Page 1       TOP OF DOC


U.S. House of Representatives,
Committee on Banking and Financial Services,
Subcommittee on Financial Institutions and Consumer Credit,
Washington, DC.

    The subcommittee met, pursuant to call, at 10:35 a.m. in room 2128, Rayburn House Office Building, Hon. Marge Roukema, [chairwoman of the subcommittee], presiding.

    Present: Chairwoman Roukema; Representatives C. Maloney of New York, Sherman, LaFalce, Moore, Watt, Inslee, Metcalf, Ryun of Kansas, Riley, and Weldon.

    Chairwoman ROUKEMA. If the panel and the guests will wait with us, we have two open questions. One, of course, I want to wait until Mr. LaFalce arrives, but, second, we are anticipating a journal vote, so if you'll wait patiently we'll find out whether or not they are actually going to have that journal vote or postpone it, so we ask for your patience and understanding.

    Thank you.


 Page 2       PREV PAGE       TOP OF DOC
    Chairwoman ROUKEMA. We will be taking our journal vote, and we will be returning as soon as possible. I believe it is only one vote, so we should be back here shortly. Thank you very much.


    Chairwoman ROUKEMA. I thank you for your patience and your understanding. We are able now to get underway with this very important hearing for the Subcommittee on Financial Institutions and Consumer Credit.

    I call the hearing to order.

    Let me begin by reminding all of our witnesses that their written statements will be included in full in the official record. That will be automatic.

    The subcommittee operates under the five-minute rule, and I would, therefore, ask the witnesses to keep their oral presentations up to five minutes. You recognize the Chairman will use her discretion as necessary, but we are most anxious to hear from you, but in consideration of the three panels that we have today, we would appreciate your cooperation.

    I think you've all had some experience at this, so you know how we are able to accommodate to each other.

    Members of the subcommittee are also, of course, entitled to submit questions in writing to the witnesses. The hearing record will remain open for two weeks for receipt of the additional submissions.
 Page 3       PREV PAGE       TOP OF DOC

    I do want to go out of order here today for a moment, at least, to observe the fact that our Ranking Member, Mr. Vento, is not here with us today. I believe many know—or if you don't, you should know—Mr. Vento has undergone recent surgery at the Mayo Clinic. He is doing very well. I am informed on a daily basis. I think it is the third or fourth day after the operation. The operation was Monday. He is doing quite well.

    As someone said, he is a trooper and his spirits are high. We all know that, don't we, Mr. LaFalce and Members of this subcommittee? His spirits are high and he has been in communication with various Members and certainly with his staff. Our best wishes and Godspeed are with him.

    I appreciate the fact that the staff is following up on all the material, as always, at his direction. He is keeping completely current on all of these issues and we are working cooperatively together.

    Now let me take a few minutes of my own to introduce the hearing.

    Many people around believe that passage of the Gramm-Leach-Bliley Act last year means that there will be no more banking reforms or initiatives that could possibly remain. I acknowledge that this was historic, landmark legislation. No question about that. But it is a misperception, in my opinion, and certainly short-sighted to think that there are not a number of extremely important issues that should be reviewed, and this hearing is initiating at least one of them.

 Page 4       PREV PAGE       TOP OF DOC
    Among those issues, as I've said, we need to look at merging the deposit insurance funds and whether or not we give attendant attention to consolidating regulators and unifying holding company regulation are related questions. But, in any case, today's hearings will initiate the issue that we will examine first, namely, merging the deposit insurance funds.

    In addition to the fund merger, I have also asked today's witnesses to address the advisability—namely, the pros and cons of establishing an upper cap on a merged fund, as well as paying rebates to the banks and the thrifts.

    These are issues that are related to the question of merging the insurance funds, but they are related, and they are currently, frankly, being debated within the financial community. So I think it is appropriate, in recognition of the reality of that—not that I believe that we necessarily should move quickly ahead, but it is important for us to understand the interrelationship of these three issues.

    Both Chairman Leach and Senator Gramm have signaled an interest certainly in merging the deposit insurance funds. For this reason I want everyone to know that it is certainly my intention to introduce legislation for the purpose of merging the funds as soon as is feasible. We'll know better what form this legislation shall take after today's hearing.

    The Federal Deposit Insurance Corporation administers, as we all know, two deposit insurance funds, the BIF and the SAIF, and these two funds provide the insurance for deposits in banks as well as thrifts.

    The financial history of these institutions is interesting, and as recently as the 1980's, indeed, right into the early 1990's, the two funds were extremely weak. We know that history.
 Page 5       PREV PAGE       TOP OF DOC

    But what a difference ten years makes. Today, both the BIF and the SAIF exceed the statutory 1.25 percent reserve ratio by large margins. The BIF holds $29.5 billion, while the SAIF holds $10.2 billion, for a combined $40 billion reserve.

    This works out to a combined reserve ratio of 1.40 percent.

    I want everyone to know that these numbers do take into account—and this I think is important to understand—do take into account the $900 million loss from bank failures in 1999, including the First National Bank of Keystone, as well as the $980 million added into the SAIF from the SAIF special reserve in November, 1999.

    In other words, both funds are both in excellent shape.

    While the BIF and SAIF provide the same product—that is, deposit insurance—the funds are not identical. BIF is much larger and much less concentrated than the SAIF. In addition, the BIF is three times larger than the SAIF in terms of fund balance and has six times as many members as the SAIF.

    The case for merging the deposit insurance funds I believe is extremely strong. The BIF and SAIF provide the same products as has been noted, and the funds are housed and administered by the same agency, the FDIC, from whom we will hear today.

    The FDIC strongly supports a merger. We will be able to hear their position and their reasons for their position today.
 Page 6       PREV PAGE       TOP OF DOC

    Both funds are extremely healthy and a merger would benefit both the BIF and the SAIF.

    As we will hear later, the banking and thrift industries strongly support a merger. In addition, the public, I believe, would clearly and obviously benefit from a merger, given a more stable fund would give the depositors confidence and promote greater depositor protection and increase the safety and soundness of the banking system.

    I think everyone will agree that the right public policy is to merge them, but the related questions are: should the merger of the funds include an upper cap on the growth of the combined fund, as well as paying rebates?

    I wanted to stress, because this is misunderstood by a number of people, that I am not advancing or an advocate of either of these positions. I am simply stating that, since these are related questions, we should keep an open mind and have a full examination of the merits pro and con as objectively as possible. We need to understand the benefits and the negatives of such proposals. Therefore, I've asked the witnesses today to address these related questions.

    First, should there be a cap, an upper cap, on the fund?

    Second, if so, where should that cap be?

    And, by the way, in all of this analysis today—and I want to stress this—I am looking for an analysis in financial and economic terms. I do not want this to deteriorate into a turf battle. Let's try to be as objective as possible. Reasonable minds, as I've indicated, certainly can disagree on the issue of an upper cap. Some would say there's no harm in letting the fund continue to grow. Continued growth would protect the U.S. taxpayers so they won't have to put up any money in a banking crisis.
 Page 7       PREV PAGE       TOP OF DOC

    On the other hand, proponents of the cap might argue that the purpose of the fund is to protect the insured deposits held in banks and savings associations. The funds should only be as large as is necessary to address the underlying purpose. Those are the questions we'll have further examination of today.

    I think it might be important to note that there is a lot of money, even by Washington standards, in the BIF and the SAIF—$40 billion or 1.4 percent of insured deposits on a percentage basis.

    The debate on what the upper cap should be, if any, needs to factor in, in my opinion, the changes which the industry has been experiencing, such as industry consolidation, the regional consolidation, and the new activities and products that are now being offered.

    I would also like to invite comment from our witnesses on the appropriateness of the minimum 1.25 percent reserve. I think you will be addressing that indirectly through discussion of the cap, but I'd like to hear your thoughts regarding the adequacy of the 1.25 percent minimum reserve.

    The banking world has changed enormously in the last twenty years. Today, we have $600 billion asset megabanks, which were unthinkable. I think it is understood that we have more concentration in the fund in the top twenty-five banks than twenty years ago. Banks are engaged in new activities and offering very sophisticated financial products such as derivatives. The question is logical as to whether or not that minimum of 1.25 reserve is appropriate.

 Page 8       PREV PAGE       TOP OF DOC
    On the subject of rebates, I have also asked our panelists to address that subject. I'm not sure whether or not there will be agreement on establishing an upper cap, but beyond that I think we also have to address the rebate issue. I know here there is quite a discussion within the banking community on these subjects.

    As I've stated with the question of the cap issue, I also want to assure everyone here that I'm looking for objectivity on this; the pro and con. I certainly want to hear what the FDIC and the Treasury have to say about their rebates and the pros and cons of that particular question.

    Of course, as I think many of us know, in the back of our minds we have concerns about capping the funds. I read with great interest this week the articles on Merrill Lynch possibly transferring $100 billion into insured deposits and its effect on the BIF's reserve ratio. I think that will be coming out in the testimony today.

    I just received, a couple of moments before I came down here for the hearing, a letter from Merrill Lynch. With unanimous consent I will include the letter from Merrill Lynch in the official record of this hearing. I will share it with everyone.

    I haven't had a chance to review the Merrill Lynch letter in any depth at all, but their position is that the press reports have been over-blown and do not depict accurately their position or intentions.

    In any event, in closing I want to say that I strongly believe that, even with the passage of financial modernization in the Gramm-Leach-Bliley Act, that there are many areas of the banking law that need to be updated and reviewed in light of the current economic situation.
 Page 9       PREV PAGE       TOP OF DOC

    Beginning here today with the BIF and SAIF deposit insurance funds merger, I think we can make a great start on examining the important banking issues. I'm just sorry that Mr. Vento isn't here, but knowing him and knowing Mr. LaFalce and other Members on the minority side here, they will all be carrying the ball and doing their job so that we can come up with a bipartisan agreement on this very profound issue.

    With that, I will yield to our Ranking Member of the full committee, who is here today and doing us the honor of attending and giving, I hope, evidence of the importance of this subject.

    Thank you.

    Mr. LAFALCE. Thank you very much, Madam Chairwoman.

    First of all, I want to say that I'm pleased that you're having the hearing. I think it is an important subject, and I find myself in general agreement with the statements that you made in your opening remarks.

    I do want to say, though, that I'm here primarily because Bruce Vento can't be here today, and I just wanted to express to Bruce and to the world my affection and love for him and say how much we're going to miss him once he retires. We hope that he will be able to return to Congress as soon as possible after his operation and after his treatment.

    The operation took place Monday, as you know, at the Mayo Clinic. From everything I've heard, it was as successful as could be expected.
 Page 10       PREV PAGE       TOP OF DOC

    The only thing I wanted to say is Bruce has many, many friends, and if you want detailed information I would refer you to the Mayo Clinic communications office, and I'm going to give you the number.

    Bruce's condition during his stay at Mayo will be available each day at 2:00 p.m. Central Standard Time by the Mayo Clinic. Some of you just might want to check up periodically and drop him a note. I'm sure he would love to receive as many notes as is possible.

    With respect to this hearing, Madam Chairwoman, I believe, as I know you do, that the merger of the Bank Insurance Fund and the Savings Association Insurance Fund is a matter of substantial public policy importance that should be addressed on its independent merits.

    A merger of the BIF and SAIF would clearly benefit the deposit insurance system by creating a single, more-diversified fund that is less vulnerable to regional economic problems.

    In addition, a merger of the funds would more accurately reflect the reality of today's financial services industry, in which 46 percent of the SAIF deposits are held by commercial banks and FDIC-regulated State savings banks.

    In fact, the funds have virtually lost their independent identities, and we should rationalize their structure. Both industries should support the change as bringing needed rationality and stability to the deposit insurance funds.

 Page 11       PREV PAGE       TOP OF DOC
    So the merger of the funds is an issue that I believe merits independent consideration and Congressional action in the near term, but I understand, as I know you do, also, that other issues inevitably arise—a merger of the charters, a merger of the OTS and OCC, and the question of rebates.

    My own continuing disposition is that the charters remain substantially different, reflect different priorities and constituencies, and should remain separate, and that a merger of the agencies is, therefore, unnecessary and inappropriate.

    I also believe it would be very premature to consider any regulatory restructuring issues whatsoever until we have some experience with the implementation of the new financial modernization law and the structure we have established.

    Beyond these merger issues, the banking industry has also put the issue of premium rebates on the table. I cannot see us making any determination on that issue without a thorough assessment of the adequacy of the current assessment system to safeguard the fund, including an examination of the existing reserve ratio and the relative merits of hard and soft caps.

    It is certainly appropriate for the subcommittee to start to air these other issues, but I do not believe we can afford to deflect the subcommittee's time from other priorities, such as—and I'd just tick off some of them—implementation of financial modernization, several pending housing initiatives, money laundering, and what I hope will be a much greater and fuller examination of consumer protection issues.

 Page 12       PREV PAGE       TOP OF DOC
    It has been far too long since we have given adequate attention and consideration to consumer protection issues.

    If we cannot proceed to independently and expeditiously act on the fund merger issue alone, then I believe we should leave these issues to further examination at a later day so we can get on with the other more-pressing priorities.

    Madam Chairwoman, I thank you for holding what I know will be an insightful hearing, and I look forward to working closely with you on what we both see as a very critical issue. This hearing presents an excellent opportunity to hear the views of the experts on the fund merger and related issues, which will be a helpful resource for future debates.

    I thank the Chair very much.

    Chairwoman ROUKEMA. I thank the Ranking Member, and certainly I endorse everything that he has said with respect to our colleague, Mr. Vento. We all look forward to his early return. I appreciate the fact that you gave that information regarding the Mayo Clinic.

    Are there other opening statements?

    Yes, Congresswoman Maloney.

    Mrs. MALONEY. Thank you, Chairwoman Roukema.

 Page 13       PREV PAGE       TOP OF DOC
    Before I begin, I'd like to join my colleagues, especially Ranking Member LaFalce, in acknowledging our colleague Bruce Vento. I know that I speak for all of us when I say that our thoughts are with Bruce. The Banking Committee, and the Congress already miss him dearly, and we look forward to his return.

    As a Member of the Banking Committee, I view oversight of the safety and soundness of the banking system and oversight of the insurance liability to U.S. taxpayers as my number one job responsibility. I am pleased that this subcommittee has the opportunity to consider reforms to the deposit insurance system at a time when the funds are so strong.

    The regulators and the industry agree that it is time to combine BIF and SAIF. With the passage of financial modernization, the differences between the charters has narrowed.

    The combined fund would be stronger with further diversification of risk. It would also eliminate the possibility of a competitive advantage that could result from a premium differential between the funds.

    For the industry, the merger of the funds would reduce the administrative burden for over 800 institutions that hold both BIF and SAIF funds.

    The Banking Committee should take this opportunity to make this consensus common-sense reform this year while we have the chance to do so.

    As the FDIC will report in its testimony, there are indications that business lending risks are on the rise. The subcommittee is well aware that the reforms to deposit insurance enacted in the last decade have yet to be tested in an economic downturn.
 Page 14       PREV PAGE       TOP OF DOC

    Accordingly, we must approach deposit insurance reform cautiously. Our responsibility is to protect the taxpayers while appropriately limiting regulatory burden and the opportunity cost to lenders and borrowers of the insurance funds.

    I look forward to the testimony today.

    Thank you, Chairwoman Roukema.

    Chairwoman ROUKEMA. Thank you, Congresswoman Maloney. I do appreciate that.

    Now, I pointed out that, with unanimous consent, that everyone would be able to introduce a statement, but I believe that I should have asked specifically for unanimous consent for Mr. Vento, who has submitted an opening statement, to be included.

    VOICES. Yes.

    Chairwoman ROUKEMA. So ruled. I appreciate that.

    Now, I also would like unanimous consent to include two items in the official record, and we will certainly have them distributed to each of the Members.

    One is a letter from former FDIC Chairman Bill Siedman. He had been invited to be here today, but he had other conflicts. I believe he is overseas. But, in any case, he has submitted a relatively short letter, right to the point on the subjects that are before this subcommittee today and I would like to have that submitted for the record, with unanimous consent.
 Page 15       PREV PAGE       TOP OF DOC

    And then the letter from Merrill Lynch, which I referenced in my opening statement, the one that arrived just this morning, relating to the subject with respect to the news accounts and the FDIC internal report, and I would like unanimous consent to include that letter in the record.

    Without objection, it is so ruled.

    Thank you.

    Chairwoman ROUKEMA. I had neglected to mention earlier that Ellen Siedman, the Director of the Office of Thrift Supervision, is very supportive of the BIF/SAIF merger, and without objection would like to have her statement submitted for the record.

    So ruled.

    Chairwoman ROUKEMA. All right. Now we'll get on with the business of the day.

    The first panel is a very distinguished panel with lots of expertise and experience.

    Donna Tanoue, Chairman of the Federal Deposit Insurance Corporation, is with us again. She has been the Chairman since May of 1998. She obviously has significant financial related experience in both the private and public sectors.
 Page 16       PREV PAGE       TOP OF DOC

    She has served as a partner in a Hawaiian law firm specializing in banking and real estate finance, and was the Commissioner of Financial Institutions for the State of Hawaii from 1983 to 1987.

    We welcome you again here today.

    I'm not quite sure, but for our second witness, I believe it is the first time I've chaired a hearing where Mr. Gregory Baer, Assistant Secretary for Financial Institutions from the Department of the Treasury, has testified.

    We certainly welcome you here today.

    Mr. Baer, in his position, is involved in all Treasury matters relating to financial institutions, and directs policy on proposed legislation and regulation relating to financial institutions.

    Mr. Baer has been with the Treasury since 1997, and prior to that was a Managing Senior Counsel with the Federal Reserve Board.

    Mr. Baer, welcome.

    Without further comment, we ask for your testimony, Ms. Tanoue.

 Page 17       PREV PAGE       TOP OF DOC

    Ms. TANOUE. Thank you, Madam Chairwoman and Members of the subcommittee.

    At the outset, I'd like to take a moment to express the wishes of all of us at the FDIC in joining you in wishing Congressman Vento a very speedy recovery.

    This morning I'd like to discuss three points: first, why the funds should be merged; second, why there is no magic number for a deposit insurance fund; and, third, why the Congress should exercise great caution in considering rebates or a cap on the insurance funds.

    Now, first, why merge the funds? As we have stressed so many times before, a merger would ensure that the risks to the deposit insurance system are as diversified as possible, thus reducing the concentrations of risk by size and number of institutions, by geography, and by types of products.

    With the ongoing industry consolidation, the FDIC's risk is increasingly concentrated in a small number of very large organizations. Added benefits resulting from a merger would be greater efficiency, including lower costs and reduced regulatory burden for about 850 institutions that currently hold deposits that are insured by both funds.

    The timing for a merger could not be better, given the current health of the banking and thrift industries and the condition of the funds.

    In short, a merger is in the best interest of the American taxpayer.
 Page 18       PREV PAGE       TOP OF DOC

    My second point: there is no magic number for a deposit insurance fund. As you know, the test of an insurance fund is not how it does in good times, as we are currently enjoying, but how it does in bad times.

    In 1981, the FDIC had a reserve ratio of 1.24 percent. That means that it had $1.24 for every $100 of insured deposits.

    Ten years later, in 1991, the Bank Insurance Fund had a reserve ratio of negative .36 percent.

    Today, the Bank Insurance Fund has a reserve ratio of 1.38 percent.

    So the question is: how large should a deposit insurance fund be? Big enough to do the job. And history offers us a cautionary tale in this regard.

    In the late 1940's, the contemporary wisdom was that a $1-billion fund was sufficient to cover almost any economic contingency, and the FDIC rate assessment was, in effect, cut back.

    As a result, assessments on the banking industry were at that time reduced $6.7 billion from what they might otherwise have been.

    It is interesting to note that in 1991, at the height of the banking crisis, the BIF had a net worth of negative $7 billion—a shortfall almost the amount that had been credited to the industry.
 Page 19       PREV PAGE       TOP OF DOC

    As we learned in the late 1980's, the deposit insurance funds stand between bank failures and the American taxpayer.

    In light of rapid change in the financial world, a strong insurance fund—one that is up to the job—is of critical importance to all of us. That is why we urge you today to exercise great caution in considering rebates or a cap.

    The Bank Insurance Fund reserve ratio has not grown in the last three years. While the amount of money in the funds has grown, the amount of deposits that the insurance fund must cover has also grown. As a result, the reserve ratio that I mentioned a moment ago, 1.38 percent, has remained unchanged since 1997.

    Deposit growth can affect the strength of the insurance funds significantly. Deposits fluctuate, sometimes greatly. Fluctuations can also occur from economic downturns or from events—for example, if—and I underscore ''if''—an investment bank were to channel billions of dollars into insured accounts.

    Losses fluctuate greatly, too. Failures last year will cost the BIF around $1 billion. And the fund finished 1999 smaller than it was at the end of 1998—the first decline since 1991. These losses were, for the most part, unexpected.

    We live in a volatile world. While some banks are seeking rebates or a cap on the funds, it is important to note that more than nine out of ten banks and thrifts currently pay no insurance premiums. They pay absolutely zero.
 Page 20       PREV PAGE       TOP OF DOC

    If Congress decides to mandate rebates or a cap, despite the concerns articulated, it should be done in the context of reforms that strengthen the banking system, that strengthen the deposit insurance system, and that do not distort economic incentives.

    Thank you. I'm pleased to answer your questions.

    Chairwoman ROUKEMA. Thank you.

    Assistant Secretary Baer.


    Mr. BAER. Madam Chairwoman, Congresswoman Maloney, Congressman Metcalf, I appreciate the opportunity to present the Administration's views on the potential merger of the deposit insurance funds and related issues. We commend the subcommittee for giving this topic the attention it deserves.

    I would note that we at Treasury today also note and miss the absence of Congressman Vento, with whom we've worked so closely in the past, and we look forward to his speedy return to the Congress.

    I'll divide my remarks into three parts: first, the benefits of merging the deposit insurance funds expeditiously; second, the adequacy of the current designated reserve ratio and the advisability of rebates; and, third recommendations going forward.
 Page 21       PREV PAGE       TOP OF DOC

    The Administration strongly supports merging the FDIC's Bank Insurance Fund and Savings Association Insurance Fund. A merger of the two funds would produce a single, more-robust fund, diminishing the chances that a series of failures could deplete the funds and necessitate a call on taxpayers.

    For the following reasons, we believe that now is the optimal time for Congress to act:

    First, a merged fund would be more diversified than either a bank or thrift fund separately. A merged fund would thus provide a small but helpful offset to the increased risk that both funds currently face from industry consolidation.

    Second, a merger would prevent a premium disparity for FDIC insurance from arising again. As we have seen in the past, such disparities lead to uneconomic and wasteful behavior as institutions work to move deposits to the cheaper of the two funds.

    Third, it is increasingly hard to maintain that SAIF is the deposit insurance fund for thrifts and BIF for banks. Both already are hybrid funds. Each insures the deposits of commercial banks, savings banks, and savings associations.

    Finally, it makes sense to merge the funds now, while the industry is strong and while the merger would not unfairly burden either BIF or SAIF members, as each fund currently would have roughly the same reserve ratio going into a merger. Both industries would benefit from such a merger.
 Page 22       PREV PAGE       TOP OF DOC

    Let me now turn to the Administration's views on the adequacy of the statutorily designated reserve ratio of 1.25 percent and the feasibility of imposing a cap on the insurance reserve and rebating funds above that cap.

    We believe that any discussion about the appropriate level of the deposit insurance funds and the possibility of rebates must come with a high level of humility and a clear recognition of the uncertainty of any predictions in this area.

    First, it is worth remembering that the thrift crisis, and, in particular, the inability of deposit insurance reserves to cover losses from thrift failures, cost the taxpayers of this country over $125 billion.

    Although the industry is currently making $793 million per year in FICO interest payments to finance the cleanup, taxpayers currently make $2.3 billion in annual interest payments on REFCorp bonds and billions more on Treasury bonds issued for the same purpose.

    Second, as Chairwoman Tanoue noted, in 1981 the reserve ratio for the BIF was at 1.24 percent, almost exactly its current designated reserve ratio. There were, doubtless, some in 1981 who would have believed that 1.24 percent was enough, yet ten years later the reserve ratio was negative .36 percent.

    Third, it is, again, worth remembering that under the current system over 90 percent of banks and thrifts currently pay no deposit insurance premiums at all.

 Page 23       PREV PAGE       TOP OF DOC
    With this history in mind, we oppose proposals to allow banks and thrifts not only to pay no premiums but also to receive rebates—that is, payments from the principal balance and interest income of the fund.

    First, we do not find sufficient evidence for concluding that any insurance fund net worth above 1.5 percent or any other level that the fund is likely to reach in the near future represents excess capital that should be returned to insured institutions rather than retained by the insurer.

    We believe that those seeking to cap the funds must bear a heavy burden of proof in demonstrating that the current levels are excessive, and we are aware of no actuarial study reaching that conclusion.

    Indeed, at its current level of capitalization, BIF's reserves could be entirely depleted by the failure of one or two of its largest members.

    To be sure, under the current law the FDIC would have the authority to replenish the fund through assessments on the industry, but such assessments would probably come at a time when the industry is least able to make those payments, and could have a procyclical effect.

    Second, rebates would exacerbate what is already a poor set of incentives around deposit insurance. Currently, more than 90 percent of banks and thrifts, as I indicated, pay no insurance premiums at all. Rebates could take poor incentives and make them worse.

 Page 24       PREV PAGE       TOP OF DOC
    In asking for our views about rebates, you asked that we consider the history and statutory authority of the NCUA to pay rebates to credit unions. A more-detailed description of that subject is contained in my written testimony, but I think it is fair to say that there are significant differences in the structure of the relative funds and also the relative industries to make that comparison not an exact one.

    Finally, your invitation asked whether we have any related legislative or regulatory recommendations in this area.

    I spoke earlier of our concerns with provisions of current law that greatly restrict the FDIC's ability to tie insurance premiums to risk. We believe the FDIC should have more flexibility to improve the pricing of deposit insurance. For example, premium rates should reflect more accurately the FDIC's risk position by accounting for secured borrowings.

    Since the FDIC stands in line behind secured creditors in the resolution of a failed bank, the FDIC should be permitted to take account of a bank's secured liabilities in determining an appropriate premium.

    That concludes my testimony. I look forward to your questions.

    Chairwoman ROUKEMA. All right. Thank you very much.

    I appreciate your addressing these issues, but I'm not quite sure I understand every part of your testimony.

 Page 25       PREV PAGE       TOP OF DOC
    I do believe that the FDIC does, as I understand your testimony, does not oppose an upper cap. You rather lean toward an upper cap, do you not?

    And what about the rebate question? You don't outright oppose rebates, but you urge that we, of course, exercise caution because, as you've outlined, there are economic influences, declines in the economy and the volatility of markets.

    Can you amplify a little bit more? You're telling us to merge the funds, but you are holding off a direct response to the other two related questions. Do I understand you? Do you favor a cap?

    Ms. TANOUE. No, that's not——

    Chairwoman ROUKEMA. That's not?

    Ms. TANOUE. That's not accurate.

    Chairwoman ROUKEMA. All right. Then I want it clarified.

    Ms. TANOUE. I would emphasize that we are saying that we can't give you a precise number, a precise level for the reserve ratio of the funds.

    Chairwoman ROUKEMA. I guess you said there's no magic number.

    Ms. TANOUE. Right.
 Page 26       PREV PAGE       TOP OF DOC

    Chairwoman ROUKEMA. Yes.

    Ms. TANOUE. There's no correct level. But what I can tell you is this: each level of the fund corresponds to a different level of risk in terms of the potential insolvency of the fund at a later date or the greater likelihood that banks would be called upon to pay higher premiums sooner.

    What I want to emphasize is that this simply isn't an opportune time to discuss either rebates or a cap. We're enjoying unprecedented economic prosperity, and we live in a time where there is tremendous innovation in the financial sector. But the true test of an insurance fund comes during bad times, and I would much prefer to have this type of discussion at the other end of the cycle, when times are not as virtuous as they are today.

    Chairwoman ROUKEMA. I don't know exactly what that means translated into the real world, because we have all kinds of experience with upturns and downturns. I would interpret that then as saying that there wouldn't be any really good time to put a cap on it. Is that what you're saying?

    Ms. TANOUE. I would say that there——

    Chairwoman ROUKEMA. Because of the uncertainties.

    Ms. TANOUE. It would be more realistic to address these types of issues when economic times are not as good as they are today.
 Page 27       PREV PAGE       TOP OF DOC

    Chairwoman ROUKEMA. Mr. Baer, do you want to comment on that further? Of course, I understand that you are opposed to the cap. I understand that.

    Mr. BAER. Right.

    Chairwoman ROUKEMA. But in the context of what has just been said, would you comment further?

    Mr. BAER. I think there are two sets of concerns about a cap. The first is having a sufficient level of confidence that you have capped the fund at the appropriate level.

    Again, given the history here and the primary interest of protecting taxpayers, we do not have any confidence that at 1.5 percent or any level that the fund is likely to reach any time soon, that you could have a level of confidence to cap the funds and start returning interest income on the funds to premium payers—in effect, the banking and thrift industry.

    The second set of concerns around caps is that it exacerbates a problem we already have, which is that, again, 90 percent of banks and thrifts are not paying any insurance premiums.

    What that means is that their marginal cost of adding insured deposits, taking an unsecured liability or an uninsured liability and making it an insured liability, is zero for this purpose.
 Page 28       PREV PAGE       TOP OF DOC

    If you were to go to the possibility of rebates, then, in effect, you could be paying a negative insurance premium, in effect paying them to take their uninsured, unsecured liabilities and making them federally-insured with the taxpayer standing behind that.

    We think the taxpayer deserves compensation before taking on that risk or being forced to take on that risk.

    Chairwoman ROUKEMA. Thank you.

    I may have some follow-up questions, but, given the fact that we have a vote coming up, I do want to give Mrs. Maloney an opportunity.

    Mrs. MALONEY. Thank you very much.

    Chairwoman Tanoue, the FDIC released two studies on deposit insurance in September, which was mentioned in your written remarks. The study, titled, ''Effects of Bank Consolidation on the Bank Insurance Fund,'' found that the BIF experiences stress in cycles, with the average period of low stress being roughly nine years.

    Given the low number of bank failures since the early 1990's and the current increase in failures that was the subject of the hearing we had last week, the obvious conclusion is that the BIF is approaching a period of increased stress.

    Your testimony states in its conclusion that, ''There are indications that business lending risks are on the rise.'' Can you comment on the BIF stress cycle and your view of increased lending risk and how that should influence our deliberations on deposit insurance reform?
 Page 29       PREV PAGE       TOP OF DOC

    Ms. TANOUE. Again, we at the FDIC would urge great caution, particularly at this point in the economic cycle.

    Many people have said that the funds keep growing and growing, but history tells us that that isn't the case.

    As I emphasized earlier, the fund's balance is growing, but the reserve ratio—this is a very important point—the reserve ratio has remained static over the last three years.

    Again, for the first time since 1991, the BIF declined in 1999.

    Mrs. MALONEY. Yes.

    Would you like to comment, Mr. Baer?

    Mr. BAER. Sure.

    Obviously, it is very difficult to predict economic cycles, but I think it is clear that, in order to protect taxpayers, the reserve ratio should be set on the assumption that there will eventually be an economic downturn.

    I think when you look at the size of the fund currently and the concentration that is occurring in the industry and will be continuing, again, we do not feel the level of confidence necessary to say that we have reached a sufficient level of capitalization for this fund that we need to start returning—not only not charging premiums, but start returning interest income or principal in the fund to the premium payers.
 Page 30       PREV PAGE       TOP OF DOC

    Mrs. MALONEY. Great.

    I have some additional questions, but I believe we have a vote on.

    Chairwoman ROUKEMA. We do have a vote on. All right. At your recommendation, then, we'll go for the vote and return shortly.


    Chairwoman ROUKEMA. Thank you very much.

    Congresswoman Maloney, you may continue, and I thank you for your patience and understanding.

    Mrs. MALONEY. Thank you.

    Chairwoman Tanoue, your testimony reports on a major investment bank that may sweep its cash management accounts into insured deposits. I really have only read press accounts, and the information is not really clear what's happening there, but what effect could this have if it becomes a trend? Specifically, what does this mean for the insurance liability to the U.S. taxpayer and for the institutions that capitalize the insurance funds and may not currently be paying premiums?

    Ms. TANOUE. We used that as a dramatic example of how deposit growth, not just losses, can affect the insurance funds and the reserve ratio. We wanted to emphasize that in a situation where you have an increase in insured funds without a commensurate increase in insurance assessments being paid into the funds, you can potentially have a decrease in the BIF reserve ratio.
 Page 31       PREV PAGE       TOP OF DOC

    I'd like to emphasize, however, that, notwithstanding that one example, there are other companies that could engage in such practices, and I would also emphasize that over the last several years there have been a number of newly chartered institutions, some 800 or so, that enjoy all the benefits of deposit insurance without paying anything for that insurance.

    Mrs. MALONEY. Would you like to comment, Mr. Baer?

    Mr. BAER. Sure.

    Leaving aside the specifics of that particular case, I think it just illustrates again what the effects of having a marginal cost of deposit insurance of zero, what those effects are.

    It is certainly rational economic behavior to wish to convert uninsured liabilities into federally-insured liabilities if you can do so at a cost of, at least in terms of deposit insurance premiums, zero.

    So I think this case just highlights that feature of the current system and, again, how that sort of current anomaly would be even worsened by any rebates or something like that.

    Mrs. MALONEY. OK.

    Can you both please comment on the consequences of raising the amount of available deposit insurance over $100,000 and pegging it to inflation?
 Page 32       PREV PAGE       TOP OF DOC

    One banking group argues that there is a competitive advantage for banks that are perceived to be ''too big to fail'' versus community banks, smaller banks, in that deposits of big banks are already assumed to be covered by the Government up to any amount.

    Ms. TANOUE. Certainly, it is reasonable to ask, as many banks are today, whether the level of insurance coverage should be increased from $100,000. There's no doubt that $100,000 today isn't worth what it used to be.

    But I would like to emphasize that this type of issue should be considered in a broader context of deposit insurance reform and not on a single issue basis.

    Mr. Baer.

    Mr. BAER. Any increase in the coverage limit above $100,000 would obviously raise serious concerns about a diminishment of market discipline and an increase in moral hazard, which I think is already something of a concern.

    I think, before even considering such a step, you really need to have a wholesale look at the deposit insurance system and think very carefully before doing that.

    Mrs. MALONEY. Could both of you please comment on extending deposit insurance to cover all municipal deposits?

    Ms. TANOUE. That also is an issue that has been raised recently. We have not yet had a chance to study that issue carefully.
 Page 33       PREV PAGE       TOP OF DOC

    Currently, many of the States require those deposits to be collateralized, and we saw some nuances of that situation with the recent Iowa failure.

    If the subcommittee chooses to move in that direction, we would want to look again at the potential implications of moving in that direction very closely.

    Mrs. MALONEY. Mr. Baer.

    Mr. BAER. I'm not as familiar with that issue, so I would say that Chairwoman Tanoue's remarks sounded very reasonable to me.

    Mrs. MALONEY. Very, very briefly, shortly, four months ago, Congress passed sweeping legislation after thirty years that will allow increased consolidation in financial services. While the insurance funds and economy are currently strong, shouldn't Congress wait to enact deposit reform beyond the merging of BIF and SAIF until we have a better idea of how the industry will evolve after financial modernization? Your comments, please, both of you.

    Ms. TANOUE. I would wholeheartedly agree on that front. And I would echo some of the comments made by Congressman LaFalce earlier, that we do need some experience with financial modernization and we definitely need to see some of the reforms that were put in place. We need to see how those are tested during difficult times.

    Mr. BAER. Yes. I think, in the wake of financial modernization and the changes it is going to represent for the industry and for the funds, I think any tinkering would certainly be ill-advised this soon.
 Page 34       PREV PAGE       TOP OF DOC

    However, I would say, though, that the merger of BIF and SAIF is still a very good idea. It's a very good idea now. It's a better idea in light of the recent financial modernization, which will, if anything, only exacerbate industry concentration.

    That's something that the Congress, we believe, should do now.

    The other issues that have been raised in the context of these hearings we do believe could use some more time to wait on, but that idea is a good idea now. It will be a good idea tomorrow. And it will be more doable now, though, than any other time.

    Mrs. MALONEY. Thank you, Madam Chairwoman, and the panel.

    Chairwoman ROUKEMA. I thank you for asking that last question. Now that Mr. Baer has commented, I was going to ask Ms. Tanoue whether I was understanding her correctly. Your most recent comment did not mean that you were backing away or had questions, reservations about merging the funds?

    Ms. TANOUE. No. Absolutely not. I would join with Mr. Baer in saying that we believe the fund's merger is a very important issue that should be determined soon, and it is definitely an issue that warrants a decision on its own independent merits. It should not be coupled with other issues.

    Chairwoman ROUKEMA. All right. Thank you. I understand that.

 Page 35       PREV PAGE       TOP OF DOC
    I'm just going to go back briefly and just acknowledge Congresswoman Maloney's question regarding bank failures and municipal deposits. I know that the bank failure in Iowa highlighted the potential loss exposure for municipal deposits. It raised a lot of concern and comment from my own banking constituency.

    Is there anything that you'd like to add to that? Do you have strong feelings on whether we should raise the coverage for municipal deposits? Or do you think this is something that should be under additional review?

    Ms. TANOUE. I would think the latter. We should study the implications of that issue.

    Chairwoman ROUKEMA. I do want to get back to that subject, and I may very well submit something to you in writing, additional, in-depth questions in writing as the issue of increased insurance coverage for municipal deposits is important to the bankers in my own constituency. They have raised the issue.

    Mr. Baer, do you want to comment?

    Mr. BAER. We'll look forward to the question for the record.

    Chairwoman ROUKEMA. All right. Thank you.

    Mr. BAER. We'll take a good look at it.

 Page 36       PREV PAGE       TOP OF DOC
    Chairwoman ROUKEMA. I have no further questions at this time, and we do appreciate your patience, your contribution here. I suspect that when we hear the next panel there may be additional questions that we'll want to get back to you on or that you will want to use the time for and submit responses in terms of the specificity with respect to the caps and the rebate question.

    Mr. BAER. Thank you.

    Ms. TANOUE. Thank you.

    Chairwoman ROUKEMA. Thank you very much.

    Will the next panel come forward, please?

    Thank you. We appreciate the second panel coming forward. We have the President of the American Bankers Association, Mr. Hjalma Johnson, who is here today. He is Chairman and CEO of the East Coast Bank Corporation in Dade City, Florida, and is representing the ABA here today.

    The second witness on the panel is Mr. Fitzgerald of America's Community Bankers. Mr. Fitzgerald is the Chairman and CEO of Commercial Federal Bank of Omaha, Nebraska. I'm sorry Representative Bereuter, my good friend from Nebraska, isn't here. I believe he has a conflict with a markup in the International Relations Committee. But we welcome you here today.

    Thomas Sheehan, Independent Community Bankers of America, is the President Elect of the Independent Community Bankers of America, and he is President and Chairman of Grafton State Bank in Grafton, Wisconsin.
 Page 37       PREV PAGE       TOP OF DOC

    We appreciate your being with us, and without further introduction we'll begin with Mr. Johnson.


    Mr. JOHNSON. Thank you, Madam Chairwoman. Thank you very much for holding this timely hearing.

    I also want to take this opportunity to thank you and certainly Mr. Vento, about who we all are concerned and hope for a full recovery, Chairman Leach, Mr. LaFalce, and others on this subcommittee for your tireless efforts in passing the financial modernization legislation.

    Assuring that the FDIC's insurance funds remain strong is critically important to the banking industry. Over the past decade, banks and savings associations have gone to great lengths to assure the insurance funds are strong, and today they are both very healthy, as the testimony has shown.

    The outlook is also excellent. There have been few failures, and interest income on BIF and SAIF easily exceeds the FDIC's cost of operation.

    The strength of the funds is further protected by strong laws and regulations, including prompt corrective action, risk-based premiums, and enhanced enforcement powers.
 Page 38       PREV PAGE       TOP OF DOC

    With the deposit insurance funds so strong, now is the perfect time to consider improvements.

    Your letter to Chairman Leach last year, Madam Chairwoman, set forth ideas for an approach that has certainly been influential in setting the ABA position.

    Last week, the ABA Board of Directors unanimously endorsed the compromise approach we put before you today.

    Three key points:

    First, a comprehensive approach is needed that should include the merger of the insurance funds, a cap on the size of the funds, rebates, and a combination of the OTS and OCC.

    In an effort to forge a workable compromise, the ABA no longer calls for a merger of the bank and saving institution charters as a necessary component of the comprehensive approach. We believe the two charters can exist in harmony and will continue to serve the country well.

    While the charter issue is less of a factor, we cannot support a merger of the FDIC funds unless it was part of a broader comprehensive package.

    Second, we believe strongly that the FDIC funds should be capped and the rebate authority expanded. Today, BIF and SAIF exceed full capitalization by $4.2 billion. With interest income exceeding the FDIC's typical operating expense by $1.5 billion a year, it is likely that the funds will continue to grow.
 Page 39       PREV PAGE       TOP OF DOC

    Will capping the funds restrict FDIC in meeting its obligations? The answer is no. The flexibility to adjust funding levels, combined with significant regulatory powers, are more than sufficient for the FDIC to meet any funding contingency, but even more important is that the banking industry has an unfailing obligation set in law to meet the financial needs of the insurance fund.

    But there must be limits on the size of the funds. The opportunity costs are simply too high. I can assure you as a banker, Madam Chairwoman, that we can certainly put rebates to good use in our community, providing loans and services to our customers.

    This will have a far greater impact on economic conditions in Dade City, Florida, than if that money sits here in Washington.

    Importantly, there is a precedent to rebate of excess funds beyond a fixed reserve ratio. The Credit Union Insurance Fund has rebate authority and, in fact, rebated over $500 million to credit unions over the past five years.

    We believe that all federally-insured depository institutions should receive rebates. We see no justification for different treatment between the credit unions and the bank insurance funds.

    We want to express our appreciation to Congressman Lucas for introducing H.R. 3278. His bill raises the interesting concept of using rebates to offset de facto obligations.
 Page 40       PREV PAGE       TOP OF DOC

    We urge the subcommittee to take a good look at this proposal.

    My third point is that a comprehensive approach should include the combination of OTS and OCC. One idea that has been discussed is that OTS and OCC be run as separate departments of the same regulator.

    Let me be clear. We are not talking about changing the rules. Each charter would continue to be regulated as it is today. What we are talking about is a common regulator of federally-chartered institutions.

    This approach—merging the funds, combining the OTS and OCC, capping the funds, and providing rebates—would represent a number of compromises by ABA and others. We believe it will have wide support.

    Madam Chairwoman, we are prepared to work with you and the Members of this subcommittee to find the best solution for a stronger, safer banking system for the future.

    I thank the Chairwoman.

    Chairwoman ROUKEMA. Mr. Fitzgerald.

 Page 41       PREV PAGE       TOP OF DOC

    Mr. FITZGERALD. Madam Chairwoman and Members of the subcommittee, we wish our prayers for Representative Vento, as well.

    I'm Bill Fitzgerald, Chairman and CEO of Commercial Federal Corporation in Omaha, Nebraska. We operate in a seven-State area with about 235 branches, representing about 700,000 households in this country.

    I'm also, obviously, here representing America's Community Bankers, which is an organization representing all types of charters and sizes of organizations.

    A strong deposit insurance system is essential to our ability to serve our customers. Last year's Congress took an important step in strengthening the deposit insurance system by returning nearly a billion dollars to SAIF, and ACB really appreciates what got accomplished last year.

    Madam Chairwoman, ACB endorses each part of your proposal to merge BIF and SAIF—the caps on the resulting deposit insurance fund, and the rebate of excess reserves over a certain level. We support each of these proposals on their own merits. They can be done separately or in a package, if you so elect. We would support either approach. Each would strengthen and improve an already sound insurance system.

    Merging the funds is based on the principle that a system that covers a large number of a diverse institutions is the most safe and sound. Recent FDIC studies reinforce that view.
 Page 42       PREV PAGE       TOP OF DOC

    Each fund is now well above the 1.25 percent reserve ratio, so no institution would see premium change because of a merger. A merged fund would immediately have a reserve ratio, which was mentioned earlier, of about 1.4 percent, or nearly $40 billion. It could reach about 1.5 percent, based on current projections, or about $43 billion, by the year 2002.

    ACB believes that unfettered growth of deposit insurance funds is probably not good public policy. The proposed ceiling of 1.5 percent is substantially higher than the statutory minimum of 1.25, so it is likely to be a prudent level.

    Rebating some of the earnings on the fund after it reaches the target level would improve the community bank's ability to serve its customers, as well as its communities.

    A decade ago, which was referred to earlier, Congress concluded that it made more sense to prevent a crisis through more stringent capital standards, prompt corrective action, and regulatory standards within the financial institutions. That has been in place for over ten years, and the results are clear. We have healthy and well-capitalized financial industry, strong FDIC insurance funds.

    ACB is gratified that today's hearing is focused on deposit insurance issues. Congress spent the last three years debating the bank and the thrift charters. With last year's passage of the Gramm-Leach-Bliley Act, Congress established the charters and the authorities. Now it is time to merge the funds and focus on serving the American public.

 Page 43       PREV PAGE       TOP OF DOC
    In conclusion, ACB reiterates our strong support for merging the funds, capping fund growth, and providing rebates.

    I'd be more than pleased to answer any questions you might have.

    Chairwoman ROUKEMA. Mr. Sheehan.


    Mr. SHEEHAN. Madam Chairwoman, Members of the subcommittee, my name is Tom Sheehan. I am President of Grafton State Bank, a $115 million community bank located in Grafton, Wisconsin. I am pleased to testify today on behalf of the Independent Community Bankers of America. I, too, send my best wishes to our neighbor to the north, Congressman Vento, and wish him a speedy recovery.

    I commend you, Madam Chairwoman, for holding this hearing. The financial health of the Federal Deposit Insurance Fund is critical to maintaining the stability and depositor confidence in the banking and financial system.

    Deposit insurance is important for another reason. It is the lifeblood of community banking. It is vital to our ability to attract core deposits, which are used to support community lending.

 Page 44       PREV PAGE       TOP OF DOC
    Deposit insurance limits have not been raised in twenty years. We are losing deposits to mutual funds, brokerage accounts, equity markets, and large regional and money center banks that are ''too big to fail.'' We do not have ready access to the capital markets for alternative funding. Easier access to the Federal Home Loan Bank System will help, but alternative funding sources for community banks are scarce.

    Large banks have inherent funding and deposit-gathering advantages over community banks because of their ''too big to fail'' status. The Federal Deposit Insurance Corporation Improvement Act says that when a failure of a bank would pose systemic risk, a Government bailout can be arranged, and more and more banks are falling into that category as the industry continues to consolidate.

    Federal Reserve Board Governor Meyer said, ''The growing scale and complexity of our largest banking organizations raises, as never before, the potential for systemic risk from a significant disruption in, let alone failure of, one of these institutions.''

    Kansas City Federal Reserve Bank President Tom Hoenig went further. He said, ''To the extent that very large banks are perceived to receive Government protection not available to other banks, they will have an advantage in attracting depositors, other customers, and investors.''

    An FDIC study released last fall showed that banking assets are becoming more concentrated. The largest 100 banks now hold nearly 75 percent of all bank assets. The largest 25 banks control over half. And Gramm-Leach-Bliley will likely accelerate this trend.

 Page 45       PREV PAGE       TOP OF DOC
    The report concluded that, despite measures such as prompt corrective action and least cost resolution, even one failure among the top ten banks could render the BIF insolvent.

    But such failure will never happen because of ''too big to fail.'' True competitive equity with these banks may never be achieved. The one tool we have to compete with these banks is deposit insurance, but the value of deposit insurance has eroded over the years because it has not been adjusted for inflation.

    Today, in constant dollars, deposit insurance is worth about half of what it was in 1980, and even less than what it was worth in 1974, when the coverage was increased to $40,000.

    The chart and table attached to my testimony illustrate this erosion.

    Regardless of the debate over the potential merger of the BIF and the SAIF, sound economic policy would dictate that the current deposit insurance limit should be doubled to $200,000, and indexed for inflation to adequately preserve the value of its protection going forward.

    You mentioned earlier the Merrill Lynch situation and what is happening in the brokerage funds. This is, again, a fact in the competitive disadvantage of the small and the rural banks of America. We can't do that. They effectively have increased their coverage to $200,000. We're still suffering with the $100,000.

 Page 46       PREV PAGE       TOP OF DOC
    In addition, there should be full deposit insurance protection for municipal deposits. These are taxpayer funds that should not be put at risk. Were it not for the State sinking fund, the recent failure of the Hartford-Carlisle Savings Bank in Iowa would have resulted in a loss of nearly $12 million in uninsured municipal deposits. Even with the sinking fund, more than $8 million has to be made up by other banks. This is unnecessary and unacceptable.

    Our analysis shows that full coverage of municipal deposits would have no significant impact on the deposit insurance funds. If all municipal deposits were added to the insured deposit base, the reserve ratio of the BIF would fall only three basis points to 1.35 percent, still substantially above the statutory minimum of 1.25 percent.

    In the context of increased deposit insurance, index for inflation, and 100 percent coverage of the municipal deposits, the ICBA could accept the merger of the BIF and the SAIF.

    Community bankers would welcome a rebate of excess reserves, but many community bankers feel that increasing levels of deposit insurance coverage is more important.

    Deposit insurance has been good for America and our financial stability. Congress should not stand by as inflation slowly erodes the value of the Federal insurance program.

    With respect to the proposed 1.5 reserve ratio of a merged fund, we believe that safeguards are in place to reduce risk to the funds, including depositor preference, prompt corrective action, and least cost resolution.
 Page 47       PREV PAGE       TOP OF DOC

    Until there is clear evidence of the risk to the funds that requires a higher reserve requirement, we believe that the current reserve ratio should be maintained.

    In summary, Madam Chairwoman, deposit insurance is the lifeblood of our Nation's community banks. It is vital to help community banks compete for dwindling core deposits. ''Too big to fail'' gives larger institutions a huge competitive and funding edge over smaller banks.

    The Federal Deposit Insurance Funds are healthier than they have ever been. We believe they can support an increase in deposit insurance coverage with little or no impact to the funds.

    The ICBA would support a package that includes merging the BIF and SAIF, increasing deposit insurance to $200,000, and indexing it for inflation, providing 100 percent coverage for taxpayer funds and municipal deposits.

    Thank you, Madam Chairwoman, for the opportunity to express the views of our Nation's community bankers. I would be happy to answer any questions you and the other subcommittee Members may have.

    Chairwoman ROUKEMA. Thank you.

    I am going to have to be leaving shortly because of a vote in another committee, but I'm thankful that I can get this question in.
 Page 48       PREV PAGE       TOP OF DOC

    I'm left with the feeling here, after hearing the first panel and now hearing this panel, I'm tempted to say, you are both right. Everyone is making good arguments. Now, I don't know how we can get to a consesus. I'm not quite sure if that is possible. I'm going to ask the ABA if they could address with more specificity the arguments that have been made by Treasury and FDIC, as well as ICBA, with respect to the question of the relationship of the cap and the rebates. Can you really go further with your argument on why you insist that the rebates are absolutely not only fair but economically sound? I'd really appreciate some amplification on this point from you.

    Mr. JOHNSON. Thank you, Madam Chairwoman.

    There is no free lunch—never has been, never will be. The Assistant Secretary mentioned that we have a zero cost or a negative cost of insurance. That would imply that the $40 billion just appeared out of thin air. It didn't. That money came out of the communities, very properly, and was placed here by the financial institutions. So we have a cost of insurance. We put that money on deposit. It's like making a one-time deposit for an annuity that you're going to collect from years later. You can't stand up and say there's no cost to this annuity. I put the money up ten years ago and haven't paid any more.

    That doesn't wash. There is a cost. This money comes from our profitability. It's a deduction from our capital. It's a deduction from our lendable funds.

    The bedrock of the financial institutions' safety is the capital of the companies that operate. Our capital today is at the highest level in the history of the industry, by both the thrift and the commercial bank. That's the bedrock.
 Page 49       PREV PAGE       TOP OF DOC

    When we take money out of our capital, albeit it for a very good purpose—to build insurance fund—we have reduced the bulwark that is there. It goes out. It's first in and first out. It goes out before the insurance fund is touched.

    So I would say there should be some limit to the insurance fund.

    I'll go back to when the FDIC fund went negative, because that point was made by the FDIC Chairman. When it went negative, it was because FDIC, in a very prudent manner, looked at possible losses and said, ''We need $16 billion to cover our estimate of losses, and we're going to take it out of the fund.'' They had that authority then. They have it now.

    The fund went negative because that money in that bucket does not count. When you look at the fund, the fund was negative.

    In fact, they used $3 billion, Madam Chairwoman, of that $16 billion. If you look at it from a macro perspective, the fund always had $13 billion in it.

    So there should be some reasonable limit to the top number, and we're not saying what that number is. We'd like to discuss that, but there should be some limit to it.

    I notice other people have comments, but that's my feeling.

    Chairwoman ROUKEMA. Mr. Fitzgerald, or Mr. Sheehan, perhaps.

 Page 50       PREV PAGE       TOP OF DOC
    Mr. FITZGERALD. You all have made a valid point. You have to determine at what point too much is too much.

    The capitalization of the banking industry today versus the 1981 period they referred to, or the 1990 period, is probably double what it was at either one of those periods of time, and the insurance reserves at the FDIC are very strong.

    I think his issue is a very valid one. What is the right level to be there?

    If we had ten more years in this country similar to what we had in the last ten—I don't think anybody here is expecting it, but if we did, and all of the sudden that 1.4 percent of the merged funds ends up being 2.10, you've got to say, ''Well, why is all that money sitting in Washington if everybody is properly capitalized?''

    And so I think our issue is there is a proper level at which time rebates make sense, and we would agree that that has to be determined. And you look at the total financial industry independently and then you look at the insurance fund to arrive at that, and that can certainly be done.

    Mr. SHEEHAN. Madam Chairwoman, if I could just make a comment?

    Chairwoman ROUKEMA. Yes, Mr. Sheehan.

    Mr. SHEEHAN. Yes, we certainly have many community bankers that would love to have rebates; however, I don't think there is any magic number. I don't think anybody has come up with a number that they're absolutely certain is the right number. And I think the right number for us is to increase the deposit insurance, which is far more important to most of our community banks, because it will then create some ability for them to be able to raise core deposits, which are their primary funding source and the thing that contributes to our ability to continue to lend in our community.
 Page 51       PREV PAGE       TOP OF DOC

    That's far more important than the rebates that may or may not become, because if the rebates come now, assessments could come later, so it is really not—that's illusionary.

    Mr. JOHNSON. Madam Chairwoman, could I make one additional comment back to your first point?

    Chairwoman ROUKEMA. Yes, if it can be brief.

    Mr. JOHNSON. Yes, ma'am.

    Chairwoman ROUKEMA. I'm sorry, no. You take as much time as you need, but I'm going to excuse myself to go to that other committee, and I will be certain that I will go over, in detail, your statement.

    Mr. JOHNSON. Thank you, ma'am.

    Chairwoman ROUKEMA. And I'll get back to you if I have a question.

    Mr. JOHNSON. That's great.

    Chairwoman ROUKEMA. Absolutely. And hopefully I'll be back here before the panel is concluded, but in the meantime Mr. Riley, our colleague, has come to chair the hearing.
 Page 52       PREV PAGE       TOP OF DOC

    But, Mr. Johnson, I will go over that testimony.

    Mr. JOHNSON. Thank you, Madam Chairwoman.

    Chairwoman ROUKEMA. Thank you.

    Mr. RILEY. [Presiding.] Mr. Johnson, if you would, proceed please.

    Mr. JOHNSON. Yes, sir. Thank you, Mr. Chairman.

    I just simply wanted to say the point was well made that 92 percent of the financial institutions represented here currently pay no deposit insurance. That is because they are well capitalized. They hit the screen ''well capitalized.''

    There is a mechanism, and the FDIC Chairman pointed out that they are seeing some weakness in lending. That shows up immediately on the nine-point grid of risk-based premiums, and that will hit those who should pay more on the risk-based premiums. That's the point I wanted to make is that the reason 92 percent are not paying is because they have a risk profile and a capital base that excludes them.

    If they start getting risky, then they hit the risk profile and they will pay.

 Page 53       PREV PAGE       TOP OF DOC
    Thank you, Mr. Chairman.

    Mr. RILEY. Let me ask one question. And I apologize for being late. I think we're supposed to get out of here today, and everybody is trying to get as much work inserted into an afternoon as they possibly can.

    Mr. Sheehan, you said a moment ago that you could not come up with a number that you thought would be appropriate. I'd like to ask Mr. Fitzgerald and Mr. Johnson, do you have a number where you think that we would have adequate safety, yet at the same time be able to give some of these community banks some relief?

    Mr. SHEEHAN. Well, I referred in my testimony that probably 1.5 percent seemed to make sense, but, obviously, this is just an insurance computation, and it could easily be analyzed and there could be a number arrived at that really has fact in base to support it.

    Mr. RILEY. Mr. Johnson.

    Mr. JOHNSON. Yes, sir. Although my board hasn't authorized this—I was just advised don't go too far out here. But we think something in the 1.35 to 1.41, 1.42, 1.43, remembering that the FDIC today, on its own authority, can create a special reserve without checking with anybody else, and that does not count in the total. So if they saw a problem that wasn't recognized on the risk base, that money is pulled out. So all of us need to remember that when we're talking about that number, that DRR and now a cap, that cap would not include that special reserve.
 Page 54       PREV PAGE       TOP OF DOC

    Mr. RILEY. Well, it just seems to me that the logical opinion would be any time you can move it up—you certainly should be able to move it down, and it's something like we were having a debate today on our surplus, whose money it is and what do you do with it. I think the similar logic or philosophy should apply here.

    Mr. JOHNSON. Yes, sir.

    Mr. RILEY. Mrs. Maloney.

    Mrs. MALONEY. Thank you, Chairman Riley.

    I'd like to ask you the same question that I asked the previous panel, and that is that we've recently passed sweeping legislation that will increase consolidation and financial services through the H.R. 10 financial modernization bill. While the insurance funds and economy are currently strong, shouldn't Congress wait to enact deposit reform beyond a merging of BIF and SAIF until we have a better idea of how the industry will evolve after this sweeping and important financial modernization enactment?

    Mr. JOHNSON. Are you directing that to me?

    Mrs. MALONEY. Yes. I'd like to ask all of you to comment on that.

    Mr. JOHNSON. Thank you so much.
 Page 55       PREV PAGE       TOP OF DOC

    I think, as I recall the hearings over the past many years, but particularly over S. 900 and H.R. 10, that there was a considerable discussion on safety and soundness issues and that the regulators, by and large, were in support of the financial modernization. In fact, they felt like they were moving forward on safety and soundness by allowing diversification in product lines, but at the same time for these separate subsidiaries in the new financial services holding company, that capital must be separated from the bank's capital.

    Again, you go back. Is that bank still well-capitalized? If not, its insurance premium goes up.

    So there was tremendous safety and soundness input from the regulators and support: and I think firewalls and capital were built in.

    I think we should not say, ''Look, we couldn't do anything with this,'' because anything we do is certainly always subject to that immediate withdrawal and creating a loss reserve.

    But I would suggest that that was looked at and examined very carefully and signed onto, to my best knowledge, by the regulators.

    Mrs. MALONEY. Would anyone else like to comment?

    Mr. SHEEHAN. I think the financial modernization that is referred to basically amalgamated, if you would, the majority of the financial charters much closer together. I think the issue we're talking about today—and that is the merger of the BIF and the SAIF fund—from your standpoint makes a lot of sense to have a stronger insurance fund that is undivided, as opposed to divided, because if there is a crisis in some portion of the financial industry in the future, you'd rather call on the full $40 billion worth of funds, as opposed to $10 billion over here or $30 billion over here.
 Page 56       PREV PAGE       TOP OF DOC

    And, by the way, you'll be forced into it in time if that really would happen, so you're better off having an insurance fund that covers all FDIC insured institutions.

    From the public's point of view, they believe that to be true, anyway.

    Mrs. MALONEY. Yes.

    Mr. FITZGERALD. And, by the way, 23 percent of my funds are insured by BIF and 77 percent are insured by SAIF. Do you think depositors have any understanding that their funds are insured by one or the other? They don't. They don't have a clue.

    So I think the issue we're dealing with today, should the funds be merged, the reality of it is yes.

    Mr. SHEEHAN. Yes. I think there is a reality to the Gramm-Leach-Bliley and the fact that there will be continued consolidation, there will be more and more combinations that will create situations like the Merrill Lynch situation. They've obviously figured out that they can be much more competitive in the market by offering FDIC insurance—$200,000, $500,000, whatever that happens to be.

    Today, my customers in my town have to go to three different banks or two different banks to get that $200,000. Believe me, they are still insured funds. The problem is the customer has to run around the community, find different banks to create that same deposit level that he had twenty years ago when that money was insured at the same economic limit.
 Page 57       PREV PAGE       TOP OF DOC

    It doesn't make a lot of sense to force the consumer to have to find different banks in order to gain that deposit insurance when he really wants the relationship with us.

    Many of my customers have deposits far in excess of the deposit limit. They actually trust us more than the FDIC does or the Congress does. They feel that they can put the money in the bank, but Congress is worried that they would increase the limit to $200,000, that would create additional risk. That's really not the case.

    Those funds are insured today, they will continue to be insured today. The difference is they will be insured in a community bank and not necessarily in a large bank that's ''too big to fail.''

    Mrs. MALONEY. Mr. Johnson, in the ICBA's testimony Mr. Sheehan indicates that larger banks may have a competitive advantage because large banks' deposits are already assumed to be covered by the Government up to any amount. They are all ''too big to fail.''

    Could you please comment on his comment?

    Mr. JOHNSON. The ABA has always opposed the ''too big to fail'' concept, but we are not so sanguine as to say that law has been repealed. But our policy has been that the ''too big to fail'' is not the appropriate concept, but, again, the systemic failure exception is in there and you could make a case that large banks could have somewhat of a competitive advantage. The case could be made.
 Page 58       PREV PAGE       TOP OF DOC

    Mrs. MALONEY. Yes. Would anyone else like to comment?

    [No response.]

    Mrs. MALONEY. OK. In the past, I've supported efforts before this subcommittee to prevent the 1.25 designated deposit ratio from being increased. I'm not now personally convinced that any one number must be absolute, but I do believe that we should err on the side of caution.

    Also, I see some tremendous administrative difficulty in distributing any potential refunds. Since the funds were recapitalized, 814 new banks and thrifts have been chartered.

    Mr. Johnson, or any one of you, could you address the difficulty in addressing any refunds, given that the simplest way to distribute refunds would be on the basis of current deposits?

    Mr. JOHNSON. Yes, ma'am. I think what we're looking at from the ABA standpoint was setting a cap. It's not as if there would be money sent back to anybody at this point, but a cap for future.

    I'm not informed enough to know how that money would be distributed or how that would go back. I really am not well enough informed to direct that. But we're not looking to take money out of the fund now. We're saying put a cap, and then for future accruals above that should be some fair method of rebate.
 Page 59       PREV PAGE       TOP OF DOC

    Mrs. MALONEY. Any other comments on this?

    Mr. FITZGERALD. From the ACB's point of view, I think the issue is: should there be a cap? And our feeling is yes. It really has to be determined at what point there is sufficient dollars, and at that point it would be easy to compute out how it should be distributed back, I think, to the insured institutions. But that time is into the future.

    As I indicated in my testimony, it's 2003 before you get to 1.5, and you're going to see a lot happen in those next three years in the financial sector.

    Mrs. MALONEY. Mr. Sheehan.

    Mr. SHEEHAN. Yes. I don't think it's something that deserves a lot of discussion. You're absolutely right—it would be a nightmare to try to figure out how to do it and to do it equitably.

    There's a new bank that just came into the system. Do they deserve an equal amount of rebate? Should it be based on the length of time in the system? I mean, there's all kinds of things that could create inequity in any kind of rebate program.

    We've talked about rebates at various other organizations that I'm part of, and it does become a very, very dicey issue.

    I think the other panelists are correct, you know, where 1.5 percent—we thought 1.25 was a pretty good number. It was established as a number that made sense when it was established. If they come up with another number, I think that may be fine. But, obviously, we're getting into an economy that there could be more risk, and we certainly don't want a repetition of the 1980's.
 Page 60       PREV PAGE       TOP OF DOC

    Mrs. MALONEY. Thank you very much.

    Chairwoman ROUKEMA. [Presiding.] Thank you.

    Dr. Weldon.

    Dr. WELDON. Thank you, Madam Chairwoman. I didn't have any questions. I just did want to thank you for calling this hearing, and particularly the very well-balanced makeup of the three panels that you've included. I was particularly pleased to see that we were getting some input somewhat from the outside from the academic community in the third panel, but that comment is in no way intended to deprecate the relevance of and importance of the input we've received from the first and the second panel, particularly the gentlemen representing the industries before us right now.

    The only other thing I'd like to add is I would agree that the timing to do something like this perhaps couldn't be better, and that if we can work through all of the various nuances of this I think it would be in the best interest of the taxpayers that we move ahead on this.

    I yield back the balance of my time.

    Thank you, Madam Chairwoman.

    Chairwoman ROUKEMA. Thank you.
 Page 61       PREV PAGE       TOP OF DOC

    Mr. Watt.

    Mr. WATT. Thank you, Madam Chairwoman.

    I wanted to apologize to these witnesses for not being here for the entirety of their testimony, and to the first panel for missing their testimony entirely.

    I'm with Dr. Weldon. I'm anxious to hear the third panel, the folks who theoretically, at least, don't have a dog in the fight on one side or the other, either as regulators or as regulated.

    I suspect that my bias on this issue will start to show itself in the next couple of weeks, because Mr. Lucas and I are working on a revision to his bill, and so I think I will pass on asking questions of this panel and look forward to hearing the testimony of the next panel.

    I'll yield back. Thank you.

    Chairwoman ROUKEMA. Thank you.

    All right. Well, again, I would simply conclude by saying that there is great merit in what you say. I facetiously said you are both right, but that's another way of saying there's great merit on all sides of these arguments. I think the safety and soundness question has got to be paramount in our mind. Attendant to that is also how we can get the best back into the economy by this policy—not only in safety and soundness for the taxpayers, but also to do the best for the economy in terms of your investors interest and your appeals in your own community and your activity in your own communities.
 Page 62       PREV PAGE       TOP OF DOC

    So we shall take what you have said under advisement. As I stated, there may be some follow-up questions that we will be submitting to you in writing, particularly in the face of what the third panel has to say, the academics' approach to the subject.

    We thank you very much. Again, under the rules, if you have further additions to your testimony, you are welcome to submit them for the record.

    Thank you.

    Mr. JOHNSON. Thank you very much.

    Mr. FITZGERALD. Thank you, Madam Chairwoman.

    Mr. SHEEHAN. Thank you.

    Chairwoman ROUKEMA. Thank you.

    Are the other panelists here?

    I thank you, and we welcome you here on behalf of the subcommittee. Let me introduce you in the order in which you will be testifying.

    Mr. Isaac, Chairman of The Secura Group, has been involved in the financial sector for over thirty years.
 Page 63       PREV PAGE       TOP OF DOC

    You must have been a boy when you started, Mr. Isaac.

    Among his experience is eight years in service on the FDIC Board of Directors, so that brings you here with some credentials. And he was, for five years, Chairman of the Board from 1981 to 1985.

    We certainly welcome you back, Mr. Isaac.

    Martin Mayer is a scholar at The Brookings Institution, and he writes extensively about financial subjects. He is not representing any institution here today, but he is giving his own important perspectives, based on the experience he has had individually and with his association with Brookings.

    Professor Ken Thomas of The Wharton School at the University of Pennsylvania, we welcome you here today. I understand that you have taught banking and economics at The Wharton School, a highly distinguished school, since 1970, and have also served as a consultant to banks and thrifts throughout the years.

    Dr. Thomas, I believe, has a special interest in FDIC issues. I don't know to what we trace that back, or if it has simply been developing over the years, but we're looking forward to your testimony.

    Thank you very much.

 Page 64       PREV PAGE       TOP OF DOC
    With that, Mr. Isaac, will you start your testimony, please?


    Mr. ISAAC. Thank you, Chairwoman Roukema and Members of the subcommittee. It is a pleasure to be here.

    I will respond to the five questions that I was asked to address in my testimony.

    My years at the FDIC, 1978 until 1986, were extremely turbulent for the financial system and the FDIC. We handled hundreds of commercial and savings bank failures, costing billions of dollars, including the largest bank failure in history, Continental Illinois.

    I am a firm believer in the importance of a strong deposit insurance system administered by an independent agency free of undue political pressures.

    I witnessed first-hand how a weak and politicized deposit insurance agency, the Federal Savings and Loan Insurance Corporation, was unable to deal with an obvious and growing problem in the S&L industry. The cost to other financial institutions and taxpayers was staggering.

    With this background in mind, let me address the five questions.

 Page 65       PREV PAGE       TOP OF DOC
    The first one called for my views on merging the deposit insurance funds.

    I support combining the Bank Insurance Fund—the BIF—and the Savings Association Insurance Fund—the SAIF—and merging the Office of Thrift Supervision and the Comptroller of the Currency.

    Combining the funds will create a larger, more-diversified insurance pool, always a desirable goal.

    The BIF stands at about $29 billion, or 1.38 percent of insured deposits. The SAIF stands at roughly $10 billion, or 1.44 percent of insured deposits. The combined fund would total nearly $40 billion, or 1.4 percent of insured deposits.

    Banks and S&Ls are engaged in essentially the same businesses today. According to the FDIC, roughly 40 percent of the deposits insured by the SAIF are in BIF-insured banks. Two of the largest holders of SAIF insured deposits are Bank of America and First Union. The FDIC administers both funds and it has regulatory authority over the member institutions in each fund. Moreover, the SAIF is in good shape today, due in part to the contributions BIF-insured contributions were required to make to restore the SAIF's financial health.

    It would be a mistake, in my judgment, to risk that a stand-alone, insufficiently diversified SAIF would get into difficulty again.

    The second question involved the issue of whether 1.25 percent is enough for the fund and is it appropriate in light of subsequent legislative development such as Gramm-Leach-Bliley.
 Page 66       PREV PAGE       TOP OF DOC

    It is important to understand that there is no deposit insurance fund. The FDIC collects premiums—taxes, to be more precise—from banks and thrifts and turns them over to the Treasury. If the FDIC collects more taxes than it spends, the surplus is counted toward a reduction of the Federal deficit or an increase in the surplus.

    The Treasury computer duly records the payments made by the FDIC. The money itself, being fungible, is spent on welfare, defense, education, and the like. Should the FDIC need money to handle a failure, the Treasury borrows the money in the market and the outlay by the FDIC counts as an increase in the Federal deficit.

    The object in collecting premiums from banks and thrifts is not to build a fund, but to ensure that over time deposit insurance program pays for itself.

    The so-called ''fund'' is simply a running score card to determine whether banks and thrifts have paid in more than they have taken out.

    It is difficult to know how to respond to the question of whether an imaginary fund should be maintained at an arbitrary 1.25 percent of deposits. The question for me is whether the banks and thrifts have borne the cost of the deposit insurance system.

    I believe they have and should not be required to pay more, absent compelling arguments to the contrary.

    We are all aware of the breakdown in public policy that led to the thrift crisis and created huge losses for the old FSLIC and taxpayers. Putting aside that massive and inexcusable public policy failure, the deposit insurance system has withstood the test of time.
 Page 67       PREV PAGE       TOP OF DOC

    Banks have contributed, including interest, some $29 billion more to the BIF over the past sixty-five years than has been expended to cover the FDIC's operating expenses and the cost of bank failures.

    This record is remarkable when one considers that from 1981 to 1992, much of which period I was at the FDIC, the FDIC handled the worst banking crisis since the Great Depression.

    The FDIC made it through this period without costing the taxpayers a dime. The fund went negative on paper for a short period in the early 1990's, only because the GAO required the FDIC to create nearly $15 billion in excess loss reserves.

    I do not believe a compelling case can be made for increasing the non-existent fund beyond 1.25 percent of insured deposits. I understand that Congress set that level in the early 1990's because 1.25 percent was the average ratio of the fund to insured deposits during the FDIC's first fifty years.

    Several things have changed since then to suggest a lower level might be more appropriate.

    Recently enacted nationwide banking should reduce materially the number of failures, as banks diversify geographically and as they become takeover candidates whenever they encounter problems. About 85 percent of failed bank assets during the 1980's were lodged in just four states that suffered severe regional economic downturns.
 Page 68       PREV PAGE       TOP OF DOC

    One of the best protections for the FDIC is that deposit insurance premiums are now on a pay-as-you-go basis, unlike the period when I was running the FDIC. There is no longer a maximum premium that banks and thrifts can be assessed. The FDIC is required to levy whatever premium is necessary to cover losses and to maintain the fund at 1.25 percent.

    We now have in place a national depositor preference law. This law gives the FDIC a higher priority claim against a failed bank's assets and is expected to reduce the FDIC's losses. Congress should consider amending this law to give preference to insured deposits. This would reduce substantially the FDIC's exposure to losses and would enable the FDIC to resolve the failures of very large banks at little or no cost.

    Some people argue that the early intervention law requiring regulators to close down a bank or thrift while it still has positive capital will reduce the FDIC's losses. I have serious reservations about that. I fear that tying regulators' hands in this fashion will someday haunt us.

    If the FDIC had been forced to observe mark-to-market accounting, which many people are advocating today, and early intervention rules in the 1980's, its losses in the savings bank industry, alone, would have been measured in the tens of billions of dollars instead of the minimal $1.8 billion we actually lost.

    Moreover, agricultural bank failures might well have been measured in the thousands instead of the hundreds, and several money center banks undoubtedly would have required intervention.
 Page 69       PREV PAGE       TOP OF DOC

    Arbitrary early intervention requirements will likely exacerbate the FDIC's losses when systemic problems arise. Regulators should be able to use judgment when a national or regional economic emergency exists.

    Thrift regulators misused that discretion during the 1980's, with considerable support from the Administration and Congress, but it was put to very good use by bank regulators. If we had not had and had not used that discretion, the economic consequences would have been severe. Stringent early intervention requirements should be abolished.

    Next is the issue of whether the fund ought to have a cap, and I'll just say briefly that I believe it ought to have a cap, and 1.5 percent makes as much sense as any other number, since, as I told you before, there is no fund. So it is fairly arbitrary wherever we set the cap, but there should be a cap.

    I would note that for every $1 billion tied up in that fund that doesn't need to be there—taken out of the banking system and put into that fund—banks are unable to make $10 billion of new loans to support the economy.

    So if we set the cap at 1.5 percent instead of 1.25 percent, an additional $7 billion will be taken from the banking and thrift institutions in the country, which means that they will be able to lend $70 billion less than they would otherwise be able to lend. So I believe that setting the cap at 1.25 percent is preferable to 1.5 percent, and I surely wouldn't go any higher than 1.5 percent.

 Page 70       PREV PAGE       TOP OF DOC
    The issue of rebates—I don't find that controversial. The FDIC paid rebates for years, including while I was Chairman of the FDIC. It's only in recent years that the FDIC hasn't been paying rebates, and so I don't see any controversy there, other than the fact that whatever the FDIC pays out does get deducted from the federal surplus because the FDIC is on-budget.

    Finally, I was asked if I would address any other issues relating to the deposit insurance system, and let me do so briefly.

    As I said earlier, I believe that the OTS and the OCC should be merged. Both agencies employ virtually identical procedures to supervise and regulate institutions under their jurisdiction. Their member institutions are engaged in essentially the same businesses.

    I believe that supervision would be enhanced and costs reduced by combining the resources and talents of these two agencies.

    A side benefit—and I really want to focus on this—a side benefit of combining the OTS and the OCC would be the elimination of one of them from the FDIC's board of directors.

    The FDIC today has a five-member board of directors, three of whom are appointed by the President and two of whom are the heads of OTS and the OCC. Whenever the FDIC board has a vacancy, which is more often than not in recent years, this situation gives the Treasury the ability to control the FDIC and undermine its independence.

 Page 71       PREV PAGE       TOP OF DOC
    A few years ago, for example, the heads of the OTS and the OCC forced the FDIC to abandon its program of participating in examinations of larger institutions and those evidencing problems. The FDIC had implemented this program in 1982 during my chairmanship, and it worked very well for years.

    Due to an FDIC board resolution pushed through by the OTS and the OCC, the FDIC is no longer able to participate in exams of Federal S&Ls or national banks without prior authorization from the FDIC board, which the Treasury is able to block through OTS and OCC.

    The FDIC staff asked for permission to examine First National Bank of Keystone and was rebuffed. It couldn't get it through the board of directors. The subsequent failure of that bank in a small village in West Virginia cost the FDIC almost as much as the failure of Continental Illinois.

    One of the very clear lessons of the S&L crisis is that we need and must maintain a strong, well-financed, and independent deposit insurer. Eliminating either or both of Treasury's two seats on the FDIC board is a critically important reform.

    I also believe that the FDIC should be removed from the Federal budget. The agency was off-budget for over thirty years, until someone figured out that its dollars could be appropriated for purposes for which they were not intended.

    If the FDIC were restored to its off-budget status, its fund would once again become a reality and we could have a meaningful dialogue about its appropriate size and we could debate whether we should eliminate the FDIC's line of credit at the U.S. Treasury, a reform that I favor.
 Page 72       PREV PAGE       TOP OF DOC

    I support other reforms to our deposit insurance system. I will not dwell on them because they are undoubtedly beyond the scope of issues the subcommittee would like to consider at this time.

    Our deposit insurance system has served us well for over sixty years, but it was constructed in a different era for a much different financial system. Federal deposit insurance was conceived in a horse and buggy financial world. The moral hazard presented by the Federal guarantee on deposits was kept under reasonable control by limiting the ways in which financial institutions could get into trouble. Competition was tightly controlled through restraints on entry, restrictions on geographic expansion, controls on deposit interest rates, and tight limits on permissible activities. The FDIC's risks were diffused through some 15,000 banks, very few of which were large and complex.

    Our financial landscape today bears little resemblance to the system of sixty or even thirty years ago. Thousands of institutions have already disappeared through mergers. Only nine of the twenty-five largest banking companies in 1980 still exist today. Global behemoths offer every conceivable financial service.

    One has to wonder how our deposit insurance system will cope with serious trouble if one or more of these mega-institutions gets into difficulty, or whether it should even try.

    One has to wonder why some mega-institutions are part of the Federal regulatory insurance apparatus, while others are not. What, for example, would the FDIC be able to do if CitiGroup got into serious difficulty? CitiGroup, at nearly $800 billion in size, towers over the $29 billion FDIC fund.
 Page 73       PREV PAGE       TOP OF DOC

    Most of CitiGroup's operations are abroad. Most of its activities are not traditional banking. And only a handful of its liabilities are FDIC insured.

    If it is determined that the FDIC should involve itself in the likes of CitiGroup, how about Prudential, Merrill Lynch, or AIG? These companies are very big and very important. Their failure would be at least as catastrophic as the failure of a major bank.

    I believe it is time for Congress to examine the structure and function of the Federal safety net and regulatory apparatus. What should be the function of deposit insurance in our modern world? What kinds of institutions should be covered by bank-type regulation and by deposit insurance? Are some too big and too complex to be included in this system? Should there be a separate system for very large and complex institutions? How can we enlist the private sector to a greater degree in reducing the moral hazard of deposit insurance?

    These are but a few of the important questions that come to mind whenever I reflect on our new financial system. We have not even identified all the issues, much less developed a plan for addressing them.

    Thank you again for inviting me to be here with you today. I look forward to returning someday soon so we can discuss some of the larger reform issues that we really need to address.

    Thank you.

 Page 74       PREV PAGE       TOP OF DOC
    Chairwoman ROUKEMA. Thank you, Mr. Isaac.

    Yes, you certainly have outlined an agenda for maybe the next ten years. Well, I'm not predicting how many years ahead, but you certainly have looked at the new financial conglomerations that are out there in the real world. I appreciate that.

    Mr. Martin Mayer, we welcome you here today. We're very anxious to hear your comments.


    Mr. MAYER. Thank you.

    I would like to begin with commenting on what a few people have said at this table earlier, and particularly on the point of the Merrill Lynch bank being able to sweep a lot of money into insured deposits. That clearly is a bad idea. There should be some way in which new institutions pay their dues to get into this system.

    Now, the FDIC, of course, has recently said that the very-rapidly growing institutions would be subjected to premiums on the grounds that historically rapidly growing institutions get in trouble—while this does not really apply to the situation we're talking about with Merrill Lynch, nevertheless, something of that sort clearly so that people do not get free insurance, do not get a free put option.

 Page 75       PREV PAGE       TOP OF DOC
    The subject of deposit insurance seems to me a very important one, and I don't think it is well understood, in general.

    Professor Milton Friedman and Anna Schwartz considered it the most successful program of the New Deal. The FDIC, under Bill Siedman, promoted it as a merit good, a costless activity that promoted the public welfare. Because its obvious function is to pay depositors when the bank can't, it is usually discussed as a benefit to depositors, and, of course, as a preventative against bank runs.

    To the extent that the insurance does benefit depositors, they pay for it in the difference between the interest they earn on insured deposits and the interest paid by alternative instruments that are not risk free.

    And the systemic benefit from the end of bank runs has a price in the moral hazard that permits these institutions to build up large losses that must then be borne by others.

    The everyday benefits accrue to the stockholders of the depositories, who are able to borrow other people's money more easily and more cheaply.

    The cost borne by these stockholders in these institutions is the irritation of intrusive rules, examination, and supervision by various Government agencies.

    I note in passing that the big banks opposed deposit insurance in 1933 and their representative at Congress for that purpose—he sat in on the committee hearings—was George Moore, who was then assistant to the president of National City Bank of New York and later the first Chairman of Citicorp, now CitiGroup. I helped George write his memoirs. The objection to deposit insurance, he said, was that the competence of bankers is not an insurable risk.
 Page 76       PREV PAGE       TOP OF DOC

    Seen through the wrong end of the telescope, as one institution among many, deposit insurance is most usefully regarded as a put option that entitles the owners of the depositories, the purchasers of the option, to sell their assets to the Government for whatever price may be required to fill a hole between the banks' deposit liabilities and the market value of the assets on their books.

    In this analysis, it is not unreasonable that any growth in the insurer's surplus should be taken into revenues by the Government, as option writers generally take into income the receipts from selling them, or that the Government should stand ready to advance money beyond the resources of the insurance fund in times of unanticipated volatility. Options writers are at greater risk than their algorithms define.

    The key fact is that the liabilities of depositories are the currency of the country. Judge Oliver Wendell Holmes, Jr., wrote, in upholding State deposit insurance laws in 1911, that ''The primary object of the required assessment is to make the currency of checks secure.''

    People's confidence in the currency is a function of their belief that there are more than enough assets in the vaults of the issuer to cover the asserted value of the circulating liabilities. Thus, for centuries there was a requirement that the issuer of paper money have enough precious metals in his vaults to cover some significant fraction of the face value of the money.

    In the United States, the requirement that Federal Reserve notes be backed by gold worth 25 percent of the total issuance, with gold valued at $35 an ounce, survived until 1968, and was removed from the law after frantic efforts by William McChesney Martin only with a two-vote margin in the Senate.
 Page 77       PREV PAGE       TOP OF DOC

    In an economy where most money is expressed by balances in bank accounts, the Government must—it's not a question of ''too big to fail,'' as I once thought. The Government must be prepared to cover bank liabilities.

    If you look at the Asian crisis of a couple of years ago in countries where they did not have deposit insurance, you find that one of the first reforms that was put in during the crisis, with IFM support—to its own surprise in Indonesia—was deposit insurance in order for people to continue to have the use of their money.

    In the end, the traditional economist argument that uninsured deposits provide a buffer for the insurance fund is simply wrong. With the exception of anomalous situations, in general they will find a way that the checks can be cashed.

    In the end, all deposits, defined here as bank liabilities that can be cashed by their holders without reference to market prices, will have to be covered because they, too, are part of the currency.

    In the words of Andrew Sheng, who was deputy governor of the Hong Kong Monetary Authority when he said them, ''The losses of a decapitalized banking system are an implicit fiscal deficit.''

    The deposit insurance funds are a way to reserve some of the capital of the banking system to reduce the likelihood that public monies will have to be committed when the decapitalization is local rather than system-wide.
 Page 78       PREV PAGE       TOP OF DOC

    For this purpose, as we somewhat bitterly recognized in the early days of the Bush Administration, when the losses of the S&Ls were first admitted, there is no difference between banks and thrifts, especially since Congress decided in 1980 that thrifts could offer transaction accounts and in 1991 that prompt corrective action should be taken against both money-losing banks and money-losing thrifts before their capital disappeared.

    Because the rationale for deposit insurance applies equally to banks and to thrifts, and because there is now enough money in both BIF and SAIF so that no immediate obligations would be incurred by anyone, there is no reason today to maintain separate insurance funds. And I would agree with Bill and with other people at this table that OCC and OTS do not have to be maintained as separate institutions, either.

    It is somewhat more difficult to answer the question whether the funds should be capped at 1.5 percent of deposits with rebates to the insured when the funds are above that level. The point by Mr. Baer that we don't want to pay people to take risks is, I think, a very good point. But the number would seem to me to be correct.

    The New York Clearinghouse requires a 1.5 percent deposit against the maximum uncovered entry permitted to a participant in chips, and the Clearinghouse of the Chicago Mercantile Exchange accepts 1.5 as the minimum gross margin for Clearing members. So the feeling among people who are watching huge quantities of money wash through is that this provides—and in the case of the Clearinghouse, it meets all of the ''Lamfalussy'' requirements—indeed, the second level of them. But 1.5 would seem to me, on the basis of what other people are doing in finance, to be a reasonable number.
 Page 79       PREV PAGE       TOP OF DOC

    Rebating to the insured is a little tricky because there can be two views of who owns the fund. In modern economic theory, the residual risk-taker is the owner and is thus entitled to any windfall gain.

    The Government, as the residual risk-taker, therefore would seem to have the right to recycle for its own benefit, as part of a debt reduction drive, the interest on its bonds that it would otherwise be asked to pay to the banks and thrifts as rebates.

    Nevertheless, I would support a cap and even distribution of the earnings above that cap for fear that a larger insurance fund would encourage extension of the safety net to non-depository activities of the banks and non-banking affiliates in the financial services holding company.

    Both Paul Volcker and Gerald Corrigan testified in the 1980's of their concern that banks permitted to engage in commerce would be unable to maintain the firewall separating the insured institutions from the rest of the enterprise.

    I know the law intends to separate out the larger group of uninsured activities from the banking activities, but the road to forbearance is paved with such intentions.

    We also have in the new law an obscure phrase about ''complementary to finance'' activities in which the financial services holding company can participate. I wish you would revisit that one ASAP.

 Page 80       PREV PAGE       TOP OF DOC
    The point was made to me—indeed, by a former vice governor of the Fed the other day—that, since financing the purchase of automobiles is finance, then presumably the sale of automobiles is complementary to finance, and a regulator who wants to be a nice guy can say, ''Sure, you can own an automobile dealership'' to a bank, because it is complementary to finance. It's a bad phrase.

    I've been trying to find out who put it in. If anyone in the room knows, I would be delighted to know later. It wasn't in the draft that went into conference.

    Anyway, that presents a heightened risk of major losses outside the normal banking franchise, and the associated risk that supervisors possessed of a very large insurance fund and terrified of possible publicity of the negligence which had made the disaster possible will find that depositor preference still leaves enough cloth to hide the dirt.

    Back in the days when derivatives were new and small, Mr. Siedman implied that the FDIC would stand behind member banks' swap obligations. The recent testimony of Mr. Greenspan and Mr. Summers to the Senate Agriculture Committee appears to argue that they are willing to put the safety net under the derivatives transactions of our biggest banks—CitiGroup and Company—as they did implicitly in September, 1998, in the LTCM fiasco.

    At best, the ''legal certainty'' they assert for derivatives pays out the derivatives contracts first, in violation of depositor preference. And the fact that no supervisor knows the extent of the open interest in fashionable derivatives contracts written behind closed doors escalates the risk to bank insurers if these instruments are treated as though they were on all fours with repurchase agreements.
 Page 81       PREV PAGE       TOP OF DOC

    Incidentally, the municipal deposit problem I should think could be solved pretty easily through repurchase agreements or through the complete separate collateralization of these things, since the municipal parties are not engaged in providing money for the banks to lend to commercial entities.

    The law should be rigidly written to prohibit the use of deposit insurance funds to pay off non-deposit liabilities inside the United States and deposit liabilities in off-shore branches and affiliates, which was done in the case of the National Bank of Washington, where every depositor in the Bahamas Branch was made whole.

    This does not mean that we must follow a sink-or-swim policy with reference to what the Fed now likes to call ''LCBOs,'' large, complex banking organizations. It means we should rethink the role of the deposit insurer and the central bank in the new century.

    I agree with Bill. We've got to rethink it. I disagree with him about where we ought to be going.

    Let me put out a thought I am in the process of developing—that in the modern world the deposit insurance fund is the lender of last resort to the banking system because of the role of deposit insurance in maintaining the security of the currency, but the central bank is the lender of last resort to the market, maintaining liquidity when panic regurgitates offers and swallows bids.

    In the course of this process, the deposit insurer may have to borrow from the central bank, as indeed the FDIC did from different Federal Reserve district banks in the Continental reconstruction and the First Republic rescue. But that borrowing should be a matter of public record, requiring the assent, probably, of the Secretary of the Treasury, as FDICIA implies.
 Page 82       PREV PAGE       TOP OF DOC

    Similarly, the central bank, the Fed, pouring money into the system through open market operations to assure the liquidity of the markets in crisis, will need help from the charterers and examiners who live closer to the banks, themselves. This is not a new story. Benjamin Strong, in 1916, recalled his experiences as J.P. Morgan's point man in the Knickerbocker Trust failure of 1907, ''I fear we must calculate that the American banker, by and large, will do in future emergencies just what he has done on similar occasions in the past. He will gather up every dollar of reserve money that he can lay his hands on and lock it up so tight that the reserve banks will never get hold of it until the crisis is past. Frankly, our bankers are more or less an unorganized mob.'' They become a mob in a time of trouble, which is why you need insurance.

    Without Gary Corrigan and Si Keehn to persuade the banks to support the market-makers in 1987, we would not have got out of the 1987 market crash with so little damage.

    That was ad hoc, and I suppose all crisis management is, in the end, ad hoc, but an established sense of who should be responsible for what would be very useful.

    The work of financial modernization is by no means complete. We can improve our understanding and planning capacity if we accept the division of function between the deposit insurer and the central bank, recognizing the banks as a special case rather than as the central concern in an age where mutual funds, alone, are a larger source of financial intermediation than all the banks.

    Deposit insurance will perform its role more effectively if the central bank, as an institution, concentrates its attention more heavily on the markets—an attention that should include more careful and transparent supervision of the creation and sale by the banks of marketable paper and of off-balance-sheet derivative instruments.
 Page 83       PREV PAGE       TOP OF DOC

    Thank you.

    Chairwoman ROUKEMA. Thank you, Mr. Mayer. I appreciate that. You've gone far beyond the immediate question of today, but——

    Mr. MAYER. I got asked the last paragraph. What else do you want to say?

    Chairwoman ROUKEMA. But you've pointed in a direction that is certainly questions that are properly being opened up with this new financial world that we're looking at.

    I'm not quite sure that we're at that point yet that we can address all those problems, but you are pointing us in the right direction.

    Dr. Thomas, please.


    Mr. THOMAS. Thank you, Madam Chairwoman. And thank you to your excellent staff, especially Pat McCarty, who is so knowledgeable on these issues and who has been very helpful in my preparation of this testimony.
 Page 84       PREV PAGE       TOP OF DOC

    I was recruited by the FDIC to go to work for them back in the early 1970's. I have been an avid student of theirs since then. Whenever an issue comes up about the FDIC I always turn to one of my favorite collectibles. This is a hard-back version of the original 1934 annual report. It says very clearly at the introduction that the purpose of FDIC is to insure depositors—not insure banks, but to insure depositors. That's the perspective I'm taking this morning—that of a bank depositor.

    Let me also say that I thank you very much for holding these hearings. I disagree with the view that, because we have GLB, we have to wait and digest it before anything else happens. I ask: how can we modernize our financial system without modernizing the insurance fund and modernizing our regulators? They need to be done all together. Just look at what happened yesterday with Merrill Lynch, as it was reported. The FDIC found itself in a position of reacting instead of proactively acting.

    Regulators and insurers should not have to play catch-up and react to banks. They need to be modernized now, and the proposals that you have set out to debate will help us in that regard.

    I would like to summarize my response to your questions by giving you the same answers I gave when I testified here exactly five years ago in March of 1995.

    First of all, I believe that we definitely should have the funds merged, as I said back in 1995. Everyone agrees with that, and I've got seven reasons documented in my testimony. I won't go into them.
 Page 85       PREV PAGE       TOP OF DOC

    However, I can say that on the rest of my recommendations, I will probably disagree with most of the other panelists.

    Back in 1995, I recommended that we increase the designated reserve ratio to 1.5 percent. Representative LaFalce at the time endorsed that. It was on the front page of the American Banker. The ABA, to quote them, was ''outraged'' by that suggestion. However, today, five years later, all of us are freely using the 1.5 number.

    It makes a lot of sense—and I have fifteen reasons in my testimony why. But, most significantly, we were at 1.24 back in 1981 and it didn't work. The fund became negative.

    Most recently the FDIC declared that it lost money in 1999, the first time since 1991, because of the failures.

    Most importantly, we have to ask: where did this magic number come from? If we look back to the 1980 DIDMCA—and the FDIC states this—it was an average over the period of 1934 to 1979, an average reserve ratio.

    Well, I went back and recalculated that using data that's in the 1998 annual report of the FDIC, and I found that someone made a mistake, Madam Chairwoman. If you calculate the average ratios from 1934 to 1979, it was not 1.25, the magic number, it was 1.425. Either someone left out the four or it was just a mathematical error. The true number we should be dealing with, the magic number, should have been 1.425, or 1.43, maybe rounded off to 1.45 or 1.5. Then we wouldn't be here arguing about this because we would have been at 1.5. The fund would never have been in a negative position in the first place.
 Page 86       PREV PAGE       TOP OF DOC

    As in 1995, I also would recommend today that we should build the fund without any cap, without any rebates, period, just as a private insurer would do the same thing and, as Representative Riley stated, just as a conservative politician would use the budget surplus to pay off the debt.

    My other recommendations I'd now like to summarize briefly.

    Number one, I would merge the OTS into the OCC, and I would consider that a first step.

    We've had many presidential and other banking commissions that have recommended the consolidation of all Federal banking regulators into one Federal regulatory agency. Although we may not be ready for that, we are not ready for a continuation of charter shopping, and we saw that just last week when the comptroller went to Tennessee to persuade a bank not to switch charters.

    Number two, on the issue of ''too big to fail,'' this is a tremendous advantage for about the twenty-five biggest banks, as Gary Stern at the Minneapolis Fed has stated. I would recommend that there be a special assessment of approximately perhaps three to eight basis points on the assets of those twenty-five ''too-big-to-fail'' banks. Also, when you walk into them you not only would have the FDIC sticker, but you also would have a sticker that says ''TBTF,'' or ''too big to fail.'' They would pay for that privilege, which they are not paying for now, in the form of a special assessment. Again, kind of an extreme proposal, but, like those I made five years ago.
 Page 87       PREV PAGE       TOP OF DOC

    My third recommendation would be for more market discipline, and the best way for that, in my opinion, is greater public disclosure, even to the point of disclosing each bank's safety and soundness ratings, and the FDIC nine risk assessment profiles. I would not disclose the FDIC problem list. I think we are at the point now, as we've seen from other areas, that it would not be ''stampede-ish'' to disclose what I have proposed.

    Number four—and this is most important—I would increase the amount of regulatory and supervisory discipline. Recent failures, especially Keystone—I've heard the term ''Keystone cops''—and the Bank of New York money laundering, were supervisory lapses, to a very great extent.

    We need a better-trained, more-comprehensive examination force, because we now have three industries, not just one, that are going to be involved, counting the insurance industry and the investment banking industry.

    In the report that GAO did based upon your recommendation, where they compared the risk evaluation procedures of the seven largest banks, it showed tremendous differences between the OCC and the Fed as to how they do their examinations. There shouldn't be that inconsistency. There should be a common approach, especially for the larger organizations.

    Finally, I would like to make a general point, especially as a depositor. There should be greater disclosure as to what is and what is not FDIC insured.

    I got a call from my mother-in-law a few weeks ago as I was preparing my testimony, and she said, ''Ken, look at this tremendous 10 percent APR rate being offered on a two-year CD. We've got to take advantage of that.'' I went to look at it. I was very interested. Then, in the very, very small print, I noticed, ''Not insured by the FDIC.''
 Page 88       PREV PAGE       TOP OF DOC

    Here, in three-inch print we have the 10 percent. These are subordinated notes of an FDIC-insured bank. The 10 percent is 44 times larger than the ''not FDIC-insured.'' She was ready to make the purchase, and I was, too, until I looked with my new bifocals and said, ''That's right. These are not FDIC insured.''

    As we move into this new era there are going to be a greater amount of people trying to get FDIC coverage. There's going to be more confusion, especially with a lot of our seniors. We must be very clear as to what is and what is not insured and, most importantly, as we said back in 1934, to protect the depositor.

    Thank you very much.

    Mr. MAYER. I guess they let Charlie Keating out of jail again.

    Chairwoman ROUKEMA. I'm sorry. We didn't hear that, Mr. Mayer.

    Mr. MAYER. I'm sorry.

    Chairwoman ROUKEMA. Or weren't we supposed to hear that?

    Mr. MAYER. I guess they let Charlie Keating out of jail and he went right back to the sale of lobby notes. It's really so shocking that that's happening.

    Chairwoman ROUKEMA. All right.
 Page 89       PREV PAGE       TOP OF DOC

    Well, I don't quite know where to begin here. I did note, of course, that I think each one of you made reference to the Keystone failure. Of course, all of you discussed the Merrill Lynch situation also. You do understand, without talking about OTS and OCC, because we'll put that aside for the moment, but I want, with specificity, how we can—and particularly from Mr. Isaac, as well as Mr. Thomas, Isaac from his experience and Thomas from his statement in his testimony here—I want to know how we deal with the obvious failure of Keystone and the failure of OCC and FDIC to work together.

    Based on your experience, how do we do that? And, based on your academic perspective and your experience, how do we put that into legislation which would merge the funds, with or without the caps and the rebates. You've said that there are total inconsistencies in the regulators' approaches to things? Can you give me a little specific help here, recognizing that we're not going to be able to rewrite, at this point in time, the whole regulatory structure, but in the context of what we're focusing on here, merging the SAIF and the BIF. Can you help us?

    Mr. ISAAC. Actually, we had the agencies working together very well beginning around 1982, when we got surprised by some very large losses in national banks, and I insisted that the FDIC was going to accompany the Comptroller's office and the Fed when they went into their banks if they were larger banks or if they were banks evidencing some kind of trouble.

    The FDIC has that authority today to do that. It doesn't require——

 Page 90       PREV PAGE       TOP OF DOC
    Chairwoman ROUKEMA. Excuse me. There evidently must be some weakness in the law or this wouldn't have happened.

    Mr. ISAAC. Well, let me——

    Chairwoman ROUKEMA. A statutory change may be necessary. Yes?

    Mr. ISAAC. I'll tell you how it got messed up, and it got messed up fairly recently.

    We were going into these banks together. It was still their exam, but the FDIC had people involved in the exam process, so it didn't increase the burden on the banks at all, but we got the insurers' perspective represented in the institution.

    That worked real well for about a decade, when the Comptroller of the Currency and the head of OTS, at a time when the FDIC had vacancies on its board, they were in control of the FDIC board at that time, and they caused the FDIC board to adopt a resolution which states that the FDIC examiners can no longer go into national banks or Federal S&Ls or Fed member banks without prior permission from the FDIC board of directors.

    Chairwoman ROUKEMA. And what year was that?

    Mr. ISAAC. Within the past three or four years that happened.

    Chairwoman ROUKEMA. OK.
 Page 91       PREV PAGE       TOP OF DOC

    Mr. ISAAC. And that resolution remains on the books today because the FDIC still doesn't have a full complement of board members and they can't overturn it. So the FDIC staff asked for permission to go into Keystone. The board of directors of the FDIC refused the permission.

    And so the answer is, if we wanted to make a very simple statutory change, and Chairman Leach has proposed this in legislation, and that is——

    Chairwoman ROUKEMA. And I'm a co-sponsor of that legislation. I did want you and the other witnesses to discuss that proposal with as much specificity as you can.

    Mr. ISAAC. That's absolutely right. Give the FDIC chairman the ability to make that decision. We should not politicize that decision. The FDIC chairman is responsible for the agency and the allocation of its resources. The chairman should have the authority to send the troops wherever they are needed, without having to go to a board that has become politicized.

    Chairwoman ROUKEMA. Dr. Thomas, do you want to——

    Mr. THOMAS. Yes.

    Chairwoman ROUKEMA. Are you familiar with the Leach legislation?

 Page 92       PREV PAGE       TOP OF DOC
    Mr. THOMAS. Yes, I am somewhat. And, more importantly, I am very familiar with the Keystone Bank.

    Chairwoman ROUKEMA. All right.

    Mr. THOMAS. I visited that bank twice in the early 1990's. It is in McDowell County, which is probably, of the 3,000 counties in this country, the poorest. I basically tried to get some public statements from that bank and I was rebuffed. They did not even want to give me the most basic, over-the-counter statements.

    So that's the first thing we have to remember. This bank was run in a very unorthodox way. They were taking out ads with pictures in the Wall Street Journal with the chairman of that bank's board and the Governor of West Virginia bragging about all of their strength.

    This, I think, had an impact on the regulators. They were somewhat intimidated, I believe, by this show of power by the bank.

    I think the biggest issue, though, is when the regulators went in, there was this dispute that Chairman Isaac refers to, and that is very bothersome. That's why I would approach it from kind of a joint perspective, the concept of putting OTS and OCC together. I see no reason why we cannot even take it the next step and have these agencies working much more closely together. In fact, I've even proposed, in areas such as compliance, that all four agencies put their examiners together in one overall agency under the FFIEC. There wouldn't be any type of competing for laxity, as Chairman Arthur Burns mentioned many years ago. They would just go in there and do their job on behalf of the taxpayer.
 Page 93       PREV PAGE       TOP OF DOC

    Chairwoman ROUKEMA. Mr. Mayer.

    Mr. MAYER. I did not know what Bill testified to about the change in the powers of the FDIC. It seems to me very clear that the FDIC, as the insurer, should have the authority to say, ''We want to go in and see what's being done in terms of our insurance exposure here.''

    Chairwoman ROUKEMA. Thank you.

    I have run out of time, but there is one question I absolutely must ask, and I'll ask it of Mr. Isaac. And, by the way, I believe that, if not all of you, certainly Mr. Isaac is in favor of rebates, isn't that correct?

    Mr. ISAAC. Yes.

    Chairwoman ROUKEMA. But I want you to address how do you respond to Chairwoman Tanoue's testimony that says ''the funds tend to grow during good times and fall during bad times. Accordingly, we believe that great caution should govern any consideration of rebates, especially at this stage in the economic cycle''?

    Mr. ISAAC. I guess we approach it very differently. There is no FDIC fund. The money doesn't sit anywhere. It has all been spent on missiles and school lunches and things like that. And if the FDIC needs a dime, it is going to have to borrow it from the Treasury, and the Treasury, in turn, is going to have to borrow it in the marketplace.
 Page 94       PREV PAGE       TOP OF DOC

    So there is no FDIC fund. The question is: how high do we want this non-existent fund to get? How much money do we want to take out of the banking system? For every dollar we take out, that's $10 worth of loans that the banks can't make. How much money do we want to take out of the banking system and out of the private sector and have it sit in a Treasury computer? That's the issue.

    And I don't think that having this fund higher than 1.25 percent is necessary. Certainly, having it higher than 1.5 percent is—I can't imagine why you'd want it higher than that. It's just taking billions and billions away from the economy. Why would you want to do that?

    Chairwoman ROUKEMA. Thank you.

    Mr. Mayer.

    Mr. MAYER. Wouldn't have to borrow from the Treasury, Bill. Bill Seidman borrowed from the Federal Reserve, borrowed from Si Keehn and borrowed from——

    Mr. ISAAC. I believe it was Bill Isaac who did that, not Bill Seidman. Continental was on my watch.

    Actually, the fact is that we didn't borrow from the Federal Reserve Bank; the Federal Reserve Bank had loaned money to Continental, and we assumed responsibility for repaying part of it.
 Page 95       PREV PAGE       TOP OF DOC

    Mr. MAYER. OK. But you didn't have to go to Treasury on it. You were able to do it through——

    Mr. ISAAC. But whenever we needed money, we needed to go to Treasury and get money.

    For example, when we put several billion dollars into Continental, we got that from the Treasury. It was on our account there. But they had to borrow it in the marketplace. There is no fund.

    Mr. MAYER. No, that's right. Clearly there is no fund.

    Chairwoman ROUKEMA. Dr. Thomas, do you want to make a short comment on that?

    Mr. THOMAS. Yes. I totally agree about the Treasury in that I would defer back to the comments made by the Treasury that there should be no rebates. Also, they said there should be no cap, because it is ultimately the taxpayers and the Treasury who stand behind the FDIC, not the banks.

    Chairwoman ROUKEMA. But is your position then that there should be no rebates and no caps?

    Mr. THOMAS. Absolutely no rebates and no caps.
 Page 96       PREV PAGE       TOP OF DOC

    Chairwoman ROUKEMA. So you are satisfied with the current situation?

    Mr. MAYER. I'm perfectly happy to see a cap, because I worry about these large sums which people can allocate, to some degree arbitrarily.

    The rebate question is a sort of trickier one. The Government—I disagree with Bill on they should cancel the line of credit at the Treasury. I think that it is perfectly reasonable that at some points in the business cycle the FDIC is shown as a credit item to the budget and at some point it is shown as a debit item to the budget, because the Government is the ultimate insurer of the deposits because they are the currency of the country.

    Chairwoman ROUKEMA. Thank you.

    Congresswoman Maloney, I thank you for your patience.

    Mrs. MALONEY. I enjoyed all of your testimony tremendously, really. It's very thoughtful and stimulating.

    But, following up on the Chairwoman's comments, I'd like Mr. Mayer and Mr. Thomas to comment on Mr. Isaac's suggestion that the FDIC should be removed from the Federal budget. The agency was off-budget for over thirty years until someone figured out that the dollars could be applied elsewhere.

 Page 97       PREV PAGE       TOP OF DOC
    I think that most of the public, most of the people believe that FDIC is off-budget or a separate pot of money. I don't think most people realize that their so-called ''insured deposit'' is flowing freely through the Federal budget.

    So I'd like to ask Mr. Mayer and Mr. Thomas to comment on Mr. Isaac's suggestion.

    Mr. MAYER. It was Lyndon Johnson who put it on-budget and it helped pay for the Vietnam War.

    Since I feel that the ultimate insurer is the Government and that there's always going to be an additional resource for the insurance fund from the Government when times get bad and it is needed, I'm not as disturbed as Mr. Isaac with the fact that it turns up as a number.

    There are various places when we pay out interest on Treasury's into a Government agency and we take the receipt of the interest the Treasury has paid on its own bonds as revenue to the Government. It's all sorts of crazy bookkeeping in the retirement funds and some other things. So this really doesn't bother me.

    In fact, in some ways, because I think the line of credit at the Treasury is so important to the plausibility of deposit insurance, I would rather keep it as it is.

    Mr. THOMAS. I agree. I would go back to the rough years of the thrift crisis, when we had to actually have a separate full faith and credit obligation. Banks were not just advertising FSLIC and FDIC. They were advertising ''full faith and credit,'' because that's what we expected and that's what we knew was there.
 Page 98       PREV PAGE       TOP OF DOC

    Mrs. MALONEY. Thank you.

    I'd like to ask Mr. Mayer—I loved all your historical references, but on page four of your testimony you express a fear that a larger insurance fund would encourage extension of the safety net to non-depository activities of institutions and their affiliates. How does having a cap on the deposit reserve ratio alter the behavior, the risk-taking of institutions and their affiliates?

    Mr. MAYER. Well, it wouldn't alter the—well, what conceivably might happen, if you got a deposit insurance fund that went up to 2 percent of bank deposits and you got an institution that was in deep trouble because of its activities in the derivatives markets, its loans to hedge funds, some effort would be made to cover that out of the insurance fund, since there is a lot of extra cash there.

    I don't think it is a major question, but I think that, because I want to see the deposit insurance fund focused on deposits—I think when it gets beyond a certain size with relationship to the quantity of deposits, you open a certain degree of temptation.

    I don't want to do an Ed Cane on you, but if the money is there, there's always some danger that they will find a way to use it, which is a stretching of the current law.

    Mrs. MALONEY. But actually, as was pointed out earlier, a lot of things have become ''too big to fail,'' and if they fail there is a feeling they've got to be rescued. So it's not really just focused on deposit insurance. If one of these major banks failed, they would be coming to Congress, ''It's 'too big to fail.' We've got to bail them out.''
 Page 99       PREV PAGE       TOP OF DOC

    I find that very troublesome, particularly with these huge mergers. Almost everything is becoming ''too big to fail'' in certain regions of the country. I find it very troublesome.

    I thought your idea, Mr. Thomas, was very interesting. Since it would be the taxpayers that would have to bail these huge institutions out, I think you raised an interesting point. But could you comment on it?

    I think it is a pure thing to say it's only going to cover deposits, but if one of these institutions, because of their derivatives or whatever else, fails, there is going to be tremendous pressure on us to bail them out because of the impact on the faith we have in the banking system.

    Mr. MAYER. The Fed, which on a good day is stingy, are the people who would have to bail them out. And I think that has to be done in a very——

    Mrs. MALONEY. Excuse me. I didn't hear you.

    Mr. MAYER. I said on a good day the Fed is stingy, and the Fed has to bail them out, and the Fed is embarrassed and hates it and dislikes the publicity and will not be looking for ways to spend the money, whereas if you get a deposit insurer with excess cash, I think there's a little more danger though.

    In fairness to Mr. Isaac, he was the guy who forced the closing of Penn Square. The Fed would have kept it open, but they wanted to keep it open on his money, right, not on theirs.
 Page 100       PREV PAGE       TOP OF DOC

    And if there was that much more money there, the less—what word should I use?—firm person in the FDIC chair than Mr. Isaac, it could be manipulative.

    Mr. ISAAC. Maybe I could just say a word here, because there's a part of my testimony that I think went largely unnoticed, and I would like to make sure it is noticed. I referred to the depositor preference statute that Congress enacted, the Federal depositor preference, and that is designed to reduce the FDIC's losses when a bank fails by putting the FDIC in a prior position to other creditors, because the FDIC assumes responsibility for those deposit liabilities.

    I suggested that we go back to something that existed in the 1930's, when the FDIC first came into existence, and that is to go back to an insured depositor preference statute, so the FDIC gets an even higher priority in the liquidation of a failed bank.

    If that happens, the FDIC could easily handle the failure of a large bank, even the biggest banks.

    CitiGroup, for example, only has $11 billion of insured depositors. If the FDIC had an insured depositor preference statute, it could easily handle the failure of a bank that size without loss to the FDIC, assuming somebody else comes in and deals with the rest of the institution.

    And I believe that we should have that kind of system. We should not expose the taxpayers to that kind of loss by an unelected group of people at the FDIC. We should not let them have that kind of money-printing ability on the taxpayers. We really need to look at this system.
 Page 101       PREV PAGE       TOP OF DOC

    You might say, ''Wait a minute. What if a big bank gets in trouble? Would the FDIC really step in and take care of only the insured depositors?'' I say, ''Why not?'' That's who we are trying to protect with the FDIC system, the depositors.

    And if we have some other reason to protect other people, whether it is Prudential or whether it is Merrill Lynch or whether it is AIG or whether it is CitiGroup, if we want to protect the system, we have to find some other way to do it than through the deposit insurance system.

    I think it is a very important reform, and it gets us past all these ''too big to fail'' arguments that people are making. There won't be ''too big to fail'' under that circumstance. I mean, we will treat Merrill Lynch and Prudential Bache and AIG the same as we treat CitiCorp. This is a very important reform that we need to pay some attention to, and it resolves a lot of the issues that people are raising.

    Mrs. MALONEY. That's really important. Thank you for bringing it up.

    Mr. ISAAC. It's very important.

    Mrs. MALONEY. You wanted to comment?

    Mr. THOMAS. Yes, I wanted to comment.

 Page 102       PREV PAGE       TOP OF DOC
    Although that's the way it should be by the book to protect depositors only, in reality we're going to have to basically bail out the entire institution.

    The way these institutions are now, in such broad areas—for example, if something happened at the Salomon Brothers sub of CitiGroup and it transformed itself through the bank, it would not just be the insured deposits; the entire institution, CitiGroup, would be at risk. And that would be the taxpayers' problem.

    Traveler's actually acquired them, but they left the ''Citi'' name on them. Why? Because ''Citi,'' ''CitiGroup'' implies the strength of CitiBank, the strength of the ''Citi'' name. That is, throughout the entire organization.

    So I would argue that that safety net would be over the entire company if something happened. The exposure would be much broader than just insured deposits.

    And I would not be bothered with the 2 percent fund number. We close a bank now, if a bank goes to 2 percent capital and we put in a conservator. If we got to 2 percent, although it's not apples and apples, that would not bother me at all.

    Mrs. MALONEY. I see Mr. Mayer is fidgeting.

    Mr. MAYER. Well, I'm fidgeting just a little. We did manage to close down Drexel. Drexel was the second-largest participant in EuroClear. When I visited EuroClear in Brussels, that was what scared them was that Drexel had no lender of last resort.

 Page 103       PREV PAGE       TOP OF DOC
    I am not so sure that you can't close down very big institutions, save the depositors, but make—now, we're talking about selling subordinated debt. The absolute one thing you must put in any subordinated debt situation is we're not going to bail you out. That's the meaning of subordinated debt. You stand last on the line.

    I think these things can be structured. Several of the recent situations have resulted from recourse on loans that banks have originated and sold, and they were bad loans. You know, they were known to be bad loans, some of them, when they were sold. The cops are in, and they're looking at these things.

    But if the regulators police the degree of recourse, if they police the issuance of paper, which can then return to the bank, and if it is understood that no insurance fund is going to stand behind the funding of that stuff unless it has absolutely insured the deposits, you may have more control than you think you have.

    The problem is that when you're dealing with these very big institutions, I mean, they are important. They spend time with kings and princes and presidents, and to tell them that you're serious about it, if they get in trouble you're not going to help them, is a difficult thing to do.

    Mrs. MALONEY. And they're bigger than countries.

    I know my time is up, but I've got a follow-up question, if I could, that goes right down to safety and soundness issue, if I could. Can I——

 Page 104       PREV PAGE       TOP OF DOC
    Chairwoman ROUKEMA. One more question.

    Mrs. MALONEY. One more question.

    I tell you, I was tremendously disturbed, and I am disturbed to this day about what happened in Long-Term Capital. That was our latest bail-out. You can call it what you want, but when the central bank comes in and forces other banks to bail them out, that is a bail-out, and our banking institution can't say no to the central bank.

    Now, in Long-Term Capital, not only were they really taking extraordinary risk, but they were over in the Cayman Islands. They weren't even paying taxes on what they were doing.

    Here they are over in the Cayman Islands making huge profits, and then they get in trouble and they want us to bail them out.

    One thing that I find tremendously troubling is when these institutions can take tremendous risks and make all kinds of money and then have fun with it, and then they have a problem and they want the Government and the taxpayers to bail them out.

    I'd like to preface it by saying my first vote on the Banking Committee was a very painful one, and that was bailing out the S&L scandal, which the regulators couldn't stop. So my first lesson in banking is I don't trust the regulators.

    Then, second, I remember Alan Greenspan's testimony on H.R. 10, and he must have said ten times in ten different ways, ''There are no firewalls. When an emergency comes or crisis comes, firewalls come down.''
 Page 105       PREV PAGE       TOP OF DOC

    And, as you said, Mr. Mayer, some of these banks are with kings and queens. Some of them are bigger than countries. The assets that they have are bigger than a lot of countries. I mean, these are huge conglomerates that are getting out there with huge power, and if they failed it would just, you know, rock the confidence of our whole banking system.

    So I see us getting into a situation where a lot of our banks are just going to be ''too big to fail,'' and whether you come in with the central bank forcing a bail-out or whether it's the taxpayers, you know, I find it scary, to tell you the truth, and I would like some comments.

    Chairwoman ROUKEMA. Will the gentlelady yield, please? I'll leave it to you as to whether or not you want to pursue this question, but I want you to know that I had already determined that I was going to submit in writing that question to our panelists, because, in the first place, it's not exactly precise to this discussion today, because that was a matter of derivatives and they were not insured deposits with Long-Term Capital Management, but there is relevance to it.

    Mrs. MALONEY. But they were bailed out.

    Chairwoman ROUKEMA. Well, they weren't bailed out. In the second place—I mean, it's according to your definition of ''bailed out.'' But, in the second place, it is very complex but I think it has some relevance to what we're doing here today in terms of the overall question of ''too big to fail.''

 Page 106       PREV PAGE       TOP OF DOC
    Of course, that was in the case of them. It was the derivatives component, not insured deposit.

    Mr. MAYER. GAO did a good job for you on that.

    Chairwoman ROUKEMA. Pardon me?

    Mr. MAYER. GAO did a good job for you on that.

    Chairwoman ROUKEMA. Well, I would just request, if we could suspend now and submit that question, a number of questions relating to Long-Term Capital Management—if you want to ask the question, fine, but I think at this point in time it might be more beneficial if we were to construct those questions and have the answers in writing, because there is a great complexity to this subject.

    Mrs. MALONEY. Well, my question is not Long-Term Capital Management. My question is ''too big to fail.'' I mean, here we had a hedge fund that's ''too big to fail.'' Derivatives—I studied derivatives. I'll tell you the truth—I don't even understand half of them.

    So, I mean, we're getting into all these new instruments that are having a tremendous impact on our economy and our whole banking system, and I guess I'll just place it back on—my question—I'll rephrase it.

    You know, the fact that Congress just passed H.R. 10, the modernization bill, which is going to move to large mergers, what is the impact that's going to have on ''too big to fail''? I'm not asking about Long-Term Capital. I'm talking about ''too big to fail.''
 Page 107       PREV PAGE       TOP OF DOC

    Mr. ISAAC. I believe that we need to do away with this whole notion that institutions are ''too big to fail.''

    The fact is, there are institutions out there that the biggest deposit insurance fund in the world, even three times the size of what we have today, or four times or five times, would not be adequate to deal with.

    And I'm not just talking about banks. We've got huge institutions that are far more complex than banks and larger. And who is going to take care of them?

    I submit to you that that is not the proper function of deposit insurance, which is to protect the small depositors, the people who need protection in the system. We can handle even the biggest banks with a fund the size we have today in the biggest banks. What we need to do is move to an insured depositor preference law, like the FDIC had when it was enacted in the 1930's. And if we want to have a system that works, we need more market discipline.

    One area where I found myself disagreeing with Professor Thomas is he was saying that we've got to maintain ''too big to fail'' and the banks should pay for it. We need more discipline in the system, not more protection.

    Mrs. MALONEY. I agree, but we're not in the 1930's, and some of our banks are so huge, I mean, they're bigger than kingdoms, as Mr. Mayer said, and if they failed it would shock——

 Page 108       PREV PAGE       TOP OF DOC
    Mr. ISAAC. Some of our——

    Mrs. MALONEY. And they're so intertwined. All of them are intertwined. So if one of them went down, wouldn't it bring all of them with them?

    Mr. ISAAC. I agree with your concern. The fact is that there are non-banks that are just as big, just as complex, and would have just as catastrophic effects on the economy worldwide if something happened to them, and we don't have an FDIC for them.

    And so we have this huge gap out there, and we've got to figure out how to deal with it, and it is not going to be by a deposit insurance fund. You can't have a fund big enough to deal with that. We've got to find other means of dealing with that.

    What we ought to do is get the deposit insurance fund back to the job it was designed to do, which is take care of the depositors, period.

    Mrs. MALONEY. Anybody else want to comment?

    Mr. THOMAS. Yes. I would just say it's just too late. The horse is already out of the barn. ''Too big to fail''—it would be nice to say we could do away with it, but, as a reality, we can't.

    A few of the large banks have said, ''Take it away from us,'' but we can't do it. We have to have it. And, the protection goes well beyond insured deposits. It covers the entire CitiGroup.
 Page 109       PREV PAGE       TOP OF DOC

    So, even when we say 1.25 or 1.5, that's a percentage of deposits. If we went to a percentage of total assets that we have effectively covered under the full umbrella, the full safety net, I agree with Chairman Greenspan, there's no such thing as a safety wall. We have to be there. We will have to bail them out, whether it's the FDIC or the Treasury. Ultimately it will be the Treasury and it will be a bail-out of the entire institution.

    Mr. MAYER. I think the stockholders can be wiped out. I think the subordinated debt-holders can be wiped out. I do. I think that you have to preserve the functions of some of these institutions. Deposit insurance clearly will never be big enough. But I do not think that these guys are beyond market discipline, and I think that, indeed, the market will discipline them rather cruelly.

    And then the question is: to what extent does the Government wish to come in through the Fed, not through deposit insurance, through the Fed, through the Treasury, and make sure that these functions are performed?

    I don't know if there's that much problem in having the stockholders take a terrific licking, and that's what they care about, after all.

    Chairwoman ROUKEMA. All right. I thank you very much. That was a very interesting and instructive initiative into this large other subject of ''too big to fail,'' a related subject to ''too big to fail.''

    I will say to the Congresswoman here and to other Members here that staff is going to review with me and others with precision how we think we've taken care of this question in relation to Gramm-Leach-Bliley, the Financial Modernization Act. But we'll get back to that. We will review it in the context of this, as well as this year ahead as we're looking to the implementation of financial modernization.
 Page 110       PREV PAGE       TOP OF DOC

    I thank you so much. You've been wonderful. I'm sure we're going to have some follow-up questions in writing for you.

    Thank you.

    [Whereupon, at 1:34 p.m., the hearing was adjourned.]