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OF 2003—H.R. 758 and H.R. 859

Wednesday, March 5, 2003
House of Representatives,
Subcommittee on Financial Institutions and
Consumer Credit
Committee on Financial Services,
Washington, D.C.

    The subcommittee met, pursuant to call, at 2:14 p.m., in Room 2220, Rayburn House Office Building, Hon. Spencer Bachus [chairman of the subcommittee] presiding.

    Present: Representatives Bachus, Royce, Kelly, Gillmor, Toomey, Fossella, Hart, Kennedy, Hensarling, Garrett, Murphy, Brown-Waite, Barrett, Sanders, Maloney, Sherman, Kanjorski, Waters, Lucas of Kentucky and Israel.
    Chairman BACHUS. [Presiding.] The Subcommittee on Financial Institutions and Consumer Credit is convened. This is a hearing on two bills, the Business Checking Freedom Act, by Representative Toomey; then H.R. 859, which is a sterile reserve bill which is introduced by Representative Kelly.
    On panel one, we have two rookies that have never testified before the Committee before, but not rookies to the issue and to financial matters. I am going to wait on my opening statement and go right to the testimony. The first one is the Honorable Donald Kohn, Governor, Federal Reserve Board; and second witness is Wayne Abernathy, who is the Assistant Secretary for Financial Institutions at the Department of Treasury. Gentlemen, we welcome you and look forward to your testimony. Have you decided on whether to go left or right?
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    Do you have an opening statement?
    Mr. SHERMAN. A short one.
    Chairman BACHUS. Okay.
    Mr. SHERMAN. I think it is important that we allow banks to pay interest on checking. I look forward to the two bills somehow being merged into one. I look forward to the bills being modified so that they cover industrial loan banks as found in California and some other states. I am glad that this bill provides for a one-year phase-in, because we are passing it a year after we wanted to pass a two-year phase-in.
    With that, I yield back.
    Chairman BACHUS. Actually, I thought the bills had been merged.
    Mr. SHERMAN. They may have already been merged.
    Chairman BACHUS. No, they have not.
    Mr. SHERMAN. They have not? But I look forward to them being merged.
    Chairman BACHUS. We have been approaching this as a package deal, but they are separate bills. I think they both have the same title.
    Mr. SHERMAN. They could be merged, packaged, fused.
    Chairman BACHUS. Although they deal with two different subjects, they are interrelated. We consider them as a package.
    Mr. Sanders, do you have an opening statement?
    Mr. SANDERS. I am sure we are in agreement. I will just be repeating what you say.
    Not really.
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    Chairman BACHUS. No. I am aware of that.
    Mr. SANDERS. My apologies for being late.
    Chairman BACHUS. We just started.
    Mr. SANDERS. Thank you for holding this hearing. I look forward to working with you as the new ranking member of the Financial Institutions and Consumer Credit Subcommittee.
    Mr. Chairman, according to revised estimates by the Republican-controlled House Budget Committee, the record-breaking federal deficit could soar to $400 billion if President Bush's tax cuts are approved on a full course this year, funded to tens of billions of dollars, according to the New York Times. The national debt is over $6.3 trillion. The cost of war with Iraq could cost between $100 billion and God only knows if we occupy that country for 10 years. President Bush's tax cuts will cost us trillions over the next decade.
    Given this reality, the question is, should the Federal Reserve be giving what amounts to corporate welfare to some of the largest banks in this country through interest on so-called sterile reserves? Unless this money would go toward reducing the record-breaking $435 billion trade deficit by expanding employee ownership, addressing the affordable housing crisis, expanding health insurance for the 42 million Americans who are uninsured, and addressing some of our increasing social needs, I think the answer should be a resounding no.
    Without going into great detail right now, the bottom line for me is this country has a huge deficit. We have huge unmet social needs in health care, education, veterans needs and so forth and so on. So I should tell you that I walk into this hearing today with some skepticism about the proposal, but I look forward to further discussion.
    Thank you, Mr. Chairman.
    Chairman BACHUS. I appreciate that.
    Ms. Kelly, do you have an opening statement?
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    Mrs. KELLY. Yes, I do, Mr. Chairman. Thank you. I want to thank you and the ranking member for holding a hearing today. Though this is a familiar discussion for many of us today, I am glad to be here talking about the bill and talking about it early in this session.
    Getting straight to the matter, my bill, H.R. 758, contains three initiatives. First, it allows the banks to increase money market deposit and savings account sweeps from the current 6 to 24 times a month. This gives the bank an increase in their sweep activities, enabling them to sweep every night, thereby increasing the interest that businesses can make on their accounts. Second, to give the Federal Reserve the authority to pay interest on reserves, banks keep within the federal system. This is a good thing to do economically because it will bring stability to the federal funds rate, which is subject to volatility when reserves become too low. This is also useful since these reserves have functioned as an implicit tax on our banks, and would offset the costs of repeal of the prohibition on business checking.
    Finally, my bill gives the Federal Reserve the additional flexibility to lower reserve requirements. This will give the Federal Reserve greater control at maintaining reserves at a specific and consistent level. It is a good measure and one that this Committee and this House have passed before, with broad support. I hope we can get the job done this year, and as I said, I am encouraged by the Committee's willingness to make this an early priority once again in this Congress.
    I anticipate that Mr. Toomey's bill, H.R. 859, will be merged with my bill later in the Committee during this month. In doing this, I think we have to be mindful of the importance of a proper transition period. We must make sure that banks and businesses have sufficient time to unwind their current relationships. My goal continues to be to assist our main street banks which are so essential to our communities, and I think this is a good step forward in this effort.
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    Again, I thank the chairman and ranking member, and I yield back the balance of my time.
    Chairman BACHUS. Thank you. I am going to ask unanimous consent that we limit the opening statements to two on each side.
    Mr. SANDERS. As long as one statement is in opposition.
    Chairman BACHUS. How about three on each side?
    Mr. SANDERS. Can we put opening statements into the record?
    Chairman BACHUS. No, just to have oral opening statements. We will have three on each side, and Mr. Royce and Mr. Toomey with unanimous consent. And on your side, is there a member that wishes to make a statement? Ms. Maloney? We will limit those to three more opening statements.
    At this time, Ms. Maloney is recognized. Well actually, we have had two on this side, so I am going to go to Mr. Royce and then back to you. And then Mr. Toomey, you will conclude the oral statements.
    Mr. ROYCE. Mr. Chairman, I thank you very much. Just to go to the crux of my opposition here, I believe that the underlying legislation is long overdue. It is necessary, but I have got to qualify my support. I believe that by not providing interest on business checking parity to industrial loan companies, many of which are chartered in my home state of California, this legislation will subject these well-regulated institutions at an unfair competitive disadvantage in the financial services marketplace. I strongly believe that this oversight must be addressed before the Committee sends this bill to the House floor for a final vote on its passage.
    I thank you very much for allowing me the time to make that statement, Mr. Chairman.
    Chairman BACHUS. The gentlelady from New York?
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    Mrs. MALONEY. I first want to compliment my colleague Sue Kelly for her work on this issue, not only in this Congress, but I think for the past several congresses this has been an area of concern on which she has worked. Last Congress, it passed the House by voice vote unanimously. We know that it really removed the Depression-era prohibition on the payment of interest on business checking accounts. The prohibition on interest for business checking was instituted to prevent larger city-centered banks from attracting deposits away from smaller institutions during the Great Depression. Given the global nature of financial services, interstate banking and advances in technology, consumers and businesses can now enjoy the full range of bank services no matter where their physical location.
    This legislation will allow businesses of all sizes to accrue interest on their checking accounts, but it will most dramatically level the playing field for small and medium businesses that do not currently have access to sweeps and to sweep account programs. The small business community in my district and in others has been pushing for this legislation for years. Banks have sought ways around the prohibition such as cutting prices on services to pay implicit interest, or offering the sweep account option.
    Passage of this legislation will increase efficiency by moving banks away from such bookkeeping maneuvers after a transition period. At the same time, we are considering legislation that allows the Federal Reserve to pay interest on sterile reserves and increased flexibility with regard to setting bank reserve requirements.
    While I am very respectful of opinions on both sides of this issue, the language in the bill tracks last year's legislation and was supported by this Committee and the full House. So I look forward to the testimony today.
    Thank you.
    Chairman BACHUS. Thank you.
    Mr. Toomey?
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    Mr. TOOMEY. Thank you very much, Mr. Chairman, and thank you for holding this hearing today on my bill, H.R. 859, the Business Checking Freedom Act, as well as Mrs. Kelly's bill, H.R. 758, and for helping to put this legislation on a fast track, which I think is appropriate given its history in the House.
    H.R. 859 is a very straightforward and simple bill. As I think many people may know, it simply eliminates a Depression-era prohibition on banks paying interest on demand deposits—an idea which I would suggest was probably not a very good one at the time, and certainly if it was, has long since outlived any useful purpose, in my judgment.
    I want to thank the other sponsors of this bill—Mr. Kanjorski, Mrs. Biggert, Mr. Gonzalez, Mr. Shays, Mrs. Hooley, Mr. Ney, Mr. Paul and Mr. Sherman—for their support. Mr. Chairman, if I could, I would like to insert into the record letters that I have in support of this legislation from the Comptroller of the Currency, the FDIC, the Office of Thrift Supervision, each of which outlines why they believe this is important legislation.
    Chairman BACHUS. Without objection.
    [The following information can be found on pages 129 through 133 in the appendix.]
    Mr. TOOMEY. With that, I will yield the balance of my time.
    Chairman BACHUS. Thank you, Mr. Toomey.
    At this time, Governor Kohn?


    Mr. KOHN. Thank you, Mr. Chairman. I will read excerpts from my testimony and ask that the full statement be included in the record.
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    Mr. Chairman, members of the Committee, I appreciate this opportunity to testify on behalf of the Federal Reserve Board on issues related to H.R. 859 and H.R. 758. The Board strongly supports the provisions in these bills that would eliminate the prohibition of interest on demand deposits, authorize the Federal Reserve to pay interest on balances held by depository institutions at Reserve Banks, and provide the Board with increased flexibility in setting reserve requirements.
    As we have previously testified, unnecessary restrictions on the payment of interest on demand deposits and/or on balances held at Reserve Banks distort market prices and lead to economically wasteful efforts to circumvent these restrictions. Those efforts are more readily undertaken by larger banks, especially for their larger business customers.
    Moreover, these bills would enhance the tool kit available for the continued efficient conduct of monetary policy. In addition, the provision of increased flexibility in setting reserve requirements would allow the Federal Reserve to reduce a regulatory burden on depository institutions to the extent that that is consistent with the effective implementation of monetary policy.
    H.R. 758 would authorize the payment of interest on three types of balances held by depository institutions at the Federal Reserve: required reserve balances, contractual clearing balances, and excess reserves. I will discuss each briefly in turn. The purpose of reserve requirements is to facilitate the implementation of monetary policy. Reserve requirements achieve this by providing a predictable demand for balances held by banks at the Federal Reserve over a two-week period of averaging. This predictable demand for balances helps the Federal Reserve hit its target for overnight interest rates. However, required reserve balances pay no interest and largely for that reason banks spend resources to avoid reserve requirements, such as through arrangements that sweep deposits into non-reservable accounts or market instruments. Authorization of interest payments on required reserve balances would substantially reduce the incentives for banks to engage in these socially wasteful reserve-avoidance activities, and would thereby improve the efficiency of our financial sector.
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    Contractual clearing balances are additional balances that banks may hold at the Federal Reserve beyond the level of their required reserve balances. Banks contract in advance to hold such balances in order to pay checks or make wire transfers without running into overdrafts. These clearing balances do not earn explicit interest, but they do earn implicit interest for depository institutions in the form of credits that may be used to pay for Federal Reserve services such as check clearing.
    Like required reserves, contractual clearing balances are maintained on a two-week average basis and are known in advance of the maintenance period. These balances also therefore facilitate the implementation of monetary policy. Explicit interest payments on these balances would make them more useful for monetary policy purposes because it would tend to boost their level and make them more stable over time by removing the link to a bank's use of Federal Reserve services.
    Excess reserve balances are balances that banks hold at the Federal Reserve beyond the level of any required reserve or contractual clearing balances. They also earn no interest. Authorization of interest on excess reserves would add a potentially useful tool for the implementation of monetary policy. The interest rate on excess reserves would tend to act as a floor on overnight market interest rates. A bank would not lend balances to another bank at a lower rate than they could earn by keeping the excess at the Federal Reserve. While not currently needed, this floor for market interest rates could also potentially help the Federal Reserve hit its target for overnight interest rates.
    H.R. 758 would also grant the Federal Reserve increased flexibility in setting reserve requirements, allowing the possibility that reserve requirements could be reduced below the minimum levels currently allowed by law, and even conceivably to zero at some point in the future. The Federal Reserve could make use of this flexibility, however, only if it were granted the authority to pay explicit interest on contractual clearing balances to ensure a stable and predictable demand for their remaining deposit balances at the Federal Reserve. If the Federal Reserve were granted the additional authorities included in H.R. 758, we would carefully study the new range of possible strategies for implementing monetary policy in the most efficient possible way for banks, the markets and the Federal Reserve.
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    The efficiency of our financial sector also would be improved by eliminating the prohibition of interest on demand deposits as provided for in H.R. 859. This prohibition distorts the pricing of transactions, deposits and associated bank services. In order to compete for the liquid assets of businesses, banks set up complicated procedures to pay implicit interest on compensating balance accounts. Banks also spend resources and charge fees for sweeping the excess demand deposits of larger businesses into money market investments on a nightly basis. Such expenses waste the economy's resources and they would be unnecessary if interest were allowed to be paid on both demand deposits and reserve balances.
    H.R. 859 would delay for one year removing the prohibition of interest on demand deposits. The Federal Reserve Board believes that a short implementation delay of one year or even less would be in the best interests of the public and the efficiency of our financial sector.
    A provision of H.R. 758 would in effect allow interest to be paid on demand deposits without any delay through a new type of sweep arrangement, but this provision would not promote efficiency. It would authorize a new interest earning account on which 24 transfers a month could be made to other accounts of the depositor. At the end of each business day, a bank could sweep demand deposits into the new account, pay interest, and then return the funds to the demand deposit the next morning. These sweep arrangements would allow banks to earn additional fees and perhaps be more selective about, in effect, paying interest on demand deposits in the one year before explicit interest payments were authorized. However, these sweeps would be another example of socially wasteful expenditure, and for this reason the Board does not advocate the new 24 transfer account.
    The payment of interest on demand deposits would have no direct effect on federal revenues, as interest payments would be deductible for banks, but taxable for the firms that receive them. However, the payment of interest on required reserve balances would reduce the revenues received by the Treasury from the Federal Reserve. The extent of the revenue lost, however, has fallen over the last decade as banks have increasingly implemented reserve avoidance techniques. Paying interest on contractual clearing balances would primarily involve a switch to explicit interest from implicit interest, and therefore would have essentially no cost to the Treasury. The payment of interest on excess reserves could also be authorized without immediate effect on the budget because the Federal Reserve does not expect to use that authority in the years immediately ahead.
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    H.R. 758 includes a provision that transfers some of the capital surplus of the Federal Reserve banks to the Treasury in order to cover the budgetary costs of paying interest on required reserve balances. The Board has consistently pointed out that such transfers are not true offsets to higher budgetary cost. A transfer would allow the Treasury to issue fewer securities, but the Federal Reserve would need to lower its holdings of Treasury securities by the same amount to make the transfer. Thus, the level of Treasury debt held by the private sector would be unchanged. Treasury's interest payments net of receipts from the Federal Reserve would be unaffected.
    In summary, the Federal Reserve Board strongly supports the proposals in H.R. 859 and H.R. 758 that would authorize the payment of interest on demand deposits and on balances held by depository institutions at the reserve banks, as well as increased flexibility in the setting of reserve requirements. We believe these steps would improve the efficiency of our financial sector, make a wider variety of interest-bearing accounts available to more bank customers, and better ensure the efficient conduct of monetary policy in the future.
    Thank you, Mr. Chairman.

    [The prepared statement of Hon. Donald L. Kohn can be found on page 65 in the appendix.]
    Chairman BACHUS. Thank you.
    Assistant Secretary Abernathy? We note that you have brought a former staffer of ours.

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    Mr. ABERNATHY. I needed some help in walking through these different parts of the building that I have not walked in before. It is a pleasure to have Mr. Zerzan with us as our new Deputy Assistant Secretary. We appreciate all the training you have given to him.
    Chairman BACHUS. Thank you.
    Mr. ABERNATHY. I now would ask that my full written statement be included in the record, and I will just provide a summary here.
    Chairman Bachus, Representative Sanders, members of the subcommittee, I appreciate this opportunity to present Treasury's views on legislation repealing the prohibition on the payment of interest on business checking accounts, and permitting the payment on interest of reserve balances at depository institutions maintained with the Federal Reserve.
    The Treasury Department supports permitting banks and thrifts to pay interest on business checking accounts. We are also sympathetic to the arguments in favor of permitting the Federal Reserve to pay interest on reserve balances, and we support the goals of the legislation. However, inasmuch as the potential budget impact of the provision is not included in the president's budget, we are not prepared to endorse that proposal at this time.
    The prohibition on paying interest on demand deposits is a relic of the Great Depression. Many policy makers in the 1930s had the belief that limiting competition among banks would reduce bank failures, even if that resulted in fewer options and higher costs for consumers. Therefore, among other competition-limiting measures, Congress prohibited the payment of interest on demand deposits. Experience has shown that limiting consumer choice is a sub-optimal strategy for bank regulation. The market has a way of asserting itself.
    In recent decades, competition for money market mutual funds worked to undermine deposit interest rate ceilings. At the beginning of the 1980s, Congress allowed banks to offer deposit accounts free of interest rate controls. Repeal of the prohibition on paying interest on business demand deposits would eliminate a needless government control. Banks could reduce the resources that they spend on procedures to get around these restrictions. Repeal would benefit the nation's small businesses by allowing them to earn a positive return on their transaction balances.
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    We favor the repeal of the prohibition such as that contained in the bill authored by Representative Toomey, H.R. 859, that would be effective one year after enactment. The bill introduced by Representative Kelly, H.R. 758, would authorize an increase in the allowable transactions between demand deposits and interest-bearing money market accounts. Combining these two proposals, as the House of Representatives did in the last Congress, would help ensure that banks are immediately able to offer the equivalent of interest-bearing checking accounts to their business customers before the repeal of the prohibition entered into effect. In any event, the Treasury Department continues to prefer a relatively quick repeal of the prohibition.
    H.R. 758 would also allow the Federal Reserve to pay interest on reserve balances. The Federal Reserve Act requires depository institutions to maintain reserves against certain of their deposit liabilities. Institutions typically meet these requirements through vault cash and a portion of their reserves held at Federal Reserve banks. The required reserve balances do not earn interest, therefore sometimes referred to as sterile reserves. Governor Kohn presented the arguments and reasons and concerns that current limitations may affect the conduct of monetary policy. We share those concerns.
    In addition, permitting the payment of interest on reserve balances would promote economic efficiency. Uncompensated reserves act as a tax upon tanks, while serving no public policy interest. To avoid this tax, banks have engaged in otherwise uneconomic activity. These costs harm the competitiveness of banks, not only with foreign institutions, but also with other financial services providers. H.R. 758 provides an offset to its budget costs by transferring a part of the Federal Reserve surplus to the treasury. Yet over time, transfers of the surplus do not result in budgetary savings. In transferring a portion of its surplus to the treasury, the Federal Reserve would reduce its portfolio of interest-earning assets. This would, in turn, decrease the Federal Reserve's future earnings and remittances to the Treasury. Budgetary receipts in the near term would increase, but only at the expense of foregone long term receipt.
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    In conclusion, we welcome action by the Congress to repeal prohibitions on paying interest on business checking accounts. Repeal would eliminate unnecessary restrictions on banks' ability to serve their commercial customers and would level the playing field between them and other financial services providers. Repeal would especially benefit the nation's small businesses. The ability to pay interest on reserve balances maintained at the Federal Reserve may improve the effectiveness of the tools that the Federal Reserve has to implement monetary policy. Financial system efficiency would likely improve.
    Thank you for the opportunity to appear before your subcommittee, and I am prepared to answer any questions.

    [The prepared statement of Wayne A. Abernathy can be found on page 47 in the appendix.]
    Chairman BACHUS. Thank you.
    According to our rules, we are going to call on members as they arrive. Some members have indicated they do not have questions, so I will not call on them. I am going to yield my five minutes to the first person on our side, which is Mrs. Kelly.
    Mrs. KELLY. Thank you, Mr. Chairman.
    I have got a couple of questions here. One of my questions is to you, Mr. Kohn. It seems to me that there has been a change in the attitude on the part of the Fed with regard to this bill. I am not sure, but it seems to me that last year when we passed this bill, the Fed was comfortable with the 24 sweeps. Now, you say you are not. That seems to me to be a change in attitude, and I would like you to explain why.
    Mr. KOHN. I think the 24 sweeps are something we can live with, but do not prefer. Our preference is to go directly to paying interest on demand deposits. The 24 sweeps, which you could think of as an interim measure, as Secretary Abernathy was talking about, for the one year, does involve more avoidance techniques for the payment of interest on demand deposits. It involves setting up the sweeps. It involves maintaining them, and it just seems to us that it is much more direct, much more efficient, much less costly to go directly to the payment of interest on demand deposits. Not that we would object to the 24 MMDA sweep provided it was reservable as it is in your bill, but it does not seem the best way to go since it does involve these extra expenditures.
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    Mrs. KELLY. We are already doing six sweeps.
    Mr. KOHN. Right.
    Mrs. KELLY. What I am doing is making it 24. One of the reasons for doing that is to help encourage the banks to go ahead and give the money that is earned with the sweeps and with allowing interest on sterile reserves, give them back something that they will be giving out to their customers, so it balances out. That is the way I see the bill, and I am just interested in why that change on your part.
    I also have another question, and that was brought up by my colleague Mr. Royce. It has come to my attention that the ILCs want to offer businesses NOW accounts as they are authorized by their state. I understand the Fed has some concerns about that and I want to know if you would elaborate on that. Mr. Abernathy, I would like to have you comment on that as well.
    Mr. KOHN. I would be glad to elaborate, Congresswoman Kelly. The proposal as I understand it is to authorize the ILCs, the industrial loan corporations, to offer business NOW accounts. Industrial loan corporations are institutions in a select number of states, I think about a half dozen states. They differ from commercial banks and other depository institutions in two ways. One is they cannot offer demand deposits or business checking accounts. The second way is that they are not subject to the same regulations and restrictions that commercial banks are in terms of who they can affiliate with. Industrial loan corporations can affiliate with commercial organizations. For example, in Utah you have such corporations as BMW, Volvo, Gateway, other commercial corporations who own these industrial loan corporations.
    So this would be mixing banking and commerce. If you allow the industrial loan corporations to offer business checking accounts, you are in effect giving them all the powers of a commercial bank. They would be equivalent to the commercial bank in terms of the services they can offer, but unlike commercial banks, unlike savings and loans, they could affiliate with commercial institutions. Moreover, banks when they affiliate even with financial institutions, are subject to certain regulatory oversight under Gramm-Leach-Bliley. That regulatory oversight is called an umbrella supervisor, so the bank holding company is subject to supervision. Even if the industrial loan corporation were to affiliate only with a financial firm—for example, Morgan Stanley owns an ILC—that would not be subject to the same regulation than if Morgan Stanley were affiliated with a bank.
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    Congress spent a lot of time a few years ago trying to draw these borders between financial, banking, and commercial and decided to keep commerce and banking separate. The board supported that position very strongly. The Congress also decided to subject the financial holding companies to umbrella supervision, as it happens by the Federal Reserve. That is not as important as the fact that somebody is doing it. The Federal Reserve supported that decision very strongly.
    We believe that allowing ILCs to offer business checking accounts would in effect undermine the restrictions and the regulatory apparatus that Congress put into place under Gramm-Leach-Bliley.
    Mrs. KELLY. Mr. Abernathy?
    Mr. ABERNATHY. I think ILCs are a great example, emblematic of the strength of the constitutional federal system of government that we have. They are emblematic of the kind of variety that we have in financial institutions because of the innovation that our dual banking system allows. We have federal institutions, we have state institutions that offer different kinds of services to meet the needs of consumers, whether they are individuals or businesses.
    With regard to the specific issue of whether or not demand deposit authority should be extended to ILCs, because that was not in the bills that we looked at while we prepared for this hearing, the Treasury has not examined that issue. So we would need to go back and consider that. We have been listening to some of the comments that have been raised about it. I think we want to look at it closely, but we do not have a position on it at this time.
    Mrs. KELLY. Thank you.
    Mr. Chairman, I wonder if I could have unanimous consent. I have testimony from a coalition of over 1,800 independent community banks that are opposed to the repeal on the ban, and I would like to have that be included.
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    [The following information can be found on page 91 in the appendix.]
    Chairman BACHUS. Without objection.
    Mrs. KELLY. Thank you.
    Chairman BACHUS. That was partially as a result of Wal-Mart trying to buy an ILC in California.
    At this time, Mr. Sanders?
    Mr. SANDERS. Thank you, Mr. Chairman and welcome gentlemen.
    Mr. Abernathy, if I could begin by asking you a couple of questions. In your judgment—I sometimes find it strange that I am the conservative around here worrying about the federal deficit, with my free-spending colleagues here not worrying so much about it. Can you give me an estimate perhaps as to how much you believe it would increase the federal deficit if the Federal Reserve were paying the interest we are discussing today? My understanding is that last year the Fed gave $24 billion to the treasury, which ultimately lowered what otherwise would have been the case with the deficit. How much less would they be giving if the Fed were paying interest on reserves?
    Mr. ABERNATHY. I think the last time that the CBO examined this issue, which was a couple of years ago, they estimated that the five year cost would be somewhere in the neighborhood of about $500 million. That was, of course, with different economic assumptions. We now have a lower interest rate environment. Whether that would reduce the cost to the Federal Reserve because they are paying less, or would that mean that more reserves would be placed with the Federal Reserve—it is hard to tell.
    Mr. SANDERS. Okay.
    Mr. ABERNATHY. The best number we have would be the old number of about $500 million over five years.
    Mr. SANDERS. Or roughly $1 billion over a ten-year period.
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    Mr. ABERNATHY. I think the ten-year number came closer to about $800 million, for some reason.
    Mr. SANDERS. Okay. Now, we are going to hear testimony later on from Professor Auerbach, who in fact comes up with a much, much higher estimate. His estimate is I believe $16 billion over a ten-year period.
    My second question is, as everybody in this room who is over 12, most people are over 12 knows, that when legislation is introduced, somebody wins and somebody loses. Usually there are beneficiaries. Probably people sleeping out on the street who are homeless are not going to gain much out of this. People who cannot afford prescription drugs are not going to be major winners out of this. Veterans who do not have health care probably are not going to get too many benefits out of this legislation. If I were to tell you that my office spoke to the Congressional Research Service and they said that the major beneficiaries would be the Bank of America, who last year made over $6.7 billion in net income; Wells Fargo, who made over $3.4 billion in net income; J.P. Morgan Chase, who made over $1.69 billion in net income; and Citigroup, which made over $14 billion in profits—would that make sense to you? Would you argue with CRS on that?
    Mr. ABERNATHY. Is this with regard to the payment on Fed sterile reserves?
    Mr. SANDERS. Yes.
    Mr. ABERNATHY. Without looking at the numbers, I could not comment in favor or opposed to them.
    Mr. SANDERS. That is what the CRS said. Does this sound to you like a reasonable proposition?
    Mr. ABERNATHY. I have not looked at the numbers. I presume that if banks maintain deposits with the Federal Reserve and they are going to receive interest payments on those, they will benefit from that. Exactly which ones those are, we have not done an analysis.
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    Mr. SANDERS. But these are some of the largest banks in America, and everything being equal, we would expect the largest banks would be the major beneficiaries. Is that a fair assumption?
    Mr. ABERNATHY. If you base it just upon the reserves, the larger the bank you are, the greater the reserves you hold in the Federal Reserve. That is correct.
    Mr. SANDERS. Right. Mr. Kohn, if the CRS gave my office that information, does that make sense to you, that the Bank of America, Wells Fargo, J.P. Morgan Chase, and Citigroup might be the major beneficiaries out of this legislation? Does that sound roughly right? Mrs. Kelly's bill I am talking about, H.R. 758.
    Mr. KOHN. I think the major beneficiaries out of this legislation would be the customers of the banks who are holding these sterile reserves. I think in effect that the competitive market system passes through these costs to the customers, in some cases directly for businesses holding compensating balances with banks. When banks calculate the implicit interest on the compensating balances, they directly subtract the cost of the—
    Mr. SANDERS. Do you think the average person would be aware of lowering his fees? Would all that stuff really impact heavily on the ordinary working person in this country?
    Mr. KOHN. I do not think it would impact heavily on anybody, because we are talking about a very small amount of money relative to the size of the banks, to the financial system. But I do think the direction would be that the average person would see slightly lower costs for services and slightly higher returns.
    Mr. SANDERS. That would certainly be a nice thing to see with fees soaring all over the country, wouldn't it be, Mr. Kohn?
    Mr. KOHN. Yes, it would.
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    Mr. SANDERS. Okay. The point that I wanted to make—first of all, I want to thank the Bush administration for not jumping on support of this, for trying to retain some credibility and concern about our deficit, because this ultimately will raise our deficit. That is number one. Number two, from what I can see, the major beneficiaries will in fact be the largest banks in this country in terms of H.R. 758.
    With that, Mr. Chairman, I yield back.
    Chairman BACHUS. Thank you.
    Ms. Brown-Waite?
    Ms. BROWN-WAITE. Thank you.
    Actually, my question is for Governor Kohn. In your testimony, you indicate that one year would be a sufficient time for the phase-in of the repeal of the ban on paying interest on business demand deposits. The bill also calls for a year's period of time. Some in the banking industry have said that it should take three years. Help me to understand why you, as well as the sponsor of the bill, obviously believe that one year is sufficient time.
    Mr. KOHN. I think the banks' systems are set up in such a way to accomodate that, and this bill has been debated and passed by the House for several years. None of this should come as a surprise to the banking industry. I think the banks' computer systems are set up in such a way that they should be able to implement this fairly rapidly. I think you will have some bankers you are talking to on the second panel, and you should certainly ask them, but my understanding from talking to a few bankers, is that implementing this is really not going to be a problem, and the sooner the better.
    Ms. BROWN-WAITE. Thank you.
    Chairman BACHUS. Thank you.
    Ms. Maloney?
    Mrs. MALONEY. Thank you, Mr. Chairman.
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    I really wanted to comment on an aspect of the bill that my dear friend and colleague Mr. LaFalce said in the last bill that we passed in the House, H.R. 1009. It contained a provision that we had worked on together that would require the Federal Reserve to perform an annual survey of checking, NOW accounts, ATM transactions and other electronic transactions. As I notice, this provision has been omitted from H.R. 758 and 859. I wanted to ask our two representatives what you think of that. Would you object to having that added back in? What is your position on that particular aspect of the law?
    Mr. KOHN. The Federal Reserve would not object to having that added back in. I do think it is important for the Congress to consider carefully what the objective is and why they want to get this information, and to keep the data collection and the requirements targeted tightly to what you want and the objectives you have for this. This will keep the burden down, both on the banks and on the taxpayers through the Federal Reserve, but we have no objection to including such a study in the bill.
    Mrs. MALONEY. Mr. Abernathy, do you have any objection to it?
    Mr. ABERNATHY. We like to look at a lot of numbers. The more data you have, I think the better you can make policy. My experience has been there are a lot of reports that nobody looks at; a lot of data that is collected that no longer serves a particular function. While I think that the particular data points that you are suggesting might be helpful, I would like to look at it in a larger context of the data that is collected, and then maybe we could focus on the things that would be most helpful for policy, and eliminate some of the report requirements that no longer meet any needs.
    Mrs. MALONEY. Thank you.
    Chairman BACHUS. Mr. Toomey?
    Mrs. MALONEY. Could I very briefly—I am supporting the bill, but I would like to ask Mr. Kohn, you mentioned earlier that the customers were the ones that were going to benefit with the checking account interest rates. How can we be assured that banks will pass through interest on sterile reserves to their customers in the form of higher interest rates or reduced fees? Historically, the fees paid or interest rates paid on checking accounts have been incredibly low. How can we be assured that this will be passed through to customers, as you mentioned in your dialogue?
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    Mr. KOHN. Right. I think there are some direct ways, as I noted in my answer to Congressman Sanders, that it would be passed through. That is, compensating balances are automatically adjusted for reserve requirements. So for at least I think that about one-third of demand deposits that are held as compensating balances, to the extent that the reserves on those earn interest, that interest would automatically flow through to the customers. I think for the rest of it, we can rely on a very rigorous competition for banking services. We have banks, we have S&Ls, we have non-banks such as money market funds offering services to customers. We have finance companies offering loans. I think a bank, offered the opportunity to gain a little bit more of an advantage in offering these services by not incurring this particular tax, would be competing very strongly with all these other financial institutions to increase market share. So I think the market system will do this.
    Mr. SANDERS. Would the gentlelady yield?
    Mrs. MALONEY. I just wanted to follow up on it. Consumer checking account interest rates have really severely lagged behind other market rates. A lot of my constituents tell me they do not even keep money in consumer checking accounts because of that, or very little. So do you anticipate that this will be the same with business checking accounts as well? If it is true that there is going to be such competition for their accounts, then it would be true for the consumer checking accounts too, would it not?
    Mr. KOHN. I think there is competition for the accounts. The interest rates are very low in part because the Federal Reserve has very low interest rates right now.
    Mrs. MALONEY. But even when it has not been the case, it has been low.
    Mr. KOHN. That is right. There are a variety of accounts and a variety of ways that banks deliver services to their customers. Some of the accounts have higher interest rates on them for less active accounts; other accounts might have a lower interest rate or a zero interest rate account if you are very active, and you do not get charged for the activity in the account. So I think there are just a whole lot of dimensions along which banks compete for this. I think the competition will remain there. I think the customers will see this.
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    We are talking about very small amounts of money. I recognize, along with Congressman Sanders, that if you add it up over a long time, it looks like a lot of money. But $100 million or $150 million a year is going to be very hard to track through. That is less than one-tenth of one percent of the income of the bank. It would be very hard to track through. But I think it goes in that direction, and I think I would rely on the market to do it.
    Mrs. MALONEY. I yield to Ranking Member Sanders, who requested the time.
    Chairman BACHUS. Actually, your time is expired.
    Mrs. MALONEY. My time has expired. Okay. Sorry.
    Chairman BACHUS. Mr. Toomey?
    Mr. TOOMEY. Thank you, Mr. Chairman.
    Just to follow up on this for just a moment, maybe starting with Mr. Abernathy. Would you say that it is widely accepted, if not universally accepted, among economists that it is not unique to the banking industry, but rather to any competitive, mature industry, the structural savings that occur by and large gets passed on to the consumers of that service? Is that a generally accepted principle of economics?
    Mr. ABERNATHY. That is one of the things that the marketplace does. It in essence, reaches a balance between your cost of providing a service, and the demand for your particular service.
    Mr. TOOMEY. Right. So this is not a unique circumstance or a unique theoretical exercise. Any industry in which there would be a reduction of a government-imposed tax, any mature industry, anyway, that is truly competitive, we would always assume automatically pretty much that most, if not all, of that benefit would be passed on to consumers. Is that correct?
    Mr. ABERNATHY. And I think it is not just theoretical. There has been study after study that has demonstrated that that is exactly what happens.
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    Mr. TOOMEY. Thank you.
    Mr. Kohn, do you agree with that?
    Mr. KOHN. Yes, I do, Congressman.
    Mr. TOOMEY. Thank you.
    A quick question—do either of you have any reservations whatsoever that the repeal of the prohibition on interest payments would introduce any kind of safety and soundness concern to our financial infrastructure or individual institutions, for both of you gentlemen?
    Mr. ABERNATHY. I do not know of any safety and soundness concerns that would be heightened. There might be some arguments that could be made that you would be introducing some elements of stability, which would improve safety and soundness.
    Mr. TOOMEY. Could you just give an example and elaborate on any improvements to safety and soundness that might result?
    Mr. ABERNATHY. I think inasmuch as banks engage in certain types of uneconomic activity to try to work around these restrictions, they are doing things that are imposing unnecessary costs on them. To the degree that you can reduce costs on their activities, you improve their profitability, which is an important element of safety and soundness.
    Mr. TOOMEY. Mr. Kohn, would you like to add anything to that?
    Mr. KOHN. I would agree with Secretary Abernathy on that. I do not see any adverse effects on safety and soundness here. Another added benefit for small banks would be an ability to reach out for deposits, where they are currently restricted, at least on the demand deposit dimension right now. So I think it would help them manage their liquidity. They have demonstrated over a long period of time that they can live in a deregulated environment. The supervisors and examiners would be sure to be careful that they were not engaging in activities that would endanger the safety and soundness. I see no problems in that dimension.
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    Mr. TOOMEY. My last question, Mr. Chairman—do either of you feel that the repeal of the prohibition on interest payments would or could be fairly characterized as in some ways leveling the playing field between the small banks and the large banks?
    Mr. ABERNATHY. I think particularly, large banks have been able to access a lot of these work-around products. Smaller banks cannot always access those. There is a certain cost involved with them, and the smaller your institution, the less willing you are to engage in that cost. So in many cases, you just do not compete in that field at all.
    Mr. KOHN. I agree. I think not only would it help to level the playing field between small and large banks because of the costs that were just discussed, but also between banks, and small banks in particular, and non-depository institutions. Small banks are at a disadvantage when competing with Merrill Lynch or another firm offering a money market fund that can attract the transaction deposits of businesses, particularly small businesses. So I think it levels the playing field in several ways.
    Mr. TOOMEY. Gentlemen, thank you very much for your testimony today and for answering my questions.
    Mr. Chairman, I will yield the balance of my time.
    Chairman BACHUS. Thank you. I appreciate that.
    Mr. Garrett?
    Mr. GARRETT. Thank you, Mr. Chairman.
    Am I correct to understand that since this bill was considered a couple of years ago that the reserve levels have actually not been going down, but been slightly going up? If that is true, do we know why that is?
    Mr. KOHN. That is correct, Congressman. They have gone up a little bit over the last couple of years. Primarily, it is because interest rates have declined. When market interest rates are low, people are less careful about keeping their transaction deposits down, which earn little or no interest. So as market interest rates go down, we find that demand deposits, NOW accounts and these reservable liabilities tend to go up. As a consequence, the reserves against them tend to go up. So yes, reserve balances have risen a little bit over the last few years.
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    I think one question which I raised in my testimony is, what happens when interest rates go back up again? I think we would see those balances go back down.
    Mr. GARRETT. Just a second question, then, following maybe in some sense where Congressman Sanders was going—the differences between the large banks and the small banks. My understanding is the various small banks, their reserve requirements are small to maybe nonexistent as far as what they have to put in there and what they may actually have on hand may satisfy that. So is there a disparity, then, on how this legislation impacts upon the two size banks as far as that goes? Is there a benefit to the small bank, other than just a larger economic issue as far as the economy is concerned.
    Mr. KOHN. I think it is true that structural reserve requirements is that the first $6 million or so of transactions deposits have no requirement on them. The next $37 million or so have a 3 percent requirement. Only after you get over $42 million, I think it is, that you get to the full 10 percent requirement. So the small banks tend to have smaller required reserves even relative to their size.
    Having said that, there are what was to me as I looked at the tables, a surprising number of small banks that hold deposits at the Federal Reserve—hold required reserve balances at the Federal Reserve. I think partly this is because they are not large enough to afford the sweep programs that the medium and larger size banks use to get rid of even the transactions deposits that they have. So if you look at the structure of who holds the deposits, yes, obviously in dollar number is it overwhelmingly the larger institutions, but there are some very small institutions that hold deposits. The medium-size institutions that get to a critical size so they can afford these sweep programs hold very few; and then the big ones hold more. So some small institutions would benefit.
    Mr. GARRETT. Okay. Thank you.
    Mr. ABERNATHY. If I could add, currently, probably the number one reason why smaller institutions do not have their deposits with the Fed is because they keep it in vault cash, mainly because of the demand at ATMs. That is only a temporary phenomenon. We have all these predictions as we develop new types of ways to carry money, such as money cards, cash cards and other instruments, where it could not be long before people are not carrying lots of cash and the demand for vault cash declines. And then you could see small institutions putting more money into the Fed because they do not satisfy with their vault cash needs.
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    Mr. GARRETT. Thank you.
    Chairman BACHUS. Thank you.
    Ms. Hart?
    Ms. HART. Thank you, Mr. Chairman.
    I am sorry I missed most of the testimony, but I did have a couple of questions, actually one main one. I was not here 20 years ago when I understand that this issue was discussed before. At that point, I understood that opponents of paying interest on business checking accounts went to the U.S. Government archives and reviewed the minutes of the Depository Institutions Deregulation Committee—it was about 10 or 11 years ago—where they discussed permitting banks to offer interest on business checking. The Committee decided not to permit banks to engage in this activity because of negative economic impact they believed that would result. In 1983, the chairman of the Fed expressed reservations about this change.
    Since that time, I am interested in knowing what has changed? Is there something specific that you can cite in the last 20 years that has changed the position of the Fed on this issue?
    Mr. KOHN. I am not sure the Depository Institution Deregulation Committee had the legal power to authorize interest payment on demand deposits. I think that is part of the law. So I am not sure exactly.
    Ms. HART. They must have just not recommended it then.
    Mr. KOHN. That is possible. First of all, I can actually recall helping Governor Partee write testimony on this issue in 1984 or 1985. I have been at the Fed for some time. We were in favor of paying interest on reserves and interest on demand deposits.
    Ms. HART. It changed from the prior couple of years, then?
    Mr. KOHN. Is that right? I do not recall why it changed, but I know that we have had the same position for at least 18 years.
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    Ms. HART. Okay.
    Mr. KOHN. I am not sure why it changed. I think right now the situation is that the banks have managed to get around a lot of the required reserves by instituting the sweeps. It is a socially wasteful and unnecessary kind of thing. It does, if it continued and intensified, make the implementation of monetary policy a little more difficult. So we can see no reason not to pay interest on required reserves. In so far as demand deposits are concerned, I think the same kind of reasoning goes. Increasingly over time, banks have found ways of, in effect, paying interest on demand deposits. It costs money to avoid the prohibition. The folks that are left behind are the small banks and the small businesses. I do not recall what the Board's reasoning might have been in 1983, but it makes no sense today.
    Ms. HART. Would it be possible to try to check out what had maybe changed that opinion? We will double check to make sure that our information is good—that that was the position. I will have my staff definitely catch up with you.
    Mr. KOHN. Sure. Okay.
    Ms. HART. One other question, and you may have answered this in your testimony, and I apologize if this is being redundant. Has there been some effort to determine the actual impact that this will have on the economy—the changes on the current institutions that have created that system that you are saying, the elaborate method that they have now to in a backdoor way provide that interest? Has there been a study done as to what that will mean to the economy?
    Mr. KOHN. As far as I know, there has not been an empirical study done, but people have given this considerable thought. The answer, I believe, is that there would be, as somebody mentioned, some winners and losers here. I think the winners would be people holding deposits, particularly the small businesses. Perhaps as interest on demand deposits rose, some services would cost a little more because they are now being subsidized by the people holding the deposits. But the overall effect, I think, would be positive for the efficiency of the economy. Services and deposits would be priced closer to their costs. The dead weight loss of all this activity to avoid the regulation would go away, and those resources—the lawyers, the accountants, the consultants, the computer programmers—could put their efforts into doing things that were more socially productive.
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    Ms. HART. I would not argue with that, but what about the reality that these institutions are going to have to be paying out where they have in the past were less clearly paying out, or less directly paying out. Was there any thought or consideration given to the possibility that they might have to increase other fees?
    Mr. KOHN. I think they might have to increase a few of the fees to the extent that they are under-pricing services now, in order to attract, quote, ''free demand deposits.'' So yes, some fees might rise a little, but deposit rates will rise a little, so that depositors will finally be receiving something without going through all the convolutions of avoiding the prohibition. I think net-net, it has got to be a plus because you do get rid of this dead weight loss. By avoiding the costs that the banks and the businesses now go through to avoid the regulation, the returns to depositors are going to go up more than the increase in the fees.
    Mr. ABERNATHY. If I may, what we would be saying to banks is, here is one more area on which you might compete with each other. Under current law, we are telling banks, you may not compete with regard to interest on business deposits. If this became law, we would be saying, here is one more element that you can put into your competition with one another. Banks have prospered, the more that they have been subject to competition.
    Ms. HART. Thank you. I yield back, Mr. Chairman.
    Chairman BACHUS. Thank you.
    This concludes the first panel's testimony. The first panel is discharged. If the second panel will take a seat. Two of the members wish to introduce members of the panel.
    Governor Kohn, we appreciate your testimony.
    Mr. KOHN. Thank you.
    Chairman BACHUS. And thank you, Assistant Secretary Abernathy.
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    Mr. ABERNATHY. Thank you.
    Chairman BACHUS. We want to welcome the second panel. At this time, I am going to recognize Mr. Toomey to introduce one of the panelists.
    Mr. TOOMEY. Thank you very much, Mr. Chairman.
    This is a pleasure for me today to introduce this gentleman because we have with us today before the subcommittee, Mr. Chairman, really one of the great post-war innovators—in fact, I would say a visionary—in the financial services industry. Bruce Bent is the CEO of the Reserves Fund. He is a great leader and a believer in the capitalist system, in the free enterprise system, and he is a man whose opinion I respect enormously. We have a slight difference of opinion on this particular bill. There are very few things on which we disagree in the economic realm, and as I said, I respect his opinion.
    I say he is a visionary because this is a gentleman who created the first money market mutual fund back in 1971. Mutual funds today, as we all know, are enormously important, holding over $2 trillion in investments. Mr. Bent's creation has been described as one of the 10 most important financial advances of the 20th century. I would say that it is an innovation that has democratized the capital markets of America in a way that no other innovation has, making investments possible, and in fact easy and convenient for millions and millions of Americans who would never otherwise have had the opportunity to invest and be stakeholders in our economy.
    So it is a great pleasure for me to welcome to our Committee today Mr. Bruce Bent. Thank you for being here.
    Mr. BENT. Thank you, Congressman.
    Mrs. KELLY. [Presiding.] Thank you, Mr. Toomey.
    It gives us great pleasure today to welcome our second panel here today—Mr. Edwin Maus, President and Chief Executive Officer of the Laurel Savings Bank, on behalf of America's Community Bankers; Mr. Michael Stewart Menzies, Sr., the President and Chief Executive Officer of the Easton Bank and Trust Company, on behalf of the Independent Community Bankers of America; Mr. Rex Hammock, President of Hammock Publishing Company, on behalf of the National Federation of Independent Businesses; Mr. Bruce Bent, Chairman and CEO of Reserve Management Company; and Mr. Robert Auerbach, Professor at the Lyndon B. Johnson School of Public Affairs at the University of Texas.
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    Thank you, gentlemen. We look forward to your testimony.
    Let us begin with you, Mr. Maus. Without objection, all of your written statements will be made part of the record, and you do understand the light system here. When the yellow light comes up, you can sum up your testimony. We would appreciate that.
    Thank you. We will begin with you, Mr. Maus.


    Mr. MAUS. Thank you.
    Madam Chairman, Ranking Member Sanders, and members of the subcommittee, my name is Edwin Maus. I am President and Chief executive officer of Laurel Savings Bank, the $270 million savings bank located in Allison Park, Pennsylvania, which is suburban Pittsburgh. I am testifying today on behalf of America's Community Bankers. I appreciate the opportunity to testify before you on the Business Checking Freedom Act of 2003, legislation whose subject matter was first brought to the attention of Congress by ACB nearly a decade ago.
    ACB strongly supports allowing banks to offer interest-bearing checking accounts, and urges the 108th Congress to pass H.R. 859. We also support authorizing the Federal Reserve to pay interest on sterile reserves, as reflected in H.R. 758. The existing ban on interest-bearing business checking accounts is the last statutory vestige of a Depression-era law that in the words of the federal banking regulators no longer serves a public purpose.
    Instead, it has created an anti-competitive business environment allowing a limited number of financial conglomerates to corner the market for cash management services. It has diminished the ability of community banks to lend to our neighbors and communities. It has prevented many small businesses from earning interest on their deposits.
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    Historically, the major beneficiaries of the ban on banks paying interest on business checking accounts have been a handful of large financial institutions. Unlike most community banks, those institutions have the financial resources to circumvent the prohibition by conducting so-called ''sweep'' arrangements. Sweep arrangements can be costly and cumbersome. In fact, many institutions that offer sweeps today do so only because they are not allowed to provide the more efficient service of paying interest on business checking accounts.
    The interest on business checking option would also provide a stimulus for America's small businesses and the economy as a whole. Many small businesses do not earn interest on their demand accounts because they cannot afford to maintain the relatively high minimum level of deposits required to maintain a sweep account. By lifting the ban on interest-bearing checking accounts, Congress can give these small businesses the opportunity to finally earn a market rate of return on their demand deposits. For many mom and pop businesses, this could mean the margin of difference from surviving a weak economy. In addition, it would open up the entire segment of potential new deposits for community banks to lend to our neighbors and our communities.
    Given the current debate in Washington over how best to revive the economy, doesn't a revenue-neutral economic stimulus tool like H.R. 859 make more sense?
    ACB is pleased to be joined in our support for this legislation by a host of organizations that supports small businesses, and by both the Federal Reserve and the Treasury Department. The legislation was passed not just once, but twice by the U.S. House of Representatives during the 107th Congress, and three other times before that. We hope that the House will follow suit again this year with a strong vote in favor of this much-needed legislation.
    I would also like to address the critical issue of timing. Much of the past opposition to this change in law has been camouflaged under the guise of unreasonably long transition periods. Institutions have had ample time to make any needed changes to their systems, operations and business plans. In 1980, the law authorizing banks such as Laurel Savings Bank to pay interest on consumer checking accounts took effect in a mere nine months after it was signed by the president. That was a major change for financial institutions to implement the interest on regular checking accounts back then. To make a similar change to business accounts today would be a very, very minor change for us to implement. While ACB would strongly prefer the legislation lift the ban immediately upon enactment, we believe that the one-year phase-in contained in H.R. 859 is an acceptable transition period. We strongly urge Congress not to extend this phase-in beyond one year.
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    I would also like to take this opportunity to express ACB's support for authorizing the Federal Reserve Board to pay interest on sterile reserves held at the Federal Reserve Bank. ACB commends Representative Kelly for introducing H.R. 758. ACB strongly endorses H.R. 859, the Business Checking Freedom Act of 2003—an important step for community banks, small businesses, and the American economy. We thank Representatives Pat Toomey and Paul Kanjorski for their sponsorship—both fellow Pennsylvanians, I might add—of this critical legislation and urge Congress to pass it immediately.
    Thank you again for the opportunity to testify before this subcommittee, and I look forward to any questions you may have.

    [The prepared statement of Edwin R. Maus can be found on page 79 in the appendix.]
    Mrs. KELLY. Thank you, Mr. Maus.
    Ms. Hart, I understand that Mr. Maus is perhaps from your district. Maybe you would like to say something.
    Ms. HART. Thank you, Madam Chairwoman.
    I am sorry, but I had to run out of the room to do a vote in Judiciary, or I would have actually introduced you before you gave your testimony. But I did get to hear it, and I thank you for it.
    For those of you who are not familiar with this guy, he is I would say it is safe to say one of our local bank wizards. He has really been with several successful organizations, and for the past probably—what?—15 years or so, with Laurel.
    Mr. MAUS. Fifteen with Laurel, yes.
    Ms. HART. Fifteen with Laurel, and it has gone really from a very little tiny, you pass up the office, then there aren't anymore, and you never hear of them again, to a very well respected and much larger financial institution under his tutelage. He is also, of course, a fellow University of Pittsburgh grad, and that is a really good thing. You probably do not know how close I really live to you, Bud.
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    Mr. MAUS. I have a pretty good idea.
    Ms. HART. We are pretty much in the same community. I think that is safe to say. I have just been watching your career, and it is a pleasure to have you here to share your wisdom with the Committee.
    Thank you, Madam Chairwoman.
    Mr. MAUS. Thank you.
    Mrs. KELLY. Thank you, Ms. Hart.
    We go now to Mr. Menzies. Is there some kind of a Pennsylvania cabal going on here, with the three of you here?


    Mr. MENZIES. Actually, I believe you are thinking of Easton, Pennsylvania, and regretfully much of my mail goes from Easton, Maryland to Easton, Pennsylvania by accident.
    Madam Chairman, thank you. Madam Chairman and Ranking Member Sanders, and members of the subcommittee, I am Mike Menzies from Easton Bank and Trust in Easton, Maryland, which is known as the wild goose capital of the world. I manage a $90 million community bank in Easton, and I am also honored to be the Vice Chairman of the Independent Community Bankers of America, Federal Legislation Committee. I am pleased to appear today on behalf of our nearly 5,000 members, and share our views on payment of interest on business checking and payment of interest on deposits at the Federal Reserve.
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    Madam Chair, as you know, repealing the bank on paying interest on business checking accounts, has been highly debated among community banks for many years. Frankly, they remain divided. Proponents of repealing the ban argue that it would increase economic efficiency and simplicity in business practices and assist in retaining their best customers and allow them to remain competitive. They believe that the current prohibition has been competitively damaging because of brokerage firms and others who are otherwise taking core deposits away from banks that banks could use to compete for loans in their marketplace.
    Opponents, on the other hand, argue that repealing the ban would squeeze their margins and they oppose the financial burden that could jeopardize their ability to compete with the bigger banks, who can afford to pay more interest. They fear the loss of business customers, and that is their concern.
    Because our membership is split, we very much advocate the alternative that Congresswoman Kelly has put on the table. We believe bankers on both sides support this alternative. Under this alternative, the ban on paying interest on business checking would remain in place, but the number of allowable transactions for money market accounts would go to 24, up from the current limit of six. Banks would be allowed to conduct daily sweeps between non-interest-bearing commercial accounts and interest-bearing money market deposit accounts. This would give banks the option of paying interest on commercial checking accounts at a cost that is significantly lower than the alternative repurchase sweep account, which the Fed has referred to as incredibly inefficient—and it is.
    Community banks are the primary source of credit for small businesses. Commercial depositors are looking for ways to get a return on their demand deposits. Increasing the number of allowable transactions from money market deposit accounts will allow community banks to remain competitive in providing cash management services to their commercial customers, and would enable commercial customers to earn a return on their funds and have funds readily available in a liquid deposit account. This is the only alternative that we are aware of, Mr. Chairman, that has not raised objections from banks on both sides.
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    Therefore, we strongly urge you and the subcommittee members to give this proposal very serious consideration. Should the prohibition be repealed, we would strongly support and urge a transition period of not less than two years or more. The transition period would be necessary to allow banks to reconfigure long-term business arrangements, certainly not the operational aspects, with commercial customers, and phase in the relative economic impact of this change, and there will be one.
    Mr. Chairman, I would also like to note for the record ICBA's historical and staunchly held support for maintaining the wall between banking and commerce, which was so strongly reaffirmed in the Gramm-Leach-Bliley Act. Thus, any effort in the context of this legislation to add provisions related to industrial loan companies would raise strong opposition from our membership, since ILCs can be owned by commercial firms. As Chairman Greenspan noted, this legislation should not be the vehicle for expansion of ILC powers.
    With respect to interest on sterile reserves, let me say that we certainly have no objection to this proposal. Many community banks have transaction deposits in the lower tranche, and this was mentioned before. Many communities do not have deposits at the Federal Reserve. Easton Bank and Trust does, as a matter of fact, have deposits at the Federal Reserve. We keep about $175,000 on deposit there right at this moment. But many small banks, in fact, would not be the beneficiaries of paying interest on those reserves. We do not oppose this legislation, however.
    It has been my honor to testify on behalf of the community banks of the ICBA and I look forward to answering any questions you may have.

    [The prepared statement of R. Michael Stewart Menzies, Sr., can be found on page 84 in the appendix.]
    Chairman BACHUS. [Presiding.] Thank you, Mr. Menzies. I will say that Easton is on the eastern shore, and it is a beautiful city.
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    Mr. MENZIES. Yes, sir. Thank you. We are very proud of Easton.
    Chairman BACHUS. Mr. Hammock?


    Mr. HAMMOCK. Thank you. While I am not from Pennsylvania, I am a native of Alabama and went to college in your district, so I make that connection.
    Chairman BACHUS. Where did you go to school?
    Mr. HAMMOCK. I went to Samford in Birmingham.
    Chairman BACHUS. My wife taught at Samford.
    Mr. HAMMOCK. Well, good. We will compare notes afterwards.
    I appreciate the chance to just summarize what my testimony is, and put the actual written testimony in the record. I appreciate the opportunity of coming this afternoon, and I thank Congressman Toomey for introducing H.R. 859. As I will tell you in a few minutes, I had an opportunity to testify about this, not even knowing it was an issue a couple of congresses ago. I feel like Chevy Chase on Groundhog's Day—you know, that sort of re-living some of these things. I have done this before.
    My company was started in 1991 and had five employees, and I actually went in and opened a business checking account, and was amazed to learn that I could not earn interest on that checking account. I fortunately knew my banker, and so in a good-natured way asked him why the archaic kind of thing was in place that did not allow me to earn interest on the checking. He suggested immediately about two or three alternatives that I could do to get around not earning interest on checking. In his case, he suggested I set up a money market fund that Mr. Bent developed, which they call a liquid asset account. So I did.
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    However, at that time, it was few years before online banking, I had to call the bank. That was before we had a bookkeeper. I was doing it myself. The accounting professor at that university we mentioned would be shocked to know that I was doing the accounting of our business. However, I did that for several years and would have to call my banker each night to transfer funds to make sure that money was not parked in the checking account, so we could earn interest on the liquid investment account. I continued to complain about this, and every once in a while I would wake up in the middle of the night and realize that I had not transferred monies from one account to the other account. You can imagine if you had to do this with your consumer account, which you would kind of think of in the middle of the night what you have paid and what you have not paid.
    Fortunately, our business has grown and a few years into it we hit a level, frankly I have forgotten what the level was, that the bank suggested a sweep account might be a better alternative. So we have that in place today. However, I do want to stress that for a small company without a financial staff—we do have a couple of people in our bookkeeping department now—but managing a sweep account is not as seamless as it appears, because I discovered that in the early days, and still the case, you have to reconcile the account every day, or the bank reconciles the sweep account every day. You receive in the mail, just like we receive on a monthly basis at home for your checking, we get that on a daily basis because of the sweep account reconciliations. So in a typical year, there would be a stack about this high of reconciliations that a typical small or medium-size business with a sweep account gets. A lot of that is done online now, but still it does add to the confusion of doing business, the reconciliations.
    I will finish by saying that about four years ago, actually to the day four years ago, five days ago I was able to testify on this issue for the first time, and frankly, why is a long story. But I complained about this and somebody heard me complain and said here is your chance to say something about it. There was a story about it that appeared in a national publication and used me as the small business owner poster child, or whatever, to complain about this. I received hundreds of calls from around the country, from stockbrokers and financial planners—everyone telling me how I could solve my problem of not earning interest on my checking account. I received one yesterday—not related to that—but I received—these are small business owners, daily almost, calls or weekly at least from any number of types of financial services providers who can tell me how to solve this.
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    So my complaints have more to do with just common sense, and just if there is something that small business owners hate to do is park money and resources in something that they are not earning money on. If there is a way around it, they are going to get around it. If there is a legal way, even the bank is encouraging that they are going to follow that. So I just think repeal of this prohibition makes sense, and I am happy to support it on behalf of the National Federation of Independent Business and its members.
    Thank you.

    [The prepared statement of Rex Hammock can be found on page 60 in the appendix.]
    Chairman BACHUS. Thank you.
    Our next witness—Mr. Bent, Mr. Toomey, although he is sponsor of the bill, introduced Mr. Bent and invited him to come. Although he opposes the legislation, that speaks well of Mr. Toomey, and our belief that everyone has a right to be heard.
    Mr. BENT. So much for democracy.
    Chairman BACHUS. Thank you.


    Mr. BENT. My full statement would be filed for the record. Number one, I thank you, Chairman Bachus, for allowing me to come. I would particularly like to thank Mr. Toomey and Mrs. Kelly for raising the awareness of the Congress to exactly what is happening out there as far as the disservice to injuries to businesses as far as lacking interest on their deposits. Surprised, right?
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    I take great pride in the fact that I invented the money fund. It is a $2 trillion industry today, and many, many people have been helped dramatically by it. My father said to me—I get a little bit emotional—that if it were not for the money fund, and not because I was giving him money, because he would not take it, he would not have been able to survive on his post office pension, except for the interest he got on the money fund. Okay. Now, that is very good and I am very proud of it, and my father is emblematic or symptomatic of a lot of other people that are out there—tens of millions of people. In fact, I would bet the vast majority of the people in this room, one way or the other, have benefited by the money fund and the competition that it created within the banking system.
    But some things happened that were not so good, and I think in order to survive, and I have survived now for over 30 years in business, one must be objective. The things that I did not like were the fact we had the collapse of the S&Ls and a cost to taxpayers of $200 billion. I attribute that to the creation of the money funds which precipitated the first crack at regulation Q, which was the elimination of interest limits on deposits. Today, we are talking about the second one.
    The second thing that I did not like about it is that balances moved out of communities. They were no longer in Fishkill or Allison Park or Defiance. They came to New York, which is great because I live in New York, but I am also an American. They went to London, which I do not really like. They went to Tokyo, which I did not like. And they went to Hong Kong. And they are still there, by and large. I would say that if I got down and did an equation on it, I would say except from New York, there is a net loss to every community in the United States, from balances moving into money funds. I do not like that.
    Now, that provided me with motivation, and my son, who is with me today, to create a thing called reserve return sweep. Reserve return sweep provides interest on checking balances for businesses in the community where the balance arises, so the balances stay in Allentown or Fishkill or even in Queens, where I was born, since everybody is looking for a hook here today—Jamaica Hospital.
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    Mrs. MALONEY. In my district.
    Mr. BENT. Thank you.
    And I think that that is critical. This reserve return sweep I am very proud of. I am so proud of it and so objective about it that I feel that the vast majority of balances that are in money funds will switch over to this new product. It is safe. It is simple. It is controlled and it is a cost-effective way of paying interest on checking. There is no limitation on the size of the people who could benefit from it. Right now, we have about 40 banks in our process and we have another 40 banks that are coming on right now. We have banks with as low as or as little as $300,000 with this process, and we have banks that have as much as $200 million in the process. So it is broad-based and it serves the people.
    I have been very concerned about this bill because of the fiat elimination of the second half of regulation Q, i.e. interest on balances. I am concerned that this again creates tumult in the marketplace for the cataclysmic introduction of interest on balances. Whether it is interest on balances or 24 transactions, it is instantaneous. Twenty-four transactions is a euphemism. That means it is happening today, because the banks will move the balances into the money market account where they do not have to pay any reserves on it, and it will be implemented instantly. So there is no transition period, and to discuss that it is, is spurious totally. It will not happen. So 24 transactions do not exist. It is effective instantaneously.
    I am very, very pleased at the effectiveness of this product. The problems that these gentlemen have had are all addressed, be it banks or my capitalist next to me—the bank is a capitalist, too. I think that what it does is avoid the crisis potential that would have if we simply made a fiat change in paying interest.
    Right now, our economy has lots of problems. We need hugs and kisses, not shocks, and I think the implementation of this bill could be a major shock for our economy.
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    Thank you.

    [The prepared statement of Bruce R. Bent, Sr., can be found on page 56 in the appendix.]
    Chairman BACHUS. Thank you.
    Let me say this, when you mentioned your dad, I think that is a generational thing, and I am now in your generation when we talk about our dads, if we have lost them or we are losing them, it is hard to do so without emotion. That is something that the younger generation sometimes does not understand, but I identify too well with it.
    Mr. BENT. Thank you.
    Chairman BACHUS. Mr. Auerbach, we want to welcome you back, as a staffer.
    Mr. AUERBACH. Thank you.
    Chairman BACHUS. You may want to recognize Mr. Auerbach.
    Mr. SANDERS. We do welcome you back and thank you for being here. Mr. Auerbach today is a Professor of Public Affairs at the Lyndon B. Johnson School of Public Affairs at the University of Texas. We thank you very much for joining us.


    Mr. AUERBACH. Thank you, Mr. Chairman, and the wonderful members of this Committee who I had the privilege of working with.
    I want to take you back to 1980—I had two different stints here—when I was working with Henry Reuss and there was chaos in the banking system, 16.5 percent reserves on deposits. You had Tom Ridge on the Committee, Henry Hyde, Charles Grassley—we were all very upset about this huge amount of reserves. These banks said they would all leave the Federal Reserve. So we lowered the reserve requirement to 12 percent. The Fed was screaming as they always do—we will lose control of the money supply without these required reserves; you cannot do it. Well, they did not. In fact, as soon as we finally settled at 12 percent, the Fed lowered it further to 10 percent.
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    Then the Fed initiated something that I am very surprised did not come up today. We put in the Monetary Control Act supplemental reserve requirements. The Fed has the power to raise in time of national emergency, which they declare, they have the power to raise reserve requirements by four percentage points and to pay interest on the reserves. That is in the legislation. Why would not the Fed mention that? If they are worried about money control, they just put in supplemental reserves and pay interest on it. How come that has been left out of this? Curious. We also raised the insurance rates in order to get the banking groups in town here to support the bill. They raised it from $40,000 insurance to $100,000—a tremendous gift to the small banks that they received at that time.
    Now let me just—I am jumping over because if I am talking against the wonderful bill that some of you have, I have got two suggestions. Later you can ask me, and I think it will improve the bill, but I will leave those to the end—something that Don Kohn, wonderful Governor—we used to work together at the Fed; he is a personal friend—told me, I think it would make the bill a bit better.
    What happened to the reserves in the system? The reserves are tremendous in the Federal Reserve system today. There is are $76 billion worth of reserves sitting there. There is only, as of February, about $9.6 billion held at the Fed. So I think it is rather irrelevant. It is a very small distortion for the system to start paying interest on those reserves. Let me tell you why. If you start paying interest on reserves, the thing that is going to happen is there will be more reserves. I learned this in my studies under Milton Friedman at the University of Chicago. You subsidize something, you are going to get more of them.
    Now, Don Kohn had in his testimony $28 billion that they had. I told him, no, if you look on the chart I have here, they had in the early 1990s $35 billion at the Fed. But a lot of these banks took the cash, which they can use to meet the reserve requirements, and they put them in ATMs. Remember, as Governor Kohn said, if you have less than $41 million, the small banks, the reserve requirement is only 3 percent. Under $5 million, it is zero. So small banks are not going to benefit from interest on reserves. They will be injured.
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    So how many more reserves will flow in? First of all, what is the interest that the Fed will pay? Well, I picked the federal funds rate and I drew a chart of it. For the last 30 years, up until March 2000 when the bubble broke, we started to crash, the average federal funds rate has been 7.7 percent. That would kind of be a worst—and remember in 1980 the federal funds rate was over 20 percent, when Ronald Reagan came into power. I worked in the Reagan administration for the first year, in the Treasury. It was a mess.
    Chairman BACHUS. Wasn't that when Carter was in office?
    Mr. AUERBACH. Carter was in—it happened right at the transition. I was with the Committee and then I went over in—you are right.
    Chairman BACHUS. That was just so big, I just could not—
    Mr. AUERBACH. You are absolutely right. But we had that problem, you know, with the double-dip recession and we had a terrific problem.
    So I would say, look, let's not—say, 7.7 percent will be—this is—for 30 years the average federal funds rate was 7.7 percent. Let's not make a worst-case scenario. Let's just say 5 percent. We do not want to take the current distress period. I do not expect the interest rates to be at 1930 Depression levels for a while. I would expect if you pay more for something, you are going to get more. I was telling Don Kohn, I think it will probably go up to about $20 billion. So at 5 percent, you would be giving an annuity of $1 billion a year to the banks. That annuity, if you discount it at 6 percent, is worth—a guaranteed annuity from the government is worth about $16.7 billion, using a 6 percent rate of discount. This is a huge payment to the banks, and who would get it? Primarily the large banks which have a lot of reserves.
    Let me just answer one other question. Would it be passed through, as Don Kohn said? Would it be passed through to the depositors? The truth is, the banks have a system of parallel pricing. They have a national prime rate. That is a whole other story. The Fed's own research in 1980 when we were fighting about this shows that they have the same prime rate all over the country and they practice price discrimination. The larger borrowers can get loans at money market rates. The same thing would occur. You are not going to pass through all this. The main benefit—I do not have time to go into the way banks price—the main benefit would be the stockholders of the big banks. They get a very respectable increase.
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    One other last point—Bruce Vento, the late Bruce Vento, in his last period here, he collected information on the concentration of banking in the United States. It was sent to him by the Federal Reserve. I had a chance to look at it. Although we have got a lot of small banks out there, the Federal Reserve has let the concentration of banking in the metropolitan areas heighten. You have got places like New Orleans where a couple of banks control much of the deposits in there. You do not have a model of free competition. It does not exist in the large urban areas. Banks will all charge the same price. What do they charge now? What do they pay—.02 percent on an account unless you are one of the lucky people that gets in on the sweep accounts.
    So I have two things that would make the interest paying thing, but my time is up. If you want to ask me—I am sorry I talked past my time.

    [The prepared statement of Robert Auerbach can be found on page 51 in the appendix.]
    Chairman BACHUS. Thank you.
    Mr. Gonzalez would have probably calmed you down.
    Ms. Kelly, I am going to yield my time to you.
    Mrs. KELLY. Does that mean that I get no time of my own?
    Chairman BACHUS. No, you get no time—or I will yield 2.5 minutes to you and 2.5 minutes to Mr. Toomey.
    Mrs. KELLY. I want to make one remark to you, Mr. Auerbach. I am not looking and I do not think Mr. Toomey is looking at this legislation as a tool for social engineering, regarding your remarks that the large banks get the most on the reserves. Of course, they do, because they put the most in. So I think my real question here is to you, Mr. Menzies. I asked the earlier panel to comment on the proposal to allow the ILCs to offer business NOW accounts, as they are authorized to, some of them by their state. Would you be willing to discuss the ICBA's position on this proposal?
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    Mr. MENZIES. I do not profess to be an expert with respect to ILCs, but I believe the basic issue is that if it walks, acts and talked like a duck, it ought to be a duck and not something else. If they are going to act like a bank and be like a bank, then they should be operating and regulated like a bank. Our primary objective is to adhere to the Gramm-Leach-Bliley spirit of separating banking and commerce, and not allowing this effort to do an end-run on that objective of separating banking and commerce. So that is the number one position, I believe.
    The other position that was referenced by the Federal Reserve and by Chairman Greenspan is that if they are going to be a bank, then have them subject to the Bank Holding Company Act and have them subject to the Federal Reserve regulations, and have them subject to all of the laws associated with banking and not be an exclusive, limited-purpose, limited-objective financial institution.
    Mrs. KELLY. Mr. Menzies, I wonder if you would be willing to talk—you say you are not an expert on this—would you be willing to discuss this in a letter and get a letter back to us?
    Mr. MENZIES. Absolutely. It would be our honor. We would be happy to get together more information on this to you.
    [The following information can be found on page 133 in the appendix.]
    Mrs. KELLY. Thank you very much.
    I am going to yield back and hope that you will give me my own time.
    Chairman BACHUS. I do not think we stopped the clock, so I do not know how much time you have—I think about a minute left.
    Mr. TOOMEY. Thank you, Mr. Chairman.
    My first question-comment is for Mr. Auerbach. Do you agree that the use of money has an inherent value, or to put it differently, that money has a time value?
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    Mr. AUERBACH. The time value of money—do you mean is the interest rate?
    Mr. TOOMEY. Yes, and that money has an inherent time value, that it is standard; that an individual or an institution that has use of money pays for that use of money, and we call that interest, and that is a norm.
    Mr. AUERBACH. Right.
    Mr. TOOMEY. I reject the idea that to pay interest on bank sterile reserves is a subsidy. I do not think when a corporation borrows money from a bank that it is subsidizing that bank. I think it is simply paying the going rate for the use of the bank's money. I think when a consumer borrows money to finance a mortgage, I do not think the consumer is subsidizing the bank. I think it is just paying for the use of the bank's money.
    Similarly, I think when banks have reserves with the government, if the government refuses to pay interest on that, in fact that is a tax because it is choosing not to pay the market value for the use of that money. Isn't that a fair way to characterize it?
    Mr. AUERBACH. I agree with you 100 percent, but let me just answer this way. At present, there is hardly any money in those accounts. It is a very small distortion. But if the interest rates rise again, as they have throughout the last 30 years, you are going to be paying huge amounts of money and you will have money transferring—you are a good free enterprise Congressman. You know what is going to happen. You are going to have money transferred into those accounts. What would happen in 1980 when they were paying 21 percent federal funds?
    Mr. TOOMEY. But of course the rate that they were paying will be in line with current market conditions. So there will be other available alternatives that also pay high rates if interest rates generally go up. If the Federal Reserve is paying 21 percent, God forbid, at some point in the future, there will be other interest rates available, other vehicles available. It would not be that we would have a current interest rate environment and the Federal Reserve would be the only one paying.
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    Mr. AUERBACH. But if the government is sending out a $1 billion a year to the banks, that is what I find is a subsidy.
    Mrs. KELLY. Will the gentleman yield on that point?
    Mr. TOOMEY. I would just like to go back. I will yield in a second.
    Chairman BACHUS. Your time is just about up.
    Mr. TOOMEY. I would just say again, I think you just said what I thought you agreed was not the case. I just do not think that it is a subsidy if the government is paying a market rate for the use of funds that belong to someone else.
    Mrs. KELLY. Your point, Mr. Auerbach—
    Chairman BACHUS. I think we went over. I am not sure where the clock is—we cannot figure out what happened to the clock, but I am sure we are over.
    Mr. Sanders?
    Mr. SANDERS. I am not quite sure what Mrs. Kelly meant when she talked about social engineering, but what I do know is that if the federal deficit goes higher, there are at least some people who use that as an excuse to cut back on Medicare, Medicaid, education, infrastructure improvement, affordable housing. So I worry about a deficit being very high, because it means many low income and middle class workers are going to see cutbacks in programs which are very often of great necessity to them.
    Mr. Auerbach, if I could ask you, what is your guess if the Fed were paying interest on reserves, what impact would that have on the federal deficit, say, over a 10-year period?
    Mr. AUERBACH. On this point, I agree with Governor Kohn that the surplus is a meaningless change from one bank account to another. The federal deficit properly estimated would decline by the amount of money paid to the banks—about $1 billion a year.
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    Mr. SANDERS. The federal deficit would—
    Mr. AUERBACH. Would get bigger—excuse me.
    Mr. SANDERS. By about $1 billion a year.
    Mr. AUERBACH. Right.
    Mr. SANDERS. So over a 10-year period—
    Mr. AUERBACH. But that is not a worst-case scenario. If interest rates went over 5 percent, it could easily get—
    Mr. SANDERS. I recognize that. No one can predict when interest rates will go up, but you are guessing that it might increase the deficit, if you like, by $10 billion over a 10-year period. Is that what you are saying?
    Mr. AUERBACH. It has to. Yes.
    Mr. SANDERS. Again, I do not know what Mrs. Kelly was referring to in terms of social engineering, but if the deficit goes up by $10 billion, I suspect there are some people who would cut back on Medicaid, Medicare, affordable housing. That concerns me very much.
    Mr. Auerbach, and then I will ask the same questions to the other members. I think you touched on this. Again, in your judgment, I am hearing that the major beneficiaries of this would be some of the largest banks in America. I do not think there is much doubt about that. Yes, they are the ones who have the money, and they are the ones who would benefit. So we are talking about—and again, I appreciate no one can make an exact prediction, it is a guess game—but you are suggesting a $10 billion increase in the deficit over a 10-year period, with the primary beneficiaries of that being the largest banks in America. I, for one, have an objection to that, but I would be happy to ask other distinguished members of the Committee if they would—is anybody up here? Any good conservatives worried about increasing the deficit, or am I the only conservative who holds that? Mr. Menzies?
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    Mr. MENZIES. I am very worried about increasing the deficit. In that regard, I believe that with all due respect to the professor's position, it presumes that banks are not reinvesting those reserves in their depositors, in their borrowers, in those receiving dividends from the banks.
    Mr. SANDERS. But what does that have to do with it? I understand that, but what does that have to do with the deficit?
    Mr. MENZIES. I believe in our system, the more we increase our economy by increasing money flowing through our economy, the prosperity of our system.
    Mr. SANDERS. Trickle down.
    Mr. MENZIES. Unless you presume that all of the money goes into the salaries of executives, in 401(k) plans where the tax is deferred.
    Mr. SANDERS. I do appreciate that, but you are not denying that the immediate effect—what you are saying is it stimulates—
    Mr. MENZIES. But I believe that the professor said that the economic impact was exactly the interest that was paid by the Federal Reserve to the banks. I am not an economist by trade, but I question that business model.
    Mr. SANDERS. That is kind of like when we give hundreds of billions of dollars in tax breaks to the richest 1 percent in the long run really is going to help us all.
    Anybody else want to comment on that? Mr. Maus?
    Mr. MAUS. I do not know that it is a fair assumption to say that whatever amount would be paid out by the Federal Reserve to banks on sterile reserves would equate to a specific number, because in doing so there is an assumption being made that the amounts that the Federal Reserve are turning back into the treasury, they would do nothing else to increase that amount. So it is not just that we are going to pay out all of this money and they are not going to do anything else in their structure to either increase income, decrease expenses or whatever, to offset some of the money that they would be paying out on the sterile reserves.
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    Mr. SANDERS. Thank you.
    That is about it for me. Thank you, Mr. Chairman.
    Chairman BACHUS. Ms. Kelly?
    Mrs. KELLY. I simply want to go back to what Mr. Auerbach said. You know, you talked about the money being reduced that is in the reserve accounts. I think it is fair to say that one of the reasons that money has been reduced is the banks can make more money by putting it in the ATMs. So if there is interest paid on the reserves, some of those reserves, yes, there might accrue a larger amount in there, which would not necessarily be a bad thing, given the volatility of the economy. Isn't that correct?
    Mr. AUERBACH. You are absolutely right. What would happen with the payment of reserves is that many, many banks would give less services through ATMs and put them in the Fed.
    Mrs. KELLY. You cannot assume that they would give less services. It just means that they may perhaps pack less money into those ATMs, but that does not necessarily mean they are going to reduce their services in order to get some sort of interest on their sterile reserves.
    Mr. AUERBACH. Instead of having $30,000 in, they might put $20,000 and they would run out maybe on the weekends, because there would be a—
    Mrs. KELLY. You cannot project that. I am sorry, sir, I do not agree with that. I think they are smarter than that. I think they can figure out their weekends.
    Mr. AUERBACH. If you are paying for them to take money and invest it with the Federal Reserve, then they will have less money in their vault cash in the ATMs.
    Mrs. KELLY. Perhaps, but they may find other ways to work with their money. That is what banks do. I think that we have had for a very long period of time much discussion, as we have heard today, over perhaps 20 years about the possibility of allowing those banks to earn something on the sterile reserves. It is not bad monetary policy. Maybe I have just a greater trust in the bankers than you do.
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    I yield back.
    Chairman BACHUS. Thank you.
    Let me ask one question. Mr. Menzies, your organization is neutral on paying interest on business checking accounts?
    Mr. MENZIES. The position of the organization is that we recommend the 24 transaction a month in a money market account as an alternative to interest on checking. That is the position of the divided interest. That is a preferential solution to, frankly, the archaic law that you all are dealing with.
    Chairman BACHUS. Let me point out something in Mr. Maus's testimony. This is actually for Mr. Menzies, but it is your testimony, which I agree with. Mr. Maus points out that repealing the current prohibition would not force banks to pay interest on business checking accounts. It just gives them the right to do that.
    Mr. MENZIES. I totally agree with that, and there is a lot of logic to that statement. The counter issue, as opposed to argument, is that the money market account traditionally is a much more stable account. By definition, it is a savings or it is an investment account. It is an account in which monies reside for hopefully a longer period of time than a, quote, ''demand deposit account'', which is subject to demand.
    The question was asked a while ago about 1983, why it is that we were not paying interest on commercial accounts. I recall talking to the regulators about that question and was told, well, it is because if commercial accounts received interest, they may chase the highest rates and it would volatize possibly the core deposit base of the banking industry and cause corporations to move their money quickly to the next highest rate, and those deposits are used to make loans, and we do not wish to volatize the liability side of the bank, which generates loans to small businesses, so let's not pay them interest. That, as I recall, was an excuse or was an argument.
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    Thanks to Mr. Bent, we have entered into the next century with respect to paying interest on liquid funds. The argument to consider the 24 transaction sweep is that it may not be quite as volatile as the demand deposit account, which is a checkable account. True, you can write 24 checks, I guess, under the current legislation or do 24 transfers, so there clearly is a level of volatility. But you are not depositing 80 or 90 checks per day in that money market account if it is a sweep account. You are putting those in your checking account. There may be merit with respect to the safety and soundness question of whether the money market account is a more stable solution than interest on demand deposits. I do not truly know the economic answer to that question.
    Chairman BACHUS. What this legislation does, Mr. Toomey's legislation, is just give the banks a choice to be able to offer those services to their customers if they so choose. It is just another choice.
    Mr. MENZIES. And banks should be grown up enough to price their products relative to the risk and relative to the cost of those transactions. It is a true statement.
    Chairman BACHUS. I think in our free market society, you would agree that that is just one more choice for the consumer?
    Mr. MENZIES. Absolutely.
    Chairman BACHUS. Mr. Bent?
    Mr. BENT. In 1980, we gave savings and loan associations the opportunity to pay more than 5.25 percent. They leaped at it because it was not an option, it was a requirement because it was in a competitive marketplace. Both the representative of the Federal Reserve and the Treasury both talk about competition going in this. Believe me, I am in favor of competition, but I am not in favor of disrupting our banking system, particularly in this economy.
    As far as the money market account being more stable, when you have 24 transactions in a money market—maybe I should not tell the banks how to figure out, but I will figure it out for them—all the checks go in and out of the DDA account; the excess cash swings over to the money market account; it stays there. At the end of the day, the bank computer, because this is not people-intensive, tells the MMDA account, the money market account, how much money it has to send over to the DDA account, the checking account, to pay the checks. So it is instantly full of liquid funds. It is an active account. It is not a savings account. It is not doing what was contemplated when the MMDA account was originally created back in 1982. It is definitely not.
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    Chairman BACHUS. Of course, the savings and loans, that is an issue we have discussed ever since I have been here in 1992. The main factor was they were borrowing short and lending long, and got caught in the squeeze.
    Mr. BENT. But why? To compete. If they could not pay more than 5.25 percent, they would have not gone through that exercise.
    Chairman BACHUS. That is right, but what I am saying is banks are in a different situation. I do not see how this being able to offer interest rates, low interest rates—
    Mr. BENT. It is low interest rates today, but if we go back to the Carter Administration—
    Chairman BACHUS. In this case, you are lending on a short-term basis.
    Mr. BENT. I am sorry?
    Chairman BACHUS. You are just paying interest on a short-term basis.
    Mr. BENT. But in order to be able to pay interest on deposits, you have to invest it someplace.
    Chairman BACHUS. But you would not have it in 30-year mortgages.
    Mr. BENT. If you go back to in the 1980s, the S&Ls could have put their money out in the marketplace, theoretically. They could have gone into 30-year treasuries and gotten 17 percent. They could have gotten T-bills, which were even more than that. But they did not. They went out and bought long-term mortgages and that is where their exposure was. Fear and greed, fear and greed—they got the greed.
    Chairman BACHUS. This concludes our hearing. No, I am sorry. We have two unanimous consent requests.
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    Mrs. MALONEY. I have one. I ask unanimous consent that a brief statement from the Commissioner of Utah's Department of Financial Institutions regarding the subject matter of today's hearing be made part of the hearing record. I hope that you will accept that unanimous consent request.
    Chairman BACHUS. It is from the ILC?
    Mrs. MALONEY. It is from the Commissioner of Utah's Department of Financial Institutions.
    Chairman BACHUS. On the industrial loan company?
    Mrs. MALONEY. He did not say what he wanted to talk about.
    Chairman BACHUS. Yes.
    [The following information can be found on page 128 in the appendix.]
    Mrs. MALONEY. Anyway, my first question is to the NFIB.
    Chairman BACHUS. I am sorry. You had not been recognized?
    Mrs. MALONEY. No.
    Chairman BACHUS. I apologize. This does not conclude.
    Mrs. MALONEY. One of the often-cited reasons for allowing the payment of interest on sterile reserves is that small businesses do not have access to these sweep accounts. How often do you hear this complaint? Is that a major concern of small businesses?
    Mr. MENZIES. I know in my case, and I can only speak from my case, that I did not have access to a sweep account until we got to a certain size. It is off the radar screen of, frankly, most small business owners. But there are work-arounds that almost any small business owner will do, that are quite legal. They are usually suggested by the bank.
    Mrs. MALONEY. Really. Well, the Fed has argued that it needs additional flexibility in their reserve requirements for the sake of setting monetary policy. I would like to ask any of the members of the panel to comment if they would like, generally, on the Fed's reasoning that the payment of interest on sterile reserves and the elimination of the floor on reserve requirements will enhance its ability to target monetary policy. If anyone would like to comment on that—anyone?
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    Mr. AUERBACH. That is an argument they have used for many years whenever we have lowered reserve requirements. I do not think it has any substance. If they are worried about control of the federal funds rate or the money supply, they have supplemental reserve requirements that pay interest on the reserves that they could put in at any time. We wrote that into the Monetary Control Act. I do not know, has someone taken that out of the bill? It is already there. I think at present, and I talked to Governor Kohn about this, they have had no trouble controlling the federal funds rate. It is not an issue at present. He was talking about, if something happened, maybe they would have trouble in the future.
    Mrs. MALONEY. Anyone else like to comment on it?
    Mr. BENT. I would like to go back to the question that you addressed to Mr. Hammock, as far as the availability of sweeps to small businesses. I would be very pleased to set up a sweep arrangement for Hammock Publishing, and every member of the NFIB, which I think is something like 600,000, so that they simply had one account on the bank and everything happened automatically through reserve return sweep, and you would get interest on your balances.
    Mr. HAMMOCK. I would like to have that option, or the option to just not to park my money in a checking account. That would be great. If you had a product that could compete and I would like, that is great. That is all I think that small business owners want, is just something that is logical and that anyone can compete for.
    Mrs. MALONEY. Thank you.
    Thank you, Mr. Chairman.
    Chairman BACHUS. Ms. Kelly?
    Mrs. KELLY. Thank you, Mr. Chairman.
    I have a unanimous consent request. When Mr. Greenspan testified before our Committee a few weeks ago, he testified about the NOW accounts. I have here a letter actually sent on April 2, 2001, that reiterates that kind of testimony, that I would like to put in the record.
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    Chairman BACHUS. Without objection.
    [The following information can be found on page 89 in the appendix.]
    Mrs. KELLY. Thank you.
    Chairman BACHUS. Are there any more requests for time or for consent requests? If not, the hearing is concluded.
    [Whereupon, at 4:14 p.m., the subcommittee was adjourned.]