you think?
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    Mr. MCCONNELL. Well, we have—we would not like an unbridled commerce and industry, something the other way; that any commercial firm could buy a bank or buy any bank and that—we don't think that is a good idea. So, that is why——

    Mr. BAKER. But you don't purport to say that a bank could buy somebody else and that somebody else couldn't buy them? I mean, if you were able to buy ''B'', ''B'' ought to be able to buy you, from a standpoint of equity. Don't you agree with that?

    Mr. MCCONNELL. I can understand your argument, but I don't agree with it.

    Mr. BAKER. Oh, I see.

    Let me pass on quickly to Mr. Schosberg, because I know he has also expressed an interest in the basket approach. Is your view somewhat similar to that of Mr. McConnell's, that the basket is yet undefined, but we want one wherever we can find it?

    Mr. SCHOSBERG. No, it isn't. We are uncomfortable with the concept, because it seems to impose a static yardstick on a fluid environment. As a matter of fact, from the standpoint of thrift institutions, to the extent we have been looking at baskets, we have been looking at reverse baskets. Because the experience that we are more familiar with is where the banking entity is substantially smaller than the commercial entity. Temple Inland, for example, is the one that comes immediately to mind.

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    The concern that our bankers have expressed repeatedly about the basket approach is that it inhibits flexibility and could impair earnings by impeding an agile business strategy. I think many of us have been lulled by a very benign economic climate. We all need to remind ourselves that it was just 4 years ago last month that we had the summit meeting on the so-called ''credit crunch.''

    Mr. BAKER. If I may, I am well over my time.

    To summarize your point, I think, is that business diversity would be good in economic difficulty. Is that it?

    Mr. SCHOSBERG. Precisely.

    Mr. BAKER. So, banks chartering up to thrifts rather than chartering thrifts down to banks seems, from your perspective, to make more sense?

    Mr. SCHOSBERG. That is our basic tenet.

    Mr. BAKER. Mr. Chairman, with your—one more?

    Chairman LEACH. Sure.

    Mr. BAKER. I won't have a second round.

    Mr. Sones, just briefly looking at the bank and what little I know about Brookhaven, I believe there—and it is a great community. You seem to have a very well-run, profitable bank, from your investors' perspective, and meet the needs of your community, I am sure, quite well.
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    As to the nature of the membership of the board, where do they come from? Who are those people and what do they do as members of your board? Are they just generic? I don't need names or anything. But are they, like, local folks? Are you locally owned?

    Mr. SONES. Yes, we are locally owned; and our board is made up of 13 individuals; and they are——

    Mr. BAKER. Local businesspeople?

    Mr. SONES. ——Local businesspeople, physicians, attorneys.

    Mr. BAKER. My point here is that the suggestion has been made that if you have a diversified business structure and you have the bank and business with a particular entity, telecommunications, and a local guy wants to get into the wireless business and comes to the bank for a loan, because you have this parent or cooperating partner, you might look with some jaundice at this competitive credit request.

    How does that work today where you have an individual who comes to the bank and the director is, say, the owner of ABC automobile dealership, and he is sitting on the board and he is going to approve the loan? Is that a difficult problem? Or how does the bank handle that today?

    Mr. SONES. Well, it is a problem sometimes. You know, in a small town, as you know, you have a multitude of different kinds of problems.
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    Mr. BAKER. I am from a small town. I know about that.

    Mr. SONES. The thing I guess that is the saving grace in a situation like that is that all 11 of my board members aren't car dealers, and so there are different perspectives that come into play.

    Probably, if we were in that same occasion, where the bank's capital was at risk and we were all, in essence, car dealers, because the bank owned the car dealership, it might be a little different situation.

    Mr. BAKER. Well, my conclusion was simply that we really have those issues present in today's banking environment. They are not new issues. Good banks make good decisions. They make good loans, and they make a profit. I don't think that changes no matter who you are in business with, but I thank you.

    Chairman LEACH. Well, thank you very much.

    I want to just return to a previous point, because I don't want us to be totally buffaloed by you. Paul, in terms of experience, I have an FDIC report from June of 1996 that lists only 28 unitaries that have activities beyond a bank holding company. And only 14 of the unitaries have activities beyond a bank holding company that aren't insurance.

    The only reason why I stress this is to point out that we are not dealing with a large universe here, and I don't think public policy ought to be driven by 14 institutions.
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    Then you come to the issue of experience, and under which I think the GAO came under some criticism today. But I think it should be stressed that there are, to my knowledge, no examples of the unitary model, or what is called the universal bank model, that has been helpful for those societies outside of the United States. The taxpayer has been put at risk in every one of those societies, and in a number of those societies, taxpayers have been called upon for assistance. There is a difference between being put at risk and actually being called upon.

    When you look at the difficult situations in the world today, where other countries have different banking systems—a leading example would be Japan—it appears that in those systems that have the intermix of banking and commerce,
a large number of Japanese banks would be in insolvency today if it weren't for the Bank of Japan, in effect, saying that it would stabilize the banking system. And the situation appears to be similar if we look at experience in country after country that have this model.

    So, the fact is that, as of June of 1996, there were 14 unitary thrifts that had investments beyond the bank holding company model that were owned by companies other than by insurance firms, especially when you make your comment—which is very important—about good times, which was particularly the last 5 years, where the market has tripled in value. Then if we go to the American experience of the 1980's, it may not precisely be in the unitary context, but the direct investment guidelines for many S&Ls were the equivalent of commercial investment authority and the United States taxpayer got a multibillion dollar hit.

    So, I think all of us have to recognize that there are liabilities that are not small, especially as we spread the bank safety net. We represent the public, and we have an obligation to be a bit conservative when it comes to spreading the bank safety net.
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    The argument is made that diversity spreads risk. However, I am not so sure. I think that in the financial services arena, I am absolutely confident that that argument is valid. When you get beyond financial services, it strikes me that there are very few anecdotal or historical examples, although there are always some; and the great exception today is GE. But, I know of very few anecdotal evidences that bankers make great businesspeople when their principal business is banking.

    Now, you can take a former banker and put him in charge of a commercial venture, and he might do rather well. But I just think that you not only have conflicts of interest, instead, you really infuse into the economy some very dangerous elements and that we should be very cautious. And that is one of the reasons that I am appreciative of the comments made by Mr. Sones, but some notes of caution have come from Mr. McConnell, and accordingly, I think we have to be very careful.

    I would like you to respond, because my sense is that if you add up, from 1980 to 1997, all of the instances of savings and loans in commercial ventures, you will find that the totality of losses is staggering. If you then say the 26 unitary thrifts that exist today, or 28 that existed as of June of 1996, are beyond this, they would probably have a pretty good track record.

    But I think this committee has to be very careful about apples and oranges, and I am not sure that you can represent to the committee that you have a model that is successful. I think you can represent to the committee that your current unitaries are probably fairly stable, which is a different circumstance.
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    Now, how would you comment in that regard?

    Mr. SCHOSBERG. Let me first point out that, according to, I think, an April 3rd document prepared by OTS—and I am sure the committee can go into this when their witnesses appear—as of year-end of last year there were 875 holding companies which owned 651 savings and loans with total assets of $632 billion, which is roughly 82 percent.

    Chairman LEACH. But how many of them own commercial ventures?

    Mr. SCHOSBERG. Granted, the number is small.

    Now, a couple of comments. The——

    Chairman LEACH. Excuse me. Could you answer that question?

    Mr. SCHOSBERG. If you get outside of insurance and real estate, for example, it is a smaller universe.

    Chairman LEACH. Yes.

    Mr. SCHOSBERG. But a couple of things should be kept in mind. It is only very recently that most institutions recovered from the ravages of the 1980's. Business strategies, as you pointed out, don't turn on a dime; nor should they. And so business options are constantly being sorted out.
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    As the OTS study notes, people come in and out of the holding company structure. They will try it for business ventures, and if it works they will stay with it. Others will abandon it, and then others come in. So, it is fluid.

    Also, I think it is very unlike the Japanese model of banking, which I would not recommend at all. It was just a few years ago that some of your colleagues were decrying the fact that, of the world's 21 largest banks, only one was domiciled in the United States. I was thinking to myself, ''Here we are again, measuring strength by size, instead of by capital and ROE.''

    Japan has had a conscious industrial policy. We have shied away from that. Japan has arguably one of the worst regulatory systems for its financial community; while ours has been upgraded significantly, particularly since FIRREA. Ours is light years beyond what it used to be.

    So, I think we have different competitive, economic and regulatory environments; and I think as we view what the unitary structure may mean in terms of a new model for modernization—and I am not saying take it and transplant it full scale, but maybe use it as a basic structure to build on—we should look at it in the context of the new regulatory standards: higher capital, risk-based premiums, prompt corrective action, as well as something that is a little more amorphous, but still significant, and that is the change in the quality of management overall.

    I will say, while S&Ls had their problems, they didn't get into LDC loans; and when it comes to direct investment in real estate, as our members were getting smart, an awful lot of commercial banks were plunging in. If you take a look at the numbers from 1986 on, they are horrendous. The charter had nothing to do with that. The quality of management had everything to do with it.
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    Chairman LEACH. I think that is very thoughtful. I appreciate that. My time has expired. Let me switch back to the Republican side.

    Mrs. Roukema.

    Mrs. ROUKEMA. All right. Thank you. I appreciate your courtesy here.

    You may be assured I will go over in careful detail all of your testimony today. I have been wearing too many hats. I committed to a conference call with a group back in New Jersey long before I knew that you were going to be appearing here today, so I apologize. But I will go over all of your testimony.

    I am concerned, Mr. McConnell, and I don't know if I am going to present this exactly right and whether or not it is in the context of when you said you didn't believe in the firewalls. You did not feel that the firewalls should be written into law. You may want to go on and explain that a little bit. I am not sure about that. You heard my expression of deep concern about OCC's action on the Zion application and for underwriting. I am deeply concerned about any regulator's ad hoc interpretation. OK?

    In that connection, in the Zion application, I understand it was stated that Zion agreed to follow the 25 percent revenue test, but that it would notify the OCC at least 30 days in advance if they were to exceed that limit. I don't quite know what that means. Do you? Do you know exactly what that means?
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    And do you think that operating subsidies engaged in securities underwriting should adhere to the Section 20 limitations?

    Do you see the controversy that arises, multiple numbers of them, if we are going to accept that the OCC has this kind of discretion? I am concerned about that.

    Would you please comment further to the specifics that I have outlined here, as well as to any general observations you would like to make?

    Mr. MCCONNELL. I will try.

    I must begin by saying I don't know a lot about the Zion situation, other than what I have read in the paper. So, I wouldn't be a good person to respond to that.

    I fear that my testimony has—it was written in such a way that it was subject to misinterpretation with regard to firewalls.

    Mrs. ROUKEMA. All right.

    Mr. MCCONNELL. If so, I apologize for that.

    The point I would like to make is that we think that there are sufficient firewalls under Section 20, that have proven to be, or it looks like they are going to be, flexible, specifically in that instance. Because the Federal Reserve, when banks got into securities activities, was very careful in regulating them and the regulations were quite tight.
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    After it became apparent that banks knew what they were doing and were doing a responsible job there, the Fed—it looks like they are going to have more room. That as an approach, it seems to me, to be reasonable.

    Rules that are written into legislation can be very difficult to change if, in fact, experience proves that they are either unnecessary or they were wrong.

    Perhaps a point in question is that banks are prohibited from underwriting municipal revenue bonds. That was something that was done 30-some years ago; and it doesn't make any sense at all, in my judgment; and yet it is very difficult to overcome.

    What we would like to ask of you is to be careful in introducing additional firewalls, more restrictive firewalls, that may prove to be not workable. Because if they are part of the statute it is going to be very difficult to change them.

    Mrs. ROUKEMA. Well, we are closer than I thought we were on this subject, but not quite there yet.

    Mr. MCCONNELL. Right.

    Mrs. ROUKEMA. I will take that under consideration, but I have a number of problems with this approach that the OCC is taking.

    Mr. MCCONNELL. I see.
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    Mrs. ROUKEMA. Would anyone, Mr. Uhlick or anyone, like to make a short comment on the commerce question, particularly with respect to your experience with the foreign banks? I heard that—in the closing comments from the Chairman, I heard him alluding to that; but I couldn't get the sense of the presentation that was made.

    There are problems with the Japanese system that are enormous, and the Germans are rethinking the exact construction of commerce and banking, but that doesn't mean they are abandoning it, and it doesn't mean that it hasn't served them well for a number of years. Do you want to make any observations,
based on your experience?

    Mr. UHLICK. Just a few quick ones. If I could just touch upon the firewalls question first?

    Mrs. ROUKEMA. Yes.

    Mr. UHLICK. I think it is important to note that in all the experience around the world, none of the other countries have required firewalls to separate bank and securities activities. In the case of the Swiss or the Germans, there have been over 100 years of successfully conducting securities activities directly in the bank itself.

    More importantly, for the last decade-and-a-half, as American banks have conducted extensive securities activities outside of the United States—and I want to emphasize extensive—there have been no firewalls applying to the large non-U.S. branches.
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    Mrs. ROUKEMA. I am sorry I let you answer that question, because you didn't say what I wanted to hear. Sorry about that.

    Mr. UHLICK. It has to be addressed. There are no firewalls in the world, and American banks have lived without firewalls outside the United States, and I think there is great confidence they can live without them in their securities activities under Section 20.

    On the banking and commerce issue, I agree with you. There is a real variety of practices in the world. I am an American bank lawyer. When it is all said and done, if we had witnesses here from other countries, some of them would defend strenuously the workings of their systems. It is obviously a major U.S. policy issue as to how to define our system.

    All we have tried to do is provide the charts attached to my written testimony which show which countries permit their banks to have industrial investments below the bank, and which countries permit their industrial companies to invest in or control the banks. I think it is fair to say, net and net, that even though in quite a number of instances the charts indicate that there is no prohibition, there is still a sort of de facto separation that exists in most of the world. I would have to acknowledge that in terms of a fair reading of the survey.

    But we are not in a position to offer a recommendation because there is such a variety of different approaches being followed around the world.

    Mrs. ROUKEMA. Thank you. I appreciate it.
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    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Mrs. Roukema.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    First of all, I am not completely familiar with the Zion case, although I do understand that they are seeking an exemption to underwrite municipal revenue bonds. If Zion is going to exceed the 25 percent rule underwriting municipal revenue bonds, they know something about the business that nobody else does, or they are taking an excessive amount of risk that nobody else does.

    But, I think there is a difference between muni rev bonds and GO bonds, and there is risk associated with them. And I think also—before we decide to move those over, I think that is just another reason why we really must move a bill and set some ground rules.

    I did have one question. Now I have a couple of questions from the previous discussion.

    One has to do with Mr. Uhlick's comments regarding the lack of firewalls for U.S. bank security activities abroad—and I believe that is true—trading operations in London or elsewhere. But aren't those separately capitalized, almost separately chartered, subsidiaries that we set up? Obviously, they are subject to foreign bank rules and foreign securities rules, but isn't there quite a greater divide than you would have under the current operating subsidy, under the Section 5 operating subsidy? Or is it the same thing?
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    Mr. UHLICK. Well, I would make the point that in connection with international experience we are talking about branches of American banks in these major money centers and whether there is a separation of the branch there from, as you properly point out, the securities affiliate. Regarding the big securities affiliates of major American banks in London, there are no firewall separations between those affiliates and the big branches of those same American banks in London; and, frankly, there shouldn't be.

    The firewalls prevent sharing personnel, and there are significant inefficiencies in having to utilize separate personnel in dealing with corporate customers. The elimination of that firewall, which the Federal Reserve has proposed, will permit a lot more efficiency in terms of serving the financial needs of a wholesale customer.

    Mr. BENTSEN. But is there a firewall that still exists between—I don't want to pick a particular bank, but let's say Citibank, for instance, has a trading operation through Citibank Europe or whatever in London. Is there a firewall or are they subject to Section 20 rules as Citibank Europe relates to the Citibank holding company in the United States?

    Mr. UHLICK. Well, there are no firewalls for Citibank's London operations. I should point out that one of the big firewalls that is being left in the United States is basically Sections 23(A) and 23(B), which have served very well over the years. In addition, the overall supervisory authority of the bank regulators would continue to apply, as was pointed out by Mr. McConnell, which enables them to deal with supervisory concerns and to require good risk management systems.
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    But as far as the offshore operations, as I said in my testimony, most American banks are operating outside the U.S. through branches of the U.S. bank and not through a separate entity.

    Only the securities operations are separately incorporated.

    Mr. BENTSEN. And separately capitalized?

    Mr. UHLICK. Yes. Yes.

    Mr. BENTSEN. And there are firewalls between the securities operation and the parent bank?

    Mr. UHLICK. No, and it has worked quite successfully because there have been no firewalls between the offshore branches and the offshore securities affiliates.

    Mr. BENTSEN. Are they subs of the foreign bank?

    Mr. UHLICK. No, they are subs of the American bank that are not restricted in their dealings with the offshore securities affiliates.

    Mr. BENTSEN. They are subs of the American bank. So, the liability runs all the way back to the American bank?

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    Mr. UHLICK. In terms of it being a subsidiary. There often is an Edge Act investment subsidiary in between.

    Mr. BENTSEN. Mr. Sones, in your testimony, you state that you oppose the wholesale financial institutions on the basis that that would drain deposits from the bank insurance fund as more of the—I guess the largest banks—just moved out of the consumer area and became wholesale financial institutions. Is that correct?

    Mr. SONES. That is correct.

    Mr. BENTSEN. And do you—I mean, I was just talking with one of your colleagues from my home State in trying to determine the penetration of money center banks that have come into Texas and how they compete with independent banks, and they tend to be more in the wholesale sector, as opposed to the consumer sector, or even the small business sector.

    So, I mean, I still don't understand what is wrong with allowing them, if they wanted to get out of the system. You don't think the system can absorb that?

    Mr. SONES. Well, as we have more concentration, we need those funds in the capital pool of States. I am from Mississippi; and we are already a capital-poor State, as many other States are, that have a lot of rural territory. But, you know, as those large banks come into our States and compete with us under a plan that would take funds out of the local capital pool and out of our State capital pool and invest them off balance sheet, sort of, in the nature of investments, we think that hurts us a lot.
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    Also, we think, you know, there is safety in numbers as far as the FDIC fund goes; and the more banks that pull out, of course, it makes the FDIC less actuarially sound.

    Mr. BENTSEN. Mr. McConnell, I know my time is up; and if you can answer very quickly. You stated in your testimony that you would seek an authorization of merchant banking activities on an equal footing with non-bank securities firms. In 30 words or less, because the Chairman is going to shut me down, exactly what do you mean by that?

    In taking positions—and if it entails taking positions, at what level of capital, or is it at a level of revenues? How would you foresee that?

    Mr. MCCONNELL. It is almost like a level playing field kind of a question. And the language in H.R. 10 is what we mean to be supporting there.

    Mr. BENTSEN. OK. Thank you.

    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Mr. Bentsen.

    Mr. Riley.

    Mr. RILEY. Thank you, Mr. Chairman.

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    I am sorry Mr. Baker had to leave. When he was having his dialogue with Mr. Sones a minute ago about car dealers, I thought I had found a market for my car dealership. But, upon reflection, knowing that car dealership, it is probably a good idea not to mix that with banking.

    Mr. McConnell——

    Chairman LEACH. Excuse me, Mr. Riley. Do you want that stricken from the record in case some buyer might read it?

    Mr. RILEY. Thank you, Mr. Chairman.

    Mr. McConnell, back to the discussion you had with Mr. Baker, if you can—let me carry it a little farther. And when we talk about that basket, are we talking about a 25 percent basket, in your opinion, based on revenues, based on capital, based on equity? How do you envision that coming about?

    Mr. MCCONNELL. I think I can best answer it, Mr. Riley, by telling you where we would like to end up.

    The reason we believe in the limited basket approach is, and it has been alluded to, that there have already been crossovers between banking and commerce. We hope desperately that out of all of this will come the flexibility that will enable banks to compete effectively in the financial arena in the next century.

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    There will be questions, it seems to me, about what kind of activities that we might want to get into that are unforeseen today because of technological innovations and one thing or another that will come up. There will be a question: Is this indeed a financial activity, or is this a commercial activity? Someone is going to decide that. And if they decide it is a commercial activity, even though it might be very close to what we are doing, then we could be closed out of that.

    So, basically, that is sort of the bottom line of why we would like to have some flexibility.

    Our concerns that I have expressed, and others have better than I have, about no restrictions in commercial activity because of economic concentration, we have those concerns. So, we would like a limited basket, very limited. I don't know whether it is 5 percent or 15.

    Mr. RILEY. Well, that was my next question. How did we arrive at 25 percent?

    Mr. MCCONNELL. What I guess we would like to do is participate in the study of something that is rational and that overcomes what—Mr. Baker gave several examples of how this can go awry. I think we could all compose others. Although we can find fault with various suggestions, it doesn't seem to me that that we should conclude, therefore, that there is no way to do this without going either fully to banking and commerce or eliminating it altogether. And we would like to be part of the process of searching for that and doing our best effort—making our best efforts to help you.
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    Mr. RILEY. Would any other member of the panel have any comments on how that basket should be developed?

    Evidently not.

    One of the questions then, assume we pick an arbitrary number—whatever, 10, 15, 20 percent—and it is, as is normally the case with most commercial enterprises, if they are successful they tend to grow. What happens when we grow past that limit?

    Mr. MCCONNELL. I don't have an answer for you, Mr. Riley.

    Mr. SONES. A very volatile situation, you know. And is it 10 percent of revenues for this year, next year, the average of 3 years? You know, it is just—we may have a good year this year and make a million dollars, I believe one of you said, and then we may have a bad year next year and make $100,000. Do we get to keep the entity that we put in our basket, you know?

    Mr. RILEY. Well, assume you buy a car dealership that becomes—I know this is a stretch—but that becomes more profitable than the bank and it grows larger than the bank? What do you do? Do you have to divest yourself of it?

    I guess this is what makes it so complex and so hard for me to understand, is how we go in and set up these arbitrary percentages and set up all the firewalls that you want. It looks like eventually you end up with a situation that is almost uncontrollable.
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    Mr. SONES. We would say, you know, that is why we oppose it. We don't think it is manageable.

    Mr. MCCONNELL. I am obviously the one that should be defending it, but you can suggest circumstances, as you have just done, which I don't have an answer to, but I would repeat the point that if we want to reach a middle ground then that is something we have to attack. And the fact that I don't have an answer, nor indeed do I suspect that very many people do, doesn't mean we shouldn't work on it.

    Mr. RILEY. Thank you, Mr. McConnell.

    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Mr. Riley.

    Mr. Hill, do you have any further questions?

    Mr. HILL. Thank you, Mr. Chairman.

    I would just suggest, for the benefit of future freshmen, that assignment to this committee ought to come with a glossary of terms; and all witnesses ought to swear to use that glossary of terms.

    Which brings me to the subject of firewalls. It appears as though it is a widely used term that has considerable difference in meaning to the various participants in this debate.
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    When I think of firewalls, I think of restrictions to the migration of risk. When I hear others talk about firewalls, they are intended to limit activity. And so in the spirit of my definition, since I am asking the questions, I want to talk a little bit about corporate structure.

    As I have listened to the debate, it seems to me as though a holding company model makes sense to me for the purpose of being able to establish the firewalls that I have just described, to separate particularly activities that I consider high risk: insurance underwriting, securities underwriting, particularly in taking market positions, and the market making and lending.

    I guess—but several of you here have been advocates of the bank subsidiary model. In fact, I think, Mr. McConnell, you commented in your testimony that one of the reasons that the bank subsidiary model is attractive to you is because of the fact that profits flow to the bank, which, of course, eliminates the ability to accumulate capital in a risk-taking entity.

    I would ask you to address that if you would. I mean, do you agree with me that there need to be barriers for the migration of risk between certain kinds of activities or not?

    Mr. MCCONNELL. Yes, I do. I think that one thing that everybody on this panel would certainly be in agreement on is that we feel as strongly as any Member of Congress about safety and soundness. I certainly don't want to lose my bank, and nobody does, and we hope we have learned from past experience, so I think we have the same objectives.
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    We don't think that operating in the subsidiary of the bank has to involve greater risk than the subsidiary of a holding company, an affiliate of a holding company, if it is structured right and the risks are controlled.

    But, on the other hand, if it—for one bank.

    Mr. HILL. Sounds like us: on the other hand.

    Mr. MCCONNELL. Right.

    For instance, right now there are mortgage companies that are owned by banks and operated in banks. There are ones that are operating the holding company. Individual financial enterprises make those decisions based upon what they think makes best sense. We don't mean to imply that we think risks shouldn't be controlled or aren't a factor here.

    As I believe Mr. Baker said, lending represents a lot of risk. We are in a risk business, and it has to be managed.

    Mr. SONES. I would say that, first, I guess if you tied down our position we would say we agree with the Chairman, that the risk involved in the activity should dictate where it is positioned within the corporate structure.

    For instance, the insurance underwriting, we feel, carries a lot of risk. We feel like it should be separated with as big a firewall as you can put.
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    There are some other activities—none come to mind at the moment—but that we feel like are less risky and maybe could be positioned at the bank level.

    Mr. SCHOSBERG. Even with the variety of corporate structures in the savings institution community now, I think that principle is recognized. You do have the holding company regulation; and, in fact, Sections 23(A) and 23(B) under the Fed apply to the thrift holding companies. But even if you look at subsidiaries and service corporations, you still have rules for containment of activities and separate capitalization.

    You also have to look at the inherent risk/reward tradeoff. As Bill pointed out, the business of banking is not to be risk-adverse, but to properly manage the risk that is inherent in it.

    Not too long ago, a savings institution service corporation in Montana kept in business the only independent insurance agency in the area. Had that service corporation and its resources not been available, the agency assuredly would have closed down.

    So, addressing Bill's point about the need for this financial support system for local businesses, I would argue again to try to look at the experiences out there and take advantage of the proven flexibility that is consistent with our concerns about safety and soundness.

    Mr. MCCONNELL. Mr. Hill, could I add one more point?

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    I didn't respond, I guess, to your statement, if I understood it correctly, to the effect that if it were an affiliate of the bank and the profits could go to the bank, whatever that implication is, perhaps the losses, too. There will be restrictions on the capital, there will be restrictions to Sections 23(A) and 23(B) on lending, and the profits that are made in this risky venture need not go to the bank, and a prudent banker would make sure that there was enough capital there, and he would accumulate those profits.

    If it is an operating subsidiary that would be available to the bank would not necessarily mean that that is where they would go.

    Finally, it could certainly conceivably provide a diverse source of income which would give the bank more protection than every new product we have that provides for some diversity and some opportunities that really represent protection rather than risk.

    Mr. HILL. Thank you, Mr. Chairman. Thank you all.

    Chairman LEACH. Thank you. We are under some time constraint because of a vote, but I did want to raise an issue particularly because of a comment Mr. Sones raised stating that in many rural States there is a depleting access to capital, and one of the fears of the community bankers is that some of the new structures put in place might put even more competitive demands on the same capital.

    So, one of the things that I am giving a lot of consideration to in this bill is the Federal home loan bank structure and the possibility of putting new capacities to provide liquidity to the smaller banks, possibly defined as under half a billion, or maybe a billion in assets for commercial lending purposes. Do you think that would be helpful to community banks?
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    Mr. SONES. Absolutely. You know, we just came from our joint committee meetings, Mr. Chairman, where we had 350 bankers from all over the country here; and you know one of the dominant questions that we discussed was the funding problems that we all have.

    I have got a bank examination going on at home right now. I will do an exit interview tomorrow afternoon when I get home, hopefully, and actually——

    Chairman LEACH. Excuse me. I wonder if you would tell the examiners that the committee concluded that you said very conservative, very prudential things?

    Mr. SONES. That is right.

    Chairman LEACH. And do you also support a strong State examination system?

    Mr. SONES. That is right.

    Chairman LEACH. And that is on the record?

    Mr. SONES. We are a State bank and trust company, so it is a State exam.

    Chairman LEACH. Yes.

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    Mr. SONES. We do like to be able to choose our regulator, too.

    Anyway, funding is just a problem that we face. You know, we are the only independent bank left in our town. We are the lender of choice for small business. I mean, they come to see us because they can come see the president. They can get an answer right now.

    But, unfortunately, funding those loans that we can make that help build our economy is a real problem.

    Chairman LEACH. And just so we have the ABA on record as well, is this a view that you would concur in, Mr. McConnell?

    Mr. MCCONNELL. I am not sure that I understood, Mr. Chairman, just what——

    Chairman LEACH. What is under consideration, as you know, right now, the Federal home loan bank system can provide liquidity for housing loans and to slightly expand their discretion to include certain commercial lending as well and apply this discretion for midsized and smaller banks. And it is designed as a way to increase or to provide liquidity, actually, for the banking system where I have heard increasing concerns that savers today are choosing in opting for other instruments, particularly money-market-fund type instruments.

    Mr. MCCONNELL. Yes, that is true.

    Chairman LEACH. And that is the reason for this circumstance, as well as the concern that Mr. Sones has indicated that possibly there will be even further competition for the same dollar today with this kind of legislation. So, it would be a circumstance the ABA would look sympathetically to?
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    Mr. MCCONNELL. I don't—it was something I think we have not studied. We do have concerns about additional powers to Government enterprises and where that might lead us in terms of competing.

    Chairman LEACH. I appreciate you raising that point, because, as you know, I share that view.

    So, the idea of this is that this would apply exclusively to the advance side of the Federal home loan bank system. Today, the Federal home loan banks have about a third of their assets in basically Fannie and Freddie products, about a third of their assets in so-called investments, meaning lower grade securities, and then about a third in advances. It is my view that they ought to increase the advances and decrease the first two types of investments.

    Mr. MCCONNELL. The way you have described it, I think we would certainly be in support of that.

    Chairman LEACH. I appreciate the recommendation and your concerns. However, I will tell you, as a legislator, my concern is that if we put this power in the bill, then it might become piggybacked for other kinds of powers that I might be less inclined to support.

    So, I would like to make clear for the record on behalf of Mr. Sones and Mr. McConnell that they might think a little more discretion in this area is appropriate without further expanding the powers. Is that valid?
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    Mr. MCCONNELL. That is.

    Mr. SONES. That is correct.

    Chairman LEACH. Fine. Well, with the vote on the floor, let me thank all of you.

    I am sorry I didn't get to you, Mr. Uhlick. But I will tell you—and I want to stress to Paul, because I differ with him—that I think you have represented your views with great succinctness and aplomb.

    And we respect you all for coming from different perspectives, which is an understood phenomenon. So, I want to thank you all for coming and I appreciate very much your testimony.

    The hearing is adjourned.

    [Whereupon, at 2:25 p.m., the hearing was adjourned.]

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