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H.R. 10—THE FINANCIAL SERVICES MODERNIZATION ACT OF 1999
FRIDAY, FEBRUARY 12, 1999
U.S. House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.
The committee met, pursuant to call, at 10:05 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding.
Present: Chairman Leach; Representatives McCollum, Roukema, Bereuter, Bachus, Royce, Lucas, Ryan, Ose, Biggert, Toomey, LaFalce, Vento, Watt, Bentsen, J. Maloney of Connecticut, Sherman, Lee, Goode, Inslee, Shakowsky, Moore, Gonzalez, and Capuano.
Chairman LEACH. The hearing will come to order. Today we continue on a third day of hearings on bank modernization legislation. We will hear from our distinguished Secretary of the Treasury, Mr. Rubin, who is joined by Assistant Secretary Carnell, and then we will hear from a panel of Federal banking regulators.
Let me just stress at the beginning that the hearings of the first two days have indicated there is greater consensus for moving toward bank modernization than I think has been registered before the Congress in recent years. It will be the intent of the Chair to move toward an orderly and timely markup, tentatively commencing on March 4th.
At the end of today's session, Congressman LaFalce and I will be issuing a joint statement indicating a desire to move forward with a committee markup with some compromises, recognizing that there will be a number of issues where there will remain differences.
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In any regard, we are delighted to have the Secretary of the Treasury, who I think will go down as one of the most formidable and thoughtful Secretaries of Treasury in the history of the United States Treasury, Mr. Rubin.
STATEMENT OF HON. ROBERT E. RUBIN, SECRETARY, U.S. DEPARTMENT OF THE TREASURY, ACCOMPANIED BY RICHARD S. CARNELL, ASSISTANT SECRETARY OF THE TREASURY FOR FINANCIAL INSTITUTIONS
Mr. RUBIN. Mr. Chairman, Members of the committee, I greatly appreciate the opportunity this morning to discuss our views with respect to financial modernization, including H.R. 10, and H.R. 665 introduced by Mr. LaFalce this week.
With respect to the overall objective of financial modernization, the Administration has always been committed to doing what best serves the interests of consumers, businesses, and communities, while at the same time protecting the safety and soundness of our financial system, and we will support legislation that achieves those aims.
Let me begin by noting that the financial services sector in the United States is stronger and more competitive today than ever. Abroad, the United States is dominant in investment banking, highly competitive in other fields, and as strongly competitive in commercial banking as any time that I can remember in my career.
Financial modernization is already occurring, as you well know, in the marketplace through combinations of firms and also through the development of products in one sector functionally similar to products in other sectors.
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Financial modernization will continue, in our judgment, in the absence of legislation. But with good legislation, financial modernization can occur in a more orderly fashion. The Treasury has long believed in the benefits of such legislation, but we also believe that any legislation has to be done right.
Let me also say, Mr. Chairman, though we favor financial modernization legislation, when you look at developments around the world over the last couple of years, the sorts of things that you and I were chatting about a moment ago, Mr. Chairman, the size of mergers that have taken place here in the United States over that same period, there are legitimate concerns about how financial modernization could affect economic concentration and systemic risk.
Let me turn now to the two bills before this committee. Both bills, H.R. 10 and H.R. 665, take the fundamental actions necessary to modernize our system by repealing the Glass-Steagall Act's prohibitions on banks affiliating with securities firms and repealing the Bank Holding Company Act prohibitions on insurance underwriting. Beyond that, however, there are significant differences between the two bills.
Today, I will focus on the concerns that the Administration has about H.R. 10. As you know, the Administration would have vetoed H.R. 10 had it passed in the last Congress, and we continue to oppose H.R. 10 in its current form. We have three basic objections to this bill: its prohibition on subsidiaries of banks conducting non-banking financial activities; its weakening of the effects of the Community Reinvestment Act, CRA; and its expansion without reform of the Federal Home Loan Bank System.
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First, the bill would prohibit financial services firms that include banks from conducting new financial activities through bank subsidiaries, and require that those activities be conducted exclusively through bank holding company affiliates. Subsidiaries and affiliates are absolutely identical with respect to the ability of a bank to transfer any subsidy that may exist in the bank. And subsidiaries and affiliates are absolutely identical with respect to safety and soundness, except in one respect, which I will discuss in a moment, in which subsidiaries are preferable.
The LaFalce bill, which allows banks to conduct merchant banking and securities activities through a subsidiary, contains the following rigorous safeguards that produce this result: Every dollar a bank invests in a subsidiary would be 100 percent deducted from the bank's regulatory capital, just as is the case with every dollar that a bank pays as a dividend to a parent holding company for investment in an affiliate. A bank would have to be well-managed and well-capitalized before and after such investment is deducted from its capital and on an ongoing basis. A bank could not invest any more in a subsidiary than it could pay as a dividend to its parent holding company for investment in an affiliate. The rules governing loans from a bank to a subsidiary would be exactly the same as they are for a loan from a bank to an affiliate.
Thus there are no public policy reasons to deny the freedom to choose either a subsidiary or the affiliate to conduct non-bank financial activities. However, there are four important policy reasons to allow that choice:
First, financial services firms should, like other companies, have the choice of structuring themselves in the way that they think makes the most business sense and this, in turn, should lead to better service and lower costs for their customers.
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Second, the relationship between a subsidiary and its parent bank provides a safety and soundness advantage. Firms that choose to operate new financial activities through subsidiaries are, in effect, keeping those assets available to the bank rather than transferring them outside the bank's reach. If the bank ever needed to replenish its capital, the bank's interest in the subsidiary could be sold, solely at the behest of the bank. If the bank were ever to fail, the FDIC could sell the bank's interest in the subsidiary in order to protect the bank's depositors and the deposit insurance fund, which means the taxpayers.
For this reason, the FDIC, a neutral observer with a paramount interest in protecting the deposit insurance fund, its current chairman, and three former chairmen—two Democrats and two Republicans—have stated that the subsidiary option is actually preferable from the standpoint of safety and soundness and protecting the deposit insurance funds. I would also like to observe that currently, under the Federal Reserve's jurisdiction, foreign banks underwrite and deal in securities in the United States through subsidiaries, and U.S. banks conduct securities and merchant banking activities abroad through so-called Edge Act subsidiaries.
Third, to the extent that the firms choose to operate through subsidiaries, the consolidated assets of the bank will be larger than if these activities are conducted through affiliates, and that, in turn, is favorable with respect to the Community Reinvestment Act.
Fourth, one of an elected administration's critical responsibilities is the formation of economic policy, and an important component of that policy is banking policy. In order for the elected administration to have an effective role in banking policy, it must have a strong connection with the banking system. That connection is currently provided through the Office of the Comptroller of the Currency, which regulates national banks. We believe if subsidiaries of national banks cannot be used to engage in new activities, then gradually banks will gravitate away from the national banking system and this critical connection will be lost.
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We also believe that it is very important that the Federal Reserve Board maintain its strong connection with the banking system. We believe that allowing banks the choice of conducting non-banking financial activities, either through an operating subsidiary or an affiliate, serves the purpose of having both the elected administration and the Federal Reserve strongly involved in banking policy. And I will have an additional comment in a moment, Mr. Chairman, on another way that we think the Federal Reserve's position can be preserved.
With respect to the subsidiary option, we support three additional steps: First, we proposed last year—and the LaFalce bill includes—joint Federal Reserve-Treasury rulemaking to define new financial activities. We believe that this arrangement would promote consistency and would eliminate the potential for unhealthy competition in laxity in defining new activities.
Second, we favor functional regulation. We support provisions like those in the LaFalce bill, making clear that securities and insurance regulators have the same jurisdiction over subsidiaries as over affiliates.
Third, we have no objection to—and I think this is quite important—no objection to requiring the largest banks to retain a bank holding company, thereby assuring the Federal Reserve a central supervisory role regardless of whether the bank operates with affiliates or subsidiaries.
Our second major objection to H.R. 10 is its effect on the Community Reinvestment Act. CRA encourages a bank to serve creditworthy borrowers throughout the communities in which it operates. Since 1993, a greatly invigorated CRA has been a key tool in the effort to expand access to capital in economically distressed areas.
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We believe that any bank seeking to conduct new financial activities should be required to achieve and maintain a satisfactory CRA record. The LaFalce bill includes that requirement, which we support. Although H.R. 10 requires a bank to have a satisfactory CRA record when it commences new financial activities, it does not require that the bank maintain a satisfactory record. If we wish to preserve the relevance of CRA at a time when the relative importance of bank mergers may decline and the establishment of non-bank financial activities may become increasingly important, the authority to engage in newly authorized activities should be connected to a satisfactory CRA performance on an ongoing basis.
Our third major objection to H.R. 10 relates to the Federal Home Loan Bank system. The FHLB is currently the largest issuer of debt in the world. Yet the system uses little of its Government-subsidized debt to further the system's original homeownership purpose.
We recognize the desire of many members to see the system lend more to community banks. Indeed, we believe that the system should focus on such lending, and not on using taxpayer funds for arbitrage activities and overnight lending which currently constitute so much of its activities. Changing this important system perhaps should be done separately, but if it is to be addressed in this legislation, we believe that changes in the FHLB system should occur only in the context of comprehensive reform.
Let me mention briefly two other areas of H.R. 10 where we have concerns. First, we believe that the current law on bank insurance sales is pro-competitive and pro-consumer and is preferable to H.R. 10's provisions, especially with respect to establishing safe harbors and restricting deference. Second, although creating wholesale financial institutions may be an appropriate step, we believe that developments in financial markets over the last couple of years raise serious concerns that need to be considered.
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Before concluding, I would like to say a few words about H.R. 665, the LaFalce bill. As I announced on Wednesday, we support the LaFalce bill. The LaFalce bill allows firms the subsidiary option, preserves CRA, avoids anticompetitive restrictions on bank insurance sales, and omits other provisions of H.R. 10 that in our opinion do not advance the cause of modernization. However, we support this bill with the caveat that we have serious concerns about the affiliation between commercial firms and depository institutions which this bill would permit.
Mr. Chairman, to conclude, let me reiterate: Our Nation's financial institutions are strong and highly competitive, both here and abroad. In our view, financial modernization legislation can produce significant benefits, but the job must be done right. We in the Administration look forward to working with you and others in Congress more broadly to construct good financial modernization legislation that serves the interests of consumers, businesses and communities, while protecting the safety and soundness of our financial system. Thank you, Mr. Chairman. The two of us now would be delighted to respond to questions.
Chairman LEACH. Thank you.
Mr. Carnell, did you want to make an opening statement?
Mr. CARNELL. No, thank you, Mr. Chairman.
Chairman LEACH. Well, first let me just say we certainly welcome your appearance and recognize there are differences of judgment on certain aspects of the approach before Congress. One of the frustrating aspects of this bill, as everyone knows, is that there are differences between and within industrial groups. There is also a difference between and within the Administration on the issue of regulation.
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At the end of Chairman Greenspan's presentation, I asked if he would be willing to meet with you and appropriate Members of Congress to help work this out and he affirmed that he would. Is that likewise your situation?
Mr. RUBIN. The answer to that question is yes, Mr. Chairman, if I could say one comment. The Federal Reserve Board and this Treasury have had a remarkable relationship. People who have been around a long time have not seen anything like the close relationship that we have had, and I think it has been a great benefit to the country across a broad array of issues. This is an area in which we have agreed to disagree. We have discussed it many, many times. We are each in the position that we are in. But having said that, if you would like us to get together with you, we would be delighted.
Chairman LEACH. I think that the Congress would certainly feel most comfortable if there is a meeting of the minds between the Executive Branch—and that doesn't mean that Congress would ever give carte blanche to such a meeting if it did occur, but I think that the resolution of this issue involves many, many nuances, and the last thing that I want to see precipitated is a circumstance where we have a Treasury-Federal Reserve Board cataclysmic rupture. The fact that at various points in time there has been unwillingness to discuss the issue on a mutual basis is disconcerting. I think it would be good for the Congress, as well as good for the public at large, to have this occur.
We had Chairman Greenspan express the view on this one subtle issue of the operating subsidiary that he could not support this bill if it came up a different way. We have the Secretary of the Treasury articulating before this committee that he would recommend a veto of the bill if it comes up the other way. That is a dilemma of fairly profound significance, given in particular the fact that structurally speaking, both approaches work, as well as points in between work.
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That being the circumstance, it strikes this Member, and I think I frankly speak for many on this panel, although I always hate to presume on anyone else, that there is an element of frustration. It was reflected by industry groups or industry individuals who testified before us as well.
And so I am hopeful something can be done. And that is all I am suggesting, as strongly as I can, and I am hopeful that we can get out of the element that we get two very strong individuals, as well as two very strong institutions, outside the realm of conflict on this very substantial and important circumstance.
Mr. RUBIN. Could I just say one more thing? You used the term ''cataclysmic rupture'' between the two institutions. Let me assure you we have lived with this difference for over a year now, and we continue to have an extraordinarily good working relationship. My guess is, having discussed this many times with Chairman Greenspan, that there is not a place that we can both get to, but I am confident that our very good working relationship in all other respects will continue unaffected.
Chairman LEACH. Thank you.
Mr. LaFalce.
Mr. LAFALCE. First of all, I want to thank the Chairman of the committee. We had a meeting this morning where we just agreed to agree as much as we potentially could, and agreed to disagree agreeably on those areas where we do disagree. But I think it was very, very productive in setting the tone and I look forward to working with him. We are both committed to producing good modernization legislation and we would like to come as close together as we possibly can. And when we can't, we will vote different issues up and down and draw final conclusions at the end.
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I also want to congratulate the Secretary of the Treasury, too, and commend him for being so conciliatory and bending over backward to find something that might be acceptable to the Federal Reserve Board on this issue. Certainly, Treasury came a long way before I introduced my bill along with Congressman Vento and Congressman Baker and Congressmen Mascara and Ackerman and others, cosponsored yesterday by Congressman Dreier also.
And in your testimony today you have gone even further in the spirit of compromise, in making the statements as to what you could live with. They go even further than our bill has gone, bending toward the Federal Reserve Board. So I just wanted to make that point. I thank you for it.
Mr. Chairman, I have an article giving a certain perspective on the issue of the so-called subsidy. It is entitled ''Exploding the Myth'' and I would like unanimous consent to insert it in the record.
Chairman LEACH. Without objection.
Mr. LAFALCE. Thank you. And now if I could just ask a few questions, Mr. Secretary, a combination. Yesterday, Chairman Greenspan referred to our concepts of operating subs creating a universal bank, and I think that is a bit in error. I would like you to give me your thoughts on that. And also I would like you to tell me if we have any experience with banks using subsidiaries, or is this a new idea? Both of those questions.
Mr. RUBIN. OK. On the first one, Mr. LaFalce, universal banks are a European concept. That is not what we are proposing. Universal banks, as I understand them, conduct non-banking activities directly or through subsidiaries that they fully fund. There are no funding restrictions. That is my understanding of how the universal bank works. That is not, absolutely not, our proposal—your proposal.
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Your proposal is that whatever can be done in the subsidiary in terms of equity investment or loans is no greater than what can be done in an affiliate. And as I said in my opening statement, if there is going to be an equity investment by the parent in the subsidiary, that can be no greater than the investment that can be made in an affiliate and has to be 100 percent charged against the capital of the bank, just as it would be if the bank paid a dividend and the holding company put it into the affiliate. And, furthermore, loans to the subsidiary cannot in any way be greater than and must be done in precisely the same way as loans to an affiliate. So there is a total identity between the affiliate and the subsidiary. These are very substantial restrictions, and they are the antithesis of how the universal bank works.
Mr. LAFALCE. And what about experience? Is the concept of an operating subsidiary a new idea or is this something that there is some historical experience that we can look to?
Mr. RUBIN. There are at least two situations in which this exists right now. The Fed will permit an American bank to conduct non-bank financial activities abroad in what is called an Edge Act subsidiary, and that is subject to Fed jurisdiction. And the Fed also has jurisdiction over foreign banks that wish to conduct non-bank financial activities in this country. The Fed has approved something like 18 of these applications to conduct so-called Section 20 activities, through subsidiaries.
Mr. LAFALCE. And that is not even taking into consideration the experience of operating subsidiaries for State-chartered banks, and I think there are a great many States that have specifically legislatively authorized this, and some bills would preempt that State law and obliterate what States have long permitted; is that correct?
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Mr. RUBIN. That is correct. The reason I mentioned the two I did, Mr. LaFalce, is that those two involved Fed jurisdiction and Fed approval. But what you said is correct.
Mr. LAFALCE. Thank you.
Chairman LEACH. Thank you.
Mr. McCollum.
Mr. MCCOLLUM. Thank you, Mr. Chairman.
Mr. Secretary, I think it was on Wednesday, the Community Bankers were not surprising us, but they expressed a strong desire to close the so-called unitary thrift loophole. The LaFalce bill doesn't address that. Do you have a view on it?
Mr. RUBIN. Well, our view, Mr. McCollum—and it is a view that I think has been affected by the experience of the last couple of years—our view, and I stated to some extent in my opening statement, though not with the clarity that you are posing the question—our view is to have very serious reservations about any combination of depository institution and commercial activity, and that would include continuing to go forward with unitary thrifts.
We do think that the resolution that you reached last year on H.R. 10, the—allowing them to exist, but on a grandfathering basis, but not permitting them to go forward, seemed like a reasonable resolution. But I think there are a lot of reasons to have serious reservations about this combination.
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Mr. MCCOLLUM. What do you think about the suggestion of allowing the existing unitary thrifts to be sold to other entities without allowing any new unitary entities to be formed? That is a topic of hot debate.
Mr. RUBIN. I gathered. Let me make sure I understand the question and I will give you my view. You are talking about an existing unitary thrift holding company?
Mr. MCCOLLUM. That is right.
Mr. RUBIN. Being sold to some other commercial entity?
Mr. MCCOLLUM. That is right. As they are now permitted.
Mr. RUBIN. As they are now permitted. I guess to me that raises a lot of the same questions. I think that anything that enables a broadening of the relationship between depository institutions and commercial activity, I think raises the same kinds of very serious concerns that I mentioned a moment ago.
Mr. MCCOLLUM. So you would prefer to allow the ones to exist that exist, but you would freeze them in place in all respects, in essence, not allowing new ones to grow and not allowing old ones to be transferred or sold?
Mr. RUBIN. As I understand, that was the resolution that you all reached last year.
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Mr. MCCOLLUM. That was the way the bill read, although there was a lot of debate over that and there still is a lot of debate over that. Thank you for that. Let me ask you about the question more explicitly, too, on commerce and industry. I know the answer based on what you are saying. Do you support the 15 percent commercial basket in the LaFalce bill?
Mr. RUBIN. We would, again for the same reasons, have very serious reservations.
Mr. MCCOLLUM. What about the definition that Mr. Greenspan gives us of ''subsidy'' in terms of banks? He says the fact that banks have deposit insurance, access to the payment system, and the discount window, creates a subsidy which means that banks can raise funds more cheaply because of their Government benefits.
Is that—do you believe that is true? Not getting into the question of whether or not you think we ought to have this done in subsidiaries.
Mr. RUBIN. Two comments in response to that question. One, they may well be subsidies. I think it is a little less clear than the statement you just made, because they do pay for insurance and they are subject to regulations and those regulations have costs. So I think it is little less than absolutely clear that they have a subsidy, but they may well have a subsidy.
And I guess my other reaction is that it is very hard to know what to compare a bank to. For example, if you compare it to a finance company with the same rating you may say the bank's financing is cheaper and that is probative. I guess my answer would be that finance companies are in very different businesses than banks. So it is very hard, I think, to infer subsidy from differences in cost of money between institutions that are engaged in somewhat or in many cases quite different businesses.
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Mr. MCCOLLUM. But would that so-called subsidy give an advantage to a bank in terms of competition in the future if we have more powers or more—you know, insurance, and securities and so forth, as opposed to a business in that area that doesn't have any affiliation in any way with a bank?
Mr. RUBIN. If, indeed, there was a subsidy—and for the reason I just said I think there may be, but I am not absolutely clear there is—if there is a subsidy, then that obviously is a subsidy that a bank can use to get some competitive advantage. And I will add, if I may, that has nothing to do with the question of an op-sub or affiliate that can be transferred to either one.
Mr. MCCOLLUM. You got to the last question and I don't have to ask it, and I will yield back to the Chairman. Thank you.
Mr. RUBIN. You did it in a very orderly way, though.
Chairman LEACH. Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman.
Mr. Secretary, we appreciate your positive participation and notwithstanding your efforts to try and reconcile this, the answer in this morning's paper and yesterday didn't seem to come back very conciliatory. In any case, my observation, not yours. We know where we are. I think the issue is if regulators can't agree, we can obviously move forward on this issue. I think it is an issue that we would prefer to have some agreement on or, as we put it, some comity.
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One of the issues here is, with the umbrella regulators, there are a number of instances where insurance individuals—we have passed a lot of the decisionmaking role to the Federal Reserve Board. We call it ''Fed-lite,'' but it is like lite beer. It makes you feel good because you are taking in fewer calories, but just as potent in terms of the amount of alcohol that is in it. This is sort of like the umbrella regulator.
In light of the fact that in the past some of the Federal Reserve Board Governors have lamented about the amount of bank regulations and responsibilities which Congress has given them, the fact is that—I mean, the question that has to be asked is whether or not adding these additional responsibilities, whether they are ''Fed-lite'' or whatever, are in fact going to be—how they are going to be exercised?
Are you satisfied with the concerns—for instance, some of the insurance, State insurance regulators suggest that the Fed, in terms of defining the responsibilities between an affiliate, an insurance affiliate and a bank affiliate, would define the nature of the instruments without guidance. Do you think we should have more guidance in the bill, and do you think that Treasury has enough voice in the case of defining these various instruments?
Mr. RUBIN. We support a strong Fed involvement in bank regulation, and I said that in my statement. I think in terms of the second-to-last issue you raised, it seems to me an appropriate way to deal with that kind of issue is with joint rulemaking between the Fed and the Treasury.
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Mr. VENTO. I agree that so far as we can do that, I think it is appropriate. One of the issues yesterday—what we are doing is sort of redefining or rewriting history, and I wanted to get your view on this. The issue was brought up about First Option and Continental Illinois. The problem that First Option had with regards to the sub, putting—the affiliate putting in money, and the OCC had ordered a cease-and-desist order and the Federal Reserve Board actually ordered money to continue to be pumped in through the affiliate. How do you see that particular problem and what do you think the remedy is to that?
Yesterday, of course, we had the Fed describe the problem as the problem of the op-sub, and using it as Exhibit A that the op-sub was the problem. In reviewing this more closely, by the time we got to the afternoon and the Chairman had left, it was pretty evident that the Federal Reserve Board had been involved as to avert problems in the market, and I don't discourage them from averting problems in the market. We saw that with Long-Term Capital recently, although they claimed to have done nothing more than bought the sandwich and the coffee, the fact is that most us think they may have had a little different role in terms of it.
Would you like to comment upon not just this type of intervention, which I think both of us might agree in a mixed economy is not a bad idea, but as to whether or not one of these governance structures one of these corporate structures is superior to the other?
Mr. RUBIN. Mr. Vento, on the question of Continental Illinois-First Option, I actually remember that somewhat. That was I think on October 19th, 1987. In any event, on the basic question of whether there was a scintilla of difference between an op-sub or an affiliate in that kind of situation, the answer is no.
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If an op-sub very rapidly gets in serious economic trouble and starts generating very large losses, the op-sub can be liquidated, sold, divested. As soon as it is divested—and this gets a little technical, I know, if the bank's books reflect any losses beyond its equity investment in the subsidiary, those will be reversed. In the final analysis, there will be no equity loss in the bank because the equity that has been invested by the bank in the op-sub has been 100 percent charged off against the capital of the bank, so there is no more that can be lost.
If there have been some loans from the bank to the subsidiary that go bad, the result will be precisely the same as—identical to what would have happened had the activity been done in an affiliate. Because there, too, there can't be any more loss on the equity, since that has been 100 percent charged against the bank's capital. And if there is a problem with the loan, that loan is no different, zero different, than the problem with the loan to the subsidiary, since they are both made subject to Section 23(a) of the Federal Reserve Act.
Mr. VENTO. One additional question. Federal Reserve Board Governor Meyer has lamented the fact that we have in the Interstate Banking and Branching Law a 10 percent limit on the total size of assets—I think it is assets or deposits—with regard to total assets in the financial institutions in the country with regards to banks. In fact, Nations has pushed up to 8 percent. When we wrote this into the Interstate Banking and Branching Law, I don't think anybody exceeded 2 or 3 percent.
I know you commented in your opening statement about the mergers and the growth of institutions. And so my—I don't know if you are prepared to talk about this this morning, but you are concerned about the 10 percent limit?
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I just would suggest to you that myself and others on the committee here wrote that into law, the 10 percent limit. You talked about mergers and acquisitions, so I would like your views on that.
Mr. RUBIN. It is 10 percent of nationwide deposits, I think, Mr. Vento. I haven't thought about it. It is a good question. I have not thought about it in terms of that law. My comment was that as you see aggregations of economic assets, particularly in the financial services sector which is so central to the economy, you can begin to have concerns about undue concentration, but I didn't relate the concerns to that statute.
Mr. VENTO. I think it is important because I do think it is something that is coming up, and obviously from our constituencies we are getting feedback from this and what the evolution is going to be in terms of the concentration and the lack of relationship in terms of services, which I think gets back to why we need strong consumer provisions in this bill as well.
Mr. RUBIN. I do think on the LTCM case which you asked me about, I do think that the Fed acted—I am no great expert in it, but based on everything I know about it I do think that the Fed acted appropriately and usefully.
Chairman LEACH. Mrs. Roukema.
Mrs. ROUKEMA. I guess I must say, Mr. Secretary, that in answer to one of Mr. Vento's questions you went very quickly through your explanation of how it really didn't make a difference and none of the things that the Fed is saying about the capital standards between the affiliates and the operating subsidiaries hold weight, but I think you went through that a little too quickly. But we will go through your testimony and get the refutation.
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I want to explore a different aspect of this issue. Needless to say, I am more favorable to the holding company structure than the op-sub. But we have talked—you have talked extensively, as have we both here today and with Mr. Greenspan, about compromise, and you have suggested joint rulemaking as one aspect of that compromise.
I wish you could be a little more explicit about that. But in the context of my concern that there is far more to this than just turf, as I am convinced, I am also concerned that, as you pointed out, the question of the Administration and your argument, the Administration and the OCC being very concerned about the economic health of the country and that is one of the leading reasons why you believe you should have more authority here, I see the reverse. I see the other side of that coin, however, as being a potential for political manipulation, and that has been rampant in many of the European, certainly the Asian countries in their system. It has been so interrelated to the ruling government.
So I wonder if you can respond to that question. Yes, we are looking for compromise, but not a compromise that is going to compromise the basic principles here that we are talking about, and not one that would invite political manipulation of the system.
Mr. RUBIN. I think it is a good question, Mrs. Roukema, and I think particularly if you look at what has happened in some of the Southeast Asian countries, you cannot help but ask that. The reason for my fast answer to Mr. Vento's question was not a desire to be obfuscating, it was just that you have a five-minute rule. I could go on, if the Chairman would give me an hour.
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Mrs. ROUKEMA. With all due respect, I understand that, and I will go over the testimony, surely.
Mr. RUBIN. But on your question, I think there are a number of distinctions that need to be made. One, if you take a look at what happened in Southeast Asia, a lot of the trouble actually came from an unhealthy nexus between the banking system in industrial countries and what I would call industrial policy, if you will, in the central government. It is one of the reasons why we have very serious concerns about the banking and commerce issue or more generally depository institution issue here.
In terms of politics, whether it is appropriate for the elected Administration to have a role in bank policy, I would break this into two pieces. With respect to supervision, we are prohibited by law from getting involved in case-specific matters, such as supervision of banks. With respect to broader banking policy, I don't see that as being any different than economic policy more generally or transportation policy or foreign policy or anything else.
These are all very important to the country, and certainly an elected Administration's position with respect to its full range of responsibilities can be used properly or misused, and I think it is the responsibility of people in elected office to use it properly. But it is possible for an Administration to badly misuse its accountability and responsibility for transportation policy.
Mrs. ROUKEMA. That is a little different. But could you comment further on the joint rulemaking, how you would see that as operating in practical terms?
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Mr. RUBIN. I think certainly one of the questions that will arise is, what is a non-bank financial activity? And my guess is you are going to see all kinds of hybrid things that are going to have to be decided. Rather than have the Fed do it for the Fed and the Treasury or OCC do it for the OCC, which has a number of potential problems associated with it, it seems to me what you should do is have the Treasury and the Fed sit together, as we do in a number of other areas now, and decide what these definitions should be. I think that is the way to avoid a lot of the problems that come from competing regulatory bodies.
Mrs. ROUKEMA. Can that be written into statute?
Mr. RUBIN. I think it could be. We would be glad to work with you on it.
Mrs. ROUKEMA. Thank you. I yield back.
Mr. RUBIN. One of the other things that does strike me is on this question of whether elected administrations are properly performing their role with respect to any policy, including bank policy, we also have IGs and congressional oversight and GAO, so there is a whole body of oversight that is built in to try to make sure that that happens.
Mrs. ROUKEMA. Thank you, sir.
Chairman LEACH. Mr. Watt.
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Mr. WATT. Thank you, Mr. Chairman.
Let me start by first complimenting the Chairman, again. I think this three days of hearings has been inordinately beneficial, perhaps even more beneficial to those of us who have been around and heard this debate one time before, because we have some context within which to put it. I am not sure how beneficial it has been to those who have been around and heard it 15 times, but for one of who has heard it only two or three times I do think it helps a lot.
Mr. Rubin, I have been an advocate of your position and Mr. LaFalce's position on the op-sub issue and because of the impact that I think it would have on CRA. I understand that aspect of it. But there is one little part of it that troubles me a little bit, that I need some clarification on. On page 3 of your testimony, the second point you make is that firms that choose to operate new financial activities through subsidiaries are, in effect, keeping those assets available to the bank rather than transferring them outside the bank's reach.
And, of course, that is true of assets. I take it Chairman Greenspan's position is that it would also be true of liabilities, not just assets, and that is what creates the potential for problems. Can you address that a little bit and help me understand why, if the bank retains the assets, that is beneficial, obviously, but why doesn't it also create the risk that are associated with the liabilities?
Mr. RUBIN. You are talking about this safety and soundness issue here?
Mr. WATT. Yes.
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Mr. RUBIN. Sure. And I think that is very central to this discussion. What fundamentally happens is that the bank can decide to do this, as you know, either in the op-sub or in the affiliate. Under the provisions in Mr. LaFalce's bill, whatever equity investment they are going to make in the subsidiary, they have to charge 100 percent against their capital, so there is no possible further loss there. That would be exactly the same if they made a dividend to fund the affiliate. If they wanted to extend any loans to the op-sub, they have to do it in accordance with Section 23 of the Federal Reserve Act, precisely the same section that would control loans to an affiliate, so there is no difference there.
If they, however—here we get to the difference—and also they have to be well-capitalized before and after they do this, and maintain that on an ongoing basis, and well-managed. Here is where the difference lies. If this entity does well, if it is successful, then the bank has an asset which, if the bank gets in trouble, can be used to satisfy either the creditors of the bank or the FDIC. And that is what I said in my opening statement, why the FDIC and its president and three former chairmen say it is preferable to the affiliate.
If the subsidiary loses money and gets into trouble, which is the example that was brought up before, then that will not put the bank in any worse position than it would if the affiliate got into trouble, because what the bank can do is simply liquidate. Say the liabilities you talked about overwhelm the assets. Then the bank can simply liquidate or dispose of or divest the subsidiary, and any losses that have been taken on a consolidated basis in the bank get reversed. If there was any diminution of capital in the bank as a result of those losses, that gets restored under GAAP accounting rules, and the bank will be in precisely the same position as they would have been had all of these problems developed in the affiliate.
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Mr. WATT. I need to study that a little bit more.
Mr. RUBIN. What I think we may do, since you and somebody else raised the same question, I have forgotten whom, maybe it was Mr. Vento, maybe Mrs. Roukema, I think we will do a little letter on this maybe. Because it is complicated and I think we can lay it out and we will.
Mr. WATT. That would be helpful. Let me ask one other question. You talked about these two instances——
Mr. RUBIN. And as you know—I apologize.
Mr. WATT. You are not going to let me get this question in, are you? I was trying to do it before the red light.
Mr. RUBIN. Under corporate law the parent is not responsible for the liabilities of the subsidiaries. Go ahead.
Mr. WATT. I am not sure the Chairman is going to let me ask it now.
Chairman LEACH. Mr. Watt, you have been the most diligent Member of the committee at these hearings.
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Mr. WATT. You are going to be kind and give me back that half-minute that I spent praising you at the beginning of my comments?
Chairman LEACH. Please, go ahead.
Mr. WATT. I am looking for additional areas of compromise here. And the reason I want to put this question out here, the two instances that you referred to—I don't know anything about the Edge Act, whatever that is, and the other instance that you referred to where this same kind of op-sub arrangement is going on, in both of those instances I thought I heard you say this application now has to be made to the Fed and the Fed passes on those.
The question I am asking is might that be an area of compromise on this op-sub issue, where an application would be made to give the capacity to do an op-sub that would be passed on not necessarily by the Fed by itself, but by the Fed and Treasury, by the Fed and OCC. Might that be an area where there could be some kind of compromise on this issue?
Mr. RUBIN. I think not in the form that you have just—what you said is right about the Fed having jurisdiction over the two situations. I don't think in the form that you just said it, it could work, Mr. Watt, because given the Fed's views on op-subs, if they had exclusive jurisdiction you wouldn't get a lot of approvals. I suppose if you said there would be joint approval for both affiliates and op-subs, that might be a possibility. I hadn't thought about it.
Mr. WATT. You would have a kind of a standoff there. You might not have any op-subs or affiliates.
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Mr. RUBIN. No, because we believe that you should have a freedom of choice and do it equally in both. We wouldn't have a problem.
Mr. WATT. You might hold up an affiliate application, put pressure on the op-sub application, maybe?
Mr. RUBIN. I haven't thought this one through, and it has its aspects, I suspect.
Mr. WATT. I will just put that out there as another possible area of compromise. I yield back. Thank you.
Chairman LEACH. Thank you, Mr. Watt. Before turning to Mr. Bereuter I would like to ask unanimous consent that written testimony be submitted for the record by the Banker's Roundtable and the National Association of Independent Insurers. Without objection, so ordered.
I would also like unanimous consent to submit for the record witnesses' questions from Mrs. Kelly, who is out of the country today, and would be appreciative if you could respond to those in writing.
Mr. Bereuter.
Mr. BEREUTER. Thank you, Mr. Chairman.
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Mr. Secretary, thank you for your testimony and your responses here. I was pleased to hear your views once again on mixing commerce and banking. Mr. McCollum asked the two questions I had uppermost in my mind, but a third area where you have criticism of H.R. 10 relates to the Federal Home Loan Bank system, and I don't think that has been much explored. As you may know, this is one of the areas that has some interest and appeal to small bankers.
You indicate the system uses little of its Government-subsidized debt to further the system's homeownership purposes. I think that is a very important concern. You go on to say that you think that any changes in the system could occur only in the context of comprehensive reform.
Mr. Baker, my colleague from Louisiana, has been very interested in this kind of comprehensive reform for some time. I have not been privileged to serve on that subcommittee, so I don't know to what extent the Treasury has expressed its interest or concerns about comprehensive reform. But would you say a little bit more about this and, in fact, has the Treasury done anything in writing as a critique of the failure of the homeownership function to be pursued adequately by the system? Could you enlarge a little bit on your concerns with H.R. 10 in this respect?
Mr. RUBIN. Let me do that, if I may, Mr. Bereuter, and then ask Assistant Secretary Carnell if he would like to add in. We think there are important functions the Federal Home Loan Bank System can serve. Our problem is that the system, as you know, enjoyed a subsidy via the market perception of an implicit guarantee by the Federal Government. And that subsidy, that difference in the cost of borrowing, is basically absorbed by the taxpayers, even though it is a contingent liability, rather than annual appropriation.
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And in our judgment, that subsidized capital ought not to be used for overnight loans and a vast arbitrage portfolio, as is now the case, but rather for specific socioeconomic purposes that Congress prescribes by law. It seems to us community banks are one good place to do that. Dealing with distressed communities is another good place to do that. And there may well be others. And homeownership obviously, although securitization has probably removed much of the need there.
But right now, an enormous amount of that subsidized capital is used for overnight loans and arbitrage, and in our judgment there is no reason in the world why the taxpayer should subsidize that.
Let me also make clear this debt is not—not—backed by the United States Government, but it is viewed in the markets as having some kind of implicit guarantee. That is the risk they are taking.
Rick, do you want to add anything to that?
Mr. CARNELL. Certainly. Mr. Bereuter, we testified some months ago before Mr. Baker's subcommittee, and we would be glad to provide copies of that testimony. We focused there on the Home Loan Bank System's investment arbitrage portfolio. The Secretary has already referred to our belief that that portfolio needs to be substantially curtailed.
Just a few more thoughts relating to comprehensive reform. Another key element of such reform, as we see it, would be to closely link the system's activities to its public purpose. And I would submit that if that is done, the system will also become more responsive to community banks than it is now.
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Mr. BEREUTER. Could you be explicit about some suggestions about how that could be done?
Mr. CARNELL. Yes sir, we can be more specific in follow-up, but let me point now to one of the clearest examples of a failure to have a link between the system's activities and public purpose. This example would be in addition to the arbitrage portfolio.
If you are a bank, you can join the system by just having a certain amount of mortgage-backed securities in your portfolio for an instant of time when you join. After that, you need not make a single housing-related loan or hold one in portfolio or do anything else, and you can still be a qualified member of the system until the end of time. You need not do anything that furthers the system's public purpose. And as long as you can present acceptable collateral—which, for example, would include Treasury securities, which have no particular connection to housing—you can borrow from the system and use the money for any purpose that your charter allows.
So that is a generic Government subsidy. There is no connection to a public purpose. And what we have suggested is that advances be limited to some proportion of the housing or other mission-related loans that the institution has on its books.
Mr. BEREUTER. Thank you.
Thank you, Mr. Chairman.
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Chairman LEACH. Thank you very much.
Mr. Bentsen.
Mr. BENTSEN. Thank you, Mr. Chairman.
Mr. Secretary, yesterday—there are two things which you may or may not know. Yesterday, one, I floated the idea of a compromise to Mr. Greenspan that the regulation of bank holding companies be transferred to the OCC and we drop the whole idea of operating subsidiaries, but he demurred on that. The other thing that he said which I think you are aware of, and I think it is important to restate, is Mr. Greenspan reversed his position on safety and soundness as it related to operating subsidiaries as compared to what he had told this committee two years before. Two years before in response to questions that I asked and others, he said the whole question of operating subsidiaries had nothing to do with safety and soundness, but he told us yesterday upon reflection with members of his staff over the last year, he has now rethought that issue and believes that perhaps there is a safety and soundness question.
Mr. Greenspan also on this question of the subsidy in response to a question I asked tried to draw a line for us, and I agree—first of all, let me say I agree with your contention that the market doesn't define a differential in a subsidy between a holding company and a subsidiary, and I trust your judgment on that from your years in the capital markets and we asked one of your former colleagues with Merrill Lynch as well as someone from J.P. Morgan the other day and they seemed to feel that the capital markets were adequate in determining the true value of an asset without some implicit subsidy because it had ''bank'' next to its name. But Mr. Greenspan tried to draw for us a picture that said the difference between a holding company and a subsidiary and whether or not you had risk in transferring value out in the form of a dividend up to the holding company or down to the subsidiary, he argued there was a difference because the bank would send less in dividends to the holding company in order to maintain a better balance sheet in the bank versus what they would do with the operating subsidiary and thus that would create a subsidy with this operating subsidiary versus the holding company. It sounded odd to me. It would seem to me and, from your experience out of Treasury, wouldn't you assume that a well-managed holding company would transfer as much out in dividends to its shareholders as it would through a subsidiary?
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Mr. RUBIN. I guess my view, Mr. Bentsen, is that is a business decision that the institution would have to make, but I don't see any reason why they would transfer more to an op-sub. If you are saying that the suggestion was that more would be transferred——
Mr. BENTSEN. More would remain in the bank with an operating subsidiary in order to build up the excess capital in the bank for the benefit of the bank, thus enhancing the subsidy to the operating subsidiary than you would otherwise with an affiliate.
Mr. RUBIN. My instinct is to think that if an institution is going to build non-bank financial activities, then they are going to have a business plan or strategy, and whether it is an op-sub or an affiliate is not going to make a difference in how much they transfer out. Having said that, I must say if they do in fact preserve more of their assets in the bank than would otherwise have been the case, then the bank will be a safer and sounder institution with the op-sub than it would have been with the affiliate. My instinct is to think there would not be a difference. But if there is a difference, it argues in favor of the op-sub as creating greater safety and soundness.
Mr. BENTSEN. Thank you. The other question. Could you explain for us, yesterday in his testimony Mr. Greenspan argued that in fact moving to an operating subsidiary structure, or, rather, not having an op-sub but having an affiliate structure would in no way reduce the number of assets under regulatory authority of the Treasury or the OCC and in fact he argued that those assets have risen over the years. Could you explain for us how Treasury would view the world if we passed a financial modernization bill that only allowed for an affiliate structure. How would you perceive national banks would act with a change to a holding company structure? What is your view of the world in the event that there is no operating subsidiary and what is the problem with that?
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Mr. RUBIN. I think there are two issues there. One is that it is our judgment that if you now permit non-bank financial activities, these activities will become important for banking organizations. But if they cannot do it with a national charter, then the national charter will lose a great deal of its value. If the national charter loses a great deal of its value, then all other things being equal, it seems to me that over time banks will gravitate away from the national charter. Why have two regulators—inevitably with a holding company and with a bank, they are going to have the Fed as a regulator anyway—why have two regulators when you can gravitate to having one?
Second, as you know the OCC charges for its examinations and the Fed does not. The Fed uses the taxpayer moneys that they earn on their bond portfolio. So there is a disadvantage in having a national charter. But it is a very good charter so a lot of banks now use it. If the national charter were disadvantaged by being precluded from having these non-bank financial activities, then I think over time you would have a very substantial gravitation away from the national charter, the national charter would lose much of its value, and the Nation would lose the various benefits of allowing structural choice that I have mentioned before.
Mr. BENTSEN. Thank you. Thank you, Mr. Chairman.
Mr. RUBIN. Including the safety and soundness and real viable options for businesses to choose whatever structure they like best.
Chairman LEACH. Thank you, Mr. Bentsen.
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Before turning to Chairman Bachus, I would like to make an announcement that we are visited at the moment by a group of parliamentarians from the country of Iceland. I would like if they could stand, Mr. Egilsson, Mr. Einarsson, Mr. Haldorsdottir, Mr. Sigfusson and Mr. Gestsson. We are honored you are with us.
For those from non-Scandinavian backgrounds, perhaps it should be stressed that next year is not only the new millennium in one sense, but it celebrates the millennium since Christianity was introduced to Scandinavia and since Leif Ericsson, I am sorry, Mr. LaFalce, discovered the New World. We are honored that our Icelandic friends are here. I must say to my mother's dismay, who was Norwegian, Leif was an Icelander whose father came from Norway. We are honored you are with us and welcome.
Mr. LAFALCE. Mr. Chairman, I want to associate myself with your remarks of welcome. On the other hand, I remember the remarks of Chairman Frank Anunso. He said, ''Leif Ericsson discovered America, but Christopher Columbus kept it discovered.''
Chairman LEACH. Mr. Bachus.
Mr. BACHUS. Thank you, Mr. Chairman.
Secretary Rubin, it seems like this whole thing about operating subsidiaries versus holding companies, there are two separate issues. One is, is there an unfair subsidy, and the second one is the safety and soundness. Mr. Watt and Mr. Bentsen have sort of talked about safety and soundness. My question is this: when you determine the safety and soundness of a bank, you look at the balance sheet, do you not?
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Mr. RUBIN. That is certainly one of the things to look at, yes.
Mr. BACHUS. I mean that is an important thing to look at?
Mr. RUBIN. It sure is.
Mr. BACHUS. A lot of it, the accountants go in and the examiners and they look at the balance sheet. Now, under generally accepted accounting principles, a direct subsidiary's assets and liabilities are attributed to the parent. Is that right?
Mr. RUBIN. They would be consolidated with the parent.
Mr. BACHUS. Because of that, just because that is a part of our accounting practice, in the case of a bank if you had a non-banking subsidiary, their assets and liabilities would show up on the balance sheet of the parent bank, would they not?
Mr. RUBIN. On the consolidated balance sheet, that is correct.
Mr. BACHUS. So because of that, any risk or any losses that the subsidiary had would be directly attributed to the parent, would they not?
Mr. RUBIN. That is correct. But the plus side of that if the op-sub develops value, then that is an asset and enhances the balance sheet of a bank and the strength and can comprise an asset the FDIC can reach. This is asymmetrical. If on the other hand the op-sub develops problems, then it can be divested and upon the divestiture, you recognize only the actual losses. Any losses that have been consolidated into the earnings statement and therefore the net worth of the bank get reversed under generally accepted accounting principles insofar as they exceed the initial equity investment.
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We are going to prepare a letter on this because of a number of members have said they thought those principles——
Mr. BACHUS. Because to me those risks and those losses would be transferred directly to the bank. I think under accounting principles.
Mr. RUBIN. Yes, but the point is, Mr. Bachus, you are raising exactly the right question which a number of other Members did, too. But if there is trouble, the bank can divest itself of the op-sub and under generally accepted accounting principles, all those problems would be reversed and you would be in precisely the same position you would have been in with an affiliate. But I think we need to get a letter to people on that.
Mr. BACHUS. We are struggling with this. I read the article by Bill Seidman, Bill Isaac and all that, so I understand. Let me go back to the unfair subsidies, whether or not there is an unfair subsidy because of access to the discount window and access to the Fedwire. I guess the other is the federally-insured deposits. Those are all benefits that banks have in our system.
Mr. RUBIN. Right.
Mr. BACHUS. I was reading something that Chairman Greenspan submitted to us in the appendix. He quoted William Brady in the Senate. Let me just read you what it said. This is a 1988 report by the Senate. It says the Senate-passed version of the financial services modernization endorses the concept that holding companies were a much sounder alternative to operating subsidiaries.
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It said that academic observers and the Secretary of the Treasury firmly support this approach since it was, and I quote: ''the only acceptable means of expanding non-bank activities.'' I will supply you with a copy of that.
Mr. RUBIN. Would you like me to respond?
Mr. BACHUS. Let me ask you this, and I do want you to respond. I then went back and I found that in 1984, and in 1983, the Treasury had submitted about a three-page testimony to the Congress. Mr. Bentsen was talking about that we get different testimony up here. We hear one thing and then we hear another. I have got about six pages here from the Treasury Department telling us in no uncertain terms that to allow affiliates to engage in non-banking activities would constitute a direct subsidy, and they go into quite a lot of detail. This is 1983 and 1984, telling us that it would be an unfair advantage. I am going to submit these for the record. But in 1988, I would admit, there is not a lot—it just makes a comment. But in 1983 and 1984, Treasury submitted—there are about three pages here that I would like you to just maybe look at. Because you did say that it is not clear whether there is a subsidy.
Mr. RUBIN. No, what I said, Mr. Bachus, was that it is not clear there is a subsidy to the bank. But it is, in my judgment absolutely 100 percent clear that under the LaFalce bill—if there is a subsidy—the op-sub has zero advantage over the affiliate with respect to the bank transferring the subsidy. The difference between 1988 and 1984 and 1983 is that under the LaFalce bill, you have a set of provisions governing both the bank's equity investment in the subsidiary, absolutely identical terms, and loans by the bank to the subsidiary, which have to be done pursuant to Section 23(a) of the Federal Reserve Act, absolutely identical. With respect to these provisions, then there is no difference. Those comments from 1988, 1984, 1983, were not written about these provisions—these rather stringent provisions, I might add—of the LaFalce bill.
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Mr. BACHUS. Were you familiar with those 1983 and 1984 testimonies?
Mr. RUBIN. I was not, but as I say, Mr. Bachus, I think that though interesting, they are not relevant to the LaFalce proposal. That proposal contains the provisions I just mentioned, which create equivalent safeguards.
Mr. BACHUS. What I would like you to do, I would like to introduce them and let y'all review those and get back and make some responses why they are not relevant today.
Mr. RUBIN. We would be delighted.
Mr. BACHUS. And why the LaFalce legislation addresses that.
Mr. RUBIN. We would be delighted. Thank you.
Mr. BACHUS. Thank you. I would offer at this time the testimony of the Treasury on January 16, 1984 before the Congress; testimony of July 18, 1983; testimony of Donald Regan before the Banking Committee; and also 1988 testimony.
Chairman LEACH. Without objection, those will be inserted into the record.
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Ms. Lee.
Ms. LEE. Thank you, Mr. Chairman.
Mr. Secretary, Ralph Nader has expressed what other consumer advocates have also emphasized when he said, and I quote: ''H.R. 10 is not a bill for consumers. It is a bill designed to create new profit centers for a relative handful of banking and financial services, corporations that will form combinations which will dominate the delivery of financial products and fuel the already alarming trend toward megamergers and the concentration of economic power.''
First, let me just thank you for your strong support for CRA. As you acknowledged, it has been really a primary mechanism for access to capital in low- and moderate-income communities. I know and I appreciate your supporting those provisions with the LaFalce bill. But there are further considerations that are important to consumers. I would just like your thoughts on four ideas that might address the gap between what financial services would like to see and what consumers need. First, requiring CRA provisions to be extended to other financial services industries, maintaining the extensions of CRA provisions as incorporated in the LaFalce bill. Second, insurance companies wishing to affiliate with a bank holding company be in compliance with the Fair Housing Act, including any consent decrees entered into by that insurance company under the act. Third, insurance companies which offer homeowners insurance policies, those companies that really wish to affiliate with a bank holding company, that they have a satisfactory record in meeting the homeowners insurance needs of the entire community, including low- and moderate-income neighborhoods in which it does business. And, finally, securities firms wishing to affiliate with a bank holding company, that they not have a past pattern of excluding securities branch sales offices from low- and moderate-income communities.
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Mr. RUBIN. Let me make a generic comment which I think may be useful in terms of all this. We, as you know, are extremely strong supporters of CRA. We have said that not only are we opposed to weakening CRA, we think CRA needs to be kept relevant as the world changes. That was why we think it is very important that if a bank wants to get into non-banking financial activities that they not only need a satisfactory CRA record at the time they do it, but they need to maintain it. I think you get into a problem when you get out beyond the banking system because CRA was, after all, originally envisioned as having a nexus to the various services that the Federal Government provided, particularly deposit insurance, but probably also the discount window and the Fedwire.
In all of these areas, you don't have that Federal provision of service that you do to the banks, and the theory, at least as I understand it, was that if you are going to get access to this important set of services from the Federal Government, then it is appropriate for you to take on the responsibility, which I happen to think is a very important responsibility, of complying with CRA. You don't have that in these kinds of situations.
Ms. LEE. But now because of the fact that possibly these financial services will be provided——
Mr. RUBIN. It will be provided by an op-sub or an affiliate that is either a sub or an affiliate of a bank, but they will not themselves have access to any of these Federal services. You asked me one particularly that I have never really thought about, but that is the one in respect to the Fair Housing Act. I think—let me ask Rick Carnell to comment. I believe we have actually said in the past that there may be some—that is something that is worth considering.
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Rick.
Mr. CARNELL. Mr. Kennedy had an amendment to that effect that this committee adopted in 1997, and we have made statements saying that we saw merit in that approach or certainly in that objective.
Mr. RUBIN. Let me also say that since these are all ideas that themselves are complicated and one would need to analyze, we really ought to take a look at that further with you and then see. As Rick just said with respect to Mr. Kennedy's legislation, we had expressed ourselves in the way we did. Why don't we take a look at this with you.
Ms. LEE. Thank you very much. I would appreciate that because I think consumers have some really serious concerns that hopefully can be addressed as we move forward because we certainly want to support these efforts. Thank you very much.
Chairman LEACH. Thank you, Ms. Lee, and for ending before the red light came on.
Mr. Royce.
Mr. ROYCE. Thank you, Mr. Chairman.
There have been, Mr. Secretary, some efforts to develop language that would provide holding companies with some flexibility in their activities by permitting a holding company to engage in activities that are complementary to financial activities. Do you have a view on such a proposal?
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Mr. RUBIN. Are you talking about complementary, but beyond non-bank financial activities?
Mr. ROYCE. They are in essence commerce, but let us say you had a credit card company that had a concierge service. There are so many situations where there is some ancillary activity that in a way is tied to the line of business, but is in fact not financial. But if you developed a definition of complementary, you might be able to handle this type of activity. I just wanted your thoughts on that.
Mr. RUBIN. Let me react in two ways if I may. Number one, I agree with what I think is the predicate of your question, which is it is sometimes very difficult to know exactly what is what in the complicated world that we are in. That is going to become more so as we go forward. Having said that, I do think if you look at what has happened over the last couple of years, it is hard not to have a lot of reservations about a combination of a depository institution with commercial activities. I think the experience of the last two years around the world, at least to me, makes all that very troubling. So I guess where I come out is I think we should—if you have the two existing categories, non-bank financial and commerce, you are going to have to decide which is which. It sounds like—complementary, although we would have to look at it to get a better understanding of it, but it sounds like that is a way of trying to pick up some of these sort of hybrid sort of things. I guess I would be a little bit troubled by it in the sense that it sounds like it is going to bring more under the tent that looks like commerce and that would sort of trouble me. But I guess we would need to look at it.
Mr. ROYCE. So I guess the answer from your standpoint would be you would be open to looking at fashioning some type of definition that would take care of existing hybrids or that would——
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Mr. RUBIN. No, no, no. If I said that, I misspoke. I apologize. No, I think I would be inclined to be skeptical.
Mr. ROYCE. OK.
Mr. RUBIN. But certainly we would be happy to look at it and see if there is something there that is useful, but skeptical because I have a feeling that it will extend this affiliation either through op-sub or affiliate out beyond non-bank financial activities, and that is the area in which we have very serious concerns.
Mr. ROYCE. Thank you, Secretary Rubin.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Ed.
Yes, Mr. Goode.
Mr. GOODE. Mr. Secretary, just one question. You stated in your remarks that you supported H.R. 665 because it avoided anticompetitive restrictions on bank insurance sales. Would that include the sale by banks of title insurance? I know in Virginia, banks operate some title companies. Would you anticipate under H.R. 665 they could continue to do so?
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Mr. RUBIN. Mr. Carnell would be delighted to respond to that.
Mr. CARNELL. We have advocated that the bill not have discriminatory restrictions on national banks' sale of title insurance. The bill passed by the House during the last Congress contained such restrictions. We think that competition here is good for consumers. We note that last year's bill didn't similarly restrict the authority of State banks. We see no good policy case for discriminatory restrictions that single out national banks.
Mr. GOODE. So they can?
Mr. CARNELL. Yes, sir.
Mr. GOODE. I yield back, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Goode.
Mr. Ryan.
Mr. RYAN. Mr. Chairman, I would like to ask you two questions relating to Chairman Greenspan's testimony yesterday. You mentioned earlier in your testimony that it is easy for a bank to dump a subsidiary that becomes a liability. He outlined a couple of cases or some circumstances whereby the op-sub could lose its value so quickly that a holding company or the bank could not dump it in time, thereby exposing the risk. Could you address in your letter that you are proposing how you address those situations? I think he cited an example where an op-sub went down in 1987 in one day.
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Mr. RUBIN. Yes, First Options, a subsidiary of Continental Illinois National Bank. I didn't read his testimony, but I know the situation.
Mr. RYAN. Right. Could you address that particular type of occasion and how does your lack of concern, and I am not being judgmental on that, but how does your lack of concern on the exposure to the taxpayer address those types of situations?
Mr. RUBIN. It is not a lack of concern about exposure to the taxpayer. I actually think, as I said in my testimony——
Mr. RYAN. I didn't mean to imply that——
Mr. RUBIN. No. But as four FDIC chairmen have said—one current, three prior—that the op-sub is actually preferable on safety and soundness and protecting the taxpayer. I think in this situation if you have that kind of a problem—whether it be in the affiliate or in the op-sub—you are going to have reputational issues you are going to have to deal with, and that is going to be the same either way. If you have that problem with an op-sub, you immediately sever the link, and then you have the kinds of consequences I mentioned before—putting the op-sub and the affiliate in exactly the same position. But let us address that in the letter if we may.
Mr. RYAN. You think the affiliate and the op-sub would have the same kind of situation should that type of occasion arise?
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Mr. RUBIN. I think you would be in an identical situation, that is correct.
Mr. RYAN. One other quick point. Chairman Greenspan advocated a two-stage process, one where we have integration and we wait and see how that works before taking a look at commercial baskets. You mentioned that you didn't like the provision, I believe, in the LaFalce bill on the 15 percent commercial basket. Do you have the same position or are you open to Chairman Greenspan's position of waiting and seeing, having a two-stage process?
Mr. RUBIN. Well, one never wants to say that one might not change one's mind in the future, because that isn't a very sensible place to be. But I must say, based on everything I know, it seems to me the last two years have increased concerns about this linkage rather than lessened these concerns. That is really all I can tell you, Mr. Ryan.
Mr. RYAN. Just trying to find areas where you guys agree.
Mr. RUBIN. I see. My instinct is to have very serious concerns right now. I can't tell you what a future Congress, a future administration and a future Fed chairman might feel five or ten years from now based on that experience.
Mr. RYAN. Thank you.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Ryan.
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Mr. Sherman.
Mr. RUBIN. Actually with any luck we would have the same Fed chairman. It just occurred to me, given the way the terms run.
Chairman LEACH. Excuse me. You mean in the year 2020?
Mr. RUBIN. No, I said five or ten years from now. Understanding how long the term was and when the reappointment comes up.
Mr. SHERMAN. Mr. Secretary, I think you have talked about the reputational risk that a financial institution, particularly a bank, runs when one of its affiliates or subsidiaries has financial problems and wonder whether if in your experience it matters whether that is an affiliate or whether it is an operating subsidiary, or does the institution run the same risk either way?
Mr. RUBIN. I think, Mr. Sherman, you would have the same risk in either way. I actually lived through this in my prior life. When you have these kinds of concerns and the markets get nervous, they can react to all kinds of things, real and unreal. I think we just simply have to do what we did. We called our creditors, we said this is our situation, this is where we are, this is our relation with this, that and the next thing to our basic business. Then you work it through with your creditors. In that case since the op-sub and the affiliate are in the exact same position, I don't think it is going to make a difference.
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Mr. SHERMAN. Is there a greater risk that there would be a piercing of the corporate veil so that the bank parents would be held liable for the debts of one of its subsidiaries with a greater possibility of risk than if it was an affiliate?
Mr. RUBIN. As you know, piercing the corporate veil very, very rarely is held in court and for good reason, because the corporate separateness is really pretty central to how our system works. But the fact is that in order to maintain that separateness, you have to observe certain formalities. That would be also true with respect to the difference between the affiliate and the bank. And if you don't observe those formalities, I think that is right. If you inappropriately behave with respect to the affiliate and the bank, you also run the risk of the two getting mushed together.
I think the answer is that that is probably at most a de minimis risk; and the risk would exist in both the subsidiary and the affiliate, I think.
Mr. SHERMAN. I am most concerned about not where there is functional integration inappropriately of two corporations or where one corporation is, in effect, generating profits for the other, but rather the more human situation that I have seen often with subsidiaries, particularly in small- and medium-sized businesses, where the corporate minutes are prepared contemporaneous not with the directors meeting, but with the request for corporate minutes by some investigator. And that if you had a subsidiary that simply ignored all the corporate formalities, didn't bother to have board of directors meetings, if it was an affiliate, wouldn't that cause the bank to be a bit safer than if it was a subsidiary?
Mr. RUBIN. Based on my own experience with affiliates, and we actually—when I was in the private sector we operated with a lot of affiliates. We at least were advised that there were formalities, and we had to adhere to them. If we didn't, we ran a real risk of the two being pulled together if creditors ever came against us.
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I suspect there isn't a great deal of difference, Mr. Sherman. I am not opining as a lawyer on that.
It also strikes me that you are going to have bank examiners that are going to be looking at these formalities and making sure they are adhered to. I think you are talking about a de minimis risk and, if it should occur, not very much difference between the two.
Mr. SHERMAN. I would think that with bank examinations coming in, that sector of the economy may be observing corporate formalities to a greater extent than other smaller——
Mr. RUBIN. Rick, correct me if I am wrong, but I don't think there has really been a problem in the American financial—there have been a lot of problems in the American financial system, but one I don't think you have had——
Mr. CARNELL. That is correct. There are thousands of subsidiaries and affiliates of federally-insured depository institutions now, and failure to observe corporate separateness has not been a significant issue in either case.
Mr. RUBIN. Maybe because of the reason you have said, because of the role of examiners. I don't know.
Mr. SHERMAN. And also, given your experience on Wall Street, did you feel your banking competitors had a large competitive advantage or subsidy advantage when they were operating in competition with you in the securities world?
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Mr. RUBIN. I am trying to think of a diplomatic way to respond. No.
Mr. SHERMAN. I have run out of questions.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you.
Mr. Ose.
Mr. OSE. Thank you, Mr. Chairman.
Mr. Secretary, thank you for coming. As I did with the Chairman of the Fed yesterday, when I passed my compliments, I want to convey that you are a remarkable steward of the affairs of this country as Secretary of the Treasury. I want to convey that to you.
Mr. RUBIN. Thank you.
Mr. OSE. My question is based more on some confusion that I have. I have heard you remark as to an apparent tradeoff between for-depository institutions between access to various services that the Fed provides and taking on the responsibility of various things that Congress or the Administration may wish to have addressed, one of which, for instance, might be the Community Reinvestment Act. It would seem to me that implicit in that comment is a suggestion that there is a value, on one hand, to access these services and that the compensatory nature—is that you need to help us on this.
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One thing I am struggling with is trying to quantify the subsidy that comes through directly to the financial institutions by access to these services. That is my first question.
My second question has to do with the regulatory scope that would come to, in yours or Mr. Greenspan's relative positions, either the operating subsidiaries or the affiliates in terms of expanding the reach into the subsidiary or the affiliate for compliance with the Community Reinvestment Act or the like. I just think that leads to an inefficient allocation of capital, and I am concerned about that.
Mr. RUBIN. I think they are two good questions. Let me try to respond to both if I may.
It is at the very least very hard and I think probably not possible—but at the very least very hard—to, in even a rough kind of a way, quantify the subsidy. The problem was indicated by one of the other Member's questions, which is that you could certainly look at a bank versus a finance company that had the same rating, look at the difference in their cost of capital in the capital markets and say that is the subsidy.
The trouble is that the finance company is in a very different and in some ways riskier business than the bank. I don't think it lends itself to comparison. I think it is very hard. There are sensible people who think there is no subsidy. There are probably more sensible people who think there is a subsidy. Maybe there is an analysis, but I have never seen an analysis persuasive as to its amount.
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Mr. OSE. Are you saying they are more sensible numerically or more sensible in terms of their sense?
Mr. RUBIN. I am not sure of the answer to that.
On the question of reaching into, we are not suggesting that CRA reaches into the subsidiary and applies to the activities in the subsidiary. That is not what we are saying. All we are saying is that if the bank has larger assets, then in some fashion that may affect how it is viewed with respect to satisfactory CRA compliance.
But let me be clear, because I think you have raised a good point. We are not saying that CRA would apply to the activities in the subsidiary.
Mr. OSE. Thank you.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you.
Mr. Inslee.
Mr. INSLEE. Thank you, Mr. Chairman.
Mr. Secretary, I noticed that you expressed a caveat regarding H.R. 665 because you said you had serious concerns about the affiliation between commercial firms and depository institutions which this bill would permit. I just wondered if you would tell us what changes, either small or large in this bill, would at least reduce, if possible, those concerns.
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Mr. RUBIN. H.R. 665?
Mr. INSLEE. Yes.
Mr. RUBIN. Let me start by saying it is a very good bill. I was a little bit surprised, but very pleased that we are in a position to support a bill at this point because I think that is a very constructive development in terms of moving forward with financial modernization legislation. The set of concerns that I caveated had to do with, as I said, depository institutions and commercial activity; and there were two subsets of that, I suppose, the basket and then the unitary thrift.
We think, with respect to the unitary thrift, that H.R. 10's resolution last year, the grandfathering resolution, was a sensible place to be.
I guess it would be fair to say that, on the basket, we just have very serious reservations, for the reasons I have stated.
Mr. INSLEE. And as far as the basket, is there a matter of quantification of percentages or the like or just its basic thrust?
Mr. RUBIN. I think it is the fundamental concept of combining the commercial with the depository institution.
Mr. INSLEE. Thank you.
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Chairman LEACH. Thank you.
The gentlelady from Illinois.
Mrs. BIGGERT. Thank you, Mr. Chairman.
Mr. Secretary, H.R. 10 has a provision that would require the Office of Thrift Supervision to notice and comment upon preempting State laws regarding consumer protection, but I guess it is H.R. 665, the LaFalce bill, does not have that. Considering that the Office of the Comptroller of the Currency is subject to such a requirement, why should not the OTS also be required to operate in the sunshine?
Mr. RUBIN. Let me ask Mr. Carnell to respond to that, if I may.
Mr. CARNELL. We haven't previously taken a bottom line position on this proposal. I note that the requirement applicable to the OCC arose in the context of interstate banking legislation.
I also note that the thrift charter has had much more of a history of an exclusive, comprehensive system of Federal regulation than in the banking area. That is, the courts have often found that rules of the OTS or its predecessor occupied the field and preempted State law.
It is partly for this reason that many observers see the thrift charter as particularly desirable for use in facilitating electronic commerce—such as when people use the internet to do transactions in which the parties' geographical location is not especially meaningful. That is a significant advantage people perceive in the thrift charter. And there is also a legal distinction of sorts. Over the years, the courts have found that thrifts are under a much more comprehensive and embracing system—and one that relies less on State law—than is the case with national banks when they deal with their customers.
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Mrs. BIGGERT. Thank you.
Then, somewhat similar, there doesn't seem to be any concern about the safety and soundness of the WFIs and that WFIs are not allowed to have deposit insurance, yet they are subject to regulatory supervision from the appropriate Federal regulator. Do you have concerns about that?
Mr. RUBIN. We were originally in favor of WFIs, but I think it would be fair to say that, as we have again looked at the experience of the last couple of years around the world and all that has happened in financial markets, that we now have developed concerns about having financial institutions with access to a fair portion of the safety net—although not deposit insurance—that would be subject to or certainly have the potential of being subject to a substantially lesser degree of regulation.
Mrs. BIGGERT. Thank you very much.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Ms. Biggert.
The other gentlelady from Illinois, Ms. Schakowsky.
Ms. SCHAKOWSKY. Thank you, Mr. Chairman.
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Let me just say to you that, as one who has never participated in this debate at all, I want to thank you for these hearings which have been a seminar without compare for someone in a position as mine.
Mr. Secretary, let me ask you a couple of questions. I am a little confused about—you see Mr. LaFalce's bill as an advantage for CRA because the consolidated assets of the bank will be greater as a result of the op-sub. By that do you see that, should a bank increase its assets by half again, let's say, that then their CRA obligation is increased by that amount in terms of dollars that would be made available to the community?
Mr. RUBIN. No, not necessarily. I think there were two respects in which I believe this to be the case. One is that the LaFalce bill requires that for you to get the new financial affiliations, you must have a satisfactory CRA record, and you must maintain it. That, I think, is a very important requirement. I think the point was not that there was some sort of numerical formula, but rather that, all other things being equal, if the bank has larger assets because it has kept these activities in the op-sub rather than smaller assets because they have done it in the affiliate, that as bank examiners look at a satisfactory CRA record they are likely to expect something more robust.
Ms. SCHAKOWSKY. So you don't see any—and perhaps this is best directed to Mr. LaFalce—but you don't see there necessarily being an increase in the amount of dollars that are available?
Mr. RUBIN. Not necessarily, but it would seem to me that, while not necessarily an increase in the dollars in each instance, on balance there would be a more robust CRA if the assets were in the bank than if they are outside the bank.
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Ms. SCHAKOWSKY. Let me ask another question that gets to the issue. It seems to me one of the ways to evaluate both pieces of legislation in the final outcome is a way that there are expanded opportunities for consumers and communities and not just financial institutions. So let me ask you what your view is on low-cost banking, lifeline banking and whether or not that ought to be a component of the final legislation.
Mr. RUBIN. Yes, I think this is all about consumers. In fact, one of the arguments we have made is that, if there is no reason not to allow a choice of forum, you should allow the choice because that would, in the final analysis, be better for consumers.
In terms of lifeline banking, we have in the past said that we very much share the objective of lifeline banking. As you may know, the Treasury has now—I don't know if we have put this out yet or not actually. I think we have put out——
Ms. SCHAKOWSKY. Are you making an announcement?
Mr. RUBIN. No, I am not. I think this is actually public long since. Electronic funds transfer requires an ETA account, which really has exactly the same objective, to bring the least well-off in our society into the banking system. It is the same objective as lifeline banking.
In terms of the particulars of lifeline banking, I think we would need to look at a proposal with you—or Ms. Waters, who, I know, is very interested in this—and see exactly what the specifics are; but it is an objective that we have supported and are actually pursuing in this other context.
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Ms. SCHAKOWSKY. Do you think its inclusion in this legislation would enhance it from the standpoint of——
Mr. RUBIN. It depends on what the provision read like. As I say, I think the objective is a sound one. Whether it should be in this legislation or not I think would depend largely on what the provision actually was.
Ms. SCHAKOWSKY. But, in concept, would you support its inclusion in this legislation?
Mr. RUBIN. I think that in concept I would support what we would support and not support what we would not support.
It strikes me that that may not be totally helpful. I have spent too much time with Chairman Greenspan.
What I meant was that we support the objective. A particular provision I can't judge in the abstract. We would have to look at it.
Ms. SCHAKOWSKY. Thank you very much.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you.
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Mr. Capuano.
Mr. CAPUANO. Mr. Chairman, I have no questions. I intend to forgo the opportunity to make a speech until a later time.
Chairman LEACH. Does anyone else want anything briefly in terms of a second round?
Mr. Bentsen.
Mr. BENTSEN. Mr. Secretary, I know you are going to follow up with a letter on this, going back to this question of the subsidiary and how it applies under general accounting procedures. But, in effect, when you are looking at the balance sheet with an operating subsidiary versus a holding company structure, the subsidiary is treated as an asset and you look at both the assets and liabilities, but is it treated like a nonrecourse investment, where it upstreams the benefit? But in the event that there is a loss there is no obligation to the parent to the subsidiary and, thus, that is what is reversed on the balance sheet?
And, second of all, from the perception of the markets, capital markets, in this instance, on the idea of the subsidy, would it not be the case that when you looked at the balance sheet of the bank as the parent, you would also value the subsidiary?
So while on the one hand you might value the subsidiary to the good of the bank when it is doing well, you would also value the subsidiary to the bad of the bank when it was doing bad. That I say from the standpoint of the subsidy issue. But from the safety and soundness issue, it is a nonrecourse investment.
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Mr. RUBIN. Yes. And I would add, Mr. Bentsen, that if the subsidiary was doing badly, just as if the affiliate was doing badly—and I actually lived through this in my old life and that started to create some kind of difficulties with creditors—I think you have to bring your creditors in and explain precisely what your position is. The answer is precisely what you just said. The bank's investment in the op-sub is nonrecourse. So I think in either case you are going to have to go through your position with your creditor. When you do, I don't think your position is one iota different whether you have a subsidiary or an affiliate.
Mr. BENTSEN. With the Chairman's indulgence, then, when you are looking at the holding company, I guess what you are saying is whether you are looking at a national bank with a subsidiary or looking at a holding company with an affiliate, in either case, if one is doing bad, it will reflect poorly on the parent, either whether it is a holding company or a parent with a subsidiary.
Mr. RUBIN. The reputational reflection is in either case and the financial reality, for the reasons you have said and I also commented on before, will be exactly the same; and you have to deal with both of them.
Mr. BENTSEN. Thank you.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you.
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Mr. LAFALCE. Mr. Chairman, I am kind of anxious to get to the second panel, but I just want to have a brief question, first, of Mr. Carnell.
Mr. Carnell, some individuals refer to the unitary thrift charter as a loophole. That usually conjures up the images of some inappropriate interpretation of a word that is vague and ambiguous. With respect to the unitary thrift charter, is it not correct that there are specific statutory provisions that call for this and outline what specifically may be done? Is that correct?
Mr. CARNELL. Yes, it is, Mr. LaFalce.
Mr. LAFALCE. So it is not a loophole. It is something that has been statutorily prescribed for several decades and specifically prescribed, is that correct?
Mr. CARNELL. Yes. Congress adopted the statute in the late 1960's.
Mr. LAFALCE. OK, good, thanks.
Secretary Rubin, since the late 1960's when the Office of Thrift Supervision and its predecessor regulators have been implementing this congressional intent, are you aware of any difficulties of significance that have been caused by the unitary thrift holding companies?
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Mr. RUBIN. As I said before, Mr. LaFalce, my concern——
Mr. LAFALCE. My question is the historical experience from the late 1960's.
Mr. RUBIN. My concern derives really from the experience we have had around the world the last couple of years in its more general sense.
Mr. LAFALCE. I am talking about the unitary thrift holding companies.
Mr. RUBIN. I understand. As to the specific question, do I personally know of problems in the unitary thrifts because of this combination, the answer is that I do not have such personal knowledge.
Mr. LAFALCE. Thank you.
Chairman LEACH. Mrs. Roukema.
Mrs. ROUKEMA. Mr. Chairman, I am not going to ask for any time in terms of an answer, but as a follow-up. I had hesitated asking for this written documentation until I heard Mr. Bentsen's question. Then I felt maybe it is appropriate, and I would like to submit it for both you and the Fed because you have very different views here, but it is central to the question of the operating subsidiaries.
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Would you please give me, because Treasury and the Fed have very different perspectives here, but it is a good case example, an object lesson it would seem for our records. That is a chronology of the Continental Illinois/First Options case? This is the operating subsidiary/holding company question. You take a very different point of view from the Fed, as I understand it, as to what occurred. I will submit a request to the Fed as well. If you could please get it to us for the record and for my personal consideration.
Mr. RUBIN. We will get both the chronology, and we will also get an analysis of how that would work under the structure that Mr. LaFalce suggested.
Mrs. ROUKEMA. Excellent. Very good. Thank you.
Mr. RUBIN. Could I make one comment, Mr. Chairman? Because it didn't come up, and I was hoping it would or I thought it would.
Chairman LEACH. Mr. Secretary.
Mr. RUBIN. There is one respect, and I think the Chairman is aware of this, that we have changed our position with respect to the op-sub from last year to this year. That is, that while I have no doubt, zero doubt in my mind, as to the identity of the situation with respect to both subsidy and safety and soundness, we also recognize that, for all kinds of other reasons, there are a lot of reservations that many Members have about having insurance underwriting in the op-sub.
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In our judgment I have to say we have always felt that the essential nexus here is between commercial banking on the one hand and investment banking, underwriting, trading on the other. And that latter set of activities, to the best of my knowledge, virtually always involves merchant banking, which is why we think merchant banking needs to be integral to that. It is that nexus of activities that it seems to us is at the heart of this.
While I think there is zero substantive reason for excluding insurance from the op-sub, we are prepared to accept that exclusion if that would contribute to getting financial modernization legislation even though we think there is zero substantive reason for doing it.
Chairman LEACH. I appreciate that. That has been duly noted.
I want to raise just a couple of observations on issues that have been raised here. One relates to an earlier discussion on the Federal Home Loan Bank System and GSEs in general and arbitrage. This committee, like the Treasury, is deeply concerned that privately, in effect, owned institutions are reaping public advantage in the marketplace which tilts the marketplace rather dramatically. At issue is not only the arbitrage in the Federal Home Loan Banks, which I believe is too large, but small institutions like Farmer Mac, which in percentage terms I think represents a virtual scandal in the country in their arbitrage activities.
When Congress creates institutions for a public purpose that have advantages in the marketplace exactly as you have represented, they should stick to their public purpose. I would be hopeful that both formally and informally the Congress and the Executive Branch can attempt to change this direction.
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Second, Congressman Vento raised an issue that relates to current law in the question of whether a 10 percent cap should be changed with regard to concentration. I will say as strongly as I can I cannot think of a greater nonstarter issue. There is no prospect that I know of that this committee would endorse raising the cap and allowing a greater concentration.
Finally, let me say that when Chairman Greenspan testified before us yesterday, the market went up. I am sorry to say it is down a little bit today. We may be asking for his return.
Mr. RUBIN. I believe markets have a tendency to be somewhat random in many respects, Mr. Chairman.
Chairman LEACH. I am sure it doesn't relate to anything that may have been murmured at this hearing.
The upshot and just by perspective is that I think the consensus is widening and deepening that financial modernization should occur in the near future. We are struggling to come up with the last remaining truly significant compromise which involves the Executive Branch. If the Executive Branch does not want to advise us, that is, the Executive Branch in concert with the Federal Reserve, we may have to work it out ourselves, which is the difficulty of legislators.
I would reemphasize that I have found in my tenure in this Congress that it is always wise to be as deferential as possible to the professional judgment of professionals in the field. When professionals in the field are at variance, it is hard to be deferential. That is the dilemma that we have.
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In any regard, we appreciate your testimony.
Secretary Carnell, we appreciate your additions. We look forward to working with you in the weeks ahead.
Mr. CARNELL. Thank you, Mr. Chairman.
Chairman LEACH. Our second panel is composed of Ms. Donna Tanoue, who is Chairman of the Federal Deposit Insurance Corporation; Mr. John D. Hawke, Jr., who is the Comptroller, Office of the Comptroller of the Currency; Ms. Ellen Seidman, Director of the Office of Thrift Supervision, and Mr. Harvey J. Goldschmid, who is the General Counsel of the Securities and Exchange Commission.
Chairman LEACH. We will proceed then with Ms. Tanoue. Thank you.
STATEMENT OF HON. DONNA TANOUE, CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION
Ms. TANOUE. Thank you.
Good morning, Mr. Chairman, Mr. LaFalce and Members of the committee. I appreciate this opportunity to present the views of the FDIC.
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H.R. 10 is a very positive and significant start toward financial modernization. The FDIC, however, believes that H.R. 10 can be improved. In particular, we believe that, absent a compelling public policy purpose, the Government should not impose an organizational structure on banking organizations.
It is true that a subsidiary structure does, under certain circumstances, provide superior safety and soundness and superior protection for the deposit insurance funds. However, there can be legitimate business reasons for a banking organization to prefer an affiliate structure. Some have argued that the Government should impose a holding company structure because the safety net creates a subsidy.
As our written testimony indicates, there is some question as to whether a net marginal subsidy from the safety net exists at all. But if it does, appropriate safeguards would inhibit a bank from passing it to either a subsidiary or to a holding company affiliate. Therefore, given appropriate safeguards, banks should have the choice of conducting new activities in either holding company affiliates or bank subsidiaries.
Turning to other issues, the FDIC continues to favor a cautious easing of restrictions on the mixing of banking and commerce; and we are concerned that, in implementing a greater degree of functional regulation, the bill reduces the authority of Federal banking regulators to determine the appropriate products and services of banks.
There are three other items I want to touch on this morning—items that strike right to the core of the FDIC's mission.
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First, we commend the committee for retaining the FDIC's ability to examine a bank affiliate to the extent necessary to protect the insured bank. We have used this authority sparingly in the past and only after careful analysis.
Second, we strongly support the provisions of H.R. 10 that would eliminate the SAIF Special Reserve. If the Special Reserve is not eliminated, it could lead to an assessment rate disparity between the BIF and the SAIF.
And, third, for many reasons, which we discuss in our testimony, the FDIC urges the committee to use H.R. 10 to merge the two Federal deposit insurance funds. Such a merger would eliminate a fundamental weakness in the Federal deposit insurance system.
The BIF and the SAIF are both fully capitalized with identical assessment rate schedules, and the members of both funds are healthy and profitable. Upon elimination of the SAIF Special Reserve, the reserve ratio of the SAIF would be restored to reflect its true level, and the BIF and the SAIF would have comparable reserve ratios, and a merger of the two funds would not result in a material dilution of either fund.
In conclusion, we have a unique opportunity to achieve financial modernization. This bill represents a good starting point, and the FDIC stands ready to work with you and Members of the committee in this important endeavor.
Thank you.
Chairman LEACH. Well, thank you, Ms. Tanoue; and we appreciate your testimony.
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Mr. Hawke.
STATEMENT OF HON. JOHN D. HAWKE, JR., COMPTROLLER, OFFICE OF THE COMPTROLLER OF THE CURRENCY
Mr. HAWKE. Thank you, Mr. Chairman. Mr. LaFalce, Members of the committee, I appreciate the opportunity to be with you today. At this hour on a Friday, I don't want to burden the committee with a lengthy statement; and if I may, Mr. Chairman, I ask that my entire statement be placed in the record.
Chairman LEACH. Without objection. That applies to all the panelists.
Mr. HAWKE. There are complex issues in this bill, but the one that has emerged as pivotal is the major issue that divides us from the Federal Reserve. The Federal Reserve would mandate that all new financial activities of banking organizations be conducted only under their jurisdiction in holding company affiliates. We support giving institutions the freedom to choose the affiliate or subsidiary format, in either case, subject to exactly the same strong safety and soundness protections for the bank.
Let me point out the inexplicable anomalies and inconsistencies in the Fed position.
First, State banks today are free to conduct through subsidiaries any activities authorized by their States, subject only to a determination by the FDIC that the activity would present no significant risk to the insurance fund. A number of States have already authorized such activities as securities and annuities underwriting, and the FDIC has approved these activities. No explanation has been offered why national banks should be denied authority already possessed by State banks, and the Fed does not propose to bar State banks from conducting activities different from what are permitted for national banks.
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Second, any U.S. bank can conduct activities abroad through subsidiaries, subject to Fed approval, and the Fed has consistently permitted securities underwriting as a permissible activity, with no apparent concern for safety and soundness threats or ''subsidy'' policy.
Third, foreign banks can engage in a broad range of activities in the U.S. through subsidiaries. For example, a significant percentage of the so-called Section 20 affiliates approved by the Fed are, in fact, direct subsidiaries of foreign banks.
In light of these precedents, a very heavy burden rests on those who would single out national banks for the kind of discriminatory treatment that H.R. 10 proposes, and I submit that burden has not been carried.
Let me now turn to the subsidy argument. The argument itself is unclear, to say the least; and there is sharp disagreement as to whether any net subsidy exists. But, for the sake of argument, let's assume that banks do enjoy some such subsidy. The question demanding a comprehensible answer is what difference organizational format makes. Before Congress outlaws the use of subsidiaries and deprives American banking organizations of the ability to use this format, it should require a compelling showing that the affiliate format is materially better in containing any subsidy than the operating subsidiary format. No such showing has been made, nor can it be made in light of the constraints that would apply.
First, the same firewalls would apply in the case of each format. The bank could not lend to a subsidiary on any more favorable basis than to an affiliate.
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Second, any equity investment by the bank in a subsidiary could be no more than the bank could pay upstream to its parent holding company by way of dividends.
Third, any such equity investment would have to be deducted from the bank's regulatory capital in determining whether the bank complied with the well-capitalized standard. Thus, the effect on regulatory capital would be exactly the same as the payment of a dividend. In fact, if a subsidy exists, funds do not need to move at all within the company. The existence of a subsidy at any place in the structure benefits the consolidated organization, and the organization can allocate the benefit of that subsidy in a variety of ways to whatever element of the organization it chooses.
To illustrate, if bank earnings indeed reflect the benefit of a subsidy, the holding company can allow its securities underwriting affiliate to use that benefit by simply lowering its prices. The affiliate gets a competitive advantage, and it all washes out on the consolidated books of the holding company.
In short, given these constraints, organizational format should be reviewed as wholly irrelevant to the subsidy issue.
Real world experience demonstrates, moreover, that banking organizations have not been acting as if such a subsidy exists. Such activities as mortgage banking, commercial and consumer finance and data processing are presently conducted both through holding company affiliates and banks subsidiaries, as evidenced in the table that I would like to submit for the record.
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Mr. HAWKE. Let me finally turn to what I think is the most compelling argument against the Fed position, the importance of the operating subsidiary for the safety and soundness of a bank.
Chairman Greenspan was absolutely right two years ago when he testified before this committee that the op-sub does not present a safety and soundness problem. If his staff has recently persuaded him to abandon that correct position, he should not have listened to them. He should be listening to the message that has come from every FDIC chairman in recent history.
The fact is that there is not a penny's worth of difference in the exposure of the bank to the risk in new financial activities when those activities are conducted in op-subs as distinct from holding company affiliates. The protections are exactly the same. In fact, if this committee had adopted the Treasury Department's proposal in the last Congress to provide insured banks with safeguards against piercing the corporate veil, those protections would be even stronger.
The most troubling aspect of the Fed position is that, in the name of guarding against the spread of some ethereal subsidy, it would in fact compromise safety and soundness.
First, it would mandate a format that would inevitably weaken banks by forcing them to use their resources to capitalize and fund holding company affiliates rather than husbanding those resources in the bank.
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Second, it would deprive banks of the opportunity to diversify their revenue flows by capturing the benefits of business opportunities generated by their day-to-day banking activities and, instead, would divert those revenue flows to the holding company where they would be unavailable to the bank.
Third, it would deprive the FDIC of the ability to cushion its losses when a bank gets into trouble by selling off profitable subsidiaries.
Anyone who had any involvement in the wave of banking failures ten years ago knows only too well how difficult it was for the banking regulators, including the Fed, to force holding companies to come to the aid of their troubled banks. Yet the Fed position today would not merely sanction the diversion of bank resources to affiliates, but it would mandate it. To me, it is simply inexplicable that an agency responsible for promoting and preserving the safety and soundness of banks would advocate a position that would have exactly the opposite effect.
Finally, let me address what I think is really at the heart of this debate. Fed witnesses have objected to the op-sub because of concerns about the evolution of a universal bank, which is a clear mischaracterization, and they have spoken about the atrophy of the holding company that would result. The notion is that if op-subs were permitted, holding companies, which the Fed regulates, would wither and die, and the Fed's window into the banking system would become less effective.
If that were a realistic threat, I could understand the Fed's concern; but I have yet to find anyone in the marketplace who thinks there is any substance to this concern. Even if op-subs were permitted, there still are a myriad of reasons for having a holding company, as any businessman will tell you.
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But if anyone has any concern at all in this regard, there is a simple answer. Congress can require that any bank over a specified size—$1 billion, $5 billion, $10 billion—that wants to exercise newly authorized activities through an op-sub must continue to maintain a holding company and be regulated as such by the Fed. This will have little or no practical impact on any institution and will assure that the Fed's present role is preserved.
Mr. Chairman, I respectfully submit that anyone who advances a proposal to impose legislative restrictions on the way our financial services firms organize their businesses, particularly restrictions that grossly discriminate against national banks, is under a heavy burden to put forth a clear, consistent and broadly understandable rationale demonstrating that only through such restrictions can well-defined governmental interests be protected. Restrictions cannot be justified either to protect competitive advantages of particular segments of the industry or to alleviate fears about a loss of regulatory jurisdiction. I regret to say that I believe that burden has not been carried in this legislation.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Hawke.
Ms. Seidman.
STATEMENT OF HON. ELLEN SEIDMAN, DIRECTOR, OFFICE OF THRIFT SUPERVISION
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Ms. SEIDMAN. Thank you very much.
Good afternoon, Chairman Leach and Congressman LaFalce and Members of the committee. Thank you for this opportunity to present the Office of Thrift Supervision's views on financial services modernization, H.R. 10 and H.R. 665.
In our experience, the modern thrift charter provides business flexibility coupled with sound regulatory oversight. Although it is not the only way to structure a modern charter, it is a model worth studying and certainly worth preserving as it continues to serve America's households and communities with over 70 percent of thrift assets in residential mortgages or mortgage backed securities.
The unitary thrift holding company provides a unique combination of permissible affiliations and restrictive operating conditions. Although a thrift may affiliate with any type of commercial entity, restrictions under which the thrift operates protect it from the types of concerns raised about the mixing of commercial banking and commerce.
Unitary restrictions provide that a commercial company may own only one thrift, although it may acquire additional troubled or failing thrifts which, by the way, helped commercial companies infuse at least $3 billion of capital into the industry in the late 1980's.
A statutory bar on lending to affiliates not engaged in permissible bank holding company activities prohibits—it doesn't limit, it prohibits—a thrift from making credit available to commercial affiliates. Our rules also limit the amount a thrift may dividend or distribute to a parent holding company.
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Maybe most important, other than the absolute prohibition on making credit available, Federal thrifts' commercial lending is constrained. These are not commercial banks. By statute, thrifts may only hold 10 percent of assets and commercial loans, with an additional 10 percent of assets for small business loans. This limit, coupled with the qualified thrift lender requirement which generally requires thrifts to maintain a consumer lending focus, effectively constrains the ability of thrifts to engage in traditional commercial bank lending.
And statutory anti-tying restrictions prohibit a thrift from conditioning loans on the requirement that a borrower purchase other services from an affiliate of the thrift, thereby preventing indirect benefits to a commercial affiliate.
In fact, despite all of the hoopla about the unitary, commercial ownership of thrifts remains very limited. Currently, only 24 of the approximately 550 unitary holding company structures have commercial activity within them; and, in many cases, it is a very small amount of commercial activity.
The vast majority of charter applications come from groups of individuals and from insurance and securities companies, all of whom could own a commercial bank with full commercial lending powers if H.R. 10 were enacted in its current form.
I am actually reminded that one of the new applicants who raises the commercial issue is Nordstrom. So I took out my Nordstrom credit card and checked what this was all about, and it turns out that Nordstrom—this credit card is issued by Nordstrom's National Credit Bank. So I checked on what that was, and it turns out that this horrible commercial combination already exists, and, moreover, it is exempt from the Bank Holding Company Act and Sections 23(a) and 23(b), which provide restrictions that are actually good but less-strong than the restrictions under HOLA.
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Another balance in the Federal thrift charter is the tie between a consumer lending focus and the ability to operate under uniform Federal standards. Unlike commercial banks, and this is Mrs. Biggert's question, Federal thrifts are statutorily required to direct most of their lending activities to consumers. In exchange, Federal law affords thrifts the opportunity to engage in these lending activities on a nationwide basis with one set of Federal laws and regulations governing their lending and deposit-taking activities.
Since September 25th of last year, three mortgage banking companies with a total of $100 million in assets and much higher originations have become thrifts, moving these assets voluntarily under CRA. We believe that one of their major incentives was the preemption. But our authority is limited. OTS rules issued after notice and full opportunity for public comment specified that even with respect to lending and deposit-taking, Federal law does not preempt State laws that further vital State interests and have incidental impact on thrift operations.
For example, we recently declined to preempt a State ATM lighting law that was clearly enacted to protect ATM users. A less obvious example involved a State law requiring lenders to correct a per loan fee from borrowers on behalf of the State. Because the State law involved a relatively minor burden applied to all lenders and had an incidental impact on thrift operations, we concluded it was not preempted by Federal law.
The Federal thrift charter also has a unique combination of consolidated regulatory oversight and functional regulation. On the one hand, OTS is the consolidated Federal regulator for all Federal thrifts, their subsidiaries and their holding companies, except where the holding company also owns a bank. This approach has worked well. We have accessed information on the institution's operations and the institution has consolidated regulatory oversight that has focused on the safe, sound and compliant operations of the thrift.
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But simultaneously, and I think this is extremely important, thrifts also operate under functional regulation with its securities and insurance activities permissible almost exclusively in subsidiary service companies or affiliated holding company parents or subsidiaries which are functionally regulated by the in State regulators, the SEC and the appropriate self-regulatory organization. Primarily, oversight of the respective activities remains with the functional regulator with whom we work closely when an issue affecting the thrift or its customers arises.
The thrift charter has allowed local, community-based organizations to offer a full range of financial products and services to consumers; and the charter encourages innovation in the design and delivery of financial systems and products, with new entrants providing more choices for consumers and new delivery systems for previously hard-to-reach markets.
We, therefore, oppose the provisions of H.R. 10 that would restrict the unitary thrift holding company or that would impose conditions on uniform Federal standards for thrifts.
We are pleased that H.R. 10 includes a provision to eliminate the SAIF Special Reserve and to return more than a billion dollars in the reserve to the SAIF. Eliminating the reserve will preserve the capital cushion of the SAIF to absorb insurance losses and to avoid the possibility of an artificial, but harmful, premium differential, the fear of which could reinvigorate that most pointless of all financial transactions, deposit shifting.
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And we continue to support a merger of the Federal deposit insurance funds. The economic and managerial inefficiencies of a two-fund structure where many institutions hold deposits insured by both funds should be eliminated.
Before concluding, I want to comment briefly on H.R. 665. It has many attractive features by focusing only on the key elements necessary for financial modernization and avoiding some of the pitfalls of other approaches. And in particular, of course, we are pleased that H.R. 665 leaves the unitary thrift holding company structure in place, allowing institutions to decide whether that structure or some other best suits their business goals and needs.
Mr. Chairman, despite our serious concerns regarding some of the provisions of H.R. 10, I do want to emphasize that we support financial services modernization and agree with your goals for such legislation. Based on our experience, both the thrift charter and the unitary thrift holding company structure meets these goals. Similarly, we support retaining existing Federal law that facilitates the implementation of the mandate under which Federal thrifts operate under uniform national standards based on the best practices found throughout the country.
And, finally, we urge the committee to take the opportunity presented in H.R. 10 to merge the two Federal deposit insurance funds and to eliminate the SAIF Special Reserve.
I look forward to working with you during the 106th Congress toward enactment of financial services modernization that achieves these goals.
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Thank you.
Chairman LEACH. Thank you, Ms. Seidman.
Mr. Goldschmid.
STATEMENT OF HARVEY J. GOLDSCHMID, GENERAL COUNSEL, U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. GOLDSCHMID. Chairman Leach, Representative LaFalce, Members of the committee, on behalf of the Securities and Exchange Commission, I would like to express the Commission's appreciation for the opportunity to testify today. I know Chairman Levitt deeply regrets he couldn't be here.
The Commission joins a consensus that Chairman Leach mentioned at the beginning of the hearing, strongly supporting financial modernization. It believes now is the time to act.
This year Congress has an extraordinary opportunity to craft a legal framework and adapt to the dynamic change the financial services industry is undergoing. America's capital markets today are the envy of the world; and, in the process, we have moved from a Nation of savers to a Nation of investors.
American families today put more of their savings in mutual funds than in insured bank accounts. And it is, therefore, critical—a word I must underscore—to insure that we have a framework that maintains the strength, the discipline, and the vitality of our securities markets. Such a framework must allow the Commission, as the Nation's primary securities regulator, to continue to fulfill its mission to protect investors and safeguard the integrity of markets.
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The version of H.R. 10 passed by the House in May of 1998, while not perfect from the Commission's perspective, did recognize the fundamental differences between banking and securities activities. As a result, the Commission expressed its support. Since that time, however, the basic principle that the Commission would retain supervisory and regulatory authority over the U.S. securities markets has been diluted and complicated.
Regrettably, Mr. Chairman, the Commission cannot support the version of H.R. 10 now before the committee. The bill as it stands creates too many loopholes, and that is a serious word in this context. Too many products are excluded. Too many activities are exempt from securities regulation. We fear the scope of these loopholes, which are ambiguously drafted, may create even greater problems and uncertainties in the future.
The bill, for example, would create the following problem: Two investors receive recommendations to buy the exact same security, one in a bank, one in a brokerage firm. However, because the bill clouds the distinction between banking and securities activities, these two investors may receive very, very different kinds of protection. In contrast to where securities laws are applicable, the bank investor may not be able to make claims against a bank for unsuitable investments.
Furthermore, he or she would not be protected by the SEC's failure to supervise doctrines, by securities licensing procedures, by securities arbitration remedies and, perhaps most importantly, by the Commission's extremely effective enforcement program. The bank investor in most cases would not even know that he or she had given up these protections.
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At best, the state of affairs is inconsistent. At worst, which may very well be the case, it is dangerous.
There are more investors in our markets today than ever before. Every day they choose from an increasingly wider array of products and providers, but they should not have to give up basic safeguards in the process.
And the same is true about the SEC's capital requirements. They provide greater protection for market exposure and volatility than the capital requirements imposed by bank regulators which focus on credit exposure.
The purpose of my testimony today is not to comment on each specific provision of H.R. 10. Instead, I would like to outline the broader points the Commission feels must be addressed by any successful financial modernization bill.
As I indicated earlier, it is critical the Commission retain supervisory and regulatory authority over our securities markets, regardless of where a security is bought or sold. In addition, we must be able to continue to determine how securities are defined.
The following five key safeguards are needed in financial modernization legislation: Provisions assuring effective, aggressive SEC policing and oversight authority over all securities activities; provisions safeguarding customer interests and market efficiency by recognizing the SEC's right to set net capital rules for all securities businesses; provisions ensuring investors will be able to count on protection through SEC enforcement of sales practices rules for all securities; provisions protecting mutual fund investors through uniform advisory regulations and conflict-of-interest rules; and, finally, provisions allowing for the maintenance of America's global competitiveness through the establishment of voluntary broker-dealer holding companies.
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In conclusion, these five key objectives are not novel; nor are they secondary. They have been the central themes of the Commission's testimony to date. We urge the committee to work toward a regulatory framework that fits today's marketplace without compromising the Nation's historic commitment to investor protection in preserving market integrity.
Again, thank you for the time.
Chairman LEACH. Well, thank you very much, Mr. Goldschmid.
First, let me just say we will take your views into consideration. We have a great deal of respect for the SEC. But I think it has to be emphasized that all of the regulatory bodies have testified that they want maximum authority within their regulatory body. And that doesn't mean that there isn't regulation that doesn't exist through another regulatory body, whether it be at the State or Federal level; and so sometimes the testimony we receive, in the view of the Chairman, it is a bit overstated.
Having said that, let me just ask you, if you take the framework today of a securities sales in a bank versus the framework of H.R. 10, isn't H.R. 10 a better framework than today's current law with regard to banking securities activities?
Mr. GOLDSCHMID. Well, Chairman Leach, let me start by saying, there is nothing territorial in this. In my case, as you may know, I am an academic. I spent most of my life at Columbia. The SEC's concerns are about one of our great industries that has been one of our most successful. The securities business works, it is a national treasure. If you take away the effective enforcement that you have had from the SEC, it is not about territory, it is about the future of a key industry, a diamond in our financial structure.
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Now, in terms of the way things work now, banks are going to be expanding out under either of the bills that have been proposed here. The problem now is real. We have been enormously concerned.
My written testimony suggests, for instance, we now can't reach investment advisers. When Glass-Steagall was written and then the 1940 act was written, the assumption was banks would not have mutual funds and would not have investment advisers. We can currently reach mutual funds, but not the advisers.
We have had very serious problems with banks in which the advisory functions have not worked well, and we haven't been able to reach supervisors or problems or get information or use our compliance system. If you continue and expand these activities, we are asking, in my not-so-gentle and not-understated view, for potential national tragedy. The securities laws work. We must not interfere with how well they are working now.
Chairman LEACH. Thank you.
Mr. LaFalce.
Mr. LAFALCE. Mr. Hawke, you gave a very, very strong statement with respect to the desirability, if not, indeed, the necessity of choice with respect to an operating subsidiary as opposed to an affiliate, and different strong words with statements made by the Federal Reserve Board. You at one time were associated with the Federal Reserve Board, were you not, and you had a rather prominent position. What was that position you had with them, when, for how long, and so forth?
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Mr. HAWKE. Mr. LaFalce, I am reminded of a statement that my late partner, Thurman Arnold, used to make as he got up into the elder stages of life. He said, ''I am an old man, and some of the things I remember best never really happened.'' But it is true that about 20 years ago I served as General Counsel to the Federal Reserve Board.
Mr. LAFALCE. All right. I think it is important for us to know that you know a little bit about the workings and activities of the Federal Reserve Board and take that to the table with you.
Ms. Tanoue, at the near conclusion of Secretary Rubin's remarks, Chairman Leach indicated that he always gets a comfort factor, as do I, when the professionals can come to a meeting of the minds. I think that is very, very helpful. But I view you and your predecessors as the quintessential professionals because you are the insurers. Everybody else can talk about it, but you are the insurers, and that is why I look at your experience and your predecessors with special care.
And if anybody were at the table to help resolve the issue, for example, of operating subs, or the appropriate mixture, if any, of banking and commerce, I would like it to be those individuals who are responsible for insuring it, the funds in question.
If we ever have enough time, I am not going to ask for this officially, Mr. Chairman, I think it might be a great idea to have a panel of all the present, past and living chairmen of the FDIC to get their perspectives on this issue and their rationales. I think that would be extremely helpful, informative and influential.
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What experience have you had as insurer for State-chartered institutions that have operating subsidiaries pursuant to State law?
Ms. TANOUE. We have had years of experience with operating subsidiaries of State-chartered non-member banks. And the activities undertaken by such entities, in many cases, are those that are contemplated by the OCC under its Part 5 rules.
I think it important to note that, in acting on those types of applications, the FDIC has developed a number of safeguards and firewalls that are very similar to those that are under discussion today; and while we have not had large numbers of institutions engaging in these activities, we have not found major concerns in terms of safety and soundness.
Mr. LAFALCE. All right. Fine. Your testimony does not need clearance by anyone, by OMB? You are an independent insurer?
Ms. TANOUE. Absolutely right.
Mr. LAFALCE. OK, good.
Why did you come forth with a defense of the unitary thrift holding company structure in your prepared testimony? You did specifically say that you had experience with them, you insure these institutions, and you did not like provisions of the law that would either eliminate or at least curtail the option before a unitary thrift respectively. Am I correct in what you said?
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Ms. TANOUE. Yes. We did point out——
Mr. LAFALCE. Could you expand upon that?
Ms. TANOUE. In terms of the competitive landscape, we did not see a public policy purpose supporting a position which would, in effect, put a moratorium on such activities.
Mr. LAFALCE. All right. Now I have never asked the past chairman of the FDIC that question. I have asked them all the question about operating subsidiaries. Do you know offhand what their position would be on a moratorium with respect to a determination of the unitary thrift holding company charter prospectively?
Ms. TANOUE. I do not know, offhand, their positions.
Mr. LAFALCE. All right, fair enough.
Mr. Hawke and Ms. Seidman, to what extent does your testimony need clearance by the Administration, OMB? Mr. Hawke, does it need clearance?
Mr. HAWKE. No, Mr. LaFalce, it does not.
Mr. LAFALCE. Ms. Seidman? Does it?
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Ms. SEIDMAN. No, it does not. Although, as a courtesy, we let them know what we are about to submit.
Mr. LAFALCE. OK, that is fine. I just wanted to clarify that.
Mr. Hawke, let me not ask you to give either your opinion, but let me just ask you to clarify a bit of history for me, if I might.
When you were the Assistant Secretary of the Treasury for Financial Policy, the immediate superior of Mr. Carnell, did not you and Mr. Carnell appear at least before committees—I can't remember whether it was official hearings or private meetings—and say, with respect to the mixture of banking and commerce, that this was a policy judgment for the Congress to make? That you at least did not recommend one option or the other, but your perspective was that either there should be some specific law permitting appropriate mixture, to-wit, some appropriate basket coupled with a termination of the unitary thrift holding company charter, or if there were not a specific provision allowing some appropriate mixture, a retention of that unitary thrift holding company option perspectively? Am I remembering correctly?
Mr. HAWKE. Mr. LaFalce, when I was Under Secretary for Domestic Finance, I testified before this committee on the Treasury proposal. And, in that proposal, we outlined two alternative ways of dealing with the issue, suggesting that the Congress consider those or any other choices that it saw fit. One was to provide a modest basket permission for nonfinancial activities for holding companies, in which case we thought that would provide a framework for unifying the thrift charter with the bank charter and unifying regulation of holding companies. Alternatively, if no basket were thought appropriate, you might keep the unitary thrift in existence as it is today together with the thrift charter.
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The purpose in either case——
Mr. LAFALCE. That is my recollection. I just wanted to have you refresh the historical record.
Ms. Seidman, you—since the 1960's, you and your predecessors have been supervising unitary thrifts, permitting them or not permitting them, and so forth, and evaluating them. To what extent, in your judgment, has the unitary thrift charter caused safety and soundness problems or other types of problems? To what extent has it been beneficial from a safety and soundness and economic perspective? What are the—what is the—give me an historical evaluation of the advantages and disadvantages of that approach.
Ms. SEIDMAN. Historically, I think we can say that the unitary thrift holding company charter has been, on balance, beneficial. I think it is extremely important, however, to divide the period into at least three parts, but definitely two, namely, before 1989 and after.
Since 1989, a tremendous number of restrictions and limitations have been put on the interactions between a thrift and its commercial or non-bank affiliates that didn't exist before; and such things as thrift investment in real estate development had been very severely curtailed.
But the fact is that we can actually trace a minimum of $3 billion in capital that was infused into 79 thrifts during the late 1980's and early 1990's by commercial firms. And, in fact, we are certain that much more money ultimately went in, but that is what we can trace by the capital infusions.
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In a number of cases, Ford Motor Company being the most obvious, the commercial entity decided that having a thrift wasn't for them. They successfully sold the thrift, but it had been significantly rehabilitated, and a huge amount of capital had been put in that thrift by Ford before it was sold.
Chairman LEACH. Mr. Vento.
Mr. VENTO. I appreciate the line of questioning that my colleague has pursued with regards to this matter and, you know, completely concur. Obviously, I wanted to go a little further, but apparently he doesn't want anyone to have to dig a deep hole that they might—that may be uncomfortable for them to be in.
Chairman Leach, my concerns spring from the go-go 1980's when we thought, or at least some thought, the best way for financial institutions to dig themselves out of the hole was to have new activities and direct investment, a variety of other things that took place by sometimes State-regulated institutions, sometimes federally-regulated institutions, was fundamentally proved to be a mistake.
But I think a mistake perhaps wasn't in the powers, but in the lack of what happened in terms of regulation; and, you know, I think that, you know, perhaps we should have known better than to give the power. I think we are sort of on the threshold issue of that today, and I think caution with regards to commerce and banking is justified.
But I mean, on the other hand, I don't think we can be blind. I think there is a testimony here that pointed out that the Chrysler Daimler-Benz merger, that Deutsche Bank owns 25 percent of that, which will deliver them to the United States of America to do banking under whatever subsidiary or under whatever they are going to do it.
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So you have got a commerce banking subsidiary type of activity to finance, you know, the purchase of my new, hopefully, new Dodge Caravan or something, you know. Well, I got grandchildren. I have to put them in something.
So I mean the concern is that it is here. And I think that, you know, this sort of denial by those that have reservations about it is what I have a problem with. Apparently, consistency doesn't matter to them, I mean, because you have got all sorts of examples of State and other institutions that are doing this.
But let me just ask a question. In this bill that we have before us, I mean, it is one thing to be inconsistent with, but we have all kinds of special exemptions through banking and commerce, but one of the—couple new policies areas here—I will leave the CEBA thing alone—is the 15-year grandfather for the insurance and securities firms.
Now, Mr. Goldschmid, you don't disagree with equity involvement on the part of securities, or on brokerage dealers; is that correct? You agree with that?
Mr. GOLDSCHMID. Correct.
Mr. VENTO. And do you think—so that is going to be something that you think that—obviously, in terms of the merger, it is sort of indifferent toward you, I guess, whether or not they become—they have a bank holding company or not, but they will be able to have one I guess for 10 or maybe 15 years depending on what happened.
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Mr. GOLDSCHMID. Our concern is that the Securities and Exchange Commission's securities law apply. We are very flexible about forms.
Mr. VENTO. Mr. Hawke, what do you think the effect would be in terms of national banks and banks holding companies in light of the fact that a—predominantly insurance or predominantly securities—firms could, in fact, have banks and that existing national and holding company apparently could not? What do you think would be the evolution of the impact upon our financial system if this particular asymmetry were to persist? Asymmetry being out of balance.
Mr. HAWKE. Well, I object to discrimination whenever I find it in this legislation.
Mr. VENTO. God bless you.
Mr. HAWKE. Let me say, Mr. Vento, I think the problem that the Congress is confronting in this debate is not really whether to open up the doors to banking and commerce, because I don't think anybody is really arguing that. The marketplace is certainly not arguing for that. The problem has been right from the start, and the reason that we proposed the two alternatives that I mentioned before, was that you have the practical reality that some firms that we want to bring in under the tent, some insurance and securities firms, have some measure of nonfinancial activity today. The challenge has been how to deal with that. How do you accommodate that and get them in on a level playing field with other organizations? And that has been a very sticky issue.
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Mr. VENTO. Well, part of is dependent upon how you define some of these instruments. I mean, if some people have their ways in terms of derivative is going to be more like an equity-type piece of paper. I mean, it could conceivably, in my mind, go in that direction. It depends upon how you define it.
Mr. Goldschmid, looking at your testimony, if I can find it here for a minute, the discussion arose with regards to page 12, the uniform mutual fund advisory regulation. Accordingly, all parties that provide investment advice now to mutual funds should be subject to the same oversight, including Commission inspections and examinations.
Now, banks and thrifts are examined almost yearly. How often are securities brokers and these institutions examined?
Mr. GOLDSCHMID. Well, we have gotten the numbers down; and we are doing sweeps. I couldn't give you an exact number today.
Mr. VENTO. Was it yearly or is it more than that?
Mr. GOLDSCHMID. I think it is probably still more. But it varies with the number and the size and other risk factors. But it is working—I mean, the point here is to keep in mind when it is in a bank—right now, for instance, a bank can act as the investment adviser. Because the 1940 Act didn't contemplate banks doing this, the investment adviser to the mutual fund could be considered an independent director of that fund.
Loans to the bank at disadvantageous rates can be made without our ability to pick that up. There are very serious problems right now that we are trying to reach. And on our compliance program, I think everyone has agreed it has grown more and more effective.
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Mr. VENTO. I want to ask you about some of that. But I was, you know, informed—the last study that I had seen on this that was done by the General Accounting Office suggested it was five years.
Mr. GOLDSCHMID. Yes, that number I think has come down. I was quite critical as an academic of that number.
Mr. VENTO. Well, I appreciate that. And, you know, but since we think that there ought to be this parity and this symmetry and so forth, this is not quite fitting into that particular—you know, the concern here, I think I expressed it looking at, you know, from the standpoint of financial institutions is that discount brokerage and other types of activities which I think—what we are trying to do is leave—do no harm in terms of what the banks can generally do today. And if they are large enough, of course, this doesn't matter.
So it is the smaller institutions that might do discount brokerage and do other types of activities, that when we come down on them, they say, ''Well, what is in this bill for me?'' They end up not being able to do some of the activities they can do today, insurance, which isn't your bailiwick, but certainly discount brokerage and sale of these, and that is the concern we have.
And I think that we are looking for—I mean, the real issue here is that, say it has to be our way or no way is a concern. I mean, listen, we have written State laws, myself, many of us have done work, and we know that States have different laws. And I mean Minnesota passed its own law and subdivided land sales practices. So I remember writing it. So there are a lot of differences between States and what the practices are even today that you have to coordinate.
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It seems to me coordinating with half a dozen regulators in terms of national banks or bank holding companies or thrifts and so forth, wouldn't be, or shouldn't be, a major problem, especially if we set up an interagency or interdepartment type of arrangement.
But one of the things that I would like—last year when we were in the midst of trying to deal with the issue of banks and securitization and so forth, we, of course, had the celebrated Nations case, in terms of the fines that came down; and, of course, this apparently was the only fine and trespass in some individual's mind that had occurred in recent memory. And it was—it received a terrific play in The Washington Post and on the House floor and other places.
So what I would really like, I think, is to know, and you just, of course, commenting about these aggressive enforcement actions, that is exactly what I would like to know about, is I would like—for about the last three years, I would like the major enforcement records, the fines, penalties and other activities that SEC can place. I am sure you have a longer list, but I am not asking for all the small things, just the major enforcement actions. Could you comment a little bit on that?
Mr. GOLDSCHMID. Major enforcement actions?
Mr. VENTO. Yes.
Mr. GOLDSCHMID. Sure, we would be to happy give you a list.
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My testimony cites another bank situation that we just brought an action, the Traba case, and we would be happy to develop a list for you.
Mr. VENTO. Not just banks. Of course, we would like to invite the scope of all of the different groups that are sitting. We treat them all even——
Mr. GOLDSCHMID. We will give you a full list of the enforcement cases. They run about roughly 500 a year. And then you have got to add to it the enormous security system that goes with the NASDR and others. They bring roughly 500 or 600 cases against brokerages.
Mr. VENTO. Perhaps we can get some common understanding just to deal with the major cases, so we can actually use the information, as opposed to just giving you on an even-handed basis.
Mr. GOLDSCHMID. I am just giving you a good feel of the nature of our enforcement process.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you.
Mr. Bentsen.
Mr. BENTSEN. Thank you, Mr. Chairman.
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Mr. Hawke, I have sort of a two-part question for you; and I ask it in two ways, one, in your capacity as the head of the OCC—and whatever capacity that is, I guess, that is an acting head of the OCC——
Mr. HAWKE. I am the Comptroller of the Currency.
Mr. BENTSEN.—and, second of all, from your both academic and professional background in the law.
We have had a lot of discussion today about the operating subsidiary, which you are quite familiar with, and the issue of risk. And, again, I will restate, as you may know, yesterday Chairman Greenspan reversed his previously-held position that he didn't believe there was a safety and soundness issue. He now, upon reflection over the last year or so, believes there is a safety and soundness issue.
But, from a legal perspective, is it possible to construct a subsidiary of a bank, a limited liability subsidiary where there is a nonrecourse investment on the part of the bank where you can upstream dividends from the subsidiary to the parent, but you cannot upstream liability, except in the instance of malfeasance on the parent's part?
Mr. HAWKE. Mr. Bentsen, I think that is precisely the nature of the operating subsidiary. An operating subsidiary is a business corporation that enjoys the usual limited liability of any business corporation, and the fact that it is owned by a bank doesn't expose the bank to any greater liability for the subsidiary's obligations than the bank would be exposed to with respect to an affiliate.
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Mr. BENTSEN. And would case history support that?
Mr. HAWKE. Yes, I am not aware of any case in which a bank was held liable for the obligations of an affiliate or a subsidiary that it had not explicitly and lawfully assumed.
Mr. BENTSEN. The sheet that was handed out that lists most common non-bank subsidiaries of bank holding companies and banks, is that yours?
Mr. HAWKE. Yes.
Mr. BENTSEN. That is yours. Do you all have any history of the failure and liability associated historically with these entities, you know, compared between bank holding companies and national banks? If you don't have it, you can get it for the record. I am just curious whether or not there is any pattern or consistency.
Mr. HAWKE. We would be happy to look into that.
In that connection, Mr. Bentsen, if I may, there has been some reference to the First Options case, which is given as an example of a problem with a subsidiary. I would like to submit for the record, and I know somebody on the committee asked for this earlier, the testimony of one of our people back in 1988 that gives the full story of First Options.
Mr. VENTO. Can I ask with unanimous consent that be put in the record?
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Chairman LEACH. Without objection, it will be put in the record.
Mr. HAWKE. The quick explanation is that when the OCC approved the establishment of First Options, it voluntarily imposed on First Options—on the bank's relationship with First Options—a lending limit constraint that did not exist as a matter of law. When First Options got into trouble, it asked for that limit to be relieved; and the OCC denied the request. The bank went ahead and advanced credit in violation of that restriction.
When the OCC found out about it, it immediately required that transaction to be reversed; and the funding was placed in the holding company. So, First Options, contrary to being an example of a situation where the subsidiary format exposed the bank, was a simple example of a violation of law that could have occurred with an affiliate or a subsidiary.
Mr. BENTSEN. And the liability from that instance—I have read one or two papers on this, but the question I would have on that, the liability in that particular instance then, would not be some structured liability. It would be liability on—a legal activity on the parent's part; and, thus, a creditor would not be able to come back to the parent and claim, because of the structure and the fact that an illegal advance of credit had been made, therefore, it opened the parent up to other claims. It would only be that the parent had acted improperly as it related to the subsidiary?
Mr. HAWKE. That is absolutely right. It was a debtor-creditor relationship between the parent and First Options or the holding company and First Options. And that, I don't think, under the piercing-the-corporate-veil doctrine would have been enough to justify imputing liability to the bank.
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As a matter of fact, the one study that we found on this question of piercing the corporate veil indicates that it more frequently occurs—I am not talking about banks, I am talking about corporations generally—with respect to affiliates than with respect to subsidiaries. But the critical issue is a factual one in each case, that is, whether the principles of corporate separateness are being observed between the two institutions. And if corporate separateness is being observed, then the normal principles of limited liability should apply.
Mr. BENTSEN. And with the Chairman's indulgence, in the difference between the operating subsidiary structure and the affiliate structure—and I would ask Mr. Goldschmid this as well, who I think said that you were flexible about form, or the SEC, was flexible about form, which I think is also a different—a newer position—is there more functional regulation under the operating subsidiary structure as it relates to securities investment product sales than under the current affiliate structure like a Section 20 or a proposed affiliate structure?
Mr. HAWKE. It would be identical.
Mr. BENTSEN. Identical.
Mr. GOLDSCHMID. In the past, the Commission—of course, when we talk about holding companies and op-subs, the definitions have been changing. In the past, the Commission has thought it was easier to work in a holding company format, but we want to look at where things are today. The key I should say for us is that the SEC continue its regulatory responsibility.
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Mr. BENTSEN. For the record, Mr. Goldschmid, if you would—I am sure you will do this anyway, but if you would provide for me the—where the SEC sees potential loopholes as it relates to consumer protection and proper regulation and enforcement of securities sales and other investment product sales under—currently under the regulation of the SEC as it relates to broker-dealers in both H.R. 10 and H.R. 665.
Mr. GOLDSCHMID. We would be happy to do that.
And I should say, on investment advisers, the current H.R. 10 is a good bill from our standpoint. It does give us the authority we need over those investment advisers.
Mr. BENTSEN. All right. Thank you.
Mr. HAWKE. Mr. Chairman, if I could have the Chairman's indulgence for just one moment to address a point that Mr. Bentsen raised earlier with respect to the accounting treatment of banks and operating subsidiaries.
I think it is important to distinguish between financial reporting conventions and economic realities. When bank examiners go into a bank, as Congressman Bachus observed, they will look at a bank's consolidated balance sheet. But what they really look at are the assets and the real value of the assets, and they look at regulatory capital. And regulatory capital is different from GAAP capital. They will also look at what really is at risk with respect to the bank's investment in the subsidiary.
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What is at risk is the amount of equity that the bank has invested in the subsidiary, plus any credits that the bank has, within legal limits, extended to the subsidiary. That is where the real risk, if any, to the bank is; and it should be measured on that basis.
Financial reporting conventions would consolidate the subsidiary into the bank, but that doesn't give a true measure of what, for example, the FDIC exposure is. Because if the bank or the subsidiary fails, the bank's exposure is only the loss of the investment that it has in the subsidiary. And if the bank is required to maintain its capital at the well-capitalized level, then the bank should be able to withstand the failure of the subsidiary and still be well-capitalized on a regulatory capital basis.
Mr. BENTSEN. And the equity investment would be over and above the regulatory capital of the bank; correct?
Mr. HAWKE. That is right. It would have to be subtracted from the regulatory capital of the bank in determining whether the bank was, on a stand-alone basis, well-capitalized.
Mr. BENTSEN. And to the extent that the examiners—and I don't know what they look at, but to the extent that the examiners look at the management capability of the bank itself, would it not be the same? That whether it is a national bank structure or a holding company structure, that a poor performing subsidiary or poor performing affiliate would be viewed in the same way where you had a dominant parent or dominant bank within the holding company structure?
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Mr. HAWKE. Yes, I think that is absolutely right.
Mr. BENTSEN. Thank you, Mr. Chairman.
Mr. VENTO. Mr. Chairman.
Chairman LEACH. Mr. Vento.
Mr. VENTO. I want to just refer to Appendix B that Chairman Tanoue has actually provided for us and just a query as to whether or not—we don't have numbers, apparently, on most of the State banking commerce type of activities; and I don't know what that definitively—it looks as though the focus—it gives some general history in terms of State roles historically, but doesn't necessarily come to a conclusion today. We need help in this example. The Nordstrom example that Director Seidman has pointed out—if that was a State-chartered institution?
Ms. SEIDMAN. No, as a matter of fact, Ms. Williams has pointed out that I made one mistake. It is a national bank, but while it is not subject to most provisions of the Bank Holding Company Act it is indeed subject to Section 23(a). Were it to become a thrift, were we to approve the charter, it is a post-October applicant.
Mr. VENTO. That is the newer applications.
Ms. SEIDMAN. It would be to stricter rules that are appropriate under——
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Mr. VENTO. But under the loose, liberal rules of the OCC it is not affected.
Ms. SEIDMAN. No, not the loose, liberal rules of the OCC. My point is that for many of these so-called banking and commerce issues there is a tremendous amount of intermingling already in the system.
Mr. VENTO. I know that, but I am trying to get a fix, if anyone can help me, in terms—I appreciate Appendix B, but what I think we would like is to have information in terms of what is happening where the State is. For instance, the chart that Comptroller Hawke gave us, does that include State activities, too, Mr. Hawke?
Mr. HAWKE. This looks at both bank holding companies and, I believe, national banks.
Mr. VENTO. And so it does not include State?
Mr. HAWKE. I am reminded that the chart includes both national and State banks.
Mr. VENTO. Well, that is one of my difficulties in terms of trying to arrive at—I don't know. It is sort of like someone who is designed against their opinion is of the same opinion still. I don't know if I will change any minds with it, but it is nice to have the ammunition.
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Chairman LEACH. Mr. LaFalce.
Mr. LAFALCE. Ms. Tanoue, yesterday consumer activist Ralph Nader expressed concern with what he said was the inadequacy of the insurance fund to meet potential future difficulties. Because of the size of the fund you are not even charging premiums now, but you should be assessing premiums to build the fund up much, much more so. Because these are good times, and if we did have bad times we need a more adequate rainy day—especially in contemplation of passage of legislation that would permit affiliation and ever larger institutions. And what are your thoughts on that?
Ms. TANOUE. That is one of the subjects that we are currently studying. We are looking at the current circumstances and the potential exposure presented by these very large and complex institutions and we are looking at the adequacy of the 1.25 percent DRR. We hope to have that work done by June.
Mr. LAFALCE. Independently of affiliations, you presently have operating subsidiaries in a number of the institutions, at least chartered under State law, some national banks, too. Well, you have a number of activities that could have been performed within the bank, but other recent regulations promulgated by the previous comptroller. You now have some activities that—in op-subs—that arguably might not have been permitted within the bank itself.
You have assessed risk-based premiums; is that correct?
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Ms. TANOUE. Yes.
Mr. LAFALCE. To what extent does the determination of the appropriate risk-based premium consider the activities in op-subs? Does it raise the premium? Does it lower the premium? Or does it do both, depending upon the activity of the sub?
Ms. TANOUE. I am not aware of any direct correlation between the activities that an op-sub might engage in and the determination of premiums.
But, again, I really appreciate the comments you made earlier about the FDIC. We are an agency that very much prides ourselves on being a neutral broker. We have looked very carefully at this issue of safety and soundness as it pertains to either approach, the bank holding company affiliate structure or the op-sub approach, and I would like to emphasize that we believe strongly that the safeguards that have been discussed that are necessary to protect the insurance funds are similar under either approach. And so long as those safeguards are maintained—and I would emphasize are enforced—we feel either approach is viable. And certainly that is why we put forward our position today that we would encourage the committee to allow institutions the choice and the flexibility to choose the appropriate organizational structure.
Mr. LAFALCE. Thank you.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you. I have a few questions.
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First, Mr. Goldschmid, you also are an independent agency that does not——
Mr. GOLDSCHMID. That is true.
Chairman LEACH. Is your preference for the holding company structure or the operating subsidiaries approach?
Mr. GOLDSCHMID. The concern is about our regulatory responsibilities. I think that we have in the past said there is an administrative advantage to the holding company structure.
Chairman LEACH. Thank you.
A year or two ago, the Treasury had a little bit of a different position on the issue of banking and commerce, and now it apparently is against. And I take it that you are against, Mr. Hawke, and you have reached that judgment independent of the Treasury; is that correct?
Mr. HAWKE. Mr. Chairman, I did not address that issue in my prepared statement. I have been intent on focusing on the interests of national banks and making sure that those interests are not adversely affected.
Chairman LEACH. So you are not opining on the issue?
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Mr. HAWKE. I am sorry.
Chairman LEACH. I meant that facetiously.
Less facetiously, Ms. Seidman, it has been suggested here that there is no great history of problems of the unitary thrift in terms of obligations to the fund. The Secretary of the Treasury of the United States has indicated that. He has also indicated that he has had some concerns looking at the world situation, particularly in Asia.
Do you know any evidence—as you are an independent individual, as you look at Asia, do you have a lot of comfort in the keiretsu kind of system? Do you like the mix of commercial owner and financial institutions? Does that give you comfort?
Ms. SEIDMAN. Mr. Chairman, obviously, the Asian situation is not one to be emulated. On the other hand, I think there are some very important differences both between the Japanese financial system in general and the American system. The transparency of the securities and debt markets, the degree of effective bank regulation, the effectiveness of the accounting rules, the transparency of the accounting rules, all of those are very, very different.
Mr. LAFALCE. The governmental influence over the decisionmaking process?
Chairman LEACH. Let me turn to a different question then. You are an institution that oversees the American thrift industry of which unitary thrifts are a part. Do you recall that in the 1980's losses accumulated in this industry, losses that cost the public $130 billion and that figure is still rising? And are you aware that in those losses, and it is unquantified, but clearly in the multibillion dimension, are losses related to what are called ''direct investments,'' which was the intertwining of commerce and banking within the American thrift industry?
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Ms. SEIDMAN. Mr. Chairman, one would have to have been not aware at all during the 1980's to have missed that.
Chairman LEACH. Thank you. Let me go on——
Ms. SEIDMAN. Let me say that the Congress responded to that; and there are many, many changes that were made in FIRREA and FDICIA, one of the most important being a severe restriction on the ability to do real estate investment in a subsidiary so that less than .04 percent of thrift assets are now in real estate subsidiaries. So that, yes, there was a problem. It was not a unitary problem, and it is a problem that Congress intervened with your leadership to resolve.
Chairman LEACH. Are you aware that in the last Congress we transferred from institutions under your jurisdiction $6 billion to $8 billion in liabilities to the commercial banking sector?
Ms. SEIDMAN. Mr. Chairman, that is the issue of the payment under which the FICO bonds would be paid.
Chairman LEACH. That is correct, with your institution's strong recommendation and also the FDIC's. Now the reason I raise it, the subsequent question, is, particularly in the light of a transfer of obligations, is there any case for institutions under your jurisdiction that had their cost structure lessened by transferring to another set of competitors who had their cost structure increased for your institutions to maintain a privileged charter?
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Ms. SEIDMAN. Mr. Chairman, I would maintain that the charter of the thrift industry is not, indeed, a privileged charter. And it is a charter that has balances. The institutions that I regulate do not do a significant amount of commercial lending; and, in fact, one institution in California has just announced that it has reached the commercial lending limits and so it is going to flip charters.
Chairman LEACH. An institution in my hometown has taken the reverse position, because they like the capacity under your institution to make what, in effect, are direct investments.
Let me just conclude by saying that, first, with regard to your Nordstrom model, it was my understanding that was not a commercial bank, but a credit card bank, and that comes under a substantially different framework. And so when you repeat the story I think it is very important that you make that clear, because that is one of the reasons that the OCC may not have exactly the same rules and regulations.
Ms. SEIDMAN. And the Nordstrom's proposal that has been submitted is a credit card proposal.
Chairman LEACH. Correct. Right.
Let me just conclude by saying that I recognize that everybody in this panel has a little different judgment on a spectrum of issues, but is it fair to say that you think that the American financial system and the American economy would be bolstered by financial modernization legislation, reserving the right to differ on aspects of its composition? Is that fair for you, Mrs. Tanoue?
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Ms. TANOUE. Yes.
Chairman LEACH. Would it be for you, Mr. Hawke?
Mr. HAWKE. I would completely agree with that, provided that in the process we don't——
Chairman LEACH. Your views are taken into serious consideration.
Mr. HAWKE. I wasn't going to put it that way, but——
Mr. LAFALCE. That is the way Mr. Greenspan put it.
Chairman LEACH. Ms. Seidman.
Ms. SEIDMAN. I think it is important that it be the right legislation, but certainly there is room for a tremendous improvement in the system with good legislation.
Chairman LEACH. Good.
Mr. Goldschmid.
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Mr. GOLDSCHMID. Yes. The Commission fully supports modernization, but we do need good legislation.
Chairman LEACH. Fair enough.
Well, I think, on behalf of Mr. LaFalce and I, we share a desire for good legislation; and so I think we have unanimity at the two tables.
Thank you all. This brings our hearing to an end.
[Whereupon, at 1:14 p.m., the hearing was adjourned.]