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FINANCIAL MODERNIZATION—PART II
THURSDAY, MAY 22, 1997
House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.
The committee met, pursuant to call, at 10:13 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding.
Present: Chairman Leach, Representatives McCollum, Roukema, Baker, Lazio, Campbell, Lucas, Metcalf, Ehrlich, Kelly, Paul, Weldon, Cook, Riley, Hill, Sessions, Foley, LaFalce, Vento, Frank, Flake, Waters, C. Maloney of New York, Gutierrez, Roybal-Allard, Watt, Bentsen, Kilpatrick, and J. Maloney of Connecticut.
Chairman LEACH. The hearing will come to order.
There is a Republican caucus just coming to an end, so Members will be coming in shortly. Before introducing the first panel of witnesses, I would like to take a few minutes to say this is scheduled to be the committee's penultimate hearing on financial modernization before moving to markup. Today the committee hears from the regulators, both Federal and State, who oversee the Nation's insurance, securities, and banking organizations. Their perspectives are important ones, because they are entrusted with ensuring the financial system is safe and sound, the taxpayers are not jeopardized, and the consumers are protected.
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At the Federal level, the country has been well served on this front in recent years by the regulators that are on the panel this morning, but I would be remiss if I didn't single out Ms. Ricki Helfer, who will be testifying before this committee for the last time as Chair of the FDIC. Ricki has made an enormous contribution to the stability of the financial system by working tirelessly with the Congress last year to ensure the SAIF was capitalized.
I am sure I am speaking for the whole committee in saying the advice and perspective you have provided has been wise, thorough, and unbiased. The committee is grateful for your hard work and wishes you the best luck in the future.
Ms. HELFER. Thank you, Mr. Chairman.
Chairman LEACH. We are anxious to hear the testimony of the witnesses on the subject and the three bills, H.R. 10, H.R. 268, and H.R. 669, which have been introduced in the House, but also greatly interested in the reaction to the Administration proposal submitted yesterday by Secretary Robert Rubin. I know this may be putting you on the spot, and if you are not able at this juncture to fully discuss the plan, because I understand it is not written or vetted yet, I would ask you submit your comments before the June 3 hearing in which the Secretary will testify.
In any regard, whatever differences of opinion may have emerged within any branches of the Government, I consider it very constructive to the process of achieving bank modernization that the Treasury has stepped forward and we expect to meld aspects of the Treasury approach in our principal markup vehicle.
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Before closing, I want to put committee Members on notice that, as I previously outlined, we will be moving forthrightly to markup on bank modernization, probably in the second week of June.
Mr. LaFalce.
Mr. LAFALCE. Thank you very much, Mr. Chairman.
I have an opening statement that I would like unanimous consent to simply introduce into the record.
Chairman LEACH. Without objection.
Mr. LAFALCE. And let me join you in some of your comments, Mr. Chairman.
First, we are always delighted to have the regulators before us. We have an outstanding group of regulators, but this is Mrs. Helfer's swan song, if you will, as the Chairman of the FDIC before us, so I, too, want to join in your kudos to Mrs. Helfer.
Ricki, you have done an outstanding job. I have been here, I am in my 23rd year; you have had as much or more knowledge; you have been at least as effective and, in my judgment, more effective; you have been more eloquent, articulate, than any other chairman of the FDIC. You are leaving enormous shoes to fill. We will miss you, and I just wouldn't want to have to follow in your footsteps because those are mighty big shoes to fill. Congratulations on the job you have done.
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Ms. HELFER. Thank you very much.
Mr. LAFALCE. I, too, believe that the Treasury Department yesterday made a very large step forward in presenting a constructive outline of the type of financial modernization legislation that they would like to see enacted, and I am very anxious to receive the opinion of the regulators with respect to that, because I think that will be a large factor in our judgmental process as we pursue the markup process.
With that, Mr. Chairman, I too, look forward to hearing from the regulators.
Chairman LEACH. Mrs. Roukema.
Mrs. ROUKEMA. Mr. Chairman, I have a lot on my mind, but I think I will save it for the questioning period and ask unanimous consent that my statement be included in the record. But I know we are under time constraints today, and I am anxious to hear from our panel, and as I have already said to Mrs. Helfer, we are going to miss her, her good advice and counsel.
And no one will fill your shoes, but we will try.
Ms. HELFER. Thank you.
Chairman LEACH. Mr. Vento.
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Mr. VENTO. Mr. Chairman, just briefly to recognize the service of the Chairman of the Federal Deposit Insurance Corporation. She has had a positive impact during the tenure that she has been there and has dealt with some tough issues. And I appreciate the help and assistance you have provided to me and others on the committee. And I would like to welcome all of our witnesses.
Mr. Chairman, with regard to the announcement by Secretary Rubin yesterday, the sort of multiple choice we received with regard to drafting assistance is very much appreciated. We do have counsel, though, that can help us draft things, and I think what we needed, in my judgment, was more of a direction with regard to policy path. And I understand the evolution that has taken place, but this, I think, is more devolution than evolution.
So, unlike the rest of the comments I have read, I am not quite as pleased with the Administration. As far as the bridges that they might build, I think they probably gave us no choice, it is either to fly or to swim when we come to those troubled waters.
So, I am disappointed especially with the Administration, because I had expectations that they would, in fact, provide us with the type of support and focus that would be helpful in terms of moving through this area into a modernization bill that would work for our mixed economy, but that hasn't happened, and I am disappointed. I appreciate the others who are providing more clarity. Even if I don't agree with some of the clarity that is provided, it is more than this multiple choice option we received yesterday. I expected more, and I am disappointed.
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Chairman LEACH. Thank you, Mr. Vento.
And, as usual, the Chair is in the position of being the defender of the Clinton Administration. Does anyone else on our side wish to be heard? Anyone else on the Democratic side?
Mr. Watt.
Mr. WATT. Thank you, Mr. Chairman.
I just wanted to associate myself with the remarks that everybody has made about Ms. Helfer and wish her well, and also say to the Chairman that I was happy to hear that we are going to take testimony from Secretary Rubin before we proceed to markup, and not so happy to hear that I have to spend my whole Memorial Day break poring over the details of financial modernization. So, I will try to be ready, later in June, for the markup. Thank you.
Chairman LEACH. Thank you, Mr. Watt.
If no one else wants to make an opening statement, we will turn to our panel, which is composed of Mr. Alan Greenspan, Chairman of the Federal Reserve Board. Ms. Ricki Helfer, Chair, FDIC; Mr. Eugene Ludwig, Comptroller, Office of the Comptroller of the Currency; Mr. Nicolas Retsinas, Director the Office of Thrift Supervision, and Mr. Arthur Levitt, Chairman of the Securities and Exchange Commission.
I don't want to introduce anyone else individually, other than to underscore that now and again, people in the public differ with the views of almost everybody, but I think the public today is extraordinarily well served by the integrity of this panel of witnesses. We are appreciative that you have been called to public service.
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Unless there is a prearrangement, I will go in the order I have introduced.
Mr. Chairman.
STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN, FEDERAL RESERVE BOARD
Mr. GREENSPAN. If I may, Mr. Chairman, I would like to join all of you who have been very thoughtful and complimentary to our colleague, Ricki. We had a dinner for her last night, and I realized when I left she is really going to be missed.
Ricki, you have been terrific.
Ms. HELFER. Thank you, Mr. Chairman.
Mr. GREENSPAN. On less important issues, I would like to discuss the views of the Board of Governors of the Federal Reserve System on the financial modernization legislation introduced by Chairman Leach, H.R. 10, the Financial Services Competition Act of 1997.
Mr. Chairman, time does not permit me to discuss in detail the Board's analysis and our views on all the important provisions of H.R. 10. I ask instead that my statement, which does provide such detail, be entered for the record.
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Chairman LEACH. Without objection, Mr. Chairman; and, without objection, the statements of all the panel will be introduced.
Mr. GREENSPAN. Let me just say that the Board has concluded that the broad financial affiliations authorized for banking organizations in this bill would bring the public considerable benefits from increased efficiency, competition, and convenience, all with only modest and manageable accompanying risks to the system.
House Resolution 10 would continue the holding company framework for non-bank activities, which the Board believes is important in order to limit the direct risk of new financial activities to banks and the safety net. Such risks have been the historic concern about new activities for bank holding companies.
But there is another risk, the risk of transference to non-bank affiliates of a subsidy implicit in the Federal safety net, deposit insurance, the discount window, and access to Fed wire, with the attendant moral hazard.
As the committee knows, the Board believes that this subsidy is more readily transferred to a subsidiary of an insured depository institution than to its affiliates, and that the holding company structure creates the best framework to eliminate such leakage.
We are concerned that conducting securities in subsidiaries of U.S. banks does not create the necessary distance from the bank, and hence the Board opposes the provision of the bill that authorizes certain activities not permitted to banks to be conducted in their so-called operations subsidiaries.
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Let me be clear that bank holding companies and their non-bank subsidiaries also benefit from the subsidy implicit in the safety net. Their capital costs are lower since a portion, currently a large part, of the consolidated assets of the organization are in subsidiary depository institutions that have direct access to the safety net.
This transfer, of course, is significantly smaller than the direct transfer to a bank subsidiary, but it is large enough to suggest that we should be cautious about extending permissible activities of banks, or financial services holding companies, to include nonfinancial commercial enterprises.
Generally, public policy should give wide range to free market competition, including business decisions on affiliations. However, when such affiliations may imply subsidy transfers at best, and taxpayer support at worst, we should be careful. Moreover, we should be careful to assure ourselves that combining banking and commerce does not distort our continued evolution to the most efficient financial system.
In earlier testimony, Mr. Chairman, I suggested that we would have to review carefully the kinds of combinations that could occur with a permissible basket of nonfinancial firms. As we have done so, problems exposed have led us to a more cautious position. The subsidy transfer concerns, and our uncertainty about the ultimate impact, suggest to the Board that at least any wider authorization of banking and commerce should be postponed while we focus on financial modernization. Concerns about ensuring a two-way street should be addressed without attempting to make final decisions now about any future wider combinations of banking and commerce.
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In an environment of greater deregulation and financial reform, market discipline becomes ever more critical in order to avoid extension of regulation and supervision over a wider ambit. Market participants must correctly perceive that non-banking entities are not covered by the Federal safety net. Providing bank-like supervision to non-bank affiliates of banks in the context of financial reform would send the wrong signal.
But consolidated oversight and bank-like supervision of non-bank affiliates are two different things. With the subsidiaries of financial services holding companies operating as an integrated entity, it will still be necessary to understand and review their centralized risk management and control mechanisms and, similarly, to review any intraorganizational fund transfers involving the depositories.
The objective of the exercise remains both to limit risks to the safety net and the transference of the subsidy from the safety net. Neither requires bank-like supervision of non-bank affiliates. H.R. 10 recognizes this in several important ways detailed in my full statement. Here let me just say that the relevant provisions would greatly enhance the two-way street by eliminating unnecessary burden and red tape.
Mr. Chairman, Members of the committee, the Board believes that the Leach proposal, excluding authorization for new activities in bank subsidiaries, accomplishes a desirable balancing of the risks and benefits of banks' participation in financial modernization. We believe it would improve the efficiency and competition of the banking services industry and result in more choices and better services for consumers.
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Thank you very much.
Chairman LEACH. Thank you, Mr. Chairman.
Ms. Helfer, who is appearing for the 18th or 19th time before the committee, welcome.
STATEMENT OF HON. RICKI HELFER, CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION
Ms. HELFER. Thank you, Mr. Chairman, Congressman LaFalce, and Members of the committee. I deeply appreciate your very kind comments. It has been an enormous honor to serve as Chairman of the FDIC.
I am pleased to have this opportunity to present the views of the FDIC on legislation to modernize the Nation's banking laws, and I commend you for this effort to strengthen our financial system. I also want to thank you and other Members of the Congress for passing legislation last year providing immediate financial stability to the Savings Association Insurance Fund. The SAIF still faces long-term risks because it insures far fewer, and more geographically concentrated, institutions than does the Bank Insurance Fund. To distribute these risks more broadly, the FDIC strongly supports the merger of the two funds as soon as practicable.
Mr. Chairman, I have detailed written testimony submitted for the record. This morning I will discuss briefly three topics; one, the lessons we have learned from our analysis of the most recent banking and thrift crises that should guide us in considering financial modernization; two, the key questions that financial modernization should address; and three, the independence of the FDIC.
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First, several of the lessons we have learned in our in-depth analysis of bank and thrift failures between 1980 and 1994—the worst financial crisis since the 1930's—should be useful to this committee. Our analysis points to the need for financial modernization. Geographic and product constraints on insured institutions resulted in inadequate diversification of income. Restrictions on financial activities, combined with increased competition, may have led many banks to riskier lending. Our analysis, however, also underscores the need for caution in easing restrictions on activities of banking organizations beyond those financial in nature. We found that without adequate supervision, rapid expansion of insured institutions into unfamiliar activities had undesirable consequences. We also found that there is no substitute for regular, on-site examinations of depository institutions for addressing specific problems, nor for the authority to close failing institutions in a timely way.
Second, my written testimony discusses five key questions that any financial modernization proposal should address. I will briefly discuss several of them.
What activities should be permitted? Financial organizations should be permitted to engage in any type of financial activity, unless the activity poses significant safety and soundness concerns or is potentially harmful to consumers or small businesses. We should, however, avoid at this time, combinations of commercial firms and banks, because they may result in undue concentrations of economic power that could affect the general availability of credit during an economic downturn and could present other significant conflicts of interest. The alternative that I favor would permit merchant banking activity through noncontrolling investments in nonfinancial firms by well-managed financial services holding companies, as H.R. 10 would permit. Should Congress, nevertheless, take a ''basket approach'' to mixing banking and commerce that permits controlling investments in commercial firms, our research shows—and it is attached to our testimony—that a commercial ''basket'' comprised of 5 percent of a banking organization's revenue may be sufficient to allow most financial service firms to affiliate with banks without divesting their commercial activities.
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How should activities be regulated? Financial reform must ensure that any regulation of a diversified holding company will not result in duplicative regulation or in the artificial restructuring of banking operations and services. It must also ensure adequate safeguards for the protection of consumers and investors. Finally, regulators must be able to review transactions between insured banks and their affiliates and subsidiaries as part of the regular examination process for insured banks. To address concerns regarding the stability and liquidity of the financial system, it may be necessary to provide for some general Federal oversight of consolidated financial organizations, but supervision of non-banking companies as banks are supervised is not necessary.
What safeguards are necessary to protect the insured entity and the deposit insurance funds? Any proposal should be consistent with the safeguards of Sections 23(A) and 23(B) of the Federal Reserve Act, and the capital adequacy of an insured institution should be determined after deducting the institution's investment in subsidiaries.
Last, my foremost concern is preserving the independence of the FDIC. The FDIC's ability to do its job of stabilizing the banking system in times of stress rests on its independence. To promote stability, the FDIC must make unbiased assessments of risk in the financial system and act upon those assessments without fear or favor. Independence gives the FDIC the legitimacy and credibility it needs to serve the public interest.
Given the lessons of the recent banking and thrift crises, the proposals the Bankers Roundtable announced Tuesday to limit deposit insurance protections that Americans have enjoyed for three generations are extremely misguided and shortsighted and would ultimately result in the unfortunate and unnecessary politicization of the process of addressing financial institution failures.
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Mr. Chairman and Members of the committee, the FDIC stands ready to assist the committee in evaluating how best to reform our financial system, and I would be happy to respond to your questions.
Chairman LEACH. Thank you.
Mr. Ludwig.
STATEMENT OF HON. EUGENE A. LUDWIG, COMPTROLLER, OFFICE OF THE COMPTROLLER OF THE CURRENCY
Mr. LUDWIG. Mr. Chairman, I too, would like to associate myself with the kind remarks that have been made about Chairman Helfer. I have served with Chairman Helfer not merely as a colleague from another agency, but also as a member of the FDIC board. She has done an outstanding job as FDIC Chairman, something we can all be proud of. So, I certainly want to associate myself with those remarks.
Ms. HELFER. Thank you.
Mr. LUDWIG. Mr. Chairman and Members of the committee, I appreciate this opportunity to discuss modernization of the Nation's banking laws, especially those governing permissible activities for banks and the appropriate corporate structure for conducting those activities. In particular, you asked me to comment on three bills, H.R. 10, H.R. 268, and H.R. 669, all of which aim to adapt our Nation's regulatory and supervisory structure to fit the realities of today's financial markets. I have written a statement for the record, and with your permission I will briefly summarize that now.
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To ensure that the banking system remains strong in today's rapidly changing financial environment, all the bank regulators have used their authority under existing law to ensure that supervision and regulation keep pace with the changing marketplace. But regulatory changes are no substitute for legislation to modernize the financial system. I commend you, Mr. Chairman, and the Members of this committee, for your thoughtful work to foster dialogue on financial modernization legislation.
My written statement details the market changes currently affecting the financial services industry and discusses why those changes require action to modernize the legal and regulatory regime within which the industry operates. All three bills before this committee recognize the need for action so that banks can offer their customers a broader array of financial services and remain competitive in this evolving financial and technological environment. All three bills move the debate forward by repealing the antiquated Glass-Steagall restrictions on affiliations between banks and securities firms for certain well-capitalized banks. All three would permit banks to affiliate with companies engaged in a broader range of financial activities than is permissible under current law.
My principal concern with these bills is that, to a greater or lesser degree, all of them would unnecessarily limit banks' choice in deciding how to structure their activities and would unnecessarily limit their ability to provide products and services they have been providing for years within the bank itself. True financial modernization requires giving financial services firms maximum flexibility in organizational structure and financial activities, consistent of course, with ensuring a safe and sound financial system and fair access to credit for all Americans. That means giving them the freedom to choose whether to provide nontraditional financial services through an operating subsidiary or through a holding company affiliate, whatever fits the needs of the individual banking company, as long as the appropriate safeguards and firewalls are in place to protect the bank from undue risk and to promote fair access to financial services.
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Secretary Rubin made this point in his speech yesterday. He said, and I quote, ''We should not, and do not, favor one form of corporate structure over another. But, by developing equal and consistent safeguards for subsidiaries and affiliates, we give companies the power to choose their structure for business, not regulatory, reasons. And let me emphasize, banks and the federal deposit insurance funds will be equally well protected under either format.''
If these safeguards are in place, there is no public policy reason to limit banks' ability to use operating subsidiaries rather than holding company affiliates to house new activities. There is also no reason to force banks to move activities they have conducted safely for years to a corporate entity outside the bank. The principal question should be whether a particular financial activity is appropriate for a banking company or organization, not whether it is housed in an operating subsidiary or a holding company affiliate.
Some banking companies may want to use the subsidiary structure because it fits their particular corporate strategy. It allows banking companies to focus their earnings strength in the banks themselves, rather than channeling earnings to non-bank affiliates. Operating subsidiaries also allow the benefits of more diversified activities to flow directly to the bank and thereby strengthen it. For community banks, operating subsidiaries can be a simpler and less costly way of providing new products and services than having to set up and rely on the holding company structure.
I am also concerned about certain provisions of the bills that would force some activities that banks now conduct safely and profitably within the bank into holding company affiliates. Such restrictions on where banks could conduct activities and what financial activities they could conduct would limit a bank's ability to compete by unnecessarily increasing its costs. This added cost is particularly onerous for community banks that want to take advantage of financial modernization. It limits their ability to meet needs of the many sectors of the economy that rely on community banks for financial services. These restrictions would also hurt banks' ability to respond to changes in the marketplace. In fact, these restrictions would have exactly the opposite result from what is intended. They would lead to a weaker, rather than a stronger banking system.
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Pushing activities out of the bank and into a holding company affiliate would force banks to either sit idly by while their asset and income stream dwindle away or seek riskier lines of business in order to maintain earnings and capital. Either way, the provisions in these bills would result in destabilized, hollow banks that are less safe and sound and less able to meet the broad financial needs of their customers.
These restrictions also would adversely affect the goals of the Community Reinvestment Act—CRA—because they would push assets and earnings out of the bank into affiliates not subject to CRA. Fewer resources would be available to banks to meet community needs.
Regardless of whether a banking company chooses to conduct new activities in a bank subsidiary or a holding company affiliate, there is a clear need to make sure that the appropriate safeguards and firewalls are in place to protect the bank against undue risk, to guard against potential conflicts of interest, and to protect the public interest. In the case of operating subsidiaries, for example, such safeguards would include making sure op subs function as independent legal and corporate entities, and that transactions between the bank and the subsidiary are conducted at arm's-length. Where the OCC is a bank's primary supervisor, it is clearly our responsibility to establish the appropriate safeguards and to ensure that they are enforced. We have the regulatory authority to establish such safeguards and the supervisory and enforcement authority to examine the bank and the subsidiary to make sure that firewalls are not breached. Our supervisory record shows we can and do require banks and their subsidiaries to strictly adhere to these restrictions.
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In my written statement, I have detailed the clear operational and public policy benefits that result when banking companies and other financial firms are free to provide new financial services in response to changing market demands and to choose the organizational structure that best suits their individual needs. Given these public policy benefits and in the absence of clearly demonstrable public policy concerns, there is no reason for Government to intervene in the private sector by unnecessarily limiting the kinds of financial services banks provide or their organizational flexibility. Banking companies, like other financial firms, should be able to choose the financial products and organizational structure that are most efficient and most likely to meet the needs of their customers, their communities, and the economy.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you.
Mr. Retsinas.
STATEMENT OF HON. NICOLAS RETSINAS, DIRECTOR, OFFICE OF THRIFT SUPERVISION
Mr. RETSINAS. Thank you, Mr. Chairman.
As a member of the FDIC board, let me join the chorus acknowledging the special contribution of Ms. Helfer. During my tenure on the board, it is clear to me, as much as you will miss her, we will miss her more.
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Ms. HELFER. Thank you.
Mr. RETSINAS. Mr. Chairman and Members of the committee, thank you for the opportunity to present the OTS views on this very important subject of financial modernization. While this debate has been contentious, I sincerely believe that open debate will make for better public policy.
Technology, the globalization of capital markets, and industry consolidation have been driving the evolution of our financial services sector for over a generation, and the pace is quickening. Regardless of how Government responds to these changes, more change is inevitable.
Nonetheless, Mr. Chairman, unlike most of the changes that led to prior legislative responses, today we are not compelled to act by crisis, but by the opportunity for Government to reexamine its role in a rapidly changing financial world, the changing financial world where we are ensured that depository institutions are no longer the dominant holder of American savings. The changing financial world where thrifts, once the core of home lending operations in the United States, are now subject to intense competition in the residential mortgage markets. A changing financial world where there is more and more integration, across and within the various sectors of the financial services industry and where technology only affects institutions' ability to do what they do now faster, they are fundamentally affecting relationships between providers and consumers of financial services.
This virtually instantaneous exchange of information raises questions about the future role of Federally-insured deposit institutions. If we wish to maintain a strong banking industry, we must make sure that banks and thrifts have the tools they need to compete effectively. Among the more contentious of the issues being discussed is whether to remove the activity restrictions placed on bank holding companies by the Bank Holding Company Act.
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Let me comment, if I could, on the thrift experience. As you know, unitary thrift holding companies are not subject to the same statutory restrictions as bank holding companies. There are currently 102 unitary holding companies, owning 73 thrifts, that actively engage in non-banking activities. The 73 thrifts hold approximately $200 billion in assets, representing about a quarter of the industry total.
In managing these affiliations between them, thrifts and non-bank holding company affiliates, we have a variety of supervisory tools at our disposal. First, we impose restrictions on capital distributions from a thrift to its holding company based on the capitalization and earnings of the thrift. Two, a thrift's dealings with its holding company and affiliates are subject to stringent transaction restrictions, including a bar on loans and extensions of credit to a holding company or affiliate not engaged exclusively in permissible bank holding company activities, and a prohibition on investing in the securities of an affiliate. And thrifts, like banks, are subject to prompt corrective action requirements which become increasingly restrictive if an insured institution's capital begins to fall.
In our limited experience—and I do stress limited—we have found these restrictions to be effective. To date, we have not found that the basis, since the passage of FIRREA, have involved greater risk to a thrift than the relationship between a thrift and a more traditional financial services company. Of course, that experience is limited, given the restrictions on the bank's commercial lending activities imposed by its statutory lending authority and the statutory qualified thrift lender, QTL test, and there is less opportunity for a thrift in a commercial unitary holding company structure to make discriminatory lending or pricing decisions.
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The statutory lending limit restricts commercial loans to 20 percent of assets, 10 percent of which may only be used for small business loans. Further, the QTL restricts commercial lending by requiring 65 percent of a thrift's portfolio assets to be in mortgage-related assets, subject to certain exceptions. I believe this combination of provisions curtails the extent of traditional commercial lending operations the thrifts can conduct.
Another issue of contention in this debate involves the potential exposure of the insurance fund to the operations of an insured deposit institution's subsidiaries. One of the questions raised, appropriately, is whether adequate safeguards can be implemented to protect a system from activities conducted outside an insured institution, but that potentially expose that institution's insured deposits.
With respect to a thrift's exposure to the activities of its subsidiaries, several points are relevant. First, a Federal thrift may engage in activities not otherwise permissible for the thrift itself only in a service corporation. In addition, that thrift may invest only 3 percent of its assets in the aggregate in all its service corporations. Finally, unlike problems in the past that arose with thrift direct investments, today investments in thrift service corporations engaged in activities not permissible by a normal bank must be deducted dollar-for-dollar in calculating a thrift's capital.
While it is not possible to completely insulate an insured institution from the operations of its subsidiaries, the separate capitalization requirement imposed on thrift service corporations by FIRREA effectively insulates a thrift's exposure to the amount of its original investment in the subsidiary.
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In addressing the thrift charter conversion raised in your letter, I note there has been concern about grandfathering existing activities of unitary holding companies. Any approach to grandfathering must be considered very carefully. Grandfathering, by definition, will impose significant costs on the affected entities, such as diminished franchise values.
A final point in regard to separate deposit insurance funds. Logic dictates that we merge those funds. As a member of the FDIC board, I am acutely aware of the need to eliminate the economic and managerial inefficiencies of a two-fund structure. At a minimum, any modernization plan that moves forward should include such provisions.
As I stated at the outset, changes in the financial services industry are inevitable regardless of what action the Government takes. While we are not in crisis, the longer we delay action, the more likely it becomes we will miss this opportunity to strengthen our system.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Retsinas.
Mr. Levitt.
STATEMENT OF HON. ARTHUR LEVITT, CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION
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Mr. LEVITT. Thank you.
I, too, would like to join the others in commenting on Ricki Helfer's departure and would say her sense of humor, her balance, her selflessness, has made her a model of what public service should be like.
Ms. HELFER. Thank you.
Mr. LEVITT. Chairman Leach and Members of committee, I appreciate the opportunity to testify on behalf of the Securities and Exchange Commission regarding the laws covering financial services. This is certainly a vital issue which has defied consensus for more than a decade, and I commend you, Chairman Leach, for your continuing persistence and creative efforts to bring financial regulation up to date.
My colleagues on this panel have described how Glass-Steagall reform would permit greater competition and efficiency in the banking industry. As the Nation's chief securities regulator and someone who has spent the better part of a lifetime in the securities industry, I approach the issue with somewhat different concerns. Those concerns center on the different cultures of the securities and banking industries, as well as the different philosophies of their regulators.
Bank regulators tend to defend their institutions from failure. We defend our institutions' right to fail. It is about as fundamental a difference as you can get, and yet each approach is right in its area. Banks lean toward safety and stability, while securities firms tend to favor risk-taking and entrepreneurism.
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In contrast with the pin-striped, genteel image of the banker, the broker tends to be the scruffy kid down the block, bare-fisted, rough and tumble, and kind of proud of it. Bank regulation emphasizes the safety and soundness of the system, tends to minimize disclosure of enforcement actions against banks, and relies on the safety net of deposit insurance to maintain confidence; while securities regulation uses the aggressive protection of investors to maintain confidence in the system.
There is a world of difference between setting monetary policy and tracking down con men and criminals and getting them out of the market with a very public kick in the pants. If reform is to succeed, an appropriate balance must be struck between preserving bank safety and soundness and serving the needs of investors in the market as a whole.
Although we agree with a number of aspects of H.R. 10 and H.R. 268, let me suggest two key areas in which we feel the bills might be improved: Functional regulation and the so-called ''two-way street.''
Today, a bank is as likely as a broker to sell securities to a first-time investor, and yet, when a bank sells a security or advises a mutual fund, the bank is exempt from the definitions of ''broker-dealer'' and ''investment adviser,'' because the securities activities of banks are governed by the Federal banking statutes, rather than Federal securities laws. In other words, two investors may buy the exact same security, one in a bank and one in a brokerage firm, and might receive two very different kinds of protection. In most instances, the investors probably wouldn't know about it.
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At best, this state of affairs is inconsistent. At worst, it can be downright unfair. Investors should be able to choose from a wide array of products and providers, but they should not have to give up basic safeguards in the process.
The SEC continues to believe that the best way to protect investors is through functional regulation under which all securities activities are overseen by an expert securities regulator and all banking activities are overseen by an expert bank regulator.
There is an unprecedented number of investors in our markets today. They deserve protection regardless of where, or from whom, they purchase securities. Consolidated supervision, I believe, is not the answer. Other countries certainly may allow bank regulators to oversee securities activities, but not one of them has developed securities markets that are as deep, as liquid, as dynamic, or as innovative as the United States.
On issues of interest to more than one regulator, the Commission certainly supports the use of entities such as the Working Group on Financial Markets. But a substantive regulator does his job best with clear responsibilities and clear lines of authority. A council of regulators would blur those lines, remove decisionmaking from the expert agency, and slow down the decisionmaking process.
Our other major concern with H.R. 10 and H.R. 268 has to do with the so-called ''two-way street.'' To the extent that banks are allowed to own securities firms, it is my feeling that securities firms should be allowed to own banks. Alternatively, if they choose, securities firms should have access to banking functions, such as the payment system, through limited purpose entities that are fully subject to banking regulation but not intrusive holding company regulation. Without such competitive equality, there is a roadblock on one side of the two-way street.
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We urge the committee to work toward a regulatory framework that adapts itself to today's marketplace without compromising our historic commitment to protecting investors. Our markets are the envy of the world, and America's securities firms are the unquestioned leader of those markets.
We should never be complacent, and we should never assume we can't do better, but I think it is important to remember that our system is far from broken. While entrepreneurs in other nations line up for scarce venture capital, our encouragement of risk-taking consistently turns small startups into top companies: Microsoft, Genentech, MCI, Dell Computers, Amgen; they certainly represent many jobs and great wealth.
The continuing success of our capital markets requires that we preserve the securities industry's ability to assume risk. It also requires that we maintain a strong system of investor protection that establishes, by word and deed, that our markets are fair and honest and that public confidence in them seems eminently justified. I look forward to continuing to work with you to achieve that goal.
Thank you.
Chairman LEACH. Thank you very much, Mr. Levitt, and all of the panelists. And there are some very, frankly, subtle agreements in this panel and some subtle disagreements, and those are implicit because we have some very difficult decisions to make.
In my own personal judgment, there are some do's and don't's of financial modernization, and the biggest ''do'' is, we should rationalize these markets and provide a consistent overlay of workable regulation, which includes Mr. Levitt's concern of functional regulation, but which also doesn't go too intrusively or too expansively.
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Now, the great ''don't'', in my judgment, and the great new issue on the table in the last 6 months—and this is one where we have differences of opinion, I think, possibly on the panel, but certainly within the committee and the Congress, is whether we go forward with merging what is called ''commerce'' and banking.
And all I would say from a public perspective—and we are, after all, a public body—I have talked to about a dozen rotaries and service clubs in my State, and I consider that the greatest body of common sense I know of in America are these service clubs. And I asked for a show of hands: How many people think it is wise for a bank to own the local grocery store or car dealership? How many people think it is wise for Citicorp to merge with GM and Wal-Mart? I cannot get a single show of hands for that support, and I think that is going too far.
I also think, from a regulatory perspective, you have got a Catch–22. A former holder of Mr. Greenspan's position, Mr. Volcker, suggested, I thought, the ultimate Catch–22. He said if you are going to have a bank own a big industrial concern or vice versa, certainly the regulator has to look at the big concern. On the other hand, no regulator has the capacity or understanding to do it well. Therefore, you have a Catch–22. Therefore, you probably shouldn't allow it. Which is a very interesting perspective.
But it strikes me if you combine these commercial entities with financial-in-nature entities; you have conflicts of interest, you have what I think would be an extension of the Federal safety net. That is, Ms. Helfer's deposit insurance fund would suddenly cover commercial activities. You have consolidation in ownership where you would be pressing America to fewer and fewer owners of economic activity. And, finally, you have a problem with experience that just hasn't worked anywhere else in the world, including in the United States with the S&L dilemma circumstance.
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So, I would first like to turn to Mr. Greenspan and ask, where is the Federal Reserve Board coming from at this point in time?
Do you think this is a time when we ought to experiment with that large notion of combining commercial and financial companies, or do you think it wiser at this stage to consolidate the financial activities—that is, investment banking, commercial banking, and insurance—and therefore emphasize creating increasing competition in that arena at this time?
Mr. GREENSPAN. Mr. Chairman, earlier this year I started off with the general view, and I think I expressed it to the committee. If we look ahead 20 or 30 years, it is going to be very difficult to differentiate clearly what is a so-called ''commercial'' enterprise and what is a financial or banking institution. And I concluded at that time that it might not be a bad idea to recognize that we will eventually be moving in that direction and that we should take some notion of that in current reform legislation.
I also said, however, that it would be important for us to look at the details of what that type of merging of commerce and banking meant in individual cases and to the structure of the system and, very specifically, to the extent to which the subsidy embodied in the safety net begins to spread beyond the purposes of the Congress.
As I and my colleagues have looked in increasing detail at the implications of moving forward, fully recognizing, as a number of panelists stipulated, that institutions in a free market should have the right to choose to be in whatever businesses they want, that caution really is required here, because we don't yet fully understand all of the implications of what would occur if we were to move forward.
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I think if we were to move forward, it is really, truly irreversible. My own guess is that ultimately we will be breaking down a number of the barriers between so-called banking and commerce. I trust when we do so, we will do it in the manner that makes sure that the safety net, which was constructed for the purpose of assuring stability in the financial system, is respected. And as I said in my prepared text, I think it is advisable that we move the first very important step; namely, essentially consolidating banking and finance; see how that works; make certain that the synergies which are inevitable, in my judgment, are managed; and then take a new and broad look at the next question of moving further. I see no necessity at this stage for doing it all at once, and I would recommend that we do it, if we were to do it, in two steps.
Chairman LEACH. Thank you.
Does anyone else want to comment on that?
Ms. HELFER. Let me add, if I may, what we found at the FDIC in analyzing the experiences of the banking and thrift crises, is that in very difficult economic times the firewalls have a tendency to get ''mushy''—and that is Chairman Greenspan's word, ''mushy.'' But what happens then is that it is very difficult to assure, absent significant regulation and absent regular supervision and examinations, the safety of the institution.
My concern with respect to the combination of banking and commerce has been that in an economic downturn, where there was a combination of a very large bank and a very large commercial enterprise, one has to question whether there would be decisions with respect to the extension of credit that would not be made on an arm's-length basis; and one would have to question whether those institutions that are not affiliated with a large financial institution would be able to access the credit markets effectively when credit is not generally available in the marketplace?
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In addition, I think there are some continuing potential conflicts of interest in other areas. That isn't to say that, over time, things that we have considered to be commerce will not ultimately be considered as banking. In Comptroller Ludwig's example, banking—such as the use of information technology and computer technology in the conduct of banking activities—are now an integral part of the banking activities. On the other hand, there may not be changes over time in what we view as banking and commerce. It is an issue that requires an enormous amount of consideration and study before we let the barriers down.
Chairman LEACH. Please, I have got a large panel, but I want each of you—if you could respond briefly, that would be appreciated.
Mr. LUDWIG. I might say, Mr. Chairman, since Chairman Helfer referred to my written testimony, I think it is absolutely the case that now is not the time, if ever, that we want large corporations, like General Motors, owning a large bank or vice versa. But it behooves the committee to be very cautious about drawing this line in too restrictive a fashion.
There are certain activities—technology I think is very significant—where allowing some evolution and give is very important. Banks will be safer if they, for example, are, as they have been, allowed to have some experience in computer software development. The computer software business is an information technology business, and banking to a very great degree is an information technology business, as you know. So I think we have to be very cautious here.
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While it is one thing to allow railroads to buy banks and banks to buy railroads, something I have been very opposed to, it is another thing to draw these lines so narrowly that institutions can't evolve in areas which are in their natural evolutionary direction.
Chairman LEACH. I agree.
Mr. Retsinas.
Mr. RETSINAS. Mr. Chairman, the question is probably not words like ''merger'' and ''combination,'' the question is probably more appropriately, to what extent? How do you make the fence impermeable? Because the march of time, the march of technology, are going to call for interfaces among different kinds of operations and, what are the parameters? There is no possible way in banking, or in financial services, or in business as a whole, to eliminate all risk, but how do you appropriately manage that risk?
Chairman LEACH. Fair enough.
Mr. Levitt.
Mr. LEVITT. I agree with Chairman Greenspan that this is a process that has to take place over time. However, the disparities, competitive disparities, have got to be addressed, and the realities of changes that have already taken place in the marketplace where securities firms must be able to compete on an equal playing field with banks that can do things that brokerage firms cannot, and vice versa, have got to be recognized in terms of a legislative context. And I think drawing the lines too hard and fast, or too quickly would probably be a mistake. Markets are taking us in a certain direction, and I think legislation has to recognize that we are not operating in a vacuum.
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Chairman LEACH. Thank you, sir.
Mr. LaFalce.
Mr. LAFALCE. Thank you.
First of all, let me thank every regulator for your testimony. It has been very helpful, and I think there are certainly differences, at least in nuance, not only amongst the regulators, but differences in nuance from your testimony today than your previous testimony, too. That is not a criticism, it is a piece of information and knowledge that I think we will have to digest and think about.
If we were debating this issue just several years ago, there would be interests, outside interests, and I think I would have been fairly safe in saying the banking interests were most desirous of financial services modernization legislation, or however you define it, and your insurance and securities interests were in large part opposed.
But, because banking regulators have taken 60-year-old legislation and given it an interpretation that could permit the banking community to exist in a safe and sound way and in a prosperous way in the years 1990s and beyond, there is not the great desire on the part of a traditional banking community for legislation. In large part, they are saying, ''We really don't need it all that much unless it is pretty much exactly what we want.''
But there is a flip. Now you have the insurance industry and securities industry saying, ''We need financial services modernization, because given those interpretations by the regulators, there is unfairness in the marketplace and now it is against us.''
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So the question is, who is the unfairness against? Before it was against the traditional banks, and now it is being viewed as against the insurance companies and the securities firms.
And when we fashion legislation, Mr. Retsinas, you say, I think, the issue is to what extent, because there is a merger of banking and commerce and banking and finance, and so forth, to what extent? And one of the questions is, should we define that, or should we articulate legislation which permits you to engage in this cautious, incremental approach and adapt to the changes in the marketplace?
And, Mr. Levitt, you have said now Bankers Trust can buy an Alex Brown, but what about securities firms? How do we handle that?
And, Mr. Retsinas, you pointed out that although it is a limited experience, you too have a thrift experience which does permit a considerable involvement between banking and commerce. It has been rather salutary, as I understand it, and you didn't say, but I say, that I think there is a movement afoot for a great many financial services institutions to consider conversion to a thrift charter, and a unitary thrift charter in particular. We are going to have to wrestle with this sometime subsequent to June 3rd, the following week perhaps.
Are there any specific recommendations you want to make to us now as we consider legislating to deal with the present and the future and to deal with the issue of competitive equity? Any specifics that you haven't included in your statement?
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Mr. Greenspan.
Mr. GREENSPAN. We are confronted with the fact that technology is moving at a very advanced pace. What this means is that, irrespective of what the Congress does or what we do, these institutions will evolve in a very largely unforecastable way, and that means that both the Congress and the regulators have got to be continuously ready to adjust and keep up with what technology is doing to our underlying institutions.
Mr. LAFALCE. Let me just interrupt for a second, Dr. Greenspan. You assume our ability to adjust, and I think the regulators have that ability. It is difficult to have Congress make periodic adjustments in the law.
Mr. GREENSPAN. I was about to get to that. I was about to say that ordinarily, I think the flexibility of regulators should be very significantly contained, and largely because it is the Congress, and not we, who should be in a position to make many of these very crucial judgments.
It may well be that given the rapidly changing phases of technology that we are going through, and all evidence suggests we will continue to be going through for the next couple of decades, a more generic type of approach which you are suggesting may be feasible. I frankly haven't looked at it, nor have my colleagues looked at this issue, in detail.
Having said that, I want to nonetheless, associate myself with Comptroller Ludwig, who has said that it should be the Congress who sets the framework and we should be very careful about giving undue discretion to regulatory agencies.
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Mr. LUDWIG. I would like to return the compliment in the sense that I very much share the view that Chairman Greenspan has just articulated in two respects. As he said, I do agree with him that it is the Congress that must set the framework, and that is one of the many reasons I think financial modernization legislation is a good and necessary route.
I also share the view that in this high technology, changeable environment, some give in the joints for the supervisor is desirable and actually necessary, because you do have this tremendous change in information technology and these businesses are information technology businesses. We see a rapid globalization, and we see an increasing change in the needs of consumers, consumers of all economic groups. There must be some give in the joints here from the safety and soundness perspective as well.
Mr. LAFALCE. Suppose I were to say we are going to be stymied in our efforts? Anybody want to do anything, convert to a unitary thrift charter now, whether you are a securities firm or a national bank, or even if you are a State-chartered bank, convert to an unitary thrift? And then we will leave it up to that regulator to deal with the problems? Does anyone want to comment on that?
Mr. RETSINAS. Well, the only comment I would make. Thank you for that kind offer, Congressman LaFalce. The only comment I would make, and it really relates to a comment you made and the Chairman made earlier: When businesses, be they banks or thrifts or other kinds of institutions, when they make decisions, in large measure, their decision and the value of the decision is impacted by their interpretation of how clear the rules are and how consistent they may be.
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So to the extent that there is ongoing debate, which is appropriate and, as I said in my remarks, productive, that mere debate will influence that decisionmaking process. It is questions about what the rules will be that influence decisions.
If, for example, there is a conclusion that it is not appropriate for financial modernization to proceed, for whatever reason you feel is appropriate, that does not mean the decisions will not be made; it is just different decisions will be made by different parties, including some of the examples you gave are certainly possible.
Chairman LEACH. Mrs. Roukema.
Mrs. ROUKEMA. Thank you.
I want to thank Congressman LaFalce for raising the subjects as you did, because you anticipated, in a sense, some of the things I was going to focus on, and I am more than a little uncomfortable here, because I have to ask some—or take exception to perhaps, my good friend and the person who has always been a financial guru for me—Chairman Greenspan. I find that his testimony today leaves a significantly different interpretation from the testimony before the subcommittee back in February. And I think you acknowledge that in your statement.
But it is very disappointing, I want to point out, not for personal ego satisfaction. Everybody referred to H.R. 10. I want you to know there is another piece of legislation before this committee known as H.R. 268——
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Chairman LEACH. If the gentlelady will yield, in my opening statement I referenced three bills——
Mrs. ROUKEMA. Not you, sir.
Chairman LEACH. Plus the Administration approach——
Mrs. ROUKEMA. Not you, Mr. Chairman.
Chairman LEACH.——Which meld together in the markup vehicle.
Mrs. ROUKEMA. Not you, Mr. Chairman.
Chairman LEACH. And the gentlelady's view will be well taken into consideration.
Mrs. ROUKEMA. Not you, Mr. Chairman. I was addressing my statement to the panel.
Now, again, I am stressing that because it is a follow-up to the subjects that Mr. LaFalce has opened, and I have got to say that legislation, H.R. 268, says that it is the Financial Modernization and Thrift Charter Conversion Act, and I want to say that that is an integral part.
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Leaving the thrift charter conversion question out leaves a loophole that is an enormous loophole for merger of financial institutions and commerce, and it is my conviction that we have got to be now taking the step in this evolving world of financial and technological changes that we are now at the point that, either we are making the choice that Congress is going to give the statutory authority, or leave it up to regulators to continue to do it ad hoc, and I find that unacceptable.
Now, I have come to the conclusion, and I think the Administration has come to the conclusion, that there has got to be a precise definition for that basket, and I would invite any on the panel to help me with that definition of what that basket is going to be, not only in terms of percentages, but whether or not those 1,000 corporations, commercial entities, are going to be in it, or whether it is defined by the gross revenue test—which I, at this point favor—or risk-weighted assets in connection with the holding company? I don't know if you want to contribute to that.
But for those of you who are here, and particularly Mr. Greenspan and Mr. Levitt, I want you to get to the heart of how we are going to construct the regulatory environment. There is considerable difference of opinion, as I see it, between the need for the umbrella regulator and the functional regulator. I think this is what we are going to come down to finally in the end on this debate and how we define the financial modernization.
I have come to, I think, the conclusion, maybe it is only tentative, but I have come to the conclusion that although my original bill didn't include it, that we are going to need an umbrella regulator. But we have to find a way to marry that umbrella regulator to the functional regulator, and that, to me—please, Mr. Levitt, Mr. Greenspan, and anyone else who can help contribute to our understandings here, because it is very important to the whole question.
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Yes, Chairman Greenspan.
Mr. GREENSPAN. I am not certain that the positions between Chairman Levitt and myself are by any means irreconcilable. There is a general view about the fundamentals of consolidated supervision which exaggerate the extent of what that supervision should be.
As I say in my prepared remarks, it should be what we used to call ''Fed lite'': A very modest degree of supervision, less than we have done in the past, largely for the reasons that I was mentioning in discussion with Congressman LaFalce. The technology is changing at a very dramatic pace, and we have to adjust to the fact that an increasing part of what I guess I would call supervision, will be more private regulation than we have had in the past, meaning the ever-elevating endeavors on the part of counterparties to evaluate each other, and they are doing that more and more. And, at root, that is the base of safety and soundness in a financial system such as ours. What we do as regulators is only a supplement to that, and to the extent that we are supplementing—either in a functional regulatory form, which is essentially the position that Chairman Levitt is taking; or consolidated supervision, which is the position that I am taking—I believe in both instances they are relatively modest supplements to the underlying private regulation which is evolving in the system and where most of the safety and soundness comes from.
My view is, we need clearly to have a securities regulator looking at securities affiliates. Banking regulators cannot do that the way a securities regulator can do that. So, what is involved here is a general oversight from the consolidated supervisor which has the sole purpose of making certain that when various entities are run by a global organization, as part of a global organization, that there be somebody there overseeing that and making certain that what we look at is the way the total structure functions.
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It does not mean considerable degrees of inspection by the consolidated supervisor of non-bank affiliates, for example. What it means generally is an overview of the system which essentially encompasses the fact that as part of this increasing technology, individual institutions are run increasingly as a single consolidated organization. And therefore, if our concerns are the safety and soundness of the financial system and, very specifically, the limitation of systemic risk in the system, then we need some function of that form. In my judgment, it should not override, or in any way interfere with the types of necessary supervision which I believe Chairman Levitt is advocating.
Mrs. ROUKEMA. Mr. Chairman, may we give Mr. Levitt time to respond?
Chairman LEACH. I think that would be very appropriate.
Mr. Levitt.
Mrs. ROUKEMA. Thank you.
Thank you, Chairman Greenspan.
Mr. LEVITT. How could I argue with such a reasoned, reasonable, thoughtful judgment? But having said that——
Mrs. ROUKEMA. Can I ask the question this way? Is the devil in the details here? Because we certainly agree in principle.
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Mr. LEVITT. I agree with Chairman Greenspan that we should approach this carefully, that this is something that will evolve over a period of time, and, if you go along with an umbrella regulator, it cannot be intrusive. In my judgment, such a regulator should, at best, be coordinating information flows among institutions, not imposing either bank capital or heavy-handed regulation or, on the other hand, securities regulation on banks. I think that, again, if we are dealing with an umbrella regulator, in those entities that have mostly securities activities, the SEC should take on that function.
Mr. GREENSPAN. I agree with that.
Mr. LEVITT. So your observation——
Mr. LAFALCE. Can the two of you get together and draft some legislation?
Mrs. ROUKEMA. Yes. I am going to get back to—really all of you—but really Chairman Greenspan and Chairman Levitt on the subject of this council——
Mr. LEVITT. I hate it.
Mrs. ROUKEMA. You hate it. All right, you have to tell me why.
Does anybody love it? You don't have to love it, but is it a necessary component here?
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Mr. LEVITT. No.
Mr. LUDWIG. I would speak in favor of the council as something that deserves very serious consideration. It is not clear to me that coordination itself is the key element among regulators to provide a safe and stable environment. We came through the last difficulties even without a formal coordination structure mandated by the Congress and, from a regulatory perspective, came through them reasonably well. There is a lot to be said for coordinating, as opposed to coordinator, and some limited role for a council approach I don't think is a bad thing. It is a healthy opportunity to get together and seriously deal with these issues on a regular basis.
Mrs. ROUKEMA. Thank you. I appreciate your help. And any further advice and counsel you can give, I am open to consideration.
Chairman LEACH. Let me say, Mrs. Roukema had an extended time. We have a large panel, but these are important questions and they have to be discussed, and this particular question of a coordinating council and the distinction Mr. Ludwig draws is important. There is a distinction between a council which has full authority within itself as a council or advisory function to each of the regulators, and what I think Mr. Levitt is insisting upon is the functional power of independent regulator.
Is that correct, Mr. Levitt?
Mr. LEVITT. Yes. I have also had as extensive experience as anyone in the business community has with committees.
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Chairman LEACH. Fair enough. But I——
Mr. LAFALCE. You have made your point very persuasively.
Chairman LEACH.——But there is a significant legislative issue here that I think we all have to understand. Several of the bottom bills have an advisory committee which forces regulators into discussion, which you may call coordinating, and then—at least tentatively—the Administration approach, which is, the committee itself has the full power to direct the regulator.
And there is a totally different circumstance here, and I think all of your views are going to have to be taken into consideration, and we would appreciate, frankly, views in writing, and I think from all of you, if that would be appropriate.
And you can take any extreme, Mr. Levitt, or in-between position that you like.
Ms. HELFER. Could I comment on that, Mr. Chairman, for a moment, because you can understand why Mr. Levitt might have reservations, because the Treasury proposal says, one—as I read it—it is an assortment of regulators, most of whom are banking regulators, who will vote on the issue of what is financial in nature, and it will not be possible to send a designee, only principals can go to the meeting.
So you can see why he might think his perspective would not be given a full hearing and that the advisory approach might actually make more sense.
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Chairman LEACH. Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman.
I think we are in the position where we can either write the history in terms of reacting to what has happened in the past or we can write a law and set some policy for the future. And I think the greatest risk we face is, we are in sort of a state of denial as to why we are here.
Everyone says we have a convergence of financial instruments trying to tell the difference between a bank note and an annuity and a security, and it is getting very difficult to tell the difference. And then all of a sudden, we get back here with the regulators and I hear an echo suggesting that, well, maybe it is not such a big problem.
And that is why I think the positions in terms of banking and commerce perspective are important. I don't know if anyone was listening, but I heard Mr. Levitt say if we are going to have a ''bringing together of these issues, we have to have a two-way street.''
I assume you were referring to the commerce issue. The fact that an insurance company, who are not yet at the table—but will be, I guess, after this panel—and their interests, that is, and their regulators—but you are talking about securities firms sometimes have an equity position.
Mr. LEVITT. Well, insurance companies and brokerage firms already have well established affiliations. Some of them have worked out rather successfully.
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And, while I certainly have great respect for the reservations about the affiliations of banking and commerce, I think markets are taking us in directions which make it essential that we consider the reality of the situation as evolving over a period of time, and I think we have to accommodate that.
I think what I am referring to is being certain that, as competition develops between various providers of the services, each of the competitors is allowed to offer consumers similar opportunities on a similar basis, mindful of the kind of protections and mindful of the warnings that Paul Volcker evoked in his testimony recently. And, again, I agree with Chairman Greenspan that we have to take this step by step.
Mr. VENTO. Well, I would agree with that. Obviously, the step-by-step, up to this particular point, has been the regulator playing around the edges in terms of these instruments, to be candid. And, you know, the greater risk here isn't that we have a banking and commerce mixture in law. It is a risk that we have; One, in fact, that isn't recognized by the regulators in terms of what is insured, what receives services by the Federal Reserve Board, or what is considered a bank? That is the greater risk here. And that is the policy path that I think we need to break.
We need to make certain that we do have the type of firewalls between those instruments. And the issue here is sort of to homogenize it, once again, in a manner to make it more distinctive, and whether or not the structure has to be a holding company structure or whether it has to be an affiliate structure or subsidiary. I think in terms of what the structure is, is important, but the point is, we are having all of these merged into one setting, based on the suggestions and terms of being too timid about getting out in front and recognizing what the reality of the marketplace is. And I don't think some of the proposals and testimony lead us in that particular direction.
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For instance, not to pick on—I might say too that one of the things we ought to do, I think, for Chairman Helfer is to work on a codification of making the FDIC statute gender-neutral. Most of us, I am sure, would have her endorsement for that, Mr. Chairman.
But one of the issues, Chairman Helfer, is you suggest 5 percent of revenue limitation with regard to financial services and commerce mixture. Do you know who would fit into that category? Would that serve the needs of most of the securities and so forth?
Ms. HELFER. What I suggested was a merchant banking approach which involved noncontrolling investments. But we did look at the issue of the ''baskets'', and the attachment to our testimony outlines which firms would be affected based upon a rough allocation between commerce and commercial and financial activities. Our reading is that substantially all of the firms in the securities and insurance area could fall within that 5 percent of revenues level. And, indeed, because that doesn't then count the value of any insured bank that would be affiliated, they probably fall, most of them, well within the 5 percent level.
Mr. VENTO. Mr. Levitt, do you agree with that 5 percent level, or would you like to write back to us about it?
Mr. LEVITT. No. I think that it is very difficult to be that absolutely precise in terms of what the right amount is. I don't know that 5 percent is necessarily better than 4 or 10 percent, but I do agree with the notion of gradualism and being certain that, whatever the percentage is, the regulator be that regulator that is equipped to deal with banking interests, if that is the preponderance, or securities interests if it goes in that direction.
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Mr. VENTO. Thank you.
Secretary Retsinas, you almost remained the super-regulator there for a minute. But one of the questions to get back to, in terms of the merger of funds and charters, could relate to this. There seems to be a growing number that suggest there is no need to merge the charters these days. What are the limitations in issuance of new unitary thrift charters?
Mr. RETSINAS. There really are. The limitations are in part derived from the marketplace in terms of their assessment of the value of the unitary holding companies, but as your colleague and my friend, Congressman LaFalce, indicated earlier, we now have several large firms looking into the application for a thrift charter through the unitary holding company structure. So that is an ongoing, moving stream. So that continues to move forward.
Mr. VENTO. And there would be no limit? That is, there is no limit in terms of their various qualifications to, in fact, be qualified for such charters?
Mr. RETSINAS. Limits. Of course, each application is viewed in terms of its merits in terms of eligibility and the number of applications affected by the market's perception of the value of such a charter.
Mr. VENTO. Mr. Chairman, I would just make one further comment, that within the regulatory scope of each of the regulators at the table, I don't think there is any shortfall. If they feel there is an action by a financial institution or other that is misusing their prerogative, whether it is the warrant and representations in bonds or whether it is the application of the deposit insurance or the use of the open window, they have discretion with regard to limiting the use of that today.
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Chairman LEACH. Since you are addressing that to me, you may be correct, but you made an earlier observation that there seems to be a movement against limiting in any way the unitary thrifts, and I would say that that is a judgment call.
This Member, for example, thinks it would be extraordinary to have two charters left after the banking community, in effect, came up with $6 to $9 billion in resources to even out the insurance fund. Then to have a unitary thrift with an advantageous charter, which, by the way, envisions full-blown commerce and banking, totally, to me is a very optimal outcome. And I know we are on opposite sides of this, but I don't want the gentleman's observation to imply that he speaks as consensus. You may be the majority of the committee, I don't know.
Mr. VENTO. I would say I am well aware of the Chairman's view with regard to that, and I happen to share it, but I think insofar as there is a resistance to address the issue and this is left in its current status, there are a set of problems——
Chairman LEACH. I think we may be thinking more alike than apart. I agree with Mrs. Roukema that this is an issue that, if we leave this unattended to, we have a very difficult financial landscape with which to deal. I do believe this is an issue that must be——
Mr. VENTO. If we leave the banking and commerce issue unaddressed and leave it as if we are writing history, as I said, I think we will have even greater problems, not just with regard to the unitary thrifts, but the securities and with regard to insurance. We will not have addressed the issue and will have moved full circle, and not ahead, in terms of writing law for the future.
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Thank you, Mr. Chairman.
Chairman LEACH. Thank you.
Mr. Baker.
Mr. BAKER. Thank you.
Before I ask my questions, Chairman Helfer, I understand this is the last time you will appear before the committee. I wish you well, and I have enjoyed working with you.
Ms. HELFER. Thank you.
Mr. BAKER. As an advocate, of some long standing, of barrier demolition, I am recognizing at the moment I may be more in an Evel Knievel league in light of the regulators' remarks this morning. But I want to explore compromise this morning.
Ms. Helfer detailed in considerable outline the advantages of a Reg. K approach and left undetermined the specific percentages that might be allocable given the Reg. K current methodology. Other regulators, to my understanding, who have expressed concern about full-blown commerce and finance have said it really should be more focused on the issue of maintaining control of the depository institution by local ownership, so that the board of directors is not intimidated by the commercial party in making its business and financial judgments.
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Rather than look to the arbitrary limits that have been discussed, and with which some agreed with and some disagreed, as to revenue, for example, my concern is, at a time when the bank needs help the most, you are going to have an arbitrary low limit on the amount of assistance that can flow from your commercial investor to the institution. It therefore defeats one of the principal reasons I am an advocate of commerce and finance, which is to have capital flow from commerce to the marketplace. I find troubling similarities with the asset recommendation.
Mr. Greenspan, my question relates to a modification of Reg. K as currently constructed, where I understand today a domestic bank may own 24.9 percent interest in a commercial enterprise with no more than 5 percent voting shares. Concurrently, a domestic bank may own up to 40 percent equity in a foreign corporation with up to 20 percent voting shares in some circumstances.
Would you strenuously object to a proposal which would increase the domestic bank's ability to own up to 40 percent of a domestic corporation's shares with a limit on voting control to perhaps 10, 15, some other number, and perhaps some increase in the representation on that corporation's board on the bank board by that corporation. Is that something that you would object to?
Mr. GREENSPAN. You are asking for a significant change in the way this is viewed in regulation, and I would not want to speak for the Board because that is the type of thing which we are required to deliberate and make judgments on in a judicial fashion, and I am not in a position to comment on something as specific as that which would commit the Board to significant change in the way Reg. K is handled.
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Mr. BAKER. I appreciate that and understand it. At least I did not get a strenuous objection, and for that I am pleased.
Chairman Helfer, you did not allocate a particular percentage of interest that would be acceptable. I look at this based on the domestic bank experience, investment in foreign corporations, as a methodology, as a first step, not the ending point, to commerce and finance.
And I would like, Mr. Levitt, to make it a two-way street, with the 40 percent noncontrolling interest of a domestic corporation in a domestic bank, no foreign investment in domestic banks, and limit the voting control of that interest to no more than 10-, 15-percent.
What that would enable us to do is get away from the contentious issue of how we construct a basket which has artificial imbalances, a balance in the marketplace as a consequence of it, allows commerce and finance to move forward on a limited basis, with control of the respective entities remaining either in commerce or in banking, and not present an untoward risk to depositors based upon past experiences.
Does anybody care to strenuously object?
Ms. HELFER. I would like to just comment on your point, which I think is enormously important for the committee to focus on. It is difficult to apply the percentages to revenue, income, capital, assets, or whatever, because these measures are moving targets. There are two examples in banking law where that has been done. One is under the Section 20 cases. The Federal Reserve Board has chosen to increase that revenue limit because there were institutions who were bumping up against the limits. The other is, as applied to what is permissible to foreign banks who operate in the United States, based on whether or not they principally engaged in banking activities outside the United States. There again, it is an income, revenue or asset standard; and that standard has been very difficult for those institutions to function under because things change and they grow. In that sense, a percentage of shares is a clear standard that doesn't change based on growth or other factors.
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Mr. BAKER. And then when the financial enterprise needs assistance, that assistance comes in the form of earnings on its shares if the partnership is successful, and it is something that the regulator can easily identify and monitor without having a nebulous set of terms.
Now, it obviously doesn't go as far as I want to go, it is obviously far short of the market at the moment, but I believe it represents a positive for the current legislative environment. And if you would choose to comment to me later in writing on it, I would welcome your remarks.
Thank you.
Chairman LEACH. Thank you very much, Mr. Baker.
I think maybe to be fair to the—well, we have a list on who arrived at the beginning, and I would like to go on that basis. Ms. Roybal-Allard is next. But we have a vote in about 7 minutes—you prefer to come back? I think that is fair. We will then recess pending the vote.
[Recess.]
Chairman LEACH. The hearing will reconvene. And as we recessed for the vote, the next in line for questions is Ms. Roybal-Allard.
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Ms. Roybal-Allard.
Ms. ROYBAL-ALLARD. Thank you, Mr. Chairman. My questions are for Comptroller Ludwig.
Insured banks and thrifts generally are pursuant to the Community Reinvestment Act, so pursuant to a CRA, an institution's supervisory agency addresses its record of meeting the credit needs of its entire community, including low- and moderate-income neighborhoods.
The financial modernization legislative proposals that we are considering would authorize a new type of uninsured financial institution called ''wholesale financial institutions.'' These institutions would be prohibited from taking deposits in amounts of less than $100,000 other than on incidental and on, you know, occasional bases. Otherwise, they would generally be able to engage in all other activities in which a bank could engage, including the making of home mortgage loans, small business and small farm loans, and consumer loans to retail customers.
Because these WFIs could take wholesale deposits from a community, have access to the payment system, and engage in many other banking activities, including offering all types of loans, shouldn't these WFIs, regardless of whether or not they are affiliated with an insured depository institution, be subject to CRA requirements?
Mr. LUDWIG. Congresswoman Roybal-Allard, I feel extremely strongly that CRA ought to apply to these new entities, which some call WFIs. Not having CRA apply would be incredibly damaging to the Community Reinvestment Program. What you could have is a banking organization split itself into a retail bank and a wholesale bank, and assets which are currently available to help in low- and moderate-income communities would be unavailable unless CRA were to apply to the wholesale bank.
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Moreover, if a non-banking entity is getting into the banking business using a WFI, but has access to the payments system and the discount window and is acting as a bank, I think it ought to be subject to the Community Reinvestment Act. I feel very strongly that having CRA apply ought to be an essential part of any legislation that includes these kinds of entities.
Ms. ROYBAL-ALLARD. OK. Thank you.
I have one other question for the Comptroller.
Under current legislative proposals, if a bank holding company were seeking to acquire securities or an insurance company, the acquisition could not be approved unless the lead insured bank or thrift, and the other insured bank and thrifts that account for at least 80 percent of the holding company's insured bank and thrift assets, have at least a satisfactory CRA rating. Under this test, one or more of the holding company's subsidiaries of banks or thrifts could have a CRA rating that would be below the satisfactory rating.
Should all the holding company's subsidiary banks and thrifts be required to at least have a satisfactory rating?
Mr. LUDWIG. I think this, too, is extremely important. I believe that every banking entity that is rated under CRA should have at least a satisfactory rating for that organization to make acquisitions.
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Let me say that CRA is incredibly important for America. We want to have true financial modernization which, at the end of the day, doesn't just benefit the financial institutions. We want to benefit the economy, and financial modernization really ought to benefit all Americans, including low- and moderate-income Americans.
It is, to me, inconceivable that you could allow entities to get into these new activities without all the banking entities having a satisfactory CRA rating. Otherwise, you have a very peculiar situation. You could have a banking organization with five banks, one or more of which had a low rating, that can go ahead and expand into these new activities without really serving the needs of the community. I don't think we can tolerate that.
This modernization legislation ought to benefit everybody. And I feel very strongly about that. We all want a better America. The Community Reinvestment Act has been a way for financial institutions to help low- and moderate-income individuals participate in the mainstream of American economic life, and it should not be weakened by this legislation. Indeed, if anything, this is something that ought to be strengthened and improved upon.
Ms. ROYBAL-ALLARD. OK. Thank you, sir. I think you will find there are many on this committee that agree with you.
Thank you.
Chairman LEACH. Mr. Lazio.
Mr. LAZIO. Thank you, Mr. Chairman.
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First up, I want to thank you for convening what, for me, has been one of the more outstanding panels that I have had the pleasure to be able to question. And I also want to take this opportunity to wish Chairman Helfer well. She has been, I think, an outstanding public servant and very helpful to me and my office.
Certainly one of the primary questions, I think, as we resolve the different versions of the Glass-Steagall Bill that are floating around has to do with both firewalls and functional regulation. I am going to address this to Chairman Levitt if I can.
I ask you, I guess as a threshold question, whether you would concede the fact that where a bank or a thrift is part of a holding company, that the appropriate bank or thrift regulator—or some combination of those two—ought to have oversight jurisdiction over the holding company, because of the nature of the public threat, which is obviously more systemic, I think, in terms of its potential public consequence than potentially securities activity? I wonder if you could answer that?
Mr. LEVITT. I am not sure I would agree that the public threat represented by bank activities is more acute than represented by securities activities. But I think the question of regulating entities that combine both of those activities should depend upon what the bulk of the activity is. If you have a combination where a banking interest predominates, the so-called umbrella regulator should be a banking regulator. If the securities activities predominate, that should be reflected.
But again, I would restate my reservations about umbrella regulation that is more than coordination. If it becomes intrusive and imposes the culture of banking on investment banking, or the culture of risk and entrepreneurship characteristic of the securities industry on the banking industry, I think that would create distortions.
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Mr. LAZIO. I think it is ideal when the regulators agree, it is problematic when they don't. And the question is, how do you resolve the differences when regulators have different perspectives when you have, regardless of the size of the holdings within the holding company and bank or securities firm, when you have differences? Let's say a banking regulator having concerns about safety and soundness based on what the activity is by the securities affiliate or subsidiary. How do you marry in the end? Do you need umbrella supervision as a threshold, and how do you marry umbrella supervision with consolidated regulation?
Mr. LEVITT. I do not believe you need umbrella supervision. I think you—those interests are ones that we have lived with for some years. Part of those interests in terms of who has responsibility and authority has been decided by the courts, and part has been decided by reasonable people working together and working out these arrangements, has taken place.
I think our markets clearly have changed. If the direction is toward having greater coordination at a time when the velocity of activity in our markets, because of the nature of the products we are dealing with today, is much greater than ever before, I can understand that. But when that supervision, whether you call it umbrella supervision or coordination, becomes intrusive, that interferes with a true market process, and I think you and I would agree that we should allow our markets to operate as unfettered as they possibly can.
Mr. LAZIO. I would agree with that, although when we say ''intrusive'', that is a term of art. And let me turn, if I can, because time is running out, to Chairman Greenspan to try and answer the very same question.
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Do we need to have a lead regulator when the bank is involved in a bank holding company, a financial services holding company apparatus? Is there a particular public threat that needs to be addressed by a banking regulator as opposed to a threat that might exist in a securities affiliate or subsidiary that might be addressed by a securities regulator?
Mr. GREENSPAN. I would say that 10-, 20-years ago perhaps, when larger institutions were essentially run as independent—the sum of independent entities, and the institution was not run as a single unit to the extent that it is run today, then I think the need for some form of consolidated supervision was questionable. With the complexity of the types of products and organizations that have evolved in the last decade or so, and the extent to which increasingly corporate management is creating an oversight to all of its subsidiaries and functions, I think that you do need some form of regulatory entity, which has consolidated supervision. If most of those subsidiaries are securities-type subsidiaries and say a bank is a small part, then I would say the consolidated supervisor should be the SEC. If it is substantially a banking-type of institution, then a banking regulator is the appropriate vehicle to oversee the substance of the general consolidated entity.
It is not something I would have argued 20 years ago, because I didn't think it was necessary. I think that it is becoming increasingly so. And if we are endeavoring to try to contain systemic risk, as well as address the issue of safety and soundness for these larger institutions, it is essential that we do something in this area.
I think that there is a general notion that it has got to be a big overall degree of regulation. If we were to do that, I think that would be a mistake. That would suppress the organization. It would prevent it from being viable and expansive and innovative. But to have none is to bias the system in a manner which creates unacceptable risks.
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Mr. LAZIO. Thank you.
Chairman LEACH. Thank you, Mr. Lazio.
Mr. Bentsen.
Mr. BENTSEN. Thank you, Mr. Chairman.
And let me echo Mr. Lazio. I think this is one of the most informative hearings we have had on this subject in the 3 years I have been on this panel because there has been a true decision between the members and the regulators. I think that is very important.
Following up on that issue, and I have a number of questions, so if you can be brief in your responses. This whole question of the regulatory structure is a very difficult one. On the one hand, I agree with Mr. Levitt that the problem is with the committees, and I also understand the concern of some of having one dominant regulator.
It is sort of the fear of the unknown, that if you have a securities firm and the Fed, for instance, is the dominant regulator. The Fed comes in and says, ''we don't necessarily agree with what your securities affiliate or subsidiary,'' as the case may be, ''is doing, contrary to what the SEC may say.'' And the securities folks may feel that they are not being treated properly.
But it is sort of a question between—or at least we have been in a question between a monarchy-type structure, or an anarchy-type structure, if we have pure functional regulation with a committee without any sort of head.
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So I think this has been very helpful to this committee, which is not anarchistic, I don't think, Mr. Chairman, as we try to develop something. I do think that at the end of the day somebody has to be in charge because of the systemic risk that may be apparent. I do not think we want to get into a situation where everybody is looking at their individual parts and not looking at the sum of the parts of the institution as you broaden it to give it more powers. But we have to be careful how we do it, and maybe we have to leave at least some latitude to the regulators, although we do have to develop the framework, as Mr. Ludwig said.
The other issue that I would like to bring up has to deal with operating subsidiaries.
Mr. Greenspan, I think you stated in your testimony that you agreed with the Chairman's bill, except as it related to the operating subsidiaries, and I think you have been pretty clear about that. Mr. Ludwig and I have had numerous discussions on this issue. I want to bring up again the Zion issue because I do have a concern. You stated that we should let Congress set the framework. Now you were speaking to the other issue we were talking about.
But shouldn't we let Congress set the framework with respect to operating subsidiaries before we go ahead and allow the underwriting of securities? Because we do have a differential that exists, and Mr. Levitt has brought this up, as it relates to the two-way street issue. And wouldn't it perhaps be better if, in effect, the Congress were to act to wait and let us go ahead and try and set up some sort of structure, whether it is affiliate or operating subsidiary? I am starting to agree more with the subsidiary structure.
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And in the same perhaps convoluted question, I would ask the Chairman, in using your concern in the past has been, firewalls melt, or, as you stated—or Ricki Helfer said, that they are ''mushy''. But if firewalls are mushy with respect to affiliates, Sections 23(A) and 23(B) can be mushy with respect to affiliates, the same would be true with operating subsidiaries. Why is there really any sort of difference that exists there?
Mr. GREENSPAN. Because I don't think the issue is Sections 23(A) and 23(B), or firewalls. It is really a question of the issue of subsidized equity, not debt, equity coming from the bank to the subsidiary of the bank. Sections 23(A) and 23(B) refer to debt. There is nothing that prevents the movement of funds which are subsidized funds from moving down. It is not a firewall issue.
Mr. BENTSEN. Do you think you can establish firewalls where you separately capitalize a subsidiary and not allow the downstreaming of equity once you have established a subsidiary?
Mr. GREENSPAN. You mean do it externally? You mean equity funds from the out——
Mr. BENTSEN. No. Using excess capital. If your concern is using excess capital of the banking institution is still subsidized equity.
Mr. GREENSPAN. I don't see any alternative to that conclusion.
Mr. LUDWIG. If I might respond to that, first of all, I think that the best evidence is that there is no net subsidy. The FDIC has looked at the question of whether there is any subsidy to transfer. In fact, a number of chairmen of the FDIC have looked at this and come up again and again—no net subsidy. So the question, again, is whether or not, if there is a subsidy, is it transferred differently to the op sub or the holding company affiliate?
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I think that no good case can be made that there is a particular transferral to the op sub when Sections 23(A) and 23(B) are in place. Remember, Sections 23(A) and 23(B) limit the degree to which funding can go down to the subsidiary level, and it is a very, very restrictive and narrow limitation. On the other side of the fence, you can take the bank's supposedly subsidized funds, however much the bank generates in earnings or however much it is able to raise in the markets, and upstream that amount of money as dividends, and then pay it over to the affiliate. So if there is a subsidy transference, I think it is fair to argue that it is much greater with respect to the affiliate than with regard to the sub, because you have a strict dollar limit going down to the sub but you have no limitation going to the affiliate as long as the bank is earning money.
But even if the bank is not earning money in a particular year, as long as the bank remains adequately capitalized, you can pay it up as a dividend, then pay it down as a contribution to the affiliate, which allows for the transference of any subsidy, if there were a subsidy, in a much more robust form, it seems to me, to the affiliate than to the operating subsidiary.
Mr. GREENSPAN. Well, the question really has to be, is there a subsidy? First, the argument is, is there a subsidy or not?
First of all, I think that you will find that whenever any holding company institution has the option of whether or not to stick a function into an operating sub of a bank, it will do so. And the reason it will do so is the fact that they view the cost of the capital as less in the bank.
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The truth of the matter is that we have examined in some very considerable detail the extent to which holding company organizations indeed upstream funds into the affiliates of the holding company. The data show fairly conclusively that all of the upstreamed funds effectively go out either to dividends to shareholders, repurchase of shares of those shareholders, or as interest payments on debentures to the basic holders of debentures of the holding company. There is very little in the way of upstreaming of funds that spill over into various different affiliates of banks. The reason at the moment does appear to be to a certain extent that the opportunities of those institutions are somewhat limited.
The problem that we have is that if you essentially open up these subsidiaries to any form of activity, there is very little doubt that you will find that virtually all of the activities which now exist in the holding company will reestablish themselves in the subs.
Let me just say very quickly, I don't think the evidence is equivocal at all on the question of whether there is a subsidy. There is a question which I think Ricki Helfer has raised as to whether the cost of supervision or regulation exceeds that. That actually is not a relevant consideration, because whatever the cost of supervision and regulation, if there is perceived to be a subsidy advantage to moving into the sub of the bank, banking organizations, will do that.
I used to be on the board of a major banking organization, and I will tell you, whenever there was a chance to move something someplace where the cost of capital was less, it moved. And I would say to you unequivocally at this stage that the subsidy exists. We know that, because if you measure different types of institutions, the cost of capital to the bank is clearly less than to competing entities outside the holding company.
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Banks have 6 or 7 percentage points less in the way of capital-to-asset ratios than nonaffiliated finance companies. Even adjusting for the fact that perhaps the finance company assets are somewhat poorer than a bank, you still have got that differential. Every banker knows that. And the issue of whether there is a subsidy or not, I don't consider it to be really a strong argument.
There is an argument about the differential upshifting and downshifting of funds. That is a different issue, and I think that ought to be addressed. But the fact is, whether there is a subsidy or not I just frankly find——
Mr. BENTSEN. And I know our time is up, and I know you want to comment, but you think that the upstreaming and downstreaming can be addressed legislatively or through regulation. But your point is more—and I am not going to get into a debate about the subsidy, but assuming there is a subsidy, just the ethics of—or the inequity of allowing the subsidy to be transferred is more your concern than the potential risk? If you assume not to deal with——
Mr. GREENSPAN. My concerns are not safety and soundness. It is the issue of creating subsidies for individual institutions which their competitors do not have. It is a level playing field issue. Non-bank holding companies or other institutions do not have access to that subsidy, and it creates an unlevel playing field. It is not a safety and soundness issue.
Chairman LEACH. I can bring this briefly to an end and offer Mr. Bentsen the chance to come out afterwards, Mr. McCollum would like to raise a question before the vote and answer it after the vote. We do have two votes on the floor. So if I can recognize Mr. McCollum for his questions, and then we will recess.
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Mr. MCCOLLUM. Thank you very much, Mr. Chairman.
Unfortunately, I cannot come back after the vote due to another obligation to the Intelligence Committee, where I chair a subcommittee. But I want to raise two questions with you that I certainly think need to be answered on the record.
One of them has to do with what I understand is the Administration's proposal that is coming forth from the Treasury, and that it has an alternative that would include the possibility that if we don't go to some form of commerce and banking to go together in the basket form I think is the way that first alternative is going to be proposed—if we don't do that, that we allow the thrift charters to remain, that we do not abolish thrift charters.
In other words, you either do commerce and banking and you allow that to happen or you leave the thrift charters alone and don't merge them.
And I would simply like to know the opinions of the panel as to whether or not it is an environmental thing in light of what we are doing with the merging and merging insurance funds and so forth to leave those charters alone or whether we should try to find a way to merge—anyway, whether we merge commerce and banking?
And the other question has to do with a concern I have over the insurance question of this whole proposition. If we assume that we are going to allow banks to own insurance companies in one form or another, whatever that structure is, is there or is there not a problem with the fact that insurance companies in many States do have real estate development and do other activities which are not going to probably be permissible for banks to do?
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And is that especially a problem if we allow the bank to own the insurance company inside the bank itself as opposed to a separate subsidiary? Is there any distinction or difference if we do that? I am very concerned about the fact that insurance companies do a lot of other activities.
I don't have time to hear the answers, but I am going to trust they will be presented and we can get that on the record.
Thank you very much, Mr. Chairman.
Chairman LEACH. Thank you. Those are very powerful questions, and we will recess and allow the panel to ponder them. We will recess till about 5 after.
[Recess.]
Chairman LEACH. The hearing will come to order. And since some of you have just heard the machinations of more bells, that is, to explain to the audience, we are in recess on the House floor, so we have some time to proceed.
The pending questions asked are those of Mr. McCollum. His first question relates to the question of whether the panel believes that there ought to remain a differential charter in effect, in particular what is called a unitary charter for the S&L industry.
And I would like to just make one explanatory background. This charter has certain powers to preempt State laws that no other financial entity has. It also has the power to mix commerce and banking. Beyond that, there is some question, if one favors mixing commerce and banking, it is an attractive power; if one doesn't, it is less than attractive.
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From an equity perspective, some in the financial community—and I would like to add on to Mr. McCollum's query because it is an equity issue as well as a substance issue—argue that they have helped provide the basis not only for the resources for the S&L bailout, but they have built up the insurance funds under the FDIC. And any new de novo institution that comes into being, therefore, has an insurance qualification for which they have paid virtually no funds prior to this point in time.
So for many current financial institutions, the irony of having a new set of institutions with more powers to compete against them when those new sets of institutions have not paid for the deposit insurance to begin with seems very large. And that is one of the reasons that some of us in this committee have felt very strongly that this issue of differential charter ought to be dealt with in this bill. But there is also a difference of judgment on the committee. So then the question becomes where do the regulators come from and what recommendations you may or may not have.
Recognizing that Mr. Retsinas regulates this particular group and his institution might have a vested interest in ensconcing this charter, others may have a little different perspective.
But let me begin perhaps with Mr. Greenspan.
Mr. GREENSPAN. Mr. Chairman, I have always assumed that we would be ending up with the single charter and the single fund. And the reason essentially is that, first, depository institutions are becoming very difficult to differentiate one from another. They all essentially do the same thing. They specialize in different things. But, fundamentally, we are moving ever more toward a homogeneous type of depository institution structure, and I would presume that that would be best facilitated by having a single charter.
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I have argued concurrently that since deposit insurance is essentially the same product that comes out of the SAIF and the BIF funds, that markets will create very major problems if those two funds are not ultimately consolidated. And it strikes me that the solution to all of this and one which I always presumed would be the ultimate goal of legislation was to end up with a single depository charter and a merging of the funds.
Chairman LEACH. Thank you, sir.
Ms. Helfer.
Ms. HELFER. I have had the same assumption as Chairman Greenspan, that we would end up with a single charter and merger of the funds. I think if you look at the specialized lending activity of thrifts, you will see that over time, in fact, banks now originate more home mortgages than thrifts do. And you see that, however, the qualified thrift lender test concentrates thrifts in ways which don't make sense from a diversification perspective with respect to safety and soundness.
Moreover, as somebody who was a strong advocate of the SAIF's capitalization last year and of the legislation that ultimately resulted in its capitalization, one of the prices for asking the banking industry to come to the table and put money on the table to service the FICO bonds until the year 2019, was that there would become a single charter and that it would follow the bank model. I believe that is the right answer, therefore, both on the substance and on grounds of fairness.
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Chairman LEACH. I appreciate that.
Mr. Ludwig.
Mr. LUDWIG. I, too, have assumed that we would have a merger of the charters and, I must say, a merger of the charters such that the resulting charter is a robust charter. I think having a uniform charter, but a robust charter where we don't needlessly restrict activities, is an attractive road.
Chairman LEACH. I thank you very much.
Mr. Retsinas.
Mr. RETSINAS. Mr. Chairman, beyond reasons of equity, I believe it is highly desirable to have a single charter, a single charter that can enhance the competitiveness of banking institutions, that can ensure that there is safety and soundness in that matter. I do think a merit also dictates that whatever the product of these deliberations, one of those results ought to be a merged insurance fund. The market, in a sense, is moving that way anyway, and I think it is highly desirable for the reasons we have previously alluded to.
Chairman LEACH. I appreciate that.
Mr. Levitt.
Mr. LEVITT. I have no particular feeling about this.
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Chairman LEACH. Thank you.
Mr. McCollum had a second question, which escapes me. I believe it related to the subject of insurance, but I would like to request that you respond in writing to Mr. McCollum's second question.
Yes, I recall it. That is right. My mind has been well recollected by my staff. His question was—and it is a serious one—relates to the fact that the insurance industry has certain powers to make real estate development. If you allow insurance within a bank, is that then allowing real estate development within a bank? And is that imprudent? And how do you get the balance, and how do you get an equity between this?
And perhaps it is most appropriate to Mr. Greenspan. It goes to the issues of what you allow—and Mr. Ludwig—what you allow within a bank and what you allow within a holding company framework when the insurance company that owns a bank can do as an insurance company vis-a-vis what it can do within the bank.
Mr. GREENSPAN. Yes, I think that is a very interesting issue. I would prefer to answer that in writing.
Chairman LEACH. In writing?
Mr. GREENSPAN. In writing.
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Chairman LEACH. Fair enough.
[Chairman Alan Greenspan subsequently submitted the following for inclusion in the record:
[The Board opposes the authorization of any activity as a subsidiary of the bank that involves a business that is itself impermissible to the bank. Banks are able to fund assets at lower costs because of their access to the safety net: deposit insurance, the discount window, and the electronic payment system of the Federal Reserve. The resultant subsidy would be transferred to any subsidiary since the bank's equity purchase in that entity would be funded with lower cost funds than would be possible to any other organization that might wish to buy or begin de novo that same business. The fact that the potential bank subsidiary (life insurance company) itself has a subsidiary (real estate development) only extends the subsidy.]
Chairman LEACH. Mr. Ludwig.
Mr. LUDWIG. I will give a full answer in writing, but I would observe that we have to make a fundamental decision whether or not activities are safe for the banking organization as a whole. If the activity is not safe, it shouldn't be conducted anywhere in the banking organization. If the activity is fundamentally a safe one, safe enough for the bank organization, I don't think it matters whether it is in a subsidiary or an affiliate. But the fundamental decision that has to be made is whether a financial activity is fundamentally safe.
Chairman LEACH. I think that is fair.
Let me just ask one other person in the panel this question, and only in this sense that there is an issue of safety and soundness. Mr. Greenspan has also raised the issue of competitive equity, which brings us to Mr. Levitt.
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The reason I raise this is that Mr. Levitt represents competitors to banks in the sense that his agency, the SEC, has principal jurisdiction over others, other than banks, and so the question of whether simply because an issue is safe and sound, should it be done within a bank or a holding company is an issue that I think applies to Mr. Levitt's judgment, if he would like to comment.
Mr. LEVITT. I am not sure I understand the question.
Chairman LEACH. You sound like my wife.
By background, one of the issues of all of the financial modernization is how many powers should be allowed within a bank itself as contrasted with an affiliate under a holding company? If the issue is exclusively safety and soundness, one can make a case that virtually any new power should be done within the bank.
If one also brings into the spectrum the discussion of the issue of competitive equity between various other financial competitors or nonfinancial competitors, one of the questions becomes, is it better to do things in a holding company affiliate? And that is where your institution may or may not have separable judgment.
Mr. LEVITT. I think that a holding company is certainly one way of doing it. How intrusive the holding company regulation becomes as it pertains to its affiliates is terribly important. If the holding company's structure is used as a coordinating device and if the holding company direction is geared toward what is being held within the holding company, so that again we don't impose securities, concepts of entrepreneurship and risk on an entity which is largely banking or vice versa, I think that certainly is one construct.
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Chairman LEACH. Thank you for that definitive answer.
Mr. Watt.
Mr. WATT. Thank you, Mr. Chairman.
I would observe that Mr. McCollum's presence in cyberspace is a lot more pleasant than it is in person. It did him justice. And having said that, I will go on.
I am going to be a little philosophical here first before I go to the specific questioning and suggest that my understanding of the testimony of everybody, including Mr. Greenspan, both in his earlier testimony before the subcommittee and in his testimony today, suggests that if that door back there is the barrier between banks doing banking and banks entering into general commerce, sometime between now and the year 2030 we are going to kick that door down or it is going to fall by its own volition.
And so between now and the year 2030, we are trying to construct the set of parameters that maintains our concept of free markets, maximizes competition, ensures safety and soundness, cuts back on the number of regulations or deregulates to some extent, allows bankers and securities companies and businesses to continue to make money. Somebody, I guess, has got to look out for the depositors in banks and the owners of securities and the consumers in the general commercial context. And to some extent, all of those things have some inconsistencies internally within them, because it is hard to postulate a system where you are moving to a greater set of things that banks and other commercial entities can do and yet, at the same time, be moving to lesser regulations or a less regulated situation unless you are going to go to a concept that really, truly goes to free markets and open competition, which has not historically been the hallmark of the banking part of our economic system.
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Mr. WATT. In fact, this whole notion of kind of the superentity regulating the whole mass of things, even—I would take it maybe even going beyond the Federal Reserve and its capacity to adjust interest rates, and I don't know what this superentity would do. It would kind of oversee all of the regulators out there; is, at some level, really inconsistent with free markets and free competition and all of the things that we hold so near and dear to our hearts.
So I am in that context trying to figure out how I get myself from this position, if I am a bank, to the other side of that door by the year 2030, and it is all responsibility to do that, taking all these factors into account. That is not a question, because I know if I set you off in that general context, you will be here philosophizing as I have for the last 4 minutes now, and maybe I should get to a question in that context.
I was struck with one thing that Mr. Ludwig said in his testimony, and that is that there are a number of entities out there already beyond doing, things already beyond the door. They are outside the door now, and whatever constructs we set up in the next couple of months, or however long it takes to get a bill out of this committee and through the process, shouldn't disadvantage them, shouldn't kind of—well, one person said it shouldn't grandfather them, and I thought I heard you say we shouldn't make them cut back on what they are doing either. How do we get that kind of—I think it was Mr. Retsinas who said, ''Hey, you have got real problems if you start grandfathering stuff,'' and Mr. Ludwig said, ''You have got people already operating beyond the door out there.'' How do you reconcile those two things?
Mr. LUDWIG. I would say a couple of things here, Congressman Watt. First, with respect to commercial banks, they may be engaged in different activities, but they are not—maybe with some very narrow grandfathered exceptions—engaged in the kind of commercial activities that are before this committee as an important decision matter. In other words, for commercial banks, they are not outside the door with respect to commerce. They may be involved now in securities activities and other financial activities that may be new to commercial banking or new to banking since the 1930's, but as to commercial banks engaged in commerce, that is essentially not the case.
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But for thrift organizations, however, now often called savings banks, it is a different matter. That is, Ford Motor Company has owned a thrift. Sears and Roebuck has owned a thrift. And, indeed, interestingly enough, there are a number of insurance companies which have owned thrifts, and the same is true for securities entities. But as to thrift ownership, I would turn that over to Director Retsinas.
Mr. WATT. And keep in mind every single one of you except Mr. Levitt, who didn't have an opinion, said you were going to merge those two charters, or at least said you were in favor of that, so this issue has to be addressed in that context.
Mr. RETSINAS. I agree, your point and insight is the appropriate one. In my statement, as you noted, I suggested that the committee proceed with caution as relates to grandfathering, because grandfathering is not the solution some might think it is, because it has some costs. I suggest as you contemplate a single charter, and as I said before, I think that is a desirable objective, we ought to find a way within that charter to accommodate the best of the existing charters. And I believe there are lessons to be learned from thrift holding companies, lessons to be learned on restrictions of transactions and other kinds of authorities that are worth keeping into account as you consider this question. There is no simple solution, and none of the solutions are painless either.
Mr. LUDWIG. Let me just add, Congressman Watt, because your philosophical musings, as you characterize them, are quite wise ones, this is a difficult set of issues, and as you put it, moving out the door is a fact or reality of this dynamic marketplace. It is a tremendous set of responsibilities for the Congress and this committee in particular which all of you have taken up. I commend you and have a tremendous amount of respect for what you are doing because these are hard lines to draw and very important lines to draw. I agree with what you said, and with Congressman Vento, that we really want to face up to these realities.
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Mr. WATT. Mr. Chairman, may I ask Mr. Greenspan one quick clarifying question?
Chairman LEACH. Sure.
Mr. WATT. It will take very little time.
I thought, Chairman Greenspan, in your testimony or in response to a question, I think it was, that somebody asked, you said banking and finance should be the first step, and then 20-, 30-years down the road you said banking to commerce would be the second step. And I am always careful to listen to exactly what you say, because they tell me that you have to read the nuances when the Chairman speaks. I notice that you left out insurance. Were you including that in banking and finance?
Mr. GREENSPAN. Yes.
Mr. WATT. Or was that intentional?
Mr. GREENSPAN. No, no. I was including it in banking and finance, meaning by finance, a fairly broad spectrum of activities. I didn't wish to imply, Congressman, that I thought we would have to wait 20 or 30 years to confront the second part of this problem. I do think, however, that if the Congress in its wisdom passes a bill which is essentially one leading toward significant financial modernization, which virtually all the bills that are on the table move in the direction of, I think in a reasonably short period of time we will learn enough about how the synergies of various different organizations work, and what potential problems exist in the overall financial system as a consequence of that, if any. At that point, if one perceives that the divisions between commerce and finance are becoming somewhat blurred, and in 20 years from now will be very blurred, that at that point the Congress might make judgments as to what a secondary piece of legislation would look like, and one conceivable end result would be, as Chairman Volcker suggested, namely, ''no, don't move, period.'' That is one answer.
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There are a number of other answers, which, in my judgment, will be far easier to make after we have seen how finance integrates. I don't see any need to move faster.
I must say I understand Congressman Baker's concerns about capital going into banking and finance. I am not worried about that. There are lots of other reasons you raise which I have great sympathy for, but I don't think the concern that we have inadequate capital in either finance or banking is a reasonable one because observing the flows of finance in the last decade or so, there is no shortage of any capital to any form of institution which is perceived to be potentially significantly profitable in the future. So I wouldn't worry about the capital part of this question, and if one doesn't have to worry about that, I don't see any particular immediate urgency to move in the direction of breaking down, as you put it, the back door very quickly.
Mr. WATT. I appreciate it, and I won't ask this for response purposes. I would just rhetorically wonder aloud whether you could take that step and ever get the genie back in the bottle?
Mr. GREENSPAN. The issues you are raising are really the crucial ones for the Congress. They may have been philosophical musings, but I agree with Gene Ludwig that these are the type of musings that are required.
My main concern is the putting the genie back in the bottle problem. I don't see any conceivable possibility that if the Congress moves forward in a manner to break the barriers between banking and commerce, let's say at this stage, that there is a way of retreating if it is perceived to have been the less-than-optimum model. And since I don't see any emergency, there is a model out there which we are going to note, and there is going to be a breaching the commerce and finance at some point. The markets virtually make it inevitable.
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But we have the time to make the right judgments, and I think there is no reason why we shouldn't wait and see how the first tranche of this system goes where we move to financial modernization with financial institutions, including insurance, first.
Mr. WATT. Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Watt.
Dr. Weldon.
Dr. WELDON. I thank the Chairman, and my question would be somewhat along the same lines as the direction of Mr. Watt in terms of it being somewhat of a philosophical question. I guess because of my personal background, having been a practicing physician and having taken an oath at one point which said, ''Above all else, do no harm'', and as well having followed the S&L disaster as a taxpayer in the late 1980's and early 1990's and being particularly frustrated about that, at least as a layman, my analysis was that some of the regulatory changes this committee undertook may have played a role in the S&L crisis; that it was actually—truly the primary factor was the revisions of the Tax Code and specifically doing away with the depreciation of commercial real estate investments.
And I guess the question I want to ask is I personally believe what controls the flow of capital in the United States is not the regulatory framework that we orchestrate here in Washington, but rather the Tax Code is 99 percent of it, and while we are—at least on this side of the aisle; I believe on that side of the aisle as well—are very concerned that we follow the Hippocratic oath and do no harm, that there will be time to analyze whatever changes we have made, and that there will be an opportunity to make further adjustments down the road, and the likelihood of precipitating a crisis is not high providing we don't simultaneously revise the Tax Code, which I guess is part B of my question.
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Is it prudent to make significant changes in the regulatory environment in the financial sector of our economy while we are perhaps doing something like passing a flat tax or a national value-added tax? Indeed, at that point I think we would be stepping into the same potential quagmire that existed in the late 1980's. Now, maybe none of you want to answer this question that I have asked you, but I guess I will pose it first to Ricki Helfer. Maybe you can comment on that.
Ms. HELFER. Well, with respect to our analysis of the lessons we should have learned from the 1980's and early 1990's, I guess I would have to say, with respect to savings and loans, it probably was the fact that largely the losses in savings and loans resulted from the fact that they had long-term assets and short-term funding, at a higher cost. This, of course, resulted from a very fast deregulation of interest rates and from a lot of other factors, I might add, that were in the economy at the time.
With respect to the changes in the Tax Reform Act of 1986, it is certainly true that the Act had some impact both on banks and on thrifts with respect to outstanding real estate loans, and we have found at various times that changes in the law can have an impact on how financial institutions function—that shouldn't surprise you—and particularly the Tax Code, because businesses try to take account of their tax obligations in doing their business.
I think it is certainly up to Congress at the time that it looks at financial modernization to understand the impact of other things that it is doing. I personally believe now is the time to look at financial modernization, and I believe it will, in fact, allow financial institutions, if they have a more expanded ability to be involved in a broader range of financial activities, to diversify their portfolios in a way such that they will be able to deal with evolving changes in the economy more effectively. One of the principal lessons from our study was that diversification allows the institutions, themselves, to be able to accommodate the different points in the business cycle more effectively.
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Dr. WELDON. I have a second question that is of a technical nature, and maybe, Mr. Ludwig, you can comment on this. There has been a proposal of various types of baskets, and what you would count as going in the baskets, and I think one of proposals being floated is counting revenue as going into the basket and 25 percent cutoff. It has been pointed out to me that some insurance companies, the way they do their accounting, they have no revenue that they actually report, so they would be effectively excluded from getting into the banking side of the financial services industry with that type of regulation.
Do you believe it would be possible to craft a regulation that would allow a certain amount of flexibility in how regulators would define what goes in the basket? Is it imperative that we specifically legislate from here in very precise terms what is counted in that basket, or would it be possible to allow the regulators to have the flexibility so that, because I think we all understand the goal or intent, and what I would not want to do is write the statute in such a way that you are effectively excluding one particular group from ever truly taking part in the modernization.
Mr. LUDWIG. Dr. Weldon, I agree with where you are going. That is why I have said that in the statutory framework that Congress sets up in this area, you want to have a little give in the joints for the regulator so that what Congress really wants to have happen happens. I do feel very strongly also about the implicit message in your comment that we want to have a system that is indeed a level playing field. What we don't want to have happen among financial services companies is somebody being frozen out in an unintended way because there isn't a level playing field. There ought to be a level playing field among these various financial groups.
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Dr. WELDON. Thank you.
Chairman LEACH. Thank you, Dr. Weldon.
Ms. Kilpatrick.
Ms. KILPATRICK. Thank you, Mr. Chairman. Of all the hearings I have been to on this subject since the beginning of the term, I think this one with the regulators has been most interesting and educational.
I want to ask Mr. Levitt, as we always talk about merging of commerce and banking in all of these meetings, and I think today is the first time I have really heard—and I think the Chairman said we should merge banking and finance and kind of take it slow on banking and commerce. In your remarks, Mr. Levitt, you talked about an unfair playing field or disadvantage that the securities find themselves in when the banks can own securities companies, but the other cannot prevail.
What would be your suggestion—and we are hearing a lot, and I am trying to distinguish between the two, actually—and I think before you answer is that, software, the Internet, the information system really is what has propelled the banking industry into a global market. Banks are producing software, and I am sure will want to own their own companies.
And getting to the commerce and banking merger, that is happening now, and I find it hard to believe it wouldn't expand and go forward as we move forward to the new millennium. I am not sure we ought not be moving to merge banking and commerce because it is already happening. From your comments I felt that you felt that you were at a disadvantage being in the securities area of the business, which, in my opinion, still is financial. What would be your suggestions, comments?
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Mr. LEVITT. Well, what you suggest in terms of what the market has brought about is quite true, that there have been certain movements in that direction. And the banks are able to do things today that they were not able to do as recently as 2 or 3 years ago in terms of securities activities. And, while I am mindful of the dangers of merging banking and commerce, I think a gradual movement in that direction over a period of time is important to see to it that securities firms are able to compete more effectively against banks in the interests of consumers. Already securities firms have affiliations with insurance companies and other commercial activities so that if you took the strictest interpretation of this, and decided there would be absolutely no affiliation between banking and commerce, it would undoubtedly call for some form of divestiture or grandfathering. I have trouble with that kind of artificial imposition upon the marketplace.
So I guess what I am saying is having started down the road of one major financial entity, having become involved in some of the activities of the securities industry, if the legislation would allow for securities firms to compete with the appropriate regulatory oversight, that would be the direction I would follow. But I certainly, again, would hesitate to suddenly say that as of December 31st anybody can do anything they please. I think that would create some great distortions, many of which Chairman Volcker spoke about, and again, Chairman Greenspan's notion of doing this gradually over a period of time is exactly the way I think we should go.
Ms. KILPATRICK. Thank you.
And to Mr. Ludwig, I appreciate your strong statement on the CRA and on the WFIs as we move forward. The CRA requirements, I hope, will be a part of WFIs, and is for $100,000 in investment, and will be more corporate than individuals and probably will be viewed as a wholesale bank.
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What recommendations would be put in force as we speak about this legislation about WFIs and their commitment to CRA? What needs to be there? As you know, right now wholesale banks have different requirements. If, in fact, WFIs are instituted and passed in this legislation, I believe both of them have them in there, both the Chairman and the subcommittee chairpersons have them in there, what would you suggest ought to be there? Will they be the same requirements, or will they be different?
Mr. LUDWIG. Congresswoman Kilpatrick, I want to say several things about this area. First, these WFIs, the Wholesale Financial Institutions, are not quite so different from retail institutions as might first appear. While the initial deposit may be $100,000, subsequent activity in those accounts, depending on how they are set up, could be less than $100,000. In other words, this is the kind of institution that could deal with individuals. So the institution itself as it operates could be quite like, in many ways, a retail banking organization.
Accordingly, this could be a very robust option for financial institutions. They may be extremely popular entities. And as I mentioned earlier, one could imagine under many of the proposals that existing commercial banks and thrifts could split their businesses in a way where they would have very large WFIs and relatively small retail franchises. So this is a very significant issue for the Congress, and particularly for the Community Reinvestment Act.
Now, my own view is that applying CRA to WFIs is not a particularly difficult exercise. While I think some accommodation has to be made for their different nature, we have to be very cautious, as we have in current CRA rule that such accommodation is made in a way that keeps the CRA application to the institutions fully robust. In other words, I think it would be very unfortunate if we were to have, to paraphrase my friend Chairman Greenspan, ''CRA lite''. I don't think we should have CRA lite in these institutions. They ought to be covered by CRA in a significant fashion.
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Now, in the current CRA rule we recognize that there are limited purpose entities, that there are different kinds of entities covered by banking charters. But this is a very important program. As I have been around the country, and you have probably seen it in your district, low- and moderate-income individuals' lives are deeply affected by whether or not this statute applies and how it applies. We have to be very cautious in cutting back on those opportunities for people.
Ms. KILPATRICK. And the WFIs may do that if they are not structured right is my point.
Mr. LUDWIG. Absolutely.
Ms. KILPATRICK. And you just testified that unless we are careful, we could find the lite CRA on the regular retail bank, when, in fact, much money has gone into the wholesale bank with no CRA, to the disadvantage of the CRA program. So as we structure the WFIs, I would hope that—and with your input and Mr. Chairman as well as Congresswoman Roukema—that we make sure and have that commitment. CRA is a national program and has done well across America for many years and should not be cut, should be enhanced. But I, too, think they ought to have the commitment and keep CRA healthy and not be able to circumvent that process.
Mr. LUDWIG. I agree. I look forward to working with you.
Ms. KILPATRICK. Thank you.
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Chairman LEACH. Thank you.
Mr. Hill.
Mr. HILL. Thank you, Mr. Chairman. I would like to echo the comments of other Members: This has been a very informative panel for me.
And I certainly would agree with you, Mr. Chairman, Chairman Greenspan, with regard to this issue of whether or not there is inadequate capital. In fact, I would argue that there is a surplus of capital in the financial institution industry, and that is what is driving people into each other's markets, and it is this desire to get into each other's markets that is where the problem appears, because not everybody can get into each other's markets as easily as others can get into one another's markets. And the modernization of the financial institutions as it is about the modernization of the financial institution regulations, and we probably wouldn't all be here if it wasn't for Mr. Ludwig's effort to try to redefine the Office of Comptroller.
Anyway, this debate seems to be driven more by industry and regulations than by consumers. So I have a couple of questions I want to ask. I believe you all said there should be a single charter and a combination of the funds. And those of you who said that, would you agree that credit unions also ought to be drawn into the issue of a single charter? I would ask you, Chairman Greenspan.
Sorry.
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Mr. GREENSPAN. Credit unions are part of the overall financial system, but the judgment about to what extent they should be or should not be in the system, I think that is for Congress to decide. The reason I say that is I am a coward.
Mr. HILL. Thank you, Mr. Chairman. You all get a chance at this.
Ms. Helfer, would you care to comment about that?
Ms. HELFER. I agree with Chairman Greenspan.
Mr. GREENSPAN. In all seriousness, I think that we are all somewhat bemused by the wrangle that is going on between the banks and the credit unions, and clearly there are good arguments on both sides of the issue. It is a very crucial question, however, for Congress to decide and not for regulators, and the reason I say that is that originally these institutions, credit unions, were set up for a specific purpose, and like any institutions, they expand, and they should expand because that is basically the nature of a viable institution. If it doesn't expand, it dies.
There are undoubtedly questions of competition that go on between these various institutions, and I don't think it is up to regulators to make the judgments on this specific issue. You can correctly ask us on certain elements within the banking structure and some of the elements involved, but this is a very clean-cut question of what types of institutions the Congress wants to set up and what types of powers they should have. I don't think that you should ask or request that the fundamental decision be made by banking regulators.
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Mr. HILL. But I would say by unifying charters you are describing how at least unified thrifts are going to be competing in the marketplace.
Mr. GREENSPAN. That is right. And I think it is up to Congress to make a decision whether it considers credit unions different from other depository institutions in a manner which leaves both their fund and the institution separate with respect to charter. You have not chosen to consolidate the credit union fund with the BIF and the SAIF institutions, and they are separate in very many distinct respects. It is really up to the Congress to make a judgment as to where it wants to define that particular structure.
Mr. HILL. Thank you.
You suggested earlier that the umbrella regulator—and if the final function of the institution was securities, it ought to be under the securities regulator; if it was banking, would be the banking regulator. What would you suggest if insurance were the primary activity?
Mr. GREENSPAN. I would say the same, it would be insurance——
Mr. HILL. Which would mean State regulation.
There is some concern about, particularly in the area of insurance, whether there is discriminatory regulation which does occur or could occur. In your opinion, who do you think should be the regulator to determine whether or not there is discriminatory regulation going on in the case of insurance if States were the umbrella regulator of insurance?
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Mr. GREENSPAN. You mean who? The question of whether something is discriminatory or not is not all obvious. I mean, it is in the mind of the beholder.
Mr. HILL. There ought to be one regulator who has the ability to define that.
Mr. GREENSPAN. Let me say this: If you have a financial services holding company, which the major part is an insurance organization, that whoever you designate as the insurance regulator should be the consolidated supervisor of that institution and make those types of judgments.
Mr. HILL. Mr. Chairman, if I might, if you would indulge me, I did not have a chance to have Mr. Ludwig answer my question about credit union single charter. I would be curious if you have an opinion about that at all?
Mr. LUDWIG. I do. I agree with Chairman Greenspan that this is a fundamental and incredibly important set of decisions for Congress.
Having said that, I would go further in this respect; there is a safety and soundness issue here that I think we have to all face up to. These entities were set up to fulfill a niche need in the marketplace and in many cases have filled that niche well. But they have expanded very, very broadly, and some would say more broadly than was anticipated when Congress set them up, as far as the people who that entity can serve. These are entities that are given a clear, significant tax subsidy, and when you have any entity in the marketplace that is Federally-subsidized to this degree, it has a clear and significant competitive advantage. And that competitive advantage translates, in my mind, into a safety and soundness imbalance which is very real.
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For example, in any community if you have two competitors with one at a 200 basis point advantage, that entity is going to take advantage of the lower risk, better opportunities while another entity which doesn't have that will have to go further out on the risk curve to be able to stay viable. And that is not a healthy situation if the advantage is that robust. So, I think this is a matter for Congress. It is a difficult set of choices, but it also, I think, has genuine safety and soundness implications.
Mr. HILL. Thank you.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Hill.
The circumstance is the following: I have committed to two of our witnesses that they would like to leave by 2:00. I have two Members who have very brief questions, and if it is possible—I know Mr. Baker wanted to follow on quickly, and Mr. Bentsen did—I would like to recognize Mr. Baker.
Mr. BAKER. Thank you, Mr. Chairman and the two witnesses, for the indulgence, and I really have no question, just a statement to clarify Mr. Greenspan's observation with respect to capital.
Chairman Helfer made a comment just a moment ago that centered exactly, perhaps, on the misstatement of the philosophy by myself when she said, ''Diversification allows financial institutions to respond to different conditions of the business cycle.'' That is precisely what I am arguing with regard to additional partners in the financial community.
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Today we have well-capitalized insurance funds, we have extraordinarily high bank profits, we have a stock market beyond all expectations. These are the days in which to make these difficult decisions. I am not going to return to south Louisiana in 1980 and watch the decline of the oil and gas industry and financial institutions folding daily. My point is that although things are good, perhaps extraordinary, we see equity income rising dramatically, which has not been historically a pattern in the financial community, and fee increases in relation to income rising rather dramatically. While nonregulated financial services providers are securing larger and larger shares of the marketplace, the bank is relegated to a smaller and smaller number of traditional customers because of the ease of getting access to capital elsewhere.
The argument I have made for the merger of commerce and finance is centered on the principle that the future will dictate a broader array of products in order for the traditional financial institution to continue to survive in a healthy and safe manner, much like geographical did with interstate over the past several years, which was also a controversial decision in that day and time.
My point is it is not a statement in the light of a healthy, fat financial institution where one says, ''We obviously need to have capital,'' but in the undeniable circumstance that business cycles are exactly that. When things are not as profitable as they are at the moment, the mixture of a commercial enterprise gives economic spread to that financial institution as a source of financial strength which it cannot now enjoy, particularly as the nonregulated market has grown dramatically and taken more of the customers away from the banking sector.
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Now, the legislature, having said that, should not view that as a regulator, a panacea for the marketplace, but the ultimate conclusion, a diversification of products provided at a better price for the consumer, and I believe the two are consistent goals.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Baker.
Mr. Bentsen.
Mr. BENTSEN. Thank you, Mr. Chairman. I have one question for the record and then two others, and I will try to be as brief as possible.
First of all, for the record, we will hear from the State regulators after this, and this may be just Chairman Greenspan, because we have had this roving discussion about the regulatory regime that might come out of this. In your case, I think using the consolidated regulator is the term you used.
Mr. GREENSPAN. Consolidated supervision.
Mr. BENTSEN. Supervision, right.
In the case of insurance, and this comes from Mr. Hill's comments, because it is State-regulated, would you assume—and you can answer for the record and if—and to my office—would you assume that it would be the State regulator from that State where the company is chartered, in the case, you know, of Prudential in New Jersey or some other company in Texas?
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Mr. GREENSPAN. I go in that direction, generally.
Mr. BENTSEN. Another short question, then I want to get back to the operating subsidiary and holding company affiliate as well as the subsidy question, but with respect to the rule on professional qualification requirements for bank securities representatives, and having read that and thinking that I believe that you all made a lot of progress in moving forward and adopting a NASD requirement for bank securities representatives, why not in the context of this whole bill that we are doing, if we do do it, in opening up more securities functions—and as Mr. Hill said, Mr. Ludwig may just do that anyway, although I hope he waits until we do this—why not go ahead and put bank securities representatives under NASD regulation, which I think Mr. Ludwig would probably prefer and the State securities regulators would prefer?
Mr. GREENSPAN. I personally haven't given enough thought to that to give you an answer.
Mr. BENTSEN. If you want to respond for the record.
Ms. HELFER. I would like to say for the record that there should be comparable regulation from the perspective of investor protection and disclosure requirements, where entities are engaged in the same kind of activity. And if banks engage in securities activities, I think it is very important that investors have similar protections.
Mr. LUDWIG. I agree with that.
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Mr. BENTSEN. Similar being the same or being subject to arbitration, being not just taking the serious 100, but also——
Ms. HELFER. I would actually favor giving investors the same kinds of remedies available in the securities area. We actually have explored with the NASD whether insured financial institutions could piggyback on their arbitration procedures where we find investors who have had problems with respect to the purchase of uninsured investment products from the banks, and we are continuing to discuss this with the NASD.
With respect to the full disclosure of other requirements, I think it is important, because we bank regulators are not regulators in the way that the SEC is with respect to consumer protection and disclosure issues of uninsured investment products. I do think if institutions are going to engage in the same kind of activity, they should be subject to the same kinds of regulation.
Mr. LUDWIG. I, as you know, have worked very hard to make our rules substantially the same as the SEC's. In fact, we have proposed a regulation that the Series 6 and Series 7 exams be required for bank personnel selling securities. I think fundamentally we ought to have a level playing field approach.
Mr. LEVITT. The problem with that is that merely taking a test and passing a test is only a fraction of the kind of regulation that has been developed over the years to apply to securities brokers to protect investors. I mean, part of it is knowing whether your broker has a record of malfeasance in the past. Part of it is seeing to it that supervisors of bad brokers are held accountable for the work, the misdeeds of the broker. Part of it is an arbitration proceeding.
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I think that, again, securities regulation and securities regulators have developed this culture over many, many years, and I don't think we should fool ourselves into thinking that because brokers at banks have passed the test that that is it. It really isn't, and if that would lead to our brokers and bank subsidiaries that file with the SEC now to move over to the banks where they wouldn't have to file, I think that would be a tragedy.
So, I think the question of brokerage regulation is a very large one and a very important one. I would not be comfortable in seeing a whole new set of regulators or a set of banking regulators taking on the responsibility for regulating the brokers that function in those banks.
Mr. BENTSEN. And I might add even Members of Congress can pass that Series 7 test.
If I could, Mr. Chairman, I would just briefly like to go back to the op sub affiliation question. Now, Mr. Greenspan, in your testimony on page 8 you state, ''Let me be clear, the bank holding companies and their subsidiaries also benefit from the safety implicit in the safety net.'' And just in thinking about this, certainly that has got to be true.
I don't want to pick institutions, but I will think of one of the large New York City money center banks that has a name that goes back to this type of finance in our history. If I understand how they set up, they set up a Section 20 affiliate under the holding company structure, but they are going to capitalize that. The money is going to ultimately come from their depository institution activities. Is that not correct, or do they go out and sell equity to finance that?
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Mr. GREENSPAN. No. In fact, the issue I am raising is that even if external capital is used by whatever institution you are referring to, and indeed if you look, they do borrow to finance the Section 20 subs, nevertheless, because a central part of the holding company is an insured depository institution, the market value of that holding company does reflect that subsidy. The subsidy is capitalized in the price. It is also capitalized in the cost of debt capital, but only in part. And the issue here is that the amount of subsidization that is employed by the holding company in financing its Section 20 sub is significantly less than it would be if it were being financed as a sub of the bank where there is no dilution going on between the depository institution, which is pure subsidy, and all of the other elements of the holding company, which are essentially nonsubsidized.
Mr. BENTSEN. And I know Ms. Helfer wants to comment, but if you look at her testimony——
Chairman LEACH. Mr. Bentsen, I made a real commitment for two of these witnesses to leave at 2:00, so if you could sum up.
Ms. HELFER. I would like to comment on what Chairman Greenspan said.
We did an extensive analysis of the subsidy issue, it was presented to the Capital Markets Subcommittee, and I have to say that with respect to the way in which funding would be permitted for the subsidiary of the insured bank, under the standards that all of us have set out, it could only be through the excess capital of the insured bank; that is, only those amounts above the well-capitalized status of the insured bank could be used to fund the activities of the subsidiary.
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I think that is an important first point because that will set a natural break on the amount of money that it is, in fact, from an economic perspective, sensible to use as excess capital funding for the subsidiary.
With respect to the affiliate, I think it is very difficult to conclude that the funding that is used for the affiliate subsidiary of a holding company is unsubsidized, but the funding that is used for the affiliate subsidiary of the bank is subsidized. Our analysis shows if you take into account all the factors that drive what the insured bank does, that there may, in fact, be very little net subsidy that is exported. But be that as it may, money is fungible, and it can be dividended up to the holding company of the insured bank to benefit the holding company just as it can be downstreamed to the subsidiary of the insured bank. So I think it is difficult to say that, in fact, there is a significant advantage.
Moreover, if you look at where the activities are conducted, activities that could be conducted in an insured bank, a sub of the insured bank or a sub of the holding company, in a number of institutions there are many other issues that are driving where that investment is made, the principal one being whether Sections 23(A) and 23(B) apply. Right now they only apply to insured bank dealings with affiliates of the holding company. We would apply it to insured bank dealings with the subsidiary, which would take away the Sections 23(A) and 23(B) judgment that is currently being made.
Mr. LUDWIG. I agree with Chairman Helfer. Number one, there is probably no net subsidy, no real subsidy. Even the Fed has been talking about a 4 to maybe 15 basis point, 4/100ths of a percent to 15/100ths of a percent, gross subsidy, but that is not taking into account the cost of regulation. And every time you do that, every time the FDIC looks at it or we look at it, it actually comes out negative. So you have to ask, is there a subsidy at all?
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If there was a subsidy, you can have virtually unlimited dividending up from the bank to the holding company and affiliates, which is far in excess of Sections 23(A) and 23(B) limitations and capital limitations which we have proposed to be applied for operating subsidiaries and I think Congress is considering in this legislation. If there is any subsidy, it is more likely to be at the affiliate level.
Moreover, you can actually look and see where banking companies place activities within the organization, today. If there was a major subsidy, they would put everything in the bank or in a bank subsidiary as distinct from a holding company affiliate.
Let's look at the pattern. In my written testimony, I have a chart that shows this. In fact, banks sometimes conduct activities at the holding company level, sometimes at the subsidiary level—identical activities where they could choose the placement. And in those instances where non-banks can compete, in terms of the same activities, non-banks tend to be the major players in those markets. If there was a significant subsidy that distorted things in the direction of the bank, you would expect the banks to have an edge. You don't see that in the marketplace. So you have got to either conclude that there is no subsidy at all, which I think is the case, or if there is a subsidy, it has no practical impact. Moreover, if there is a subsidy, it doesn't seem to benefit the subsidiary to the extent it potentially could benefit the holding company affiliate.
Mr. GREENSPAN. I disagree with this.
Mr. BENTSEN. So——
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Mr. LEVITT. So do I. I share Chairman Greenspan's reservations about subsidiaries, and I believe there is a subsidy, and I would be far more comfortable with an affiliate structure.
Chairman LEACH. Well, the ends of the table are in agreement.
Let me thank this panel very much, and it has been a very helpful panel. The issues are meaty, and the discussion has reflected that, so I want to thank Chairman Greenspan, Chairman Helfer, Comptroller Ludwig, Mr. Retsinas, Mr. Levitt. Thank you very much.
If the hearing could come back to order, I would like to introduce the next panel. Our first witness is G. Edward Leary, Jr., who is the Utah Commissioner of Financial Institutions, on behalf of the Conference of State Bank Supervisors; Mr. George Nichols, III, the Kentucky Commissioner of Insurance on behalf of the National Association of Insurance Commissioners; Ms. Denise Voigt Crawford, who is the Texas Commissioner of Securities and President-elect of the North American Securities Administrators Association; Mr. James L. Pledger, who is the Texas Commissioner of Savings and Loans and Chairman of the American Council of State Savings Supervisors; Mr. J. Kenneth Blackwell, Ohio State Treasurer on behalf of the National Association of State Auditors, Comptrollers and Treasurers.
Before proceeding, I would like to make two statements. I would like to recognize Mr. Bentsen for introductions.
Mr. BENTSEN. Thank you, Mr. Chairman, and Mr. Chairman, I wanted to make an introduction. It is unusual, although I think probably appropriate, that we have not one, but two of our regulators from Texas who are appearing before us today. Denise Voigt Crawford is the incoming President-Elect of the North American Securities Administrators Association. She has been with the Texas State Securities Board since 1982, serving in many capacities, Staff Attorney General, General Counsel and now Securities Commissioner, and we welcome her here.
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And, in fact, James Pledger has testified many times before this committee in his capacity not only as the Texas Commissioner of Savings and Loans, but now the Chairman of the Council of State Savings Supervisors, and we welcome both of you here.
Chairman LEACH. At the risk of some scheduling change, I was approached by Mr. Blackwell earlier. He has to address his legislative committee in his own State today and he asked if he could go early. I know it is difficult for everybody because all of us have constrained schedules, but I made that commitment, and I would like to begin with Ken, who has also testified on a number of occasions before us, and we have certainly appreciated his judgment in the past.
Chairman LEACH. Mr. Blackwell.
STATEMENT OF MR. J. KENNETH BLACKWELL, TREASURER, STATE OF OHIO, ON BEHALF OF THE NATIONAL ASSOCIATION OF STATE AUDITORS, COMPTROLLERS AND TREASURERS
Mr. BLACKWELL. Thank you, Mr. Chairman.
Mr. Chairman and Members of the committee, I appear before you today representing the National Association of State Auditors, Comptrollers and Treasurers. NASACT represents the interests of State governments across the spectrum of intergovernmental finance. Our association appreciates the opportunity to testify to legislation to revise the Nation's banking laws and the possibility of creating a comprehensive framework for linking banks with security firms and insurance companies. To the extent that revisions will improve the overall efficiency and competitiveness of financial markets, they should be considered, but an extremely careful review should be made prior to undertaking any revisions. Further clearly and specifically defined safeguards should be included in any modernization effort with due regard for safety and soundness.
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Large security and insurance firms have indicated their desire to own banks. If you can accept the dynamics of the financial markets and the premise that some consolidation is inevitable, one question remains: How should that change be embraced? NASACT believes like a porcupine—with extreme caution.
We cannot expose taxpayers and consumers to unnecessary risk. Neither can we risk the integrity of the greatest financial power in the world. The Federal Reserve Board and the Comptroller of the Currency are rapidly rewriting the script of national banking regulation. Congress needs to recast its role in a manner that protects its responsibility to set the framework for linking the banking, insurance, and securities industries.
You have heard two extremes of position on how to do it: Completely remove all Great Depression-era restrictions between banking and commerce, or build an impregnable wall between them to ensure the free enterprise system. Concerning the former, it is my belief that allowing banks and brokerage houses to gain access to billions of dollars of new business is a good idea, but to do so without building the necessary walls to promote soundness and safety would be foolhardy.
The vantage point of an extreme position doesn't allow for a clear view of the whole issue. NASACT trusts Congress to see clearly between the extremes and to scout the soundest way to growth and prosperity.
Without comprehensive empirical analysis on the effects of financial market deregulation, NASACT can only support the more moderate provisions for scaling back restrictions on the affiliation of banking and commerce. For example, provisions that strike a balance between the need of the securities industry to preserve its ability to assume prudent risk and the banking industry's need to preserve safety and soundness.
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Any financial services modernization bill must draw from the best aspects of all participants, not settle for the lowest common denominator in regulation or performance.
First, take commerce and banking. Recognizing that there are benefits of banks joining forces with commercial enterprises, one must also measure the risk involved. Liberalizing the merging of banking and commerce will increase the volatility associated with commercial banks. Right now, that volatility is quite low. Any increase in risk to the payment and settlement system must be reviewed carefully. Changes, if any, should be made incrementally.
If a financial services holding company is created and composed of both commercial and banking entities, the banking portion should be protected by adequate capital reserve requirements. Neither account holders nor the FDIC should bear the cost of a failure in the holding company's commercial operation.
Second, consider holding company regulation. As I said, any modernization plan should draw from the strength of its participants. So NASACT must disagree with the concept of granting one authority, a new bureaucracy, regulatory responsibility for financial services holding companies. Each area of a holding company's operation should be regulated by those who know it best, while moving closer to a coordinated system of regulation by functions.
The SEC, State security commissioners and the self regulatory organizations should continue to regulate securities industry activities. Federal and State banking officials should continue to oversee banking activities. State regulation of insurance operations should also continue.
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Granting authority does not ensure expertise. One regulator would not have the comprehensive understanding in all areas of operation of a financial services holding company. Therefore, that regulator will still rely on those regulators already in existence. There may be a need to coordinate the current regulators but not the need to create a new one.
In closing, I can only say that our banking industry is a reliable battleship in an ocean of financial uncertainty, reliable but limited in certain respects. It doesn't turn on hairpins. I urge you to steer us by inches.
Thank you, Mr. Chairman and Members of the committee, for your attention. I have submitted a longer version of this testimony for inclusion in the committee's official records.
Chairman LEACH. Thank you, Mr. Blackwell, for a very helpful statement.
Now we will go in the reverse order. Mr. Leary.
STATEMENT OF MR. G. EDWARD LEARY, COMMISSIONER OF FINANCIAL INSTITUTIONS, STATE OF UTAH, ON BEHALF OF THE CONFERENCE OF STATE BANK SUPERVISORS
Mr. LEARY. Thank you, Mr. Chairman, Members of the committee.
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I am Edward Leary, Commissioner of Financial Institutions for the State of Utah and Chairman of the Conference of State Bank Supervisors. I am pleased to be here today and share our views on financial modernization.
Mr. Chairman, CSBS applauds your long-standing support for the dual banking system. We greatly appreciate this committee's continuous efforts to defeat State bank exam fees.
In addition, I want to personally thank you, Mrs. Roukema, Mr. Vento and Mr. LaFalce for your work toward passage of H.R. 1306, the Riegle-Neal Clarification Act of 1997. The House vote yesterday in favor of this bill was gratifying and will help ensure that a dual banking system continues to thrive.
I also, on behalf of CSBS, would like to thank Chairman Helfer for the partnership with the State banking regulators that the FDIC has developed under her leadership.
Mr. Chairman, we also commend your efforts to modernize our financial system. CSBS believes that the keys to accomplishing this are to enhance competition in the financial marketplace, offer opportunities for innovation and products and delivery systems, provide flexibility to regulators and bank management, and allow the market to promote efficiency by preserving investor choice.
Regulation should not drive new products and services or new delivery systems; rather, the market should drive changes in the industry. Regulation in a market-driven environment can promote safe and sound behavior by supplying incentives for well-managed institutions and by limiting the activities of unhealthy banks.
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H.R. 10 includes many provisions that advance these goals.
States have traditionally authorized a wide range of powers for their State-chartered banks. These activities have primarily been in the fields of insurance sales, real estate agencies, sales of uninsured investment products and travel agencies.
Until 1991, States could also authorize their banks to engage as principal in a wide range of expanded activities. Section 24 of FDICIA restricted State bank activities to those permitted to national banks, unless the FDIC determines that the activity poses no significant risk to the deposit insurance fund. We ask that the committee consider streamlining this process by changing the current application requirements to a notice procedure. This would both reduce regulatory burden and help move forward with new products and services.
State initiatives have spurred most advances in U.S. bank products and services. When new activities emerge one State at a time, systemic risk is minimized. If an activity proves too risky, unprofitable or harmful to consumers, it is much easier for a single State to change its law than for the Federal Government to reverse itself.
When changing Federal law, we must preserve the States' ability to experiment independently with new products and services, new structures and new delivery methods.
State-chartered banks that are not members of the Federal Reserve System generally have the option of conducting their State-authorized expanded activities within the bank or through operating subsidiaries. In fact, many States that allow their banks to engage in expanded activities require that they do so through subsidiaries. This structure provides for consolidated supervision of a bank's entire business by the State bank supervisor.
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States may also require that subsidiaries such as insurance agencies receive separate licenses from the appropriate State regulator. This combination of functional supervision with consolidated oversight has worked well at the State level.
We feel strongly that banking organizations should have the option of conducting bank securities activities through subsidiaries as State law currently allows or through holding company affiliates. We are pleased that H.R. 10 incorporates the operating subsidiary approach.
As we learned all too well during the savings and loan crisis of the 1980's, the key to expanding powers is effective supervision. Therefore, State and Federal banking agencies must supervise any banking organization that engages in additional activities from the top down, and from the bottom up.
Effective supervision of the entire organization will reduce the need to enact specific firewalls into statute. Enacting rigid requirements into law almost always creates loopholes, while limiting the regulator's ability to address those loopholes. Regulatory guidelines are a better approach than rigid statutory requirements.
We are not comfortable with a functional regulation model that disregards the banking regulator's responsibility for the overall safety and soundness of the organization. However, we do believe that functional regulation may play an important role, especially in the area of consumer protection. Successful functional regulation will require the cooperation and coordination of all regulators involved.
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Toward this goal, we have formed a joint task force with the National Association of Insurance Commissioners and are in the process of forming a similar task force with the North American Association of Securities Administrators. These task forces will share information and coordinate our supervision of financial institutions toward our mutual goal: a wide range of safe, responsible, accessible financial institutions for our States' citizens.
House Resolution 10's proposed committee to advise the Federal Reserve board on activities that are financial in nature does not envision the participation of the States. We recommend that a State bank supervisor be added to this committee, either in H.R. 10 or in any similar proposal the committee adopts.
A significant portion of the assets that State bank supervisors oversee are held by foreign banks. Both H.R. 10 and H.R. 268 attempt to provide national treatment to foreign banking organizations operating in the United States, an effort we strongly support.
CSBS also heartily endorses H.R. 10's preservation of the State thrift charter. The choice of charter is fundamental to the dual banking system, and States are continuing to innovate by developing new charters. We cannot close this avenue toward future improvements in financial services.
State bank supervisors are an integral part of this Nation's banking system. Preserving the authority of each State to decide the bank structure, products and services that best suit its citizens' needs strengthens the system.
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House Resolution 10 is a good beginning to modernizing our Federal banking system. It recognizes that the lines between traditional banking and other financial services are disappearing. It provides for a system of comprehensive oversight. We look forward to working with you in adapting our dual banking system for the 21st Century.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you very much, Mr. Leary.
Before turning to Mr. Nichols, let me thank Mr. Blackwell and say, of course, he is excused; and we would like the right to send questions in writing, if you would agree to that.
Mr. BLACKWELL. Yes, sir. We will respond promptly. Thank you, sir.
Chairman LEACH. Thank you.
Mr. Nichols.
STATEMENT OF MR. GEORGE NICHOLS III, COMMISSIONER OF INSURANCE, COMMONWEALTH OF KENTUCKY, ON BEHALF OF THE NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS
Mr. NICHOLS. Good afternoon, Mr. Chairman and Members of the committee.
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My name is George Nichols. I am the Commissioner of Insurance for the Commonwealth of Kentucky, and I chair the National Association of Insurance Commissioners' Special Committee on Banks and Insurance. I would like to thank you for this opportunity to bring the perspective of State insurance regulators to this discussion.
All of us agree that insurance, banking and securities make up the core of financial modernization. Together, they can be symbolized as a three-legged stool.
The regulation of one leg is handled by State and Federal bank regulators, a second by State and Federal securities regulators. The bill that has been introduced recognizes those two legs. The third leg is made up of insurance regulators, State insurance regulators.
It goes without saying that no one will watch out for insurance consumers if we do not do it in the State. Kick aside one of those legs and the stool collapses, and along with it your efforts at financial modernization also collapse.
I want to offer you some insights today into many of the ways State insurance regulation benefits consumers. I also want to offer some background so that you might understand how and what State insurance regulation is about, and I also want to reiterate our support of functional regulation.
Safeguarding consumers is our primary mission at State insurance departments. Insurance is critical to nearly every American household. Insurance expenditures represent 6.8 percent of all household spending, placing it behind only the expenses for housing, transportation, food and retirement savings.
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Seventy-eight percent of American households own life insurance, the average owning about $160,000 in coverage. From life insurance alone, American consumers received $166 billion in benefits in 1995. Moreover, fully 95 percent of homeowners insure their homes. Insurance also affects consumers in another very tangible way, by providing over 2.2 million jobs.
Important regulatory safeguards are in place in every State. We have fostered a marketplace that develops competitive products. We know, based on our experience over the last 125 years, how to evolve with insurance markets.
We regulate an industry that wrote nearly three-quarters of a trillion dollars in premiums in 1995. State insurance departments nationwide enter over three and a half million consumer complaints on an annual basis. We employ nearly 10,000 people across the country and with a combined annual budget of some $700 million.
Mr. Chairman, now let me take a few moments to shed some light on just what we, as State insurance regulators, do for the people of our States.
Solvency regulation is our main tool of safeguarding consumers. The States and the National Association of Insurance Commissioners have developed some of the most sophisticated databases to monitor insurance solvency. Indeed, the NAIC houses the world's largest insurance financial database to which all States have instant on-line access. We have also developed state-of-the-art analysis and examination tools to accompany the database.
As much concern that was raised today for the FDIC's security, we also would hope that this committee would recognize the security of the guarantee association funds that exist across the country which are the financial safety nets of the consumers as related to the business of insurance.
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Market conduct regulation is another key tool of ours. Here, again, we have developed sophisticated databases to track the conduct of companies and agents so we can weed out bad apples.
The NAIC system of voluntary model law serves as an example States can use when establishing their own regulatory frameworks. In fact, Mr. Chairman, these model laws deal with many of the same issues with which you now struggle. For instance, the States have been working on an issue such as mutual holding companies for years.
Now allow me to offer some details regarding our support for functional regulation. To define the term, whoever conducts the business of insurance should be subject to State insurance regulation. In March of this year, the NAIC membership adopted a resolution that expressed our support for functional regulation. The resolution also put on the record our opposition to Federal legislation that would preempt State laws regarding the business of insurance.
To gain a greater perspective on functional regulation and the views of various interest groups, the NAIC held a public hearing on April 29th titled, ''The Road to Financial Modernization, Defining Functional Regulation.'' At that hearing, we gathered comments from consumers, insurance industry representatives, insurance agents, the banking community and the securities industry. Regulators from over 16 States received testimony from 25 witnesses, and we have been working with other State and Federal officials in support of functional regulation.
Governors and State legislatures agree with us that the expertise and experience embodied in the State insurance regulation must be acknowledged in any proposal dealing with financial modernization. We also have placed a priority on maintaining a dialogue with the OCC and have several joint efforts planned to foster a relationship.
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In addition, just last week we wrote to the Comptroller on the subject of the recently enacted Rhode Island Financial Institutions Insurance Sales Act. In brief, Rhode Island's legislation does not conflict with the National Bank Act. We are opposed to the preemption of State law by the Comptroller.
State laws are passed by legislators and signed by governors, both elected by the people. I want to reiterate that for State insurance regulators, the key component of financial modernization is safeguarding the consumers of our States. That is a call that we have been heeding for more than 125 years.
We strongly believe that one key component to our Nation's challenge of competition in a global marketplace in the evolution of financial services is a sound plan to carry out functional regulation. State insurance regulators must serve as equal partners in this endeavor.
Mr. Chairman, we stand ready to work with you and provide you with whatever assistance we can offer so that, together, we might come up with a plan that works.
We are appreciative of the comments that were made by the Federal regulators regarding their support of functional regulation. We are especially appreciative of Chairman Greenspan's comments that any function that, in terms of a structure, that an insurance company would own, that it would continue to be regulated or supervised by the insurance regulators.
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We appreciate the opportunity of being here with you today and are prepared to answer any questions that you may have.
Chairman LEACH. Thank you for that thoughtful testimony.
Mrs. Crawford.
STATEMENT OF MS. DENISE VOIGT CRAWFORD, COMMISSIONER OF SECURITIES, STATE OF TEXAS; PRESIDENT ELECT OF NORTH AMERICAN SECURITIES ADMINISTRATORS ASSOCIATION
Ms. CRAWFORD. Good afternoon, Mr. Chairman and Members of the committee.
My name is Denise Crawford. I am the Texas Securities Commissioner, and I am the President Elect of the North American Securities Administrators Association. We are the organization that is comprised of, among others, the 50 State securities regulators across the country.
NASAA, which is the acronym for our organization, has testified before the U.S. Congress a number of times on issues related to banks' entry into the securities business; and now we are very pleased to be before you today to discuss the issues associated with financial regulatory modernization.
That is really what we are talking about, Mr. Chairman and Members, is the regulatory modernization. I think that everyone has come to the conclusion that it makes some sense, some good sense, to have an expansion of activities among the entities themselves. That envisions a future where all products and services are available equally by all financial service providers.
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That future, of course, entails regulation; and one of the questions about financial services reform is whether or not that regulation is going to be Congressionally directed or directed by, in essence, the Federal banking regulators.
NASAA has been deeply disturbed by the efforts on the part of the Office of the Comptroller of the Currency to deregulate on an ad hoc basis. We don't think that this is healthy for the country. It is another reason why we are here before you today. We want to encourage you and commend you in your efforts to take on this huge task but one that is so vitally important.
At one of your hearings, Mr. Chairman, you mentioned that there was nobody there representing John Q. Public. Well, I am here before you today representing both John and Jane Q. Public. What I do every day is investigate securities fraud, bring cases against those who would violate our laws, particularly those individuals who violate the law to the detriment of older Texans, and my colleagues across the Nation do the very same thing on a daily basis.
We also are responsible for licensing individual securities agents or stockbrokers, if you will, on the State level; and, as was pointed out by the first panel, that involves much more than just taking an examination. It involves rigid background checks using sophisticated national databases. We check with the White Collar Crime Center, for example, and also check databases that are run by our fellow regulators in other areas.
There is a sophisticated screening process for these individuals before they are allowed to get into the business; and one of our deep concerns, Mr. Chairman, is not just the theoretical possibility but the reality that the bad brokers, those with the disciplinary histories, are going to migrate to the less-regulated environment. They will move from the mainstream securities business into banks and other financial institutions if, by doing so, they can evade the enforcement powers of State securities regulators and the screening process for licensing.
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We are, as you might guess, very strong proponents of functional regulation. It makes no sense to try to duplicate an extremely sophisticated system of regulation that is currently being carried out by experts in the fields.
What functional regulation means and how it would work are questions that you are having to wrestle with, and we understand that hard decisions will have to be made then. But when you do come to the point where you have to make those decisions, please bear in mind that there must be a place at the table for State security regulators, insurance regulators, and State banking regulators.
The Financial Services Advisory Committee that is being discussed in your bill, Mr. Chairman, makes good sense from our perspective if it is a coordinating body. If it turns out to be an entity that functions as a super-regulator, we see it as unnecessarily bureaucratic and perhaps even dangerous, because it would obviously have the ability to second-guess the expert regulators.
Echoing some of the remarks made by Chairman Greenspan earlier today, don't go too far too fast. This notion of allowing commercial entities into these areas raises a whole host of problems. You don't necessarily have to revolutionize the world. We just need to modernize. And we would hope that you would pay careful attention to the potential for great risks as a result of unstudied legislation.
In closing, Mr. Chairman, I would appreciate it if my written materials could be included in the record today. And, once again, I appreciate appearing before you here today and offer our services.
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Chairman LEACH. Well I thank you for that thoughtful testimony. And let me say that, without objection, fuller statements of all the witnesses will be inserted into the record if you did not read your full statement.
Ms. CRAWFORD. Thank you.
Chairman LEACH. Mr. Pledger.
STATEMENT OF MR. JAMES L. PLEDGER, COMMISSIONER OF SAVINGS AND LOANS, STATE OF TEXAS; CHAIRMAN OF AMERICAN COUNCIL OF STATE SAVINGS SUPERVISORS
Mr. PLEDGER. Thank you, Mr. Chairman and Members of the committee.
My name is Jim Pledger. I am the Texas Savings and Loan Commissioner. I also serve as the Chairman of the American Council of State Savings Supervisors, the national professional association of State thrift institution regulators; and it is in that capacity that I appear here today. I want to express our appreciation for the opportunity to be here and to offer ACSSS' views on financial reform and the modernization of our financial services industry.
This has been a fascinating panel today, all day long. Few issues are going to be more important in the continuing competitiveness of the American banking system as those that we have talked about today, and so we very much appreciate the opportunity to present our views.
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As the Nation's State thrift regulators, we learned firsthand the impact that Federal legislation can have on the dual banking system with the passage of FIRREA in 1989. As a result of FIRREA's duplication of regulatory activities on the Federal side and the higher regulatory cost imposed on State-chartered savings associations, the State thrift industry in many States virtually disappeared. It did disappear in a number of States, and in many other States it was severely crippled.
We appreciate and support many of the provisions in H.R. 10 that support and enhance the dual banking system. That bill ensures the rights of States to charter the types of financial institutions that they believe to be in their best interest, and it establishes the FDIC as the primary Federal regulator for State-chartered banks and thrifts.
House Resolution 10 also contains a 2-year transition period for converting Federally-chartered savings and loan associations to retain their existing powers. But after that point, States appropriately would continue to be able to authorize powers and activities for their financial institutions that are different from those available to national banks, subject, of course, to the review and approval by the FDIC for safety and soundness and risk to the insurance fund.
ACSSS strongly supports these principles as well as the merger of the insurance funds.
One of the key issues that this legislation deals with is the extent to which we should be considering combinations of banking and commerce. In this regard, as Congressman Vento pointed out earlier, there is already a mixture of banking and commerce in this country. Banks sponsor mutual funds. They sell insurance. They sell securities. Securities and insurance firms own thrift institutions, and some of the largest corporations in America own Federally-insured depository institutions today.
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Regulatory constraints exist that effectively deal with some of the risks that are associated with these combinations. Sections 23(A) and 23(B) of the Federal Reserve Act and Regulation O are effective constraints on abuses in these areas.
Furthermore, transactions involving holding company affiliates are very carefully scrutinized as part of the examination process for conflicts of interest and transactions involving affiliated parties in a holding company; and subsidiary financial institutions that are part of a holding company are subjected to the same kinds of supervisory and capital standards that are applicable to all financial institutions.
There are benefits to be derived from commercial affiliations between banks and commerce, notably broader managerial expertise and access to capital markets. We encourage the committee to at least use the experience of unitary thrift holding companies as a mechanism for evaluating how far in the future broader affiliations between banking and commerce can be carried.
There have been no indications of significant supervisory problems involving these combinations or higher risks associated with these affiliations, and ACSSS believes that the Savings and Loan Holding Company Act should not be eliminated.
We suggest that it is inconsistent and counterproductive to be curtailing similar activities of existing unitary S&L holding companies while the committee is simultaneously considering the expansion of affiliation and activity rules for bank holding companies. Until a final conclusion is reached on whether and to what extent these affiliations should be allowed, it would be premature to restrict these relationships in thrift institutions. If, in a few years, Congress does decide to broaden the affiliation relationships for thrift institutions, any constraints that you impose on existing unitary holding companies will have been unnecessary and will have been extremely detrimental to these institutions.
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As the dividing line between banking and commerce is relaxed for other depository institutions, holding company regulation needs to be limited to those functions that directly impact safety and soundness of the depository institution subsidiaries. The current system of savings and loan holding company regulation focuses on capital and transactions with affiliates primarily. This is a sound and workable solution and a very sound and workable system.
As we talk about functional regulation versus umbrella regulation, I think it is important to remember what the purpose is with respect to financial regulation. We need to be sure as financial institution regulators that we have jurisdiction throughout a holding company structure in order to address and deal with any transaction that affects the financial institution. So that if the inspection institution is involved with a security subsidiary in the holding company or securities affiliate in the holding company, the financial regulator needs to have authority to deal with that.
In the same respect, we also don't want to be securities and insurance regulators. If you sell insurance as a financial institution in Texas, you are subject to the regulation of the insurance department and, likewise, for the sale of securities; and we believe these are very important structural constraints that ensure effective compliance across the board for all kinds of financial services.
One of the issues of the bill that causes the most concern relates to the grandfathering provisions for unitary holding companies. The grandfathering provisions for holding companies is not only the most onerous part of the bill, but we believe that it is completely unreasonable and not consistent with an expansion of combinations between banking and commerce.
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We believe a convincing case can be made that if the authority for unitary holding companies is eliminated, existing S&L holding companies should receive a broad grandfathering without provisions for termination of those important rights.
We have proposed a number of changes to the bill. One of them, very important, the date for the grandfathering of unitary holding companies should be the date of enactment, not January 1, 1997; and we have offered a number of other recommended provisions to the triggers which result in the loss of grandfathering rights for these institutions.
Again, we would encourage the committee to allow these entities to continue to operate within the framework of their existing statutory and regulatory constraints if for no other reason than to learn more about combinations of banking and commerce so that we can determine how broadly these affiliations can be expanded in the future.
You have a perfect example already in place of institutions that have a broad affiliation, and to require them to scale back would be a loss of a very significant opportunity in the ongoing process of this modernization.
With respect to the elimination of the Federal thrift charter it is important to realize that there is no overriding safety and soundness or business reason to eliminate the Federal thrift charter. But we believe this is an issue that is strictly up to Congress and is completely within your jurisdiction.
In the same respect, we strongly support the provisions of H.R. 10 that recognize the legal and Constitutional right of States to offer whatever types of financial institution charters and regulatory structures that they believe to be in their respective best interest.
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We fully support the provisions requiring the FDIC to ensure that State-chartered thrift institutions are adequately regulated. The States are equally committed to ensuring that all depository institutions in this country are operated in a safe and sound manner.
Coming from one of the States that was most devastated by the late 1980's, I can report to you that the thrift industry is very healthy. But financial modernization does not need to leave these institutions less competitive than they are today.
If this effort at financial modernization does not result effectively in a chartering-up of the process, then it is going to be very difficult to call it modernization and is not going to be any reason for eliminating any financial institution charter. The goal should be to make all financial institutions more competitive and our banking system stronger.
In conclusion, Mr. Chairman, we strongly applaud your efforts to move this legislation forward quickly. Thrift institutions have been subject to unreasonable uncertainty as to the continued existence of their charters and their activities for entirely too long, and it is simply time to resolve these issues.
Thank you very much.
Chairman LEACH. Well, thank you all. Let me say I have agreed with 99 percent of everything that was said except Mr. Pledger——
Mr. PLEDGER. I understand.
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Chairman LEACH.——With whom I agree with about 40 percent.
And I would say, first, to Mr. Nichols, I think it is very important that we very definitively in statute place precise insurance language that assures State regulation of insurance. That is a critical part of going forward.
Mr. NICHOLS. Thank you.
Chairman LEACH. What Mr. Pledger is arguing for—and I think we have to be very careful about this—is the maintenance of a preferential charter for a limited number of institutions, and so this preferential charter is called a unitary thrift charter. And I would like to ask——
Well, first, let me just give some background. I believe you have to look at this legislation in the continuum of what this Congress has done over time and what has happened in the public. In this continuum, we had a problem in the 1980's of a very substantial debacle that occurred in the S&L industry. Somewhere between 5 and 15 percent of the public cost related to something called a ''direct investment authority'' in certain States, including Texas, in which the United States public lost, unrelated to the direct investment, $140 billion, over 30 years, two-and-a-half times that; related to the direct investments, probably in the nature of $10 to $15 billion in current dollar terms.
So Mr. Pledger is suggesting that we ought to keep in place the kind of structure that led to that taxpayer loss. As a conservative representative of the public, I must say the experience of the last 15 years is imperfect, and the case for doing that imperfect.
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Second, if you look for the balance of obligations, the United States public stepped in with 85 percent or so of the cost of the S&L debacle. Other existing S&Ls in the banking industry have stepped in for the rest.
So to suggest that those that stepped in, particularly in the banking side, will be left with a less positive charter than those that benefited is very difficult. And I will say, from the country's perspective, way over half of this occurred in a few States; and so we had a transfer of wealth. So for those institutions and those States that didn't get this public transfer of funds to come out at the end of the continuum with a chartered disadvantage relative to those that got the benefit, there is a lot of angst.
Now I will tell you that those institutions that currently have this power, they are well run, they are well managed, they are solid institutions. Because they have survived, they themselves may not have cost the taxpayers money. Although some of them benefited a great deal from picking up assets at a substantially positive price position, they have also benefited from an insurance fund that has largely been paid for by the strong people.
And for one element of the industry to come in and say it has had uncertainty in its charter after Congress has gone to put certainty into it with the placing a burden on commercial banks to bail out the last elements of the S&L debacle, I would say you have got a case for certainty. And the case for certainty is homogination, that we all have a single charter, not to end up with a preferential charter, which is in an element of fairness I can only say is mind-boggling.
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Then, when you know what that charter is—and I particularly want to address Members of the Minority side on this—unitary thrifts have the power to have 100 percent breaching of commerce in banking. They also, under their regulator, unlike the OCC and State banking regulation, have preemptory authority to go over CRA laws, consumer protection laws and a whole host of other laws.
This is one of the reasons why everyone is saying, in coming to the United States Congress, we want the unitary thrift model. All of us as Members of this committee have heard many people come to us and say, ''Charter up for the unitary model''; and I am asking people to say we must ask very defined questions of what it is we should charter up to.
I am for some chartering up. That is what bank modernization is all about. It is about chartering up to allow institutions to get into insurance, which is extremely important for your Texas institutions with two representatives of Texas here. It is to get into the investment banking arena.
But should it include preemption of CRA, preemption of State consumer protection, should it include full bore commerce and banking, and should it include it for the industry that has been bailed out by the other industry? I find this a case that lacks not only judgment but social equity.
I am asking all my colleagues to give very serious attention to this particular issue, because it is going to be one of the most dramatic, and it is one of the real shifts in the last 3 months that people—very powerful figures have figured out the unitary thrift charter is of enormous power. So they have come to this committee and they have said, ''It is too controversial for you to dare to tamper; but, by the way, we would be happy if you merge the funds. We would be happy, as you did last year, to take our obligations away from us, from the S&L industry; but we also want to keep the special powers.''
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And I personally think that this committee ought to reject this request and very strongly. I would also point out that the four principal national banking regulators that were here today unanimously took that position, firmly, unanimously, without equivocation.
So my question first to three of the panelists that haven't commented, Mr. Leary, do you believe you ought to have a differential charter at the end of the road with some having substantially greater powers and others substantially less?
Mr. LEARY. Mr. Chairman, I would respond to your question. I think whether or not to eliminate the thrift holding company charters is really a decision of Congress and up to the Federal Reserve governors in that regard. I would ask that you leave the States with the authority or the ability to continue to innovate.
I think it is important with respect to banking—and this may not be precisely germane to your question—that, with respect to banking, FDICIA gave us the Section 24.
In order for a State bank to have powers beyond that of a national bank, we have to go through a process. We have asked for a streamlining of that process. But there is an evaluation performed in that process of, does this activity constitute a risk to the fund? State banks are under that procedure at this point in time.
But, directly, I would answer your question, I really think the elimination of the thrift charter is an issue up to the Congress.
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Chairman LEACH. No, but there is a second issue here. I mean, we have the thrift charter. We also have a unitary circumstance. It is a differential charter.
And the real question is whether we have in the past had a different charter of two different functions? Now we have a charter of substantially greater powers.
And I would also stress to everybody here that the defense of this power has only been exercised as of at least June 30 last year by between a dozen and two dozen institutions. And for the sake of these two dozen institutions, the Congress is asked to make this enormous breach in what is called commerce and banking.
Then Mr. Pledger has suggested and objected strenuously to the grandfathering provisions that I have suggested in a model statute of mine, which is to protect people to do what they are, so we are not cutting back on individuals but saying they shouldn't be transferred.
If you go to the transfer right, what that simply means, and people should understand this, is that any major corporation from Citicorp to GM to whoever can simply buy up a unitary thrift of trivial size, de minimus size, and suddenly have full-blown rights of full commerce and banking as well as all the preemption powers that the OCC does not have, the Federal Reserve does not have, State regulators in virtually all States by State law do not have; and I am suggesting that that is as great chutzpah as a notion as I have ever entertained as a Member of Congress.
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Mr. PLEDGER. I think I would like to respond to this, Mr. Chairman.
Chairman LEACH. Please.
Mr. PLEDGER. First of all, let's talk about the distinction between unitary holding companies and direct investments. There is a vast difference between unitary holding companies and direct investments.
Direct investments were a serious problem. They were a serious problem, but they were all in either the institutions or in its subsidiary, meaning they all used depository institution funds. The unitary holding company is not depository institution funds. And we can get into the argument that took place earlier today about a subsidy. But we are talking about the holding company's activities——
Chairman LEACH. You are perfectly correct.
Mr. PLEDGER.——Completely distinguished from those of the depository institution, and in many of these cases the depository institution is a very small part of their overall business.
Chairman LEACH. And I would say, again, in the model I have suggested, we are grandfathering the right to have this outside ownership. There is no suggestion that one has to divest. The only suggestion is that you cannot use this structure to then make direct investments or whatever you might want to call it.
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Mr. PLEDGER. Well, I think the key is that——
And let me make one other point, and that is a point that Chairman Greenspan made this morning about once we cross over this line are we going to be letting the genie out of the bottle. And I would contend we have already let the genie out of the bottle for at least these institutions that are there.
Chairman LEACH. Well, it is de minimus.
Mr. PLEDGER. Well, then——
Chairman LEACH. If that is the case, Mr. Pledger, my first preference is divestiture of this; and I have backed off of this because I want to be as fair as I can to your industry. So I haven't pressed that.
But I say, in terms of hardship, all of these institutions in the last 4 or 5 years that I know of—and there are probably exceptions, there are about 700 of them. But only, again, a dozen or two dozen that have used these extraordinary powers have increased in value three- to five-fold. I mean, there is a huge market for them. So you are not talking about divestiture of one that takes losses.
I am willing to relinquish the precepted divestiture for grandfathering. And I will tell you, a year ago, your industry, that was virtually everyone I talked with, that was very appreciative. They wanted a little bit more, but they accepted it.
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Now in the last 6 months, last 3 months in particular, there is this new power verve, so it is more than grandfathering they want. They want the full right to be the only people left in the financial community to do certain things, which then gives them advantages and also skyrockets their potential value to outside people.
And I just think it is so preeminently unfair that it truly defies explication. And I think our effort to try to grandfather, to protect these investments which you and other people that have represented the industry now say is inconceivably unfair, after a year ago thinking that was, well, that is all right, I just think you are asking for a bit much.
Mr. PLEDGER. Well, first of all, our position has supported continuation of the unitary holding company structure in a very consistent manner over the last few years. But let me say this——
Chairman LEACH. And it has gotten an awful lot. And also everybody in your industry has well understood that there are tradeoffs.
I mean, last year this committee took a very strong stand on what is called the Frist Amendment, that there would be no merging in funds until such time as there was a consolidation of charter. I mean, this is not a position that as Chairman of this committee I am out on a hair on. I mean, we are, and everybody in your industry was more or less kind of cognizant of all of this, and your industry wanted very much for BIF and SAIF to be resolved, and we resolved it.
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Mr. PLEDGER. Absolutely.
Chairman LEACH. With a clear understanding that there would be a movement toward a consistent charter without anyone having a special preference.
Now you are coming in with the BIF/SAIF having been resolved, and then you are calling for a special charter, and I just think it is a bit much.
And I would also say that the reaction, I mean, in the rest of the financial community is enormously negative to this. I mean, every small bank in America thinks this is enormously unfair. The ABA has, the larger banks now have come to this conclusion. There are an exception or two among larger banks.
And, as we all know, there is a growing in which our committee has gotten a lot of information about. There are a series of very large interests in this country that want to get a unitary charter now so that they can breach commerce and banking. That is, a commercial company can own a bank and a bank can own lots of commercial endeavors. I just find it very difficult.
But I want to get Mr. Nichols' views. Do you have a view on this?
Mr. NICHOLS. No, sir. This is not something that we have taken up. We have began to look at some of the other banking issues.
I think, from a philosophical standpoint, where we would sit is still allowing States to be able to determine what the law should be, what is in the best interest for the constituents.
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Chairman LEACH. Ms. Crawford.
Ms. CRAWFORD. We do not have a position on this, Mr. Chairman.
But I will say, from a general point of view, we are in favor of a level playing field. So to the extent that this would create a situation where it is, you know, a lack of balance, we would have concerns about it.
Chairman LEACH. Fair enough. Thank you.
Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman.
I know my colleagues have been sitting here, so if they have to be on their way I would be happy to yield to them. But if they are going to stay, I wanted to, in a sense, amplify on what the Chairman said with regard to the merger of the funds; and I was very much a part of that agreement that we had last year with regard to merger and the Frist Amendment. I preferred not to have had that, but I think it is become increasingly apparent that there was some wisdom in doing so. I think this becomes really much more important.
I think the reason that Mr. Leary, Mr. Chairman, had trouble answering your question is because, in the context of his testimony, he elaborated on some of the commerce-like activities that are within some of the State-chartered banks. He illuminated some of them.
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So, even in the legislation you proposed and frankly, I am aware and I think most are aware, that you included the unitary thrift provision as a means of indicating the status quo in terms of a compromise, not as an invitation to expand the number or the activities. And just as we have in the legislation that you have introduced, the non-bank bank issue, which again takes the cap off in terms of growth, is again an issue. So I think this sort of underlines the issue in terms of how are we going to reconcile this commerce and banking issue?
And I think the real question that it sort of gets back to is with direct investment, which the Chairman and I agreed upon. Are we, in fact, writing legislation with regard to financial institution modernization that is possible to regulate? Can regulators actually regulate it or is this some leap in faith?
When I go back and read my statements in one of the first bills we passed along this line, I thought it was pretty much a leap in faith at that time. But the reality is—and I won't repeat myself—that, of course, these are converging. These activities are converging, and I think we are going to have an increasingly difficult time to treat them as if they are distinct. I think that they are converging, and they begin to look more and more like one another and behave that way, and we are going to have to do our best to regulate in this area.
I think insofar as the unitary thrift issue becomes more important when it becomes apparent that we are not going to have in place a policy path that permits some recognition of that in the marketplace, then I think that we look for, you know, for the non-bank banks or you are looking at a State charter versus a Federal charter, or you are looking at a unitary thrift versus a Federal? That is where and why I am there.
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And you talked about a level playing field; Mr. Levitt, the SEC leader, director, here pointed out that, under the legislation, because an insurance company and/or a securities—a broker has an equity position in terms of a corporation, that they have profits from that. They would obviously then be precluded from the opportunity to, in fact, own a bank and direct and control that bank.
Now, of course there may be some—maybe the operative word here could be ''control.'' There has been some suggestion about that. But how level a playing field is that going to be under those circumstances?
So if you talk to the insurance companies—and I am not talking about the retail sale of insurance which has, obviously, tied us in a lot of knots around here. I am talking about the entities that actually do the underwriting.
In essence, this discussion about trying to, if it works all right here in the rarified air of the committee room, about talking about them as separate. But they are not so separate when we begin to look at what the marketplace is like in this Nation in terms of how it has structured itself and globally. And, you know, therein lies the problem. And, of course, how the interregulatory structure fits with this is where you all come in to tell us what you can and can't do, you know, within whatever type of structure.
Of course, there are none of us that come to the table as a regulator that are in context. We have certain interests. You know, for instance, Mr. Leary points out that the FDIC actually regulates these products that these institutions and State banks offer. Isn't that correct, Mr. Leary, that under the FDICIA law that they have to approve the new products and looking at many of the old ones that you offer?
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Mr. LEARY. I think the power exceeds that granted to national banks. There is a regulatory hoop that must be jumped. That is concurrence of the FDIC that this new product or new service does not represent an undue risk to the fund. Yes, that occurs.
Mr. VENTO. They are not going back and looking at, in some of the States, 17 of the States have real estate. Real estate should get our attention, Mr. Chairman.
Chairman LEACH. Yes, sir.
Mr. VENTO. And it doesn't get much better than that, does it? And if a new State comes in and they decide to extend a real estate power to the financial institutions or the State-chartered banks, does the FDIC approve that then?
Mr. LEARY. I am not sure with respect to, if the State grants specifically that authorization to their State-chartered banks, does the FDIC have to approve it? I am not sure with respect to the answer to that.
Mr. VENTO. I don't know about you, Mr. Chairman and other Members. I am a little bit concerned about whether or not the FDIC or, for that matter, any Federal agency is ready to, in fact, tell someone whether or not the appropriate type of investment is appropriate. That is a concern I would have.
I mean, there is a question here, a threshold question of whether or not the FDIC, under the guise of the insurance fund, has the ability to, in fact, deal with that. I mean, I guess the assumption is they have it right now, and we have it, and it is differentiated in a variety of ways, you know, as you go through and look at what the expectations are with them.
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Does the FDIC, in fact, approve the insurance activities within a financial institution? Mr. Nichols.
Mr. NICHOLS. I would like to comment for a moment.
One of the things I think Representative McCollum is trying to get to that was not clearly answered by the panel that was here earlier is that if you conceptually say that we want financial modernization and we are going to combine insurance companies, banks and securities, you are already bringing commerce into the equation because of some of the current holdings of insurance companies.
It is interesting that we keep focusing on whether or not the FDIC will cover that or whether the bank will be allowed to do that. The real question is, are you going to force insurance companies to divest themselves of some of their large holdings?
Mr. VENTO. That is why——
Chairman LEACH. If the gentleman would yield.
Mr. VENTO. I would be happy to.
Chairman LEACH. We very, very precisely would not. And it is understood that insurance activities will continue as they are and will be regulated as insurance activities by insurance regulators.
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Mr. NICHOLS. I guess I am speaking of——
Chairman LEACH. And if you are asking the question does this—which is true—does it kind of mean a slightly different expansion of activities by people that haven't participated before? The answer to that is ''yes''—just as this bill envisions merchant banking, which envisions some expansion of activities. So that is absolutely valid.
But this is—and again coming back to Chairman Greenspan, I mean, this is in the nature of a controlled kind of step. But it isn't a leap into the wilds.
Mr. NICHOLS. Then, in that regard, are you still allowing that in this level playing field that an insurance company with these other holdings is allowed to own a bank?
Chairman LEACH. Yes, of course. Absolutely. There is total reciprocity.
Mr. VENTO. Well, you know, it is obviously an area where, Mr. Chairman, we see an equity position, ownership, and other types of activities. I think the major concerns may be not as great as anticipated. I mean, first, I think you have to start out with the idea.
I think one of the major concerns, quite frankly, that hasn't been brought up—and it isn't necessarily this panel's job to answer it—but where we have had similar financial institution modernization in Canada there is, I think, one independent large investment banking firm remaining. Others have all been purchased by banks.
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Ms. CRAWFORD. Mr. Vento, I would like to address that if I can.
Mr. VENTO. Yes, if you could.
Ms. CRAWFORD. NASAA has, as part of its membership, all of the Canadian provinces and territories. I chair the committee where they are represented, and they are very disturbed about that outcome. There has been a consolidation, and it has been exactly as you described, and it is worrisome.
Mr. VENTO. You know, the issue in terms of commerce and banking, which is important, yields major concerns and maybe we could be looking at some other aspects of this and how we could deal with it. Because that surely is going to happen.
Here we have already saved—for instance, if we are talking about a principal regulator who is going to regulate the bank in New York that works with the investment banker—I don't—you know, I would be happy to yield.
Chairman LEACH. Well, I think there is very good consensus emerging. The Administration bill is not an outline very different from the approach that I have set forth where you have the securities functions regulated by the securities regulator, the banking functions with the banking regulator, and then there is a belief that there may be cracks, in which case you might have an umbrella regulator of fairly like dimension. But these are all various approaches. And each one differs, but these are all very defined.
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Mr. VENTO. I appreciate the Chairman's effort, and I think part of this meeting, why it ended up being an interesting meeting, it ends up being the Chairman and Members talking. We ought to get together more often.
But I do think that, you know, much of the testimony today, even with regard to the affiliate, the holding company versus the subsidiary—in other words, Mr. Leary, you are suggesting that this particular model in H.R. 10 may be good for the Feds, but that is not what you want to see occur in the States. Is that correct?
Mr. LEARY. I think the States have and would allow both models there. I think generally States have approved activities and subsidiaries of the financial institution.
Mr. VENTO. I mean, the purpose for that is because we have approved it. Do you have any insights as to why institutions have opted for one of these particular corporate structures?
Mr. LEARY. I think mostly—and this is just a personal observation—if the institution has a holding company structure already, it is most comfortable with that structure and therefore carries out the activity in an affiliate. If the bank does not have a holding company or, for whatever reasons, is more comfortable with it as a subsidiary, it carries out that activity.
Mr. VENTO. The bill of the Chairman doesn't interfere with that particular State rule, but it changes when you get to the Federal level; it tends to change at that basis.
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I thought probably one of reasons why the smaller institutions tend not to be holding companies, they would rather go through a subsidiary, sometimes relates to size and their model of the market.
Mr. LEARY. I would agree, the options and the variety of reasons exist there.
Mr. VENTO. Mr. Chairman, my time as expired, and others are waiting.
Chairman LEACH. I appreciate your questions.
But not all of my bill is directed at the Fed. Part of it goes to expanding the OCC as well, particularly within the operating subsidiary function.
Mr. Hill.
Mr. HILL. Thank you, Mr. Chairman. And I want to explore what you and Mr. Vento were talking about with Mr. Nichols. My understanding of H.R. 10 would be that if we have an insurance holding company, which frequently today have commerce, extensive commerce. Manufacturing companies own insurance companies, hotel companies own insurance—my understanding of H.R. 10—I guess. I would ask you your understanding of H.R. 10. Those types of holding companies would not be able to buy a bank; that would be my understanding. And therefore we don't have a level playing field with those kinds of financial institutions.
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Is that what you are concerned about, Mr. Nichols?
Mr. NICHOLS. Our concern is that as you get into the conversation about the commerce piece of it, I don't think there is full recognition of what insurance companies are involved in, for one.
The second issue that is of great concern is the fact that true functional regulation says that the insurance regulator at the State level has responsibility over all insurance activities, not preempted by the OCC or any other entity. I think that was the most amazing thing to me this morning, I think it was a very, very good productive conversation that this committee had. The most interesting thing was, there was no discussion of insurance, and it seemed to be an afterthought in regard to that.
Mr. HILL. I did ask an insurance question.
Mr. NICHOLS. I am sorry, you did. There were some Members that brought it up.
But the thing is, if we are talking about a situation with a level playing field and true functional regulation, and the State regulators, and there is either an umbrella approach or something else, and you are bringing in a bank regulator or the OCC, first of all, that status quo, that is what we have today with the OCC making decisions, but you also have a group of people who don't have the understanding of insurance.
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If you talk about banks getting into the business of underwriting, and let's say they get into the business of underwriting and the property casualty business, and let's say Hurricane Andrew comes back. Now, are we ready to allow the bank to take on that kind of a risk and take the bank down? I don't think the banks have that kind of understanding.
I think the Academy of Actuaries has made a great point. Most of the discussion and comfort level that everybody is involved in today is that we have got to do something for banks. We think that is great, and we think bringing insurance companies, which we consider financial services companies, involved in that approach is good, but there is a difference between investment risk and insurance risk.
An investment risk, what was discussed here this morning, is talking about the loss of value associated with some investment, whether it be in a bank or security. But what we are talking about is the loss of personal property, be it my health, my home, my car. That is a different level of risk.
The risk associated looking out in the future is much, much different. What property casualty companies have to deal with, if there is a hurricane, what will be the loss, what will be the loss if 40 percent of city goes under water? Those are the things that I don't think have really been taken into consideration when we talk about this integration of the financial services world and what true functional regulation means.
Mr. HILL. And, Mr. Nichols, your members have the job of assuring the safety and soundness of insurance companies; right?
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Mr. NICHOLS. That is correct.
Mr. HILL. And you do very well at it. I often point out to people, at the time taxpayers were bailing out the savings and loan industry, insurance holding companies were replenishing the capital of insurance companies because of risks involving product liability, pollution liability, a whole field of things.
The case that you have just described is why I am a very strong advocate that insurance underwriting has got to be distinct from other financial services. In order for you to function, for you to regulate the safety and soundness, there has to be a fairly distinct entity here. Would you agree with that?
Mr. NICHOLS. I think it is easier if there is a distinct entity, and we have had discussions among our members whether that should be an insurance company or some other entity. For us at this point, not knowing all the details, as long as there is a separate entity that we can say that has an insurance activity and we can regulate it, it is much better.
What we get into is, if you are going to allow the underwriting inside the banks, do we have the authority to go in, or are we going to get in a battle with a bank regulator on a Federal or State level about that issue because it is within the bank? So we have always thought it is a lot cleaner to have that outside, whether it be an affiliate or subsidiary.
Mr. HILL. Mr. Chairman, I hope we have another round because I have some more questions in this area.
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Chairman LEACH. Thank you very much.
Mr. HILL. Thank you.
Chairman LEACH. Mr. Watt.
Mr. WATT. Thank you, Mr. Chairman.
I honestly was about to leave before you started your round of questions about the unitary charter. I had intuitively thought that there was something that I needed to ask some questions about and, in fact, had written a note to my staff person asking her to give me some background on this unitary thrift holding company charter. And then you got into a very interesting discussion, and now Mr. Hill has gotten into a whole new interesting discussion, so I am glad I stayed around. It is always nice to know that I can learn something from my colleagues, and I generally do. I don't mean that facetiously.
Let me ask Mr. Pledger: At least one of the questions that I put on the sheet to my staff person was: Are there any unitary thrift holding companies in North Carolina? I hate to make this kind of a parochial issue, but at least that is where I need to start from.
Mr. PLEDGER. There are not any that I know of off the top of my head.
Mr. WATT. All right. So I don't have to worry about the hometown politics of that issue.
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Chairman LEACH. If the gentleman will yield, there are about 700 in the country, so I assume there are some in North Carolina. There are 700 unitary thrifts. There are only one to two dozen that have used powers beyond what this bill authorizes.
Mr. WATT. Those are the ones I am looking for, first of all, because those are the ones that I guess are in controversy, because that is the question we have got to address, because it is what the charter ought to be authorizing these institutions to do.
The Chairman mentioned that those 6 to 12 are concentrated in one or two States. Where are those States? I guess one of them must be Texas. Otherwise you wouldn't be here.
Mr. PLEDGER. There are a few in Texas; there were a few in California; I think there was one in Ohio, just off the top of my head.
Mr. WATT. And the kinds of things that they are involved in that are outside the authorization of the regular bank charter are what?
Mr. PLEDGER. A whole variety of things.
Mr. WATT. Such as?
Mr. PLEDGER. Ford Motor Company was a diversified holding company. Beatrice Foods owned a savings association. Sears and Roebuck owned one. So it is—one of the largest ones in Texas is Timberland, a diversified forest products company. It is also an infinite list of possibilities.
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Mr. WATT. OK. And who regulates those now? I mean, who is the regulator and how does that—how does that non-bank—how does that commercial activity get regulated in the current structure?
Mr. PLEDGER. The private and Federal regulator for one of these institutions is the OTS, and they are regulated under the Savings and Loan Holding Company Act. There are very strict capital constraints. You talked this morning about constraints on distribution of capital. There are very strict constraints on transactions with holding company affiliates.
Mr. WATT. What is your response to the Chairman's—I don't think I have ever seen the Chairman quite as aggressive on an issue as he seemed to be on the issue related to your testimony. What is your response, if you have one, to his concerns about the tremendous value that those 6 to 12 institutions might have if we just allowed them to be transferrable and—I mean, it is one thing to grandfather them. But how do you respond to that?
Mr. PLEDGER. Well, the key is that when these institutions acquired savings associations, they acquired them at a time, or at least a number of ones in Texas that I know of personally, acquired institutions at a time when the Government was desperate for other entities to inject capital in savings institutions. And what they acquired was a savings and loan institution that could be owned by any type of corporation. And to say that if they sell it they have to sell it to a very limited scope of entities very well could diminish the franchise value of that entity to them.
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Now, it may not, but I think that at least an argument can be made that to expand that——
Mr. WATT. You sound like you subscribe to the notion that Mr. Greenspan—I was surprised to hear him say that, ''You either got to grow or you got to die.'' I mean, that is not what you are saying. You sound like you are saying, ''You either got to be able to sell or you got to die.''
I mean, these things can continue to grow on their own, I take it. Even under the grandfathering provisions, they just couldn't be sold and transferred to anybody else. Just the ability to grow and continue to operate as they are operating sounds to me like a tremendous advantage.
Mr. PLEDGER. It could be.
Chairman LEACH. If you will yield just further, to clarify Mr. Pledger's—they can sell to anybody as a financial institution. It is their unitary right that can't be transferred. So let us say——
Mr. WATT. They can build up another 10 years and then sell?
Chairman LEACH. That is right, but they can sell to any, you know, as any other financial institution can be sold. It is the unitary right that doesn't transfer. But even here they would be allowed to buy other unitaries or sell to other unitaries, or merge, of course.
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Mr. WATT. OK. Well, just as a matter of curiosity, maybe I can ask the Chairman at another time how he responds to Mr. Hill's concern about the insurance provisions.
Chairman LEACH. I think Mr. Hill raises fine concerns for which I identify. Actually, and again, there are different model bills with different approaches. The one that I have laid on the table——
Mr. WATT. Talking about H.R. 10.
Chairman LEACH.——Which is H.R. 10, specifically calls for State regulation of insurance. It is supported by the approach we laid on the table, all of the insurance interests that I know of, and, to my knowledge, has been pretty well supported by the insurance State regulators. And so I think our approach pretty well handles the issues Mr. Hill has raised.
Now, there are different approaches in other bills that may or may not—most of the other bills don't touch insurance at all. I don't want to mention people on the committee, but they just don't address the issue, which leaves Mr. Nichols in the awkward position, among other things, of being subjected to what many in his business, or both business as well as the regulators, believe is a Comptroller who might be encroaching in our attempts to set a framework of law. That framework of law is one that assures, in the insurance arena, State preeminence, under the understanding that we have to some degree been dealing with a bill called Glass-Steagall reform.
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There is another law called McCarran-Ferguson, which this country has had embedded since the late 1940's, which says you have State regulation of insurance. Our bill fully enforces that precept and also, in effect, says that any financial institution selling insurance products has to come under State regulation.
And so to my knowledge, everybody in that industry more or less supports our framework. There are, frankly, very subtle things that there are differences of opinion on about how you define insurance, and we worked at great length in that area.
Mr. NICHOLS. Mr. Chairman, we are appreciative of the fact that you did include functional regulation in your bill. The concerns, I think, that came out with us are: One, that insurance would be defined as those insurance products identified as of January 1 of 1996, which means that any products defined in the future that had an insurance component, we would only have a consulting role with the OCC, which then puts the OCC at determining what is insurance and not insurance. And there was another issue of preemption of redomestication issues in your bill that, again, we are getting right back to an issue of preemption of State laws related to the regulation of the business of insurance. And I think those are where our concerns are.
But we do recognize and appreciate your support of functional regulation.
Chairman LEACH. And we also have a methodology of resolution in which there can be legal appeals and so on.
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Mr. NICHOLS. But I think the legal appeal is the same one they have today, and what we have seen the courts do, the courts have shown deference to the Federal regulators and not State regulators.
Chairman LEACH. And here there is a difference of opinion. For example, banking authorities want to have the right to sell insurance, which I agree with, and then they don't want to have prejudicial rules against them. So how you define that language, frankly, the insurance people and the banking people have little differences in judgment.
Mr. WATT. I think that is something we can deal with. I think what Mr. Hill was raising is the ownership issue which I——
Chairman LEACH. It is a cumbersome banking issue, and what we have said is, that comes under State regulation and will stay as it is.
Now, what Mr. Hill also implicitly said, and what I caught was an implicit warning, was that insurance is a very difficult industry, and I don't think they necessarily think they are going to get into it with an understanding of terrific profitability. Maybe right; maybe wrong. And Mr. Hill as a prudent regulator has, in fact, placed a warning on the table that this is not a risk-free world and there is a role for good solid regulation, something about which I think he is quite correct.
And it would be my guess, frankly, that some banks will get into insurance and do really well, and some won't, and, likewise, there will be some insurance companies that get into banking and do well and some won't, and there is a role both for the market and for regulation to ensure that the public is not disadvantaged.
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Mr. NICHOLS. And one of the things, I don't know how it is—the issue of clarification is that even in the functional regulation, the importance of making sure that there is an equal plane which we are operating on, and not to be disrespectful at all to any of the committee Members.
In financial modernization, we are talking three issues that we already know we will agree to, but there was no representation of insurance this morning. It is here. And I recognize we are a very, very unique animal. I mean, even we recognize we are a unique animal because we are made up of our membership, we regulate individually by our States.
But the difference between me and my colleague sitting here is, there is no dual system here. There is one system of insurance regulation that has been in place for over 100 years. We have been able to manage that system. That system has grown under our regulatory authority. And if insurance is one of the pieces in the financial modernization, the hope is that Congress would recognize that insurance regulation is on an even plane with the OCC, and the securities—if we are going to be responsible, because it is the guarantee funds that provide the safety net if something falls apart, and now all those things are regulated today by the State.
Mr. WATT. I think I am inclined to agree with Mr. Nichols on that, especially—I mean, it is one thing to talk about allowing banks to sell insurance, but that gets to be even light years more true if you are talking about allowing banks to own insurance companies.
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Chairman LEACH. Sure.
Mr. HILL. If the gentleman would yield, could I comment on that, having been in the business of selling insurance? It seems to me what part of the rub here is that it is whom you can sell to. One of the things that makes insurance sales and insurance underwriting attractive to banks is that they can sell those services to their customers, and what I sold as an insurance agent was a list of customers. They have tremendous value.
So one of the questions the banks have concern about is, would some States allow them to sell insurance to their customers? Would other States not allow them to sell to their customers, which is discriminatory regulation or the potential thereof.
Another issue is that many States don't require the licensing of employees of insurance companies, but they do require the licenses of the agents, so there is a different licensing requirement; again, a discriminatory activity.
But the thing that I think concerns folks in the insurance industry that are underwriting companies is that if, because of their commercial affiliation, they are barred from buying banks, they don't have access to customers the same way that banks who could buy insurance companies would be able to sell underwritten products to their customers. In other words, you have an unlevel playing field being created.
Now, I have—I mean, I share a lot of the Chairman's concern about the concentration of economic power that is associated with commerce and banking, but in this particular area, if our legislation bars insurance companies from being able to access customers through an affiliation with a bank, but allows banks to underwrite insurance and market insurance to those customers, we have created an unlevel playing field, and that has to be addressed somehow or another, it seems to me, in this process.
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It does seem to me that we have two examples here, unitary thrifts and insurance, where we have commerce affiliated with financial services in which that has been a healthy relationship, it hasn't been a detrimental relationship, which certainly supports Mr. Baker's argument in all this. I haven't taken sides. I am just trying to figure it all out.
Mr. HILL. But if I could ask a couple of specific questions of you.
Chairman LEACH. Could we just hold off, Mr. Hill? We have long left with Mr. Watt's time. Let me come to you on a regular basis with your time.
Mr. HILL. I understand.
Chairman LEACH. And I think it is Mr. Bentsen's turn. Or is it Mr. Vento's turn?
Mr. BENTSEN. I think it is back to our side.
Chairman LEACH. Mr. Bentsen.
Mr. BENTSEN. Thank you, Mr. Chairman. I was concerned the Senate might finish debating the budget and we would be called for a vote before we got done, but we may have another 5 to 10 hours.
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There are a couple of issues. First of all, let me say, you know, Mr. Nichols, other than the other 10 or 15 issues that we have problems with, you have hit on a couple of them that are going to be issues we will have to deal with in the final bill. One is the whole commerce issue, not the broad commerce issue, but the small commerce issue, of how you develop a two-way street and whether it is 5 percent, 10 percent, 15 percent of whatever, and how we develop that equation, and so that is part of the problem.
The other, which we haven't talked a whole lot about—specifically, we have talked about it in the broad concept of the regulatory regime—is product definition, and you brought it up in terms of insurance. The securities people will certainly bring it up in terms of securities.
I can think of an example of derivatives is a hedge; an insurance product, is it a monetary product; is a counterparty agreement a security, or is it a trust product? So that is something that we are going to have to deal with. And McCarran-Ferguson is perhaps a blessing and a curse because on the one hand it preserves State regulation, but it disallows us from having somebody sit at the table this morning.
I have said repeatedly in these hearings that—and I want to be very clear I am not calling for this—but there is a case that could be made for Federal regulation of insurance just for this very fact alone, that then you would have one person to go to. But I want to keep my seat in Congress for a little while, and so I am not going to argue in favor of that. But it is a serious problem.
I also don't know that I agree with my colleague Mr. Vento. When you look at Canada, I am not sure you can completely compare—or comparably compare those two economies. In addition, previous experience would lead us to believe that when you look at the Section 20 experience with banks getting into the securities business, they have come to find that it is not all that it is worth, and if you look at American Express and their billion-dollar experience in the securities business, you will find that sometimes they realize that money is only made when things are good, and a lot of money is lost when things are not so good. So that is a problem.
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But let me turn to an issue with respect to consumer protection, and I talked this morning with Ms. Crawford about it, and I want to—I hadn't had a chance to look at your testimony when we talked, but in looking at your testimony you had expressed a concern that H.R. 10 and some others might—or the final bill might result in a preemption of those States which have State securities administrators which have regulatory oversight over both broker-dealers and bank securities activities which are not defined as broker-dealers, and that concerns me a great deal.
Furthermore—and you raise the issue which Mr. Levitt, your Federal colleague, raised about the possibility of transfer where bad brokers shift to somewhat unregulated areas. One, I would like to get your opinion on the idea of saying, instead of having similar-type regulation of bank securities sales personnel, why not just make them all subject to the same regulation, NASD regulation?
The other, you have mentioned in your testimony, and I would like clarification of this, that it is possible—it says it also calls into question the enforceability of Federal market conduct requirements such as the T+3 delivery rule.
I would like clarification of that. If there is, for instance, a double standard or dual standard of things like delivery, that is something that we need to clarify because I don't think there ought to be. I think it ought to be a uniform rule. So if you could comment on that.
Ms. CRAWFORD. Certainly, I will be glad to. First of all, we need to make a distinction between NASD self-regulation versus State securities enforcement regulation. The NASD, the National Association of Securities Dealers, is a self-regulatory organization that does have a membership that is comprised of just about everybody. However, it is an organization that is limited in its enforcement capability.
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It does not serve as a substitute for being licensed as an individual agent or stockbroker on the State level. And it is that screening process that I was talking about earlier that comes into play, a rather more significant extent on the State licensing level.
Also, with regard to criminal activity, it is the State securities regulators that essentially put people in jail. The NASD, for the most part, doesn't get involved in that sort of activity. Referrals are made to State securities regulators to do that.
So there is a big distinction between State-based licensing and self-regulatory organization activities.
Having said all of that, that is one of the reasons that it is so critical that State securities regulators have a place at the table. The SEC does not license individuals. They do have oversight of the NASD, but licensing is a traditional, historical State function, and we would be very concerned if this professional area suddenly became preempted, either literally or factually, because of the setup or the new regime of H.R. 10 or one of the other bills that is under consideration.
With regard to the T+3 delivery, that was used as just one example of many possibilities that could exist if banks operate outside of the traditional securities regulatory scheme. There are many, many Federal rules that broker-dealers and agents have to comply with that may not exist at all if the bank itself is engaging in the securities activities, or, at most, they may exist in the form of guidelines. In other words, there would ordinarily be no public enforcement-type action taken for their violation. They are just guidelines rather than enforceable rules.
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And again, things like T+3 become very critical questions when you are talking about international securities trades, for example.
So as much as anything else, I want to point out that the SEC and the State securities regulators do different things. It is a complementary system of regulation rather than a dual regulatory approach or a redundant regulatory approach. And we think that many of the consumer-based issues, in fact virtually all of the consumer-based issues, need to be addressed at this council or committee level, and we would like to have a place at that table when they are addressed because we are the experts in that arena.
Mr. BENTSEN. I would just say, Mr. Chairman, that certainly I would be concerned if there were settlement differences of similar securities within different institutions. I think consumers would be greatly affected by that.
I am also very concerned about the licensing issue. I would also say in our discussion with the prior panel, were we to go to some sort of roving council, as I think Mr. Greenspan suggested, and I raised the question of would it be the insurance commissioner or regulator of the State where the company is chartered, that perhaps, is the chief person? It may also be appropriate that you do the same with the State securities regulator as well. It may be more complicated, but those are subjects we have to look at.
Finally, and I know my time is up, but I just want to say, Jim, if you would look at—and I don't know where to come down on this unitary thrift issue. There are some in our State, obviously—that I understand the concern the impact divestiture has on value, and I agree with some of what the Chairman has said. I don't know if there is that much loss of value so long as the asset can be sold into the market. It just can't be bought by another commercial firm. There may be some discount that occurs, but it seems to me there is still liquidity which affects price. And so I would just ask you to think about that, and if you have any comments, to let me know about that.
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Mr. PLEDGER. OK.
Mr. BENTSEN. Thank you, Mr. Chairman.
Chairman LEACH. Well, thank you.
I might mention one other minor aspect of all of this, and I don't want to be too presumptuous in talking about a continuum, but on your price issue, Mr. Bentsen, that with the consolidation of the funds, the SAIF and the BIF fund, that have the effect of moving savings and loan values upward relative to where they were with banks; that is, commercial banks up to that point in time were selling about 150 to 300 percent of book; S&Ls were selling 75 to about 175 percent of book. With consolidation of the funds, that moved upward the relative valuation of the S&Ls as the commercial banks took on S&L liabilities.
So from an equity perspective, there already has been a valuation upward, and it is a very kind of subtle background to this debate today.
Also, I would only add that Mr. Nichols mentioning that there are no—it was interesting to me, there was no reference to insurance, but part of it was there were four noninsurance regulators, because we have where they are all national regulators.
Mr. NICHOLS. But they want to integrate what we do.
Chairman LEACH. Of course. I would also say that all of the regulators have been talking to insurance interests in a very active way, particularly the Fed over the last 6 months. So there is a recognition, among other things, of new issues that neither the industry nor the regulators have dealt with before. And I think you are bringing some warnings to the committee that are very well-founded.
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I don't have any further questions, but I know several people do, and I know Mr. Hill does, and I suspect Mr. Vento does. I don't.
Mr. Hill, please.
Mr. HILL. Thank you, Mr. Chairman.
Last week, I believe, one of the insurance agents and brokers groups testified in support of a program they are promoting that would provide for the creation of an organization very similar to the National Association of Securities Dealers to deal with the licensing of insurance agents. As you know, Mr. Nichols, this is a real problem for the interstate activities.
And their proposal would ban discriminatory practices such as countersignature fees; require a universal licensing application form and education requirements and that sort of thing.
I have some concern about that because I am a strong advocate of functional regulation of insurance at the State level, and this would at least seem to be a first step to break that down. But on the other hand, there is a real concern here, particularly given what I was talking about earlier, because not everybody who sells insurance is regulated the same way in every State or even within any given State.
So I would ask you, number one, do you believe that it would be possible, particularly in concert with the National Association of Insurance Commissioners, to have provisions in any modernization legislation that would create a mechanism that would provide for something similar to the NASB—or NASD for insurance?
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Mr. NICHOLS. First, let me comment that the proposal that the insurance agents and brokers were making we have concerns with because, again, you are correct, it leads to preemption, and that is not something that we would support.
I think I have to answer this philosophically from the standpoint of as we, as members of the NAIC, have begun to address this whole issue and recognizing there is a changing world in front of us, part of our discussion should be—if we have regulated and we have evolved over the last 125 years, which we have—then we, as an organization, should take the responsibility to address what you would call maybe, ''minimum standards.'' That those are things that we would do, because we understand the overall implication of that and not get into a situation where that, when there are certain issues that come up that agents may bring—or even companies would bring—that we take that to the Federal level and try to get some preemption.
I think that—I understand their frustration, believe me I do. But I do think it is better that since we have been doing this, we have the expertise in doing this, that if there is an issue of a minimum standard that is to be set in insurance, that it should be driven by the members of the NAIC and not by the Federal Government. I mean, that has been our belief, and I think that the issue that they raised, the issue that ACLI is raising about redomestication, the issue about antiaffiliation, those are real legitimate things that I think we as an organization need to face up to. And I think that we can sit down and say, how do we implement that across the country so that we can maintain a level playing field; we are not getting into situations where there may be potentially what some will perceive as discrimination issues against other participants in the system?
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I believe we can do that. We have done that. If you will look at historically the accreditation program, the same issue of us not being responsive, I think, occurred back in 1988 when we first started talking about the accreditation program. That program was implemented. There are 49 States that participate. The one State that doesn't, there are minor issues that I think we are moving toward addressing that may even bring them into compliance.
So I think that the NAIC has shown historically that we can address those real issues that agents and brokers are bringing up, that companies are bringing up, but we can do it within our system and recognize the overall impact that it would have on insurance regulation versus, yes, this is a problem, let's fix it, but it may create other things.
Mr. HILL. It could very well be, though, that this committee is going to get asked to have some provision in here for discriminatory practices, and I would just urge your association to be working with us to make sure that if that does occur, that it occurs in a fashion that truly does keep insurance regulation at a State level.
Mr. NICHOLS. Right.
Mr. HILL. But does address the fact that theoretically at least—and as I see it, almost all the proposals before us would not provide for a level playing field to those people who are selling insurance.
Mr. NICHOLS. That is correct.
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One of the other things that I would like to point out, when we talk about the preemption of State laws, is the value of the McCarran-Ferguson Act of giving stability. I agree with Mr. Bentsen that it is a positive and a negative to us in some regards, but what we do in New York is not best for what we do in Kentucky. And our ability to allow flexibility for some more sophisticated consumers in our market in Kentucky than those who are not so sophisticated, I think we should try to create that vehicle there. But to say that we are going to force something on Kentucky that they do in New York would be a very difficult approach for anybody.
I remember a bank board that I served on when we started Sunday hours, and then someone found out it was a thing they did in New York. Well, Kentucky is a part of the Bible Belt, and it was the worst thing we could have ever done. So, I really think that Congress, and even us, have to be very cognitive of the fact that we have allowed States to evolve. When Kentucky is ready, we can look to New York and learn from their experiences and try to implement it correctly.
But I think that is the value in something that is so very focused on consumer protection. Everything we do is based on consumer protection, not protecting deposits, not protecting investments. That is a part of the scheme, but ultimately, how do I protect the consumer?
Mr. HILL. Well, my time has expired, but I agree with you. One of the reasons I am a strong advocate of State regulation of insurance is the fact that probably more than any regulatory agency of any level of government anywhere, not just insurance, but in the areas of securities as well, you have done an outstanding job of seeing to it that consumers are protected and served, and I think that is why most everyone recognizes that. So it is very important to me.
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Mr. NICHOLS. Thank you.
Mr. HILL. Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Hill.
Mr. Vento.
Mr. VENTO. Mr. Chairman, just briefly.
Mr. Nichols, the discussion—or the absence of insurance discussion this morning, I think I even mentioned that you were going to be on this afternoon's panel so——
Mr. NICHOLS. I didn't mean to imply it, because I do appreciate the comments of any of the Members.
Mr. VENTO. No, no, no, no problem.
But I think much of the discussion that we have had, Mr. Chairman and the panel, on insurance, has focused on who can sell it. It hasn't really focused on the underwriting and the major functions. It has focused on who can sell it. And obviously, within many of our States, like in my home State of Minnesota, as you know, a goodly part of the insurance business is done within the banks already.
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Mr. NICHOLS. Right.
Mr. VENTO. I mean, like 60 percent. And so I mean we are usually talking about—and, of course, this is the issue. So when you start talking about underwriting standards or actuary experience or measuring risk, apparently they must know what they are doing. They can sell it, but, I mean, I don't know that they—you know.
Mr. NICHOLS. The debate last year, I guess, was on sales, and I think that is where everyone focused. It is interesting that in our meetings with other organizations, the bankers and securities, everybody says, ''Well, we know what you all do. You license people, and you address the issue of sales.'' And we do a whole lot more in that regard.
But I think that every State has recognized that the Barnett case gives banks the ability to sell insurance. I don't think that is the issue any longer.
Mr. VENTO. Well, you know, that obviously was the issue of discrimination. It was something that lived out there, so there is a certain element, even though they have had people come to the table and suggest to us that they now have, in light of the Barnett decision, yielding on that point. Then they proceed to send us legislative drafts that seem to contradict that particular issue and seem to take us into areas that are problems with regard to simply, you know, the sale of the product.
Mr. NICHOLS. And I think that is in some of the States, and I am not positive of the number, but I think there are only three or four States that may have antiaffiliation statutes.
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Mr. VENTO. These weren't born in heaven. These suits came about in the various States, the series of suits the last few years, because there was an effort to, in fact, curtail financial institutions' role in terms of at least the sale. Here, of course, we are talking about the underwriting and basic sharing the risk and the issue of whether or not insurance companies have commerce entities, and whether this will be a two-way street. I don't know what the solution is with regard to the State regulatory regime with regard to insurance. No one, I guess, is proposing to change it, but it does present us with a unique problem in terms of trying to deal with the issue of insurance powers.
So, there has to be some coordination that goes on in these instances, and that represents a special challenge, especially if you are proposing something that moves too far from functional regulation.
Mr. NICHOLS. We have been working very hard to try and assist everyone that is involved in this and how—first of all, we don't think there is a need for a Federal insurance regulator. I think that there are several reasons. First of all, the expertise already is sitting there in the States.
When you think about the number of people we have out there, the 10,000 folks that do this for a living, and we know about insurance regulation expertise that is out there, there is no sense in trying to create that on the Federal level. Then when you look at the budgets of over $700 million that we are investing in trying to regulate that, so I don't think there is a need to create a Federal insurance regulator.
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I think the NAIC, again, has historically shown its ability to evolve and respond to new challenges and new market developments in insurance. And that is what we are here to do now. The development of the special committee, the fact that you have allowed me to be here before you today, and what we have been involved in and what we are challenging our members to be prepared to do to make sure that there is a level playing field, consumers are protected, but that we are not barriers to the advancement of the globalization of our financial market.
We have been dealing with the international community. The international community is envious of what the insurance regulation is in America.
Mr. VENTO. Let me tell you that one of the problems, though, is, of course, the very firms that you regulate that, as Mr. Hill implied, are looking for the affiliation-type of synergy.
Mr. NICHOLS. And we want to help them get that because, again, if I am sitting here asking to make sure there is a level playing field, we have got to make sure our members are prepared to do that, too.
What we have said, though, is there was never a discussion—first of all, we know that people that we regulate are not going to like everything that we do and that they are going to take opportunities similar to this to go and try to get their cause advanced. But we have said to the ACLI, we have said to the AIA and to the agents and all other organizations, let's sit down and figure out what we need to do, where that is easier, and we begin to evolve as we need to so that we can keep regulation the way it is today at the State level, which I think is in the best interest of the consumers.
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Mr. VENTO. Thank you.
Thank you, Mr. Chairman.
Mr. NICHOLS. Thank you, sir.
Chairman LEACH. Well, thank you, Mr. Vento, and I want to thank the panel. You have done an absolutely wonderful job.
I want to apologize to Mr. Pledger. Among other things, I know he is reflecting his national association's perspective. It is more credible than perhaps I gave it credit, and I am sorry if I differed as strongly as I did.
But I want to also express my appreciation for each and every one of you.
Before ending, as long as there is another Member of the Minority present, I would like to ask unanimous consent to place in the record, in yesterday's record because it fits better, an article by a witness named Henry Kaufman, who was unable to join us. Without objection, so ordered.
This hearing is in recess.
[Whereupon, at 4:20 p.m., the hearing was adjourned.]
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