Segment 3 Of 3 Previous Hearing Segment(2)
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EXAMINATION OF FINANCIAL
MODERNIZATION WITHIN THE JURISDICTION
OF THE COMMITTEE ON BANKING AND
FINANCIAL SERVICES
WEDNESDAY, MARCH 19, 1997
House of Representatives,
Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises,
Committee on Banking and Financial Services,
Washington, DC.
The subcommittee met, pursuant to call, at 10:00 a.m., in room 2128, Rayburn House Office Building, Hon. Richard H. Baker [chairman of the subcommittee] presiding.
Present: Chairman Baker, Representatives Cook, Snowbarger, Riley, Sessions, Kanjorski, Vento, Roybal-Allard, Barrett, and Watt.
Also Present: Representatives Leach and Roukema.
Chairman BAKER. Good morning. I would like to call this subcommittee on Capital Markets hearing to order and welcome everyone here.
I am certain other Members will be joining us as the morning progresses. I have been notified by a number of offices that they will be participating.
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The purpose of this hearing this morning is to continue the subcommittee's work with regard to proposed regulatory and system changes for our financial markets. It has become increasingly clear, as the subcommittee has engaged in this activity now for some time, that the changes in the marketplace are very rapid and broad-reaching and, in fact, may have outstripped our current regulatory structure's ability to safely, or properly, govern.
Further, in retrospect, it is clear from time to time there have been commercial and financial relationships permitted under the law, and even in the current day, there are numerous examples where these relationships continue to exist and prosper without undue or unreasonable risk.
It has become apparent, however, as the technology press continues and new opportunities are created for relationships, that regulators cannot really determine the nature of the instrument and, therefore, who should properly govern or regulate it.
There are some who express, as I am sure our distinguished Chairman will this morning, concerns as to potential systemic risk issues, and perhaps concentration of asset concerns. I look at the current market regulatory structure sharing those concerns, but with one additional element of attention, and that is the question whether the government should really be determining outcomes in the marketplace, whether by regulation we should, in fact, determine winners and losers or who, in fact, can participate at all.
It is my hope that at the outcome of this process we will be able to facilitate the construction of legislation which will enable everyone free access to an open market without placing undue risk on the backs of the taxpayer and keeping the consumer at all times informed as to appropriate choices available to them.
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It is my hope that the hearing this morning will facilitate us as we hear from our most-distinguished financial regulator in the American finance system, who will outline for us--in some detail--the elements he believes important for the subcommittee to consider in this most important work.
I welcome him here this morning and know that all Members of the subcommittee will be very interested in hearing his remarks.
[The prepared statement of Chairman Baker can be found on page 320 in the appendix.]
Chairman BAKER. Mrs. Roukema, would you choose to make opening comment?
Mrs. ROUKEMA. No, thank you.
Chairman BAKER. Mr. Leach.
Mr. LEACH. I just also would like to welcome the distinguished Chairman and apologize that I am giving a talk on a similar subject elsewhere and so will not be able to hear the full statement.
Thank you.
Chairman BAKER. Thank you, Mr. Chairman.
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It is my pleasure to welcome this morning Chairman Alan Greenspan. Welcome, Mr. Chairman.
STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN,
BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM
Chairman GREENSPAN. Thank you very much, Mr. Chairman. I thank you very much for inviting me to present the views of the Federal Reserve Board on the supervision of our Nation's banking organizations, should they be authorized by the Congress, to engage in a wider range of activities.
Mr. Chairman, I would like to summarize my statement this morning and ask that the complete statement be entered into the record.
As you know, the Board has supported financial modernization for many years. However, in the context of these hearings, reform may well mean that future banking organizations will be sufficiently different from today as to require, perhaps, substantial changes in the supervisory process for banking organizations. Just how much modification may be needed will depend on the kinds of reforms the Congress adopts.
The Board believes that the Federal Reserve must have a significant supervisory role to carry out its central bank responsibilities--monetary policy, crisis management, and management of the payments system.
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Second only to its macro-stability responsibilities, is the central bank's responsibility to use its authority and expertise to forestall financial crises--including systemic disturbances in the banking system--and to manage such crises should they occur. Our financial system--market-oriented and characterized by innovation and rapid change--imparts significant benefits to our economy. But one of the consequences of such a dynamic system is that it is subject to episodes of stress. In such situations, the Federal Reserve stands ready to provide liquidity, if necessary, and monitor continuously the condition of depository institutions to contain the secondary consequences of any problem. The objectives of the central bank in crisis management are to contain financial losses and prevent a contagious loss of confidence, so that difficulties at one institution do not spread more widely to others.
The Federal Reserve's ability to respond expeditiously to any particular incident does not necessitate comprehensive information on each banking institution. But it does require that the Federal Reserve have in-depth knowledge of how institutions of various sizes--and other characteristics--are likely to behave, and what resources are available to them in the event of severe financial stress.
A crisis can begin, and certainly can spread, through the payment and settlement system. Day-in and day-out, the settlement of payment obligations and securities trades require significant amounts of bank credit. In periods of stress, such credit demands surge just at the time when some banks are least-willing, or able, to meet them. These demands, if unmet, could produce gridlock in payment and settlement systems, halting activity in financial markets. Indeed, it is in the cauldron of the payments and settlement systems, where decisions involving large sums must be made quickly, that all of the risks and uncertainties associated with problems at a single participant become focused as participants seek to protect themselves from uncertainty. ''Better solvent than sorry,'' they might well decide, and refuse to honor a payment request. Observing that, others may follow suit, and that is how crises often begin.
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Limiting, if not avoiding, such disruptions and insuring the continued operation of the payment system requires broad and in-depth knowledge of banking and markets, as well as detailed knowledge and authority with respect to the payment and settlement arrangements and their linkages to banking operations. This type of understanding and authority--as well as knowledge about the behavior of key participants--requires broad and sustained involvement in both the payment infrastructure and the operation of the banking system. Supervisory authority over the major bank participants is a necessary element.
While financial crises and payment systems' disruptions arise only sporadically, the Federal Reserve conducts monetary policy on an ongoing basis. In this area, too, the Federal Reserve's role in supervision and regulation provides an important perspective to the policy process. Monetary policy works through financial institutions and markets to affect the economy, and depository institutions are a key element in those markets. Indeed, the Federal Reserve must make its monetary policy with a view to how banks are responding to the economic environment. This was especially important during the so-called ''credit crunch'' of 1990. Our supervisory responsibilities give us important qualitative, and quantitative, information that not only helps us in the design of monetary policy, but provides important feedback on how our policy stance is affecting bank actions.
For all of these reasons--crisis management, the critical role played by payment and settlement systems, and the relationship between monetary policy and supervision--the Board believes the Federal Reserve needs to retain a significant supervisory role in the banking system. Just exactly how that is achieved depends critically on the types of reforms that Congress enacts, and the direction the banking industry takes in structuring and conducting its activities. In the Board's view, its current authority is adequate for the current structure. For today's financial system, we are able to meet our obligations by the intelligence we gain from--and the authorities we have over--the modest number of large banks we directly supervise and the holding companies of these and other large banks, over which we have a direct umbrella supervisory role. Our information is importantly supplemented by our supervision of a number of other banks of all sizes, namely, State member banks. Currently, the latter group gives us a good representative sample of organizations of all sizes outside the largest entities.
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The large entities are essential if we are to address the Federal Reserve's crisis management and systemic risk responsibilities, deal with international financial issues involving foreign central banks, manage risk exposures in payment systems, and retain our practical knowledge and skill base in rapidly-changing financial markets. Large bank holding companies are typically at the forefront in financial innovation and in developing sophisticated techniques for managing risks. It is crucial that the Federal Reserve stay informed of these events and understand directly how they work in practice. Directly supervising both these large organizations, and a sample of others, is also critical to our ability to conduct monetary policy by permitting us to gain first-hand, on-the-spot intelligence on how changes in financial markets--including those induced by monetary policy--are affecting money and credit flows.
While the current structure is adequate for our needs today, if the holding company becomes a less-clear window into the banking system, the Board believes that the Congress would need to change the supervisory structure to assure that the central bank is able to carry out the responsibilities I have discussed today.
In addition, the Congress, in its review of financial modernization, must consider the role to be played by umbrella supervision. The Board believes that umbrella supervision is a realistic necessity for the protection of our financial system and to limit any misuse of the safety net.
Risks managed on a consolidated basis in banking organizations--increasingly the only way an integrated unit operating to take advantage of synergies can behave--cannot be reviewed on an individual, legal entity basis by different supervisors. Retreat from consolidated supervision would, the Board believes, be a significant step backward.
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In the Board's view, those entities interested in banks are really interested in access to the safety net, since it is far easier to engage in non-safety net activities of banks without acquiring a bank. If an organization chooses to deliver some of its services with the aid of the sovereign credit by acquiring a bank, it should not be excused from efforts of the government to look out for the stability of the overall financial system. For bank holding companies, this implies umbrella supervision. Although that process will increasingly be designed to reduce supervisory presence and be as non-intrusive as possible, umbrella supervision should not be eliminated, but recognized for what it is: the cost of obtaining a subsidy.
Mr. Chairman, my prepared statement contains a more detailed discussion of the subsidy issue, particularly in the context of bank subsidiaries. In the interest of time, however, let me just say that the Board believes that as the Congress moves toward financial modernization, the newly-created structure of financial organizations should limit--insofar as possible--the real and perceived transfer of the subsidy inherent in the safety net to non-bank activities. To maintain a level playing field for all competitors, non-bank activities must be financed at market, not subsidized, rates.
The Board also believes that financial modernization should not undermine the ability and authority of the central bank of the United States to manage crises, assure an efficient and safe payment system, and conduct monetary policy.
We believe all of these require that the Federal Reserve retain a significant and important role as a bank supervisor. In today's structure we have adequate authority and coverage to meet our responsibilities, as I indicated earlier, but should erosion occur, as would likely be the case if new activities are authorized in bank subsidiaries, the Congress would have to consider what changes would be required in the Board's supervisory authority to assure that it continues to be able to meet its central bank responsibilities.
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Thank you, Mr. Chairman. I am available for questions.
[The prepared statement of Hon. Alan Greenspan can be found on page 322 in the appendix.]
Chairman BAKER. Thank you very much, Mr. Chairman. I very much appreciate your remarks.
Let me begin by talking about the concern I have with the current regulatory system and market developments in today's world as they move rather rapidly.
I am concerned today that in many cases products are developed rather quickly, move to the market, and we, on the regulating side, do not have the ability, really, to understand how exactly these products are working and, therefore, the appropriate regulatory model that should be applied in that case.
If that is potentially true, I see the markets moving further and further away from our current regulatory system as we prescribe rules for a much older system that no longer is functioning. In listening to your remarks, it is clear to me that you believe that the role of the Fed should be to insure that crisis management tools are available, that monetary policy remains stable, and that no development leads to potential systemic risk.
To that end, do you feel it necessary to have an internal view of, perhaps, the larger number of institutions that control vast resources? I do not know where that line is drawn, and so let me ask it this way:
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Of the approximately 12,000 institutions out there today--10,000 of them, perhaps, or less--are the smaller institutions in size, and perhaps the top 10 percent of those institutions may well control 80 to 90 percent of the assets. Is that about where large versus small begins to be an issue, or where are we drawing the line as to what is ''large'' in relation to this structure?
Chairman GREENSPAN. Our definition really is a more qualitative one, and then we have to refine it to put a specific number on it.
We endeavored to separate institutions by whether, in fact, should they become troubled, they have significant systemic risks associated with them. In other words, there are certain institutions--that without any desire on their own part because they are so large--should they have troubles, it does spill over into other aspects of the system.
And if, indeed, we have, as the Congress has chosen to have, a very large safety net, we do have to be terribly careful that what we not do is create a degree of moral hazard that is an expansion of the subsidy in a manner which could create significant systemic problems.
And so, our concern is to find a cutoff level of major institutions which we examine with some degree of detail, in order to assure ourselves that we are not dealing with a systemic problem, especially one that is induced by a misuse of the safety net.
But having said that, Mr. Chairman, let me reiterate something which is important to say when we talk about banking and financial regulation, which is not often acknowledged. The most fundamental, and primary source of regulation, is the market itself. If you look at a number of the non-supervised or regulated financial institutions in this country, they have set up various means to evaluate the relative creditworthiness of their counter-parties in such a manner that, should they decide that they do not like what they see, they require additional collateral or, in certain instances, certain organizations have been induced to set up AAA-rated subsidiaries with which other counter-parties would be more willing to deal, rather than with the parent.
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So, we do get a very substantial amount of regulation existing in the private sector itself. The purpose of Federal regulation is only to fill in some of the gaps as we see them, and to protect the safety net, which is our fundamental purpose.
Chairman BAKER. And on that point then--as I am understanding the direction--your need to access information is to the larger institutions, whether intentional or unintentional, which have relationships that could trigger losses on a broader scale, beyond the institution itself, if they engaged in financial activities leading to losses, and that you would be able to draw a line for us at some level?
Chairman GREENSPAN. Yes, obviously, the line has got to be somewhat arbitrary, but we know, if we were to look at the structure of various banking institutions, we have a certain judgment as to where that cutoff line is.
It is very easy to try to make it a very low cutoff, because of what I consider a regulatory bias in the system. We like to do more, rather than less, and I think, we will hopefully avoid that type of inclination.
But it is pretty obvious, having watched the way this system has evolved over 10 years, that it is, as you point out, Mr. Chairman, moving fairly rapidly, that the nature of how we supervise and regulate is changing and, as indeed I said before to Chairwoman Roukema's subcommittee the other day, that we see the need to adjust the way the Federal Reserve supervises, to be increasingly in line with the rapid changes that are occurring, and that implies less rather than more supervision and regulation.
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Chairman BAKER. Let me ask a question on the other end of the scale, as to the smaller institutions. Some have objected to the potential merger of commerce and finance on the belief that larger entities would acquire smaller financial entities in communities where there may be only one or two service locations for customers, and that that may well lead to concentration of asset concerns.
I do not share those opinions, but if the Congress as a matter of public policy were to suggest that smaller institutions below some asset size simply could not be acquired by a commercial entity, carving out a protected environment for them, is that bad public policy? Would there be reasons beyond the shareholders who want to sell?
Chairman GREENSPAN. You have to have a broad, general principle, and I would be very careful about categorizing each type of group of institutions.
In line with the principle which you have stated, with which I agree, that government should not decide who the winners and losers are, I would be careful as to where you put various restrictions.
Let me just say this. Our community banks are really extraordinary institutions, in general. I have seen innumerable endeavors by large financial institutions trying to move into markets and out-compete them, and there is a certain element of ability in a small institution in which, say, the president or the CEO of the bank is there for many, many, many years, knows all of his customers, and does what we used to call ''character loans.'' I defy any large branching operation to come in and compete against that type of personal service. Time and time again these institutions have demonstrated that they are really a very important cog in our system.
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The issue of how one treats them in reorganization, of any form, requires that one recognizes how important they are to our system and requires that one makes certain that they remain viable. But on the specific questions with where you structure the cutoffs and who can do what, I would say you cannot answer those questions without having a full context.
Chairman BAKER. Understood. This is my last question, and I realize I'm abusing my time a bit here, but, with regard to how we regulate the blend of commerce and finance--and all proposals currently in the debate suggest some level of involvement, varying in the degree and the manner in which it is perceived to be permissible. One suggestion that another regulator brought to our attention over the concern of the community bank perspective, I believe, is that the acquisitions be limited in a manner where the commercial entity acquiring a financial institution find a financial institution that would be an asset size at least three times larger than the acquiring commercial entity.
One of the benefits, I presume, that would flow from allowing these new affiliations would be that at the time of financial distress for the insured institution, assets from a participant in the holding company could flow to the bank to help it during these difficult times.
It would seem that an arbitrary limit to the size relationship of the commercial entity--to be smaller than that of the bank--is adverse to the whole reasoning for commercial and financial affiliations in the first place. It would seem to argue in contradiction to the source-of-strength doctrine, and even further, against your own view that if there is an affiliation between a holding company and a small insured depository institution, the Fed, at least at this point, does not see a necessity to be looking at that type of holding company, even when there is a small insured depository institution.
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Is the proposal to limit the acquisition to an instance where the commercial entity would have to acquire a financial institution at least three times larger, in your view, consistent with these other policy observations?
Chairman GREENSPAN. Well, let me say, first, that we at the Board have under review a fairly significant evaluation of this whole question, since it is really something which has not moved forward on the regulatory agenda in recent years. There is a lot of catch-up to be done.
We are finding things which I, frankly, find surprising. When I appeared before Chairwoman Roukema's subcommittee the other day, I said that it is very tough to set a number, for example, for a basket, without getting a sense of what it would mean very specifically with individual institutions that we know.
What we are learning is, that as you begin to look at the real world of what type of things can occur out there and the ability of institutions with some range of error to manipulate some of the variables which are employed--in other words, the issue of revenues can be altered by a very good accountant and, needless to say, book earnings, or a variety of other types of measures like gross assets, or what-have-you, is capable of being altered to some degree, as we found out in our Section 20 evaluations.
But more importantly than anything, is the extent to which, if you want to restrict the initial thrust of the move to commerce and banking, which in our view is probably the right thing to do, and mainly we talked about pilot projects, I think you will end up finding that the size of what you deal with is a lot smaller than a number of people have been discussing, and I think that what the Congress has got to do is, rather than make a whole series of ad hoc judgments of the type you are raising, to try to look at this total question as to where you want to be in 20 years, how would you get there, and what the various legal structures imply with respect to the gradual blurring of the lines between commerce and banking.
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I would be very hesitant to say, ''yes'' or ''no'' to any specific proposal short of seeing all the proposals on the table, because they all interrelate. They all have significant impacts on the way the structure is evolved.
So, I would hope that the Congress, rather than think in terms of amendment here or amendment there, that you look at the total, because this is a really major change in the way our system functions, and, as I said before the subcommittee a few weeks ago, I think that technology is going to make it very difficult to differentiate what is a non-financial and a financial institution in 20- or 25-years. We should, nonetheless, be certain that we do not inadvertently create a legislative structure which has failed to recognize all of the apparent impacts that you are going to get when you open up this very broad issue.
My major concern is not so much about the question of commerce and banking. It is the issue of the spreading of the safety net in that process inadvertently and thereby distorting market forces and the efficiency of the system.
It would be great irony if our purpose was to open up markets for full and fierce competition and find that in so doing, in the name of free market private enterprise, we create a system that is substantially financed by government subsidies.
Chairman BAKER. I agree, and I have come to the conclusion that neither revenue limits, nor asset limits, have any real relationship to whether or not the associations result in untoward risk-taking. Rather, it is the quality of the participants, and that often can only be determined on a case-by-case basis.
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So that arbitrary limits appear, in my judgment, to not be working for the long haul and that what we perhaps should be looking at, is a regulatory system that requires analysis based on certain public policy concerns: systemic risk; we do not want casinos running banks; whatever it might be, and have a regulator empowered to look at those relationships when they occur with rather large institutions.
But I had better give up my time here.
Mr. Kanjorski.
Mr. KANJORSKI. Thank you very much, Mr. Chairman.
It is pleasure to see you before us again.
Chairman GREENSPAN. Thank you.
Mr. KANJORSKI. I think the subcommittee, the Congress, and the American people have a great deal of respect for you and the function of the Federal Reserve, but what we are talking about now that I am interested in, is the concentration of economic power.
If, in the nature of how we structure the financial service modernization, we concentrate that power in one entity, we may be constructing a more powerful, independent entity outside of the political control of the people that exceeds the power of the President or any other elected official in government.
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Now, there have been some people who have suggested that the battle that has been occurring over the creation of these new activities, and whether they should be conducted in an affiliate of a holding company or in a direct bank subsidiary is, in fact, a struggle for turf, and I recognize that your term has limits, so that we are probably not talking about what you will do as a Chairman of the Federal Reserve, but what some other chairman will do 5-, 10-, or 15-years from now.
Would you have any difficulty in sharing the information that you have accumulated with other individuals, so that if we do not adopt the subsidiary approach for handling the additional activities, but, in fact, follow the model of an affiliate of a holding company, but changing the primary federal regulator of a national bank institution with a holding company, to the Comptroller of the Currency, and that, in the instance of a State-chartered, or non-bank bank, to be regulated by the FDIC?
Would you support that, or is this, in fact, a desire or a feeling on your part that control really has to be totally concentrated under the Federal Reserve and only the one methodology of the holding company to be used?
Chairman GREENSPAN. No. Our view basically is that the central bank has certain obligations, and we have--at this particular stage--authorities which, in our judgment, are adequate to meet the needs of what it is we do.
We are open to any alternate structure that solves that particular problem. My main concern about altering the structure is two-fold.
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One, that if we move to a universal banking type of model, which we will surely do if we open up the powers for subsidiaries of banks, then the holding company system will disappear and the Federal Reserve's particular mechanism to foster its supervisory role will have atrophied.
Now, that does not mean that is the only way in which we can do it, but an alternate means, in our judgment, will be necessary if that occurs.
My concern about the subsidiary of the bank, however, is also an issue of concern about level playing fields in the financial markets, and the question of the extension of the subsidy embodied in the safety net. Those are actually two wholly separate and individual issues.
If we were concerned about turf, we would not have supported the issue of going to interstate branching, which, if anything, creates a major value for the national bank charter versus the State charter, and in that regard it is inevitable. When in June the changes begin, there will be, as we have always recognized, a significant move toward national charters.
I would hope that the States are able to handle that, but the point at issue is whether or not it creates a decline in State member banks or not. In our judgment, the McFadden Act and the whole issue of prohibitions on interstate branching was bad public policy, and I have been before the Banking Committee on numerous occasions arguing in favor of eliminating those restrictions.
If we were interested in turf, the last thing we would have done would have been to do that.
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Mr. KANJORSKI. Yes, and I think, you have reacted to my use of the word ''turf,'' and maybe it is too emotionally-charged in this city. I did not mean it in that way. I meant in the sense of concentration of power.
As you know, I was worried about the Federal Reserve taking the seat on the European Reconstruction Bank.
Chairman GREENSPAN. The Bank for International Settlements, yes.
Mr. KANJORSKI. Right, and the expansion of power of the central bank of the United States becoming really a world central bank power. That was an unusual extension of power.
Now, if we move all of these new activities under a holding company concept, we really do create an awful lot of concentrated economic power in the hands of one small body that really is not subject to control of the legal process.
Chairman GREENSPAN. No. Congressman, I agree with you on that, and in fact, a couple of years ago, or 2 or 3 years ago, I testified at length why I was very much concerned about the issue of monopoly of regulatory power, or the convergence in any respect in this country, toward a single regulator.
I think it would be a mistake. It would be a type of situation in which supervision and regulation would deteriorate, because it would not be what exists today, a very effective competition amongst regulators for efficient regulatory systems.
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So, I would very strongly concur in your concerns that none of us should have inordinate concentration of power, because I think that would undercut the effectiveness of the dual banking system.
Mr. KANJORSKI. Thank you very much, Mr. Chairman.
Chairman BAKER. Mr. Cook.
Mr. COOK. Yes. In your testimony, you made the argument that the bank subsidy is more apparent in any kind of a bank that is engaging in riskier activity--or in the case of a major turndown in the economy, a problem with the economy--that subsidy does have significant value and implication in terms of a transfer to any non-bank activities.
Could you expand on that a little bit, or why that is so?
Chairman GREENSPAN. Yes. First, let's look at where the safety net comes from. The safety net, incidentally, is structured for the purpose of assisting the economy and, in the case of deposit insurance, assisting depositors. That there is a subsidy related to it is a consequence, there was not a specific decision on the part of the Congress to subsidize banking.
It very clearly is a terribly important issue when the economy is under stress because, for example, in earlier periods when we have had some very major, unsettling conditions, the ability to have deposit insurance and access to the discount window to essentially liquidify illiquid assets of depository institutions, plus the ability to get final riskless settlement at a reserve bank, those have been very important values to maintaining the franchise of an institution.
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So that when you get a very severe stress in the system, maybe once in 10-, 20-years, an awful lot of depository institutions, were they not protected by the safety net, would go under. And when one measures the degree of what constitutes the value of the safety net, you can get different readings at different times. And indeed, in today's environment where risk is perceived to be quite low, the value of the safety net is less than it was in an earlier period. And indeed, we have actually changed, through prompt resolutions and a variety of other related issues, some of the risk elements involved in periods of severe stress.
But the point that I think is crucial here is that at all times the markets clearly indicate that there is a very substantial subsidy in banking. And indeed, when you look at, say, the difference between finance companies with the same credit rating as banks and the same interest payment on debentures, you see that in today's market, the finance company which has got a similar portfolio to a bank, requires 6- or 7-percentage points more in the way of capital relative to assets than does a bank.
Some of that probably is the fact that, on average, finance companies may have somewhat-riskier portfolios, but clearly, it is nowhere near the 6- or 7-percentage points that the markets now show is required for comparable types of institutions.
So, the subsidy varies by time and amongst institutions. Obviously, the more risk prone and the weaker the institution, the greater the value of the subsidy. There are a number of financial institutions in this country which are so sound that the safety net has very little value to them. Yet, I should mention that in no cases have we seen anybody make a judgment who is now a bank and decide that the costs of regulation, or the other costs of being a bank, override the implied view of what the subsidy is.
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If they were to do that, as I indicated in my prepared remarks, they could do banking activities outside of a banking charter, and if they perceive that the costs of supervision and regulation were in excess of the value of the subsidy as they perceived it, they would drop their charter.
There have been no charters dropped.
Mr. COOK. That does not happen. Well, thank you.
Chairman BAKER. Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman.
I welcome the Chairman of the Federal Reserve Board, Governor Greenspan.
Chairman Greenspan, there is a lot of discussion about the holding company versus the subsidiary structure, and, you know, I think that most of us recognize that whatever the structure that exists, we want the Federal Reserve Board to continue to play its role, to do its thing, so to speak. As your predecessor said, you have the deep pockets, and when crisis looms, we want you to be available to participate fully in doing your thing.
The structure obviously here becomes the mechanism, and I think your comments today about if Congress decides that this structure, in terms of this bank holding company, is going to be modified, you know, you have a problem in terms of dealing with and addressing the exercise of your role.
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But this is not really anything new, in a sense. I think, if we look at the United States banks operating in the international marketplace abroad, let's say, in France or Britain and other countries, they have really different structures, don't they? They choose their own structure, whether it be holding company or subsidiary in those instances.
Chairman GREENSPAN. Yes, they do.
Mr. VENTO. And so, I mean, the issue is we already have this selection process going on, which may give you more or greater.
Now, in the international scene, don't you have a supervisory role there without the holding company structure that has served us quite well? There is some track record we can look at here in terms of modeling what we might do in terms of that particular reference point.
Chairman GREENSPAN. Yes. Congressman. The irony of what is going on with respect to that is, as you know, the European Continent essentially has a universal bank system. Certainly the Germans do and the Swiss do.
Mr. VENTO. Yes.
Chairman GREENSPAN. What we have is an increasing evaluation and questioning of that, so that as we are looking toward them, saying that maybe they do something better than we, they are looking at us and saying maybe they ought to be shifting in our direction.
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The answer to the question is that you cannot create the optimum structure and say it works worldwide. It depends to a very large extent on individual circumstances, and the United States' financial system is sufficiently different from the rest of the world that importing structures from Europe or elsewhere, which are perceived to have worked well, strikes me as not particularly appropriate.
We have to ask ourselves what works in the United States? And as far as I can see, the holding company structure, which has evolved over the years, has really worked rather well for us.
Mr. VENTO. I was not clear enough, I guess, but I think, you obviously make an important point with regard to the rethinking that is going on abroad with regard to the universal structures that exist in some countries, such as Germany.
But, what I was really referring to is the U.S. banks and institutions that are operating in an international marketplace--that are abroad--that have subsidiaries abroad versus the holding company structure. They have chosen, obviously, one structure or a different structure to operate there, and my point being that you have a supervisory role in those particular instances. And I am just trying to say in that frame of reference, we are not disadvantaged by that or you are not disadvantaged by that, in terms of exercising your role, are you?
Chairman GREENSPAN. No. At the moment, we are not.
Mr. VENTO. No, and so I think, I was suggesting that maybe looking at what the role is that you have there, in other words, yielding to the point that there is a role for the Fed, that maybe that could serve as a model to look at what sort of powers or activities we need to deal with in terms of the modernization legislation we are working here.
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Chairman GREENSPAN. Well, the reason, Congressman, I raise the issue about domestic versus foreign is that we structure ourselves abroad to be consonant with the nature of the financial economic system of the country in which our subsidiaries and branches reside, and we are more likely to focus on the competition that exists between American affiliates abroad and foreign banks abroad.
Mr. VENTO. I understand.
Chairman GREENSPAN. So, that we will tend to create types of vehicles which look more like the foreign banks, because that is the type of organization against whom we are competing.
Mr. VENTO. No, I understand the mirror-effect and the similar treatment in terms of those host companies, just as we afford the same opportunity here to international institutions or foreign banks that might operate within our marketplace.
But, I mean, our problem, of course, again, is that in terms of the work we are doing here, in terms of the activities between financial institutions, between banks and brokers and insurance companies, is that if we are going to have a two-way street, we have to accommodate the issues of other regulators and the issue of commerce, which is obviously very difficult.
The emphasis that you had made before the Roukema subcommittee was the issue of control versus the Sections 23(A) and (B) provisions of law which permit bank involvement, investment up until the point of 5 percent or 10 percent, but it cannot exercise control.
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I thought maybe you would like to refer to that. My understanding is the bills that we have progressed with, with percentages in, retain the Sections 23(A) and (B) provisions which, of course, limit control. So, is there something further that we can explore in terms of this legislation vis-a-vis the issue of control? That is, whether commerce activities--an entity in commerce activity, an ownership--would, in fact, control a financial institution; or a financial institution, to turn it around, would, in essence, control a large commerce entity?
Are there some threshold questions that we ought to be looking at, since there seems to be a concern with regard to this, that there needs to be some screens that we can put in place that would provide some, as you were, ''circuit breakers'' in this system, some system that would back this, or give some regulatory authority here, that would not be present with simply a percentage statement?
Chairman GREENSPAN. Yes, you are raising a somewhat similar issue to what the Chairman is raising with respect to trying to find some mechanism other than specific numbers. Let me just reiterate something which I think is important, and I found it very edifying when I started to look at the detailed numbers subsequent to my testimony before the Roukema subcommittee.
The Congress has to make the judgment as to what degree of merging of commerce and banking occurs. There are lots of issues here which go beyond finance. Congressman Kanjorski raises the question of concentration, and these are very broad issues.
We cannot answer those. We can give you judgments as to the economic effects of various different things, but qualitative issues with respect to how the United States is structured or, as Chairman Leach said in testimony here, I believe, about who owns America, those are issues which the Congress obviously has got to make a judgment on.
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The only thing I can suggest to you in moving in that direction is be very careful to start, first, with looking at various different entities, business entities, non-financial businesses, and financial institutions, and banks, and simulate what might happen under various different baskets or even something, Mr. Chairman, of what you are suggesting. I think you will find it very interesting when you get beyond the numbers, which tend to be somewhat arbitrary, and think ''what is happening in the real world?'', and then ask yourself: is that the structure you feel comfortable with or want to move toward?
And I would say once you have looked at that, it is very easy for people like ourselves. If you say, ''What would such a structure imply about a regulator that would be implicit in legislation to achieve that?''--we probably, with some assistance, and we are struggling at the moment--probably could do that. So could a number of our colleagues in the OCC, or in the SEC, or elsewhere.
What we cannot do for you, and I do not think it is appropriate for us to be involved with, is make these very fundamental judgments as to the balance of powers within this Nation.
Mr. VENTO. Well, Mr. Chairman, I realize my time has expired.
My point is, of course, that you do regulate, or supposedly under Sections 23(A) and (B), are looking at the question of control. That is why I pointed you in that particular direction.
Chairman GREENSPAN. Well, remember that Sections 23(A) and 23(B) have limits. They currently say nothing about the movement of equity between a bank and its subsidiaries. They also do not govern the issue of control of boards of directors or voting rights. Sections 23(A) and 23(B) refer, generally, to the issue of the granting of credit, and the purchase of equity by a bank with respect to its holding company affiliates. The purchase by a bank of equity of its subsidiaries is currently outside the range of those provisions, although the Board has authority to cover such transactions under Section 23(A), under certain circumstances.
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Mr. VENTO. There is a provision, and maybe I am referring to the wrong reference point, in terms of there is no controlled-decision that the Federal Reserve Board makes with regard to the 5 percent or 10 percent.
Chairman GREENSPAN. Oh, yes.
Mr. VENTO. You know, perhaps I have the wrong citation, but the reason I raise it is because here is a mechanism that does exist, a responsibility already, and you might, you know, edify, you know, be able to speak to the issue of whether or not that, in fact, does work.
So, I mean, we will make the decision all right. I agree with that, and you know, it may not be in stone, but we will make it.
Chairman GREENSPAN. Yes. If you tell us roughly what it is that you, in qualitative terms, think is appropriate, we probably could come back to you with what we would perceive to be appropriate regulatory language which would achieve that end.
Mr. VENTO. Well, Mr. Chairman, the issue is, you already have exercised this judgment with regard to control, you know, with the degree of equity.
Chairman GREENSPAN. Yes.
Mr. VENTO. So, it is not so much the percent of activity, but whether or not, in fact, you exercise control. So, in essence, if that is something that is a responsibility you have now, with whatever precision we can do it, and I hope it is more than just roughly, that then you would then look back at that frame of reference you are using today.
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But my question really is, you know, how does that work in the practical? That is my question. How is it working today in terms of that role?
Chairman GREENSPAN. Yes.
Mr. VENTO. I think it is more limited, obviously, than what it might be.
Chairman GREENSPAN. It works reasonably well. I mean, it does not work exactly because the issue of what constitutes control is not all that simple.
We have had discussions around the Federal Reserve Board for, I would not want to say hours but it felt that way, on whether a specific institution was controlled by X or Y, and the numerical barriers in general tend to work. But I will tell you that when you get down to the margin or determining whether, in fact, a certain share ownership is effective control or not, it is less than self-evident in a very large number of cases.
Chairman BAKER. If I may, Mr. Vento, thank you.
Mr. VENTO. Thank you.
Chairman BAKER. Mr. Snowbarger.
Mr. SNOWBARGER. Thank you, Mr. Chairman.
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Chairman Greenspan, let me get back to the issue of an umbrella regulatory agency. As I understand your testimony, the Federal Reserve Board believes that such an umbrella organization would be necessary. Am I to take from your testimony that you believe the Federal Reserve Board should be that umbrella regulatory agency?
Chairman GREENSPAN. Not necessarily. We think that it is probably desirable to maintain the bank holding company structure in which we would then be supervisor, but we see no need or, indeed, necessarily any advantage, for us to be the umbrella supervisor if such is needed to exist in other than bank holding companies.
And I would define a non-bank holding company as a whole variety of institutions in which banks, if they exist as subsidiaries, are only a small part. Remember that I say that you need some form of umbrella supervision of banks, but I also indicated early to the Chairman that let's be aware there is a very substantial amount of supervision which the market itself creates, and unless one judges that you need something over and above what counter-party supervision and regulation, if I may put it that way, creates by its presence, unless you do that, unless you can make that judgment, it does not necessarily follow that umbrella supervision, per se, is necessary in all instances.
I myself can consider a number of hypothetical financial services' holding companies in which a Federal umbrella supervision would, in my judgment, probably not add very much.
Mr. SNOWBARGER. And is it by function, rather than size, as we have tried to discuss it up here?
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Chairman GREENSPAN. I am sorry?
Mr. SNOWBARGER. By function of the organization, the product they are providing, as opposed to something other than banks? Is that what you are saying or what?
Chairman GREENSPAN. Well, I am saying that there are, as I indicated earlier, a number of investment securities firms other than the broker-dealer part, which is regulated, who engage in fairly-sophisticated evaluation of their counter-parties and in a sense do things which Federal regulators cannot do.
In other words, they do not and should not depend on a Federal regulator to make a determination of whether somebody with whom they have a, say, derivative contract, is potentially capable of going into insolvency. They make those judgments themselves and, where required, as I indicated before, they will ask for additional collateral. They will ask for the creation of subsidiaries which are AAA-rated, which you can do by the way you move your capital around.
In other words, they do what Federal supervision is supposed to do and probably in many respects, far better than any Federal regulator can do it. So, I am essentially saying that let's be careful not to merely presume that we need umbrella supervision from a Federal agency everywhere.
We think that because of the safety net that is essential in banking organizations, but unless there is a government subsidy in an individual institution, it is by no means clear to me that the need for a Federal supervisory authority is there.
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Mr. SNOWBARGER. Well, let me follow through and see if I understand. Again, your case for the umbrella regulator in the banking area is so that we make certain that that company does not take advantage of the subsidies or the safety net that you have talked about; is that right?
Chairman GREENSPAN. Yes.
Mr. SNOWBARGER. So, if we have the Federal Reserve Board as the umbrella regulator to try to insure that banks are not financing non-bank activities with these subsidies, how do we do that without having Federal Reserve Board now involved in regulating activities that you historically do not have any business in, such as insurance?
Chairman GREENSPAN. Well, you are talking about a bank holding company structure.
Mr. SNOWBARGER. Yes.
Chairman GREENSPAN. Our view is that you do not need to go into non-bank affiliates of the holding company in a manner which we have not done and do not think is necessary. What we do require is to be sure that in observing how the overall organization functions, which is what an umbrella supervisor would do by looking at the risk control mechanisms at the parent, is to make a judgment as to whether, in fact, an individual subsidiary, a non-bank subsidiary, is in a sufficient form of difficulty that it would on occasion require us to go and look at it to make certain that the system as a whole is protected and that the bank is protected.
But that the degree of such supervision should be quite minimal and only for cause. So our view, as I indicated earlier, is that we have gradually observed that as we shift the nature of financial organizations more to sophisticated market-related structures, that the role for specific examination and supervision for ourselves and our colleagues should be going down, because we would be observing increasingly and evaluating the process by which decisions are made within these organizations and evaluate their risk-based models, for example, and increasingly move away from the issue of detailed examination of reports, going into loan files, doing all of the things which historically was what was perceived to be regular bank regulation.
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That is becoming increasingly obsolete, and we at the Federal Reserve Board and, indeed, our banking supervisory colleagues are increasingly moving away from the old models and trying to make certain that we keep up with what is going on. In that context, it will be important that we tread very lightly because, as the Chairman pointed out, quite correctly, that with products changing and mechanisms changing in a fairly-rapid manner, heavy-handed regulation can do more harm than good by a large order of magnitude.
We recognize that, and our view is that what we perceive of as umbrella supervision of banking organizations is a much lower level of intrusion than I think, historically had been the case.
Mr. SNOWBARGER. Well, I certainly do not disagree that we need to both modernize the regulations that we have, as well as maybe lessen them, but to me the discussion of an umbrella regulator seems to be adding a layer of regulation. Even though it is a lighter burden of regulation, it still seems an addition to.
Chairman GREENSPAN. Well, Congressman, the issue really relates to the question of protecting the safety net. The problem that concerns me is that, as I indicated before, if we had a situation in which there is no subsidy, the role for Federal regulation, in my judgment, is really questionable.
To the extent that the bank subsidies spill over into non-bank institutions, in my judgment that brings with it some degree of Federal oversight, and it is in that regard where I think, the issue lies, and we have no interest whatever in just putting in a new level of supervision. We already have that level of supervision now. The question is: what do you do with it?
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But the argument with which I would find a great deal of sympathy on not putting additional regulation in, is that unless you have some evidence that there is an endeavor to employ the sovereign credit of the United States to finance new activities rather than market activities, there is no need for supervision. Indeed, if it is our judgment within a holding company that there is no spillover into these organizations and any problems which emerge, I think, the argument for us doing anything in the way of increased examination is very minimal.
Mr. SNOWBARGER. Thank you, Mr. Chairman.
Chairman BAKER. Thank you.
Mr. Riley.
Mr. RILEY. Thank you, Mr. Chairman.
Chairman Greenspan, I am from Clay County, Alabama, and this is all very complicated and very technical. To follow up on what Mr. Snowbarger was asking, for a practical standpoint, and I have no illusions that we need Federal models; we need Federal regulatory systems in place, but from a practical point of view, if you have a securities company who buys an insurance company, who in turn buys a bank, even with the umbrella supervision that you speak of today, how effective will that be for each independent part of that organization?
Chairman GREENSPAN. Well, let's assume that the bank is a modest size and does not reach the level of creating potential systemic risk. I could name names, and I just do not like to do that, but I see no need for Federal supervision of those organizations.
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There are now a number of smaller banks--well, some people would not call them too small--but medium sized banks which are currently existing in those types of non-bank organizations, which are supervised either by the OCC, ourselves, or the FDIC in certain instances without going beyond that. In other words, we think that in these cases, for individual banks which are not part of a systemic issue, provided there is adequate capital, provided that Sections 23(A) and 23(B) function appropriately, provided the basic, normal banking evaluations are carried forward, I see no particular need, certainly not for Federal Reserve presence, beyond that.
So if somebody is saying that the Federal Reserve should become the umbrella supervisor of holding companies in which, say, an insurance company is the major player or a securities firm is the major player, I am not sure I agree with that. I do not know. It is not terribly obvious what public purpose it would serve, except giving us more work to do, which I am not necessarily anxious to do.
Mr. RILEY. I can imagine that is true.
One other thing. When it relates, especially in my district, this is primarily small, rural, Southern banks, and I agree with what you said earlier. There is a market out there. There is a market that I do not believe will be served by holding companies. I do not think they will be able to compete effectively, these small rural banks.
But when you look in your crystal ball down the road 10 to 15 years, how effective do you think that these small community banks will be at that juncture?
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Chairman GREENSPAN. I have thought about that, Congressman, and I see no reason for a deterioration in their position within the financial community for a very important reason. The one thing that will not change is human nature, and there is a value which is very difficult to put a number on, but it is very obviously there, and it has always been there, on personal banking.
Some of these larger institutions set up these personal banking divisions where it is supposed to be replicating what a small banker can do. It never works.
Mr. RILEY. Right.
Chairman GREENSPAN. And the reason it never works is you keep moving people up and down the ladder in these large organizations, and you do not have the fact that you have known the head of your local bank, who may also be the lending officer, for 25 years. He knows you. You cannot replicate that in all the technology we can imagine.
And I have observed this over the years, and I say to you that unless these institutions really fall behind the times, and there is no evidence that they are, they can move up with the technology, and they are finding ways to compete with some of the high tech type of things the large banks have by out-sourcing and getting consultants and the like. I do not see any reason why smaller banks in this country should not be as effective as they have been.
Mr. RILEY. Thank you.
Thank you.
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Chairman BAKER. Thank you, Mr. Riley.
Ms. Roukema.
Ms. ROUKEMA. Thank you, Mr. Chairman.
Chairman Greenspan, I started out with some questions on my mind to ask you with more specificity, but as I have heard your responses to some of the questions asked, I am not quite sure where we are.
As you know, particularly in your very fine testimony before my subcommittee and what has subsequently been enunciated and articulated, we are hopefully going to be successful this year and we are making progress on financial reform. You know that when I introduced my legislation and subsequently at the hearings, I indicated that I was going to be working with others to refine the regulatory structure and was moving toward umbrella regulator and defining with more specificity how we do functional regulation in relation to the umbrella regulator.
Now, I thought we were seeing eye to eye on that, but maybe not based on what I have heard here today. You see a minimalist role for the umbrella regulator.
Chairman GREENSPAN. No, not in bank holding companies.
Ms. ROUKEMA. Would you explain that, and then I will get to my specific question? Please explain that.
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Chairman GREENSPAN. Yes. First of all, let's talk in the abstract about the distinction between what you used to call functional regulation and umbrella supervision.
Many years ago we used to have holding companies which were essentially organizations which held the stock in a whole series of subsidiaries and viewed them as individual businesses. Where there was a supervisory role to be played, each institution was regulated by a different Federal regulator, and there was no such concept as a synergy of the total.
As technology has changed, we have gone increasingly toward what I would call unitary organizations which are managed in total, and what is happening is that we now find in the more sophisticated bank holding companies that the key decisionmaking is made at the parent company level essentially amalgamating all of the various different elements so that there is a trading off of risks engaged in one entity versus another, and managing the risk of the system in total.
For supervisors not to adjust to that phenomenon is to fail to do their job. Therefore, in bank holding companies where this has been changing very dramatically, our view is that umbrella supervision is increasingly evidently required. The question there is because we have got the safety net and the subsidies implicit in the safety net springing out all over the place, that we need an umbrella supervisor, although, as I indicated to your colleague's earlier question, I think that the level should be much less as, indeed, it has been because of the changing structure.
Where you determine what is a bank holding company and a non-bank holding company is where the issue really lies. In my judgment, as one possible way of handling this, if a holding company owns a bank which is of sufficiently large measure that it could create systemic problems, I would define that as a bank holding company.
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If, however----
Ms. ROUKEMA. Do we have to do that in the legislation step toward change?
Chairman GREENSPAN. I would think you would probably have to, depending on how it related.
If, however, you have merely another holding company, in other words, where, for example, a securities firm buys a modest sized bank which is not of a sufficiently large magnitude, I do not see the Federal requirement for an umbrella supervisor in that regard unless there are other reasons to do so because I do not see, if the bank is appropriately capitalized and Sections 23(A) and 23(B) functions, that we need worry about the effect of the safety net being compromised by this non-bank holding company.
So that while one can argue for other reasons----
Ms. ROUKEMA. The capital requirements apply regardless?
Chairman GREENSPAN. Well, the capital requirements apply to the bank. If you decide----
Ms. ROUKEMA.----And the non-bank holding company?
Chairman GREENSPAN.----But, see, what I am getting at is that is a different decision to make. You need capital requirements on the holding company of a bank because of the subsidy structure and the nature of that institution. You may or may not decide to have capital requirements in the holding company of what I would call a non-bank holding company, but it would be for different reasons, and what I am suggesting from the point of view of the Federal Reserve is it is not something that we see as integral to our central bank oversight.
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Ms. ROUKEMA. All right. I appreciate that, and I think I understand exactly what you said. I do not know whether or not I necessarily agree with it, but let me ask the question in a different way, the way that I have been handling it in my thinking process, and it may require you to repeat a lot of what you just said, but let me think of it this way.
Can you give with some more specificity examples of what would happen if we address the risk management question and its relationship of dealing with risk management, which I think is the heart of things, and how that could be reviewed by the functional regulators in concert with the umbrella regulator?
Chairman GREENSPAN. Yes.
Ms. ROUKEMA. Is that a good question?
Chairman GREENSPAN. Yes.
Ms. ROUKEMA. All right. Please address that.
Chairman GREENSPAN. Let's take the bank holding company. Let's take a bank holding company which has got a number of non-bank affiliates, which would be and indeed are today examined by, for example, the SEC.
What an organization does it is recognizes, for example, what its underlying risk structure is in its Section 20 securities affiliates, for example. It looks at some of its other affiliates. It looks at its various banks. It looks at its foreign exchange exposure, its interest rate maturity exposure, a whole variety of things, in the totality of the institution.
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In other words, what you will find is that an individual customer can have relationships with four or five different affiliates of the bank, and what the central operation of the parent will do is to consolidate all of those various risk exposures to a specific customer and say, you know, its exposure is X in the securities affiliate, Y in this affiliate, and so forth, and this so-called global exposure which triggers a concern on the part of the parent to say, ''You know, X is a great customer of ours, but should we be giving them lines of credit of this order of magnitude?''
And the answer is, if no, then you regulate it in some manner or other. That is what the operation at the parent company does.
What the umbrella supervisor does is to oversee that process as distinct from what is going on in the specific examination of the individual affiliates by either a banking or a non-banking regulator.
Ms. ROUKEMA. All right. I appreciate that. I would just observe, I guess, and it is on page 11, you referred to the fact that the Board is reviewing supervisory structures that reflect the market directed shift and the internal risk management process, and I do not know if you could fill us in on that later, not now. We do not have time now, I do not think, but on how that is going to be done and how soon and how we can proceed with that information?
Chairman GREENSPAN. I would be glad to.
Ms. ROUKEMA. OK. Thank you.
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Chairman BAKER. Thank you, Ms. Roukema.
Mr. Sessions has returned. Mr. Sessions.
Mr. SESSIONS. Mr. Chairman, thank you.
Mr. Chairman, it is good to see you today. Congratulations on your impending marriage.
Chairman GREENSPAN. Thank you.
Mr. SESSIONS. I hope things are proceeding well for you there.
Chairman GREENSPAN. Thank you.
Mr. SESSIONS. Mr. Chairman, being new to the Banking Committee I hear a lot about and have heard these words today: safety and soundness and risk management and a lot of these terms, and a common thread of things that I hear from people who are involved in the banking and financial services community, as well as housing, is a lot about bankruptcy.
My question is really twofold to you. First of all, how prevalent is bankruptcy today? Is this seen by you and the Fed as a threat to the safety and soundness and to the risk management part?
And the second part is as bankruptcies occur and as people are within that system, no matter whether it be Chapter 7, 11, whatever it might be, how do you see that playing out?
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In other words, as it gets in the court system, is the court effectively handling a person who should and could pay versus the ability to skip out? Because I think that all wraps in together.
Chairman GREENSPAN. Obviously, we do not have any evident significant problems in the commercial world. That is, the charge-offs and delinquencies of commercial industrial loans and a variety of things are very low. The problem really is essentially in the consumer related areas where, as you point out, there has been a really quite dramatic rise in personal bankruptcies, and that has been the result of two things: one, changes in the law and, two, I guess in the stigma associated with the issue of going bankrupt.
It has been of particular concern to the banking industry because in years past, in viewing, say, consumer loans, whether they are credit card or other loans, banks would often see that they would first observe an increase in delinquencies, in, say, 90-day delinquencies and 180-day delinquencies, and then at the end of the day, bankruptcy.
What is happening now, much to their chagrin, is that you are going from a state of being in compliance with requirements to pay down loans and you go immediately to bankruptcy, and this has created some considerable concern within the industry, and it has induced a degree of caution which had not been there before because they had leading indicators, if I may put it that way, and now they are finding that that is no longer the case.
But it is really quite remarkable in the current environment that personal bankruptcies have risen so dramatically in recent years, and it is a concern. It is not a major concern. I mean it is not something which is creating considerable retrenchment, but it is enough to have caught everybody's attention, and there has been some pulling back, specifically in credit card issuance, as a consequence of that.
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Mr. SESSIONS. Along that same line, sir, you talked about the stigma. I think a lot of this has to do with advertising from people who talk about the ability to take you from a problem to bankruptcy where you resolve the issue. Can you speak with me about what is occurring within these bankruptcy courts, about how they deal with these issues and maybe letting people off the hook without looking at avenues to pay?
Chairman GREENSPAN. Congressman, I am not sufficiently familiar with some of the details, but if you would like, I would be glad to have something in written remarks.
Mr. SESSIONS. I would appreciate that, sir.
Chairman GREENSPAN. I will try to find out an answer to that question and respond to it.
Mr. SESSIONS. Good, because there has got to be a reason why, if the changes in the law and the stigma changes. There is something there that people are utilizing, and I think it is better that we catch on early on than find out.
Chairman GREENSPAN. It is an interesting question.
Mr. SESSIONS. OK. Mr. Chairman, how much time do I have? Are we on 5 minutes?
Chairman BAKER. No, we have been pretty liberal if you want to take one more shot at it.
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Mr. SESSIONS. OK. Well, I will, and thank you, sir, and I will try and hold that down with one question.
I met with members of the Fed down in Dallas on Monday, and I asked them a question, one which I did not know, and I am not sure that they really deeply answered the question, but if we take this scheme of things to where we go to where we merge banking and commerce and we evolve 4-, 5-, or 6-, 10 years down the line, at what point does a shareholder assume a responsibility for mistakes, mismanagement, or just simple debt as opposed to, under the current system, the deposit insurance and then the taxpayer?
In other words, at some point do you see something down the line? Because I was listening to your words early on where you said the major concerns are some unintended consequences. Does your crystal ball see something down there that a shareholder then takes down a large company or have I been too broad?
In other words, the shareholder, if we get into----
Chairman GREENSPAN. Which shareholder?
Mr. SESSIONS. Well, of a corporation, an investor.
Chairman GREENSPAN. Right.
Mr. SESSIONS. Do they pick up the risk as opposed to a taxpayer or a deposit insured at some point?
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Chairman GREENSPAN. You mean if we expand?
Mr. SESSIONS. When we expand this, yes, sir.
Chairman GREENSPAN. I think that is the crucial question, to what extent that is the case. There is another issue that is involved here, which is not that the taxpayer loses, but that if you have subsidies roaming around the system, you change the level playing field for competition, and what you will do is distort the system in a manner which is quite alien to the most efficient workings of the market.
I am less concerned about the issue of taxpayers picking up the tab. In other words, I do not have great concerns about our deposit insurance system or something of that nature now that we have brought it around, I think, in a fairly adequate way.
I am concerned, however, in the context of our discount window access and the payment system, or any instance in which the sovereign credit of the United States is involved that we or any governmental agency has lends that credit to private parties to create an unlevel playing field for them relative to their competitors, and I think that is a serious problem.
But the broader question that you raise, I think, is what we are really trying to address, namely, to what extent are we dealing with a spreading of the sovereign credit of the United States when we break down the lines between banking and commerce? I think all of us who are in favor of moving in that direction either because we think that, as the Chairman said, the government should not decide who are the winners and losers or that technology is such that it is futile to try to prevent it from happening.
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What we hopefully can do is prevent the safety net from inadvertently expanding in a manner not intended directly by the Congress.
Mr. SESSIONS. Thank you, sir.
Mr. Chairman.
Chairman BAKER. If I can suggest a procedure for this next round, I have indicated to Chairman Greenspan that we would end this hearing in time for him to be relieved by noon at the latest. We have got six folks. We stick to the 5 minute rule in this round, and everybody can have another question if they like, and we can meet our obligation.
So in that regard I am going to start the clock on me.
Chairman GREENSPAN. Thank you.
Chairman BAKER. Mr. Chairman, I have several questions which I know you have answered previously, and you can be very brief in your response because I just want to reconfirm.
Regarding the Fed's role of supervision of a non-bank holding company in which there is a small insured financial institution in relation to the asset size of the holding company, that is not an entity which draws appropriate Fed regulation?
Chairman GREENSPAN. The relation to the asset of the organization is not the only relevant factor, but also whether in and of itself the insured depository institution is of sufficiently large order of magnitude to have an impact on the payment system or on other things. Its size relative to its parent or its consolidated organization is not something which we consider to be the only relevant factor.
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Chairman BAKER. That is even better than I hoped.
Secondly, with regard to a financial in nature holding company, insurance, securities, but without a bank, that in itself is not an entity with which the Fed would be concerned since it represents no risk to the payment system or to the deposit insurance system?
Chairman GREENSPAN. That is correct, Mr. Chairman.
Chairman BAKER. So that if we move from those observations to the types of affiliations that may occur, I have not heard you to date say that there are specific activities which should be prohibited, although the Congress may prescribe some; that the affiliation basket, as it is called, is now not in your mind constrained to certain activities, but should be constrained on some other basis, whether it is revenue, asset size, or some other mechanism yet to be determined.
Chairman GREENSPAN. Yes. But obviously, the Congress may decide that there are certain activities which they would prefer not be sanctioned under such legislation, but my concern and my colleagues' concern is largely the question of the total size of the operation.
If, as we were recommending to Chairwoman Roukema's subcommittee, we move toward a pilot project, to go slowly in this regard because our concern is that the implications of what we are doing are not readily available to us, and if we go relatively slowly, we will learn a great deal, and this is not a situation in which you need to go from Place 1 to Place 2 that is the only alternative.
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Going slow is, in my judgment, a not inconceivable approach to this whole process.
Chairman BAKER. Sure, but even in going slow, determining what those first steps look like prejudice what later steps must be taken, and what I am suggesting here is there are certain areas of interest for regulatory oversight, no particular constraint on the types of activities which may be affiliating with one another at the moment, except for what the Congress may prescribe as being inappropriate, and that we empower the Fed to handle crisis management, to avert systemic risk or ultimately maintain a stable monetary policy.
If we enable the Fed to do those things, principally with the larger financial institutions under the direct scope of your review, then we are moving in a direction which makes some progressive sense in light of a new commerce and finance relationship.
Chairman GREENSPAN. Yes, I would say with one just minor addition, namely, that our ability to have a significant sampling of State member banks of smaller types so that we have a sense of what the market is doing is also, in our judgment, something that we find most useful and, indeed, probably necessary for the central bank to be effective.
Chairman BAKER. In that regard, I would look to you or the agency to define what is large as to asset size of an institution, and second, the criteria under which a State member bank would fall under that potential review process. So that we would look to you to tell us where those lines are drawn.
But I am much more comfortable now at the conclusion of this discussion today as to the broad parameters, certainly not the specific details yet, but the broad parameters of what might be included because one of the principal concerns was to what extent the Fed or another umbrella regulator would be involved in the activities of a holding company, and I think you have made that very clear as to what would be the principal areas of attention.
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Beyond that, as to structure, whether it is an op. sub. or whether it is in a holding company, still that could be driven in large measure by what the marketplace participants think most advisable for them if there is a way in which we can price the subsidy so that the implicit flow does not go through unrestrained to the commercial participants. For example, the FDIC now has the ability to have a risk based premium on a marginally capitalized financial institution. It would seem not beyond the scope to have risk based premiums assigned based upon the affiliations that you engage in.
Is that something that could be used as a lever?
Chairman GREENSPAN. Risk based pricing of Federal deposit insurance premiums is desirable, but the presumption that you price it fully at the market values, I think, is unrealistic, and the reason is that the Federal deposit insurance is a monopoly product. There are no private insurers out there who can compete, and as a consequence, the Federal Deposit Insurance Corporation cannot price adequately to effectively create a degree of indifference between some organizations and others. Nobody drops deposit insurance, which tells you that it is being priced at a large bargain.
I do not know of a way that that can be avoided. To do otherwise without undercutting the purpose of deposit insurance, which is to protect depositors and to create some stable systemic risk. As part of that process it is inevitable that a subsidy is created because in order to price Federal deposit insurance, which remember is an insurance which gets paid only in an extreme event and in an extreme event that would be a very serious question as to whether private insurers would not go bankrupt also.
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The Federal Government will never go bankrupt, and therefore, that insurance is invaluable and not replicable in the private sector. I find no way that I am aware of that you can create an insurance premium structure which could properly and fully price that in a manner which would make individuals indifferent, short of some very high numbers.
I can conceive of numbers in which you created premiums which are the present value of all of your potential deposits or something of that nature, but that would eliminate deposit insurance, and it would eliminate the purpose of it.
So I think we are caught in a dilemma where we are going to have a subsidy. It cannot be eliminated by pricing our way out of it.
Chairman BAKER. Thank you, sir. I am out of time, but I would just quickly add that your comments will be helpful in finalizing our proposal. We have talked about an alternate proposal that certainly I would like to get finished and get over for your review in a timely manner, and your comments today have been most instructive, and I appreciate it.
Mr. Vento.
Mr. VENTO. Thanks, Mr. Chairman.
You know, the converse of this, Mr. Chairman, would be that there is the implicit association with a regulator, such as the Fed or the FDIC and/or the OCC, as a matter of fact, and that these would somehow convey an implied assistance or subsidy in the time of stress.
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I mean the issue is that by extending in essence the Federal Reserve Board supervisor or regulatory role, that implicit in that would be the condoning of the activity and the sort of moral hazard that would be associated with the use of the Fed in these times of crisis or in times of problem.
So it is, I think, trying to find the right balance here. I mean, I think it is a very elusive commodity in terms of trying to define the sovereign credit.
As you know, there is a debate that has raged between us as to whether or not the cost of regulation and the other requirements that we properly place on, I think, financial institutions in terms of social welfare requirements in a mixed economy, and I mean it in the broad sense of the term, neither welfare nor social, but in the sense that those offset it.
But wouldn't there be and isn't there some moral hazard in just suggesting the Fed is there, that you are supervising, that you have a role, that there is basically a blessing being given to those institutions? And how do we limit that?
Even today we have not been very effective at doing it at least that I know of.
Chairman GREENSPAN. No, I think that is a very important point, Congressman. One of the reasons that we are not overly anxious to be involved in the number of these organizations where we do not perceive a subsidy being relevant and would be a major expansion of our oversight is precisely the concern that you raise, and we would share that very much.
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Mr. VENTO. One of the concerns that has been raised was with the size of institutions. You, Congressman Baker, the Chairman, and myself have raised the question in terms of a percentage issue not be inadequate, but it is one screen, but it is not enough of a screen perhaps, and the issue here is that there does not seem to be in the marketplace, and of course, I know that this gets back to more of, again, a qualifying question or asking not a quantitative question, but in terms of size, there does not seem to be any great advantage in terms of large commerce institutions forming with large financial institutions.
Chairman GREENSPAN. Well, this is a tricky question because economists have always struggled to find economies of scale in a lot of these different mergers and acquisitions. Obviously the companies, their shareholders, and their managers believe there is, and ultimately we are all aware of a number of conglomerations which have gone downhill from the day they merged, but there have been others which are successful.
I do not think that we, the Federal Reserve, and I am not sure anybody has got the capability of making the types of judgments which we would like to be able to make about whether there are synergies of scale or whether or not there are great advantages in some of these large organizations or do you create concentrations of wealth which produce political problems for some groups?
Mr. VENTO. Well, I think you touched on this when you talked about the community banks and the ability for them to fill a particular niche, and I think it is, you know, not dissimilar in terms of other type of business activities beyond a certain size, that you lose some of the advantages that you might regularly have.
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All I know is when they merged the price of the stock goes up, and when they divest it goes up. So the market does not tell us. It is not making a judgment at that time. I think it sort of looks to where they can get profit, but I mean, the fact is I think there is a limit here in terms of raising this out.
Obviously theoretically we have had the work done by the Federal Reserve Board for the Chairman with regard to bringing these all together. I do not know that it is likely or not likely. I think there is some concern about whether the would be consolidation, and the culture of the investment banking, for instance, the impact in terms of consolidation in a relatively small capital base might be adversely affected. I think some of the other suggestions are less.
I think we have more concern within the financial institution area in terms of the specialties as opposed to what happens in terms of commerce and financial institutions merging. That is less troublesome, I think, but we have more problems, I think, within the basic convergence of activities that are already taking place in terms of financial institutions. It needs to be given some attention. We might be passing over that, and there is more probability of consolidation there because of the small capital base of those investment bankers.
Chairman BAKER. Mr. Vento, your time has expired.
Mr. VENTO. Yes, sir.
Chairman BAKER. I am sorry.
Mr. Cook.
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Mr. COOK. Yes, sir.
Chairman Greenspan, getting back to what you were saying about deposit insurance and the possibility or impossibility of getting a private way to duplicate that, at least is there any way of creating a two-tier kind of system?
For example, a bank or a holding company that is diversified into other financial businesses to pay maybe more for their deposit insurance than a bank that just confines itself to just traditional banking. I mean, would there be any usefulness?
Chairman GREENSPAN. I think you could do that, but I'm not terribly certain that it serves a great purpose. You can create, as indeed has been on the table, various endeavors to restructure or finance a wholesale bank which is prohibited from taking retail deposits, and that would not have deposit insurance associated with it.
You can construct a number of different vehicles. This is one thing I am pretty sure you can't succeed at, as hard as we have tried, is short of raising premiums until you observe certain institutions start to drop out of the insurance business and until you get to that point, you really do not know that you have priced these things correctly, and my impression is that the size of that premium in order to find an adequately large number of institutions who have dropped deposit insurance because the price is too high would be probably much too high for the essential purpose. The original purpose of deposit insurance was not the question of subsidizing banks, but of trying to protect depositors and to protect institutions from runs on banks as a consequence. So if you are going to get those benefits, I am not terribly certain there is a way it can be done without simultaneously creating a subsidy which we cannot price out of the market.
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Mr. COOK. Thank you.
Chairman BAKER. Mr. Riley.
Mr. RILEY. Mr. Chairman, it is not often that we get an opportunity to talk to the Chairman of the Fed, and I would like since I am last and we do have 10 minutes left, I will not take it all, but I would like to ask one question.
Chairman BAKER. And we do have another Member.
Mr. RILEY. I will cut it even shorter.
[Laughter.]
Mr. RILEY. Recently I read an article where the Clean Air Act may cost our businesses $60 billion. I would just like to know from your perspective how that will affect our economy, how it will affect our productivity, how it will affect our interest rates and financial markets.
Chairman GREENSPAN. Economists have been struggling with this issue for a number of years. The general conclusion, as best I can judge, is that there are certain property rights that people find are abrogated by those who could spew waste materials into an environment which they do not own. It is the same thing as dumping garbage into a neighbor's yard.
So, there is a property right question here, and the question is: how is that property right protected?
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And in evaluating it, there has also been a general conclusion that to the extent that you want to do it, generally whatever is the first 95 percent is relatively cost effective. The problem always exists when you are dealing with the last 2 or 3 percent, and the general view of the economics profession is that you have got to be a little careful about what part of it you trade off.
If you price it properly in the market, its economic effects are probably de minimis. The issue of trying to get the last .1 or .2 out of something usually is something which concerns most economists.
So aside from those general principles, which those of us who are evaluating it would involve with any particular legislation or any particular issue, I think you will find that economists are all over the place, and all that tells you is that some of these issues are not easy to solve.
Mr. RILEY. Thank you, sir.
Chairman BAKER. Thank you, Mr. Riley.
Mr. Barrett.
Mr. BARRETT. Thank you, Mr. Chairman.
Mr. Greenspan, if I could touch on this issue that is this raging debate about subsidies and whether there are subsidies in the current system and how that should affect whether business operations are done in a holding company structure or subsidiary structure, in analyzing whether there is a subsidy to a bank, I would imagine that a response that you would get from some banks is that there are also costs, and one of the costs that is most criticized is the Community Reinvestment Act.
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And I would imagine that there are people on this subcommittee who certainly agree that that is a cost. I am someone who thinks that the Community Reinvestment Act is good, and my concern is if there is a subsidy and you want to avoid a subsidy problem and a way to do that is to move financial dealings away from banks and subsidiaries into other elements of a holding company, aren't we encouraging less coverage and less penetration with the Community Reinvestment Act? Is that something that you have considered or something you think is appropriate?
Chairman GREENSPAN. Well we have been standing on the sidelines during this debate as to whom should that Act apply, and it is wholly a Congressional question.
The interesting issue is to what extent it is costly to the bank and to what extent it merely creates new profitable opportunities for them. I have a suspicion that both issues are involved.
As far as we can judge, most of the community reinvestment lending is not at a loss, but bankers tell us that clearly part of it is probably somewhat below what their market would be, but I have a suspicion there is a lot of exaggeration that goes on on both sides of these arguments, and we have essentially supported it on the grounds that our belief is that you should not overlook all potential profitable opportunities, and in our judgment there has been a significant amount of that.
Our main concern is that an endeavor for some form of credits of some form or other, that there has been too much lending in certain areas, and this is the reason why the rates of return tend to fall, and as a consequence of that it is somewhat bothersome that rather than have banks merely look at their communities and try to lend where they think they are profitable and to try to encourage people to become conversant with how to, for example, handle mortgage loans appropriately, rather than doing that, there has been more in the way of trying to view the CRA as how to get credits of some form for other reasons within the bank regulatory structure, and I would hope that we could minimize that.
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Mr. BARRETT. And I agree with that, but, again, the concern I have is if we are moving transactions out of an entity that is controlled by CRA into an entity that is not controlled by CRA, isn't that going to less our CRA?
Chairman GREENSPAN. Well, at the moment nobody is arguing to move stuff that is applicable to CRA, which would be the bank and the bank's sub, to the holding company. What my argument is with respect to the subsidiary of the bank is not that the existing authorities which are in the bank and also in the bank's subsidiaries be moved to a holding company, but rather that the extensions of authorities which are not now available to the bank sub be made.
In other words, it is that that concerns me, not the removal of existing authorities which would reduce the size of the organization to which CRA would apply.
Mr. BARRETT. Mr. Chairman, if I could have one quick question, I know we have to leave. This is changing gears a little bit, and this might be a basic Economics 101 question, and it has to do with the stock market very quickly if I could.
If we are concerned about the stock market getting too high, why are we not looking at raising margin requirements? Wouldn't that be a way to take some of the sizzle out of this?
Chairman GREENSPAN. Well, I do not want to comment on the question of whether it is too high or too low.
Mr. BARRETT. I understand. I am not trying to have you make that----
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Chairman GREENSPAN. We have argued that our authorities on margins is, one, an anachronism and, two, inappropriately positioned in the Federal Reserve. It may be many years ago, when this whole question of margins came up and margin authorities really mattered, but in today's modern financial system, it is not terribly obvious to any of us what these margin authorities effectively do, and we have eschewed from changing them since 1974 for good reason.
Chairman BAKER. Mr. Barrett, if I may, I have to call your margin at the moment. Sorry.
Mr. Chairman, I wish to express my appreciation for your participation here today. This is the final hearing by this subcommittee on the subject of financial modernization, and I have to say that this has been most instructive and helpful.
For the record, our purpose here is to insure that consumers are well served, that consumers maintain their confidence in the depository system, and yet at the same time those consumers get the benefits of diversified market delivery system.
I am confident that your remarks will be very important to this subcommittee. I intend to formulate a proposal and have it before the subcommittee in short order and would like to have your comments and have you review at an appropriate time.
Thank you very much for your participation.
Chairman GREENSPAN. Thank you, Mr. Chairman.
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[Whereupon, at 12:00 noon, the hearing was adjourned, subject to the call of the chair.]