Segment 1 Of 3     Next Hearing Segment(2)

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FINANCIAL MODERNIZATION—PART II

WEDNESDAY, MAY 21, 1997
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 Bereuter, Baker, Campbell, Lucas, Fox, Weldon, Snowbarger, Foley, LaFalce, Vento, C. Maloney of New York, Watt, and J. Maloney of Connecticut,

    Chairman LEACH. The hearing will come to order.

    Let me say, I will take a few minutes to outline some of the four considerations and then the circumstance of this hearing.

    First, as many in this room know, the House was in session until 3:30 last night, and so it is an awkward time to begin the next morning with full participation.

    Second, between 10:30 and 10:40 a.m., a Banking Committee bill of modest size will be on the floor and we will make a decision at that time whether to continue the hearing or recess for 40 minutes or so. It is a Suspension Calendar bill.
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    Third, let me just stress that this is the third of five full committee hearings on the bank modernization process that has followed from a series of subcommittee hearings that have also taken place on this issue.

    The Administration, at noon today, as has been publicly announced, will be unveiling its approach to bank modernization, and I would just like to say that I have been briefed on their approach and I consider it to be constructive that they have come forth. I will, as many might suspect, differ with some points in it, but I think it is a very positive development and that this committee is prepared, after the fifth hearing, which will be June 3 with the Treasury Secretary, to proceed on a very rapid basis with markup of bank modernization, with the goal of it being completed certainly in June, if at all possible, and preferably by mid-June.

    There are a number of subtle issues of somewhat extraordinary proportions and a number of—and at least one overwhelming issue of nonsubtle dimensions, although there can be very subtle techniques dealing with it—which are symbolized by the differences of opinion that are largely going to be expressed between two very eminent outside counsel in our first testimony this morning.

    It is my view that it is very, very important that this committee keep as much perspective as possible and recognize that legislation about the financial community affects all other sectors of the public, and that there can be very enormous ramifications to certain approaches. In the final measure, whether bank modernization legislation is going to be credibly received in the full House context, as well as be viewed as good for the economy, will depend on how several of these issues are dealt with.
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    In any regard, I just want to stress that the process will be going forward very forthrightly on a timely basis and that I expect this committee to have some very close judgment calls and the witnesses and their views today will be seriously considered.

    Mr. LaFalce.

    Well, this is unusual. We have a quorum call. But Mr. LaFalce.

    Mr. LAFALCE. Thank you very much, Mr. Chairman. I am pleased in joining you in welcoming today's witnesses.

    I am especially pleased that the views of the consumer groups will be represented here today, and their voices will add a very important element to the debate that we have been participating in.

    I believe that financial modernization will inherently be of benefit to consumers and communities. Greater competition and integration of services should result in easier access to a wide range of services at lower cost. Not all financial providers will welcome this increase in competition, but I believe consumers will.

    But the consumer interest in this legislation does not end there. Our financial system is getting increasingly complex, and because of its complexity, it can be a consumer nightmare in which the consumer's rights become unclear, risks are left unidentified, and privacy is invaded. So our legislation should help alleviate those problems, not add to them.
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    I support, and for years have fought for, the right of banks to offer a wider range of financial products. But it is also essential that sales of uninsured products by insured institutions be conducted so that consumers and investors are adequately protected. Consumers must have rights, they must know what those rights are, they must understand the nature of the product they are purchasing, they must be given complete disclosure regarding the costs and risks of their investments, and they must be fully protected from any deception or coercion in the marketing of products.

    Consumers and communities also have legitimate concerns about economic concentration and monopolization of the distribution of capital. These concerns have been reflected in their general opposition to any mixing of banking and commerce. As Ranking Member of the Small Business Committee, I think I have been particularly sensitive to those concerns.

    But there are two sides to that issue. Many of our financial services providers who now have commercial affiliates or parents have consistently delivered high-quality service to consumers and market innovators and posed no identifiable risk.

    And so I think it can be prudent to have what I think is virtually impossible to deny: Some mixture of banking and commerce. I think it does exist in the marketplace, and I think some prudential legislation should be passed to clarify the ability of our financial services providers to engage in this appropriate mixture. I do not believe we need to preclude such a mixing to alleviate concerns in this area.

    I believe the speech of Secretary Rubin today will articulate these general principles and give us some alternative approaches that we should consider during the course of markup. I look forward to today's testimony as an aid in that markup process. And, again, I thank the Chair.
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    Chairman LEACH. Thank you, Mr. LaFalce.

    Mr. Snowbarger.

    Mr. SNOWBARGER. No opening statement, Mr. Chairman.

    Chairman LEACH. We have invited, in order, Mr. Mayer and Mr. Wallison. It is unclear to me whether the case for change is perceived for the case against change. Have either of you discussed which would prefer to go first?

    Mr. MAYER. I don't care.

    Mr. WALLISON. I will go first.

    Chairman LEACH. Why don't we begin then with you, Peter, please? Mr. Wallison.

    Mr. WALLISON. Move on, as we would say.

    Chairman LEACH. Let me just explain these bills for a second. I am really perplexed, with so few Members here and such an extraordinary witness alignment. But we have apparently had a former-Member circumstance. The House is going to go into meeting at 10:30, as it works out. This is not a quorum call, as I originally thought.

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    Our bill is likely to be up at 11:00 or 11:20 or 11:30. So we can proceed directly, and I am just mortified that we have so few people. But let's proceed, Mr. Peter Wallison.

STATEMENT OF MR. PETER J. WALLISON, PARTNER, GIBSON, DUNN, AND CRUTCHER

    Mr. WALLISON. Thank you, Mr. Chairman.

    Mr. Chairman and Members of the committee, first I would like to thank the committee and staff for inviting me to join this panel. The question I would like to address today, whether the continued separation of banking and commerce continues to make sense as a policy, is as important as any in banking, as you have indicated, Mr. Chairman. And I am pleased to have the opportunity to offer my views.

    I would like to submit my prepared testimony for the record and proceed with a summarized version.

    Chairman LEACH. Without objection, your statement, as well as Mr. Mayer's, will be fully placed in the record.

    Mr. WALLISON. Thank you.

    The central point I would like to make today is that continuing a policy of separating banking and commerce will ultimately weaken the banking industry rather than protecting it, and that none of the reasons advanced by the opponents of reform is well grounded either in current banking law or in the realities of today's financial marketplace.
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    Most of the debate about this issue has focused on the dangers of combinations between large organizations and large commercial firms, and on nightmare scenarios in which banks controlled by commercial firms use their deposits to aid their affiliates.

    In reality, in this area as in others in our economy, bigness per se is not a problem. There must be some specific harm that flows from it. As I hope my testimony will demonstrate, despite all the claims and fear-mongering, there is no specific harm that can flow from combinations between banks and commercial firms, as long as the laws are observed and the financial markets remain as competitive as they are today.

    Indeed, the financial markets are crowded with lenders today. U.S. banks, foreign banks, commercial finance companies such as GE Capital, leasing companies, insurance companies, mortgage bankers, and securities firms that will place debt instruments from short-term commercial paper to long-term bonds.

    In this highly competitive market, banks are fighting for every customer they can get, and they are losing market share not only in financing large commercial firms but also in financing small business.

    As for the consumer market, anyone who gets mail can tell you that it is dog-eat-dog, with offers pouring in from banks all over the country offering credit cards, mortgage loans, home equity loans, and 57 varieties of consumer financing.

    In this market, it is impossible to say that banks have any market power—that is, the ability to grant or withhold credit on any basis other than the creditworthiness of the borrower. And unless banks have this power, they are no different from any other financial source. All the concerns about concentrations of economic power are just concentrations of scary words.
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    With this background, I would like the committee to consider three objections recently advanced by former Fed Chairman Paul Volcker in testimony before the Subcommittee on Financial Institutions:

    First, the bank with the commercial affiliate will lend preferentially to its affiliate.

    Second, the bank will not lend to competitors of its commercial affiliates.

    Third, if the bank's commercial affiliates get into trouble, the bank's resources will be marshaled to bail it out, whatever the law says.

    These seem to me to be the principal objections to combinations between banks and commercial firms, recited over and over by opponents of change as though they were self-evident. They were all repeated most recently in an article by Henry Kaufman in the business section of just this past Sunday's New York Times. The surprising thing about these assertions is that they are made by sophisticated people without any apparent awareness either of the requirements of banking law or of conditions in the marketplace which make these fears wholly unfounded.

    Before beginning to deal with these fears and objections, I would like to make a general point. If these concerns are valid, they are not limited to the situation in which a bank might be affiliated with a commercial firm. Under existing law, a bank holding company is permitted to engage through subsidiaries in a large number of activities, such as commercial leasing or mortgage banking, that compete with companies which are not affiliated with banks.
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    All the current bills before this committee will make it possible for even more businesses to be affiliated with banks. If banks can preferentially lend to these companies or effectively deny credit to the competitors of their affiliates, an unfair and anticompetitive situation already exists.

    Financial firms, such as leasing companies, mortgage banking companies, and securities firms, have the same needs for financing as so-called commercial firms. There is no difference between allowing banks to affiliate with these firms and allowing them to affiliate with so-called commercial firms. The fact that we don't hear anything about abuses in the current relationships between banks and their non-banking affiliates should tell you something about whether these nightmare scenarios—focused on combinations between banks and commercial firms—truly reflect reality.

    Turning then to one of the nightmare scenarios, a combination between Microsoft and Citibank, we should first consider the possibility that Citibank will preferentially make loans to Microsoft, transferring to Microsoft the lower cost of the funds that the bank presumably enjoys by virtue of its ability to issue a Government-insured deposit instrument.

    For purposes of this analysis, I will assume that there is a subsidy, and that banks have a lower cost of funds. I have some question about this, but that is not the thrust of my testimony. In any event, I will also leave aside the fact that this kind of financial assistance is severely limited by current law. Sections 23(A) and 23(B) of the Federal Reserve Act require all such loans to be fully collateralized; limit them in the aggregate to 20 percent of the bank's capital; and require that such loans be made on an arm's-length basis.
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    This means that Citibank cannot legally lend to Microsoft at below market rates. However, again, for purposes of analysis, we will assume that Microsoft is willing to collateralize the loan so Citibank bears no significant risk and that a way is found to charge Microsoft a lower interest rate than that charged to arm's-length borrowers from Citibank. If all this is done, what is achieved by the combined entity?

    Microsoft gets a lower rate on its loan, but Citibank receives a lower return than it would get if it lent the same funds to an unrelated borrower. The parent's profit is the bank's loss, and the net result to the parent is a wash.

    The combined entity would have done just as well by borrowing from an independent third party lender or by lending to some independent third party. Indeed, Microsoft could probably borrow from an independent bank without any collateral but would be required by law to collateralize its borrowing from Citibank.

    Well, then, let's assume that Microsoft couldn't get a loan from any other bank. Perhaps the advantage to Microsoft is that it can now get credit from its affiliate that it couldn't get elsewhere. This is difficult to imagine since the law requires that Microsoft put up adequate collateral in order to borrow from Citibank. And if it has this collateral, it can presumably borrow from anyone.

    It is important to keep in mind that in today's financial world, there are legions of banks and non-bank lenders out there willing to lend to anyone—from Microsoft to the corner shoe store—if the borrower has either the requisite financial strength or the requisite collateral. Thus, if there is some advantage to Microsoft in owning Citibank, it does not come from preferential access to Citibank's lending.
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    Perhaps, then, the advantage comes in the fact that the affiliate bank will not lend to competitors of Microsoft. By denying them credit, it gives Microsoft a major advantage. This scenario is probably the basis for claims that combinations between commercial firms and banks will create some kind of concentration of economic power. But is this credible? Is it possible to believe that Microsoft's competitors would have only one source of credit? Again, the answer, in the current market, is no.

    In the competitive commercial lending world of today, if Citibank refused to lend to a creditworthy competitor of Microsoft, some other bank or non-bank lender would be delighted to do so. Owning Citibank would give Microsoft no advantage in denying credit to its competitors, and if it should be so foolish as to try such a course, it would only make Citibank less profitable.

    These facts make clear that fear-mongering about giant financial conglomerates, or concentrations of financial and economic power, are wholly misplaced. They are based on an outdated picture—really, a New Deal perspective—concerning the importance of banks in today's competitive financial system. Perhaps at one time in the past the ability to control the bank could bring a commercial firm real financial and market clout, but today commercial credit is available everywhere and controlling a bank would probably bring only headaches.

    There is still the question of whether the resources of a subsidiary bank would be marshaled to support a failing commercial affiliate, no matter what the laws and regulations say. This, too, is a fallacious argument.
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    First, as I noted earlier, there is nothing special about a commercial affiliate that enhances the danger that the bank would be overreached to support that failing affiliate. Banks have all kinds of holding company affiliates today that are engaged in activities—leasing, securities brokerage, mortgage banking, and dealing in derivatives of various kinds—at which they can readily fail. If there is any truth to the argument that the bank's resources will be marshaled to assist such an affiliate, then it will occur whether or not the affiliate is a commercial firm.

    I know of no study which demonstrates that commercial activities are more likely to fail than financial activities, and thus there is no reason to suppose that commercial activities by any affiliate pose any greater danger to the bank than financial activities by those affiliates.

    Moreover, bank managements face simply enormous personal penalties if they should violate the law or regulations by making an illegal loan to prop up a failing affiliate. The penalty for deliberate, knowing violation of Sections 23(A) and 23(B) is a civil fine of up to $1 million a day. We are not talking about a fine paid or indemnified by the bank. We are talking about personal jeopardy for the bank officials who authorized the loan. In the face of this, is it really possible to imagine that bank managements are going to violate the law to save an affiliate?

    There is also the subtler argument that if commercial firms own banks, the safety net will have to be extended to them. The logic is this: If a commercial firm affiliated with a bank is in financial difficulty, the bank will suffer massive withdrawals. If the bank is big enough, the regulators, despite the laws that make this very difficult, will declare the bank too-big-to-fail. Then, the Government will assist the commercial firm affiliated with the bank that caused the problem in the first place.
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    You have to wonder why people reach for arguments like this in order to make the case against combinations between banks and commercial firms? First, there is the assumption that if a commercial firm is affiliated with a bank that is in financial difficulty, the bank will suffer massive withdrawals, despite the fact that the bank itself is financially sound. There is no reason whatever to suppose this.

    The thrift crisis showed that people left their money in insured institutions even when those institutions were known to be insolvent, because they knew their deposits were insured. But even if the bank were to suffer a massive run, the safety net would not be implicated unless the bank were so large that its failure would have systemic effects that can trigger a too-big-to-fail rescue.

    This means that the number of bank failures that would stress the safety net would be limited to a few of the very, very largest; certainly no more than 5 or 10. Thus, the argument that combinations between banking and commerce would inevitably stretch the safety net to non-banking firms can only be referring to a very few cases and not—as those who make this argument imply—to all cases in which commercial firms and banks are combined.

    Even if a bank large enough to be considered too-big-to-fail were threatened by the failure of a commercial affiliate, what would happen? The Government would step in with financing for the bank, not for the commercial affiliate. The Government assistance would provide the bank with liquidity—temporary loans—to replace the cash lost in the massive withdrawals we are supposing.

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    If the bank is in fact sound, the Government loses no money in this process. It satisfies those who want to withdraw their money, but the bank retains all the sound assets that made it financially strong in the first place. When the panic subsides and the market sees that despite the failure of its affiliate, the bank is sound, the depositors return and the Government gets its money back.

    Thus, the arguments advanced against affiliations between banks and commercial firms are largely without substance and should be rejected by this committee and by Congress. Like the question, ''Do you want Microsoft, IBM, or Amoco to acquire Citibank?'' Their purpose is largely to frighten and shock, but they do not stand up to analysis.

    It is significant that Chairman Greenspan, in his testimony on February 11 to the Subcommittee on Financial Institutions and Consumer Credit, did not cite any of these reasons as the basis for his position. These are arguments of the past, based on a world that no longer exists, and Chairman Greenspan's silence acknowledges as much.

    It bears repeating that we do not prohibit economic combinations principally because the result is bigness. Some specific harm must be shown. The advocates of continued separation of banking and commerce have failed to meet this test. This, in itself, should be a reason for the committee to proceed with the Baker-D'Amato proposal.

    Time and again, it has been demonstrated that unwarranted Government restrictions on private sector activity bring unpleasant real world results. The fate of the railroads in the United States is a cautionary tale, and we should not forget that both the banking industry and the thrift industry, both heavily regulated, went through a period of catastrophic failures that have never occurred in any unregulated industry.
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    This is true in large part because the firms that are subject to the dead hand of regulation are unable to respond rapidly to the changes going on around them. As a result, they are more vulnerable to weakness and failure. Accordingly, preventing banking organizations from expanding into new activities, which is the consequence of separating banking and commerce, does not strengthen or protect banks, it weakens them. Since there is no demonstrable danger from allowing banks to affiliate with commercial firms, continuing the current policy poses far more of a threat to the safety and soundness of the banking system than permitting affiliation to go forward.

    Mr. Chairman, that concludes my testimony. I would be pleased to answer any questions that the committee might have.

    Chairman LEACH. We will have several, but I think it appropriate to begin with Mr. Mayer.

    We welcome you, sir. I appreciate personally your willingness to come. As I do Mr. Wallison.

STATEMENT OF MR. MARTIN MAYER, GUEST SCHOLAR, THE BROOKINGS INSTITUTION

    Mr. MAYER. Thank you, Mr. Chairman.

    Mr. MAYER. I would like to express a tribute that is not in my testimony to the work of Congressman Castle's subcommittee on electronic money, which I think all of us who have worked in this field have found extraordinarily useful. I especially admired the intelligence of the questions asked.
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    There is a big piece of news today, which I would like to start with, which is that the British Government has taken bank supervisory authority away from the Bank of England and turned it over to the Securities and Investment Board. Thus, we are in an international environment now where, in general, as at the Bundesbank, the central bank will be responsible for monetary policy and people who are also involved with the markets and securities will be responsible for bank regulation.

    I think that we should pay very close attention to these developments as they go on, because there will be a European central bank and the European central bank will not supervise banks, it will conduct monetary policy, while national authorities, which are also involved with securities regulation, will do the bank supervision.

    I would also like to extend one thing that is in my prepared testimony, which is the reason for the privatization of the payment system. The synergies to be achieved are in the connection of electronic data interchange and electronic funds transfer. If you look at what is being done in Chicago under the auspices of the Chicago Clearing House, where you have companies like Motorola and 3M which are submitting files of receivables. The bookkeeping associated with those receivables moves with the payments through this EDIBANX group that has been formed by 15 or 20 of the largest banks. You can see the advantages we can hope to get from this technological improvement. This is not business the Fed should or can be in.

    FedWire is a very limited operation. It is a Government securities operation, as well as a funds transfer operation, but it is basically a payment system. The economies to be expected and hoped for in the future are from the involvement of corporate accounting systems with the payment system. The Fed cannot do that. The retention of payment system work by the Fed is likely to hold us down and slow us down.
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    On Mr. Wallison's points, and on the general question of banking and commerce, my feeling is that so long as there is a Federal safety net administered by banking regulators, by their own rules, mixing banking and commerce is dangerous and unwise. The kind of people who run banks are not going to be very good at running some of these other things.

    Indeed, one of the major promoters of the mixture of banking and commerce said to me the other day that he was for it, in part because it wouldn't matter, that it is only in the techno areas that you really have a synergy, and that you would probably want to encourage that language. These other things wouldn't happen because there are no synergies, and banks can't run it and the other guys can't run banks, they are different activities.

    That strikes me as an insufficient argument, because the fact that people don't do things well tends not to stop them from trying.

    The Fed demands entity regulation because bank regulators must supervise everything that touches on the payment system. The failure of a nonfinancial enterprise owned by a bank or a bank holding company would also endanger the confidence that depositors and lenders must feel when they provide funds to a bank. Thus, the bank would turn itself inside out to support a failing subsidiary and would do so with the support of the banking regulators, for the bankruptcy of a bank-owned company would surely spook some part of the community of funders.

    We would find, indeed, that in a crisis the banking regulators would eventually demand to supervise the nonfinancial as well as the financial subsidiaries of a bank or bank holding company. The breaches in the firewalls that always occur in a crisis—remember Continental Illinois and First Options, would quickly make the bank regulators interfere in the operations of non-bank affiliates.
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    We have a number of examples from recent years, both here and abroad. The Banque de France got very closely involved with the nonfinancial businesses of Credit Lyonnais, and indeed, got involved in the sale of MGM Studios. The Banco de Espaná was plagued with the problems relating to the department store holdings of Banesto.

    If you could get the regulators who were at Citibank in 1990/1991 to talk to you about what they were doing, you would find that they were, in fact, taking charge of the sale of the Citicorp subsidiaries that had to be sold, because Citicorp needed cash so badly at that point in the game.

    If you talk to the people who worked with American Savings and Loan in Stockton, California, during the S&L crisis, you will find that the Federal Home Loan Bank Board took over pretty complete control of all of their operations, some of which were not financial operations, in the hope of keeping this thing afloat. It was going to go down if the stock market hadn't collapsed in 1987 and bond prices hadn't gone up.

    Or, we have the sad story of Charlie Keating. One notes, as the mark of Cain on the current proposals by the Comptroller, the fact that one of the first applications by a bank seeking to go into a non-banking business was for authorization to enter the field of real estate development, where the business cycle closely tracks the business cycle of banking, implying an intensification, rather than a diversification of risks.

    The committee can also look back at Bank of the United States in San Diego and its involvement with the Westgate Properties there. There is a whole long history of these things where these guys get in trouble and where the Government then bails them out.
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    When First Republic of Texas was failing, L. William Seidman sent its chairman a letter to be published, announcing that the FDIC would pay back everybody who put money into First Republic, whether the form in which that money was received was a deposit or any form of loan.

    Mr. Wallison refers to deposit insurance. Deposit insurance is the least of the safety net. Sixteen percent of the liabilities of the U.S. banking system today is in demand deposits, which is presumably what we are trying to protect in the system; 84 percent is borrowed elsewhere. That is where the safety net now is. That is why the banking regulators fear what Mr. Sprague called a ''wire run'' in his book about his experiences at the FDIC. That is why the examiners were at Citibank, not because Citibank couldn't get insured deposits—of course, it could, but because most of its liabilities were in the form of borrowings out in the market, and the market was fleeing, because these liabilities were not insured, they were not guaranteed by the Government. They can't be guaranteed by the Government.

    It is, in part, because I think the Fed should be the regulators of the holding company that I believe the mix of banking and commerce should be prevented; in addition, and it is very important to me, that the securities company and the holding company must be separated out for regulatory purposes and ruled by SEC.

    If the Fed believes that the failure of a securities affiliate could cause systemic trouble in the banking system, then a tightening of the Glass-Steagall controls should be the recommendation, not their elimination. I don't believe that. I don't believe the Fed does either. I think the Fed is grabbing turf. But this is part of the argument, that anything that touches on the payment system, the Fed must have the ultimate control.
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    Securities companies do fail and must be allowed to fail. A week ago, I testified with former SEC Chairman Richard Breeden, before your colleague Mr. Oxley, and he told the story of Drexel Burnham. He consulted the Fed before exercising his authority to close down the brokerage house, and the Fed urged him to forbear. Drexel was indebted to the Government of Portugal. How would the markets react to the failure of a debtor to the Government of Portugal? Mr. Breeden said he told the Fed he thought the markets would giggle.

    Now, the truth of this matter is a little more complicated, because hard work had to be done to make sure that the Drexel failure made ripples rather than waves, but because Mr. Breeden's agency understood markets, he knew he could close Drexel without significant systemic risk.

    Bankers, college professors, and bank regulators do not understand risk very well. The Fed is simply risk-averse when it deals with banks, and it always will be. Paul Volcker strongly resisted closing Penn Square. But markets require risk-taking. Markets need regulation, rules that all the players must follow, not supervision, which, by definition, is at least partly individual and arbitrary.

    The Fed supervises. Indeed, the Fed has never been much good at supervising the markets with which it is now closely involved, the Government bond markets. Look at the Salomon Brothers scandal, Drysdale Securities, Lombard-Wall, Gibson Greeting Cards, Procter & Gamble, Daiwa Bank. There is reason to believe that the Joe Jett-Kidder Peabody matter got as messy as it got because the Fed, knowing that Kidder had misreported its Treasury strip and mortgage tranche positions, permitted an enormous and continuing buildup of the miscategorized holdings.
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    On the other hand, when bank regulators look at the market activities of banks, they tend to be too tolerant, because they assume that the banks know what they are doing. Indeed, banks that must submit all their loans, however complicated, to examiner scrutiny are permitted to value their own derivatives positions without hindrance on the grounds that they know better than the examiners.

    With the approval of the Fed, the Bank of England handled the Barings matter, which really did present serious systemic risk, as though it were simply the failure of a medium-sized bank. The banking regulators, both in England and here, did not understand that the failure of Barings' derivatives subsidiary might, and almost did, provoke a failure at the Singapore Commodities Exchange Clearinghouse, which is joined at the hip with the Chicago Merc.

    Thank God, it was Mary Schapiro at the Commodities Futures Trading Commission, and not the Fed that had the regulation of the Commodities Division of Merrill Lynch. When I look at the Fed's regulation of the Government bonds market and contemplate extension of its activities to the securities and commodities markets, I feel as William Schwenk Gilbert felt about the House of Lords, that ''Noble fingers should not itch to interfere in matters which they do not understand.''

    More seriously, there is a real culture clash here which the Congress ignores at great peril to the financial sector and the economy at large. Banks are run, to a large extent, in secret, and banking regulators enforce secrecy. Examiner reports are so secret that a bank acquiring another bank and performing a due diligence that requires a look into every nook and cranny of the institution to be acquired, is theoretically forbidden to see its examination report.
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    I am authoritatively informed by counsel to banks acquiring other banks that this law is honored in the breach, like some other bank regulatory rules—supervision, as noted, is individual and arbitrary—but it is the law. Secrecy is required, the banking regulators say, to maintain confidence in the payment system.

    Markets, by contrast, are public information systems, and the thrust of our securities laws is disclosure and transparency. Not the least of my fears in the extension of banking regulators' authority over securities houses, is that they would sabotage in the securities markets as they have sabotaged at the banks, the work of the Financial Accounting Standards Board, which draws its authority from the Securities and Exchange Commission and sets the rules of generally-accepted accounting principles that are the bedrock of all securities valuation in this country.

    The major source of the authority of banking regulators over banks today is their power to value the assets. Alan Greenspan has been the most consistent warrior against the mark-to-market ethos of the securities markets. In the derivatives context, the Fed has actually approved procedures by which banks can price their derivatives position without the intention, or even the willingness, to do business at the prices they assert for accounting or regulatory purposes.

    The Chairman's recent suggestion of a regulator-approved form for expressing a bank's gross derivatives exposure is clearly prompted by the need to counter the SEC's already announced and much more revealing disclosure standards for such instruments. The securities markets activities of financial institutions must continue to be regulated by the SEC.
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    As Chairman Greenspan's recent speech to the Chicago Bank Structure Conference indicates, the Fed is interested only in the profitability and stability of the banks and the banking system. It is the need of the regulator to see all the aspects of the holding company, not the need for the public and the markets to receive and evaluate information, that drives the Chairman's analysis. Quote: ''Regulation,'' he argued, ''must fit the architecture of what is being regulated.''

    But, in a world where the capital markets dominate the credit markets, to steal Dennis Weatherstone's admirable phrase, that architecture cannot be dictated by bank regulators. Indeed, if there was to be a single dominant regulator of the financial services holding company, we would be better off with the SEC as the final arbiter for the bank holding company, and we must leave open a path to get there, though for the time being the bank regulators must retain ultimate control of the bank.

    I say for the time being, because within the next few years, real time gross settlement processes will take care of the banking end of systemic risk. The European central bank is coming, and with it comes the Target system to provide Real Time Gross Settlement for Europe. The Japanese are on the same track, and the Swiss are already there.

    Real Time Gross Settlement means that nobody will be able actually to enter a payment into the system until he has the money, and it is the credit to the payee, not the debit to the payor, that moves through the system.

    Thus, credit risk can arise only when the payor must borrow to make his payment, a process clearly to be managed in the private sector with the central bank present and alert as a potential lender of last resort. The present New York clearinghouse CHIPS system, with its limits on exposure and its collateralization rules, can be adapted by the smart people who run it to operate as a continuous flow. EDIBANX at the Chicago clearinghouse settles every morning by 9:00, but by its nature it is a continuous flow operation.
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    The most important implication of Real Time Gross Settlement is that it will complete the process of severing the payment system from the lending system, which is the most important development in modern banking, with which I must note, H.R. 10 makes no contact at all, and I imagine that the Treasury proposal will make no contact at all.

    These improvements to the payment system and, equally important, the expansion of the electronic data interchange component of payments processes, will require privatization. Experts tell me that there are only 35 banks in this country today that can handle electronic data interchange, and the obvious reason for this disaster is that the Fed is fat and happy with its own systems and does not wish to encourage its member banks to enter any activity not invented at the Fed.

    The most likely scenario for the future is that the content providers—the First Datas and the FiServs and the EDS's, will take over the business and use the banks as their marketing facility. This process has gone much farther than most people realize. First Data, with 40,000 employees, has issued something like 100 million credit cards, nearly all of which have the name of a bank on them somewhere. Its activities in the payments area generated last year a revenue stream approaching $6 billion.

    Last I looked, EDS owned something like 13,000 ATM machines, nearly all of them with bank logos on them; did the complete nightly accounting for a couple of thousand banks; and had a revenue stream of about $2 billion a year from banking services.

    The banks and their regulators have left something like 15 million Americans without bank accounts, and the Treasury and the Defense Department are now mandated by law to make all of their payments by electronic funds transfer beginning January 1, 1999. That legislation—and it is imperative not only for budgetary reasons that it be retained intact in this Congress—will work immense and beneficial changes in our banking system. H.R. 10 doesn't know it exists.
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    To the extent that technology reduces systemic risk through Realtime Gross Settlement, the safety net can be diminished. Deposit insurance for ordinary people must, of course, be retained, but beyond that, nothing. The safety net can once again become, as intended, a support for people, not for banks and their regulators.

    If systemic risk worries are reduced, bank secrecy can be reduced. A dozen years have passed since Bill Isaac, on his way out as FDIC chairman, suggested to this committee that examiners' reports should be published. As ever-increasing fractions of bank portfolios are in the form of securitized, rather than directly-administered loans, the privacy aspect of bank secrecy has therefore declined in importance.

    Certainly, accounting standards at financial services institutions should be standardized. To say that a securitized loan has one value at a bank and another at a brokerage house, which is where we stand today, is not an intelligent way to regulate financial services. The accounting problem is far and away the most urgent.

    Recent studies for the International Accounting Standards Committee had proposed that accounting for financial instruments should be at fair value, whether those instruments are part of a bank portfolio or part of a security firm's portfolio. Quote, ''Understandability and comparability must suffer,'' the study argues, ''if measures of reported financial position and income are the result of adding together numbers that are determined on different bases, or that have little relationship, or an unclear relationship to accepted economic realities of value and risk.''

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    House Resolution 10 permits American bank regulators to continue their idiosyncratic accounting rules, making it far more difficult for a market to judge whether a given bank is a suitable investment or depository. Indeed, the banking regulators hope to keep for themselves, as much as possible, judgments on whether banks are acceptably managed. At a time when the capital markets are so much stronger than the credit markets, this King Canute approach to the future of financial services is improper and dangerous.

    Having reduced systemic risk and the safety net and having improved accounting procedures, we can invite true market discipline into the financial services industry. At that point, we can approach more rationally the juncture of different financial services activities into a single entity and, indeed, the mixture of financial and nonfinancial activities.

    In any event, financial services modernization should be seen in the context of changing technology and institutional response, not in the context of whose ox is gored today, who will oppose it if he doesn't get this goody, who can be tempted to support it if he does get that goody, which regulator is to occupy which turf.

    The recent Telecom legislation and its results—higher prices to consumers, no service improvements, declining stock prices for the companies involved despite the bull market everywhere else, should stand as a warning to those trying to write banking legislation that can be blessed by the lobbyists.

    Thank you.

    Chairman LEACH. Well, I appreciate both of your testimony, particularly your last warning. It sounds very Eisenhowerish. Maybe we ought to put this in the portals of these doors, that any legislation that is blessed by the lobbyists, da, da, da, da, da, da.
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    First, let me turn to Mr. Wallison, who made a very strong assertion that there is no demonstrable danger of mixing commerce and banking. That is a very powerful statement, Peter. I am not so sure it doesn't defy history.

    Now, it is consistent. You have long been an advocate, in your role at the White House in the Reagan years, of direct investment guidelines. As you know, I was somewhat on the other side of those battles. Direct investments are exactly mixing commerce and banking.

    Most observers of the S&L debacle—these are really hard things to estimate—say that cost between 5 and 15 percent of the total S&L costs, which ranged to $140 billion in current dollars, two-and-a-half-times that. With interest 5 percent of that, it is a nice hunk of change to advance a philosophical theory that didn't work.

    The examples around the world, I mean, Mr. Mayer and others have pointed out one bank in France, Credit Lyonnais, cost the government $14 billion. Banesto, the keiretsu system in Japan, and the German system, do not seem to be working.

    I relate less to your arguments about whether a commercial firm can own a bank than I do, coming back a little bit to the nature of bankers and entrepreneurs, some of Mr. Mayer's argumentation that there aren't many demonstrable examples of bankers being good entrepreneurs and vice versa.

    Now, GE, to me, stands out as an exception. I think one can say GE has been pretty good at a little bit of both, but there are very few examples. In fact, the world appears to be, as we look at the fast changing nature of things, rewarding decentralist rather than centralist.
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    One of the problems of the model of mixing commerce and banking is, in my view, that investment banks have really developed an enormous capacity to overleverage and to purchase. You combine that with new capacities through the banking system to get cheaper money, you could really see some consolidations occur that could be rather gigantic for no particular reason. There is, to my knowledge—and the GAO has reported this in a survey of all the literature of the area—no demonstrable economic benefit of mixing commerce and banking.

    I think Mr. Mayer has some interesting observations on regulation, but he also—I mean, nowhere has anyone come and said, ''Here is a demonstrable economic advantage to the economy at large.''

    Now, in terms of downsides, you do have a public safety net; you do have at least the last generation of experience with centralization versus decentralization. There are just very few GE examples that have worked, although there are a couple. And the question is: Why do it?

    And what is the public case for Citicorp to merge with GM and Wal-Mart? What is the public case for the local bank to own the corner grocery store and the car dealership? Is there a public case?

    Sir?

    Mr. WALLISON. Mr. Chairman, I certainly don't want to avoid the first part of your question, but in my prepared testimony I noted that I was talking about cases in which commercial firms would acquire banks, or bank holding companies would acquire commercial firms, not the direct investment case that you cited to me.
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    I think, however, that there is a strong argument for the direct investment case that the Comptroller has made, where you impose the kinds of legal restrictions that exist in the case of a bank holding company acquiring a commercial firm, and that is the imposition of the restrictions of Sections 23(A) and 23(B), which limit the ability of a bank to finance its commercial affiliates.

    But passing beyond that, and also the foreign examples which I don't think really are applicable to the United States for a variety of reasons, one is the much greater competition we have in our market, and second is the legal system we have here, which does place many more restrictions on the activities of banks in relation to their affiliates.

    The keiretsu system in Japan is a whole different story. The Japanese banks are in trouble because they lent, not because they were associated with commercial firms. And the lending, by and large, was not to their commercial affiliates, which got them into trouble. It was in a real estate bubble market, which has really caused them the difficulties they are in today.

    But, I would like to turn to the third part of your question, which I think really is a significant issue for this committee to consider when they are looking at the issue of banking and commerce, and that is, why do it? All these risks have been raised; all this dust has been thrown up. There are all kinds of problems.

    Now, first, in the testimony that I just delivered, I suggested that the problems really weren't there, and I don't think they are. And in general, we don't have to demonstrate in our economy why something is not going to be a problem when we permit people to undertake all kinds of combinations in our markets. We would permit any company in any industry to acquire any company in any other industry, unless the problem can be demonstrated arising out of that combination.
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    One of the advantages of our market is that we permit managements to make these judgments; we don't legislate about these judgments. So the question would be, why not let it happen, unless you can point to some specific problems? And the essence of the testimony I tried to give today, was that there are no specific problems that anyone can point to.

    What, however, are the advantages? I do think there is an advantage, quite apart from all the other—the absence of a disadvantage, there are significant advantages. One of those advantages is something I think this committee ought to consider. We know that the banking system, right now, although profitable today, is under stress from time to time. We also know that banks are losing market share in relation to all other financing sources.

    Eventually, the banking industry is going to have to downsize. How is it going to downsize? Is it going to downsize in an orderly way; that is, through banks repurchasing the—using their capital to repurchase the shares that they have outstanding? Or are they going to compete themselves into a position in which they are all failing?

    I think there is a significant possibility that the latter will happen. Well, why is that? That is because managements generally do not like to give up the capital they have already accumulated. They want to continue to ride it, to use it, to hopefully earn yields on it.

    In the case we are talking about here, banking managements, in the form of bank holding companies, can use the capital that they have accumulated in the bank, which is no longer earning as much as would be hoped in a market in which banks are being squeezed by other competitors, use it for other kinds of activities. We don't know what those activities might be; they could be financial activities; they could be commercial activities; but they would be the kinds of activities that the managements of these organizations think would bring profit to the organization.
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    That permits capital to be drawn out of the banking business and into all kinds of other activities in our economy, healthier for the banking business, because that capital would otherwise be yielding much less, and eventually would be lost in a highly competitive economy in which banks are losing market share, and much healthier for our economy as a whole because it will make available to the economy a lot of capital that is not being efficiently used.

    So, there is an affirmative reason for allowing bank managements, in the form of bank holding company managements, to make acquisitions of firms that are not in the banking business, or even in the financial business. Let them make that choice.

    Chairman LEACH. Excuse me. I am just being updated on some things. We do have a bill on the floor that is going to commence in a few minutes. Let me turn though to, I guess, Mr. Watt as the Ranking Democrat.

    Mr. WATT. Thank you. I think I was here after these gentlemen, if you are going in the order that people arrived, Mr. Chairman, but I am happy to go. If you are going in the order that people arrived, I think I arrived after both Mr. Bereuter and Mr. Baker, but I will be happy to go if you are honoring the other side.

    Chairman LEACH. We try to do it in order, but we also try to go in order for parties present. You are the distinguished senior Democrat represented here.

    Mr. WATT. It is not often that I have the opportunity to take advantage of that, so maybe I should go ahead and do it while I can.
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    Mr. Wallison, I apologize for missing your testimony, and for some reason I don't even have a summary of it, so I can't deal with you very much.

    I do want to come back to you, though, on the last point you made, but I want to start with Mr. Mayer.

    Is it Mayer?

    Mr. MAYER. Mayer.

    Mr. WATT. Mayer.

    We have had an interesting debate over several hearings between the Comptroller of the Currency, Mr. Ludwig, and Mr. Greenspan; one taking the position that this Federal safety net has no value, the subsidy is not worth anything to banks; the other one taking the position that it has substantial value.

    I take it from your testimony that you come down on the side of Mr. Greenspan, who believes that the Federal safety net has substantial value to banks?

    Mr. MAYER. That is correct.

    Mr. WATT. And I take it from your testimony that over time, the way this processing takes place, the value of that subsidy will become less and less?
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    Did I understand that, or am I overstating what you said?

    Mr. MAYER. You are overstating it. I think that if we proceed along the course I think we should proceed along, that it would become less, but since we are not going to do that, I think it is——

    Mr. WATT. Well, I am assuming that we would proceed without mixing banking and commerce at this point. Assume that that is the case. Over time——

    Mr. MAYER. The value of the subsidy relates to the operation of the bank and how the bank is funded and the Fed's concerns about the safety net. The more you have a safety net, the more you worry about systemic risk, the greater the value of the subsidy to the bank, which will be enforced by the banking regulator.

    Mr. WATT. OK. But some part of the value, I take it, is this processing capacity, which I thought you were saying, over time, electronic and computer capacities will basically erase.

    Mr. MAYER. Not unless we design it that way.

    Mr. WATT. OK. If that were designed that way, how much of the——

    Mr. MAYER. Then the value of the subsidy would be much less, and I would be much less concerned about the market being able to value questions, such as Mr. Wallison's questions, about whether there should be mergers of banking institutions and nonfinancial institutions.
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    I am most concerned about it now, because I think that the Federal safety net is continuously involved. And if you compare a bank to General Electric Capital, which was being done, and you visit any bank and you visit GE Capital, boy, you are seeing two different institutions. One of them has a Federal subsidy and the other doesn't, and you can see it from the moment you walk in the door.

    Mr. WATT. Assuming that we didn't do anything on this legislation, do you see, over time—you seem to be suggesting in your testimony that over time, computer technology, and the system, is going to make that subsidy less anyway.

    Mr. MAYER. Sure.

    Mr. WATT. OK. Over what time do you think it would take to get all the banks to that position?

    Mr. MAYER. It depends on whether they are encouraged or discouraged, in part, by the regulators. I would say that we are talking about a 5- to 10-year time horizon here to get to Real Time Gross Settlement, and it should be closer to 5. And that will indeed diminish the value of the subsidy.

    But, the important question in my testimony, I hope, is the question of transparency. I am perfectly happy to have market judgments in these matters, but, we don't have them now, because we have different accounting standards for banks and other institutions, and because the Fed protects its ability to value the assets in the banks.
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    If you don't have comparable numbers, the market cannot make the decisions that Mr. Wallison assumes the market will make. We don't have them now.

    Mr. WATT. Let me, before my red light comes on and I have to relinquish my status as the most senior Member over here—let me enjoy it while I can. Mr. Wallison, quickly, you said the way our system should work is that we should not be looking for an excuse not to do something, we should be looking for an excuse to have the Government intervene.

    But if, in fact, there is a value to this subsidy, we have already intervened as a Government and we are providing something of value. How does that play into your equation? Or, do you not accept—are you on the Greenspan side of this value of subsidy, or the Ludwig side of this value of subsidy?

    Mr. WALLISON. I am agnostic on the subsidy.

    Let me say this, though, that there is an awful lot of evidence that there is no subsidy of significance.

    First of all, I am a member of the Shadow Financial Regulatory Committee, which is made up of a number of financial economists and financial professors and that sort of thing, and a lawyer. And we have looked at this subsidy question.

    The conclusion of that committee, which was announced early in May, was that if there is a subsidy, it is so small as to be competitively insignificant.
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    Mr. WATT. But, if you concluded otherwise, I mean, if you concluded there was some value to the subsidy, would that change your analysis of——

    Mr. WALLISON. No.

    Mr. WATT. You would still say the market ought to be able to do whatever it wants to do, rather than—shouldn't we just then get out of the business and quit subsidizing anybody?

    Mr. WALLISON. Our laws are structured on the assumption that there is a subsidy, so that the laws that I referred to in my testimony, Sections 23(A) and 23(B) of the Federal Reserve Act, restrict the ability of a bank, which presumably has a subsidy, to transfer that subsidy to its commercial or its financial affiliates.

    So, I can accept the——

    Mr. WATT. Well, it does now, but I am not sure what it does after we get through tinkering with the law.

    Mr. WALLISON. If you are tinkering with Sections 23(A) and 23(B), then all bets are off. But I don't imagine you are going to be doing that. If you don't, then I think there is protection for that subsidy, if it exists. It will remain in the banks, where Congress wanted it to be.

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    Mr. WATT. Mr. Chairman, I enjoyed this status immensely, and I appreciate all my colleagues for not showing up.

    Chairman LEACH. Well, I am always impressed with shadow committees. I always considered myself a charter member of the shadow of the Federal Reserve and Football Coaches Committee, and with great gravity I would express my opinions on Sundays and Mondays.

    Mr. Bereuter.

    Mr. BEREUTER. Thank you, Mr. Chairman.

    I would say to the witnesses, your testimony has been intellectually challenging and stimulating.

    I would like to turn to Mr. Mayer for my time. I was hoping, as I flipped to the last page, that there would be a summary, a prescription.

    Mr. MAYER. No.

    Mr. BEREUTER. As we look at the subject of modernizing our financial institutions, I would like to know, in your best golden words, what we should do, or avoid doing?

    Mr. MAYER. I think that we have to diminish systemic risk. One of my problems with the shadow regulatory committee is, they don't believe there is systemic risk. If you don't believe there is systemic risk, you also don't believe there is much subsidy. And I think there is. And I think that the first thing we have to do is to take whatever steps we can to diminish that and that this leads us to Real Time Gross Settlement as a procedure. And you can look at what is being done in Europe, to a lesser extent in Japan, and you can see the steps that can be taken to take it—to move you in that direction.
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    Once you have diminished the need for the safety net, once you have diminished the systemic risk in the banking system, there will still be systemic risk in the securities and commodities markets, but once you have diminished it substantially in the banking system, then you can look at a great reduction of government intervention generally, because the reason for government intervention in the banking history is systemic risk.

    Once you have diminished that, you can cut back on the deposit insurance, you can certainly eliminate all of these ways in which we now tell the market it is safe to lend money to a bank, to buy a bank's CDs, to do repurchase agreements with a bank, to buy and sell Federal funds if you are another bank. All of these are things that we have said to people, ''Don't worry about supplying money to a bank, the Federal Government will pay you back if the bank can't.''

    Once we eliminate that safety net, then you put banks on a level with other enterprises in their competition for money in the market, and you also will require the banks at that point to present their accounts in ways that the market considers much more trustworthy. Then I am happy to see market discipline, and if the market believes that there are synergies to be achieved by a noncommercial entity and a bank, you are getting the two together. I can think of very few situations where the market would believe that, but then it will happen.

    The problem right now is that because of the safety net, because of the accounting conventions that are dictated by the safety net, because of the essential opacity of the banks, because of bank secrecy situations, and because of the Government safety net, you have an institution which can make a direct investment by creating money, because the Government has given the bank authority to do that.
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    The depositors' money is still the depositors' money, and the bank uses it to make a direct investment. You cannot, so long as you are guaranteeing the depositors' money, so long as you are a Federal safety net, you cannot avoid this imbalance, this avoidance of market discipline, which presumably is what we are trying to get.

    Once we have done that, I would relax a lot of these laws. I wouldn't even worry too much about Sections 23(A) and 23(B). It would be a holding company like any other holding company. But right now, the banks are indeed special, as Jerry Corrigan said, for awhile to come, and it would be dangerous to allow that to bleed off, particularly since my instinct in looking at all of these guys is that the opacity—people don't want to keep honest accounts anyway. That is the basic problem in Japan, nobody knows what the hell is going on. And if you give them excuses not to keep honest accounts, which is what you wind up with when you have a bank at the head of a holding company, I think we have a very dangerous situation.

    Mr. BEREUTER. Thank you.

    Mr. Wallison, if I could ask you one question, and it relates to the subject of industrial espionage. Some argue that the mixing of banking and commerce could lead to industrial espionage.

    Take your example. You are talking about the mergers of Microsoft and Citibank. Citibank lends to a new computer firm, which has an innovative product not offered by Microsoft. Citibank officials see potential and inform Microsoft of not only the product but how the company is going to produce, market, and sell their product.
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    Is that a major problem? If it is a major problem, how do we effectively police that kind of collusion or avoid that kind of collusion?

    Mr. WALLISON. I don't see it as a major problem, because I don't see that it is limited to banks in any way. There are all kinds of financial firms, General Electric Capital, for example, that lend money to small computer firms or large computer firms and in doing so conduct a due diligence review in which they will learn everything there is to learn about how that company does business. They can then pass that information on to anyone else.

    I don't see any reason why we would single out banks as being particularly vulnerable to that kind of problem or why that problem should be treated as a reason for denying banks the opportunity to do what everyone else can do.

    Mr. BEREUTER. They may not be particularly vulnerable. There may be a situation that evolves already in the structure we have. But the fact that we have that problem today, do we want to avoid accentuating the problem by bringing in another part of our financial structure and permitting them to influence industrial espionage?

    Mr. WALLISON. Well, I think if we deny to banks the opportunity to do what everyone else is able to do because of some concern about industrial espionage, which doesn't exist—I have never heard of it existing in any other area of our economy, we are making a big mistake; we are allowing the tail to wag the dog.

    Mr. MAYER. May I make a brief comment on that?
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    Mr. BEREUTER. Yes.

    Mr. MAYER. What we are dealing with here is a history of relationships in the banking industry and the deterioration of that situation. And while you have relationships, you have obligations, new obligations, which include maintaining secrets.

    Once you go from relationships to transactions, you begin to see some erosion of that fiduciary sense. And now we are moving from transactions to products. And when you have got products, you have got none of that. So that there is a problem not just at banks but there is a problem throughout the society of what the duties of one businessman are to another.

    And this has been one of the good things about banks historically, is that they have felt that they have had obligations and relationships with their borrowers and their funds providers. When you turn it into just another business, it is like when you turn law firms into just another business, it is not good for the country.

    Mr. BEREUTER. Thank you.

    Chairman LEACH. Thank you very much.

    Mr. Baker.

    Mr. BAKER. Thank you, Mr. Chairman.

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    Good morning. Mr. Mayer, if I am understanding properly, your position is that any breach of the veil between commerce and traditional banking activities is ill-advised given the current subsidy and regulatory constraints?

    Mr. MAYER. Yes.

    Mr. BAKER. In that light, are not equity investments currently made permissible by the Fed by banks to hold up to 25 percent interest with only 5 percent voting, wouldn't that violate that principle, and is that ill-advised?

    Mr. MAYER. We have got a hodgepodge now.

    Mr. BAKER. No question.

    Mr. MAYER. And how you make the hodgepodge work, different people can have different judgments on. It has been interesting to me that the Section 20 subsidiaries of the banks have all chosen to be regulated by the SEC. They didn't have to be. Bank of America, for a little while, as I understand it, wasn't. But they weren't credible in the market without it.

    I think that, so long as we have the information out there where people can see it, and I think in this area we do, though I am not 100 percent sure of that, I am less concerned than anything that is done under a veil of bank secrecy.

    Mr. BAKER. Let me explore that point. That is very interesting. So if you were to suggest—which you are not this morning; this is my suggestion—if you were to review a proposal that followed some guidelines the Fed now makes permissible, up to 24.9 percent equity investment under the disclosures currently required, that is not as troublesome to you from an operational perspective as a true commerce and finance relationship?
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    Mr. MAYER. It isn't, and what the Comptroller suggests troubles me a great deal more.

    Incidentally, I would like you guys to beat the Comptroller over the head about lifeline banking while you are at it, because that is not what we are really talking about.

    Mr. BAKER. I am sure it will go on a list somewhere. Thank you.

    Mr. MAYER. Fine. If we are going to have to make all of our payments to people by electronic funds transfer and the States want to experiment with ways to do that, the Comptroller should not use his authority to exempt national banks from following State law in that area.

    I am worried about the Comptroller generally. I am worried about a lot of what has come out of that office, but I think that in general he has much too much confidence in the ability of the institutions he supervises and of the people—and the diminished cadre, by the way, of people—that are supervising them to really find out what is going on.

    Mr. BAKER. Let me return to another area of somewhat discontinuity in the market, and that is what started most of this discussion, at least from what I understand the Administration's concerns were to be with regard to the merger of the bank and thrift charters.

    Given your view, I suggest that you probably would rather see the thrifts charter down, in common terminology, as opposed to allowing the banks to charter up. And depending on the charter which the thrifts may hold, they are engaged in a number of commercial enterprises. How would you deal with that issue?
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    Mr. MAYER. Unified thrift charter bothers me a lot less. As a matter of fact, I think it is a reasonable safety valve.

    Mr. BAKER. Now you are talking.

    Mr. MAYER. It gives people like First Data and ADP and Merrill Lynch an opportunity to acquire an end point in the payment system, thanks to the Rocky Mountain case of 17- or 18-years ago.

    If I ran a bank, I would probably hate credit unions and I would hate the unified thrift charter too, but I don't own a bank, and from a purely public perspective, since thrifts do not create money the way banks do, since thrifts are indeed limited in commercial operation—in lending operations, I do not see a need right now to tamper with the unified thrift charter.

    I do not think that the dangers that I would perceive in the bank area really apply to the same degree to that. I can imagine situations where it might. Right now, I think it is a useful safety valve.

    Mr. BAKER. My conclusion then from your comments, which have been very helpful, that there are mechanisms that perhaps would, in a technical sense, allow the veil of commerce and finance to be breached, as opposed to the wholesale proposal, perhaps what some called the wild Baker-D'Amato approach, that could be acceptable in the marketplace without untoward or undue risk?
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    Mr. MAYER. Sunshine is the correct disinfectant for most of these things.

    Mr. BAKER. One other point, and I also understood that your concern was focused on one other aspect, and that is the deposit insurance system.

    Mr. MAYER. Yes.

    Mr. BAKER. You would view more kindly a proposal that allowed diversification without constraint if there weren't concurrently the multiple accounts now being insured by a bank for a single depositor, either $100,000 per account or no insurance at all?

    Mr. MAYER. That is part of it; plus a statement by the banking regulators that they would not bail out nondepositors—I mean, plus a statement by the regulators, cross their heart, hope to die, we really mean it, that they have accepted FDICIA. My observation is that they have not accepted FDICIA.

    Mr. BAKER. Thank you. You have been most helpful.

    Just one other request, Mr. Chairman. I wanted to explore Mr. Mayer's thoughts, but I do have that statement of the Shadow Financial Regulatory Committee of May 5, 1997, and would like to submit it, as well as a statement by Charles Calomiris of May 1997, with regard to the issue of the commerce and finance question, with the caveat, ''the Shadow knows,'' for the record.
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    Thank you, sir.

    Chairman LEACH. If the gentleman would lead with the caveat, of course, without objection, they are submitted for the record.

    Mr. BAKER. Thank you.

    Chairman LEACH. Dr. Weldon.

    Dr. WELDON. I don't have any questions at this time, Mr. Chairman.

    Chairman LEACH. Thank you.

    Mr. Foley.

    Mr. FOLEY. Thank you very much.

    Just a few questions as I try and wade through this new committee that I have been fortunate to be seated on. Just finishing the housing bill, it is fun to get right into another controversial aspect.

    I guess a concern I would have is just from the business perspective. You know, years ago when certain banks had affiliates like credit life companies, if you were going to get a loan on an automobile, they kind of encouraged you to buy the credit life from their affiliate. We provided here one-stop shopping. It necessarily wasn't implied, but, you know, it was mentioned that, you know, the loan would go a lot better if you happen to buy credit life.
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    You know, we are talking about having affiliated companies. What is to prevent us, in a global system, if you have a huge corporate entity, a bank, that happens to own another company—now, there may not be any direct loans to prop up the company, but if I am a huge international bank and I have big clients, and I may suggest to one of my big borrowers that, listen, I need some help over here in one of my affiliate companies and I would like you to buy some debentures, some capital acquisition or what-have-you, in my little affiliate company, since I can't necessarily do the direct from my balance sheet to theirs, and, you know, we will certainly be able to help you on your acquisition financing or extension of credit if you can possibly see your way to do business with this company that we—I mean, what are the firewalls to prevent those kind of steerings, if you will, of business transactions within that global banking network?

    Mr. Wallison first.

    Mr. WALLISON. I think the ultimate firewall is competition. There was perhaps a time in the past when a bank could say to a customer, ''You know, I will lend you this money if you do something else for me.'' That is market power.

    In today's world however, banks don't have that option anymore, if they ever had it. There are too many other lenders. If a bank were to say to a borrower, ''I will lend you this money if you do something else that is going to cost you something.'' The borrower is going to say, ''I am sorry, I can go to another bank where that request will not be made of me,'' and the bank will lose that business.

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    There is a cost to every one of these requests. And when the bank asks someone to do something for it, it is imposing another cost, and the borrower is going to be sensitive to that cost and go somewhere else in a competitive market.

    So, a lot, I think, of the fears about combinations between banking and commerce arise, I believe, out of what I called in my testimony a ''New Deal'' mentality. That is, a harking back to the time when the banks used to be very important and people applied to a bank for a loan and they waited with anxiety until the bank gave them the loan. That is no longer the case.

    Banks are fighting tooth and nail for the opportunity to make loans, and if you get mail every day, you know that that is true. And if you are a commercial borrower, you know that you are getting visits from banks and leasing companies and mortgage companies and insurance companies and everyone else to offer you loans. There is plenty of money around.

    So when a bank makes that kind of request of a potential borrower, they are risking the loss of that customer, and it won't happen, not in today's competitive market.

    Mr. FOLEY. Sometimes you are at a point, though, where you are kind of hanging by a thread and need that loan so you are willing to make any deal in order to further the credit extension. And I am suggesting that certainly my concern is, when you have a board of directors, you have a number of board members sitting there, it becomes a club, if you will, and everybody is making deals within their own organizations to continue to stimulate their own opportunities, and then the shareholders or the depositors and ultimately the Federal taxpayers may have to come to the rescue.
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    I noticed in your statement you said you would only be bailing out the commercial bank, not the affiliate. But, again, if all the money is run out of the bank and you are now calling on the FDIC to come to the aid of the primary bank, the damage is already done.

    So I guess I just want some assurances, as we head down this path, that we are not going into an area where there are going to be unusual powers to extend pressure on the free market system to say, by the way, since we hold $50 million of credit extension to you, or $100 million, there is also an issue I need to resolve and there is some stock that I need to sell, and if you could help me with that, we could certainly—and I know that, you know, again, this is all conjecture.

    But I served on a bank board, I served on a savings and loan board. A lot of things get done in a board meeting that you question afterwards saying, how did we ever get this loan? I mean, why did they pass 1,000 banks to get to this? I am in Florida and I am lending to a property in Alabama? How did this happen? You find out, well, they were paying bonuses for loan production, not on safety and soundness. It was giving a person a point on bringing a loan in the door.

    So we are throwing money out to capture loans that were probably destined to fail from the beginning, but we were rewarding on the wrong incentive, not on safety and soundness but on production. And everybody was saying, look at our volume, look at our numbers. Well, we were heading over the cliff.

    So I guess when we are looking at now the global reach of banks, that is where I just get a little bit concerned we are going too fast in trying to maintain, you know, the independence that currently exists in law.
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    Mr. Mayer, if he has a comment.

    Mr. MAYER. I just wanted to say that I think Mr. Wallison is greatly exaggerating the quality and quantity of information available and that your problem is handled, once again, best by transparency. You know, if the Internet tells you what everybody is charging, then maybe you can have better competition.

    Chairman LEACH. I didn't mean to cut you off. Here is our circumstance: Our bill came up a minute ago on the House floor. Unless Mr. Campbell had a question, I was going to propose that we recess at this time.

    Then what I would propose is that we recess. First, excuse this panel. I think you have been very helpful and inconsistent in your views toward some of the Chairman's positions, but nonetheless thoughtful, and your appearance is extremely appreciated.

    The hearing will be in recess pending this particular issue, which is likely to be 30 to 45 minutes on the House floor, and then we will convene the second panel.

    [Recess.]

    Chairman LEACH. The hearing will reconvene.

    Our next panel is convinced it is—is convincing, yes—but it consists of Allen Fishbein, who is the General Counsel for the Center for Community Change; John Taylor, President and CEO of the National Community Reinvestment Coalition; and Mary Griffin, who is Insurance Counsel for the Consumers Union.
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    We had invited Ralph Nader, who couldn't come; but he has submitted testimony. Without objection, it will appear in the record following the testimony of the three of you.

    I am prepared to go in any order you may wish. It will go as I have introduced you, unless you have prearranged something else. If not, then we will just begin with Mr. Fishbein.

STATEMENT OF MR. ALLEN J. FISHBEIN, GENERAL COUNSEL, CENTER FOR COMMUNITY CHANGE

    Mr. FISHBEIN. OK. Thank you, Mr. Chairman; and I appreciate the opportunity to testify here today.

    My name is Allen Fishbein. I am General Counsel of the Center for Community Change, and I am here to present our views on financial modernization and on H.R. 10 and other legislative proposals before the committee.

    In my written testimony, I focus on the implications of further bank deregulation legislation for modest income consumers and communities and also speak to why strengthened community reinvestment and consumer protections are needed to address the problems that are emerging from the changing banking environment.

    My organization is a nearly 30-year-old not-for-profit organization that was established to assist community-based organizations serving the needs of low- and moderate-income communities.
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    For some time now, deregulation, new technologies and increased competition, both domestically and from abroad, have been reshaping the banking and financial services industries. Judicial rulings and regulatory agency interpretations of existing law have further eroded the legal walls that bar banks, securities firms and insurance companies from poaching in each others' business. As a result, this committee is contemplating passing sweeping legislation to allow broad affiliations between financial institutions and perhaps permit cross-ownership of banks and commercial and industrial firms.

    Should this occur, in the near future we can expect to see a far different banking system than we have now, one with fewer and larger financial conglomerates operating nationwide and offering a bewildering array of financial services.

    While further bank deregulation will have enormous consequences for most Americans, all too often the discussion on these topics is dominated by narrow turf issues and various financial industry wish-lists. But to paraphrase former French Premier Clemenceau's comment about war and generals, ''Banking is much too serious a matter to be entrusted to the bankers'' or, for that matter, the Wall Street brokerage houses.

    The debate over the need for financial modernization and whether further deregulation is desirable need not be strained solely through a narrow funnel. It can also provide an opportunity for a broader discussion about the type of financial system most American families want and need. The bank restructuring that is occurring also presents an opportunity to determine the types of obligations and public responsibilities that should apply to all financial institutions to better address the needs of underserved communities and businesses.
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    Industry proponents of the need for a repeal of the Glass-Steagall Act and other long-standing protections in this area claim it would promote greater competition between financial service providers and thereby benefit consumers in the form of better and cheaper products. However, from the standpoint of most consumers and small businesses, the case for making sweeping legislative changes at this time is less than compelling.

    The banking industry has never been stronger, and it is enjoying record earnings, and we see no evidence that Americans are clamoring for fewer and larger banks or for the emergence of financial supermarkets.

    Authorizing broader affiliations between banks and other financial institutions or, worse still, allowing combinations between banks and commercial firms, will mean unprecedented concentration for our banking and financial markets. Yet, there is no evidence that consumers have benefited from the concentration that has occurred thus far as a result of the merger frenzy that is gripping the banking industry.

    Moreover, there are also indications that small businesses, small farms, modest income communities, may find themselves subject to less access and a higher costs for financial services as banks become bigger and bigger.

    Thus the question that should be before Congress is whether repeal of long-standing statutory prohibitions against financial concentration serves the broad public interest, not just the interests of a handful of large financial giants. In any event, such expansion of powers will not necessarily benefit the residents of underserved urban and rural communities and households unless community reinvestment safeguards are strengthened and consumer protections are put into place to protect against existing and likely abuses.
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    In particular, and we set out in our testimony in detail, we believe the Community Reinvestment Act must be upgraded and adapted to this changing banking environment. The law has proven to be a tremendously effective tool for stimulating lending and capital investments to low- and moderate-income communities, but it must be allowed to keep pace with the changes that are occurring within banking and the broader financial services industry.

    In my written testimony, I discuss three specific areas in which CRA-related concerns need to be addressed. First, we believe financial modernization should do no harm to the existing CRA statute; second, the need to upgrade CRA to cover non-bank lending affiliates of parent companies that own banks; and, third, extend CRA to all financial institutions receiving some form of Federal benefits, either directly or indirectly.

    Finally, regarding the specific questions that you posed in your invitation letter, Mr. Chairman: First, we strongly are opposed to legislative proposals that would permit common ownership of banks and commercial firms. Such alliances would create powerful conglomerates that would dominate the Nation's economy, undermine the independence of banks as impartial arbiters of credit and pose a dangerous risk to the deposit insurance fund and, ultimately, to the American taxpayer.

    The so-called basket and other approaches that would open the door are equally unacceptable because they would permit immediate significant bank ownership of commercial firms and would begin a slide toward massive commercial firm bank ownership.

    Second, should Congress vote to repeal the Glass-Steagall curbs on affiliations, we believe there will be a continuing need for an umbrella supervisor to oversee the totality of the financial services holding companies, in addition to particular functional regulators.
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    And, third, we favor the maintenance of current restrictions on financing of affiliates by commercial banks and other kinds of self-dealing that have long been part of bank regulation. But, at the same time, it needs to be emphasized that permitting bank commercial firm affiliations would greatly expand the universe of credit transactions that would have to be monitored by banking regulators in order to prevent credit extensions on preferential terms.

    In his testimony last week before this committee, former Chairman Volcker of the Fed said. ''It is an illusion to think firewalls can themselves meet the need.'' We agree.

    Consequently, if bank commercial firm affiliations are to be permitted, the issue of supervising loans to customers and suppliers of affiliates would have to be addressed in a far more comprehensive fashion than is being proposed by the bills before this committee.

    This concludes my oral testimony, and I would be glad to answer any questions you have. Thank you.

    Chairman LEACH. Well, thank you very much for those very thoughtful observations.

    Mr. Taylor.

STATEMENT OF MR. JOHN E. TAYLOR, PRESIDENT AND CEO, NATIONAL COMMUNITY REINVESTMENT COALITION

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    Mr. TAYLOR. Thank you, Mr. Chairman, Congressman Campbell and other Members of the committee who are here in spirit. I do appreciate the opportunity to appear before this committee and also to not have the 5-minute rule imposed on us as we normally have; but I will try to keep my remarks, nonetheless, brief.

    I bring you greetings from the National Community Reinvestment Coalition and also from Shelley Sheehy of the Iowa Coalition for Housing and Homelessness and a constituent of yours in Iowa. I promised her that I would make sure she was in the record, and I guess she is now.

    Let me say that I do request that our written testimony be entered into the record.

    Chairman LEACH. Without objection, the testimonies will be admitted fully in the record; and proceed at your own pace.

    Mr. TAYLOR. I have also included with our written testimony a copy of an article authored by Mark Pinsky and Valerie Threlfall of the National Association of Community Development Loan Funds, and I submitted that with my written testimony. I would like to have that entered as well.

    Chairman LEACH. Without objection.

    Mr. TAYLOR. Mr. Chairman, since its passage in 1977, the Community Reinvestment Act has leveraged over $160 billion in reinvestment dollars for home loans, small business development and economic revitalization programs in minority and low-income neighborhoods across the country. Financial modernization legislation such as H.R. 10 has the potential to either intensify the gains in community reinvestment or to wipe them out.
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    CRA, as you know, only applies to depository institutions. Yet nondepository institutions like securities companies and insurance companies control more than 70 percent of the assets in this country.

    The danger posed by financial modernization legislation is that non-bank financial companies would be allowed to affiliate with banks without any obligation to comply with community reinvestment requirements. Under this scenario, much of the capital devoted to banking activities regulated by CRA could be diverted to non-banking financial affiliates exempt from CRA.

    The amount of reinvestment dollars flowing to minority and low-income communities would plummet. Our Nation's traditionally underserved communities would suffer a new round of disinvestment that could inflict more devastation on disadvantaged neighborhoods than red-lining practices decades ago.

    I might add, Mr. Chairman, that just about a week ago a study was released from the Center for National Policy and the Local Initiative Support Corporation, entitled ''Life in the Communities.'' I don't have that with me, but I will send it to the committee. It begins to document some of the positive side of CRA and what we are beginning to see in several major cities in the United States, where neighborhoods, traditionally underserved neighborhoods, high concentrations of working poor and minorities, are beginning to turn around and are showing signs of life and promise; and it would be a shame for withdrawal and less of a commitment under CRA to turn around what has been some good work.

    Instead of a looming threat, financial modernization could be a rare opportunity to achieve democratization of wealth and credit. For this to happen, CRA must be extended to all financial institutions such as mortgage companies, credit unions and insurance companies allowed to affiliate with banks. The lending and checking services offered by these companies would then become more accessible to low-income and moderate-income communities.
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    In addition, millions of low-income Americans could have access to mutual funds, pension funds and other forms of equity which will not only increase their wealth but the wealth in the communities in which they reside.

    Providing opportunities for wealth accumulation is the secret to this Nation's prosperity and the unparalleled prosperity of its financial industry. What could be a better rationale for extending CRA?

    Financial modernization legislation will intensify the pace of mergers and acquisitions in the financial industry. Banks, insurance companies and mutual funds will be eager to enter into the broader affiliations sanctioned by H.R. 10 and other financial modernization legislation.

    While mergers and acquisitions may increase the profitability of financial institutions, a number of studies sponsored by the Federal Reserve banks conclude that mergers decrease CRA lending, particularly for small business lending. In order to protect the progress achieved in community reinvestment, CRA enforcement must be more rigorous. All financial institutions must be required to pass CRA criteria when they submit applications to Federal regulators seeking permission to change their services or merge with another financial institution. As proposed, H.R. 10 would exempt some financial institutions from CRA criteria when they submit applications.

    In addition, H.R. 10 creates a safe harbor whereby financial institutions with satisfactory and outstanding CRA ratings would automatically pass CRA criteria of any application process. After considering safe harbors for 10 years, a bipartisan Congressional Majority has rejected them because of their unreliability. NCRC supports the operating subsidy structure as the preferred option for organizing financial institutions.
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    Since CRA currently applies to banks, the assets of these operating subsidies would be considered part of the total assets available to the banks to engage in CRA activities. Moreover, since banks directly control and own operating subsidies, NCRC and the general public will have expectations that their operating subsidies will engage in CRA-like activities.

    While NCRC endorses the operating subsidy structure, our endorsement should not be construed as supporting any particular bank application to acquire or establish an operating subsidy. In fact, NCRC member organizations will be closely monitoring the OCC's bank application process in order to determine whether the banks and the OCC recognize their responsibilities to attach CRA obligations to the creation of operating subsidies, including those that sell or underwrite securities.

    NCRC opposes the authorization of wholesale financial institutions and investment bank holding companies. Under H.R. 10, these institutions would be exempt from CRA. In addition, if wholesale financial institutions are authorized, no firewalls would be strong enough to prevent bank holding companies or financial services holding companies from shifting insured deposits to closely held financial institutions. This would lessen the deposit base available to the FDIC fund, and this could threaten the reliability and soundness of the fund.

    NCRC opposes all proposed combinations of bank and nonfinancial commercial firms. Removing the separation between banking and commerce has led to spectacular bank failures abroad and will not increase the overall efficiency of the economy. In fact, it is likely to retard technological innovations since the small business sector in this country will find it difficult to compete against bank-owned small business operations.
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    Moreover, allowing affiliations of financial and nonfinancial corporations would thwart the objectives of CRA by impeding the growth of the small business sector in low- and moderate-income neighborhoods.

    Since many of the impacts of the financial modernization on community investment are unknown, it is incumbent upon policymakers to commission regular studies of the CRA-related impacts of major structural changes in the financial industry. If the level of CRA activities declines in the wake of financial modernization, the annual study mandated by Congress would recommend legislation and regulatory changes to reverse this downward trend.

    NCRC believes that primary oversight of the activities of securities affiliates' financial service holding companies should be vested with the Securities and Exchange Commission instead of Federal banking agencies. While functional regulation will remain necessary, NCRC believes that an umbrella regulatory agency must have responsibilities to monitor the activities of entire financial institutions. Only an umbrella regulator can ensure that capital flows are not motivated out of a desire to evade CRA obligations by shifting capital from CRA-covered affiliates into those that are not covered.

    I have a few more comments about consumer matters, but I am going to defer to my colleague from Consumers Union. And, like Mr. Fishbein, I will stay around for any questions if there are any.

    Thank you very much.

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    Chairman LEACH. Well, thank you very much, Mr. Taylor.

    Well, Mary, please proceed.

STATEMENT OF MS. MARY GRIFFIN, INSURANCE COUNSEL, CONSUMERS UNION

    Ms. GRIFFIN. Thank you. My name is Mary Griffin, and I am Insurance Counsel for the Washington, DC., office of Consumers Union. Thank you very much, Mr. Chairman, for the opportunity to testify today on H.R. 10 and financial modernization.

    We support financial modernization if it promotes competition, provides a regulatory structure that ensures safety and soundness and protects consumers as they make their way in an expanded and increasingly complex marketplace. We understand the desires of the various industries to expand their financial services powers, but it must not be at the expense of consumers.

    Consumers have already experienced problems with banks selling insurance, annuities, mutual funds and stocks; and with bank profits soaring from increasing bank failures many wonder whether bank involvement will promote competition or just provide an opportunity to squeeze more out of consumer pocketbooks.

    Consumers have cause for concern. Take, for example, a woman in California who thought she was purchasing a guaranteed investment when she invested $60,000 with her bank. She found out that she invested in a bond fund only after she lost $8,000 on it. A senior in Michigan was luckier. She thought she had bought a CD, but her son-in-law quickly informed her that it was an annuity and she was able to rescind the transaction in time.
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    On the track record of banks in the area of credit insurance, it shows more concern with increasing profits from commissions of the sales of rip-off insurance than with promoting a competitive market. If consumers are to benefit from financial modernization, consumer protection laws must be modernized.

    I would like to point to four areas of protection that are needed to help ensure financial modernization benefits, rather than harms, consumers.

    First, there should be full functional regulation to ensure consumer protection laws apply regardless of whether a consumer purchases a product from a bank, an insurance agent or a registered broker.

    While H.R. 10 includes some functional regulation, it falls short. For example, it does not fully do away with the exemption of banks from the definition of broker-dealer. Although it provides a regulatory scheme for investment products sold by banks comparable to investor protection rules under the SEC, which we support, it does not provide a right to recourse for consumers.

    In the area of insurance, the bill provides for State regulation of the manner in which insurance is sold but essentially exempts annuities from most State regulation.

    In addition to functional regulation, consumers need Federal minimum standards specifically related to sales by banks. Study after study indicates that consumers do not understand that products sold in banks are not FDIC insured and that banks push risky and inappropriate products on consumers. Additional measures are needed to prevent confusion.
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    While the bill provides some disclosure requirements, additional measures are needed to prevent confusion. Also, any legislation should include anti-coercion rules that allow sales of non-banking products only after the decision on the loan application has been made.

    With regard to privacy, banks should be permitted to share or disclose information only if the consumer has provided prior written consent. And, most importantly, any legislation should give consumers an enforcement mechanism so they can recover directly from the wrongdoer for violations of these rules.

    The third component involves a clarification that State consumer protection laws apply to bank activities unless they are inconsistent with Federal laws.

    There are various preemption provisions in H.R. 10 that are troublesome for us. For example, while no State should be able to prevent banks from exercising their insurance powers, we are extremely concerned that the ''significantly interferes with'' language is overly broad, allowing too much discretion to pre-empt a State's insurance laws.

    As you know, we are also extremely concerned about maintaining the ability of States to apply and enforce their laws on out-of-State banks branching in from other States.

    House Resolution 10 contains language similar to H.R. 1306 which we oppose because it would undermine the ability of States to enforce consumer protection and other laws on their out-of-state banks. We urge the committee to preserve State rights to ensure States can protect their citizens.
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    Finally, modernization should not add risk to taxpayers. While activities such as insurance and securities underwriting present risk to Federally-insured depository institutions, we believe it would be minimized through the separately-capitalized affiliate approach. While H.R. 10 provides such an approach, it permits securities underwriting in operating subsidiaries, an approach we believe is more risky.

    Permitting financial firms to affiliate represents an enormous and risky change in the market. To broaden the scope of financial modernization to permit financial firms to merge with any kind of business could create disastrous effects for our economy and increase the risk for American taxpayers. We believe the potential overconcentration of economic power, possible skewing of credit markets and general safety and soundness concerns are all reasons not to break the long-standing barrier between banking and commerce.

    We look forward to working with the committee to ensure that consumer protection laws are modernized in this process.

    Thank you very much.

    Chairman LEACH. Well, I thank you all.

    Let me ask a couple of questions. I am not sure I have this right, but I think there is consensus of the three of you that there is a lack of desirability of merging commerce and banking. Is that valid?

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    Mr. FISHBEIN. Yes.

    Ms. GRIFFIN. Yes.

    Mr. TAYLOR. Yes.

    Chairman LEACH. Is it also the case that you see some merit in breaking Glass-Steagall itself between commercial and investment banking? Is that valid or invalid?

    Mr. Fishbein.

    Mr. FISHBEIN. Speaking for myself, we would be the first to recognize that changes have occurred in the marketplace; but we think the regulatory decisions by the Fed and the Comptroller really provide a laboratory, and I would say a very large laboratory, to experiment with how these changes are likely to play out and whether they will be in the broader public interest or whether additional protections are needed.

    Our view is that legislation to further those changes is not needed at this time until there is a body of experience that has emerged about the success of what the two regulatory bodies have done.

    Chairman LEACH. Mr. Taylor.

    Mr. TAYLOR. As in my comments, I think those that allow to affiliate with banks, as long as there is some CRA obligation—I mean, our major concern is that if credit, whatever the vehicle is, that credit be made available to traditionally underserved populations, those, you know, that have been through the red-lining experience, neighborhoods, communities.
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    Chairman LEACH. Let me ask you, one of the precepts under consideration is the possible creation of a WFI. It is in some of the models but not all the models. If CRA would be applied to WFIs, would that cause you to be supportive?

    Mr. TAYLOR. Well, I would say it would be more supportive than not, without it. But because—let me say this, Mr. Chairman. Because we are a coalition of organizations, that question has not been presented to our membership. The question that has been presented is, do we want to have these at all, these WFIs? And I think our membership is expecting that question, but we haven't seen any proposal to that effect, so we haven't put it to them. So I couldn't, on behalf of our membership, speak to that directly.

    Chairman LEACH. How about you, Ms. Griffin?

    First, my impression has been your organization has not been totally unsympathetic to moving toward merging investment and commercial banking. Is that valid?

    Ms. GRIFFIN. I think our position would be it is already happening to a large extent in the market and with the regulators, so we believe that legislation to create a structure for that to happen is needed.

    Chairman LEACH. OK. Fair enough.

    Mr. Fishbein quoted Clemenceau or—excuse me—paraphrased Clemenceau, that ''Banking is too serious to be entrusted to bankers.'' I am not taking off on the war and generals. I think the better quote would be, ''Entrepreneurial activity is too serious a business to be the principal concern of bankers.''
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    But sometimes we get quotes from foreigners who we think are all wise, but Clemenceau was the European leader that probably did more than anyone to see that the League of Nations failed, to insist on large post-World War I German reparations to see that Europe wasn't stabilized. So as wonderful a term as he has developed, let's be careful about the source.

    Mr. FISHBEIN. That is why you have to be careful, Mr. Chairman, with using quotations that people who have studied history will play back at you.

    Chairman LEACH. That is right. Well, I am more worried about those that quote what I say accurately.

    In any regard, I think all of you raised major concerns.

    I personally think the big consumer issue, to use that term—because it is a hard term to define—''consumer,'' is less on the issue of change in the so-called consumer protections provisions of various banking laws, but whether or not we move toward a conglomerated society, which I believe mixing commerce and banking would potentially lead toward. So I think truly the big consumer issue is the issue of merging commerce and banking. Is that valid, Ms. Griffin?

    Ms. GRIFFIN. I would say that it is a large consumer issue, and obviously one that we are concerned about as well. I guess we also see a variety of other issues as very important. With consumer protections, we are particularly concerned because the marketplace is already happening in the absence of these protections.
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    But, yes, obviously the banking and commerce issue is a very large issue for consumers and what can happen down the line when possible monopolization is allowed in the market and other effects from doing that.

    Chairman LEACH. Would you agree with that, Mr. Taylor?

    Mr. TAYLOR. Well, when we did reach out to our membership and solicit their opinions on this matter, one of the things that kept coming back was they are maintaining—and perhaps they have been influenced by local bankers or whatever, but they are maintaining that in order to keep the branch, particularly in working class neighborhoods, what they have been hearing from the branch managers and bank managers in those branches is the need for them to be able to offer different products and services. And that struck us as probably valid, that although—but the products and services ought to stick with financially related products and services, so insurance and that sort of thing.

    And if that is what is going to help maintain full-service branches in working poor neighborhoods, we support that. Therefore, you know, you are asking a much broader question.

    Chairman LEACH. Yes.

    Mr. TAYLOR. I understand that; one that I still have to say that I can't answer because, as a trade association, we really do ask the members and solicit their views and so on, and that is as far as I can go on that.
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    Chairman LEACH. Well, I appreciate that. It is a very unusual trade association that you represent, and I would just say that the work that I am familiar with of your organization is very impressive and has produced some very substantial results around the country, including in my State of Iowa.

    Mr. TAYLOR. Thank you, sir.

    Chairman LEACH. Is there anything any of you want to—if you were to say what is the single most important thing you are concerned about here—I mean, sometimes when you give testimony for 5 minutes one misses the big issue. Is there any single point you would like to make, Mr. Fishbein?

    Mr. FISHBEIN. Mr. Chairman, to address the question you posed before, because that is the point that I would like to make before the committee. The issue for us is concentration, whether it happens through cross-affiliations between banks and commercial firms in the general economy or whether it happens just within the financial services industry. The issue is whether concentration is beneficial for the majority of Americans, particularly for those Americans that have not been well-served with the existing banking structure; and our view is that the case still has not been made as to whether concentration will work better than the system we have now.

    In fact, the evidence seems to suggest that as financial institutions get larger, they sever their links or tend to pull away from local communities, charge higher fees to consumers, have a tendency to want to make larger loans that are more standardized and do not necessarily work in every community they operate.
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    Now, I guess you would say to the extent that they shun local communities perhaps other, smaller institutions will rise up and try to fill that void; but I think the experience has been in banking that that doesn't work equally well in every community; and there will be pockets within these communities that will not be served and not necessarily have their services addressed through niche banks or through banks that open in the suburbs and not in the inner city. So we would hope the committee would be very careful about these considerations when undoubtedly these changes are going to hasten a much more concentrated banking system than we have ever seen before.

    Chairman LEACH. Thank you.

    Mr. Taylor.

    Mr. TAYLOR. Yes. A fellow by the name of E.F. Schumaker wrote a book called, ''Small is Beautiful.'' I think if Congress wrote that book, it would be titled, ''Bigger is Better.'' I am not sure either one is actually preferable.

    But, I do think Allen has made some points, and I am not going to repeat what he said, because I think he said it well. But, we are concerned about the notion that bigger institutions and the facilitating of that, and, obviously, the Interstate Banking and Branching Bill, which takes effect in July, is going to continue to facilitate that happening. We are concerned about its impact on neighborhoods, and particularly traditionally underserved neighborhoods.

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    So, my only point, within this other effort, is to address a desire that is going to impact an industry now that has had the 5 most profitable years in its history. To make sure that the gains that we have had, and the gains that we should have and continue to have under community reinvestment, are not maintained, but they are strengthened, so that all Americans are going to be able to participate in the capitalist system and become stakeholders and contribute to our society. That is what this is all about.

    I want to make sure that nothing that happens on the bank modernization, or any other piece of legislation, impedes that progress that we have been making.

    Chairman LEACH. I think that is very reasonable. Let me say, I am personally very open, if we have WFIs, to consider placing CRA on it.

    Ms. Griffin.

    Ms. GRIFFIN. I will answer that question broadly and then specifically.

    Broadly, I say that from our perspective, keeping the eye on the consumer interests and the effects of modernization on consumers, at the same time as making sure that the various industries are taken care of, in terms of what they need to operate, is essential in this process.

    More specifically, because other people are focusing on different areas, and we are focusing on the area of consumer protections for retail sales. I would say specifically, that is the most important for us. To make sure those protections are included.
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    Chairman LEACH. Well, thank you.

    Ms. GRIFFIN. Thank you.

    Mr. TAYLOR. Thank you.

    Chairman LEACH. There being no further questions, let me thank you all; and your testimony is much appreciated.

    The hearing is adjourned.

    [Whereupon, at 1:15 p.m., the hearing was adjourned.]


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