Segment 3 Of 3 Previous Hearing Segment(2)
SPEAKERS CONTENTS INSERTS
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FINANCIAL SERVICES MODERNIZATION
TUESDAY, FEBRUARY 25, 1997
House of Representatives,
Subcommittee on Financial Institutions and
Consumer Credit,
Committee on Banking and Financial Services,
Washington, DC.
The subcommittee met, pursuant to call, at 10:05 a.m., in room 2128, Rayburn House Office Building, Hon. Marge Roukema [chairwoman of the subcommittee] presiding.
Present: Chairwoman Roukema, Representatives Bereuter, Barr, Kelly, Paul, Leach (ex officio), Vento, LaFalce, Watt of North Carolina, Bentsen, and Kilpatrick.
Chairwoman ROUKEMA. The hearing will come to order.
I do appreciate the attendance of my colleagues here today. We are under the unfortunate circumstance of the timing here. We had fully expected that today would be a voting session, but apparently it is not, so some Members have been delayed in returning to Washington after the President's Week recess.
Again, as I am sure all in this room know, but we want to have it on the record, and certainly Mr. Volcker knows, and the other panelists should know, that these records are all official records of the subcommittee and the full committee and the full testimony will be available not only to the public and the press, but in detail to every Member of the committee.
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Today, we are concluding our first set of hearings on financial services reform. We have already heard testimony from both the Federal banking regulators and industry groups over a period of a week-and-a-half. Today, we will hear from the former Chairman of the Federal Reserve Board, Paul Volcker, and various community and consumer groups. We are certainly appreciative of the fact that Mr. Volcker has taken time out of his busy schedule, a schedule that takes him both nationally and internationally, and rearranged his schedule in order to be with us here today.
I, for one, am encouraged by the amount of agreement that has been expressed by the participants in these hearings so far. Clearly, there is broad support for financial modernization, but key questions, and I hope not intractable questions, remain as to the appropriate supervision of the holding companies, the mix of banking and commerce which is a contentious issue and how best to merge the banking and thrift charters.
As I have previously stated, both in my questioning period and my opening statements, and certainly when I introduced the so-called Alliance Bill, H.R. 268, I have stated that I considered that legislation to be the best vehicle to bring everyone to the table to iron out agreements and what is in the best interest of this country and financial services.
Congress has been abdicating its responsibility for all too long and, as we know, the regulators have been filling the vacuum.
While everyone seems to agree on the need for reform of our current system of regulating holding companies, the consensus ends there. We heard Chairman Greenspan make the case for continuation of an umbrella supervision. However, many industry groups testified in favor of a structure that supervises on the basis of function. Indeed, referring to Mr. Greenspan's assessment, the questions remain as to whether H.R. 268's holding company oversight is adequate.
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Specifically, the proposed legislation would leave the agency regulating the lead bank of the established financial services holding company to implement and enforce the assessment and management of the risk of the affiliates. The Alliance maintains, and has so testified, that this oversight structure would maintain the safety and soundness. The Fed and the SEC, under whose authority risk management system is modeled, expressed great concern that this change from the current system would affect the government's ability to monitor systemic risk.
When it comes to banking and commerce, there are continuing concerns. Many of our witnesses made the point that rapidly changing technologies are altering the definition of finance. As time goes on, it has been stated over and over again, it will be more difficult to tell the difference between financial institutions and non-financial businesses. That very fact dictates that we carefully review the current legal barriers between banking and commerce.
House Resolution 268 includes a ''basket'' approach, which would allow us to approach the issue incrementally with a further mix of banking and commerce. The bill would limit financial services holding companies non-financial activities to 25 percent of the total business. While many of our witnesses testified in favor of a much broader mix, this is an issue that deserves a thoughtful and deliberate consideration, and I am confident that Chairman Volcker will address this issue.
However we proceed, we must be careful to make sure the appropriate safeguards are in place to ensure the safety and soundness of our insured financial institutions and to assure that they are preserved. This is more than just a matter of firewalls between banking and commerce. In this age of megacorporations, we must ensure that we do not allow the largest segment of the Nation's economy to be concentrated in one entity.
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I was certainly encouraged by Chairman Greenspan's support for the ''basket'' approach, similar to what is included in H.R. 268. He indicated that a, quote: ''small basket'' unquote, approach should be available to organizations that either have to establish well capitalized and well managed bank subsidiaries, an approach the Fed is already overseeing in Section 20 affiliates.
In any event, we are most anxious to hear from our witnesses today, our first panel and the second panel representing the various consumer and business groups.
[The prepared statement of Hon. Marge Roukema can be found on page 560 in the appendix.]
With that, I will open it up for comments from my colleague, Mr. Vento, the Ranking Member of the subcommittee.
Mr. VENTO. Thank you, Chairwoman Roukema.
I would like to welcome our witnesses, especially Paul Volcker, who has graced this panel and this Congress with past testimony and service at the Federal Reserve Board and in other capacities.
I think that the tone that you struck in your opening comment is about right, that almost everyone agrees with modernization. Most everyone talks about harmonization, integration, the convergence of the various financial entities that sustain our mixed economy as, in fact, overlapping in significant ways and in the way they function in this economy today.
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Updating the law, it is interesting, of course, that we deal with regulators, former regulators, like Mr. Volcker and others who come here who help us, tell us, what we really meant by the Holding Company Act and others, and the courts.
In any case, in his testimony talking about that it is very interesting to reflect upon it. I guess at one time I was of the mind that we could actually have more separation of these functions, but I think today it is pretty apparent to almost all that that is not the case, just calling our attention to money market mutual funds that have now eclipsed the deposits in other institutions.
In any case, everyone agrees that deposit insurance should not be spread to parts of the market, other parts of the free market; that we should not displace that; that we, in fact, need to have functional regulation. There is, I think, one aspect of the measure that we have before us, as we know, a bill that was largely put together by some of the competing groups to try and find some common ground. I think that that is helpful. But I think one aspect, or one group that has not been heard from, or reflected altogether in this, is the consumer groups. So their testimony, I think, will be key.
We know that we need, throughout this process of the expansion of powers and functions, disclosure, accountability, transparency, up to the point where we are dealing with proprietary information. And, in fact, if we accomplish our task right I think that we should keep in place the consumer protections, if not enhance them and reinforce them.
Just as we are extending powers and a new role and responsibility to financial entities, we should be certain that the consumers, in essence, that the consumer law that has, that does serve the constituencies that we represent, it follows, that in fact the franchises and the enterprises that are spin off from and are developing in the marketplace actually provide the foundation of credit and financial services that are necessary and needed by the constituencies we represent, both the consumers, as I said, the businesses and something called the social welfare.
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Obviously, all within the mantle now, while we may agree generally upon where we are going, of course, there are differences about how we are going to regulate and how we are going to achieve that in law. I think, though, that that hopefully can be done, if not perfectly, I don't think we are going to work ourselves out of a job here, but I think that we should, in fact, put in place a new foundation, as it were, with regard to these powers and recognize that we are going to have to carefully follow and make certain there is accountability and that it is working smoothly to accomplish the objectives that all of us have for the success of our economy.
So it is really a privilege, I think, to have someone like Paul Volcker come and participate, who has done the work. While we may not all agree with his conclusions, we certainly appreciate his participation, Madam Chairwoman. Thank you.
Chairwoman ROUKEMA. Are there other opening statements on our side?
Chairman Leach, do you have an opening statement? We are honored by your attendance.
Mr. LEACH. Thank you, Madam Chairwoman. No, I don't. I just wanted to welcome Mr. Volcker. Pleased to be with you. Thank you.
Chairwoman ROUKEMA. Congressman LaFalce.
Mr. LAFALCE. Yes. Thank you very much, Chairwoman Roukema. It is always a pleasure having Chairman Volcker before us and I look forward to his insights.
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I think the stars are in alignment right now in 1997 and 1998. I think it is possible to bring about financial modernization, in part because of the players in Congress and the Administration but, in part, too, because some institutional groups that had hitherto had one position have now come to have a different position, so there is more consistency amongst the groups; the securities industries and the insurance industry, along with the bulk of the traditional banking industry that now is much closer together than they have ever been before.
But there are going to be at least two very sticky wickets. You know, one is banking and commerce. And we can't just say, ''Oh, put that aside.'' I just think that is an impossibility to just put it aside. We must deal with it. The question is how we deal with it. We have a mixture of banking and commerce today and we have prohibitions against banking and commerce. It is all a question of how you define it.
There are some financial institutions that are able to do more than other types of financial institutions, and so forth. So there is a wide range there. I am hoping that we can come up with some consensus so that we do not have to take the approach just: A: Forget about it or; B: All or nothing at all. There may well be something that we could reach consensus about on that.
But whatever we do, the most important thing in this modernization effort, especially with the technology that exists today, is that we do not lose sight of the consumer. And I presently believe that none of the bills before us, including the one that I have cosponsored, adequately deal with consumer concerns. I think it is imperative that we not have a final product unless it, at the very least, adequately deals with consumer concerns.
There are a host of consumer concerns, but whenever financial institutions are offering a multiplicity of products, it can be very confusing, and we must make sure there to minimize the confusion and minimize any potential intimidation, and so forth.
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I have written to the Administration, Mr. Hawke and to Mr. Ludwig, on this point, hoping that their legislation will provide at least threshold legislation for consumer protections. I look forward to working with all the consumer groups to make sure that their voice is a very loud voice in these deliberations.
Speaking of consumer protections, Madam Chairwoman, and this is off the subject, but I think the most important consumer issue that our subcommittee could take up this year would be the area of advertising with respect to automobile leases. Very shortly I will be introducing legislation similar, but slightly revised from the legislation I introduced in the last Congress.
I defy anyone here to pick up the Washington Post, the Washington Times, the New York Times, and be able to tell me which auto dealer is giving a better deal. Based upon the advertising that they do, it is virtually impossible. It cries out for reform.
Thank you, Madam Chairwoman.
Chairwoman ROUKEMA. Thank you, Mr. LaFalce.
Other opening statements?
Ms. Kilpatrick.
Ms. KILPATRICK. I will pass.
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Chairwoman ROUKEMA. Thank you. Thank you.
Mr. Volcker, we are so pleased to welcome you here today. Many of us on this subcommittee have worked with you in the past and, of course, we are all now aware of your work, not only in financial institutions, but also recently expanding your concerns with respect to the Swiss banking system and its relationship to the Holocaust victims and that rectitude that needs to be addressed.
But I am most pleased to have you here, and I know you did change your schedule in order to comply with the subcommittee request, but I don't believe that there is anyone who has more established experience in both the private and the public sector in both banking, as well as securities and investment issues, and has more practical experience spanning the years, which doesn't, is not meant to imply anything but ''aging is saging'', but at the same time, I don't know of anyone who has a greater integrity, has a reputation for greater integrity and objectivity on these issues. So we welcome you here today.
Mr. VENTO. Madam Chairwoman.
Chairwoman ROUKEMA. I yield to Mr. Vento.
Mr. VENTO. I just wanted to point out: One, I suppose a sour note, and that is that this disclosure requirement form, that inadvertently apparently our first witness has not answered the last four questions. As far as I am concerned, I am certain it was just an oversight, but I would just point out for the precedent of the subcommittee, the committee, the Chairman is here. I know we have had some disagreements about the importance of doing this and the purpose of doing it, but as long as we are offering this latitude, I certainly want to extend that and recognize it just so that we are treating other witnesses in this same manner, as we are trying to find our way through this new rule.
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Chairwoman ROUKEMA. Mr. Volcker, my colleague here insists on raising this issue at every turn, and I don't think we should take up any more time. You will have the opportunity to respond, but our differences are not substantive, but they are procedural here, as far as I am concerned.
Yes, Mr. Volcker.
Mr. VOLCKER. I apologize for not having filled out the form completely. I think I must have interpreted ''no answer'' as meaning ''none,'' and all of those other questions should be answered, ''no, no, no, no.''
Mr. VENTO. OK. Thank you.
Chairwoman ROUKEMA. Thank you. Go ahead, Mr. Volcker.
STATEMENT OF HON. PAUL A. VOLCKER, CHAIRMAN, JAMES D. WOLFESOHN, INC.
Mr. VOLCKER. Let me say that, Madam Chairwoman, Mr. Chairman, I appreciate your invitation to come here. You referred, obliquely at least, to my age, and as I was preparing for this testimony I realized I had been involved in these things for something approaching 50 years, when I started out in the Federal Reserve upon graduating from college.
You said you had had sessions with the regulators and with industry people. It occurred to me, you could have started the other way around and had me first because you can get it wholesale as an old regulator and currently an industry person. I am, in the interest of disclosure, a director of a bank and a director of an insurance company.
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But this has been a long process and it has been a frustrating process, as all of you already know. I am struck by these issues which are virtually the same as issues that I addressed myself to when I was in the Federal Reserve 15 years ago. There has not been much legislation in this general area, there has been on strengthening supervision, but not in this general area in all that time.
I hope the stars are in better alignment. I tend to feel the stars are in better alignment, but I must say one element of frustration I feel. Some of the commentary I read about what is going on and saying ''the stars in better alignment,'' seems to me to suggest that this is a matter of, kind of, providing a negotiating table for all the industrial groups to come to some kind of coalescence. While that is part of the process, I think it is really important, as I am sure you do, to keep our eyes on what is in the public interest, not in what is in the interest of a collection of industrial groups, all of which, for understandable reasons, tend to want to liberalize their particular area and keep other people out of their business.
I think there is a very strong underlying public interest in all of this matter, and I just want to bring that out clearly in my statement. And in that respect, I do emphasize the importance of core commercial banking functions. I say ''core commercial banking functions'' because commercial banks these days encompass a lot of activities that overlap other institutions and that are not core functions. But there are certain key functions. They are the major providers of the money supply. They are the transmission belt for monetary policy. They are custodians for the payment system. They are residual suppliers of liquidity in the economy.
When there is a problem, people go to the banks to see the economy and to see institutions over temporary problems. There is nobody else that can provide liquidity in large amounts so flexibly, and I don't know any other institutions that provide those other functions. All those functions in the United States traditionally, and in every country of the world which has got an advanced economy, are protected and supported by regulation on the one side and by actual financial support on the other side when the institutions that conduct these core functions are in trouble. I think that is of some significance.
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Those general comments cover the introductory pages in my statement. I would like to go on to develop the three key points that I concerned myself with in the statement, and I think it begins at about page 3 of the copy you have. I do think that your legislative considerations have to take account of three important realities.
The first, which you have all referred to, is that the evolving financial services industry must be dealt with as the closely interrelated complex it, in fact, has become.
Second, I do think provision must be made for capable, comprehensive and coherent oversight of institutions participating in a variety of markets, insofar as those institutions include within their ambit the core commercial banking functions to which I have referred.
And then finally, with the traditional separation of commerce and banking as a basic element, there must be meaningful structural protection against conflicts of interest in the provision of capital and credit and the concentration of economic resources.
Let me discuss the need for broad legislation.
The traditional distinctions among financial institutions, still embedded in present law, are rapidly eroding. New technology, global competitive pressures, and powerful business logic has simply overpowered the idea that commercial banking, investment banking, and investment management are distinct and separate lines of business. In truth, the overlaps are large and growing. Many large institutions feel a compelling need to engage in all, or most of, those activities to remain competitive, not only with their domestic counterparts, but internationally. Even relatively small banks are pressured by competition to provide their customers with access to brokerage, mutual funds, and increasingly, insurance.
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There is, as well, increasing recognition of the large investment element in much of what is still labeled ''insurance.'' Conversely, insurance companies themselves, like many other financial institutions, have felt a need to compete over a very broad range of services and to seek new marketing outlets.
Now, I don't need to belabor those points because they are so widely recognized.
Moreover, in one important area of overlap, that is between investment and commercial banking, the institutional separation embodied in the Glass-Steagall Act has, in practice been largely abolished by regulatory fiat, implicitly blessed by the Congress and explicitly by the courts. It seems to me an ad hoc approach is hardly a satisfactory way of proceeding.
The effort to adopt and reconstruct outmoded law by regulatory liberalization has inevitably been incomplete, with a residue of essentially arbitrary and dysfunctional distinctions among particular institutions. As a result, some organizations are relatively advantaged over others. Moreover, to my mind, there have been elements of unhealthy competition among regulatory authorities as they adopt novel or aggressive interpretations of law in ways that leave the playing field uneven.
In the process, artificial incentives to engage in or to restrict certain activities arise. At best, efficiency suffers, with competitive inequities. At worst, prudential safeguards may inadvertently be weakened, neglected, or applied inconsistently.
There are those, to be sure, who may be relaxed about that situation, feeling they are, by design or otherwise, in a competitively privileged position. But that is hardly an equitable result. It does not effectively serve the broad public interest.
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Now, I referred earlier to one element in that public interest that deserves special emphasis: Certain core commercial banking functions as custodian of the payments system, as the conduit for money creation and monetary policy, as residual suppliers of liquidity are especially critical. It is these functions that have long justified more intensive government regulation and supervision, as well as a special support system embodied in deposit insurance and Federal Reserve liquidity facilities. I know of no legislative proposals under active consideration that do not rightly respect the continuing need for such support to support the stability of the financial system as a whole.
At the same time, a strong banking system requires that commercial banking institutions be able to participate in more rapidly growing and profitable sectors of the financial services marketplace. That is the logic behind the need to expand the powers of the bank holding company. Or as some would prefer terminologically, a ''financial services holding company.''
Commercial banks can now engage competitively in fund management, and there is, I believe, now wide agreement that they should be able to affiliate with investment banks and that, reciprocally, those financial businesses can acquire a bank affiliate. The time may well have come to extend that same logic to the insurance business, in whole or in parts.
That much is common ground among most of the proposals for reform. The challenge is to achieve that competitively desirable result consistent with the safety and soundness of the banking system, and with financial stability generally.
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So I turn to the need for capable and coherent oversight. Experience in one country after another over the past decade has forcibly reminded us of one fact of financial life: The advances in technology and the new and sophisticated techniques of risk management have not ended the risk of financial crises. Markets have a way of exaggerating moods of optimism or despair. Profitable and attractive leveraging of capital in an equable economic environment can quickly threaten bankruptcy when conditions worsen. The possibility is real that particular failures will impact on others so that the consequences are amplified through the markets so-called ''systemic risk.'' Indeed, that risk may be increased by the closer institutional and even global interdependencies today, reflected in the daily movement of trillions of dollars among banks.
We have learned firsthand of the enormous financial and economic consequences of crisis, in the savings and loan failures of the 1980's in this country and in the banking strains of the early 1990's that affected the economy. The effects of the sudden Mexican crisis in late 1994 are still felt in that country and in other parts of Latin America. In Japan, the aftermath of the financial bubble almost a decade ago is still restraining growth.
I can think of no recent exception to the rule that faced with crisis, and whatever the specifics of law, governments will de facto step in to support and stabilize the banking system. But, of course, it is better to head off the crisis by effective regulation and supervision and to deal with points of strain before the system as a whole is threatened. Essentially, that is why the United States, like other countries, has long regulated and supervised commercial banking institutions and provided for them an official ''safety net'' by a means of deposit insurance and Federal Reserve lending.
A key question that you must deal with in financial reform is how to maintain that necessary degree of protection for core banking functions in a world in which many banking organizations will be active in other areas of finance. Extending fully the degree of regulation appropriate for banks through the whole of the financial system is not attractive. Even less should we want to contemplate spreading Federal insurance or direct access to Federal Reserve credit to non-banking functions. So the challenge is to find a workable balance, a means of credibly protecting the essential core, the money supply and the payments system, while minimizing intrusive regulation and the government's financial exposure.
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Now one approach with surface attraction is to isolate the essential commercial banking functions from affiliated organizations by the creation of strict firewalls; at the extreme, prohibiting cross-marketing, linked services, and use of a common name, even geographic proximity. But I have to tell you that approach runs directly across the logic of a bank or financial services holding company. The point is not to run a group of isolated businesses, but to seek synergies in the provision and marketing of services. Moreover, the reputation and commercial effectiveness of one part of the holding company organization cannot be insulated from its affiliates. The natural tendency of management, faced with the possibility of failure of one part of the organization, will be to bring the resources of the whole to bear. Given the fungibility of money and the resourcefulness of financial managers, no practical system of firewalls can be fully successful in isolating a problem.
Now, clearly, some limited degree of separation of the core banking functions can be maintained as it is at present, particularly in prohibitions of direct lending. As a matter of policy, official assistance can be directed to the banking affiliate rather than to other parts of the holding company. But for that approach to be effective, I believe there is an absolutely compelling need to continue oversight by a single supervisory authority charged with assessing the overall safety and soundness of the entire holding company.
I don't mean to suggest that current arrangements for a bank holding company need to be replicated in all of its aspects. The authority exercising oversight need not have exclusive or primary jurisdiction over the various affiliates. The SEC, the Comptroller, the State banking and insurance authorities and others could be functional regulators, providing consistency with their own legislative purposes and responsibilities. But in the end, someone must be able to evaluate any bank holding company as a whole, lest some parts become so weak or so large a drain on the entire organization that the core banking functions are jeopardized.
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Now, it will not surprise you when I suggest that as a practical matter the appropriate agency for undertaking the oversight of a bank holding company containing a bank within its structure is the Federal Reserve. It is simply a fact that no other agency today has the same combination of resources, including both human and financial resources, of independence, of breadth of responsibility and of experience. The only alternative to the Fed as an overseer, it seems to me, would be to start afresh with a new umbrella organization. That would be a difficult and uncertain task. And even if that group were to be chosen, certainly the Federal Reserve would need to have a large degree of influence in its governance and in the implementation of its policies.
I come to the question of commerce and banking. I emphasized at the start the need for new legislation to respect the need for strong structural protection against conflicts of interest in the provision of credit and undue concentration of resources. In my judgment, permitting banks or bank holding companies to extend their activities into commerce and industry, contrary to Anglo-Saxon traditions of finance, would be directly contrary to that need.
Now, I am, frankly, puzzled as to why this question recurs each time the Congress considers broad legislation. Of course, I understand there are a handful of large companies, some of which already have substantial finance company or credit card arms, who feel that ownership of a bank might enhance their market position and in particular permit greater financial leverage, financial leverage common to bank holding companies.
Conversely, there may be a few commercial or investment banks that have ambitions to expand their activities in industry, but it has never been clear to me that those interests are widespread, and the concept, for good reason, has never commanded broad public or legislative support.
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It is interesting how the rationale of the advocates has changed over the years. A decade or so ago, the German, or so-called ''Continental'' system, which has de facto permitted some substantial and controlling ownership of large industrial firms by large banks, was cited with a good deal of admiration for its presumed strength and stability.
Very few would make that claim today. There have been obvious difficulties experienced by some of the largest and proudest banking firms in Germany, France and elsewhere, as a result of industrial holdings. It is an ironic fact that just as a proposal to relax our restrictions is pressed by some, debate has emerged in Germany and elsewhere about the wisdom of their approach, partly because of the implications for corporate governance and for the concentration of economic influence.
Now, I trust that those supporting banking and commerce combinations are not contemplating replication of the Japanese kiretsu system in the United States. Their large banks and savings companies have a network of reciprocal stock holdings. Individually those holdings are relatively small. You might say they are the size of a ''basket''. They are typically 5 percent or less of a company's capital stock. In combination, however, those holdings are associated with close and relatively favored trading and financial arrangements within the group. The anti-competitive implications are very clear and have frequently been a matter of concern for American companies wanting to penetrate the Japanese market.
Now, a few years ago, it was alleged that banking equity was in such short supply that banks needed to draw upon stronger industrial firms to shore up their capital position. That argument never made much sense as an excuse for basic structural change, implying as it did that American financial markets are unable to allocate capital with reasonable efficiency.
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Now, the fact is, of course, the American capital market is the envy of the world. It is New York and London, not Frankfurt or Paris or Tokyo, the homes of banking and commerce combinations, that are the centers of innovation, of trading, of capital raising in all shapes and sizes. American banks today are as well capitalized as at any time in memory. Far from being unable to raise capital, many are in the process of buying back their own stock in the market. All that has been achieved without relying on any industrial ownership or alliances. Surely, it is precisely the fact that such alliances play a relatively small role in our banking and financial markets that helps account for the adaptability and flexibility of those markets.
I believe there is an instinctive and valid disposition in this country to avoid combinations of our largest banks and industrial firms. This morning, I join with many others in advocating a broadening of the powers of bank or financial holding companies. No doubt, the result will be to encourage some further consolidation among financial institutions. In those circumstances, it seems to me to become even more important to maintain the traditional distinction between banking and commerce.
We should want decisions on the allocation of credit, on the underwriting of bonds, on the sale of stock to reflect unbiased financial judgments, free of taint of serving the interests of a commercial affiliate. We do now make some rules to limit and regulate transactions directly among different parts of a holding company. But as a practical matter, as I said before, full insulation is impossible, and effective policing of transactions with third parties is absolutely beyond reach. How likely would it be, for instance, that a bank affiliated with a powerful retail chain will eagerly lend to a local or regional competitor of that retail chain? What about a one bank town, where the choices of smaller borrowers are already, at best, limited? What about the temptations to lend to, or otherwise indirectly support, a weak commercial affiliate?
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Now, I discussed earlier the compelling need for supervisory oversight over an entire bank holding company. To do otherwise would unnecessarily jeopardize the safety of the bank and place the economy in general, and the American taxpayer specifically, at risk.
To go further and permit combinations of commerce and banking would be to produce an insoluble dilemma for supervision. To forego any oversight of important, and perhaps dominant, parts of the holding company would create new risks for the bank, and thus for the financial system and the taxpayer. But to extend regulation and supervision into the non-financial world would imply an enormous stretch of government oversight that nobody would want. The practical and policy implications of either choice are simply not acceptable.
Now, no doubt you will hear arguments that these concerns are exaggerated, that they can be dealt with or ameliorated by compromise. I have heard that comment made this morning. There are, after all, already combinations of finance companies, some very large, and industrial firms. There are some limited ''non-bank banks'' owned by commercial companies, a residue of earlier attempts to square the circle. Surely, it will be said that these existing situations should, in an extension of the principle of grandfathering, be accommodated in new legislation that liberalizes the powers of bank holding companies.
Beware, beware of the implications.
The Bank Holding Company Act today already permits what amounts to incidental holdings of the stock of non-financial companies, holdings defined as less than 5 percent of the total capital stock and absence of control. That leeway is not much used. It is not much used precisely because control is the issue. There is no strong incentive to own stock if there is not a common business strategy, if there is an absence of strategic influence. It is precisely when there is a common business interest, when there is reciprocal influence, that the conflicts and incentives for self dealing arise.
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A number of touted initiatives by particular firms to combine commercial and financial activities have fallen by the wayside in recent years. Other combinations have, indeed, become large and profitable. They have done so without any need to perform core commercial banking services. Those organizations can and should be given a clear and perfectly equitable choice: Continue without a bank affiliate or give up the industrial and commercial affiliation. That is the same choice that should face any non-bank financial firm: Remain free to affiliate with an industrial firm or with a bank, but not with both.
Now, you know from experience, better than I, that the idea of making limited exceptions to a general rule breeds complications and inequities. By adopting special ''baskets'' or other compromise approaches to accommodate particular interests this year, you will inevitably be presented in the years ahead with the argument that the compromises are arbitrary and inequitable. An enlarged phalanx of lobbyists is sure to appear, dedicated to enlarging whatever room for maneuver has been achieved. And the arguments will be the more forceful because there will then be established economic interests to defend and enhance.
Now, I have argued this morning the logic and practical desirability of finally eliminating Glass-Steagall restrictions, of generally enlarging the powers of bank holding companies in the financial area, and of providing effective supervisory oversight over bank and financial holding companies. All of that is important.
And, finally, after 15 years of recurrent effort, the necessary intellectual consensus and will to act in a comprehensive way seems to be coalescing. Failure by the Congress to seize this opportunity to modernize the legislative framework for banking and finance would be sad indeed.
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But I also have to say that none of that would be worth the risks and costs of embarking on a new experiment, an experiment entirely foreign to our own traditions and experience, of relaxing prohibitions on combinations of banking and commerce. The Hippocratic injunction to, above all else, ''Do no harm,'' has its application to banking legislation.
In my judgment, this subcommittee could make no greater contribution to speeding constructive legislation than by making clear now at the very start of the legislative process that the idea of combining banking and commerce should remain off the table, just as it has in the past. After all, your agenda is already very full without adding such an indigestible and foreign ingredient.
Thank you very much, Madam Chairwoman.
Chairwoman ROUKEMA. Thank you. You were quite explicit, Mr. Volcker.
[The prepared statement of Hon. Paul A. Volcker can be found on page 562 in the appendix.]
Chairwoman ROUKEMA. Let me ask, please, that we will try to invoke the 5 minute rule on the questioning period, so if staff will take care of that. I will try to contain myself, as well.
I don't know where to start with my questions at this point. Mr. Volcker, you have, and I know you were very definitive on the question of the commerce issue, and as you may know, and certainly I referenced in my opening statement, that Chairman Greenspan did indicate an incremental approach, but I understand that you are totally opposed in any form, even an incremental approach. Is that correct?
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Mr. VOLCKER. Yes, ma'am. Yes, ma'am.
Chairwoman ROUKEMA. Would you amplify on that?
Mr. VOLCKER. I think the very term suggests my concern.
Chairwoman ROUKEMA. The 25 percent ''basket'' specifically?
Mr. VOLCKER. ''Incremental'' implies there will be more ''increments.'' Incremental approaches don't stop. They increment over the years. I think that is implicit in the term, and I think the place to stop it is right now.
Now, I have looked at, maybe not sufficiently, these ''baskets.'' I don't even know what the definition means. I don't know how the ''baskets'' are defined. Obviously you are early in the process. It is 10 percent, or 25 percent or whatever, of what? I don't know whether the 25 percent is the size of the industrial firm, or the financial firm, or the bank, or whatever. All I know is if you have got big institutions, you have got banks with hundreds of millions, hundreds of billions, of assets. Twenty-five percent of that is a big number. And when you have industrial firms of hundreds of billions of assets, 25 percent of that is a large number.
I don't know what you are contemplating. To me, it is a combination that over the years will be enlarged once you start it, because people will come in and say, ''Well, you know, what's so magic about 25 percent?'' They will say, ''We made this other acquisition, and now we are threatened with this arbitrary number.'' It is like when the Federal Reserve said ''10 percent for Section 20 affiliates,'' and everybody came in and said, ''We used up the 10 percent and now we want to go higher.'' It is inevitable.
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Chairwoman ROUKEMA. Let me ask the question another way. The definition is precise in the legislation in terms of 25 percent, but the commission would determine, make its determination, as to how that is invoked and how it is applied practically.
Mr. VOLCKER. It will be a full time job for that commission, if I may suggest so.
Chairwoman ROUKEMA. All right. Very fine. But let me ask the question another way. I don't think there is any dispute, and I did not hear any dispute in your testimony, that there is a new world out there and that the new technologies have virtually made antiques out of our present system.
How do you, in both the international and the national marketplace, deal with those new technologies and still maintain this absolute separation that you are speaking of? Now, this overlaps with the whole holding company and regulation.
Mr. VOLCKER. There is a lot of overlap through technology in particular, the cost and efficiency of data processing and communications, that made a big difference. And there is a lot of overlap in a variety of services, which is why I strongly advocate what has come to be known as the ''financial services holding company,'' where you can combine commercial banks with investment banks, with investment management firms, and I think you could move into insurance in whole or in part.
The question is where you draw the line. There is no substantial overlap, except where Congress has permitted a few little compromises in the past, between industrial firms and the core commercial banking functions. That is the distinction I would make.
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Access to the payment system, operation of the payment system, access to the Federal Reserve, the creation of money. The definition of ''money'' may evolve over time, but still the core of the money supply is clear. It is bank deposits and demand deposits, and those are the only things you can write a check on and call up your office and make a wire transfer, and those are the things that are transferring a trillion dollars a day through the Federal Reserve, and a couple trillion dollars a day through the foreign exchange markets. Those are core banking functions, the stability of which is important to the entire financial system.
And I don't think at this point there has been an overlap, or a significant overlap. If that day arose, then you face a different problem. We can be back here in 2015 and discuss what to do about the new payment system that doesn't require any money and is running through the Internet. I don't think the payment system is running through the Internet today.
Chairwoman ROUKEMA. My time is up, but I do want to come back, or perhaps you could weave into some other follow-up questions that my colleagues would ask, how you respond to both insurance companies and the securities people, particularly those regulators, as to the form of regulation that you have outlined, because there are fundamental differences of opinion as to who supervises whom, and why Mr. Levitt at the SEC should let the Federal Reserve Board chairman, whoever that might be, have oversight.
Mr. VOLCKER. That is the easiest one, it seems to me.
Chairwoman ROUKEMA. I am going to enforce my own 5 minute rule. I will either come back to that, or perhaps you can address it in the context of some other questions.
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Thank you, Mr. Volcker.
Mr. VENTO. I think it is a good point for me to question. Shouldn't the Federal Reserve Board be able to do this without being the lead regulator indirectly through qualifying use of the index window or other factors? Why would we need to have, in fact, this sort of holding company structure? I don't know if you are advocating that wholly. It seems to me you referred to a ''financial holding company.'' Perhaps I misunderstood.
Mr. VOLCKER. I frankly prefer the term for what I am referring to as ''bank holding companies.''
What is distinctive about what I am talking about is whether the holding company includes a bank. Holding companies that don't include a bank may require some supervision too; they certainly get supervision from the SEC and others. But when they include a bank and operate the core banking function, then they need supervision, and the whole holding company, for the reasons I tried to suggest, I think, needs supervision. It may not be the intensity of supervision that the bank itself requires, but it needs some oversight to make sure the organization as a whole is solid and has safety and soundness. Now, this really gets into the question the Chairwoman just posed.
Mr. VENTO. Let me just add a little something too. I am trying to get two for the price of one here, to talk about the Fed, shouldn't the FDIC itself make, I think your statement might have been taken by Chairwoman Helfer and others to say, ''Well, we have to have safety and soundness, we have to get appraisals.''
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So I don't know it is even a holding company issue. It seems to me what you are really speaking to is affiliations and subsidiary. If you have to have adequate regulation and none of us would disagree with that, but we come to the various forms and who is going to do it. I think the arguments you make could be easily made by the FDIC as well.
Mr. VOLCKER. You can ask Chairwoman Helfer as to whether she is willing to make that argument, whether the FDIC has the experience, the breadth of experience, to oversee whole holding companies. I don't know what she would say. It seems to me that the Federal Reserve, partly as a matter of history, but it is not just a matter of history, the Federal Reserve has a function in the financial system that forces it to take a broad look, quite properly, I assure you.
I will make an empirical observation to you: When a bank gets in deep trouble, and when a non-bank financial organization gets in deep trouble, and, to a considerable degree, when a non-financial firm gets in deep financial trouble, whatever their ideology, they are likely to make a phone call to Washington.
I will tell you the desk to which that phone call is most likely to come, and it is not the FDIC, it is the Federal Reserve; and it is not the SEC, it is the Federal Reserve; it is not the CFTC, it is the Federal Reserve. Not because they are giants or gods. Among other things, the Federal Reserve has money that they can use rather flexibly, and money is sometimes an ingredient in the solution, and there is no use going to some agency that doesn't have the influence, or the authority, or the money, to respond.
Now, you can make up a new organization, that is quite true; you can take some combination of these organizations; but as I said, I think even if you do that, unless you have a radical change in the whole situation of central banking, the central bank is going to have a prominent role in that new organization. You can do that. It is complicated.
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Mr. VENTO. One of the thoughts that just occurs to me, of course, I understand the FDIC function in terms of insurance, but, nonetheless, many of the decisions they make have a profound impact in terms of banks.
It seems to me what is being suggested here is because of the role of the Fed having the ability, the money multiplier, the credit functions, the Fed wire, the window and so forth. I don't disagree in the sense I think when we have a crisis situation, we need to use the best resources we have in terms of the Fed. But I think the thing is, in terms of the day-to-day regulation, it seems to me not to be the role of the Fed.
Adding to that a little more dimension, and that is, I think this is evolving more quickly than you, in terms of the sweep accounts, the secondary market, and a variety of other factors that are increasingly diminishing the corpus of what constitutes commercial banking. Many of us see that very often the distinction is not that we don't need a role for the Fed but whether it should be this lead regulatory role, and how we, in fact, weave that into what we do here is important because of our mixed economy and the role of the Fed; I don't disagree with that.
Whether or not it has to be the, sort of, construct of a holding company or an affiliate or subsidiary, I think substantive and good regulatory ability is important, but then the intervention in terms of crisis is important. So we have to weave that all together.
Of course, maybe we have to change the makeup of the Fed in order to satisfy some of the arguments with the non-commercial banking interests; I don't know.
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Mr. VOLCKER. Let me just make clear one point, if I may, to avoid misunderstanding.
The FDIC is a strong actual and potential bank regulator. The reason I think that they are not as natural for this function is, they don't have much experience outside of commercial banks, pure and simple.
The element we are discussing now, I thought we were discussing, is who has oversight over the whole holding company. It is in that connection where I think historically the FDIC has had a more limited mandate. They could well be the lead regulator of some or all the banks, if you want to go that way, when you are just talking about the bank. But I was addressing my comments to who is the lead, who is the umbrella supervisor, so to speak.
Chairwoman ROUKEMA. Chairman Leach.
Mr. LEACH. Actually, there is a great deal of consensus on virtually all aspects of moving forward to consolidation within the certain aspects of finance, insurance, securities, and commercial banking, but the nub of the differences that exist has been raised at the moment.
You have come out with a very defined position. I would like to go over it a little bit.
The two huge differences that exist in judgmental factors are: Should there be a holding company oversight circumstance? That is, everyone that I know of favors functional regulation, but there is a question of whether functional regulation is sufficient.
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So there is nothing that I think is on the table to take away the power of any of the functional regulators. The question is: Is it sufficient? And here the Federal Reserve has authority over the discount window, it has authority over the payment system.
When you talk about fast moving changes occurring in finance, one of the interesting aspects of it is that we are right in the cusp of a great deal of internationalization of finance. So one of the questions becomes: Are we going to have foreign firms that might have access to the United States payment system, the United States discount window? Are we, without Federal Reserve oversight? It is an extraordinary thought.
Second, in terms of international regulation, because as finance becomes internationalized, there are things that happen in other countries that are very relevant to the safety and soundness of the American system, is the Federal Reserve the natural place to interrelate with foreign regulators, and does it carry more clout, among other things, because it has money, compared to any other potential regulator? It strikes me the answer is ''yes.''
Now, I know that there are some industrial parties that have made a decision that they chafe at the Fed and want to get out from under the Fed. I am also under the impression that a number of these parties are rethinking that circumstance.
I hope that Members of this subcommittee do not think that all of these industrial groupings are locked in stone, that they cannot have some sort of Fed oversight for taking over new access to the payment system and, in new ways, the discount window.
The other issue, of course, is commerce and banking. You have made a very definitive statement. I would just like to stress that there is some awkwardness to the definition. What one of the bills talks about in the precise definitions is the 25 percent ''basket'' that relates to the business of the financial services holding company. An alternative bill is a little more definitive and talks about 7.5 percent of ''consolidated total risk-weighted assets of an investment bank holding company,'' which is a more defined sort of precept.
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Business activity varies dramatically, and how you define it is something that is a very difficult thing to do; as well, there is a size factor that is fairly substantial. My guess is, you have come out against anything, and that the likelihood is the subcommittee will come out with some sort of a compromise.
I think the indication for doing that is, you have laid down the warning that if you do something at all, you lay the basis for rather substantial inequities in the marketplace as well as challenges in the future.
I would like you to comment on that. How serious do you think that will become? How constrained do you think Congress should be?
Mr. VOLCKER. Well, you have raised a number of issues I would like to touch on. On this last issue of commerce and banking, let me express, I think, the position in its most general form. What is at issue here is control and the desire, the natural desire of business managers, to run interrelated parts of a business in a completely, mutually supportive way, and sometimes more directly than that.
If you were just talking about passive portfolio investment, you would have a different kind of concern, and I think that is what present law kind of forces, passive portfolio investment, and there isn't much of it done.
Once you begin talking about control and influence, then I think it is very hard to compromise, because that is precisely what you are worried about. What kind of distortions, what kind of conflicts of interest would arise? What kind of biases arise in the lending decision? Indeed, ultimately, what kind of concentration of resources you have, which is a problem in Germany. That is what the debate is about in Germany.
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Once you permit controlling interconnections, then I think you are on a very slippery slope, because where do you stop? That is a non-statistical answer I would give you to that question.
Now, your other question about international, I was very conscious, in writing my statement, that it sounds a little anachronistic, as a lot of this debate sounds anachronistic, because of a lack of an international connection here in the actual written words. But the international dimension is certainly there. It increasingly requires consistency in regulation across borders. And an enormous conceptual step was taken in that area about 10 years ago with the common agreement on capital standards for banks and for bank holding companies.
But that is not the end of the story. That is an agreement that largely, entirely, really could be worked out among central banks, because central banks almost uniformly have authority for that kind of thing directly or indirectly in their national governments.
But a lot of other areas where you need coordination: What are the capital rules for an investment bank arm of a holding company? There is no uniformity there? What are the rules for trading in derivatives that have become so important, and what kind of capital does that require?
Then there has been a certain amount of progress among banks, but that market is half conducted outside banks. I think it is roughly 50—50. Half of it is done in banks; half of it is done outside of banks. And you can't have a lot stricter requirement on banks than you have in the rest of the market, because obviously then all the businesses will go out of the banks into the rest of the market, and you will not have increased the safety of the system, you will have undercut it.
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Now you have got to deal with the regulators of, particularly, investment banks. You have to deal with the SEC's around the world. And you have got to deal with, I forget what it is called, the ''international organization of securities,'' something or other.
I have to tell you as a practical, empirical matter, it has been a lot harder to get coordination in that group. It is hard enough in the central banks, but it has been harder in that group because they haven't had the same experience in working with each other and they have different concerns.
Now, that goes partly to the Chairwoman's first comment. The SEC, above all, is investor protection and consumer protection, a perfectly legitimate objective. That has not been the first priority of the Federal Reserve, in fairness.
I would think the way this gets worked out is, the SEC, in our context, has responsibility, primary responsibility, for investor protection. They will apply their rules and regulations and examine, if necessary, that public interest is being protected.
The Federal Reserve's oversight, if that is the way it went, of the whole institution will be concerned with the safety and soundness of the operation. Now, that might be examined in the first instance by the SEC too in this particular case.
But I would think there would be some conversation between the umbrella oversight person and the particular functional regulator to make sure the functional regulator is encouraged to develop the kind of information, and force the kind of capital or other regulations, that are desirable from a safety and soundness standpoint, and that the information from examinations is available to the Federal Reserve.
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So that ordinarily the Federal Reserve, or whatever the umbrella regulator is, would not have to be intrusive. I think that umbrella regulator would, in the end, have to have some residual authority to go into any part of the holding company and find out what is going on, if that turned out to be necessary. But that could be a rare residual power.
There certainly are other objectives that have to be considered and defended, other than the safety and stability of the institution. So it gets complicated, but it is complicated now.
Mr. LEACH. Thank you, Madam Chairwoman.
Chairwoman ROUKEMA. Thank you.
Congressman LaFalce.
Mr. LAFALCE. Pass.
Chairwoman ROUKEMA. Congressman LaFalce passes.
Congressman Paul.
Dr. PAUL. Thank you, Madam Chairwoman.
Welcome, Mr. Chairman. It is nice to see you back before the Banking subcommittee.
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I have a couple comments and a couple questions. I think I share a lot of your concern about spreading this risk that the system provides for the banks into other industries and other financial institutions.
Chairman Greenspan called this a ''subsidy''. I don't know whether you would use a word that strong or not, but he called this a ''subsidy,'' and it sounds somewhat like a subsidy when you make the comment that: ''Banks are creators of money.'' If all men are created equal, why can't we all create money? But it sounds like they do have a subsidy, and since we do have a lender of last resort, the banks do have license to do things that others cannot do. And I share your concern about spreading this risk.
I also am concerned about the spreading, or the expansion of, regulation. The idea that we have one body that does not have tremendous oversight of, and that is the regulation of other industries which they would have to do. And I am not interested in doing that. I am interested in your comments about the heading off of a crisis, and you refer to it as an ''insoluble dilemma.'' if we overexpand our responsibilities. And I certainly agree with that as well.
I am concerned, not only about the expansion of the problems of credit and the role as lender of last resort and the chance of expanding regulations, I am also concerned about the current conditions.
In 1994, a book came out by the name of ''The Central Banks'' by Marjorie Dean, and they have a couple quotes there they ascribe to you. I just want to use those in my questioning:
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''. . . It is a sobering fact that the prominence of central banks in this century has coincided with a general tendency toward more inflation, not less. By and large, if the overriding objective is price stability, we did much better in the 19th Century gold standard in the past than with central banks, with currency boards, or even with 'free banking'. . . The truly unique power of central banks, after all, is the power to create money, and ultimately the power to create is the power to destroy.''
I am the first one to recognize we don't live in the 19th Century, we barely live in the 20th Century, and we have to be thinking about the 21st Century. But I don't think that changes some of the truisms of this ''power to destroy'' any expansion of credit.
I see that under even the current conditions that we have today, that we have not achieved what you indicate we should try to achieve, that through regulation we can compensate and protect against the next crisis. But we had regulations in the 1960's and we had the Bretton Woods breakdown in 1971. We had the regulations of the 1970's and had a dollar crisis at the end of the 1970's, requiring the calling-in of a special individual to the Federal Reserve in order to save the dollar at that particular time. We had regulation in the 1980's and had an S&L crisis and banking crisis. And now we have still more regulations, and yet everybody is reassuring us that ''There is no crisis, there is no financial bubble, there is no inflation, and we have no concerns whatsoever.''
But inflation is not always measured in terms of prices. In the 1920's they reassured us there was no price inflation and we had no worries. Today they use the same argument. Yet we look at the financial markets and see tremendous amounts of inflation. We also note that inflation has spread worldwide, that central banks now do a lot of inflating.
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My question is simply this: Do you believe regulations can really compensate for this concern that you have, that this power to destroy can compensate to prevent the next crisis? Or do we have to look at other things, not only prevent getting ourselves into getting into more trouble, but even looking at our current positions?
Mr. VOLCKER. I think the kind of crisis to which you are referring and I guess to which I was referring in those comments you read, basically, an inflationary kind of crisis, is a different subject. It is overlapping, but it is not going to be dealt with by the kind of regulation I am talking about this morning.
All I am talking about this morning is protecting, and that will not be perfect, but protecting to the extent we reasonably can, consistent with free and open markets, the institutional structure. That doesn't say we can prevent devaluations, inflation, market turmoil, upset in the real economy; all those problems will still exist.
The only thing I would say in response to that is, relative to previous decades, I think right around the world, much more priority is given to the importance of price stability than was the case earlier, which is the cause I think that you have championed through the years. That ought to, I hope, give you, as it does me, a little reassurance that we can avoid the worst of some of those crises in the future if we persist in that priority.
Dr. PAUL. Thank you.
Chairwoman ROUKEMA. Thank you.
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I would remind my colleagues of the 5 minute rule. We will try to comply with that.
Ms. Kilpatrick.
Ms. KILPATRICK. Thank you, Madam Chairwoman. I followed intensely your comments, sir. Thank you for coming.
Your last paragraph, or your last statement, sounded like throughout your testimony you were saying ''Yes, we should do this,'' and using the financial holding companies and so forth, but then at the end you talked about, ''. . . the best thing we can do would be the idea of combining banking and commerce should remain off the table.''
Mr. VOLCKER. Right.
Ms. KILPATRICK. I am confused.
Mr. VOLCKER. Well, if you are confused, I have failed, I guess.
Ms. KILPATRICK. I am new too, so that may have something to do with it. I am also a fresh person.
Mr. VOLCKER. We are considering three overlapping circles. One, the smallest in a way, but the most critical to the functioning of the economy, is what I think of as ''core'' commercial banking functions, that is, bank deposits, paying checks, sending wire transfers, the place you go when you need money in a hurry.
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There is a larger circle of all the other financial activity, selling securities, selling stocks and bonds, trading securities, so-called ''derivatives.''
I think those two functions can overlap, or at least the institutions conducting those functions can overlap.
Ms. KILPATRICK. And that is happening today?
Mr. VOLCKER. And that is happening de facto today and is happening with a lot of regulatory deregulation, most notably the Federal Reserve and the so-called Section 20. There is a lot of overlap.
Let's make it clear what is permissible, what isn't permissible; let's level the playing field, because it is uneven now. Recognize that is happening. But if it happens, make sure somebody is looking over the whole organization so that the whole thing is reasonably solid. Otherwise, we threaten those core banking functions.
Ms. KILPATRICK. And that is the intent of H.R. 268?
Mr. VOLCKER. That is, I think, the intent of a lot of bills, and I think that ought to be supported.
Where I draw the line is this other circle, which impinges upon the financial circle a little bit. Not very much, but it overlaps it to some extent. It is the whole world of industry and commerce and retailing and manufacturing and operating computers and software and all that stuff.
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I say we don't have to overlap the banking and industry circles, there is no need to go that far; I don't see any public interest in going that far in the sense that it is necessary to effectively compete in the markets. It is not essential to the strength of financial institutions, it doesn't help the efficiency of the financial institutions, and it might do the opposite by leading to undue concentration of resources.
So I say when we come to that biggest of all circles, let's keep it over there.
Ms. KILPATRICK. OK. Isn't Sears into the financial and banking industry now?
Mr. VOLCKER. Sears is an extremely interesting case, because 10 years ago, 15 years ago, Sears decided they wanted to go in the financial services business, and I don't know whether they were unhappy with retailing----
Ms. KILPATRICK. Expanded their market, is what they did.
Mr. VOLCKER. They wanted to expand the company, that is for sure, and they wanted to go into the financial services business, and they spent a lot of money, among other things, in visiting Congress to convince it.
They were the leaders in wanting to combine commerce and business 10 years ago. I think it is fair to say, they had a change of heart, apparently, a few years ago and decided the financial services business was not for them. In fact, they lost a lot of money, and they have gone out of the financial services business. They still have credit cards. You can use your credit card.
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Ms. KILPATRICK. My time is almost up. Could General Motors, whose pockets are much deeper? I am trying to parallel this, because you are saying there is no need to regulate because they are not in it?
Mr. VOLCKER. I don't want to regulate General Motors. Again, they have a finance affiliate, and Ford has a finance affiliate, and General Electric has a finance affiliate. Some are very profitable and expanding. I think they all do fine.
And that is OK. I don't think that creates a threat to the Union. It doesn't create a threat to the world. It doesn't create a great threat to the economy.
But I don't want the health, safety, and soundness of the banking system dependent upon the health, safety, and soundness of Chrysler, just to take a firm that maybe was not so secure some years ago. I want to maintain that separation, and I don't see any need, from a public interest standpoint, for General Motors to go into the banking business.
What purpose is being served? They may have some particular purpose; they may think they can save a little bit of money; they don't have to pay another bank for doing this, that, or the other thing.
The interest that many firms see, and I don't speak about General Motors, but one thing that is apparent is that once you are in a big holding company, part of a bank holding company, the fact that you are part of a bank holding company implies a degree of governmental support that permits you to operate with less capital, with higher leverage.
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A freestanding finance company outside of a bank will typically have a capital ratio twice that of a bank. So they say, ''Well, we get a banking license, we can leverage ourselves further.'' And they can leverage themselves also further because they have governmental support implied. I don't want to spread that. In fact, you know, I don't want to spread it beyond the financial world.
Chairwoman ROUKEMA. Yes. Congresswoman Kelly.
Mrs. KELLY. Thank you, Madam Chairwoman.
Mr. Chairman, I am delighted to have you here with us this morning. I was very interested in your testimony about a number of things. In one piece of your testimony, you spoke of, ''. . . talking about not isolating businesses, but looking for synergies in the provision and marketing of services.''
If we seek in furthering the financial markets these synergies, there has got to be some kind of a system, it seems to me, of use of firewalls or something, some way of regulating. I am not sure that functional regulation is enough to do it.
I feel, after listening to your testimony this morning and looking at some of the other things in the past, that your recommendations for proper protections seem like a situation of trying to have our cake and eat it too, and try to lose 20 pounds at the same time. It is tough to try to evaluate all of this.
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I would like you to further explain your ideas on the whole business of ''firewalls,'' and what you recommend.
Mr. VOLCKER. I think you have got two conceptual possibilities in approaching this, let's say, financial services holding company, with all the synergies that is wanted and all the rest. You could adopt firewalls. The idea is, we will make a very strict distinction, particularly between the bank and the rest of the holding company, to avoid the kind of thing I am talking about, conflicts of interest and undue risk. Or you can say, ''Let's accept the consequence that we have to have some oversight over the whole thing,'' which is what I advocate.
I don't go for the ''firewalls'' because, first of all, it does violate that basic business logic. The purpose of the combination in the first place is to operate together. So you are running against human nature, you are running against business logic, and you have to have very intrusive regulation to maintain that ''firewall.''
How do you prevent joint marketing? How do you prevent saying. ''I will lend you some money if you use my other service over here in the other arm.''?
You can make rules against those. We used to have some rulings against those in the Federal Reserve, and they have gradually weakened.
Interestingly enough, the Federal Reserve, since my day, when they first began permitting investment banking, they said, ''We will have a lot of 'firewalls'.'' They were very intrusive. But they weren't as strict as you would need for this purpose.
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But through the years, they have either abolished, or greatly limited, the firewalls, because they say it is not workable. They get constant complaints from the banks: ''How can we observe all these detailed, intrusive firewalls? They are extremely cumbersome.'' So they have either eliminated or reduced them, and understandably so.
But once you do that, then you have to go back and have the overall supervision so you can maintain some obvious protections. Nobody has taken away the general prohibition on a bank lending directly to its affiliate in a risky matter. Even that has been weakened, but it is supposed to be at arm's length with perfectly secure securities. It is an easy thing, relatively easy, to enforce; it is not very intrusive; you can do that.
It is an entirely different thing to say, ''Now you are dealing with a third party.'' What kind of rules do you make up so that you are not lending to your affiliate directly, you are just lending to somebody that the ''affiliate'' is interested in? And you say, you know, ''If you use our service over here in some affiliate, we will lend to you.'' It is very hard to prevent. It can be more indirect than that.
Then if you keep chasing that tail, you keep running against the business logic that they want to do this stuff together, because that is the purpose of it. Otherwise, if you had completely effective firewalls, nobody would be interested in the holding company. You would be a collection of portfolio investments. You would be a fidelity. You wouldn't be a bank. You would just be owning stock for the purpose of seeing the stock go up.
Mrs. KELLY. Thank you.
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Chairwoman ROUKEMA. I don't know whether you are straightening things out, Mr. Volcker, or you are complicating our judgments on this. No more editorial comment from me.
Congressman Bentsen, please.
Mr. BENTSEN. Thank you, Madam Chairwoman.
Mr. Chairwoman, I think the dilemma for us on the regulatory oversight structure, of course, beyond the turf battle that exists, is the choice between the chaos that might exist with a subcommittee structure, pure functional regulation, versus a potential dictatorial system with an umbrella regulator. So I think that is one thing we have to deal with.
In reading your testimony and your discussion regarding firewalls and your difficulties and your discussion just now, I have a couple of questions about that.
First of all, there is a difference in this subcommittee and among those in Congress that are looking at this as to whether or not we should use an ''affiliate'' structure or a ''subsidiary structure.'' We will just talk about the investment banking and commercial banking, because I think you have been pretty clear on where you stand on commerce.
But is there any difference between ''affiliate'' versus ''subsidiary,'' or do the same systemic problems exist?
Mr. VOLCKER. I believe there is a difference. If you have a ''subsidiary'' structure at the bank instead of an ''affiliate,'' then I think it is quite clear that if you have a problem in the subsidiary, it becomes a problem in the bank quite directly, because the bank's own investment and own capital is at stake. And I have said that while I think there is a great danger of infection of one affiliate from another, that is just aggravated and increased if you have a direct subsidiary.
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Of course, the reason you have this fight between affiliates and subsidiaries, I think is a turf question. I don't think anybody can reasonably argue that the subsidiary is not more of a risk. It is a question of who is doing the regulating.
Mr. BENTSEN. But you don't believe, with the subsidiary, that it could be structured in a way that would preclude, or block, the upstream risk that might come?
Mr. VOLCKER. Well, you know, there was a famous case which I might as well cite. It may be the first time that the decision was made by the Comptroller to put something in a subsidiary that probably, at least by earlier precedents, would have gone to the Federal Reserve.
A bank was applying for an options clearing organization, a sizable investment, and they applied in the ordinary course to the Federal Reserve. It is a bank that had had some difficulties, and the Federal Reserve was, in its usual style, cautious about the approval process. This tells you something about firewalls.
So the bank said, ''Well, I am a national bank; I will go to the Comptroller and get it to a subsidiary instead,'' and got prompt approval from the Comptroller. The Comptroller said, ''Of course, we are going to make a strict firewall, so, as you suggest, this can't be upstreamed. You cannot lend to that subsidiary, period.'' Fairly straightforward; a very strict injunction.
This was all done a week or two before the stock market collapsed in 1987. That options clearing company, in the midst of the 500-point decline in the Dow-Jones average, became insolvent. The bank lent to its subsidiary without asking the Comptroller, directly against the agreement it had made with the Comptroller 2 weeks earlier, as I recall it.
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Now, the interesting thing about that, I think if the supervisor had been asked, I suspect if I had been asked, you are sitting there in the middle of a 500-point drop in the stock market, nobody, I think, was eager to see the bankruptcy of a large options security firm announced that afternoon. You probably would have said, ''Yes, I think the wise thing to do is to recapitalize that company out of the bank,'' which was what was done.
But it seems to me it is an illustration of precisely the problem, that when you undertake these other activities, you are going to look to the bank for support in certain circumstances, and that is perfect, I don't object to it. It is the way business firms operate.
In that particular instance, it is the way they should have operated, in my opinion. But the implication is, ''You'd better be reasonably careful about what you are doing and there better be some oversight.''
Mr. BENTSEN. Thank you.
Thank you, Madam Chairwoman.
Chairwoman ROUKEMA. Thank you.
Mr. Barr.
Mr. BARR. No questions.
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Chairwoman ROUKEMA. Congressman Watt.
Mr. WATT. Thank you, Madam Chairwoman. I appreciate the comments that the Chairman has given us.
Unless I am mistaken about Chairman Greenspan's testimony, he seemed to think that it was inevitable that by 2015 we were going to be at this juncture where commerce and banking were one.
We are not at 2015, obviously, but we are going to get there one of these days, if we live long enough, and those of us who don't live long enough, somebody is going to get there even subsequent to us.
How should we be planning for this inevitable outcome? Maybe I should ask it in two stages. First of all, do you see it as inevitable, as I think Chairman Greenspan indicated it was, that we will get there? And if, in fact, you do see it as inevitable, what steps ought we be making in the interim between now and then?
I take it you say we shouldn't go there at all, we shouldn't allow it to happen, but if it is inevitably going to happen, how would we move from where we are today to where we need to be in 2015?
Mr. VOLCKER. Well, I think that is a very relevant question, and I obviously don't think it is inevitable. But that is kind of beside the point; nobody knows. But when you put it in the context of 2015, I think that is probably about the right context, and 2015 is almost 20 years away.
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I think we will have a better idea maybe in 2010 whether that is inevitable in 2015, and I don't, you have no idea, collectively we have no idea what shape that might be in, and I don't know how to deal with it and don't deal with it.
One way of dealing with it, not completely dealing with it, but I think people ought to be put on notice once again that those who operate the payment system and those who do essential banking functions are going to be regulated, because I think it is extremely likely, whatever the technological change is that might take place, that people are going to continue to think the economy is vulnerable to a breakdown of the payment system. Therefore, there will be a public interest one way or another in regulating it.
So maybe you ought to put non-financial companies that have ambitions in that area potentially, a little gleam in their eye for 2015, on notice that if they are going to go into that business, they are going to be regulated.
Mr. WATT. You mean companywide, or just the core banking functions?
Mr. VOLCKER. Precisely the question. Then you say, ''Companywide'', we are going to regulate the whole company, because they have a bright enough idea in the payment system?
Mr. WATT. I am trying to figure out what you would tell them.
Mr. VOLCKER. I would tell them they ought to plan, who knows about the future? But one plan they ought to have, if they want to get in this business, they ought to realize they are going to have to make a choice down the road and either operate the payment system or do some other business. So they shouldn't build their whole business strategy around the idea they are going to be combined.
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The question is very interesting, because that is precisely what I am worried about, and that is, I think, the signal that the subcommittee ought to be giving is: ''Don't plan that way,'' because it is obvious if somebody wants to get into the payment system, and it is a big company, it just has to put its toe in, and then its foot in, and it is not very much, and it can go in in a ''basket,'' and then they are going to come to you and say. ''We are already in this business, but we obviously want to expand it, and, you know, it would be terribly inequitable for you not to now permit us to expand this thing.'' And you are caught. So you ought to put them on notice right now.
Mr. WATT. So it would be fair to say your position on this would be, first of all, if we start putting in place some regulations and some steps leading to 2015 now, that will actually hasten the day that 2015 will get here?
Mr. VOLCKER. Yes.
Mr. WATT. If we get to that point at 2010, when it is inevitable, we ought to start dealing with it at that time, rather than worrying about it in the interim?
Mr. VOLCKER. You can worry about it now, but I wouldn't like to see steps put in the regulatory legislative structure that assume that is going to happen and facilitate it, because I think that potentially obviously creates problems. You have a lot of problems you have to worry about in 2020, how you are going to pay my Social Security and all that stuff.
Mr. WATT. Thank you, Madam Chairwoman.
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Chairwoman ROUKEMA. Thank you.
Congressman Bereuter.
Mr. BEREUTER. Chairman Volcker, thank you very much for your testimony. I had to be at another hearing where we are getting our first exposure to the Foreign Aid Bill. I have read your comments and heard staff analysis, and I am very supportive of the comments and the cautionary notes you have given us.
On page three, you talk about the need to avoid the conflict of interest that we could find when we break down the traditional separation of commerce and banking. On page seven, you reference your hope, your trust, that those supporting banking and commerce combinations are not contemplating a replication of the Japanese keiretsu system. I certainly hope so too, but I think it is almost inevitable that you get some American variant of a keiretsu system to some degree in this country if you break down the barriers. Along with it is the anti-consumer practices and the corruption and the domestic and international inefficiencies that go with the keiretsu-type system.
But the keiretsu system makes me think of something I have been concerned about a long time, and that is the situation in Japan. I think the situation in the Japanese economy and the strength of their banking system today ought to be a cautionary sign, if not a stop sign, for us when we look at the possibility of combining banking and commerce. I would hope that it is not inevitable, that we need to look at what is happening in Japan.
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The way I see it, it is a whole range of macro-economic factors and a wrongheaded kind of urban tax development problem that put them in a deep recession there. The fact that they had broken down the barriers between commerce and business means that the economic peaks are higher. And we looked with envy at the kind of assets the Japanese banks had as compared to American banks some time ago. But also I think it means that the valleys are deeper and perhaps wider, the economic valleys are deeper and wider. So what you see is an exaggeration of the economic trends when you have banking and commerce mixed.
So at a time when you have industrial problems and when you have got problems in the economy in general in Japan, at a time when you need a stronger set of financial institutions, they are weakened by the fact that you have combined commerce and business.
I think that the commerce and business combination in Japan is one of the reasons Japan is having such a tough time pulling out of that recession.
I would welcome any kind of comments you might want to make on this subject. If you have any areas of agreement, or disagreement, with my concerns, I would appreciate it.
Mr. VOLCKER. I think there is a lot to what you say. There is a real irony to me that, by general assent, the American financial system is the most vigorous, flexible, innovative, quickest to change, most efficient in allocating capital, and it has been done by maintaining the separation.
So the burden of proof seems to me to be on those who want to end the separation. We are doing fine without it, and without exception those countries that have more connection between banking and commerce are noted for having inflexible systems. Whether it is cause and effect or not, I don't know, but it is true.
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As you were talking, I happened, I don't think we are going to go very closely to a keiretsu system, I certainly hope not. I don't want to create the opportunity. But one of the problems, I think, plaguing Japan now is that, relative to American standards, industry is very highly leveraged, and the banks traditionally have been very highly leveraged. And one wonders whether the leverage of Japanese industry has not been made possible by the close perceived connection, and actual connection, between industrial firms and banks.
They always had kind of a ''house'' bank upon which to fall back. And I don't think that was the only factor, but I suspect it was a factor in contributing to an environment in which Japanese industry, by and large, has been pretty thinly capitalized.
Mr. BEREUTER. I have no doubt about it.
What about the possibility that I am suggesting that, in fact, breaking down the barriers between commerce and business really exaggerates the economic trends in an economy?
Mr. VOLCKER. I don't know. I think that is possible. I think it has complicated the Japanese recovery from, not exactly a depression or recession, but just a long period of sluggishness from this bubble that they had.
Now, did it contribute to the bubble? It could easily have done so. That cause and effect, I think, is hard to establish. It might well have done that. Again, how did they expand so much in these markets on such thin capitalization without a feeling that those big banks were there supporting it?
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Mr. BEREUTER. Thank you.
Chairwoman ROUKEMA. I thank all my colleagues for their cooperation. There are so many questions, Mr. Volcker, that we have on our minds. We have restrained ourselves and we are respectful of your time commitment.
I would simply say that, unanimous consent, all Members will have their full statements included in the record. But with your agreement, Mr. Volcker, if we could submit additional questions in writing for you to be submitted for the record, I think that would be most appreciated. I know I, for one, have at least one that I want to follow up with.
Would you like to make a concluding statement?
Mr. VOLCKER. I would just like to make a concluding comment that occurred to me.
I don't want to travel over all this area again, but just to come back right to the United States. We did have one experiment in the combination of banking, quasibanking, thrift banking, with industry in the United States in the 1980's, with the so-called ''direct investment.'' There were other problems in the savings and loan industry in that time, but I don't think there is any doubt that a major contributor to the savings and loan crisis was the connection between savings and loans and real estate development, a particularly volatile kind of commercial business.
It cost the taxpayers many, many tens of billions of dollars, as well as ended up with a few people in jail. It was not a very happy circumstance.
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Chairwoman ROUKEMA. Thank you, Mr. Volcker. I won't repeat my usual statement about being a full fledged battle scarred veteran of the savings and loan wars, but there are a good number of us on this subcommittee who do remember and will not forget the lessons of those years, as well as the lessons of FDICIA. So it is an appropriate ending for your testimony, and we appreciate it.
Again, we express our deepest appreciation for your time and effort.
Mr. VOLCKER. I appreciate your invitation. It is a subject I feel strongly about.
Chairwoman ROUKEMA. I noticed.
You know, there was little ambiguity about your testimony. For that, we are appreciative.
I would go into adjournment for 5 minutes while the second panel takes their positions at the table. Five minutes, please, and be promptly back.
[Recess.]
Chairwoman ROUKEMA. All right, we are going to bring the hearing to order here, please. We don't want to hold up our panel, as they have been so generous and patient with their time. So we will get this under way if everyone will come to order and if they will close the doors, please.
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Will the staff please close the doors?
Thank you.
I want to greet our panel here. Congressman LaFalce has not yet returned.
I know Congressman LaFalce has a constituent here, but we will begin, and when Congressman LaFalce returns, he will make his obvious welcoming remarks.
We will hear the testimony in the order in which you are located at the table. I will first introduce and you will help me with your name; I have a name that people have difficulty with too, Mr. Mierzwinski----
Mr. MIERZWINSKI. You always get it right, Madam Chairwoman.
Chairwoman ROUKEMA.----Is the Consumer Program Director for the U.S. Public Interest Research Group, better known as PIRG. Certainly he is no stranger to this subcommittee, and he has a long time history as a public advocate for consumers.
We look forward to your testimony this morning. Thank you.
STATEMENT OF EDMUND MIERZWINSKI, CONSUMER PROGRAM DIRECTOR, U.S. PIRG
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Mr. MIERZWINSKI. Thank you.
Madam Chairwoman, Members, Mr. Vento and other Members, it is a privilege to testify before you and provide you with the views of the United States Public Interest Research Group, which, as you know, is the national lobbying office for the State PIRGs, which are consumer environmental watchdogs active in about 37 States.
Chairwoman ROUKEMA. Excuse me, I have been reminded and I should have announced, I will have to invoke the 5 minute rule on those testifying. I will try to be courteous about it, but if you could comply to the best of your ability.
Mr. MIERZWINSKI. Thank you. Regardless of which legislative proposal before the committee is enacted, consumers will face increased strains in a less regulated marketplace. It is incumbent upon the Banking Committee to ensure that steps are taken to ensure that proposed legislation solves already existing problems and anticipates future and potential problems.
In a recent letter from the major consumer organizations to Chairman Leach, Chairman D'Amato and to Secretary Rubin and others, we made four points which we feel ought to go forward if financial modernization is brought forward in the 105th Congress.
First: Any bill must close the loopholes that allow banks to sell securities without being subject to the investor protection rules that registered brokers must follow. I would concur with the detailed analysis that is made in both Consumers' Union and Chairman Levitt's and other testimony that goes into some of the problems in this bill and others on that matter.
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Second: Consumer groups recommend anti-coercion and other sales practice rules for insurance sales to protect against banks forcing, or duping, consumers into buying products that they do not want, or do not need.
Last month PIRG joined the Consumer Federation of America in releasing a major report documenting that each year consumers overspend on the order of approximately $400 million a year for the unnecessary rip off product called ''credit life insurance.'' Many banks already sell this product, along, of course, with car dealers and small loan companies. Consumers are often pressured into buying it. It is very often unnecessary, and it is, most of the time, extremely overpriced.
Our study found that the average loss ratio, or benefit to consumers on credit life insurance is approximately 42 cents on the dollar in 1995. Even the National Association of Insurance Commissioners, who are not characterized as a left leaning or liberal organization, believe that 60 cents on the dollar is a reasonable minimum, and the major consumer groups believe 70 cents a reasonable minimum.
Now, in addition to credit life insurance, I would point out, as well, that banks are increasingly marketing with their credit cards companion products such as ''credit disability, credit unemployment.'' All you have to do is look at all the so-called ''preapproved'' offers you receive in the mail for credit cards and look carefully at the offerings and you will see the aggressive marketing of these add-on products that I think are underregulated at this time.
Third: The consumers groups recommend tough disclosure in advertising rules to make sure that consumers know the products they buy are not insured or guaranteed and that they carry some risks. Whether the studies are done by AARP, Consumers' Union, the North American Securities Administrators, or even by the FDIC, I think it is clear that when consumers buy investment products at banks, they do not understand that they are uninsured. They do not know that they carry higher risks, including the risk of loss of principal, and that is under current conditions and under current law.
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Fourth: The consumer groups recommend an enforcement mechanism to enable consumers to recover directly from the wrongdoer when the bank violates minimum Federal protections. As Chairman Levitt pointed out to the subcommittee, H.R. 268 does not grant bank customers a forum to address grievances, nor do the Federal banking laws contain private rights of action for investors.
Unfortunately, neither the financial services marketplace, nor the current bank regulatory structure, adequately protects consumers. We have a number of additional recommendations in our testimony to protect consumers, and we urge that if any financial modernization proposal goes forward that consumer protections be highlighted.
I want to commend Congressman LaFalce for the letter that we just received a copy of, urging the regulators to make sure that they make consumer protection an important part of anything they bring forward.
Thank you.
Chairwoman ROUKEMA. Thank you.
[The prepared statement of Mr. Edmund Mierzwinski can be found on page 576 in the appendix.]
Chairwoman ROUKEMA. Congressman LaFalce, would you like to do the honors in introducing Mary Griffin, Legal Counsel?
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Mr. LAFALCE. Yes, it is my pleasure to introduce a native Buffalonian, Mary Griffin. I have known her parents for a great, great many years. Her father is one of the most prestigious attorneys in Buffalo's largest and most prestigious law firm, and she has followed in his footsteps, actually gone a bit beyond that, not only obtaining her JD degree, but then getting her Master of Law degree and has worked in the consumer vineyard for a great many years now as insurance counsel to an insurance union, Consumers Union. We are very, very pleased to have Ms. Griffin with us.
STATEMENT OF MARY GRIFFIN, INSURANCE COUNSEL, CONSUMERS UNION
Ms. GRIFFIN. Thank you, Congressman LaFalce.
Chairwoman ROUKEMA. Thank you.
Ms. GRIFFIN. My name is Mary Griffin, and I am with the Washington office of Consumers Union. We appreciate the opportunity to testify here today on H.R. 268 and the issue of financial modernization as it affects consumers.
I, too, would like to take this opportunity thank you, Congressman LaFalce, for your letter to Mr. Hawke and Mr. Ludwig about the need for consumer protections, because obviously this is very important for consumers as banks move further and further into the financial services marketplace.
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Financial modernization is a laudable goal if it promotes competition, provides a regulatory structure that ensures safety and soundness and ensures consumers the needed protections as they attempt to make their way in the new and diversified marketplace.
Today I would like to focus on the need to modernize consumer protection laws as part of any financial modernization package. Contrary to what many believe, banks have already made a substantial mark in the area of retail sales. According to industry estimates, bank insurance premiums totaled an estimated $16.3 billion in 1995. Their annuity sales accounted for one-third of all annuity sales in that same year.
Consumers have already experienced problems with banks selling insurance, annuities, mutual fund stocks and other non-banking products, and with bank fees increasing, many wonder whether banks' further expansion will promote competition, or just provide an opportunity to squeeze more out of consumers' pocketbooks, and consumers have cause for concern.
Study after study reveals that banks are not informing consumers about essential information relating to non-banking products. Banks argue that their expansion into the financial services marketplace will promote competition and help underserved areas. But as Mr. Mierzwinski just discussed, the track record for banks in the area of credit insurance, which is the second most sold insurance product for banks, shows more concern with increasing profits than with promoting a competitive market.
How can Congress help ensure that banks' expansion in the financial services marketplace helps, rather than hurts, consumers?
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First, the gaps in investor protection rules must be closed. Banks are currently exempt from the Federal securities laws. This means that banks don't have to comply with investor protection rules that non-bank brokers have to comply with, rules such as the requirement that salespeople recommend only products that meet the financial needs and goals of the particular customer, or as many people refer to it as, ''suitability rules.''
Most importantly, consumers do not have recourse to arbitration for violation of the rules as they do under securities laws. Unfortunately, H.R. 268 does not fully close this gaping loophole.
Second, strong disclosure in advertising rules are needed to ensure that banks don't mislead consumers. While H.R. 268 has some disclosure rules, they do not require disclosure prior to sale, which is the most important time. Nor do they cover insurance affiliates.
Third, any modernization proposal must contain consumer protections to prevent coercive and deceptive practices in insurance sales. For example, banks use high pressure tactics on loan applicants awaiting their loan approval. To prevent this, banks should be allowed to sell insurance only after the loan decision has been made, and consumers must have an enforcement mechanism to recover directly from banks when they violate these rules.
Finally, Congress should not preempt State consumer protection laws. The preemption language of H.R. 268 is very broad. In the area of privacy, we believe the bill does not go far enough to protect consumer privacy of the information they give to banks. In addition, we are also concerned that H.R. 268 may preempt State privacy laws that provide greater protection.
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In addition to the consumer protections we just discussed, we also would like to touch upon structural issues that have gotten quite a bit of attention. First, with regard to the mixing of commerce and financial firms, we are opposed to it because of the potential overconcentration of economic power, the possible skewing of credit markets and general safety and soundness concerns.
In terms of risky activities such as underwriting securities and insurance, we believe the less risky approach is through a separately capitalized affiliate rather than permitting the activities in a federally insured bank subsidiary.
We thank you for this opportunity to testify and look forward to working with you in this endeavor.
[The prepared statement of Ms. Mary Griffin can be found on page 582 in the appendix.]
Chairwoman ROUKEMA. Thank you.
Mr. Allen Fishbein is General Counsel for the Center for Community Change and is no stranger to this subcommittee. He has been an advocate for consumer issues for a good number of years.
Thank you. Welcome.
STATEMENT OF ALLEN J. FISHBEIN, GENERAL COUNSEL, CENTER FOR COMMUNITY CHANGE
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Mr. FISHBEIN. Thank you very much, Madam Chairwoman. It is a pleasure to be here and appear before the subcommittee. I appreciate the opportunity to present my views and the views of the Center for Community Change on financial modernization and on H.R. 268.
I want to commend you, Madam Chairwoman and Representative Vento, in particular, for holding these hearings.
In my testimony, I want to focus on the implications of financial modernization and restructuring for modest income consumers and communities and the need for the modernization of the Community Reinvestment Act.
For some time now, deregulation, new technologies, increased competition domestically and from abroad, have been reshaping the banking and financial services industry. I don't think there is any question about that. As a result, Congress is contemplating legislation to allow interfinancial institution affiliations and perhaps even allow banks and commercial firms to own one another. But to paraphrase former French Premier Georges Clemenceau's comment about war and generals, we think that ''banking is much too serious a matter to be entrusted to the bankers.''
But, unfortunately, as we all know, the debate over the necessity of these changes is all too often dominated by narrow turf issues and various industry wish lists. However, issues of financial modernization should not be allowed to proceed along narrow lines.
It presents an opportunity for a much broader discussion about the type of financial system American families want and need and what the appropriate public responsibilities should be for all types of financial institutions to better meet the needs of underserved communities and businesses.
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From the standpoint of most consumers, the case for making sweeping legislative changes at this time to our banking and financial system seem less than compelling. The banking industry is strong and enjoying record earnings. There has not been a huge outcry from most Americans.
The need for financial supermarkets authorizing broader affiliations between banks and other financial institutions, such as securities firms and insurance companies, will unquestionably lead to increased concentration and the rise of a handful of superbanks. Yet consumers have not benefited from the concentration that has occurred thus far from within banking.
There are also indications that small businesses, small farms, modest income communities may find themselves at greater risk should financial institutions become larger and larger. However, should Congress decide, after careful consideration of these and other relevant issues, that these sweeping changes are needed now, we urge that strengthened community safeguards and stronger consumer protections be incorporated into these legislative measures to help ensure that the broadest possible segment of Americans benefit from financial restructuring. In particular, and we set out in detail in my written testimony, we believe that the Community Reinvestment Act needs strengthening and modernization in order to maintain its effectiveness for stimulating increased lending and investments in underserved communities. We know it has been a tremendously effective law in the past, but it stands to become functionally obsolete if these changes are not made. And I propose in my testimony three areas that need to be addressed:
One, financial modernization legislation should do no harm to the existing CRA statute. CRA can be undermined indirectly just as much as it can be through direct amendments to the statute;
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Two, that CRA must be modernized to reflect new realities between banks and non-bank affiliates of the same parent holding companies; and
Number three, community reinvestment obligations should be expanded to non-bank financial institutions.
There is an excellent article, by the way, on the public benefits that non-bank financial institutions receive, called the ''Parallel Banking System and Community Reinvestment'', which I would like to be offered to be introduced into the record.
[The material referred to can be found on page 607 in the appendix.]
Finally, we do not support cross ownership between banks and commercial firms. I see I am on safe ground with Chairman Volcker's testimony.
While House Resolution 268 permits only limited forms of non-financial activity through a newly created financial services holding company, we are concerned that this would be seen as a foot in the door for those who would prefer no restrictions to cross ownership at all. Permitting commercial firms to own banks will inevitably lead to a much greater degree of financial concentration in the hands of a few all purpose giants, and we do not think that will be good for the American consumer, in general, or for America's neighborhoods.
This concludes my testimony. I would be glad to answer any questions you have.
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[The prepared statement of Mr. Allen Fishbein can be found on page 597 in the appendix.]
Chairwoman ROUKEMA. Thank you, Mr. Fishbein.
Mr. John Taylor, National Community Reinvestment Coalition.
Mr. Taylor.
STATEMENT OF JOHN E. TAYLOR, PRESIDENT AND CEO, NATIONAL COMMUNITY REINVESTMENT COALITION
Mr. TAYLOR. Good afternoon, Chairwoman Roukema, Mr. Vento and other distinguished Members of this subcommittee. My name is John Taylor and I am the President and CEO of the National Community Reinvestment Coalition.
NCRC is the Nation's largest community reinvestment trade association, comprised of 603 community-based organizations. Our philosophy promotes proactive partnerships among banks and low-income and minority communities, NCRC is dedicated to increasing access to capital and credit. As President of the trade association neighborhood organizations, I have been privileged to represent the community perspective on the Federal Reserve Board's Consumer Advisory Council, on Fannie Mae's Housing Impact Council and other bodies. I request that my written testimony be entered into the record.
Chairwoman ROUKEMA. So moved.
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As in the case of each of you who is testifying, the full statement will be included in the record.
Mr. TAYLOR. NCRC thanks you for the opportunity to testify on this subject, bank modernization, that carries profound impacts on access to capital and credit for the Nation's underserved communities. With access to banking products and services, our communities thrive and create wealth through expanded home ownership opportunities and small business creation. Without access to capital and credit, our neighborhoods die.
Legislative and regulatory changes have profound impacts on access to capital and credit. For example, as Alan just mentioned, since its passage in 1977, the Community Reinvestment Act has leveraged over $160 billion in reinvestment dollars for minority and low-income neighborhoods. Bank modernization legislation has the potential to either intensify the gains in community reinvestment or to wipe them out.
On the one hand, H.R. 268 can increase access to capital and credit for the underserved if amended to expand the Community Reinvestment Act to wholesale financial institutions and national market funded institutions sanctioned by this bill. On the other hand, if it does not expand CRA coverage, H.R. 268 can devastate low-income neighborhoods by facilitating the flow of capital out of institutions covered by CRA into the new nationally chartered behemoths exempt from community reinvestment obligations.
In addition, H.R. 268 would exacerbate disinvestment if it does not expand CRA coverage to existing financial institutions such as security firms that would be allowed to affiliate with financial service holding companies.
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House Resolution 268 will accelerate the rate of consolidation in the banking industry. Recent blockbuster mergers, including the merger of Morgan Stanley and Dean Witter, would become more common since H.R. 268 would permit banking and non-banking financial combinations. Already, the banking industry's newspaper, or the newspaper that covers the banking industry, American Banker, is full of discussions of much anticipated mergers of banks and securities, and other types of financial firms. Without strong public policy initiatives and tough CRA enforcement, mergers and acquisitions will hasten disinvestment from low-income and moderate-income communities.
A number of studies suggest that mergers and acquisitions decrease CRA performance, particularly in the small business lending area. For example, of the 11 largest mergers in New England during 1993 and 1994, Madam Chairwoman, examined by the Federal Reserve economists Peek and Rosengren, 8 of the post merger institutions decreased their small business lending. In addition, Federal Reserve economists Berger and Scalise estimate that small business lending would continue to decline in the next 3- to 5-years at the same pace, about 33 percent, as in the last 5 years.
Small business lending declines after a merger because it is the type of lending that depends on an intimate knowledge of community businesses that only loan officers and local branches possess. After mergers and acquisitions, decisionmaking is often centralized in headquarters located hundreds of miles away from what used to be the local branch office.
For example, a recent Small Business Administration study concluded that KeyCorp succeeded in capturing the highest dollar market share of small business loans of under $250,000 because it had a more extensive branch network than its big rivals who relied more upon mailing of preapproved applications. I have a number of comments I want to make on consumer disclosure, but I would just say that I agree wholeheartedly with what has been presented by Mr. Mierzwinski, as well as Ms. Griffin, so I will pass on that. But do I want to make a comment about the financial and non-financial companies and the combination of the two.
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Safety and soundness in the financial industry will deteriorate significantly if financial services holding companies are allowed to derive up to 25 percent of their business from non-financial corporations. We should learn from the mistakes of foreign countries who have had particularly disastrous experiences allowing the combination of financial and non-financial companies.
In Finland, combinations of commerce and banking resulted in loans that, in proportion, exceeded our savings and loan crisis. One of the world's biggest bank failures totaling $14 billion involved Credit Lyonnais in France, which was a banking and commerce conglomerate. In Spain, Benesto Bank had a similarly spectacular collapse, and later it was taken over by a Banco, my Spanish is terrible, Banco Santandor, which had sold off its non-financial business and invested the proceeds in our own First Fidelity.
The entry of banks into non-financial activities will impede the growth of the small business sector.
Let me just end very quickly by saying we make several policy recommendations, including, you know, the need to really expand CRA to these new financial institutions that are created, and a more rigorous enforcement of CRA. Madam Chairwoman, we are very distressed to see the regulatory bodies, which seem to be really taking CRA more seriously now, passing out CRA evaluations and passing grades as if it is candy and Christmastime. We are just not, we are seeing very few institutions and all institutions receiving satisfactory or outstanding CRA ratings, and the enforcement that I think this subcommittee, and the Banking Committee as a whole and Congress as a whole, hoped would become fairer, as well as more vigorous, is not, we are just not seeing that.
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I am going to, because my time is up, I am going to thank you for the opportunity to speak and again ask that my written remarks be put in the record.
Thank you.
[The prepared statement of Mr. John Taylor can be found on page 629 in the appendix.]
Chairwoman ROUKEMA. Thank you, Mr. Taylor.
Our next panelist is Michael Fink, and he is here representing the National Association of Home Builders. It goes without saying that home builders have a strong and constructive interest, pardon the pun, a constructive interest in financial services reform and also the strong relationship between banking and the thrift industry that is included here.
But Mr. Fink has another claim to fame, or infamy. He is a constituent of mine from Mahwah, New Jersey.
Welcome, Mr. Fink.
STATEMENT OF MICHAEL FINK, ON BEHALF OF THE NATIONAL ASSOCIATION OF HOME BUILDERS
Mr. FINK. Thank you, Madam Chairwoman, Ranking Member Mr. Vento and other Members of the subcommittee. It is my pleasure to be here before this subcommittee representing the 190 member firms of the National Association of Home Builders and their over 8 million employees, all of whom are engaged in providing homes and shelter to our fellow Americans.
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I am a home builder from Mahwah, New Jersey. That is how I make my living and that is how I feed my family. We were requested to discuss here today: One: Whether there is, in fact, the need for financial services modernization; and Two: To address the potential impact of H.R. 268 on industry and homebuying consumers.
Perhaps the question relating to actual need for financial services modernization is best left to such financial experts as the distinguished Paul Volcker and others who have come before, and will come after him in that area. In the few minutes which we have available today, we would like to highlight from our written submission what we foresee as the potential impact of H.R. 268 on our industry and the consumer homebuyers and users.
Home builders and small businesspersons, as the Chairwoman correctly indicated, rely heavily on loans from thrifts and banks in our capital intensive industry. A recent survey of the NAHB members showed that 87 percent of our members rely on commercial banks or thrifts for their housing production funds.
The National Association of Home Builders adopted some time ago, a very specific policy on the subject matter of the bill we are considering today. It states, quote, ''Banks should be granted new powers only if steps are also taken to preserve a system of community-based depository institutions. Banks should be allowed to exercise new powers only if they are providing housing financial services in all of their local service areas, if both the bank and non-bank subsidiaries are well capitalized, and if the deposits are insulated from non-bank activities,'' unquote.
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Madam Chairwoman, we thank you for the provision in your bill which prohibits regulatory criticism based on an institution's housing finance specialization. We think that is very constructive.
Since enactment and implementation of the Riegle-Neal Act, home builders have witnessed a reduction in the number of smaller community banks and thrifts. As national branching becomes fully effective later this year we have little doubt that further merger and consolidation of the banking industry is inevitable. The effect will be to further reduce institutions' ties to local areas and their credit needs, creating financing gaps in communities around the country.
If I may, just this year, one of my colleagues related this experience: The bank he had been using for over 20 years in Bergen County, New Jersey, was gobbled up by an out-of-state mega bank. Renewal of his business loan was being determined by bankers up in Boston, who had never met the borrower, nor had they ever been in the community. Although a payment had never been missed and the loan was current, Boston decided that this New Jersey business didn't meet their criteria.
Fortunately, my colleague's business, which employs over 100 persons in the homebuilding industry, still had a community-based institution around to turn to. For if not, you could imagine, as well as I, the disastrous results for his business and the families of his business' employees.
We believe that certain modifications to the bill should be made to retain the banks' focus on lending within their service communities and to address the concerns outlined above.
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As discussed more fully in our written statement, we believe that financial services modernization does not necessarily have to include elimination of the thrift charter. NAHB opposes eliminating Federal savings associations or forcing them to convert to another charter.
The recently enhanced thrift charter allows these institutions flexibility to compete in today's financial services marketplace, and we believe that depository institutions should be free to choose whichever charter best suits their business needs. Elimination of the thrift charter is not a necessary prerequisite to expansion of bank powers. Thrifts could remain thrifts, while other banks expanded their activities if done within the context of safety.
House Resolution 268 also calls for dissolution of the Office of Thrift Supervision. As a matter of general policy, NAHB supports regulatory streamlining. However, any consolidated agency ought to have a branch or division specified in the legislation to specialize in homebuyer permanent financing, as well as housing production finance.
The staff could use its' expertise to be responsible for development of regulatory policy affecting institutions which specialize in housing finance and to participate in teams' involvement in examination and supervision of their institutions, as well as to collect and publish detailed data on housing lending and investment by insured depository institutions.
As set forth in our written submission, we also believe that the Federal Home Loan Bank system can be utilized very safely and effectively as a means to foster housing lending, and I would agree with a good deal of what has been said by some of the others regarding enhancement of the Community Reinvestment Act.
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In sum, as Abraham Lincoln noted, ''The strength of the Nation lies in the homes of its people.'' To ensure that all Americans have access to safe, decent and affordable housing, NAHB believes that it is essential for housing sector borrowers to continue to have access to locally focused and based lenders who are familiar with the community, have a substantial commitment and focus to serving their needs and understand those needs.
We offer our assistance, to you, Madam Chairwoman, and to the rest of the subcommittee, to ensure that any efforts toward financial services modernization also enhance the focus on community-based lending for housing production, mortgage credit and small business needs. Thank you.
[The prepared statement of Mr. Michael Fink can be found on page 643 in the appendix.]
Chairwoman ROUKEMA. Thank you. Thank you, Mr. Fink.
And finally, we welcome James Pledger, who is the Chairman of ACSSS, which represents State thrift supervisors.
ACSSS, I can imagine, has strong and relevant views on the questions that relate to thrift conversion in H.R. 268 and the regulatory structure.
STATEMENT OF JAMES L. PLEDGER, CHAIRMAN, AMERICAN COUNCIL OF STATE SAVINGS SUPERVISORS
Mr. PLEDGER. Yes, ma'am. Thank you very much.
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I spend most of my time as the Savings and Loan Commissioner of Texas, and in that capacity I regulate and supervise all State chartered savings and loan associations and State savings banks in Texas. I am also the Chairman of ACSSS, and it is in that capacity that I appear today. We appreciate the opportunity to be here.
First, let me commend you, Chairwoman Roukema, for a number of real significant improvements and progressive provisions that you have incorporated into H.R. 268, particularly as they compare to legislation that was dealt with last year even. It is a dramatic improvement. The bill contains a number of critical provisions that support and protect the dual banking system in this country and, specifically, the dual thrift system.
Most notably in the bill's proposed elimination of the Federal thrift charter, H.R. 268 ensures continuity in the authority of States to offer whatever types of financial institution charters and State regulatory structures that they believe to be in the best interest of their States. The bill provides that the FDIC will be the primary Federal regulator of all State chartered financial institutions, including State savings and loan associations. We believed this to be the right approach in 1989, when Chairman Leach proposed it as part of FIRREA, and we continue to believe that it is an important provision today.
The bill also includes a 2-year transition period in which converting federally chartered savings and loan associations would retain all powers and authority. The important point in this issue for ACSSS is that after this 2-year period has expired, there is no national standard of banking powers that would be imposed automatically on the States. States, appropriately, would continue to be able to authorize powers and activities for their financial institutions that are different from those that are available to national banks, specifically subject to the authority of the FDIC to review it based on safety and soundness, and review it based on risk to the insurance funds. And we think this is very important.
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ACSSS strongly supports these principles, including the merger of the thrift, of the insurance funds, all of which are contained in H.R. 268.
There have been some significant improvements in the grandfathering provisions relative to unitary thrift holding companies, and as we spoke about these, as we have spoken about holding companies today, we have exclusively focused on bank holding companies, but as I think all of you know, thrift holding companies do not have the same kinds of constraints and the same kind of wall between business and commerce that exists in the banking holding, in the bank holding company structure. And it is important because there have been a large number of institutions that have acquired institutions, failed institutions, for example, in Texas, in 1988, we had a number of large institutions that acquired failed thrifts, made substantial contributions to the capital account; and they acquired these businesses with the reasonable expectation that they would be able to continue to own them and to operate them, and at some point down the line be able to sell what they bought, and that is a financial institution that could be owned by a nonbusiness corporation.
To require such a company to divest itself of major portions of its business activities in the event of a merger or some other type of normal business transaction, in my view, is the equivalent of taking that authority away and could raise significant Constitutional issues.
We believe very strongly that the savings and loan holding company structure has been very effective. I think many of you know that there have been some very large, very productive savings and loan holding companies. Ford Motor Company, Sears & Roebuck, Temple Inland in Texas and a variety of smaller entities that have been very successful. These companies have provided substantial managerial experience and financial experience and contributed capital if their institutions needed these issues, and we would strongly encourage the subcommittee to allow these entities to continue to operate within the framework of their existing statutory constraints.
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You can stop chartering new ones, but they have been, they have made, substantial contributions to the industry and we have found no significant supervisory problems that justify taking away the structure that they acquired.
Shifting to the issue of the elimination of the Federal savings and loan charter and the OTS, I think it is important to recognize that there is no overriding reason to eliminate the State and the Federal thrift charter. As I think many of you know, many States have consolidated the State counterparts that are counterpart to the OTS and the OCC for a variety of reasons.
We have intentionally not taken a position on the issue of the elimination of the Federal thrift charter. I think many of you know that a lot of States have started chartering State savings banks for the primary purpose, in response to this proposal, of eliminating Federals to allow companies to continue to operate in the manner that they have proceeded.
How you, as Congress, choose to deal with that issue is, we believe, in your discretion entirely. But ACSSS strongly believes that States have the legal and Constitutional right to offer whatever types of financial institution charters and State regulatory structures that they believe to be in the best interest of their citizens.
Finally, to conclude, there is much in H.R. 268 that we find we support. But we would encourage Congress to act promptly on these issues. For too many years thrift institutions have been subject to an enormous amount of uncertainty as to their continued charter existence and their powers, and the time has come for these issues to be resolved. And we strongly support your efforts, Congresswoman Roukema, in establishing a very good foundation for this, for these issues to be considered.
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I would be glad to respond to any questions.
[The prepared statement of Mr. James L. Pledger can be found on page 649 in the appendix.]
Chairwoman ROUKEMA. Thank you, Mr. Pledger.
I also would ask unanimous consent that the testimony from the American Land Title Association and the North American Securities Administrators Association be submitted for the record. They were unable to be here today. But without objection, so ordered.
[The information referred to can be found on pages 654 and 661 respectively in the appendix.]
Mr. VENTO. Madam Chairwoman, I would ask that the document that Mr. Fishbein referred to be, with regards to banking commerce, the valuation, be submitted for the record. The title of that was the----
Mr. FISHBEIN.----Parallel Banking System and Community Reinvestment.
Mr. VENTO. Yes. I would ask unanimous consent that that be made a part of the record.
Chairwoman ROUKEMA. So ordered. So ordered.
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I will try to be brief in my questioning here. I have a question for both, I think it was Mr. Mierzwinski, as well as Ms. Griffin and perhaps others, that alluded specifically to the question of securities and the disclosure and the regulations that would be required to protect the consumer under existing securities law, that is, rules that apply to the SEC and grievance procedures. There were references to gaping loopholes.
I am not quite sure with precision how you would--you were proposing to address this? And we may not have the time to go into it today. If you want to add just a brief explanation of where you see the problem arising and how you do not believe it would be covered by this legislation, I would appreciate it in writing, if you would do that.
Do you have anything, very briefly, that you want to add to your statements today?
But I took particular note of that. That is an interest of mine, and I would like to look into it further----
Ms. GRIFFIN. I would like----
Chairwoman ROUKEMA.----But I am not yet convinced that there is a loophole there.
Ms. GRIFFIN. Oh, OK. Part of it is in the bill. Although the bill does modify the definition of ''broker-dealer'' and that is where the banks have been exempt. It only closes that loophole for those banks operating within the financial services holding company structure; it does not close the loophole for banks outside that structure. I mean, that is one, that is a major part of the loophole.
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Chairwoman ROUKEMA. All right.
Mr. MIERZWINKSI. I would agree.
Chairwoman ROUKEMA. Thank you.
Anything further that you want to submit in writing for the record I would appreciate, and I will look into that further.
The National Association of Home Builders, Mr. Fink, I am not quite sure that I understand your concerns about this. Or I understand your concerns; I am not sure that the record has demonstrated it.
But how, with precision, would you attack this question of the investment in the local communities without getting into another defined regulatory system that would parallel the CRA and all the problems that we have had in interpreting that? I don't know whether or not you are prepared to address that here, but I would appreciate any further help you could give me, because by no means do we view, nor does the thrift industry view, per se, the fact that we are going through this procedure and the combining of the charters, you know, the merger of the charters, that that would be the consequence.
Do you have any further observations, how we can protect you without creating another regulatory morass that would end up being restrictive rather than proscriptive?
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Mr. FINK. Well, I think part of the solution will come out of further discussions as the bill begins to take on better, more shape, based upon comments from various people.
But we do believe that the thrifts have had an historical focus, and a very clear focus, in their communities. We are concerned that by simply doing away with the charters, that focus may change, and one of the ways to ameliorate that is to be certain that there be, within whatever the regulatory body is, this division, or section or unit, which is very focused on lending within the communities and, in particular, housing lending, so that there can be a body of regulation that would be developed to address these issues.
We also think that through the CRA and enhancing the way that CRA operates, in particular by causing the banks to have to provide clear data which traces the funds from the communities' use back into the communities, that we will be in a much better position to enforce laws already on the books and to make sure that investments are real investments, not, for example, educational classes which, although worthy, don't really meet the issue.
And, of course, our staff would be more than happy to work with the subcommittee as things develop to try to find other areas that are not overregulation.
Chairwoman ROUKEMA. Well, certainly that is a commitment that I will make. I would also particularly point out, you referenced it in your testimony, but for my colleagues here, New Jersey has a more advanced history because we have regionalized our banking systems, as you referenced, perhaps, and have more history here and experience than perhaps some other regions of the country. So I think your experience will be particularly instructive to us.
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But I am a little bit from Missouri. I don't have a clear vision here, but I want to work with you on it----
Mr. FINK. Thank you very much.
Chairwoman ROUKEMA.----To get a better understanding.
Congressman Vento.
Mr. VENTO. Thank you, Madam Chairwoman.
You know, a couple of problems. One is the concentration issue and merger, and that is happening. Obviously what we do here will have some influence on it, but I think most of us see that happening and hope that what we can do is gain some better efficiency and service out of it.
Of course, that is always the predicate for the actions, and the proposed actions by advocates is that they are going to somehow enhance the benefits to consumers and the general economy by virtue of these changes. But I think we are, in a sense, recognizing the convergence of all of these financial in nature products at the very least, and defining it. ''I know it when I see it'', I guess, is the description. But in essence, even some of it overlaps.
So you talked about concentration. You talked about the commerce and banking, and that gets into the financial in nature. That is one of the questions that, sort of the dilemma, I think, that is epitomized in Mr. Mierzwinski's testimony when he says granting greater flexibility to the financial regulators such as defining ''financial in nature'' to this national subcommittee that we have is precisely the problem we have.
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I could do this if that is all I had to do as a full time job, but we are, sort of, the part time students of this. And so, you know, I don't know if there is a way out of this dilemma. It is like last year when the Congress was attacking the rules and regulations of the agencies, I mean, the rules and regulations are the laws. They are basically the way we put laws into effect. I mean, if you don't have rules and regulations, then the policies that we vote on never become law, never have any effect.
So I don't know, you know, that there is a better means. I mean, in terms of flexibility, we may be definitive, we will try to be as definitive, as we can. Some think we are far too definitive with regards to FIRREA and FDICIA, as a matter of fact.
Mr. MIERZWINKSI. Very briefly, Congressman, my concerns are that the agencies have too much flexibility on the enforcement of consumer laws, and I think they need to be, either there needs to be another agency of the consumer that has as its constituency consumers, rather than banks, or the Congress needs to order the agencies to enforce the community and consumer laws better.
I know we can't answer that in 5 minutes today, but our view remains that when it comes down to a choice between preempting State law or protecting a stronger consumer law, the agencies tend to want to preempt the law. They tend to not enforce consumer laws, all things being equal; and I don't have all the answers, but obviously we need to look closer at it.
Mr. VENTO. Well, we have some dilemmas there. We have had some votes on the floor, you know, on the Fair Credit Reporting Act. You noticed that, even though it may have some improvements based in the last session, it also had some preemption in terms of affiliate sharing and so forth. So we are very cognizant of that. I guess there was one reference in the statement to the overriding of State laws in a lot of the four statements.
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One of the other major issues that comes up, of course, is the CRA and the suggestion that larger institutions, and I think, logically I think, there is some reason to believe that smaller institutions and smaller businesses generally are able to be more responsive. They have more trouble with the paperwork, but nevertheless is that the reason that we get reports back that say larger banks, really, in my area, in most areas, are doing better than small banks in terms of CRA?
Mr. Fishbein.
Mr. FISHBEIN. Well, of course, the large banks are just beginning to be examined under the new CRA rules this July, so we don't know how they will fare. The evidence with the small banks in the first year of implementation of the new rules is that virtually all of them get satisfactory or outstanding grades. From our analysis, the rating distribution doesn't seem to correlate with the level of activity that the small banks are involved in meeting underserved needs. Certainly the committee and the subcommittee need to look very closely at continuing oversight in this area. I think your interest is going to be critical in that.
I think there is what I describe in my written testimony as a general ''institutional incompatibility'' between very large sized financial institutions and certain kinds of credit needs, such as small business loans. The senior vice president of one of the largest banks in the United States said in a public meeting that I was at not too long ago that ''You have to understand, for our bank, a $40,000 small business loan is not a loan; it is a grant.'' This is the ''institutional incompatibility'' that we have to recognize will occur from industrywide concentration.
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Now, perhaps the market will work to address situations in which large banks become too insensitive to the needs of small businesses, and we would hope that would happen. But I think we know, have enough history to know, that at least some portion of small businesses, particularly very small neighborhood-based small businesses, are going to suffer the most if small banks do not remain in their communities to address their particular needs. And there is no evidence to suggest that that will happen.
Mr. VENTO. That is why I am getting back to some of the microcredit. Then just one other statement, and I will yield, Madam Chairwoman, if I could.
You touched upon insurance, you touched upon the SEC. Both of those end up being jurisdictional problems in terms of where we are trying to go. You know, if you, of course, I think that our effort here is probably not to solve every problem, because if we try to do that, we are trying to reduce the number of issues so we get it sizable.
But I understand your concern is consumer issues with regard to the problems of insurance. But you are bringing up obviously existing credit insurance debates and other matters and expecting us to, maybe there is an opportunity here to solve some of that at the same time. But you know, I am concerned about it because I think in the end if we don't concentrate and focus on the areas where we can achieve some success, perhaps with CRA and some of the other aspects, that we end up losing the focus and not being able to accomplish some step forward with regards to this modernization legislation and consumer issues.
Thank you, Madam Chairwoman.
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Chairwoman ROUKEMA. Thank you.
Mr. Barr.
Mr. BARR. Thank you, Madam Chairwoman.
Mr. Taylor and Mr. Fishbein, both of you used some figures in your presentations, your written materials here, that are just huge figures, and there are discrepancies here. I am wondering where you all get your figures from?
Mr. Taylor, you talked, you sort of cavalierly throw around the term ''$160 billion in reinvestment dollars.''
Mr. Fishbein, you talked about ''$100 billion.''
Where is the--why such a vast discrepancy? Where do you all come up with these figures?
Mr. TAYLOR. Yes, Congressman Barr. I didn't mean to sound cavalier about it, but my apologies if I did.
As a matter of fact, what we did was, we did a study of financial institutional commitments to poor and underserved communities and looked at the amount of those commitments. We also rely upon comments from the hardly left, hardly liberal leaning Federal Reserve Board members, who maintain that on the average now there is probably about $7 billion a year, this is Board Governor Lindsey's comments, in community reinvestment lending. So I think that cavalier sounding statement is actually quite substantiated at this point.
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Mr. FISHBEIN. And I would answer also that we have been cataloging commitments that lenders have made since CRA went into effect in 1978. Our figure of $100 billion, which we concede is a conservative one, is based on actual public commitments that lenders have made, targeted to affordable housing, small business lending and community development.
Mr. BARR. Maybe the, maybe other institutions use these figures. I am always curious as to where people come up with these huge figures. If you all have any information that provides a basis, a specific basis for it. I sure would appreciate seeing it.
I am also intrigued by the huge discrepancy in the two figures.
Mr. TAYLOR. We do have a publication, Mr. Congressman. I will make sure that that is submitted to the subcommittee.
Mr. BARR. Thank you. I would appreciate that.
Mr. Fishbein, in your written testimony, you say, quote: ''In 1977, when CRA was enacted, banks and thrifts controlled nearly 60 percent of all financial assets. Now 20 years later these depository institutions control about half that amount. Consequently the law stands to become all but functionally obsolete.''
I don't understand the link there, ''consequently,'' because the current ratios, the current percentage, has changed, why does it stand, why does that mean that it will be ''functionally obsolete?''
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Mr. FISHBEIN. Well, the effectiveness of CRA depends upon the degree that it encourages the widest number of institutions to help meet underserved needs. And to the extent that banks control less of the financial resources in the current marketplace, this means the reach of the Community Reinvestment Act is less than it was in 1977.
That should come as no surprise. There have been a lot of changes in the marketplace since 1977. But we believe that CRA has been a vitally important law for getting lenders to take a second look at underserved communities and certain segments of our economy. CRA enables lenders to find profitable new sources of lending activity, and ultimately, to earn new profits and also to find new sources of loans that are very prudent to the institutions. It is also necessary to extend CRA's reach so that other financial institutions, that are either affiliates of the same parent company or that enjoy certain public benefits as financial institutions, should also come under the reach of some type of community reinvestment obligation, although not necessarily identical to the actual CRA statute.
Mr. BARR. Mr. Taylor basically comes right out and urges that CRA coverage be expanded to cover existing financial institutions, such as securities firms. I don't know whether you will go quite that far, but I am still somewhat confused. On the one hand, you all are saying that CRA has been a tremendous boon to, what term do you use, underserved----
Mr. FISHBEIN. Underserved communities.
Mr. BARR.----Or ''un-banked'', or some strange term that I saw in here.
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But on the one hand, you are saying that CRA has been a tremendous boon, and you are citing these figures of so many billions of dollars every year, including, I presume, right up to the current day, otherwise, your figures would be inaccurate and then on the other hand you are saying it is becoming ''functionally obsolete.''
Either it is working or it isn't. I am not quite sure. You seem to be playing both sides of it----
Mr. FISHBEIN. No.
Mr. BARR.----Issuing this dire warning at the same time as you are saying it has been a ''tremendous boon and is pumping billions of dollars into underserved areas'' or something.
Mr. FISHBEIN. Well----
Mr. BARR. Is it working or not?
Mr. FISHBEIN. My comment is that it has been working.
This statement was made in the context of financial modernization legislation, which everyone would agree would make sweeping changes in the way banks operate and the nature of banking. And I am putting on the table the notion that if this change is going to be allowed to occur through legislation, there also ought to be an equivalent way of allowing the law to keep pace with the changes that are occurring; and I don't see that as being inconsistent.
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Mr. TAYLOR. Congressman Barr, if I could answer as well. CRA is working, but it has only really begun to work fairly recently. I mean, CRA has been around since 1977, but it really wasn't until President Bush instructed the Attorney General to apply the Civil Rights laws to the first financial institution in this country, as a matter of fact, in your State it wasn't until the regulators began to take this more seriously, and to the credit of the regulators and this Congress, the work to reshape the CRA evaluation system so it is performance based as opposed to a process based system.
All that has resulted, I will tell you, of that $160 billion we talk about $100 billion of it is in the last 5 or 6 years.
Mr. BARR. Really what you are saying is, perhaps, and our time is short here, but what you are saying then is the effectiveness of CRA perhaps has more to do with policy decisions of an Administration. And you are saying that it has been working better in recent years, as opposed to Mr. Fishbein, who is saying it is working less because the banks have a decreasing share of the market?
Mr. TAYLOR. I am sorry; that is not what I heard him say.
But let me say what I am saying is that if this legislation, if H.R. 268 goes forward as is, it is going to decrease the actual number of institutions and assets available for the purposes of having some CRA obligation so that, you know, I mean, in the 1960's we used to say, ''All we are saying is give peace a chance.''
Mr. BARR. Some of us said that.
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Mr. TAYLOR. You don't want to give peace a chance?
Mr. BARR. Never mind.
But anyway, today it is: ''All we are saying is give capital a chance.'' This is how we are really going to revitalize our neighborhoods and underserved neighborhoods. Congress doesn't have enough money to make a difference in these neighborhoods, but the banks do, and that's what CRA is all about. We are saying, ''Give capital a chance'' in these neighborhoods and it has only begun to have a chance.
I can bring you to neighborhoods in L.A. and Pittsburgh and Boston and elsewhere where, because of CRA and because of lending institutions, communities are on the way back. Now you hear, you know, fairly mainstream trade associations like the National Association of Home Builders and realtors and others who are getting on board recognizing, ''We need these banks in these communities.'' And that is the issue we are taking with this legislation.
We want you to be as concerned about the health of consumers and underserved consumers as you are about the health of an industry that is now the rival, as Chairman Volcker said, of other financial industries in the world.
Chairwoman ROUKEMA. Mr. Barr, would you like to have the last word here?
Mr. BARR. Well, I would really prefer, I appreciate the Chairwoman's forbearance, and maybe if Mr. Fishbein could just briefly wrap up, since I discussed some of his testimony.
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Chairwoman ROUKEMA. Another minute for Mr. Fishbein.
Mr. FISHBEIN. Thank you, Mr. Barr.
I would say, again, that we think CRA has been a very effective law. The cases demonstrate this over and over again. The question really is, ''What is CRA going to look like in the next century?'' Just as we talk about what the financial services industry is going to look like, we also have to keep our eye on keeping this vital and necessary law strong, functioning and serving the need that it serves, which we believe will be more necessary than ever as we go to a highly concentrated system that is dominated by 10 or 12 large, major financial institutions.
Mr. BARR. Thank you.
Thank you, Madam Chairwoman.
Chairwoman ROUKEMA. Thank you.
Congressman Bentsen, please.
Mr. BENTSEN. Thank you, Madam Chairwoman.
Mr. Mierzwinski and Ms. Griffin, in your testimony you talk about, Ms. Griffin, specifically, you raise the issue of retail sales. You talk about consumer issues. As you know, there was a report by the General Accounting Office last year that talked about bank mutual fund sales and some of the problems that existed with that. I believe it was late last year, the interagency working group of the SEC, the Fed, the OCC, FDIC, I believe, put out a proposed standard for security sales within banks, which I think included in some ways bank eligible securities.
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Are you familiar with that?
Ms. GRIFFIN. Are you referring to the--I think it is coming from NASD, the National Association of Securities Dealers. That is, for sales and securities in banks, they were issuing a rule?
Mr. BENTSEN. Working with the NASD, and actually, in effect, what it does is it tries to bring the non broker-dealer elements in line with the broker-dealers in following NASD guidelines, requiring Section 8, or Series 7 and other type licensing for people who sell securities within non broker-dealer institutions.
Ms. GRIFFIN. We are familiar with that. The problem with that, though, is that it doesn't really go far enough because while it requires Series 6 and Series 7 exams, it still does not require registration as broker-dealers for bank personnel, and the registration is what kicks in the investor protection rules.
Mr. BENTSEN. So it doesn't require membership or registration with the NASD as a----
Ms. GRIFFIN. No, not for banks, not for a person now selling in banks. It only requires that they take the exam.
They are using the exam, basically, the OCC is using the exam, to make sure that those personnel that are selling securities have some level of training or expertise or evidence of that. But they are not, no, it doesn't----
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Mr. BENTSEN. It doesn't make them subject to NASD----
Ms. GRIFFIN. No.
Mr. BENTSEN.----NASD enforcement guidelines or anything like that?
Ms. GRIFFIN. The rules of fair practice would be invoked if they require registration. They are still exempt from being registered broker-dealers, so no.
Mr. BENTSEN. Thank you. That is very insightful.
Mr. Pledger, in your testimony in the last paragraph, you talk about the transition, the next to the last paragraph, you talk about the transition from a ''Federal savings association to a State savings''; and the bill, as we are discussing, discussing the transition provision that allows a federally chartered thrift to retain existing branches, including branches in those States which would not otherwise allow a State chartered thrift.
But then I am confused, and I may not be reading this correctly, but I am confused. Do you then disagree with the bill and believe that it should be treated somehow differently once the federally chartered thrift converts to a State chartered thrift?
Mr. PLEDGER. No, sir. Our understanding of the bill is that a Federal savings association that converts to some other type of charter would be allowed to keep all of its existing branches, regardless of location.
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Mr. BENTSEN. Up through January 1st of this year?
Mr. PLEDGER. No. I don't see that date strike. I think they can keep their branches going on forever.
But what happens is, what happens in 2 years or 3 years? Are they going to be able to expand their activities in other States? This is a very contentious issue amongst a group of State regulators from a variety of different States.
Meeting people, I, for example, believe that institutions ought to be able to branch into a variety of other States. But some States have very restrictive limitations and do not allow that kind of broad branching. And as we sit down to try to devise a policy on this sort of thing, once you get past the question of the conversion and you are allowed to keep all of your existing branches that you have on the day that you convert and you will be able to keep them in perpetuity, the question is, ''Would you then be able to expand your branching activities, either in that State or into other States?'' And the policy of your organization is that it should follow State law, as your bill provides.
Mr. BENTSEN. Thank you.
Thank you, Madam Chairwoman.
Chairwoman ROUKEMA. That is the existing bill?
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Mr. PLEDGER. Yes, ma'am.
Chairwoman ROUKEMA. Thank you.
Mr. Bereuter.
Mr. BEREUTER. Thank you, Madam Chairwoman.
Gentlemen, Gentlelady, thank you very much for taking the time to testify here and to present your views to us. It is important.
I heard the comments about CRA before, and I would just suggest that maybe one of the reasons my colleague from Minnesota and others seem to have some doubts about the performance of small banks is that the CRA continues to be ill adapted to small banks. And I would hope that those of you interested in a more effective CRA would not just automatically shut the door to future reforms in the area, because I am convinced that a systematic CRA evaluation of financial institutions, instead of what I would call an ''event initiated CRA focus'' would be a much better process. But we are stymied by the inability of people on this subcommittee and in this Congress to look carefully and realistically at adapting the CRA process so it would work better.
But I think that is a minor part of where we are at here today.
I want to just review a couple of things that I have read for the record, since I was out visiting with constituents for part of the time when you were making your presentations.
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Ms. Griffin, you say, ''We do not support the mixing of banking and commerce because it poses risk to the national economy and consumers.''
Mr. Fishbein, you say, ''We do not favor removing the current prohibitions against banks owning and being owned by commercial firms.''
And, Mr. Taylor, you say, ''Removing the separation between banking and commerce has led to spectacular bank failures abroad and will not increase the overall efficiency of the economy,'' and you urge us to disallow the ''ownership of national market funded institutions by non-financial corporations.''
I don't know if anybody else is speaking very specifically on this issue, but I appreciate your sentiments. I agree with them and I wanted to put them on the record.
Mr. Fink, you say you believe that ''The further merger and consolidation of the banking industry is inevitable and that the effect will be to reduce institutions' ties to local areas and their credit needs, exacerbating financial gaps in communities around the country''; and you go on to suggest that is particularly true for potential homebuyers.
And I certainly have those concerns about the potential modernization legislation before us, and we need your help to make sure that we try to avoid that kind of impact. I think it is a serious concern that you raise.
So you have in there the suggestion that we support further financial service modernization only if steps are concurrently taken to preserve a system of community-based depository institutions. Banks should be allowed to exercise new power only if they are providing housing and other financial services in all of their local service areas.
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How we are going to do that is the question, and I certainly want your help on that, and others who are interested, in trying to provide credit for housing purchase and construction.
Now, we had testimony here, I understand, at a previous hearing from America's Community Bankers, that is the official title, as you know, of the organization and they talk about an example where a financial institution in South Side Chicago used a real estate development subsidiary to good effect. And I want to ask you, what should happen to the real estate development subsidiaries once the thrifts convert to banks? What is the position of your organization on that subject?
Mr. FINK. I am not sure. If you would just bear with me one second, let me see if one of the staff can remind me.
We oppose them converting, to begin with, so I guess that answers that part of it. But I think that it is very important that we maintain safeguards and make sure that the kind of lending that has been done in the past for the housing sector is maintained and enhanced, because if we don't find a way to do that within the confines of modernization, I have very, very little doubt that millions of small businesses that are in the housing industry, and many more millions of homebuyers and homeusers, will be left out in the cold to sort it all out for too long a period of time.
Mr. BEREUTER. Well, Mr. Fink, reach the assumption you don't want to reach in the future, if you would, that we are going to have a conversion of these thrift charters. Then I would like to have, if that happens, kind of analysis from you. What should we do with the real estate development subsidiaries?
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And for any of you, the others of you who want to think about this issue, because it does affect people that you are interested in protecting and helping. Please give us your advice on what to do with those subsidiaries if we merge charters, which I think will happen.
Thank you very much.
Thank you, Madam Chairwoman.
Chairwoman ROUKEMA. Thank you, Mr. Bereuter.
To some extent, not with the specificity that you just went into, but to some extent I presented the same issue to Mr. Fink, and we agreed that this required further discussion. I am glad that you brought the subject up again, and let's see if we can come to terms with it. I surely hope that we will.
Again, it should be remembered that there is still a State chartered option. But you are correct; I believe that the decision was made on the merger of the charters in the last Congress, and that is incorporated, that assumption is incorporated into this legislation.
Mr. VENTO. Madam Chairwoman.
Chairwoman ROUKEMA. Yes, I yield.
Mr. VENTO. Not to extend it, but I think the issue is how much of this is outside the ambit, outside, you know, I think that there is some objection to a banking and commerce mixture, except for those that are doing it, I guess. And so the issue is how much of it is outside that 25 percent in terms of what is going on, because that is a pretty generous amount. And, you know, we are supposed to get some idea of the magnitude of how much of that is going on today.
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We know we have some corporations that own banks, and some non-bank banks that have other activities that that overlay. So it is a question of bringing this all together.
Chairwoman ROUKEMA. Yes, of course. Let me say, though, I think we would have agreement here that with these hearings, and with the work that has already been done on this subject, we are getting to that consensus, and that our agreement is still that we are going to form a consensus bill that hopefully will be passed early in this term in this 105th Congress.
Recognizing that everything has not been ironed out, but I think these hearings, the three hearings that we have already had, have brought us considerably closer to agreement, with some specificity. So we will continue to work that out.
I thank all of you who have been here today and, again, I invite you to submit for the record any further comments you have. And if there are follow-up questions we will be submitting them to you in writing for the record.
Thank you so much. The hearing is adjourned.
I hope Mr. Vento has not yet left. I did want to remind everyone that there is a revision in the schedule for the Credit Union hearing tomorrow. It will be at 9:30 in the morning to accommodate the travel plans of some Members of the panel and to provide time for Congressman Frost from Texas, who has requested an opportunity to testify.
The hearing is adjourned.
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[Whereupon, at 1:15 p.m., the hearing was adjourned.]
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