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FINANCIAL MODERNIZATION—PART I
WEDNESDAY, MAY 14, 1997
House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.
The committee met, pursuant to call, at 10:14 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding.
Present: Chairman Leach, Representatives Roukema, Bereuter, Baker, Lazio, Castle, Campbell, Barr, Fox, Kelly, Weldon, Ryun, Cook, Snowbarger, Hill, Sessions, Foley, LaFalce, Vento, Frank, Kennedy, Maloney of New York, Gutierrez, Roybal-Allard, Barrett, Watt, Bentsen, Kilpatrick, and Maloney of Connecticut.
Chairman LEACH. The hearing will come to order.
This is the second in a series of full committee hearings on the issue of Financial Modernization. We have 14 distinguished witnesses scheduled to appear before us today, starting with Paul Volcker, the former Chairman of the Federal Reserve Board, who has brought with him a conflict of interest statement.
In light of the large number of witnesses, it is not my intention to make any opening statement, but if Members would like to, they are welcome to.
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Mr. Vento.
Mr. VENTO. No, Mr. Chairman, I will follow your good example on that.
Chairman LEACH. Would anyone on our side wish to make any opening comments?
Well, then let me introduce our first witness, who is probably not well known to many people. Paul A. Volcker currently is serving as director and consultant to a number of corporations and nonprofit organizations, recently retired as Chairman and Chief Executive Officer of Wolfesohn and Company upon the merger of that firm with Bankers Trust, in which Mr. Volcker became a director.
Previously, Mr. Volcker was Chairman of the Board of Governors of the Federal Reserve System, from August of 1979 to August of 1987, initially appointed to that position by President Carter for a 4-year term. He was reappointed in 1983 by President Reagan. His tenure covered the period during which the United States succeeded in restoring a greater sense of price and financial stability, following the turbulence of accelerating inflation and the international debt crisis.
Finally, let me just say, Paul has also committed a lot of time to something for which I personally have a deep respect, and that is the future of the Civil Service of the United States, and it is a subject upon which not many people have dedicated much thought, and Paul could well be the preeminent authority in the country. And as one who is absolutely convinced that an independent, strong Civil Service is in the best interest of our country, I want to express my gratitude to Paul for his time and effort in that arena.
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Mr. Volcker, if you would proceed as you wish. Your full statement will be part of the record.
STATEMENT OF HON. PAUL A. VOLCKER, CHAIRMAN AND CEO, JAMES D. WOLFESOHN, INC.
Mr. VOLCKER. I will read parts of it and maybe leave a few parts out.
I am delighted to be here, and I want to recognize your leadership in this difficult area of trying to get some legislation that has been before you for many years.
You may be interested or discouraged, one or the other, in the fact that in preparing for this hearing, I looked up some testimony I made in 1991 before your sister committee, the Commerce Committee, on precisely these issues. I could read that statement word for word, and it would be totally relevant to what you are talking about, what we are both talking about this morning, with one exception.
There was a paragraph about the Treasury's concern about weakly capitalized banks at that time. I think that is no longer relevant.
The rest of that statement deals with the same issues that you have raised and asked me to talk about and that I want to talk about.
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I, of course, urgently think that we need banking legislation and comprehensive banking legislation, but, also, the thrust of my statement is that there are some provisions of a potential bill which seem to me far too high a price to pay for legislation. We don't want to open the door to banking and commercial conglomerates; we don't want to expose the economy to new risks; we don't want to expose the Federal taxpayer to added costs.
Let me just say, you touched upon my background, but in the interest of disclosure, I am a director, currently, of a major commercial bank that now and prospectively is heavily engaged in investment banking. I also happen to be a director of a large insurance company. I am a director of a couple of commercial firms. I once managed a small investment bank. I once directed planning for a major commercial bank.
During most of my life, I have been in Government and had responsibility directly or indirectly for supervising and regulating banks. But against that, I think, perhaps, I don't need to say, I am not representing any of those particular interests this morning, but I do want to draw upon that variety of experience.
I will focus my remarks on the issues that you have raised with me instead of elaborating the case for providing a coherent legislative framework, a framework that is suited to today's competitive and technological realities.
I would point out that a lot of adaptation has taken place through regulatory and court decisions in recent years to try to adjust to the changing circumstances. I think some of those interpretations make existing law, as I understood it, almost unrecognizable, but it has produced change and adaptation.
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I want to point out one practical consequence of that piecemeal ad hoc regulatory relaxation. I don't think there is any doubt some sectors of the financial services industry, and some particular institutions, now find themselves in what they feel to be an increasingly advantageous position competitively, so perhaps understandably they have been losing interest in the idea of broad and comprehensive reforms. Why, they ask themselves, should they forgo present advantage and potential future benefits that may accrue from agency rivalries or court decisionmaking?
I trust this committee, which has really unique oversight and legislative responsibility, will reject what are inherently divisive interests, because you have the opportunity to provide the kind of leadership that reflects not just parochial pleading but the national interest.
Now let me just emphasize that a key part of that interest, a key part of your interest, in the United States—indeed, in many countries—has been to protect the Nation's banking and financial system from systemic breakdown, protect it from the kind of banking crisis that would indeed gravely impair the growth and stability of the economy as a whole and, not so incidentally, place a heavy burden on the system of deposit insurance. And I think experience over the past 10 or 15 years, not just in the United States but elsewhere, amply demonstrates how costly banking crises can be in economic and budgetary terms.
There is a lot of effort going on internationally to achieve some bolstering and strengthening of cooperation and protections against crisis. So I hope that in considering the regulatory structure, you do take care of the need to protect the stability of the system, to provide appropriate regulatory oversight, because in the end, whatever the particulars of law, the Federal Government will not escape ultimate responsibility and cost when a banking crisis appears.
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And the amounts of money involved, I might emphasize, looking backward at the crises, just in this country in the past 10 years, have been very large relative to this debate about balancing the budget that you are currently having in the Congress. You are not talking about limited risks.
Now what I want to address this morning, what you have asked me to address, is the separation of commerce and banking, the proper approach toward holding company regulation and the role for firewalls. They are all fundamental to this issue of systemic risk.
Now you know the law and tradition of American banking, which follows the general Anglo-Saxon pattern, has been to maintain a separation of banking and commerce. That tradition has been incorporated legislatively in the Bank Holding Company Act. But even where there has been no explicit legislation, as in the United Kingdom and some other countries, the practice, de facto, has been to maintain a distinction between the providers of money and credit, the banking system, and the ultimate users of credit, the commercial and industrial world.
Now there are exceptions to that. In Germany and particularly some other Continental European countries, linkages have been more common, but I would emphasize, even there, they are not the usual practice.
In Japan, the major banks have long maintained cross-holdings of equity with groups of commercial and industrial customers. They typically form a keiretsu, implying especially close ties of cooperation. Maybe I should read ''cooperation'', as ''anticompetitive''.
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Some banking systems in developing or emerging economies also have banking and commercial ties, but what stands out from that experience, I think, without any contest, is that it is the countries in the Anglo-Saxon tradition that have the most competitive, innovative, and flexible banking systems. It is their capital markets that are the envy of the world. No country can begin to match our system in the variety of large and small banks and other financial institutions, in the provision of risk capital in support of small and emerging ventures, and in providing narrow margins between borrowing and lending rates.
Moreover, our banks today are more profitable than in many years. They have strong capital positions. They are, in fact, in a position often to retire their stock. Should they need more capital, they certainly have ready access to the world's greatest markets on attractive terms.
In contrast, there is no doubt there is experience in other parts of the world to suggest the problems with banking-commerce links are not just theoretical. Look, for instance, right now at the drastic decline in the value of Japanese stocks and the aggravation and pressures that has created on bank capital, an important factor retarding the recovery of the Japanese economy. The successive and extremely costly official rescues, one after the other, of France's largest bank have been greatly complicated by their ventures into commerce, specifically including American moviemaking.
Similarly, a few years ago, one of Spain's largest banks with aggressive management pushing toward substantial industrial ties faced failure, as well as legal indictments.
In Germany, there have also been severe and unexpected losses in industrial affiliates of banks. They could, in fact, be handled without systemic damage because of the exceptional capital strength and the underlying profitability of its large major banks.
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But it is an interesting fact, too, that I don't think many observers would look to either Germany or Japan as a model of an effective, innovative banking system. Quite the contrary, I find it ironic that this issue of combining commerce with banking continues to arise in the United States when doubts have arisen both in Japan and in Germany about the validity of their traditional linkages.
One need not look abroad for the illustrations of the dangers. Right here in the United States, it was not so long ago that savings and loan associations were provided authority under some State laws and, to a degree, under Federal law to make what were antiseptically labeled as direct investments; in other words, to take controlling interests in nonfinancial businesses.
I well recall that we had academic authorities, some sponsored by the industry, writing and testifying before you about the theoretical benefits of diversification of those institutions into new businesses, even as much of the activity took the form of real estate development, surely among the riskiest of commercial activities.
Now there were other important factors in the savings and loan debacle, importantly including imprudent and inadequately supervised commercial lending. But it is clear that the nonfinancial businesses greatly contributed to the more than $100 billion cost of stabilizing the industry.
In the wake of the crisis, legislative and regulatory rules were tightened, but how much better to have foreseen the entirely predictable problems, and how discouraging to see the proposals today for banks to undertake real estate development.
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Now the main thrust of the legislation before you is to permit and to encourage a broadening of the powers of banks and so-called financial services holding companies. The net result in the end will presumably be that a great many smaller and specialized financial institutions will remain, but there will also be greater consolidation of the financial services industry. The clear corollary, it seems to me, is to reinforce, not weaken, the importance of maintaining the traditional separation of banking and commerce.
This country has always had a strong aversion to massive concentrations of economic power. Pragmatically, we like lending decisions and the sale of stocks and bonds to reflect independent and widely dispersed financial judgments, judgments without the bias, conflicts of interest, and opportunities for self-dealing that are absolutely inherent in the business interests of affiliated companies.
As nearly as I can tell, there is no groundswell of political support for changing our traditional approach. Consumer groups, retired people, unions, small businesses, and community organizations are not, to my knowledge, supportive. Quite to the contrary, my own sense is that most larger banks and other financial institutions are themselves doubtful—and I put that mildly—of the merits of broadly combining banking and commerce.
Now I know there are some insurance companies and a handful of investment banks that have appeared before you, that have ties to commercial firms or to non-bank banks. They would like to extend their operations more broadly into commercial banking. There are some industrial firms that would like direct access to the payment system, bypassing their existing banks, and establishing an essentially captive source of credit for their customers.
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Banks and bank holding companies are typically much more highly leveraged financially than commercial firms, another perceived advantage of bank affiliation. But is any of that a sufficient reason for overturning a tradition that has served us well, of diminishing the role and strength of independent banks, of placing greater burdens on the system of deposit insurance? I think not.
Let me point out, no one is proposing that those financial firms with commercial ties lose any option they now have. This is not a grandfathering situation. In the context of the bills before you, investment banks and insurance companies will continue to be able to own commercial or industrial companies, and so forth. Investment banks and insurance companies will be able to buy commercial banks. What they cannot do is associate with both a commercial bank and a commercial firm, and none of their competitors could either.
Now I sense the force of these arguments is rather widely appreciated, yet there is an understandable urge in a political setting to compromise, to somehow try to reconcile all the claims. I would suggest to you that is just not possible. The proposals for various baskets involve highly arbitrary distinctions that cannot be logically and practically maintained.
What is the rationale, for instance, of a basket that would permit a large bank to affiliate with a large commercial firm, aggravating concentration and conflicts of interest, while a large firm could not be affiliated with a small bank? What is the relevant measure of size? Capital, revenue, employees, or something else? Would not the appropriate measure vary industry by industry?
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What happens when the size of a commercial affiliate increases or the bank shrinks? Are affiliated commercial firms to be prohibited from growing or merging with another? What is the practical difference between the hundredth largest company and the hundred first, or the thousandth and the thousand first? And won't those rankings constantly change? If a bank can buy a commercial firm, shouldn't a commercial firm be able to buy or start a bank to handle its business, even if the net result is to weaken the system as a whole?
Surely, various compromises could be devised that so restrict banking-commerce combinations that the danger of affiliation are de minimis. That may be the case with H.R. 10, but there simply can't be any doubt that once the foot is in the door, the pressures to ease the necessarily arbitrary and illogical limits, lubricated by ever larger political contributions, will grow stronger. The fissures in the dike will erode, new compromises will be struck, and the risks and concentrations will inexorably mount.
Now I realize, at the margin, elements of administrative judgment will be required in implementing legislation separating banking and commerce. At what point, for instance, is the provision of computer services or management consulting sufficiently closely related to finance to permit its affiliation with a bank? But those are the kinds of distinctions we have lived with for years, and I believe Congress can provide relevant fresh guidance.
Moreover, regulators can be asked to make distinctions between controlling and noncontrolling holdings of industrial or commercial firms. Congress should also set out the extent to which equity acquired in the ordinary course of underwriting and of merchant banking activities might be permitted for limited periods. Present law already provides scope for such activities and permits noncontrolling holdings of equity.
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That seems to me to be the key point. We can permit incidental and noncontrolling equity holdings in the ordinary course of business. What we want to avoid is banking and industrial firms coming under common control, with all that implies for concentration of resources, biased lending decisions, and new risks for the stability of the banking system.
Turning to holding company regulation, rather comprehensive supervision and regulation of banking and financial institutions is commonplace right around the world. It is the essential corollary of the official support provided in the face of threats to the stability of a banking system. Nor can there be any doubt that whatever their ideological predispositions, major banks do benefit from and rely upon the presence of a Federal safety net in time of strain. To some extent, that has become the expectation of other regulated financial institutions as well.
Now those simple facts and undeniable facts have important implications for financial regulation. A business organization will be managed as a cohesive whole. They may be centralized or decentralized in operation, but one part is necessarily affected by the fortunes of another. It is, of course, precisely the search for synergy in marketing and production and in the joint use of shared resources that is the driving force of business combinations.
The clear implication is that if the banking system is to be officially protected and supported, then the regulators and supervisors need to be concerned about the well-being of the business organization as a whole. As a practical matter, it is neither desirable nor feasible that such regulatory oversight be extended into the commercial and into the industrial world. That, in itself, is a powerful reason—conclusive, in my mind—to avoid affiliations of banks and commerce.
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The situation is quite different with respect to financial institutions. They are already subject to official regulation by States, if not by Federal agencies. There are scores of such regulators within and among States. There are more than half a dozen at the Federal level with significant responsibility for enforcing prudential safeguards.
Obviously, that presents complications in regulating and supervising institutions ranging over many areas, functionally and geographically. But I think it is true, the number of regulators also reflects continuing realities. A variety of significant objectives are served, and different agencies have different priorities, different areas of competence. The American style of Government abhors unnecessary concentration of authority.
Recognizing the force of those considerations, I know of no support for the idea there be a single monolithic regulator of bank or financial services holding companies, as simple and logical an approach that in the abstract that may seem to be.
The presumption of most of the proposed legislation is that something like the current regulatory apparatus will remain; the banking agencies will regulate and examine banks; the FCC will write the rules for disclosure and investor protection; States will regulate insurance activities, including sales practices. All that amounts to functional regulation, and it is broadly appropriate and practical, as far as it goes.
But disparate functional regulation is not by itself enough. The overriding and distinctively Federal interest in safety and soundness requires that some authority, armed with adequate authority, be charged with broad oversight and surveillance over the entire holding company. Otherwise, the clearly protected and supervised part of the holding company, the commercial bank, will be blindsided and potentially overwhelmed by crises originating outside of the bank itself. That is precisely what happened when direct investment destroyed so many savings and loan associations in this country, and, similarly, the woes of financial and commercial affiliates have disrupted and damaged a number of European and Japanese banks.
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Now, conceptually, one might perceive of an approach toward this problem by authorizing and convening a sort of council of regulators, meeting regularly to exchange information and coordinate approaches. But practical experience within the banking area, of which there has been a good deal and which should be easier, strongly suggests neither approach is efficient nor consistently workable. At the least, there would be need for a strong lead agency with clear responsibility for enforcing coordination among agencies with disparate priorities, traditions and competence. Without that, there is no chance it would work.
The more effective approach would be to designate one agency for oversight responsibility insofar as prudential considerations are relevant. Functional regulation for a variety of purposes could and should continue. Individual State and Federal agencies, equipped with appropriate legal authority and competence, would implement their particular mandates.
The primary assignment of the oversight agency would be to work with the other agencies to assure itself that their approaches are reasonably consistent and adequate to protect the safety and soundness of the whole.
Moreover, experience has demonstrated that with even closer and more intense competition across traditional lines, there is a compelling need to seek functional equivalence in regulatory approaches in some areas.
Now, by nature of their responsibility and interest, only the United States Treasury or the Federal Reserve would appear a logical candidate for the oversight function. It will not surprise you for me to suggest that between the two, by virtue of its experience, its resources, financial and otherwise, and its relative freedom from client and political pressures, the Federal Reserve would be the logical choice.
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And finally, a few words about firewalls. One approach toward minimizing the need for supervision of an entire financial services holding company would be to erect so-called firewalls between a commercial bank, the institution we most want to protect, and its affiliates. Indeed, some common sense restrictions on financing of affiliates by commercial banks and other kinds of self-dealing have long been part of law and regulation and would be retained, for instance, in H.R. 10.
But at the same time, it is really an illusion to think firewalls can themselves meet the need. That would require restrictions on lending or other financing transactions with third parties, prohibitions on cross-marketing and link services, and even limits on the use of common names and symbols. Such strong firewalls would run right across the grain of what businesses want to achieve when they combine. Few managers want to be truly passive owners of another business. They will naturally want to bring the resources of the entire organization, including the bank affiliate, when any important part is financially threatened.
In sum, given the fungibility of money and the resourcefulness of financial managers, no practical system of firewalls can be fully effective in insulating a bank from the difficulties of its affiliates without, at the same time, strangling the business operations. Indeed, what we are seeing in practice is a tendency to ease or remove existing restrictions on interaffiliate transactions and management interlocks.
In sum, Mr. Chairman and Members of the committee, the need for new regulation to define and direct the world of financial services is amply clear, probably more than ever before. Industry participants are prepared for reform, and key elements of a consensus have developed.
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But in encouraging that and nurturing that consensus, it remains crucially important we not neglect the costly lessons of not the distant past, but even the recent past. That we not abandon a legislative and regulatory philosophy that has served this Nation well and that we guard against financial crises and systemic breakdown.
In the end, as you well recognize, the object cannot be to satisfy every particular interest or respond to individual wish-lists. Encouraging combinations of banking and commerce or dispensing with effective and coherent oversight of a consolidated bank and financial holding company, simply cannot be sensible public policy.
If, at the end of the day—more accurately, before the end of this Congressional session—you are not satisfied that the broad public interest and strong, diverse, and independently managed banks and financial institutions will be protected and enhanced, or that the risk to the economy and the future taxpayer will be reduced rather than increased, then the implication is clear: Better no legislation at all.
But there is no good reason to anticipate that conclusion and that result. It is your committee that carries the main responsibility for steering the needed effort in the right direction, and I, of course urge you to do just that.
Thank you.
Chairman LEACH. Well, thank you, Mr. Volcker. We appreciate your perspective.
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If I could just start with the first question, I would like, if you could explain how Germany and Japan, which have been considered in the past models of commerce and banking, are now attempting to shift their structure somewhat? And isn't it ironic that, given their experience and their efforts to shift structures to become a little bit more like the American system, we are contemplating becoming more like their systems?
Mr. VOLCKER. I find it ironic and really inexplicable. In fact, the German interlocks originated, in good part, out of financial difficulties in the past. When major customers of German banks got in difficulty, they arranged, in effect, to substitute equity in those organizations for bad loans that they had had or to otherwise rescue, as part of a national effort, major German firms. Then they kind of got used to that, and it was ingrained.
There has not been a lot of new activity, to the best of my knowledge, in banks acquiring industrial firms. My sense is that many of them are restive that they have this exposure because it does create not only financial risk but conflicts of interest, which they well recognize.
Some of the political parties in Germany are restive about that and have talked about legislation. It hasn't gone very far, but it has become a matter of national debate.
In Japan, I think the situation is somewhat different. The banks don't tend to own big chunks of particular companies, they own small chunks of a lot of companies. But, in their Japanese fashion, they get together cooperatively quite deliberately.
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And cooperatively means in that case that mutual preferences are extended. In effect, the banks will be particularly solicitous of the needs of those companies in which they own stock, and companies that are stockholders of the banks reciprocally will look to those banks as a lead bank. And those traditions are very strong, and for a while, as part of the Japanese corporate consensus system, it worked quite well.
It has not worked very well when the stock market has dropped by 50 or 75 percent, because that meant pressure on the capital position of the banks that held the capital stock, and it has complicated, and I think it is generally recognized to have complicated, economic recovery in Japan.
It is very difficult to change that system. It is much harder, I think, than in the case of Germany, because it is so ingrained in the whole banking system. But the net result has been Tokyo has been losing position as a financial center because of its relative inflexibility.
Chairman LEACH. One of the arguments that came from Germany that surprised me a bit is one that you have just indicated, that in our country we have historically looked at commerce and banking as the insertion of conflicts of interest and concentration of ownership.
In Germany, there is a lot of angst that companies have been kept capital-short because the banks that have interest have wanted to make them loans, rather than to have them more capital-intensive. And this is a complaint I have heard in the last year. Do you find this in other countries, or is this simply in Germany a public concern?
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Mr. VOLCKER. I don't want to claim more knowledge than I have, but my sense is not so much that the German firms are capital-short, but they certainly do not have a variety of options when they are raising money.
Because of these ties with banks, the capital market has been relatively poorly developed, so you don't have the major investment banking firms. Historically, you have not had an active bond and stock market of anything like the magnitude and flexibility that you have in the United States and the United Kingdom. So they go to the U.K. and do a lot of their financing. And symbolic of all that is the Deutsche Bank, feeling it had to modernize itself, in effect, and participate in world capital markets, had to go buy a major investment banking firm in London, and announce publicly, ''We want to go the Anglo-Saxon way,'' in adapting to the modern world.
So there we have the Deutsche Bank wanting to go to the Anglo-Saxon world, and apparently there are people here who want to go the Deutsch Bank way, or the German way. I don't understand it, really.
Chairman LEACH. Thank you.
Mr. LaFalce.
Mr. LAFALCE. Thank you, Mr. Chairman.
Chairman Volcker, always a pleasure.
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Chairman Volcker, how, in your vision of the future, would you deal with unitary thrifts? And a couple of questions into what has been the historical experience, to your knowledge, of unitary thrifts.
And then, if you had to fashion a law for the future, how would you deal with unitary thrifts that exist and, also, that might exist? Because it is my understanding, especially because of changes in the law that were made last year, that a good many commercial banks, insurance companies, many other companies, are considering going to a unitary thrift charter.
Mr. VOLCKER. Well, I am not an expert and familiar with all the permutations and combinations of recent law. I have been a little bit distant. But I think the logic of the situation is clear enough.
Unitary thrifts have been an exception to the general rule against banking and commerce on the theory, at one point, that they were not banks. They were limited to mortgage lending, very specialized institutions. It was never an exception that I was pleased with, let me say, but it was never very important because unitary thrifts were not a major player in the financial scene.
The logic of the situation is quite clear as you rationalize this situation. That exception ought to be ended. They ought to be treated like the banks that they now are, so you can't have one particular kind of charter and say it is alright to do essentially a banking business, and you can combine business and commerce, but if you are another kind of bank, the ordinary kind of bank in historical terms, of a slightly different name, you can't do it. You should clear that up. So there may be some need for grandfathering in that particular case.
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Mr. LAFALCE. Well, there are three questions that would come to mind in connection with that. Number one, what is the problem that they have brought about, if any? And should we come up with a solution to a nonproblem, if there has been a nonproblem?
And then, two, if you are going to do something about those that exist, you have two options; divestiture or grandfathering. If you have grandfathering, then how do you handle a competitive advantage or disadvantage? Do you put limitations on their growth, as we did in CEBA, and then see the idiocy of that later on and then change it, or what?
Mr. VOLCKER. Well, my impression is, these are not a major factor, even now in the financial scene. While they exist and sometimes have been owned by an industrial firm and sometimes, my impression is, almost equally frequently been sold by the industrial firm because they have not proved to have much synergy or use. You would grandfather them, yes, or at least you could grandfather them. You face the ordinary questions that you face with grandfathering. If they are subsequently sold, grandfathering is probably removed. They can't acquire additional firms and enlarge themselves, except by natural growth. You say they haven't created a problem.
They certainly——
Mr. LAFALCE. I have just asked the question. I am not aware of any.
Mr. VOLCKER.——They haven't created any national problem, that is for sure. They can't create any national problem because there weren't very many of them and they didn't have the size and the generality to create that kind of a problem.
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But I think we are in the business of foreseeing problems that would exist if that kind of an arrangement became generalized, and we don't want to create temptations, incentives, to engage in that business and then find out later we have to shut it off.
You establish the policy now so that people don't make business decisions that could lead to problems and then force changes later which they won't like, quite understandably, so tell them what the rule is now.
Chairman LEACH. Thank you, John.
I would just add briefly that at the last hearing we established that out of the 700 unitaries, there were only 14 or so in the country that had exercised a power beyond which this bill would grant, but something like 26 of those exercised in the area of insurance that this bill would authorize. So, in theory, of those currently in the system, literally only 14 have exercised these powers.
And then we go back to Mr. Volcker's earlier observations that the S&L industry did experiment with direct lending, which is the exact same thing, and that experience is pretty lousy, but in these 14 institutions there have been no particular problems.
Mr. Bereuter.
Mr. BEREUTER. Thank you, Mr. Chairman.
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Chairman Volcker, thank you very much for your most important testimony.
We often engage in hyperbole here, but I would say to my colleagues, I think this is among the most important testimony we have received in this committee with its explicit warnings in several decades.
I have had a long interest in Japan because of my other committee assignments, and I have been convinced that the combination of commerce and banking there has introduced anticompetitive factors into their society. It has had a negative effect upon growth at times, it is detrimental to consumers. It has inhibited the current difficulties, it has inhibited the economic recovery in Japan. And I think in general it accentuates economic trends. And, accordingly, I am trying to learn something from what has happened there.
I asked early last month the Congressional Research Service—they are experts on commerce, industry, and banking—to prepare memoranda for me, and we will release them to Members of the committee and the public generally as soon as possible.
I wanted to read for my colleagues, and for the record, but also for reaction from you, Chairman Volcker, three excerpts from an early memorandum delivered to me on April 30. It reads as follows, on those three excerpts:
''In terms of the U.S. interest, the negative side of this system in Japan seems to be that the main banks make inordinate efforts to keep their companies from going bankrupt. This keeps foreign firms from entering the market by buying assets at distressed prices. It also means that main banks have more interest in the competition among companies than their exposure loan would warrant. Main banks have more to lose than just their loans if one of their companies is wiped out by foreign competition.
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''To the extent that the large Japanese banks can and do influence Government economic policy, the network of cross-shareholding between banks and industrial companies may have increased the level of trade protectionism in Japan.''
Second, ''Bank ownership of stocks puts pressure on the government to keep stock prices up. When there is a stock market crash, moreover, the cross-shareholding magnifies the effect on cross-shareholding companies. Not only does the value of the shares of the company decline, but the value of their stockholding also falls.''
And the third excerpt: ''Japan's stock market has fallen from a high Nikkei average of about 40,000 in 1989 to 18,700 today. Combined with the drop of 40 percent in real estate values, this has caused Japan's banks to face an enormous problem with bad loans. The banking sector is currently carrying more than $300 billion in nonperforming loans. This continues to threaten the solvency of certain financial institutions and weakens the Japanese financial system.''
I would like to know if you have any reactions to these preliminary conclusions of the CRS?
Mr. VOLCKER. I generally agree with them, and I think they go in the right direction.
The one thing that struck me there that I have not been sensitive to anyway, is whether it really adds to the trade restriction pressures that are endemic in Japan? But the general idea that this leads to interlocks among corporate interests, financial and nonfinancial, and mutual hand-holding is certainly true.
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What you find characteristic of the Japanese banks is—I should say in the interest of full disclosure, my old firm has been involved in a joint venture with a large Japanese bank—that when one of their customers gets in trouble, as you described, they do support them and try to keep them open, and that is often manifested by putting their own management in.
Nominally, the management may put a different hat on in terms of the related company, but it will be an ex-bank official—or officials—that, in effect, take over that company and maintain, of course, the very close relationship.
Mr. BEREUTER. Thank you, Mr. Volcker.
I would say to my colleagues that I am sending a letter to Secretary Rubin on this subject, and I hope you will consider joining me on it.
I think at a time when Japan, for example, needs to have strong and solvent banks to bring itself out of its economic recovery, by the nature of the mixture of commerce and banking in Japan, its banks are really weakened in that capacity to help the government pull itself out of the economic recovery.
So I think there are a lot of important lessons for us to learn on what has happened in Japan. It boggles my mind that we might consider emulating that kind of combination.
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Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Bereuter.
Mr. Kennedy.
Mr. KENNEDY. Well, given how much I heard of Mr. Volcker's testimony, why don't I yield to Mr. Jackson, who has been here longer than I, Mr. Chairman. Thank you.
Mr. JACKSON. Mr. Chairman, let me first thank——
Chairman LEACH. Excuse me. I won't consider this a yield. Let me just recognize Mr. Jackson.
Mr. Jackson is recognized.
Mr. JACKSON. Let me just first thank you, Chairman Leach, and Chairman Volcker for coming before our committee today.
I am going to read again Chairman Volcker's testimony with interest, and if, in fact, Mr. Chairman, I have any questions, I will submit them to Mr. Volcker, and hopefully they will be entered into the record at the appropriate place.
I have no further questions of the witness, Mr. Chairman.
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Chairman LEACH. Thank you, Mr. Jackson.
Mr. Baker.
Mr. BAKER. Thank you, Mr. Chairman.
Chairman Volcker, just a couple of items I think are important to insert in the record.
First, Mr. Chairman, I withheld and do have an opening statement. I would like it for adoption in the record.
Mr. BAKER. Second, with regard to the nearly dead horse of unitary thrift issues, although the total number of entities affiliated with commercial interests under the unitary structure are significantly limited, they do in fact represent a third of the total thrift industry's assets. I would suggest that that is not inconsequential.
With regard to the subject of the separation of banking and commerce generally, I would like to recite just briefly from an Arizona Law Review article by Mr. Ferraro, which is an academic overview of the structure.
''As for the regulatory separation of banking from general commerce, although some suggest this separation has a long historical tradition''—be aware this is another academic—''shows that it is not of recent vintage and always has included major loopholes.'' This notes that non-bank corporations, in fact, were permitted to own any number of banks until the 1956 Bank Holding Company Act, then were permitted to own one commercial bank until the 1970 Holding Company Act. From 1970 to 1987, they were permitted to own non-banks. They are still permitted to own one thrift. Individuals, moreover, have always been permitted to have controlling interest in banks and commercial firms, which continues to this day. With the note that Chase Manhattan Bank began in 1799 as a subsidiary of a non-bank corporation and that National Citibank, now Citibank, has long-standing links in the 19th century to non-bank corporations through joint private ownership, allowing the combination of banking and commerce through the ownership of the single thrift, but not through the ownership of a single commercial bank. History puts you to sleep.
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If this reflects that there is no principal or meaningful distinction between commerce and finance, Mr. Volcker, I am understanding you either were, or are now, a director of Bankers Trust?
Mr. VOLCKER. I am now a director of Bankers Trust.
Mr. BAKER. I have their annual report, and I have made my way through it entirely. I got hung up in the leverage derivative section.
But in the interesting beginning, I noted that there were significant equity investments, which you acknowledged in your opening statement. Net revenue for 1996 from equity investment transactions was up $65 million, or 45 percent from 1995, which was up $37 million from 1994. The increase in 1996 was primarily due to gains realized in the private equity investment unit of investment banking. The results included a $62 million gain on the sale of a portion of the corporate Merchant Banking investment in Northwest Airlines Corporation.
Given your view, isn't that an investment in a commercial enterprise, considering the fact that that return would not have occurred had Northwest, as a counter-party, not performed in a commercially profitable manner?
Mr. VOLCKER. As I indicated, banks are able to hold some equity investment in the course of underwriting and the course of merchant banking and Bankers Trust has done so at times. To extend it beyond that, they would have one director who would object.
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Mr. BAKER. As a director, though, would you take the position that this is an ill-advised investment strategy?
Mr. VOLCKER. I would not take the position that it is an ill advised investment strategy if it arises out of the ordinary course of an underwriting business and merchant banking. In fact, Bankers Trust is aiming to make an acquisition of an investment bank that does a fair amount of equity underwriting; Bankers Trust itself does not. And it will lead to some, I presume, transitional holdings of equities, which I would allow for.
Mr. BAKER. But my point is that, other than the legal mechanism, which appears to be the line of defense, the bank is actually investing in the success of a commercial enterprise, which is the blending of commerce and finance, with some legal constraints. You do not see it that way?
Mr. VOLCKER. No, I do not see it that way.
Mr. BAKER. If Northwest had not performed in a commercially profitable manner——
Mr. VOLCKER. They would have taken a loss. But Bankers Trust, to the best of my knowledge, was not in management control——
Mr. BAKER. So the distinction would be as to controlling interest as to——
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Mr. VOLCKER. The controlling interest is a very important distinction.
Mr. BAKER. Why wouldn't that be a problem in a small hometown bank where a director is the owner of a local automobile dealership and you want to get a loan to borrow money to open a new dealership? Wouldn't that be a problem where you have 100 percent control in the hands of small-town bankers?
Mr. VOLCKER. I don't think it is much of a problem.
Mr. BAKER. But the issue is the same?
Mr. VOLCKER. I don't think the issue is quite the same. In some specific instances, you have individuals in small towns where prominent, or nonprominent, local businessmen with some money may well be a sponsor of a local bank or a part of a group that owns a local bank. I think that has gone on for a long time, and we have never interpreted this restriction as going so far as to say individuals cannot hold interests in non-financial institutions and banks.
While in particular instances there could be a problem, as a threat to the banking system, as a threat to the country, it is almost inconceivable to perceive, because they are individuals and they don't have that concentration of capital.
If I may say so, Mr. Baker, you can get a lawyer writing a lot of studies, and I looked into this very carefully over the years, and I have read some earlier legal documents trying to poke holes in the basic tradition about the separation of commerce and banking. Of course there have been exceptions.
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In 1789, a water company started a bank called the Bank of the Manhattan Company. It didn't last very long, and most combinations of banking and commerce did not last very long. Those exceptions do not change the fact that the broad tradition in the United States has clearly been separation.
Mr. BAKER. As to your opening comment in response to the last question, it was the control issue that was troublesome to you?
Mr. VOLCKER. Well, yes, a bank holding company can hold noncontrolling amounts of stock in an industrial company.
Mr. BAKER. Sure.
Mr. VOLCKER. That is present law.
Mr. BAKER. And that is not a problem for you?
Mr. VOLCKER. That is not a problem.
Mr. BAKER. That is called a basket.
Mr. VOLCKER. It is not a basket.
Mr. BAKER. But there are handles.
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Mr. VOLCKER. It is not a basket at all. There is no limit on the aggregate. They are noncontrolling interests, and if they reached the point where they affected the fortunes of the bank, I would worry about it. In fact, I am not interested particularly in noncontrolling interests becoming a big part of the institution, so it is not a problem, and you wouldn't expect it to become a problem, and it is not a basket.
Mr. BAKER. I understand.
I have overused my time. I appreciate your response.
It is more of a bowl, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Baker.
If Mr. Kennedy would like to be recognized.
Mr. KENNEDY. Thank you very much, Mr. Chairman.
I have had a chance to look through some of your testimony, Mr. Volcker, and, first of all, welcome back. It is good to see you again. And I have actually heard you on this issue a number of times in the past, which is what makes me sometimes wonder why we are continuing to have these hearings.
But in any event, I wondered, as I sort of understand, basically, your thrust is that while you have always been—and I think going back to 10 years ago or more—you have always shown a great deal of concern about the possibilities of abuse if, in fact, all of these companies end up getting together.
You also recognize at this point that through not perhaps the Congressional action, but through the individual actions of various regulators and the like, there is an awful lot of breakdown of the firewalls that had been set up when you were running the Fed, for instance.
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One of the issues—I guess there are a couple of issues that sort of surface. One is whether or not, by virtue of the fact you get these very monolithic organizations, that that ends up instead of perhaps—while obviously those organizations themselves may be much stronger, that the consumer's choices could be actually more limited over a longer period of time.
I wonder, along with that, and with the sort of consumer perspective, whether or not you feel you actually could build firewalls that could actually protect deposit insurance within the context of any of these new superstructures.
And, third, we have had a great deal of debate on this committee with regard to how consumer coercion has taken place, you know, with regard to everything from credit reports to the sort of diminution of community reinvestment and how the various new entities' deposits would be covered under CRA.
I wonder if you might just speak of this with regard to what is the smaller consumer perspective with regard to these new structures?
Mr. VOLCKER. Well, first of all, the question of firewalls. I think you could protect a bank, conceptually, with firewalls, but you would have to make the firewalls so strong that nobody would want to have the holding company in the first place. So you have got a dilemma, and the fact of the matter is, they won't be strong.
Mr. KENNEDY. So under none of the various proposals—there are about four or five proposals hanging around that some folks hook themselves to and others don't and the like. But, under any of them, would you suggest that there is a proposal out there that has a firewall between the deposit insurance sort of foundation and all of the other companies? Is there any single proposal that you think is out there today that accomplishes the stoning off of those?
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Mr. VOLCKER. I don't know of any.
Part of the difficulty is, if you really want to wall it off, you have to deal with transactions with third parties. It is not just with transactions between the two parts of the holding company, but whether the bank will come to the assistance of a customer of another part of the holding company, which would be a rather common temptation. And to deal with that kind of a problem, you are really in a mare's nest, and I don't think you can do it effectively. So I don't think any of them would take care of that kind of problem successfully.
You ask about the consumer. I think the consumer groups can speak for themselves, but I think the consumer is interested in a diverse competitive banking system, and to the extent widespread commerce and business combinations would do the opposite, the consumer isn't going to be served.
The problem I think you have in dealing with this issue is, of course, there is no danger to the system as a whole with a handful of these combinations, but you can't write a law for a handful of people, a handful of companies. You have to write a general policy, and if you permit it, it will be done. And it won't be done with just a handful; presumably, over time, it will be done by a lot of people and the dangers arise, including the dangers to the consumer.
Mr. KENNEDY. Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Kennedy.
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Mr. Lazio.
Mr. LAZIO. Thank you, Mr. Chairman.
I wonder, Mr. Chairman, if you could give us a sense of the impact of—the recent announcement I am thinking about is Brown, in particular, but the consolidation between the securities interest of the Section 20 affiliates in the banking industry, and what that says in terms of the need to have a permanent reform of the financial services regulation?
Mr. VOLCKER. Well, I think it points very decidedly to the need and, really, to the responsibility of this committee and the Congress to clarify the situation and make some general rules.
What you have within the financial world, due in a major way to technology, is an overlapping of the services provided traditionally by banks, investment banks, insurance companies, investment management firms, and others. That has been recognized through court decisions, through regulatory decisions, but it has left a very uneven kind of field where banks can buy investment firms, but it is much harder for an investment firm to buy a bank. The banks can encroach upon the insurance function without insurance companies in the same way encroaching on some of the traditional banking world. And you could use other examples.
So it is unfair and unbalanced and itself is not conducive to most effective competition and could even create some dangers from the safety and soundness standpoint.
So I think the logic is, you accept an overlapping and a melding of various financial services, but you maintain the old line of commerce and banking, modernized to commerce and finance, and create a more equitable playing field. It probably never can be completely even, but we can do a lot better than what we are doing now.
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Mr. LAZIO. There has been a good deal of discussion about the fact that, at least in some quarters, bank regulators don't have a feel for the texture of the securities industries. And some even argue that the Barings failure should have been caught by the Federal Reserve and that there was failure there.
And I guess my question is basically about functional regulation and to what extent should the Federal Reserve, or what we now have as a bank regulatory apparatus, with all the cultural differences and the securities regulation, which is primarily based on transparency in banking regulation, which is more, I would perhaps argue—more hands on. Give me a sense, characterize, where you think we ought to be on that.
Mr. VOLCKER. You have a complicated, an inherently messy situation. That is true today, so it is not going to be very different when you change it. But I think the way you try to reconcile these various needs is to maintain a basic structure—you may want to alter it a bit, but the basic structure, and use the expertise of the SEC about certain investment banking operations—as we have now.
Now they are largely directed, as you suggested, toward investor protection and disclosure, rather than safety and soundness, but they do have some safety and soundness concerns too. You have that multiplicity of State insurance regulators who have certain traditions and approaches and have developed policies toward sales practices and other things. They also have some interest in safety and soundness.
But you have an overall concern with the safety and soundness question. That is not the only question, but that is the important question here, particularly in terms of risk to the taxpayer and risk of damage to the economy. Somebody should have adequate authority, prestige, influence, capacity, to take an overall look with those other agencies to make sure there aren't gaps, absences, failure to develop appropriate standards of safety. And, indeed, we need assurance not to have inconsistent regulations so that one type of institution is greatly advantaged over another. And I don't think you can do that without some oversight, and——
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Mr. LAZIO. I guess the problem really comes not when the different regulators—if you have functional regulation, agree, but when they disagree, and who in the end resolves the differences.
Mr. VOLCKER. When they disagree or fail in some sense to take adequate account of the prudential side. The overall oversight fellow, in my opinion, isn't going to disagree or shouldn't disagree—or it doesn't make any difference if he does disagree—with what the SEC says about disclosure, for instance, or what the State regulators are going to say about sales practices in the insurance industry, or what is being done precisely to regulate investment companies.
Where he gets concerned is if he feels that maybe in some areas of the country insurance companies are not adequately regulated from a safety standpoint, and if they are—only if they are owned by a bank, or affiliated with a bank—then he says, ''Look, what is going on here'', with an investment company, or whatever, and say ''Something has to be toughened up here.''
Now the insurance regulators themselves have been concerned about this, obviously, and have come up with a rather elaborate scheme for risk-based capital, I think following roughly the idea that the banking regulators started on risk-based capital.
And there is a question: If they are combined and competing with each other, are those standards reasonably comparable? Should somebody look and say, ''Look, it is too weak here, too strong there,'' and work toward avoiding competitive advantages or disadvantages that are gross. You can't do that without, again, I think somebody with oversight over the whole shebang.
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Mr. LAZIO. My time has expired. I thank the Chairman.
Chairman LEACH. Thank you, Mr. Lazio.
Mr. Maloney.
Mr. MALONEY OF CONNECTICUT. No, sir.
Chairman LEACH. Mrs. Roukema.
Mrs. ROUKEMA. Thank you.
Mr. Volcker, I am sorry I had to be out while you had that interchange, or communication, with Mr. Baker. I am not going to revisit that specifically, because I know your position on the mixing of commerce, and I think I will go over in some detail what you and Mr. Baker had to say with respect—not agreement, not coming to an agreement, but with respect to a very legitimate question that I think Congressman Baker raised with respect to the equity interest.
Now if you want to add to that, Mr. Volcker, feel free to, but, as you know, I am looking at a basket of commerce, not full commerce, but a basket of commerce, and, again, this is another subject where the devil gets to be in the details.
Just as you have outlined on the regulatory structure in response to Mr. Lazio, we are all for proper regulation, but when you come right down to it, it is difficult to define. But I think we are getting very close there with an umbrella regulator or a definition of umbrella regulator and whatever we define functional regulation as being. So I think we can get there.
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But I am still disturbed about this question of banking and commerce. I see the basket approach as a legitimate one. I would just ask your help on that. How we define the basket is where I have gotten to now, and I guess that is what the Administration is trying to determine as well, how you define that basket.
Could you give me your opinion as to—recognizing you have a problem with it, but if you are going to define the basket, how do you define it? Do you define it on the basis of the gross revenue test, as with the Section 20 affiliates, or the one I am now looking at, contemplating a capital test, based on the risk weighted assets?
I would like to have your advice on that subject and your understanding, based on your own experience and the integrity that you bring to this subject.
Mr. VOLCKER. I find myself repeating myself quite naturally, I suppose. But I would suggest to you, Mrs. Roukema, the trouble you have in defining a basket and the trouble the Administration has in defining a basket and the trouble anybody has in defining a basket is, they are not logically definable, and that is why they struggled. They are not logically definable in having a kind of inherent business logic that makes them sustainable.
Now it is quite true, you can write a basket—and I am sure you would—that in the first instance didn't seem to present any great threat to the system, because if it is small enough, if you make a basket and it is a peach basket, it is not going to threaten the system. But it just seems so inevitable that that will be so arbitrary that you will immediately be barraged with compelling arguments to increase it.
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Now Mr. Baker referred to the fact, quite rightly, that there are a lot of particular exceptions to commerce and business. The implication is, that is an argument for opening up the dikes. You are going to create a situation where the dike is very weak, and people will come to you and say, ''Why is it my competitor across the street, that happens to be twice as big as I am and have twice as much capital as I have, can buy that nice little attractive manufacturing firm in the next town, and I can't? And he really presents more danger to the system than I do, because I am a small bank and he is a big bank.''
Mrs. ROUKEMA. Conversely, Mr. Volcker, though, aren't you living in a past world? Is there any real way, given the global economics, the financial competition that is already out there, and the new technologies, by the way, I don't know what Mr. Greenspan is going to say now, but he was very clear about the fact that with the technological changes in the global economy, it is virtually impossible to continue to maintain the fiction that we are going to be able to separate these two.
So the only thing we are able to get back to is a reliable system of regulation, no?
Mr. VOLCKER. With all due respect.
Mrs. ROUKEMA. Yes.
Mr. VOLCKER. My general answer would be to adopt a Nancy Reagan approach.
Mrs. ROUKEMA. Well, I don't want to use that as a parallel, because that has been a disaster too, so let's not discuss that. All right? I mean, drug use, that is what I am referring to. Let's not use that as a parallel.
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Mr. VOLCKER. I think you are probably right. But with all this technology and all this impossibility of making a distinction, I ask you, why do all these people come before you and say ''drop the restrictions''? If they made no difference, if they were all so technologically comparable, if everybody could do everything, you wouldn't have all these people in this room, I assure you.
Mrs. ROUKEMA. I guess we don't have any more time. But if we are not going to have time now, I sure would like you to put it in writing. What are we going to do about the firewalls? Let's assume we are going to do something and we need firewalls, whether it is for bank and commerce or affiliates and holding companies, but we need the firewalls.
Mr. VOLCKER. I would have some common sense firewalls, but I just don't think you ought to kid yourself that they are going to solve the problem.
If I may say——
Mrs. ROUKEMA. Please.
Mr. VOLCKER.——On this technological side of things, so to speak, remember what we are doing. We are not saying that finance companies cannot combine with industry; they are already combined to some extent, although many of the ventures in that direction have not been very successful. It is not a very popular thing now as it was thought to be some years ago.
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But we are not going to prevent it; we are not going to prevent banks from joining up, largely for technological reasons, with financial firms. All we are doing is saying you can't do both, you can't have both a combination of finance and industry and the combination of finance with banks. So you can't have banks; we are drawing the line at banks, because banks are the most protected core of the financial system. They do the payment system, they create the money supply, they are essential for the Federal Reserve, the ultimate source of liquidity. That is what we are protecting, that is what we have protected in the past, and that is what every country protects; and I don't want to protect the commercial owner of a bank.
Mrs. ROUKEMA. I don't think that is what we are proposing.
Mr. VOLCKER. I don't think that is what you are proposing, but I think that is the logic, the end result of what you are proposing.
Mrs. ROUKEMA. We differ, but we will continue this dialogue.
Mr. VOLCKER. I am not saying you are trying to do that, but I am saying that is a tendency by which things go.
Mrs. ROUKEMA. Thank you.
Mr. Chairman, I return the time.
Chairman LEACH. Thank you.
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Mr. Campbell.
Mr. CAMPBELL. Thank you, Mr. Chairman.
I would like to make four quick points and put them all out front and then, Mr. Chairman, get your responses, if you could.
First of all, my mind is open on this legislation; I have not taken a position, but I was taken by Mr. Baker's point that percentage ownership may be more important than control. So I am going to try to make the four points briefly, but let me make the first one.
If a bank has a large amount of its exposure in a commercial firm, then whether it has control or not, it seems to me, is secondary, except possibly for loss of face.
Second, I represent an area that has a lot of venture capital firms. I am from Silicon Valley in California and the venture firms offer an attractive counterpoint. They frequently will supply capital and take an equity position, and sometimes take management of one of the firms in which they have invested. And the word I hear is they are ruthless; they will cut a company off, and they will supplant management when necessary.
The second point on this being, there may be a counter example to the Japanese model, that Japan did it wrong; and the way I would make this case would be, finance is an input, and there is some logic for a steel company to acquire a supply of iron ore—you would pretty much agree with that, I would think. Or another way of putting it would refer to the theory of the firm. The theory of the firm is that at some point, integration of services outside the market is efficient, and that is where one defines the firm. Occasionally you would include within a firm things that other industrial organizations would have in the market, you would include them within a firm because it is more efficient; and I don't see why, logically, finance should be any different. That is my second point.
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Third, there may be synergies that benefit a customer. We haven't talked about that much, except my colleague from Massachusetts was asking about consumer protection, but it is possible that a customer who wants to get a bank loan and wants to buy a car, so he or she gets a GM car and GMAC financing. There is a logical synergy; I don't have to go to another place to get my financing.
I know on the next panel we will have a witness who has some experience in this, but at one point, Dean Witter, Allstate, Discover and Sears were offering what might be synergies that the consumer would value; and I just think those are the plus sides that I don't think have been addressed.
And my fourth and last point, since I am leaning this way—although as I truly mean, my mind is open—I come down to the real point being Federal insurance. I mean, my attitude is go ahead, experiment, take your chance, but not on the taxpayer's dollar; and if we made sure that the Federal insurance system was not at risk, I, for one, would be tempted to say, go ahead, give it a shot.
The rest of my time I would like to give to you to respond.
Mr. VOLCKER. I will try to respond in a reasonable amount of time.
Your first question was about venture capital. A reference was made to Bankers Trust, and they are a big venture capital supplier That will be, particularly if this merger goes through, as part of the merchant banking function they foresee. I think you can write rules that permit that kind of merchant banking. What you have to consider more broadly in this kind of context, would all the Silicon Valley constituents of yours be better off if banks were owned by IBM and Microsoft? They may not be so eager to finance your new ventures. That is precisely one of the troubles; you get this concentration of resources—that is the German situation. Do you want—you haven't got all that many banks in California anyway, relative to other States—major banks in California basically to be arms of big companies that may have no interest in facilitating innovation in Silicon Valley?
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Mr. CAMPBELL. I am just going to say briefly, the reason I brought up venture capital was for a different purpose; it was to say that ownership of a controlling interest did not necessarily yield bad results. That was my reason for raising that.
Mr. VOLCKER. On that point—there is a difference, I think, between controlling and noncontrolling because an owner that controls will feel more responsibility for that firm in keeping it financed and keeping it alive that a pure passive investor will. The business management will certainly feel that, and there are lots of examples of it. If you get your name on the door and you are controlling it, it is your institution and you are going to protect it; and if it is a passive investment, you don't get your name on the door and there is a difference. Of course, if you keep it small enough, it is no great hazard, but can you hold that line? And that is the problem.
On the synergies point, you mention Sears Roebuck, which is a lovely example. They were very eager to go into the financial business, and they were very eager to go into the banking business; and to the best of my knowledge, for a decade, they were the principal proponents of industrial firms buying banks. Well, they retreated and they decided there weren't so many synergies as they thought they had. And they weren't doing very well while they engaged in that campaign, they sold Allstate Insurance, they sold Dean Witter, and they no longer want to go into the banking business. And I would think that perhaps has some significance.
To the extent there are perceived synergies and actual synergies between industrial firms and financial firms, commercial firms and financial firms, OK; it goes on. We are protecting the bank, which gets to your question of insurance.
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If you could say, ''Look, I am not going to insure the bank so, therefore, you can do anything you want,'' it sounds good. In fact, it is not realistic. You may not insure the bank legally, but I tell you, if that big bank gets in trouble, you are going to protect it.
Mexico is not insured, but it was protected, with $40 billion of U.S. money and IMF money. The two biggest banks in Sweden were not insured, but the Government took them over when they got in trouble. The Government practically took over the banking system in Norway; there was no deposit insurance. But no country is going to put its financial system and its banking system in jeopardy, with or without insurance, and that is going to be true here.
Mr. CAMPBELL. Thank you.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Campbell.
Mr. Bentsen.
Mr. BENTSEN. Thank you, Mr. Chairman.
Mr. Volcker, I apologize for missing your testimony earlier. When you spoke to Mrs. Roukema on the subcommittee earlier this year, we talked a little bit about the operating subsidiary structure, or subsidiary structure versus an affiliation structure; and as I recall, you brought up the First Chicago first option issue. I have subsequently looked at that. To hear First Chicago's story, it wasn't quite as bad as you might have suggested.
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But what I want to ask you, in looking at your testimony, you talk about holding company regulation and the idea that you have to have some functional regulation but you also have to have somebody who is in charge, somebody who looks at the sum of the force.
Mr. VOLCKER. For safety and soundness, right.
Mr. BENTSEN. I think you are right, somebody has to look at the sum of the parts, somewhere between the umbrella and the functional regulation.
You then talk a little bit about the holding company structure. I guess my question is this, and I have asked you this before, but I will ask again: If you have a proper regulatory structure that puts safety and soundness as paramount, and you have similar firewalls to Sections 23(A) and 23(B) with an operating subsidiary structure, and you net out capital, what really is the difference? Isn't there the same systemic risk that would be the case whether you had an affiliate or a subsidiary?
Mr. VOLCKER. Well, if the firewalls were strong enough, it would diminish it, but I think there is going to be some practical difference; and when push comes to shove, whether a bank can insulate itself from its own subsidiary. The problems are similar, but I think there is a potential difference in degree, among other things—the subsidiary is going to directly affect the capital of the bank, whereas an affiliate might only indirectly impair it, and resources from elsewhere in the holding company are there to help the affiliate and so forth. I think there are some differences, but it is an exaggeration of the difficulty that exists anyway.
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Mr. BENTSEN. But you don't believe you can net out capital for the subsidiary and legally separate the capital?
Mr. VOLCKER. You try to meet that problem by netting it out, I am sure, but at the end of the day, the capital of the bank is going to be reduced and its liability is going to be reduced. But when the market looks at it, the capital is reduced. It will be netted out against the failure of that particular asset.
My basic problem is, I don't think those really tough firewalls—they are very hard to impose, really tough ones, and they don't last. One is affected by his experience. In a somewhat different context, when the Federal Reserve decided to let banks buy savings and loans—which made all kinds of sense—there was a political problem. Public policy had been against it, but there came a certain point where the Federal Reserve said, ''This doesn't make sense, not permitting it.'' There was a lot of political opposition.
So we permitted it in a couple of notable cases with a lot of, in effect, negotiation with the Congress and with State authorities, with a lot of firewalls, so that they couldn't be operated synergistically. We permitted it with the full approval of the bank about the conditions—I mean, the bank was glad to buy them.
So it was all laborious, but harmonious, and we broke the prohibition and permitted what seemed to be very sensible. I don't think it took 6 months, certainly not a year, for the bank to come back and say, ''We agreed with all the firewalls, but they are totally unworkable in terms of a business organization; you have to give us some relief.'' And of course their case was very persuasive because the firewalls were extremely awkward.
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Now, this was not a safety and soundness thing, but it is an illustration of how difficult it is, even in that case with the agreement of the institution because they wanted to get it done, to maintain very cumbersome firewalls. And, you know, again, if you make them very tight, people won't do it, because if they thought they were going to be sustained and they are very tight and they don't permit synergies, in effect, or maybe they permit some synergies, but they don't permit 75 percent of the synergies they hope for, it won't be sustained.
Mr. BENTSEN. Well, that may be true, but if you transfer Sections 23(A) and 23(B) into a subsidiary, I mean, it is already working, apparently to some extent, with Section 20, and so why not use that? And then, of course, as you said, there are other reasons, as we have talked before; it is not as vogue today to own a securities firm as it was in the 1980's.
Mr. VOLCKER. Don't mistake me. I would keep some of these prohibitions because you don't want to make it easy for them in Sections 23(A) and 23(B); you know, prevent some of the most easy and egregious conflicts and self-dealing. People can operate within that and I wouldn't abandon them. All I am objecting to is the thought that you can achieve complete insulation; and Sections 23(A) and 23(B) have not prevented holding companies from being affected by the difficulties of one part of the holding company. That is quite difficult.
I think there is a lot of experience. Bank holding companies have gotten in trouble as much because of their affiliates as because of the bank; and the existence of these appropriate, but not very strong, firewalls hasn't prevented that.
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Mr. BENTSEN. Thank you.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Bentsen.
Mr. Cook.
Mr. COOK. Thank you, Mr. Chairman.
Mr. Volcker, your position and views on the mixing of banking and commerce are certainly well known.
Mr. VOLCKER. I don't keep them secret.
Mr. COOK. Excuse me?
Mr. VOLCKER. I don't keep them secret.
Mr. COOK. Over some period of time some kind of incremental approach legislatively is something you are not for in terms of commingling?
Mr. VOLCKER. No, I am against it. Precisely, I think the word ''incremental'' describes why I am against it. It is not that some small increment is going to destroy anything, but one small increment almost inevitably leads to more increments. I don't know how you stop it. Once you accept the principle, you can't stop it.
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Mr. COOK. Let me make sure I understand the risks you are concerned about. It is the risk of a major problem with the American payments system?
Mr. VOLCKER. That is the clearest risk; and to prevent that risk, you would then have to extend banking supervision and regulation much further than I would like to extend it. If I would try to put myself in your position, I would ask myself some questions. Does this change in policy promise to increase competition or reduce it? Does it lead to more conflicts of interest and more self-dealing or less? Does it lead to more concentration of resources or less concentration of resources? Does it lead to more risk to the taxpayer or less risk to the taxpayer? And I think the answer to all those questions is quite unambiguous.
Mr. COOK. And I think you do make a persuasive case for that conclusion, but tell us, please, in spite of these risks, in spite of your feelings, what are the opportunities that we are going to forgo if we don't have some kind of a merging——
Mr. VOLCKER. Well, you will forgo—there are some business firms clearly that see some advantage and some synergy in combining not only commercial and industrial activities and financial activities, which they can do, but also banking activities. Now you have to ask yourself whether some, perhaps, real advantage to a particular firm is consistent with the general public interest.
These firms—one thing that they have said in the past—want direct access to the payment system, the heart of the banking function in the United States. That is understandable. They think they can do it cheaper on their own. Why pay Chase Manhattan or why pay Morgan Guaranty to transfer funds and collect checks and make wire transfers? They have got a lot of them; do it themselves and save a few dollars. And maybe they could.
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But then you have to ask yourself whether that individual advantage is worth, in effect, boring holes in the foundation of commercial banking. Are you going to weaken the whole system in the end and lead to a general melange which isn't regulated?, because I don't think you can regulate that much.
And then you ask yourself, what happens when they do get in trouble—which they inevitably will? They will get in trouble whether or not they are owned by industrial firms; that is not the point. But we have a system for taking care of banking crises, but I don't want to take care of the whole economy by, in effect, bailouts, because we have to protect the payment system and we have to protect the banking system.
Mr. COOK. So you are——
Mr. VOLCKER. I think as maybe the Sears Roebuck illustration suggests, you are not forgoing very much. They thought it was very important at one point. They don't seem to think it is important anymore, if I understand them correctly. And it is interesting, they are making more money now than when they thought it was important.
Mr. COOK. Thank you.
Chairman LEACH. Dr. Weldon.
Dr. WELDON. I thank the Chairman, and I apologize for being late. I was trying to read over your testimony, Mr. Volcker, and I just have one quick question.
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One of the arguments that has been raised with me by some of the advocates in support of commercialization is that it is going on already, and that where it is going on—say, in State-regulated banks—it seems to be going OK, and the area where there are some personal individuals who own banks and commercial operations. What are your comments to counter that?
And then the other question I have is the competitiveness issue. I have had some people pointing out to me that the banking industry, in terms of its percentage of handling of the investments out there, it is rapidly declining. And with the growth of the securities industry in managing financial instruments, as well as the growth of the credit union industry, where do we want to see banks in the mix here, and does this play a role in making sure that they can continue to be competitive in the financial marketplace?
Mr. VOLCKER. Obviously very relevant questions.
On the first question, it is going on around the edges by State regulatory decisions, potential Federal regulatory decisions or otherwise, but it is very much around the edges. And because it is around the edges, it doesn't present any threat at the moment.
But what we are talking about is what we do over time, as a matter of philosophy; and if we change the law, I assure you it won't be around the edges anymore. And that is what we are talking about, and then I think you do have dangers.
What about the strengths of the banking system? It so happens right now the banking system is in the best shape I have seen it in my adult lifetime in terms of profitability, capital strength, important measures of strengths. It is true that as a portion of the total flow of credit and capital through the economy banking has declined, oh, maybe in half from the immediate post-World War II period. It declined more rapidly in the 1980's; I think it is probably stabilized right now.
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But I think it is important to have some kind of a balance, just as philosophy. We don't have to have the banking system dominate the whole financial world, and I think that would be unfortunate. We want some competition, we want some innovation. We don't want it so small and so weak that when we protect it, we are not protecting very much.
Where is the exact balance? I don't know. But this is one of the basic reasons you want the basic legislation, so that banks are not competitively handicapped in the world of finance, which is what they have been. I think that is what you want to see.
You want to maintain a strong banking system, an effective banking system, a competitive banking system, so let's clean up this area of permitting banks to engage in investment banking and investment management and insurance, fine, and that will guarantee you they will remain strong. But don't go to the other direction, which I think, in time, will produce weakness, rather than strengths.
Dr. WELDON. Commercial operations?
Mr. VOLCKER. Commercial, which produces conflicts in a concentrated market, all of these things. Concentration of resources, conflicts of interest, competition, it all comes down to the same question. And I think exposure to the taxpayer.
If you can answer those questions and say, yes, it reduces exposure to the taxpayer, it reduces conflicts of interest, it reduces concentration of resources, then I wouldn't have any argument. But I think those answers to all those questions are no. It increases concentration of resources, it increases conflicts of interest and biases in lending, it increases exposure to the taxpayer; so I say, we shouldn't adopt it as a philosophy.
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And it is not just me talking. The American financial system is better and stronger and more diverse than the German or the Japanese that have a different philosophy. The British would have the same philosophy; they have a strong, flexible banking system, so the burden of proof, it seems to me, is on those who want to change.
Dr. WELDON. Thank you. I thank the Chairman.
Chairman LEACH. Thank you, Doctor.
Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman. And I apologize, as I was here at the start of the meeting and had to leave for an activity of some import.
First of all, Chairman Volcker, I appreciate the response to my earlier questions from the subcommittee, and have studied those a little; but for the record, I just wanted to point out, first of all, that all these financial modernization bills before the committee addressed functional regulation of financial activities conducted in a bank or in a non-bank affiliate or holding companies. These bills differ, though, on the extent for authority has been the moniker granted an umbrella regulator.
Do you think, Mr. Volcker, it is appropriate or necessary to grant, for instance, the Federal Reserve Board or the SEC or the FDIC the authority to conduct examinations of, for instance, security insurance affiliates of proposed financial services holding companies already subject to functional regulation by the FCC or, for instance, the State insurance regulators?
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Mr. VOLCKER. I think my instinct on that would be, there would have to be or should be some kind of residual authority. If the oversight authority really felt concern—for some reason or another—there was a danger not recognized by the functional authority, which may not have that as its prime concern.
Mr. VENTO. I think the concern I have with this—and I read it—is we might get regulatory constipation here if everyone that has the FDIC or the SEC or others, so the concern about having someone in charge or some move to a committee, you see that as being cumbersome. I mean, I appreciate that, but I wanted to state for the record my concern.
Let me just move to another question, and there is plenty of time here, I think, for my question; but I want to get on the table, too, you see a systemic problem in terms of banking and commerce, but the experiences that we have had here, putting aside the S&L problem with the thrifts, the unitary thrifts themselves. Do you see that there has been a systemic problem with the unitary thrifts in the fact they have a mixture of commerce and banking?
Mr. VOLCKER. No, because they are a very limited exception, they have not been very popular, so we can live with them without creating any systemic problems.
Mr. VENTO. I mean, one of the things the banks are coming back to us with and saying, ''We don't want the unitary thrifts to charter down to what our charter is, we want to charter up to what their charter is.'' Would you think that would be a good proposal?
Mr. VOLCKER. I think you have to look at particular powers and authorities to resolve that question, but I would not, advance, obviously, the banks to the unitary savings and loan charter that permits a combination with commerce; I obviously would not do that.
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I would grandfather what exists. We had that conversation earlier.
Mr. VENTO. I guess I wasn't here for that.
Mr. VOLCKER. If you are looking at systemic problems, you can't look at limited exceptions at present in the United States and say there hasn't been any problem, because they are very limited, and they are limited because the law has been against it. You have to look at Japan, you have to look at Germany, where it is not the exception—even in those countries, in Germany, it is the exception, but there are many more and they are important in Germany and do you like their system better than our system?
Mr. VENTO. I am not saying that, I am just saying we have a different culture in terms of our mixed economy, is what I would suggest; and I don't think most Americans have quite the acceptance of what the government might do in Germany, as an example. There are some times I might regret that, but most often I am very happy for the independence and contankerous nature of the skeptics that I represent. And I think we all are, and it is sort of part of our tradition.
So, I think culturally and in terms of our economy, what we accept, and I think another question is in terms of who does the type of proposals that are being made here—and I think it is very legitimate and I think you are very helpful with this—exceed the regulatory ability to regulate? Is that what you are suggesting? I sometimes thought it was a leap of faith.
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My concern is, there has been such a convergence of activities in financial institutions and commerce, this is inextricably coming, and so if we pass legislation that doesn't actually recognize it, provide for a two-way street, in terms of the affiliates of—with regard to investment banking and insurance that we basically are going to——
Mr. VOLCKER. I think you ought to be on my side on your argument, because there is obviously a problem with the proliferation of regulatory authorities and overlapping authorities.
Mr. VENTO. Let me get in one more question before—my time is about to expire—and that is the issue of control.
One of the ways the Fed has dealt with this has been dealing with the question of control in terms of commerce activities that banks are involved in. I think that would be a model that we could look at in terms of trying to limit what the impact is of commerce on banking or banking on commerce.
Mr. VOLCKER. I think quite explicitly, in a functional sense, the issue here is control. The issue is control, but also a reasonable facilitation of what I would think of as ordinary investment banking or merchant banking, which would require and does entail transitional holdings of stock—not necessarily control, but transitional holdings. And I think both of those to some extent are allowed for in present law, and you should look at those provisions; and to the extent they should be liberalized or changed or rewritten, do so.
Mr. VENTO. Well, Mr. Chairman, I think this is helpful in terms of looking at where we might take some guidance in terms of trying to put some sort of screens on the inevitable; and a mixture of banking and commerce in terms of this control question is maybe one of the avenues we could look at that would be an area of common ground. And if you would like to elaborate—I am sorry I gave you such a series of questions and didn't permit you to answer; if you want to elaborate further——
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Mr. VOLCKER. I would be glad to elaborate further on that and be a little more precise, but if I may make one general comment, your concern about the amount of regulation involved is one of the reasons that I think argues against going to commerce, because you are going to have to regulate it to some extent. If you are going to protect it, you have to regulate it. So let's not carry the protection and the regulation any further than we have to.
Mr. VENTO. I think the question is to give a legitimate task to the regulator, rather than one that is not workable; and I think that is what we are both talking about.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Vento.
Mr. Hill.
Mr. HILL. Mr. Chairman, I will pass.
Chairman LEACH. Mrs. Maloney, if you can keep it to 4 1/2 minutes or so.
Mrs. MALONEY OF NEW YORK. I will be very, very brief.
You testified, you believe commercialization would make our banking system weaker. But would it make individual banks stronger? Would we end up with just a few giants controlling our system with immense political power? What would happen?
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Mr. VOLCKER. If you open the gates completely, I think you would get some very large concentrations of commercial firms and financial firms and banks, and you would get more concentration, including commercial activity.
I am not sure in the end it is going to be very efficient, I don't think it will be, you are going to have a German-kind of system, you have a tendency in that direction, where you have this kind of concentration.
Mrs. MALONEY OF NEW YORK. Would some banks be stronger?
Mr. VOLCKER. Some might be stronger, some might be weaker. But you are putting yourself in the hands of the fortune of their own acts, or their associates, and if the industrial firm becomes weak unexpectedly, the bank will become weak; and my problem is, that may be unpredictable in particular instances.
But, I don't want the Federal Government to be responsible for the health of big commercial firms or big industrial firms. Why do we want to spread the Federal interest still further, with the implication that requires some regulation and supervision? I don't want to regulate and supervise. If I was in the Federal Reserve, or wherever I am, I don't want to regulate and supervise the commercial side of the economy; it is bad enough supervising the financial side and the banking side.
Mrs. MALONEY OF NEW YORK. Well, with commercialization, as you mentioned, the regulations, how far would you have to go to protect deposit insurance? Would Government regulators be inspecting commercial firms?
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Mr. VOLCKER. Well, that question arises if you have the combination, and I don't want to do that and that is why I don't like the combination.
Mrs. MALONEY OF NEW YORK. Well, you have very interesting testimony. Thank you.
Chairman LEACH. Thank you, Mrs. Maloney.
Let me just end with the observation that I think that our colleague from Nebraska was very prescient in suggesting this was as important testimony as he has heard in the last couple of decades. That is a very strong statement, and I happen to concur in it, and we thank you.
Mr. VOLCKER. Thank you, Mr. Chairman. And I wish you and the committee good luck in making some sense out of all of this and finally, to my knowledge, after 15 years of this testimony, you get something.
Chairman LEACH. I hope you are right.
We have a vote on the floor, at which point we will bring on the next panel, but so that everyone is on the same timeframe, it is about 5 after 12. If we said we would start at 12:25, there is a little cafeteria floor below us, if you want to get a sandwich or whatever, so the hearing is in recess until 12:25.
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[Recess.]
Chairman LEACH. The hearing will come to order.
I would like to make one announcement. On the House floor, a major rule on a major bill has gone down, and that has put things a bit in flux. With that being put in flux, the leadership has tentatively rescheduled final consideration of the housing bill to commence in about an hour or so. That is awkward for this committee, because it is our jurisdiction, and it is the final debate on the bill. So there will be some discombobulation in that process.
In any regard, our second panel is composed of John G. Heimann, who is Chairman of Global Financial Institutions of Merrill Lynch and well-known to this committee and well-respected throughout the financial community; Mark Lackritz, who is President of the SIA, I think one can say likewise; Matthew P. Fink, President of Investment Company Institute, who has a wonderous reputation; Christine Edwards, Executive Vice President and General Counsel of Dean Witter, and we are pleased to that you are with us as well, Christine; and Jeffrey A. Tassey, who is Senior Vice President of Government and Legal Affairs of the American Financial Services Association, a group that has spent an awful lot of time on concepts related to this legislation.
Chairman LEACH. I would like to begin in the order in which the individuals were announced. I would also note that I have been informed that Mr. Heimann may have to leave at a given point.
In any regard, we will begin with you, John.
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STATEMENT OF MR. JOHN G. HEIMANN, CHAIRMAN OF GLOBAL FINANCIAL INSTITUTIONS, MERRILL LYNCH & CO., INC.
Mr. HEIMANN. Thank you very much, Mr. Chairman.
Chairman LEACH. If I could, I will say all of your statements will be submitted in full for the record. You have the choice of proceeding as you wish.
Mr. HEIMANN. Thank you, Mr. Chairman.
I realize time is brief. Distinguished Members of the House Banking and Financial Services Committee, my remarks will be restricted to the 5-minute time limit.
My name is John G. Heimann, Chairman of Global Financial Institutions at Merrill Lynch and Company. I also serve as a member of the Executive Management Committee of Merrill Lynch.
For more than a decade, Merrill Lynch has been calling for comprehensive legislation to modernize the regulatory framework for the U.S. financial services industry. Today, the need for such legislation is more urgent than ever.
Allow me to point out in passing, Mr. Chairman, that it was 21 years ago, before this committee, that I first testified on Glass-Steagall reform, when I was the Superintendent of Banks for New York State. I do have a sense of deja vu.
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In recent years, the world of finance has changed dramatically under pressure by the users of the financial system, the consumer, businesses and Government; by the liberalization of the domestic financial system in many nations, those that wish to free up the financial sector along market-driven lines; and by the overwhelming influence of technology.
As you know, Mr. Chairman, we are in the midst of a global consolidation in financial services—an ''end game'', if you will—that will relatively quickly determine what companies and which nations will emerge as the financial superpowers of the 21st Century.
By all accounts, the U.S. securities industry should be vying for a central role in this end game. Today, American securities firms are global leaders. Indeed, the top three U.S. securities firms annually account for 30 percent of all debt and equity underwriting in the U.S. and cross border markets worldwide.
Laws that were constructed in the 1930's to address the problems of the 1920's are sadly antiquated—in fact, totally inadequate—some 6 or 7 decades later to confront the modern system of finance, both nationally and internationally. Whatever changes have been brought about in the antiquated structure governing the financial services industry have been the result of regulatory actions upheld by the court.
This has happened around the Congress which, despite your efforts, Mr. Chairman, has been unable to resolve these pressing issues. Without Congressional action, the regulators have seized the initiative. Therefore, the changes introduced have been uneven, favoring one side or the other, dependent upon the aggressiveness of the particular regulator.
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Today, insured depositories can and do own securities companies, while securities firms cannot own a full-fledged commercial bank and instead are only permitted the ownership of tightly restricted institutions, generally known as limited purpose banks.
We applaud the basic thrust of the three legislative proposals for financial modernization, all of which would create a modern structure for the financial services industry through the creation of a financial services holding company and would rely upon functional supervision.
In considering these pieces of legislation, the committee should focus intently upon some basic principles which will govern your decisionmaking: One, protection of the deposit insurance fund, or the determination of what level of risk will be permitted within an insured depository; two, safety and soundness of the financial system as a whole; or the prevention of a systemic breakdown or systemic collapse; three, the mixture of banking and commerce, or to what degree it is good public policy to permit businesses to own banks and vice versa; and, four, competitive equality, or how to balance the competing demands by banks, securities firms and insurance companies so that they are on a level footing when engaged in similar activities. This also involves how to create a framework so that the United States financial institutions are not at a competitive disadvantage to their foreign counterparts, both here and abroad.
Let me begin with protection of the deposit insurance fund. The fundamental issue is what level of risk will be permitted within the insured depository. Since the financial services holding company framework permits financial institutions considerable flexibility, additional activities by the insured depository that introduce with a new risk component should be housed outside of the insured bank.
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The underwriting of securities is one example. Another would be proprietary trading accounts. Obviously, new activities which do not have inherent risk components, such as discount brokerage, could be housed in the insured depository.
The second issue is safety and soundness. There is a clear need for supervisory oversight of the financial system as a whole in order to protect the safety of the insured depository funds, the safety of the payment system, and to oversee the totality of financial intermediaries in order to prevent systemic breakdown.
Furthermore, in the new world of global financial supervision, host countries look to the home country supervisor for assurances of the stability of the individual financial institution. Here in the U.S., our home country supervisor must have respect and standing with its international counterparts.
As a global financial intermediary operating in some 45 nations, we at Merrill are in agreement with the concept of a consolidated supervisor—an umbrella supervisor, if you will—in the context of the new financial services holding company framework suggested by these various bills.
The third issue is the mixture of banking and commerce. This debate is often confusing as it incorporates two different concepts: One, commerce owning banks; and, two, the financial services holding company, which may include a bank, investing in nonfinancial companies.
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We believe that financial services holding companies should be permitted to affiliate with nonfinancial companies within limits. Indeed, such combinations today are a normal part of our business in the form of strategic investment.
Furthermore, merchant banking is a widespread financial activity and should not be categorized as nonfinancial. These are traditional activities of investment banks, important to serving our clients and to the overall success of our business.
As to commerce owning banks, we recognize that Congress may see the need for some prudent limits on the mixing of commerce and banking—again, commerce owning insured depositories—especially the ownership of large banks by large commercial companies, a practice which is not allowed in most industrialized countries.
The salient issue as we see it is not whether a bank should own a commercial enterprise or vice versa. The issue is whether or not a financial services holding company can engage in limited strategic investment.
The forth principle deserving your attention is competitive equality. We strongly urge Congress to create a financial services modernization bill which simultaneously treats all competitors equally while giving them the ability to compete with non-U.S. financial institutions on an equal footing both at home and abroad. Simply put, if banks can own securities companies, then securities companies should be able to own banks. This will increase competition with the inevitable end result of products and services for the users of the financial system at lower cost.
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Regulation of affiliates within a financial services holding company framework would be equal as a result of functional regulation. Banks would be regulated as banks, securities companies as securities companies, and insurance companies as insurance companies.
We are not suggesting a melding of these activities; rather, each activity would stand on its own subject to the requirements of its functional regulator.
Additionally, as the world of finance continues to globalize, U.S. institutions should be able to compete with their foreign competitors without being disadvantaged by U.S. laws that are a throwback to previous times. This does not imply any lessening of supervisory due diligence. Rather, the U.S. financial system should be redesigned to permit maximum flexibility within the supervisory constraints deemed desirable. The financial services holding company model does just that.
In sum, Merrill Lynch urges Congress to act quickly on financial services reform. We believe you need to take action to ensure that American consumers and businesses receive the innovative and integrated services they need from strong companies prepared to compete globally in the 21st Century. We at Merrill Lynch stand ready to work with you in any way to support that effort.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, John. I appreciate your perspective, and also you have led in thinking on this issue for a long time.
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Marc.
STATEMENT OF MR. MARC E. LACKRITZ, PRESIDENT, SECURITIES INDUSTRY ASSOCIATION
Mr. LACKRITZ. Thank you, Mr. Chairman.
I am Marc Lackritz, President of the Securities Industry Association; and I appreciate very much, Mr. Chairman, the opportunity to present SIA's views on H.R. 10 and the other measures before the committee.
We commend you, Mr. Chairman, and the committee for making financial restructuring such an important priority for this committee. We share your goal of enacting comprehensive legislation that increases competition, encourages innovation, and ultimately leads to more and better choices for consumers and investors.
At the outset, we believe that financial services modernization legislation must comply with three basic principles: competition without Federal subsidies, a full two-way street and functional regulation in order to protect taxpayers, keep the U.S. capital markets open, competitive and free and ensure that all sectors of the financial services industry operate with flexibility.
Provisions that do not advance these three goals will inhibit our industry's ability to serve customers and to compete globally.
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The committee specifically requested us to comment on several issues on which my written testimony elaborates. Here I will talk briefly about banking and commerce, an umbrella regulator, securities underwriting by banks, and functional regulation.
First on banking and commerce. We commend you, Mr. Chairman, for modifying H.R. 10 to permit some affiliations between banks and insurance companies. This provision is a critical element of a two-way street because many securities firms are affiliated with insurance companies and most retail securities firms offer insurance products. We believe that investors would benefit from financial services firms that can offer the widest range of products and services and engage in vigorous competition.
We believe, however, that H.R. 10 should be expanded to allow commercial firms to affiliate with financial services holding companies subject to the antitrust laws and other appropriate safeguards. Commercial activities should be conducted only in a separately organized and capitalized affiliate of the holding company. Appropriate restrictions on affiliated transactions should be established to prevent insured deposits from being put at risk by commercial activities.
Turning to the subject of an umbrella regulator, we believe that the holding company regulation provisions of H.R. 10 are unnecessary. If a bank and a securities firm affiliate in a financial services holding company, the SEC would regulate the securities firm and the appropriate Federal banking regulator would regulate the bank. Another layer of regulation at the holding company level would be both redundant and expensive.
Depositors and investors would not receive any significant protections that would justify the cost and burdens of additional regulation. Instead, we support the regulatory model in H.R. 268 which would not impose a holding company regulator and would allow a bank's regulator to request necessary information about an affiliated securities firm from the SEC. Likewise, the SEC could request necessary information about a bank from the bank's regulator.
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We believe that the experience of the Market Reform Act is instructive on this point. This law was developed to address precisely the concerns expressed by proponents of an umbrella regulator and has served the industry regulators and the public well.
We are concerned that provisions of H.R. 10 would permit subsidiaries rather than separate affiliates of banks to engage in securities and dealing activities. We believe that all securities activities should be conducted in a separately organized and capitalized non-bank affiliate of a financial services holding company.
Allowing bank subsidiaries to engage in these activities directly makes it more likely that the bank would use the deposit insurance system to prop up the financially troubled securities subsidiary. In fact, permitting a bank to own a securities firm directly would put a stamp of approval on the OCC's campaign to expand the national bank charter without authorizing legislation.
Finally, we are concerned that H.R. 10 does not achieve true functional regulation. Banks would be permitted to engage in a broad range of securities activities directly in the banks without registering with the SEC as a broker-dealer. In addition, it would give the Federal Reserve considerable discretion to permit banks to underwrite and deal in securities that it determines resemble bank products. By contrast, securities firms would be completely prohibited from accepting deposits.
SIA supports a functional regulation approach that would require banks to register with the SEC as broker-dealers if they engaged in any securities activities in the bank. This system is in the best interests of investors and consumers because the SEC is the most knowledgeable and expert securities regulator.
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In conclusion, Mr. Chairman, SIA hopes that Congress will seize this opportunity to pass comprehensive financial services and modernization legislation. We thank you again for the opportunity to testify on this most important subject and look forward to working with you as you move ahead in the legislative process.
Thank you.
Chairman LEACH. Thank you, Mr. Lackritz.
Mr. Fink.
STATEMENT OF MR. MATTHEW P. FINK, PRESIDENT, INVESTMENT COMPANY INSTITUTE
Mr. FINK. Thank you, Mr. Chairman.
I am Matt Fink, President of the Investment Company Institute, which is the national association of the mutual fund industry. I want to thank you for being given the opportunity to testify on this legislation.
The mutual fund industry believes that there are five principles that should underlie financial reform legislation: first, grant commercial banks full mutual fund powers; second, modernize the Federal securities laws to take into account bank mutual fund activities; third, permit the affiliation of banks, securities firms, insurance companies and commercial companies; fourth, provide for functional regulation of each entity; and, fifth, create an appropriate oversight system for the new diversified financial service holding companies.
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While my written testimony discusses each of these points, I would like to spend the time available here to focus on an appropriate oversight system.
If we sit back and look at these three industries, banking, securities and insurance, we find that each one, for decades, if not hundreds of years, has been subject to a system of Government regulation. But each system of regulation is based on very different philosophical premises and relies upon very different regulatory tools.
For example, the securities markets of this country, the greatest in the world, are founded on risk-taking. In keeping with the nature of this marketplace, the Federal securities laws administered by the SEC do not seek to limit risk. Thus, the securities laws do not limit the kinds of companies with which securities firms can be affiliated.
Similarly, the securities laws do not regulate the activities of affiliates of securities firms, but only the securities firms themselves. Instead, the securities laws require disclosure of risk.
As you well know, Mr. Chairman, banking regulation rests on a very different foundation than securities regulation. Unlike the Federal securities laws, banking regulation does seek to control risk. Thus, banking regulators traditionally have limited the types of firms with which commercial banks may affiliate; and banking laws have regulated the operations of both banks and their non-bank affiliates.
House Resolution 10 and the other bills before this committee propose to permit banking, securities and insurance firms to affiliate and to form new diversified financial services organizations; but it does not follow that Congress should impose the old traditional form of banking regulation upon these very new types of organizations.
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Unfortunately, H.R. 10 does, to a great degree, impose this old system on new organizations in the form of consolidated bank holding company supervision. Consolidated supervision will create inefficiencies for the new organizations and their non-bank subsidiaries and potentially will interfere with their ability to compete. It could very well subject financial firms to duplicative and potentially conflicting regulatory requirements.
It almost certainly—and I would stake my fortune on this, such as it is—will lead to the inappropriate imposition of safety and soundness regulation on securities firms; and it may very well lead the public to believe that the non-banking entities in these conglomerates are protected by the Federal safety net.
I do not believe that proponents of consolidated bank supervision have shown that it is necessary to protect either the banking system or the financial system. First, making sure that the Federal Reserve Board has adequate authority over banks would appear to address most concerns. Enactment of mechanisms that would provide the information to the Federal Reserve Board with current and full information about the holding company and its non-bank subsidiaries would appear to address the remainder of concerns.
In short, the legitimate concerns of the Federal Reserve Board, as very well expressed by Chairman Volcker this morning, can be addressed without making the Federal Reserve Board an umbrella super-regulator.
The Institute believes that a new oversight system should be created to oversee these new conglomerates. Specifically, we believe that this oversight system should be based on three concepts: functional regulation; bank-centered supervision and enforcement; and, enhanced regulatory coordination.
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For example, enhanced regulatory coordination means giving the Federal Reserve Board mechanisms for cooperating with the other regulators in carrying out its functions. For example, as Mr. Lackritz said, the legislation would provide the Federal Reserve Board with authority to receive information regarding the holding company and its non-bank subsidiaries, and then the Federal Reserve Board could use that information in dealing with the bank.
We believe that an oversight system grounded on functional regulation, bank-centered enforcement and regulatory coordination would maximize the public interest, while minimizing the potential for marketplace distortions.
If one thing is clear, it is that Congress should not impose traditional banking regulation on the new diversified holding companies. Traditional banking regulation was designed for the old world, where bank holding companies were primarily engaged in banking activities; but the pending legislation you have introduced would create a whole new system of diversified financial services holding companies. Congress concomitantly needs to create a new system of regulation for these very new kinds of entities.
I appreciate the opportunity to appear before you today; and, if I have one second, I thought you might appreciate a quote I saw from President Theodore Roosevelt which may explain the conundrum you and your colleagues are facing.
When he was considering banking legislation at the turn of the century, he wrote, ''This financial business is very puzzling. The minute I try to get action, all the financiers and businessmen differ, so that nobody can advise me.''
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Thank you, Mr. Chairman.
Chairman LEACH. Well, thank you very much, Mr. Fink, for some of what you have said.
I will note you also have a quote from Chairman Greenspan, but his conclusion is the opposite of your conclusion.
Mr. FINK. That is right.
Chairman LEACH. Christine.
STATEMENT OF MS. CHRISTINE A. EDWARDS, EXECUTIVE VICE PRESIDENT AND GENERAL COUNSEL, DEAN WITTER, DISCOVER CO., ON BEHALF OF THE FINANCIAL SERVICES COUNCIL
Ms. EDWARDS. Mr. Chairman, Members of the committee, I am Chris Edwards, Executive Vice President and General Counsel of Dean Witter, Discover and Company. I have spent the last 25 years in the financial services industry, first as a businessperson and then as a lawyer.
My company is a founding member, and I am a board member, of the Financial Services Council. I am pleased to be here today to represent the Council's views on financial modernization.
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At the outset, I would like to say that Paul Volcker and I agree on two things: first, it is a nice day and I am glad to be here; and, second, the financial services industry needs legislation. Beyond that, we debate.
For over 10 years the Council has joined others, both in industry and Government, to argue that consumers and markets would benefit by unshackling the financial services industry from an antiquated legal structure. Laws designed 60 years ago, such as the Glass-Steagall Act and, more recently, the Bank Holding Company Act, were responses to a marketplace and to problems that no longer exist.
We strongly believe it is time to replace those laws with a more workable system that will set the framework for the delivery of financial services in the new century; and we believe that Congress, not the regulators and not the courts, should address that system.
In recent years, the debate has come a long way on the thorny issue of the question of permissible affiliations for banks. Most parties now agree that affiliations between banks, securities and insurance firms should be permitted.
The central focus of the current debate is the extent of commercial involvement in the financial services arena. The three Congressional proposals approach this question very differently.
Your bill, H.R. 10, Mr. Chairman, does not provide for a financial services holding company to engage in commercial activities nor a commercial firm to engage in traditional banking. Congresswoman Roukema's bill, H.R. 268, addresses the appropriate extent of commercial activity for a banking organization, but not the corresponding opportunities for commercial firms. A third, more comprehensive, approach introduced by Mr. Baker, H.R. 669, addresses both by lifting all restrictions to affiliations.
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The Financial Services Council believes that a workable solution can readily be crafted by accommodating the activities and affiliations that exist today. By building on this experience, Congress has the background to address both the financial services holding company's commercial affiliations and a commercial firm's ability to offer banking services.
Rather than speculate about potential dangers from bank affiliations with commercial firms and erect permanent barriers to prevent them, the committee should look closely at affiliations that exist today and at safeguards that are already in place to protect financial institutions.
Modifications to this model may be needed to prevent potential abuses that are not addressed by the safeguards that exist today, but first the committee should consider safeguards that are already in place. If they are inadequate, changes should be made; but new requirements should be added only when necessary to address such concerns.
House Resolution 268 offers an alternative, albeit limited, approach to commercial affiliations by creating a basket for nonfinancial activities of a financial services holding company. The basket approach acknowledges that commercial activities are not uncommon amongst financial services companies. If Congress chooses to restrict affiliations, a basket is the absolute minimum needed to create a true, two-way street for the securities and insurance sectors of the financial services industry.
Another issue central to this debate is whether there is a need for another level of regulatory oversight, the so-called umbrella supervisor. The Financial Services Council believes that a coordinated system of functional regulation can be made to work without creating a super-regulator. Coordinated efforts are preferable and adequate to oversee operations of all of the affiliates of a financial services holding company.
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More difficult is determining the need for additional holding company oversight and regulation to monitor risk on a consolidated basis. Surely there is a need in any model for mechanism to address legitimate concerns about the impact on an insured bank, the payment system, and the deposit insurance system of the activities of banks' affiliates and of risk management decisions made at the holding company level; but it is important to keep a focus on the specific goals of such oversight.
We feel strongly that rigid bank holding company regulation, which was designed to govern the activities and limit the risk of entities engaged primarily in banking activities, is both unnecessary and unworkable for holding companies that will engage in a far broader range of activities, financial and otherwise.
We think that the structure reflected in H.R. 669 and H.R. 268 is a sound one. This provides a mechanism for bank regulators to access the information they need to ascertain the potential impact on banks of the activities of other holding company entities, but does not empower a single regulator to oversee activities in which it may have limited or no expertise.
Mr. Chairman, in your letter of invitation you also asked for comments on provisions in H.R. 10 and H.R. 268 that abolish Federal savings association charters and require thrift holding companies to become financial services holding companies.
A number of diversified financial firms, including Dean Witter, have acquired thrift charters to offer our customers a wider array of products and services. Diversified owners of thrifts are reluctant to give up this avenue for expansion of product lines so long as there is substantial uncertainty with respect to the scope of activities permissible for financial services holding companies and the degree of holding company regulation that will be imposed under new financial services legislation.
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In the interest of enacting meaningful reform, it may be prudent to delink the issues until a new holding company structure is in place and tested in the marketplace. This would provide a safety valve for those who might be left behind should Congress choose not to opt for the unrestricted unitary model or who would resist the enactment of a modernization approach that includes more onerous umbrella supervision of the holding company.
In concluding, I repeat the call for financial services modernization legislation. The financial services industry is moving in the direction of expanded activities and increased competition, driven by financial innovation, technological change and global competition. But an evenhanded and comprehensive structure for the financial services industry cannot be achieved without Congressional action. Modernization will allow firms to better serve their domestic customers and meet international competition in an industry that is vital to the Nation's future.
Mr. Chairman, I appreciate the opportunity to testify and for the Council to work with you and Members of the committee in fashioning financial services legislation.
Thank you.
Chairman LEACH. Thank you, Ms. Edwards.
Mr. Tassey.
STATEMENT OF MR. JEFFREY A. TASSEY, SENIOR VICE PRESIDENT OF GOVERNMENT AND LEGAL AFFAIRS, AMERICAN FINANCIAL SERVICES ASSOCIATION
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Mr. TASSEY. Thank you, Mr. Chairman, Members.
My name is Jeff Tassey, and I am presenting this testimony on behalf of the American Financial Services Association. AFSA appreciates this opportunity to express our views on financial modernization, and we look forward to working with the committee to bring about a financial services industry where consumers and markets determine what financial services are available and how they are delivered, while promoting the substitution of private capital for Government regulation. The affiliation issue is at the root of our support for financial modernization.
AFSA represents an extremely diverse group of lenders, primarily market-funded and, accordingly, subject to intense scrutiny and regulation by the markets. A great many of these entities have a wide range of functionally constrained affiliations with some type of federally insured institution. There has never been any evidence that any of these entities pose any systemic or deposit insurance risk as they go about their business of providing approximately 20 percent of all consumer credit.
AFSA strongly supports the ability of commercial firms to own or otherwise affiliate with such a holding company. The prohibition on banking and commerce dates from 1970 and has always been shot through with exceptions, due in part to the difficulty of defining precisely what is ''commerce,'' and due in part to the fact that the Bank Holding Company Act does not apply to individuals.
Thousands of individuals own banks who also own many and varied commercial interests, none of which are subject to the same holding company affiliation restrictions and oversight as banks owned by corporate entities. If it is harmful for banks and commercial entities owned in the corporate form to affiliate, then the same restriction should apply to the thousands of wealthy individuals who freely mix banking and commercial enterprises.
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The history of commerce and banking in the United States not only shows no greater propensity of commercial and banking firms to fail as banks but, to the contrary, indicates that commercial ownership has provided greater protection to the bank without anti-competitive impacts.
The primary argument postulated against banking and commerce is that such a holding company form would result in large concentrations of economic resources. Such concentrations are far more likely to occur in small towns where, as described earlier, there is only one bank owned by an individual who also owns other major economic units, such as the local independent insurance agency, car dealer, feed store, and so forth.
Economic concentration, particularly in today's global market, is not just size, but size in relation to the market in which the entity operates. A very large institution operating nationally and internationally is subject to competition at every size level, from the smallest independent bank to the largest foreign bank. As long as our economy and culture remains the same, open to all forms of competition, keiretsu and zaibatsu and the other problems we have seen in other countries are not likely to develop.
Another argument is that commercial ownership of insured institutions will somehow create unfair competition for small community banks or otherwise cause their demise. Eighty-seven percent of all FDIC-insured institutions represent only 15.3 percent of all banking assets. Sixty-three percent, those under $100 million in assets, represent 6.5 percent of all assets. It is absurd to maintain that the entrance of commercial firms for the purpose of acquiring the small amount of widely distributed assets held by thousands of small institutions otherwise would have a harmful effect. The experience of commercial ownership of thrifts bears this out.
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Whether the concerns over banking and commerce are real or fallacious, it is easily possible to meet them through means of structural limitations placed on commercially owned institutions. For instance, a commercial firm could be restricted only to a de novo institution which is prohibited from branching. Alternatively, since consumer and commercial lending pose widely different risks, differentiations could be made on that basis.
In terms of the regulation and oversight of the holding company, AFSA supports reliance on the principles of functional regulation as opposed to the extension of some form of current bank regulation to the non-depository affiliates. In particular, we support the risk assessment approach based on the Market Reform Act of 1990 and successfully in use in the securities and commodities future trading industry.
The best means of controlling risk to the insured affiliate is through proper insulation between holding company affiliates and by assurance of sufficient capital levels in the bank such that it can remain solvent regardless of the failure of any affiliates. Coupled with appropriate information-sharing requirements among the functional regulators and strong divestiture provisions, this model gives up nothing to safety and soundness, while avoiding excessive regulatory burden in the form of duplicative examination and reporting requirements.
While they have received little in-depth consideration, the existing affiliate transaction restrictions contained in Sections 23(A) and 23(B) of the Federal Reserve Act are very stringent and do an excellent job of protecting the insured depository in any holding company structure.
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AFSA urges this committee to fully review the insulation provided by these two provisions when considering the risk assessment model. We have attached, I guess, a plain English description of Sections 23(A) and 23(B) to our oral statement.
We strongly support the efforts of the committee to develop a modern legal framework for the financial services industry and urge you to move forward and thank you again for the opportunity to appear.
Chairman LEACH. Thank you very much.
I would like to begin with Ms. Edwards' testimony.
I would like to read you half a sentence: ''H.R. 10, introduced by Chairman Leach, does not provide for financial services holding companies to engage in commercial activities.''
Ms. Edwards, that is false. What H.R. 10 provides is for insurance affiliations, of which commercial activities are a part. H.R. 10 provides for merchant banking of which, for a period, commercial investments are a part under certain non-controlled stipulations. H.R. 10 provides for the principal holding company regulator to authorize investments in activities ''financial in nature'', which is a much broader definition than the current restriction which is ''closely related to banking''.
These are intended to be very realistic steps to match the economy and the activities of competitors.
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What the Financial Services Council—and I want to be very careful here, because you have given testimony on behalf of the Financial Services Council, and presumably in coincidence with your firm's position.
I spoke to a gathering of the Financial Services Council 5 or 6 months ago, and I gave my well known views about commerce and banking, and I was stunned at the number of representatives who came up to me and said they thoroughly agreed. I said, ''But your Council doesn't.'' ''Well, they don't speak for all of us.''
So, I want to be very careful here, and I want to ask you, do you speak for all members of the Financial Services Council or the majority of activists?
Ms. EDWARDS. I speak on behalf of the Financial Services Council, Mr. Chairman, and that is our position.
I think that when you get into the intricacies of what constitutes commerce, much of what we are looking at can be characterized as ''commerce in the eyes of the beholder.'' There are a variety of activities which would not be incorporated in the definition in your bill that are ordinary course of business activities—incident to financial service activities—that should not be considered to be commerce.
Chairman LEACH. Second, you have in your bill, your approach, an objection to conforming the thrift charter with a banking charter. It is my view that you have to look at all of this as a continuum, and the continuum—what we did last year was spectacular for the S&L industry in the BIF/SAIF Resolution and also in allowing the S&L charter to be broadened to include more commercial activities.
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Out of fairness, it seems to me totally impractical to leave two separate charters alive and well in the financial services industry. That is very unfair to a group with the lesser charter, which is the overwhelming number of financial institutions. It is particularly unfair if you look at this as a continuum.
There is great angst that the banking community got stuck with a $6 billion to $9 billion liability from the S&L industry and, having gotten stuck with it, that now the S&L industry will be left with a better charter. That strikes virtually everyone as somewhat dubious, from the banking industry's perspective and from the perspective of what I believe would be someone sitting on the moon. It strikes me that, with the exception of making certain grandfather situations available, to leave a separable charter circumstance is just simply unfair to the banking industry.
Does that seem unreasonable or would you argue against that?
Ms. EDWARDS. Well, I would like to, first of all, say that we don't take a position as the Council of objecting to the thrift and bank charters being conformed. I think what we are suggesting in our testimony is that it might be wise at this point to defer action. This leads to your second point: is that unfair for the banking industry?
The issue is that the diversified unitary savings and loan holding company charter has been in place for, I think, 30-some years. It has been in place for that period of time. To now suggest that we conform the activities—which would necessitate some giving up or grandfathering certain activities—may not be as appropriate in this context as in others.
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Chairman LEACH. Let me just respond there.
There are about 700 unitary thrifts as of last June 30th, in testimony given to the Committee at its last meeting. It appears that about 14 unitary thrifts as of that particular date had activities beyond what this bill authorizes. That is, if you exclude insurance or if you include insurance, there might be 40 beyond the current landscape. But there are about 14—14 and 14 only—that have activities beyond this bill.
And for Congress to pass laws for 14 institutions versus 10- or 11,000 seems to me rather awkward. It also seems awkward to leave two sets of laws in the books.
Finally, let me just say you have a number of banks in the Financial Services Council. I have been in contact on a continuum with these banks; and it may be true that last fall some of them approved full-blown commerce in banking, which is your testimony. Since then, virtually all of them have backed off from that; and they backed virtually all of them, from some of the bigger basket approaches.
So, I just want to be very clear that you may speak for the Financial Services Council, but you do not speak for all of the membership of the Financial Services Council.
Now, that isn't totally unique. Very few associations have total unanimity. But I don't want any implication that you have asserted that you speak for all of them. Is that a valid observation of mine?
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Ms. EDWARDS. Mr. Chairman, my company is a member of each of the trade associations that appears here today on the panel; and I would say, from time to time, our company has had some differences with positions that are taken by the trade associations——
Chairman LEACH. Sure.
Ms. EDWARDS.——But we are still basically aligned as members in pushing forward legislation that we think is appropriate in order to try to bridge some of the individual requirements of companies to achieve broader legislation and reform.
So I think that, yes, there are probably members of the Council, and members of the trade associations represented here, who might not totally agree with their associations' positions; but, as a collective group, we have come up with these positions; and that is what we are proposing.
The other thing we would like to suggest relates to the 14 institutions that you referred to that are diversified unitary savings and loan holding companies. I have been around long enough, and have been part of a diversified unitary savings and loan holding company, to remember a time when the Federal Home Loan Bank Board, when it was still in existence, came to diversified unitary savings and loan holding company holders to request that we inject additional capital into those institutions to actually provide a source of strength for, not only those institutions, but for the rest of the industry. At that time we did so, as did other diversified owners.
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So I think that there are pluses to having diversified owners of the institutions. They are known to the regulators, are highly regarded by those regulators, and do not constitute a threat to the insured institutions.
Chairman LEACH. Well, I appreciate those past actions, but I would say that is no different than the actions that are required from time to time for banks.
Bank of America had to do certain things required by regulators. Beyond that, the institutions that were purchased were at discounted value, and virtually everyone has made a small fortune from being pressed into those self-interested actions.
So I don't want you to be a great martyr, but I recognize your point.
Ms. Kilpatrick.
Ms. KILPATRICK. Thank you, Mr. Chairman and Members and visitors.
We have had quite a bit of discussion over the last 3 months now on the Chairman's bill, as well as Congresswoman Roukema's bill regarding modernization and whether it should be broad affiliation, or limited. I understand from my staff that most members at the table like the broad affiliation.
I wanted to ask Mr. Heimann from Merrill Lynch—and my staff was in New York and felt that he was the one who put in perspective much of our debate today in the banking industry—will that affiliation—and I think that is some of the concern we are hearing in various corners—provide sufficient safeguards so that the industry is not disadvantaged? Will things be in place? And what things will you propose be in place so that the industry continues to thrive as we move to whatever it is going to be and, in your case, a broad affiliation?
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Mr. HEIMANN. Thank you.
Let me try to put this in the perspective as I understand the concept of the financial services holding company. Unless we do that, we tend to get ourselves terribly confused on language.
The basic concept of the financial services holding company was that you would have a holding company which would have as affiliates an insured bank, an insurance company, a securities firm and perhaps entities engaged in other activities. Each one would be independent in the sense that it would be functionally regulated by the relevant supervisor who would do what the supervisor is doing today: setting capital standards, assuring that the entity is operating in full compliance with the relevant laws, and so forth.
Theoretically, under the concept of the financial services holding company, you would have total regulation of the individual entities under the existing laws and statutes regarding how they operate for safety and soundness, for consumer protection, and so forth.
The second step in all of this is the question of what could be affiliated within this holding company? You could have a broker-dealer—that is, a securities firm. You could have an insurance company. You could have a bank. And, of course, one of the questions that arises is, could the holding company hold a bit of companies engaged in commerce? That is the issue that has been addressed by Mrs. Roukema and others in terms of the basket, without arguing what the size of the basket should be.
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It is clear that if the bank wants to make an investment in a commercial company, the banking regulator would have to approve it, because the bank is an insured depository. And if it was the broker-dealer that wanted to make the investment, presumably the SEC would have a say if they thought for any reason that it might disadvantage the safety and soundness of the operations of the broker-dealer. The same would be true for the insurance commissioner of the relevant State.
So you have a system in which affiliation, within limits, seems to be no problem, as long as the functional regulators are responsible for their individual bits. This raises the question of what occurs if the strategic investment is made by the holding company, not by the bank, the broker-dealer or the insurance company? This returns to the question that has been raised before: What is the role of the oversight supervisor, the umbrella supervisor, as it has been called?
From my experience as both a bank regulator and a private sector participant in insurance and banking as well as securities activities, I believe that is the key. If the bank regulators can decide what the bank can do or permit or not permit, as they do today, then the issue is, what is the role of the oversight regulator in all of this in case the activity is outside the sphere of any of the functional regulators?
What is missing at this stage of the game is a definition of the oversight regulator's role—what his or her responsibilities will be in this mixture. It is very clear, as some of my colleagues have said here that the traditional bank holding company legislation regulation was not designed for the securities and investment businesses. Indeed, I don't think that the Fed argues that it was.
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The issue is, if you have functional regulation, then what is the need for the oversight regulator? Chairman Volcker pointed some of them out today.
First, there is the overarching need of safety and soundness of the system as a whole and the payment system. I don't think one can argue with that.
Second, there are other issues which cover the activities of each of the affiliates, how they impact each other and how this interaction might affect the safety and soundness of the whole. Someone has to look at these issues, such as double leveraging of capital.
Third, something that hasn't been mentioned today is that because of technology and innovation, many products can be in an insurance company, a bank or a securities company. What you don't want to have happen in the system is something you might call ''product arbitrage'', where the level of capital required by one regulator for a certain activity is less stringent than that required by another regulator, so that companies will try to design the product so that it fits into the least rigorous functional regulatory regime. There has to be an entity that looks at all of that so that you don't have differences which would argue for placing products into the insurance company or the bank or the securities company.
If the system operates the way it should under these various concepts—with a better definition of what the oversight regulator does, and it clearly is not the role proscribed by the existing bank holding company regulation—then there shouldn't be a problem, frankly. You would have the functional regulators as the first line of defense with the full sharing of information and full coordination, cooperation and communication with the oversight regulator. There should not be a situation in which a problem in a particular affiliate escapes notice and affects the entire organization.
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The other question really is, what are we trying to protect? And there are two issues, the insured depository institution because of taxpayers and the overall safety and the soundness of the system as a whole.
Speaking generally, the oversight regulator's role should be quite limited and only gets into details when one of the functional regulators points out there is a problem or might be a problem.
Ms. KILPATRICK. Mr. Chairman, if I might, just a moment, then with the oversight regulating, where we already have the other two and what is going on, the commerce is already merged and it goes through some type of umbrella oversight, is the industry prepared to offer that to the Congress or to leave it up to Congress to give it to you?
Mr. HEIMANN. I think it would be very useful for a dialogue to occur between the various industry participants and the Congress as to what oversight regulation should all be about. The final decision will, of course, be yours, but I believe the conversation would be very helpful.
Ms. KILPATRICK. That is the point I want to make, as you outlined that very eloquently for me. Thank you very much. That is the discussion I want to happen. I think that is very important.
I think that industry has to come, not always getting everything you want, but certainly in a unified voice to the Congress in that regard. We have heard it 3 or 4 months now.
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And I missed some of Mr. Volcker's testimony today, but I did hear him at another time before Chairwoman Roukema, and I am really urging the industry, and I appreciate your testimony.
It is happening. We are in the 21st Century now, 1933 Glass-Steagall is antiquated and must be changed, and I commend many of you for your testimony.
And Ms. Edwards, you were saying earlier, the definition of commerce is different to different people. That needs to be identified and brought to the Congress so that we can be on at least the same page.
Thank you very much.
Chairman LEACH. Thank you, Ms. Kilpatrick.
Mrs. Roukema.
Mrs. ROUKEMA. I think Ms. Kilpatrick read my mind, because she asked one part of the question that I was going to present to this committee, and that was the whole question of the umbrella regulator.
I think I should observe, Mr. Heimann, you were at one time a banking regulator, so it gives you a very broad perspective on this and perhaps an oversight that maybe some of the rest of us don't have.
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Mr. HEIMANN. Yes, I was Superintendent of Banks in New York State and then U.S. Comptroller of the Currency.
Mrs. ROUKEMA. Yes, it was Comptroller of the Currency, I should have known that. That was exactly the question I was going to ask of this panel, and I was going to preface it with a little inside joke here, because my bill, I determined that I would be either silly enough or brave enough to introduce, as a means of bringing everyone to the table.
However, if I had known the Teddy Roosevelt quote you had, that you gave here today, and I am going to memorize it, believe me, because it is exactly what is happening to me, it seems, or this legislation, every time we think we get everybody around the table and in agreement, we find that something is slipping through the cracks here.
So I am following pretty much with my staff in working out refinements in the legislation that I have, pretty much the model that you just outlined of an umbrella regulator and its relationship to the functional regulation. If I heard correctly from the rest of the panelists, however, they don't seem to go along with that. But I think I have become convinced that there has to be some form of umbrella regulation. I think you may have heard me allude to that with Mr. Volcker.
Now, the trick comes, then, when you get into the details of that umbrella regulator and how it relates to the functional regulators, and the so-called or, we haven't given it a name yet, but the coordinating committee. And if anybody on the panel would like to specifically refer to that, fine, make your statement now, but I think each one of you avoided the question of the firewalls. So whether it is functional regulation or firewalls, I would love to have you comment, and then, if we still have time, I want to ask you the commerce question.
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Yes, Mr. Fink.
Mr. FINK. On firewalls, I'll speak from an analogy. I represent the mutual fund industry and the core statute on mutual funds is the Investment Company Act. The core of the Act is a series of firewalls walling off the mutual fund from the manager of the fund and other affiliates.
In fact, I spoke to one of the draftsmen of one of the very early financial services reform bills 10 years ago, who said he modeled much of the proposed bank holding company legislation on the Investment Company Act. There have been all kinds of stresses in the mutual fund industry since 1940. We had market breaks. Those firewalls have been very strong and impenetrable.
There are very few, if any, cases where the managers reached into the fund, and the reason is that you have a tough regulator in the Securities and Exchange Commission. If some of the transactions we have seen in other industries went on, those people would be serving time. So a lot of it is not just the firewalls, but a question of whether the regulator will really enforce the laws and crack down, or under stress, will the regulator buckle?
Mrs. ROUKEMA. You are the first one I have heard turn it around. The others, who have all testified, have said the firewalls melt, not that the regulators melt.
Mr. FINK. I think the firewalls melt because the firemen—well, I can't do the analogy or the metaphor.
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Chairman LEACH. Excuse me. If you don't mind.
Mrs. ROUKEMA. No, I would be happy.
Chairman LEACH. I apologize. The housing bill has just come on the floor and I am obligated to be there briefly. I would like Mrs. Roukema, if she would care to take the chair, and she has several minutes left on her own time and can certainly manage there.
Mrs. ROUKEMA. [presiding.] Thank you. I would be happy to. Please continue.
Mr. FINK. Well, when I was reading, I looked at some of the other cases that people cite as to why you need an umbrella regulator. I looked at First Options. There was a case where you had an umbrella regulator—there was a bank with a subsidiary in the options business, regulated by the same regulator, which happened to be the Comptroller. The bank didn't pay any attention to the firewalls and I don't know what the Comptroller did, but First Options is a case of the regulator not enforcing the firewalls.
Firewalls, at least in our area, have not melted under stress. So I think it is possible to create them, but you need, you know, whatever the metaphor is, a policeman or a fireman, who will make sure if somebody does try to cross the line, they will get slapped. I don't think firewalls are the full answer.
Mrs. ROUKEMA. No, no, I am not implying that.
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Mr. FINK. But I think they are one of the components, and a very important component.
Mrs. ROUKEMA. Anyone else on that particular subject, or going back to the question of the umbrella? Mr. Lackritz.
Mr. LACKRITZ. I just wanted to draw attention that currently the Federal Reserve is in the process of lifting all 28 firewalls that are currently in place. We think that is a mistake right now and we think that is the significant mistake, given the fact we don't have a level playing field or a two-way street at this point. When we get to the point of having a modernization bill, the kind of protections that you need in a holding company involve considerations like with Sections 23(A) and 23(B) of the Bank Holding Company Act, that would be it.
Mrs. ROUKEMA. Thank you. Ms. Edwards.
Ms. EDWARDS. I would like to address both of the issues. First, on the issue of an umbrella regulator, I might just change the terminology a little bit to indicate what we think would be a little bit more effective, and that is an umbrella review. That would be a review of the activities within a financial services holding company that would be engaged in collectively by the financial services regulators, based on the areas of the industry where they have the greatest expertise. I think, quite frankly, that type of umbrella review currently exists, but there needs to be additional opportunities for those regulators to work together, particularly in times of crises.
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We have seen in past crises they have been able to work together and focus on resolving issues, but there may be some additional information that they require.
On the issue of firewalls, let me present a somewhat different perspective and that is from the person within the company who actually must ensure that the firewalls are abided to by a company. I can tell you that since there has probably been a banking bill passed each session of Congress, at least since 1987, which is the last one I was involved with, there have been additional firewalls and additional protections that have been imposed on financial institutions during that period of time, each of which has had much of its focus on protecting the insured deposits, the depository institutions in a broader context.
For example, any banking institution that currently has $500 million or more in assets must have, as part of its Board of Directors, an independent audit committee which must review on an ongoing basis transactions that occur between affiliates of the bank and the rest of the company. Those reviews are to ensure that those transactions are done on an arm's-length basis, and I can tell you, since I sit on the board of our banking institutions, that there is an active review. We have to then demonstrate to our bank examiners on what basis we made the determination that these were arm's-length transactions. So there is much that is in place that Congress has passed that addresses a lot of these issues.
Mrs. ROUKEMA. Thank you. Mr. Lackritz, did you want to add anything? No.
Mr. LACKRITZ. Mr. Heimann did.
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Mrs. ROUKEMA. Mr. Tassey, and we will get to Mr. Heimann. And my colleague is being patient here, but I will let you ask the commerce question, OK. Mr. Tassey.
Mr. TASSEY. Yes, just two quick comments. The whole point of the umbrella regulator is, is it necessary to protect the insured affiliate? And your bill, in addition to the risk assessment model in Sections 23(A) and 23(B), you prohibit all interaffiliate—all lending to the nondepository affiliates, and you have very strong divestiture provisions, in addition to the other provisions in current law that others have alluded to.
And it seems to me it hasn't been demonstrated that there aren't adequate tools available to protect the insured depository institution. Your primary protection is your capital level.
The second concern, of course, is what is the relationship, what kind of transactions can the insured institution engage in with the affiliates? Again, if you look at Sections 23(A) and 23(B), not many. Your provision, about no lending to the affiliates, and I don't think there is any question that the insured institution can be prevented from lending to the affiliate. Once you get past that, you have to ask, what are the other things you can do that are really a problem? The second, and I am not really sure what those are, I am sure people can come up with them. I don't know how realistic they are. The second point I would like to make is in my industry, we do not have umbrella oversight. We don't have a holding company regulator in the bureaucratic sense. What we do have is a very effective market regulator, the commercial paper markets and the rating agencies.
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If anything happens in the parent or in the insured institution that is deemed a problem by the markets, then the credit rating of both is impaired, and either the parent has to downstream capital to the financial institution or the financial institution has to shrink and is liquidated. And it is very swift. It is not fair, necessarily.
Sometimes the financial institution is doing great, but the parents get into trouble; too bad. And I would just like to point out, on a related matter, back when there were problems with Chrysler and all that, there were no problems with Chrysler's financial institution. Yet, it was not used to prop up the parent, and as a matter of fact, as soon as the parent got into trouble, the institution, even though it was doing very well, had to shrink. It could no longer raise funds in the commercial paper markets, and I am sorry that the aspect of market regulation, in trying to find ways to bring more market regulation back into the banking sector of the economy has been ignored.
It seems to all go in the other direction, that bureaucratic regulation should be imposed on other parts of the financial services and commercial industry, whereas the safety and soundness record of the commercial paper markets in the United States is unparalleled. Thank you.
Mrs. ROUKEMA. Thank you. I will have to think about that last portion that you just presented. I will think about it.
Mr. Heimann, and then we will turn this over to Mr. Baker.
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Mr. HEIMANN. The only purpose of the umbrella regulator, someone said earlier, would be to protect the insured affiliate. I don't agree with that. There are other purposes that I mentioned before, but I want to raise one more.
We are talking about keeping American financial institutions competitive in the world so that they can continue to innovate and grow and do all the things we have done. One of the basic standards of international finance today—in terms of the system as a whole—is the concept of consolidated supervision.
I mentioned this in my testimony, but I do want to stress the point.
Regulators around the world look to the home country supervisor to qualify a financial institution when it comes into their country, the host country. It is mandated in the European Community, where there is a directive called the BCCI Directive, which requires that any securities company or banking company that operates within the European Community and has the passport must have consolidated supervision. They don't define that term. We are using it in the sense of the oversight regulator. The banks all have that, but the American banks and securities houses do not have those terms. If you want us to continue to be competitive and do what we have done in the past—and I note in my testimony, the American securities houses represent almost 30 percent of the equity and debt underwriting of the world on a crossborder and U.S. basis—then this problem has to be addressed.
A second issue I'd like to address in context of the umbrella supervisor is firewalls. If, in fact, the functional regulator set up the rules as to what can be done—the banking regulator says you cannot lend more than 10 percent of your capital or 15 percent, for example—if each functional regulator does his or her job properly in terms of this issue of affiliates within the financial services holding company, then complicated firewalls are unnecessary.
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And, as Mr. Lackritz has pointed out, the Fed is removing them all. We know they don't work. We cannot legislate morality. The job of governing a financial institution is up to the board of the directors and the management and the regulators to make sure they are following the law. So, functional regulation properly done with oversight should take care of the firewall problem.
Mrs. ROUKEMA. Thank you.
Mr. Baker.
Mr. BAKER. Thank you, Madam Chairwoman.
Mr. Heimann, I want to focus my question in your direction to get your response, and others certainly can jump in at some point. We have a two-step problem. One, before we decide how we regulate, we must determine what we are regulating. I think that would be a logical order. If we are going to talk about what it is we are to regulate, there have been various suggestions made from Chairman Leach's perspective of limited activities within the wholesale financial institution, to the Roukema approach, which does not restrain the types of entities which may affiliate, only limits the degree to which that occurs. Yet, undefined to a, quote, ''wholesale commerce and finance approach.''
It is my understanding that there—other than the previous testimony this morning and perhaps a limited number of folks have objected to commerce and finance as a practical matter, more so, only to how you govern it so it is not unconstrained. For example, Merrill Lynch, perhaps, would like to acquire a bank, but may have a problem with the bank buying Merrill Lynch, so that is how the shoes fit on each other's feet. It will present some interesting problems.
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However, if it is asset limit, an asset size, the Treasury proposed it once, that the bank would be at least three times larger than the entity it acquired. That doesn't work for me. If it is a revenue limit, when you are making money, you don't really need it from your affiliate. When you are losing money, that is when you need it most, but yet the constraint is to limit the revenue to 25 percent of your own earnings. It is like saying, ''You are sick. I have the medicine, but now you can't have it.''
The next approach is the one the Fed currently authorized with equity investments and commercial entities, which allows you up to 24.9 percent position without regard to the size of the entity or the revenue generated by it. We are getting closer. My thought is rather than constrain the types of entities, only focus on those public policy concerns that have been eliminated by the debate so far; concentration of assets; systemic risk, whatever that is, in terms of the Fed; public policy, don't allow casinos to own banks; the financial health of the two participants; and, a better-rated corporation can merge or affiliate with a well-capitalized financial institution.
Outside of those, are there other issues that we should be concerned about? Because commerce and finance, frankly, is not the debate. It occurs today. Everyone says ''Let's do it'', but they all say ''Let's do it carefully. Let's do it slowly.'' Let's put a basket over it or a bucket or something.
Now, am I missing some points that are a concern beyond those four?
Mr. HEIMANN. It is an interesting question you put forth. Let me try to rephrase it slightly. I do think there continues to be confusion in who is buying whom, commerce buying banking or vice versa. The issue is whether a financial services holding company—and I use that term on purpose because I am not talking about a bank; I am talking about a financial services holding company under the various bills—can purchase some ownership position in a commercial enterprise.
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The answer, I think, should be, ''yes.'' We have plenty of examples of that occurring in the normal course of our business at Merrill Lynch and at other firms like ours. Bloomberg, which is well known to everyone, is probably the best example of a company in which Merrill Lynch own an equity position. It was in part because of the orders that came from Merrill Lynch that Bloomberg became an extraordinary company. We had nothing to do with management, and we were not on the board.
However, our equity investment gave benefits back to our shareholders because we helped to create those values. We think that is correct. Obviously, the question of control would be part of your concern. In this example, it was not a question of control. Management has to manage. We're simply a purchaser—a user of the service—as well as an investor in the service.
Mr. BAKER. But the relationship between the acquiring entity and the entity that is acquired, does the danger to the public interest derive from the question of control?
Mr. HEIMANN. No, the danger to the public interest would depend on whether it was an insured depository or not, because that would then affect the depository institution. We are talking about the financial services holding company; this is not taking place in a bank. This is taking place in a securities company or somewhere else.
Now, merchant banking is different. That is the normal course of what banks and securities companies do today, which is to make limited investments for client purposes in a variety of ways. When raising Bloomberg, I am talking about strategic investment, not merchant banking, if I can put it that way.
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The other part of the question is whether or not commerce can buy a bank? Here, of course, is where the real debate takes place, much more than in the case of the financial services holding company making limited strategic investments. The real issue is whether General Motors could own Chase.
Mr. BAKER. In making that point, would you explain to me the philosophic business economic—what is the concern raised by that question?
Mr. HEIMANN. I am not sure why General Motors would want to buy Chase, but let's say they did. The question becomes, if General Motors is allowed to buy Chase, is it subject to the same oversight regulation that would occur if Chase bought a hunk of General Motors? That means, in my lexicon, an oversight of the type that we have been discussing, which would be over General Motors, just the way it would be over Merrill Lynch, just the way it would be over Chase. In reality, I doubt that that would ever happen. It simply just doesn't seem practical to me that commercial enterprises that have been largely free of regulations would willingly put themselves under some kind of governmental oversight.
Mr. BAKER. But your reason for saying it is not advisable is not because there is an inherent business risk in a corporation ''X'' owning a bank. It is simply, in your view, that if that were to be permitted, it would require such a high level of regulation on the corporation, they would deem it ill-advised?
Mr. HEIMANN. That is correct. But let me just say, sir, the issue goes further, as to whether or not the commercial enterprise could use the bank for its own purposes. As I was mentioning this morning in testimony and I think that is a concern that has to be carefully considered. The possibility of this would depend on their control over the financial enterprise that they acquire.
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Mr. BAKER. I think there is sufficient regulation to be prohibitive to self-dealing and the concerns that you raise. I am simply trying to get to the point. There appears to be agreement commerce and finance is OK, as long as we can regulate it in a manner that is not threatening to my own particular interest.
If ''A'' can buy ''B'', ''B'' ought to be able to buy ''A''. If that is not the case, we will still have a, quote, ''one-way street'' in the marketplace where some people can engage in a market advantage, but the entity on the other end of the pipe cannot, because of Government regulation, rather than market forces. That is what is troubling.
Everybody says commerce and finance, except Mr. Volcker, in some degree or measure is acceptable. The regulatory constraints are the principal concern, and yet we still can't define the manner in which that relationship should exist. That is very troublesome.
Mr. HEIMANN. I agree the debate has been very murky. I don't think it has been explained properly at this stage, other than with regard to concerns of safety and soundness.
Mr. BAKER. I have been so abusive, but the Chairwoman has been very kind. One last thing, a regulated approach, whereas I outlined at the beginning, conditions which would obviously be of concern to anyone, financial health of the participants, public policy reasons, systemic risk, concentration of assets. Would it not be a possible way to consider, to allow affiliations between entities, on application, if they did not violate those broad public policy reasons, subject to appropriate regulation?
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Mr. HEIMANN. I don't know, Congressman, I would have to contemplate that further, frankly.
Mr. BAKER. Thank you very much.
Mrs. ROUKEMA. We will give Mr. Campbell the opportunity to address the panel.
Mr. CAMPBELL. Thank you. I wanted to start with Ms. Edwards just to make one thing very clear. I am only sorry that Chairman Leach is not present.
Is it, or is it not true, that your testimony today expresses the consensus of the Financial Services Council?
Ms. EDWARDS. That is correct.
Mr. CAMPBELL. Thank you.
Two questions to all members of the panel and there is one big one. I thought Chairman Volcker had one point that is still troubling. I think the others, frankly, did not convince me, but the one that remains is the too-big-to-fail argument. So, I would like to give each of you a chance, and if you could just take 30 seconds to tell me why you don't think the too-big-to-fail argument works? To wit, that even though we might, on law, in the words of the statute, ''limit the obligation to the taxpayers by the financial institution,'' the insurance institutions, like FDIC, in reality, won't let it fail. Therefore, the bigger the entity, the bigger the risk.
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The second and last question is, I would like you to give me the reason to do this. The more specific you can be, the better, because what I am hearing, to be candid, coming into this with a very open mind, is a lot of worries, about what will happen if you do it. Candidly, at least up until this moment, only rather vague expressions of why it is a good idea to do it, such as, ''Bring us into the 21st Century''; or ''Allow us to compete on an equal playing field.'' Those are my two questions. Why is too-big-to-fail a good or bad argument? And second, what do you want to do that you are presently not able to do in a concrete way? If you could be as short as you possibly can, we will give all of you the time within my 5 minutes, and let me begin at the end because we heard so much from Mr. Heimann.
Yes, Mr. Tassey.
Mr. TASSEY. In terms of too-big-to-fail, are you talking about the whole entity?
Mr. CAMPBELL. You heard Chairman Volcker, respond to his point, is my question.
Mr. TASSEY. Well, there are two separate issues.
Mr. CAMPBELL. You know what, I am impolite. I forgot Mr. Heimann has to leave.
Would you begin.
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Mr. HEIMANN. I am so sorry.
Mr. CAMPBELL. No, I am impolite and I forgot that. I just want to give equal time to the others.
Go right ahead.
Mr. HEIMANN. ''Too-big-to-fail'' is a doctrine that exists throughout the world. The reason it does is because Government and bank regulators do not wish to see their citizens disaccommodated and lose money because of the failure of financial institutions. The bigger financial institutions are, the more there is a question that has to be solved, number one.
And let me make another comment in defense of the regulators. You never see a regulator in the newspapers when they save a bank because nobody knows about it. The only time they are ever in the newspapers is when a bank fails and then everybody knows. The whole system is geared toward protecting the depositors, the small business people who are the ones who are hurt the most when a bank fails. That is why the too-big-to-fail doctrine, whether it is expressed, is in play in this country and it is in play in every other major country.
Mr. CAMPBELL. So you agree with Chairman Volcker on that?
Mr. HEIMANN. Yes, I do.
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Mr. CAMPBELL. Is there something you wish to do specifically that the Roukema or Baker bill will allow you to do that Chairman Leach's bill will not?
Mr. HEIMANN. Well, no. Actually, it is all three bills in combination. I must say, all of the bills, if you put them together, would create the perfect legislation. We have some problems with each one, but in general, we approve of the overall thrust of your approach to modernization.
Mr. CAMPBELL. Thank you so much.
Mr. Tassey, pardon me.
Mr. TASSEY. In terms of the insured institution being too-big-to-fail, in 1991, in FDICIA there was a provision adopted called depositor preference. This question is more properly for the FDIC. I don't fully understand it, but there is some view that this takes care of the ''too-big-to-fail'' problem while protecting insured depositors. Whether, you know, in practice, under severe tests, that would work, I don't know, but that is a question worth asking the FDIC.
Second, in terms of the commercial firm being too-big-to-fail. To me, that is a separate issue. There have been decisions made to bail out large commercial firms, sometimes for national security reasons, sometimes for union pressure reasons.
You know, I don't know what to say. That will probably, unfortunately, continue to some degree. We haven't done a lot of it in this country, but there are a couple of instances of it.
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Mr. CAMPBELL. What do you want to do that you can't presently?
Mr. TASSEY. We cannot presently own an insured depository institution in the form of a bank.
Mr. CAMPBELL. Why do you want to?
Mr. TASSEY. Because right now my members who are engaged in financial services, my commercial members, we spent a lot of money acquiring our customers and keeping them happy. We would like to offer them a few more products. We are consumer lenders.
Mr. CAMPBELL. I will cut you off to give time to the others.
Ms. Edwards.
Ms. EDWARDS. Let me address the issue of why should we permit commerce and banking, what are the advantages to the financial services system for those types of affiliations? Let me step back for a second and say that much of what we have been talking about today, in terms of commerce and banking, deals with acquisitions. In many instances, because financial services providers other than commercial banks have not been constrained in the types of activities that they can engage in, they engage in commercial businesses that are natural offshoots of their financial services activities.
Let me give you an example. And the reason for giving the example is to demonstrate that this provides a tremendous amount of competition, provides opportunities for financial services providers to meet the needs of their clients, both institutional and retail clients, and provides for a very competitive financial services marketplace.
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An example would be as a subsidiary of ours which is a credit card processing company. That company engages in the full range of credit card operation for retailers: it will go into the local retail store and will run their whole credit card operation for them. That requires a tremendous amount of system support as well as employees.
As a consequence of that, we have an opportunity to use those systems to then engage in other types of transaction processing, such as health care processing. We go into doctors' offices, and we provide medical claims processing for them which essentially uses the transaction processing capabilities that we have.
In terms of using our people, we have operations centers to respond to calls from our credit card clients, but we also have additional capacity there. We have been providing help lines for such companies as Prodigy to respond to consumers' questions about how to use their systems and their software packages, better.
But both of those examples are outside of banking. They would traditionally be considered to be commercial activities, although those activities are engaged in by employees and by systems that are part of a bank.
Without being able to use such resources to branch into other areas that are incident to financial activities currently engaged in, financial services providers wouldn't be able to efficiently compete with others.
Mr. CAMPBELL. Madam Chairwoman, I recognize my time is up.
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Mrs. ROUKEMA. Let's give the others time.
Mr. FINK. On ''too-big-to-fail'': that doctrine relates mostly to banks, and you have that question today. The question is, by passing legislation, would you increase the chances of somebody failing and having to be rescued?
I think if properly done, you do not, even if you extend it to commerce. I think if you use the risk assessment model that I think most of the witnesses here have called for, where the Federal Reserve Board gets information on all the transactions by the affiliates and the holding company that could affect the bank, as long as the Federal Reserve Board can intervene with the bank, I don't see how the problem would be any worse than it is today.
Second, on why people want legislation. I think financial services companies want to offer the full range of products, differences among which are more and more blurred. They want to offer securities, bank products and insurance products.
Why you need to put commerce in, I think, is what Ms. Edwards gave an example of. There are securities firms and insurance companies that have never had a bar on having commercial affiliates, and many of our members, speaking for a lot of people at the table, have those affiliations with no problems.
You know, why suddenly because you are going to—the thrust of legislation is banking and securities and insurance are so similar—let them come together. Why does it axiomatically follow that because we historically have not let banks have commercial affiliates, that such should be the rule that governs the new organizations? It doesn't seem to me the evidence points that way.
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Mr. LACKRITZ. Can I respond?
Mr. CAMPBELL. It is the Chairlady's decision.
Mrs. ROUKEMA. Sure.
Mr. LACKRITZ. On the ''too-big-to-fail'' doctrine, I think the relevant question is, is that more likely to be invoked with legislation or without legislation? And it seems to me we are currently at the position where some observers, for example, like Chairman Volcker, see the bottle as half empty, they see a lot of risks out there, and the risks get bigger with the changes. I think we see risks and we see some opportunities that are created, and the legislation is necessary for the new opportunities and the new innovations, and the new opportunities to, frankly, use some of the new dynamic hedging opportunities and the portfolio theory and some of the new derivative techniques that have come up in a more aggressive way that will make it less likely for the ''too-big-to-fail'' doctrine. It is always going to be there. Whether this legislation passes or not, we think this would help to reduce the risk of that.
With respect to why legislation is necessary, I want to make a simple analogy. Initially when the banking legislation was first passed and thought of, you had banking and you had commerce. In the meantime, because of technology, because of competition, because of a lot of other factors, you get financial services, which is a whole range of activities, ranging from securities firms, to mutual fund companies, to other financial services providers, and that is sort of—it is in between there.
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Financial services companies have never been limited in terms of what they can own or who can own them, and it has been one of the remarkable success stories of our free enterprise system in terms of how successful and how well the new financial services firms have served consumers.
Yet we are still laboring under this sort of old ideology that breaks down this wall between banking and commerce, without taking into account that now banking and financial services are merging and financial services and commercial activities have always been there. So you have this sort of grand merger taking place, and you have people saying, ''Wait a second here, we can't go to the new world.'' The new world is filled with a lot of opportunities, it seems to me, for financial services firms, and we ought to be able to take advantage of them in some of the ways Ms. Edwards already outlined. Our firms want to be able to own depository institutions and offer those services, and that is another reason why this legislation is necessary.
Mr. CAMPBELL. Thank you, Madam Chairwoman.
Mrs. ROUKEMA. Thank you.
Mr. Chairman.
Chairman LEACH [presiding]. Mr. Fox.
Mr. FOX. Thank you, Mr. Chairman.
There have been varying proposals with respect to which agencies should have the authority to determine what activities are permissible for holding companies. H.R. 10 proposes the Federal Reserve should determine what are permissible and impermissible activities for holding companies, while H.R. 268 creates an interagency committee which is given such authority. What is your view, sir?
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Mr. LACKRITZ. Our view is that we prefer H.R. 268, because we don't believe there is a need for a regulator of the holding company. We think that with good functional regulation, with each of the component parts of the financial services holding company being regulated by its functional regulator, the SEC or the relevant bank regulator, or States for the insurance companies, there is not a need at the holding company level for a specific holding company regulator, so that which is outlined in H.R. 268 is preferable to us.
Mr. FINK. I agree with Mr. Lackritz 100 percent. The problem is, if you look at the legislation—it has been looked at two ways. You hear the discussion here. Some of us see it as Congress' attempt to recognize what has gone on in financial services generally and to create a new financial services holding company with a system of regulation to govern that new entity.
Others, apparently, see it as just an extension of bank powers, and, therefore, since banks and bank holding companies always had the Federal Reserve Board as the czar, extending that regulation creates a lot of the debate.
We have our own views; Chairman Volcker has other views, but without being pejorative, I think it is anachronistic and backward-looking and an approach that will hurt the financial sector and the country to have a czar. And I wouldn't want the SEC as the czar. I wouldn't want one regulator as the czar over a diversified financial services holding company.
Ms. EDWARDS. The Financial Services Counsel also supports the committee or interagency approach in H.R. 268. And picking up on something that Mr. Fink was just describing, I think the fact that you have a number of different agencies each with their own areas of expertise, sharing information about all kinds of brand new financial services products that are being created every day, whether increasingly complex or wonderfully simple in their application. This requires a number of different areas of expertise to come to figure out how those new financial products, and new providers of those financial products, ought to be looked at. A coordinated effort ought to be encouraged to make the financial services industry more effective.
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Mr. FOX. Jeff, would you agree?
Mr. TASSEY. We support the model in H.R. 268. I don't have anything to add to the reasons the other witnesses have given, but we strongly support it.
Mr. FOX. Thank you.
Mr. Chairman, I have no further questions. I appreciate the panel's indulgence.
Chairman LEACH. Well, thank you very much. This has been a thoroughly interesting panel of intellectual heavyweights, of thoughtful people representing various industry perspectives.
But I will tell you one of the modest frustrations as a committee Chairman on issues of this nature. It is very important that the committee hear from each industry group, but there is no such person that can have a tag at the table that says ''John Q. Public.'' And, you know, the question of whether a person labeled John Q. Public doesn't think there should be certain protections for the taxpayer, which may be slightly at variance with an industrial prospective, is awkward, and so I just would stress that.
Now I personally think, in my own mind, that some of this reform is very much in the interest of John Q. Public, that certain of the issues may not precisely be. And I just throw that out for perspective. Anyway, I thank all of you, and we will move on to the next panel.
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Our next panel is composed of Gary Hughes, Vice President and Chief Counsel of Banking and Securities, American Council of Life Insurance; Mr. Craig Berrington is Senior Vice President, General Counsel, of American Insurance Association; Mr. William V. Irons is a Chartered Life Underwriter, Irons and Associates, on behalf of the National Association of Life Underwriters and the Independent Insurance Agents; Mr. Robert A. Gleason, Junior, is president of Gleason Agency, on behalf of the Council of Agents and Brokers.
But at this point, let me say I have been informed by staff from Pennsylvania that Mr. Gleason has a wonderful reputation in Pennsylvania, and also by Members from Pennsylvania.
Mr. Brent Larsen is Director of Government Affairs for Grinnell Mutual Reinsurance Company, on behalf of the National Association of Mutual Insurance Companies. And, in case there is any doubt, one of the several finest small colleges in America is called Grinnell College, and it is in the State of Iowa, and Grinnell Mutual is one of the wonderful insurance companies in the country. And we welcome you, Mr. Larsen.
Mr. LARSEN. Thank you, Mr. Chairman.
Chairman LEACH. Mr. Michael P. Grace is an agent with Wright and Percy Insurance, appearing on behalf of the National Association of Professional Insurance Agents; Mr. Russell K. Booth, President, National Association of Realtors; and Mr. Booth, I understand, is from Utah. And Merrill Cook of Utah wanted to make a very nice presentation on your behalf and said if he couldn't be here, he would like me to note how appreciative he is of your friendship.
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Mr. BOOTH. Thank you.
Chairman LEACH. Oh, I forgot Mr. Dan R. Wentzel, who is the Chairman and CEO of North American Title Insurance Company, on behalf of the American Land Title Association, who is so ably represented in this town.
Mr. Hughes, let's begin with you.
STATEMENT OF MR. GARY E. HUGHES, VICE PRESIDENT AND CHIEF COUNSEL, SECURITIES AND BANKING, AMERICAN COUNCIL OF LIFE INSURANCE
Mr. HUGHES. Thank you, Mr. Chairman.
Chairman LEACH. Excuse me. Before you begin, let me note what is happening on the floor because it is going to have an effect on this panel.
In approximately 10 minutes or so, there is going to be a vote on what is called the Kennedy Substitute Housing Bill. That will then be followed by a motion to recommit, and that will then be followed by a final passage on the housing bill, assuming that the motion to recommit or the substitute doesn't prevail, in which case the committee will have to break for these votes and it will be a longer time period than normal. It will probably be about a 30-minute time break because of the series of votes. And between one of the votes, there will be modest room for debate.
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Please, Mr. Hughes.
Mr. HUGHES. Thank you, Mr. Chairman.
The American Council of Life Insurance appreciates the opportunity to express the views of life insurance companies on your efforts and the efforts of Congress to modernize the financial services industry. As we have seen, this is certainly a very top priority for our business.
We do believe that the time is ripe for Congress to act, particularly since most of us who have argued against this type of legislation in years past have now reversed our positions. We don't think you've ever before had such broad support for legislation that would once and for all put to rest the controversies that have served to divide the financial services industries and been a constant source of distraction to the efficient operation of our businesses.
And, Mr. Chairman, we are particularly appreciative of your efforts to move this process forward. Without question, in H.R. 10 you have put on the table a solid foundation for modernization legislation, and we note very favorably yours is the only bill that has language on functional regulation of insurance.
From our perspective, functional regulation is one of the keys to effective integration of the insurance, securities, and banking businesses. Without question, though, that concept entails more than simply establishing who regulates what. It also requires, as we have heard throughout the day, making certain that very different regulatory regimes can operate in harmony and can fulfill the purposes for which they were put in place.
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Our written statement sets forth our views on various aspects of functional regulation, and we also offer a number of suggestions for refining the language in H.R. 10. I won't repeat those views, except to emphasize two points.
First, we believe there is still a long way to go in rationalizing the States' regulation of insurance company solvency with the role of the Federal Reserve Board in regulating bank holding companies.
The second point we would like to emphasize is that we do not believe there is a place in a so-called modernized financial services environment for one regulator to be in a position to preempt another.
Historically, the Federal Reserve Board has regulated holding companies that have done little more than own banks or bank-related businesses. But the legislation Congress is now contemplating would dramatically change that. Insurance companies could now acquire banks, and mutual insurers in most jurisdictions would have no choice but to acquire banks as downstream subsidiaries. So an operating life insurance company, a company that is fully regulated for solvency by the States, would now be the bank holding company.
We believe when you overlay State solvency regulation with the Fed's authorities and responsibilities under the Bank Holding Company Act, you find the two systems of regulation are simply not compatible.
Mr. Chairman, at your urging, we have discussed this situation with the Fed. I think they are cognizant of the problem, and I think it is also fair to say they agree more thought is necessary in this area.
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On the issue of preemption, we believe that Congress must consider the following question. If legislation affords national banks all insurance powers, both sales and underwriting, and if that same legislation establishes a workable standard that prevents States from unreasonably interfering with the exercise of those powers, what possible justification is there for the Comptroller of the Currency to retain its preemptive authority over the States?
We believe that the only reason would be to sidestep the very rules of the road that you will be putting in place. And make no mistake, this is precisely what bankers are asking you for. They will say, ''We will abide by all the rules on insurance unless there is something we don't like; then we want the ability to petition the Comptroller to remove that obstacle.''
But we don't think that is modernization. We don't think that is a fair and evenhanded restructuring of the financial services landscape that appropriately balances the interests of State insurance regulators with those of their Federal banking counterparts.
If the Comptroller and the SEC disagree over whether something is banking or insurance, or how that thing should be regulated, one regulator doesn't assert the other as preempted. There is no right of preemption. Why should insurance be treated any differently?
Do any of you really believe that it is good policy for bank regulators to have effective veto power over insurance regulators? You have a clean slate here. You can write the law in any way you see fit. We strongly urge you not to write it in a way that fundamentally, unfairly, and unnecessarily discriminates against one industry's regulators.
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In closing, Mr. Chairman, let me say a word about the political dynamics at work here. To a great extent, the same banking industry that year after year after year has come before this committee and asked for the very type of legislation that is included in H.R. 10 is now nowhere to be found.
Certainly banks would accept a dream bill, but they really aren't pushing anything. I think the reason is quite simple. They don't believe that Congress can improve on what their regulator is already doing for them. Now that is not a criticism of banks. It is an acknowledgment that banks have simply made a realistic assessment here, and for that reason, we suggest there is no utility in Congress waiting for banks to reach some sort of final agreement with the insurance and securities industries on a legislative package. There just isn't enough incentive for banks to do that.
But I think it is also fair to say that much of the legislative package has been agreed to, if not in substance, then at least in concept. Functional regulation would be a prime example of that.
You know what the positions are, and you have the capability of fashioning legislation that treats everyone fairly. The longer you wait, the less relevant your opinions will be and the more skewed the balance among competing financial service providers will become.
We recognize that concerns about passing banking legislation in the face of banking industry disinterest or opposition can be significant, but we suggest no one should shy away from the consequences of enacting a fair bill.
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Thank you.
Chairman LEACH. Thank you, Mr. Hughes.
Mr. Berrington.
STATEMENT OF MR. CRAIG A. BERRINGTON, SENIOR VICE PRESIDENT AND GENERAL COUNSEL, AMERICAN INSURANCE ASSOCIATION
Mr. BERRINGTON. Thank you, Mr. Chairman.
My name is Craig Berrington. I am General Counsel of the American Insurance Association. We represent major property and casualty insurers doing business across the country and around the world. It is a privilege to be here today. Thank you very much.
In a nutshell, property and casualty insurance is all insurance, except life and health, and includes auto, homeowners', renters' insurance, includes Workers' Compensation, and it covers just about any type of commercial risk that insurers believe appropriate to write, coverage for businesses large and small. So we have a major business stake in this debate, but we also believe there are major societal issues at stake here too.
Thus, we come to this hearing with a deep respect for the lessons of American history and an appreciation of this committee's responsibility for the protection of America's financial system.
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No one who has heard stories of the Great Crash, has had vivid family discussions, can underestimate the care that must be brought to this legislative endeavor. Yet few can be comfortable with the way the landscape for financial services competition is being changed today, through courts and regulators rather than through the legislative process.
It is for these reasons at AIA we believe carefully crafted financial services legislation should be enacted and we would like to be part of the process for doing so. Within that context, I have five points I would like to make today.
First, we would urge that the safety and soundness of the insurance mechanism be a high priority for this committee. This may seem a truism that need not be stated, but it is to us a truth we dare not ignore today, and, indeed, today the discussion has focused on protecting the safety and soundness of the banking system.
No less than banking, however, insurance is vital to a democratic free market economy. Thus, financial services legislation must protect the safety and soundness of the insurance mechanism no less than it protects the banking system.
Our initial concern is the Federal Reserve's source-of-strength doctrine. Applying that doctrine to circumstances where a bank and insurer are in the same corporate family could have the effect of impairing the insurer's financial resources in order to rescue its related bank which is in financial difficulty.
The problem is that once the banking regulator has required the insurer's assets be risked to rescue the bank, the insurer's subsequent financial distress will become the financial obligation of the entire insurance industry if that insurer should then suffer losses it is unable to meet. This is because an insolvent insurer claim obligations ultimately become the responsibility of all other insurers. This happens through the insurance guarantee funds that have been established in every State under State law but which are financed by the insurance industry. Thus, what is a source of strength for the bank can result in the financial impairment of the insurer.
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Any Federal legislation, therefore, should start from the premise that the source-of-strength doctrine not be available to force financial transfers to banks who are affiliated with an insurer.
Second, we believe when banks and insurers are affiliated, the insurance underwriting function should be walled off and be sealed off from the banking function. The ways to do this include having the insurance underwriting and a separate corporate entity that is financially separated from the bank prohibiting the underwriting of property and casualty insurance in the bank and prohibiting the characterization of any property or casualty product as banking, related to banking, or the functional equivalent of banking.
To avoid regulatory gamesmanship on this point, we would suggest any legislation specifically referenced property and casualty insurance lines of business as being out of bounds for underwriting within the bank, and then give the insurance regulator the authority to determine whether any particular banking product is nothing more than a version of property and casualty insurance, thus prohibiting its underwriting at a bank. That is an important firewall.
This approach, Mr. Chairman, should pose no problem for the bank because the bank, through its affiliation with an insurer, will be able to underwrite any insurance product it desires so long as it is underwritten in the affiliated though walled off insurer. Thus, under properly crafted legislation, there should be no incentive for banking regulators to recharacterize an insurance product as a banking product.
Third, we believe legislation must include appropriate consumer protections, but we would want to make certain that those consumer protections are not used as a cover for anticompetitive provisions. It is one thing to protect consumers, it is quite another to protect competitors from the rough and tumble of the marketplace.
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Fourth, we believe the legislation needs to be anchored to principles of functional regulation where insurance regulators have responsibility for insurance matters, no matter where the insurance is carried out or by whom.
We believe a strong system of functional regulation will allow the full play of each sector's regulatory mechanism and, more important, will protect the public from the possibility of cascading financial reverses. If the legislation contains this type of regulatory construct, we are skeptical of the need for an umbrella regulator. At the very least, we believe the burden then shifts to those who favor an umbrella Federal regulatory agency to clearly demonstrate why that would be necessary and exactly what regulatory authority, now lodged in other regulatory mechanisms, it would replace?
Fifth, Federal legislation should permit insurers to affiliate with both banks and commercial entities, subject to insurance regulatory oversight, which is quite broad. Under insurance holding company statutes, insurers are prohibited from upstreaming any money to a holding company without insurer regulatory authority, and purchases or investments by insurers or subsidiaries are also stringently regulated.
Thus, in sum, Mr. Chairman, we believe the time has come for comprehensive Federal legislation. We believe appropriate legislation can enhance consumer choice and improve the competitiveness of our companies around the world and continue to provide American citizens and businesses with the most responsive, effective, and safest insurance marketplace anywhere.
Thank you.
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Chairman LEACH. Thank you, Mr. Berrington.
Senator Irons. And I am hopeful for your sake you have more insurance interests than banking interests in your district. Please proceed.
STATEMENT OF RHODE ISLAND STATE SENATOR WILLIAM V. IRONS, CHARTERED LIFE UNDERWRITER, IRONS AND ASSOCIATES, ON BEHALF OF THE NATIONAL ASSOCIATION OF LIFE UNDERWRITERS AND THE INDEPENDENT INSURANCE AGENTS OF AMERICA, INC.
Mr. IRONS. I have neither, Mr. Chairman; I just have homeowners.
Good afternoon, Mr. Chairman and Members of the committee.
My name is Bill Irons, and I am an insurance agent from Rhode Island, and today I represent NALU and the IIAA and their half-million members and employees.
As a Senator, I also chair the Rhode Island State equivalent of the Banking Committee. We commend you and your committee on your dedication to this issue. This is not the first time that I have appeared in this room. Fifteen years ago, I testified regarding the so-called ''South Dakota Loophole.'' Since my last appearance here, however, Congress has not acted in the area of banking reform.
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As you know, Federal banking regulators have substituted their vision of what public policy should be, for Congress's legislative action. As you have recently observed, Mr. Chairman, we now have Government by administrative decree rather than by law. That is exactly backward. Elected legislatures should be setting public policy. Regulators should be implementing what the legislature decides.
Chairman LEACH. Excuse me. If I could interrupt. Every once in a while when someone says something extraordinarily profound, it ought to be concentrated on. Please proceed.
Mr. IRONS. Mr. Chairman, H.R. 10 calls for State functional regulation, but, unfortunately, Mr. Chairman, it doesn't clarify the current state of uncertaity and confusion concerning State regulation of national banks' insurance activities.
We know your sincerity on this issue. It is imperative that it is clarified from the current standard, otherwise it will be a meaningless accomplishment, and we know that is not your goal.
In the past several years, and not merely with this Administration, we have seen an OCC that has, to put it mildly, pushed the envelope in empowering its regulated constituency, and what the OCC has done, without Congressional authorization, is to dramatically alter the landscape regarding banking activities. The insurance field is only one example.
Just because a court upholds the OCC's actions, however, does not mean the agency policy decisions have been endorsed. Far from it. The courts have echoed the refrain, ''Congress should act. Congress should act.'' We hope that is precisely what Congress is poised to do now.
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Insurance agents do not come to you today to roll back history. This has not been an easy decision for us. Accepting a world in which banking and insurance are fully integrated is a radical departure from our historical positions, but we are ready to move forward. We have but one requirement: true State functional regulation. By this, we mean every entity, including every bank that engages in the business of insurance, must be regulated by the States.
States have historically had virtually exclusive regulatory authority over insurance, and there is no logical alternative. We agree that States should not prohibit banks from selling insurance or from affiliating with insurance agencies or companies, but beyond this, beyond direct or indirect prohibitions, the States must be free to shape the type of insurance regulation they believe best serves their citizens, your constituents, including the regulation of bank sales of insurance.
The so-called ''Barnett Standard,'' to prevent or significantly interfere will not work. This too is subject to interpretation and prone to interpretation. It leads to uncertainty and confusion for everyone involved. What we are experiencing now in Rhode Island is a clear example of that.
As I said, I am chairman of the committee which approved the consumer protection bill designed to level the playing field between bank affiliate insurance sales and non-bank sales. The bipartisan group of State legislators who enacted that law wanted to avoid consumer confusion, prevent consumer coercion, and protect consumer privacy. We had absolutely no desire to hamper banks ability to sell.
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The entire premise of the Rhode Island law is that banks are in the business to stay. In fact, we went so far as to grant any State bank, regardless of its location, the ability to sell insurance, which historically had been prohibited. We went far beyond what Barnett required.
Yet the OCC is threatening to rule that our Rhode Island law, even before our regulator finished his work, which now he has done, is not applicable to national banks doing business in our State. And when we crafted that law, as good legislators, we gave our regulators the latitude they should have.
OCC staff is telling other States that it is looking at their laws as well. Rhode Island is just the first in line in this outrageous process, in what Senator D'Amato recently called a ''power grab'', and this is wrong.
What is needed from Congress is straightforward. First, get the OCC out of the business of preempting legitimate State insurance laws. Second, provide everyone with a clear standard for State functional regulation. You have the opportunity to accomplish both these goals in this legislation, something this Congress has been unable to do for 15 years. We hope you will act. We applaud your leadership on this issue.
Thank you.
Chairman LEACH. Thank you, Senator Irons, for a very thoughtful statement.
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Mr. Gleason.
STATEMENT OF MR. ROBERT A. GLEASON, JR., CHAIRMAN AND CEO, THE GLEASON AGENCY, ON BEHALF OF THE COUNCIL OF INSURANCE AGENTS AND BROKERS
Mr. GLEASON. Mr. Chairman, Members, I am Rob Gleason of the Gleason Agency in Johnstown, Pennsylvania. I am here today representing the Council of Insurance Agents and Brokers, where I serve as an officer and member of the board of directors.
The Council of Insurance Agents and Brokers represents 3,000 of the Nation's largest commercial property and casualty insurance agencies and brokerage firms. The members of our association annually place some 75 percent, more than $90 billion, of the commercial property and casualty insurance premiums in the United States. We are grateful to have this opportunity to present our views.
Mr. Chairman, on the broad issues affecting insurance regulation as a part of broad financial modernization, our association generally concurs with the remarks just made by Senator Irons. The legal developments of the past year have assured that national banks either are, or are going to be, in the insurance business.
We are not asking the committee to overturn the results of the Barnett Bank case which gave the banks the green light on agency activities. In fact, many of our members of the association are in the process of creating joint business arrangements with banks, and we expect they will profit from those relationships. But without your action, there is great uncertainty about which State insurance laws banks are going to have to obey in the long run.
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Under any of the new structures proposed by Members of this committee, whether that of Chairman Leach, Chairwoman Roukema, or Congressman Vento, or that of Congressman Baker, we believe that there should be regulation by function of the various entities within the holding company.
The State oversight of national bank insurance activities should not be allowed to prevent the exercise of the banks' insurance sales authority, but every entity that seeks to engage in the same business should be subject to the same governing standards.
At the same time, financial modernization should not affect only the interests of the institutions affiliated with commercial banks. We think there is a need to enhance the efficiency of State-licensed insurance producers who provide services to customers in multiple jurisdictions, while still preserving the States' rights to license, supervise, and discipline those producers.
Our statement outlines a proposal to create the National Association of Registered Agents and Brokers, NARAB, to provide a mechanism through which insurance agents and brokers who apply for licenses to act as producers in each of the States in which they would do business. We are encouraged with the reception this proposal has received both within the insurance industry and the banking industry, and we strongly urge the committee to consider its inclusion in your legislation.
Mr. Chairman, in 1938 our association formed its first task force to work with the National Association of Insurance Commissioners on uniformity and State insurance licensing laws. Almost 60 years later, the volume of interstate insurance transactions has risen exponentially, but the situation is as bad as ever. For all the efforts of the NAIC, the political will doesn't exist on a State-by-State basis to streamline the process and eliminate the discriminatory statutes.
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The current system requires licensing on a line-by-line, class-by-class, producer-by-producer, State-by-State basis. As a result, it is not unusual for a single insurance producer to be required to obtain 100 licenses or more, especially if that agent or broker is forming a national program for specific lines of insurance.
The hassles of licensing have little to do with achieving standards of professionalism. They include statutes that require, for example, a resident State agent to countersign any policy written by an out-of-State agent and for the countersigning agent to receive half of the commission or fee income without having added value to the transaction.
All the insurance agent groups as well as the NAIC are on the record as opposing countersignature laws. We believe that countersignature statutes and other residency requirements are indefensible, anticonsumer, protectionist, anachronistic, and antithetical to interstate and international commerce.
Our proposal to address the licensing issues would first give the States a period of 3 years for a majority of them to achieve basic licensing uniformity. If they don't do so, NARAB would be enacted. It would be a self-regulating, self-funding, totally voluntary organization, modeled after the National Association of Securities Dealers. Its professional standards for membership would exceed those of any State. Any agent or broker who meets the criteria for membership would still pay the licensing fees to the States in which they conduct business. The States would retain full authority to police any unfair trade practices.
We are not advocating the displacement of State law, only the standardization of the licensing components of State law. As we conceive it, a majority of the members of the governing board of NARAB should consist of State insurance commissioners.
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In conclusion, Mr. Chairman, we believe the uniformity fostered by NARAB would be beneficial for many of the affiliated entities that any financial services modernization legislation would be designed to foster. We are creating a body that would be responsible for establishing and operating a uniform licensing regime. Professional standards of insurance agents would increase, consumers would be better off, efficiencies in the marketplace would be achieved, discriminatory barriers would be removed, and the States would retain their proper role as the primary regulator of insurance activities.
Thank you.
Chairman LEACH. Thank you, Mr. Gleason.
Mr. Wentzel.
STATEMENT OF MR. DANIEL R. WENTZEL, CHAIRMAN AND CEO OF NORTH AMERICAN TITLE INSURANCE COMPANY, INC., ON BEHALF OF AMERICAN LAND TITLE ASSOCIATION
Mr. WENTZEL. Thank you, Mr. Chairman, Members.
My name is Dan Wentzel, and I am Chairman and Chief Executive Officer of North American Title Insurance Company, Walnut Creek, California. I also serve as President of the American Land Title Association, which I will refer to as ALTA. ALTA represents 2,400 title insurance underwriters, agents, abstractors, and attorneys across the Nation whose searches examine and insure land titles. We appreciate this opportunity to comment on the important issue of financial services reform.
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All members of the national insurance community, both underwriters and agents, have historically supported separation between banking and insurance. In the title insurance sector, support for this separation has been especially strong. This reflects the fact that title insurance is a mortgage-based product.
Title insurance is almost always purchased in conjunction with a real estate loan transaction and paid for only once. There is no renewal and no after-sale market. As a result, there is an opportunity for a banking institution to create a captive market for title insurance products, virtually eliminating other competition.
In their unique title insurance marketing position, a banking institution can jeopardize the interests of consumers with respect to both pricing and product. For example, several years ago a consortium of savings and loans caused the failure of their captive title insurer when they used reserves to shore up their institution.
ALTA has successfully litigated against bank entry into the title insurance industry, challenging the OCC's determination that sale of insurance was incidental to banking, and winning in the Second Circuit in ALTA v. Ludwig.
That said, ALTA is now prepared to support financial modernization in the form of affiliations involving banking and insurance entities conditioned on strict State functional regulation and adequate consumer protection.
As with other insurance trade associations, this support is more a recognition of the reality of the marketplace following the Barnett Supreme Court decision rather than a change in perspective.
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ALTA's members continue to believe that bank participation in the sale and underwriting of title insurance will create significant problems that must be addressed. We believe these problems can be dealt with most effectively by permitting banks to engage in title insurance activities only through bank holding company affiliates and by requiring that those activities be subject to consumer protection law and State regulation.
We strongly believe that bank holding company affiliates engaging in title insurance activity must be supervised on a functional basis by those State agencies historically engaged in such regulation and most capable of doing so.
ALTA believes that limiting title insurance sales and underwriting to affiliates will minimize the threat to both bank and insurance solvency, promote functional regulation of insurance, and help keep a level playing field. ALTA also believes that every entity engaged in the sale or underwriting of title insurance should comply both with RESPA and other specific State regulatory requirements such as insurance reserves, consumer protection, antikickback, and controlled business statutes.
We have examples that underscore the importance of this issue. The most recent of these involved a large bank holding company affiliate which has begun marketing a look-alike title product outside the State regulatory system to its bank customers in Iowa and other States. The net result is that consumers are paying the price for title insurance without receiving insurance.
In my own State of California, controllers of title insurance business are subject to restrictions on the percentage of business that can be obtained from affiliates. This requirement is designed to ensure that those in a position to refer business cannot create sham entities designed to collect fees for referring business without providing real services.
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In addition, many States have anti-tying provisions designed to protect consumers from other unfair practices.
We look forward to helping the committee develop legislative solutions to ensure that financial services modernization includes adequate consumer protection while maintaining the integrity of the title insurance products, and, more importantly, the safe and secure transfer of ownership of farms and homes across America.
Thank you.
Chairman LEACH. Thank you, Mr. Wentzel.
Mr. Larsen.
STATEMENT OF MR. BRENT LARSEN, DIRECTOR OF GOVERNMENT AFFAIRS, GRINNELL MUTUAL REINSURANCE COMPANY, ON BEHALF OF THE NATIONAL ASSOCIATION OF MUTUAL INSURANCE COMPANIES
Mr. LARSEN. Mr. Chairman and Members, thank you, and good afternoon.
My name is Brent Larsen. I am Director of Government Affairs for Grinnell Mutual Reinsurance Company of Grinnell, Iowa. I also chair the Financial Services Reform Task Force of the National Association of Mutual Insurance Companies, or NAMIC. I ask that the Financial Services Task Force report be included in the record.
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Chairman LEACH. Without objection.
Mr. LARSEN. Thank you.
NAMIC's nearly 1,200 member companies, ranging from the smallest to largest insurers, write about 32 percent of the property casualty insurance business in the U.S. NAMIC members support legislation to comprehensively reform and modernize the financial services marketplace, including allowing affiliations between banks and insurance companies. We have four specific recommendations for such legislation.
First, it must provide for functional regulation of insurance; second, the OCC's authority to determine which insurance activities are permissible for banks and to override State regulation of insurance must be curtailed; third, banks and insurance companies should be allowed to affiliate through a holding company structure that is accessible to mutual insurance companies; finally, Federal regulation of the integrated holding company must be limited.
What does functional regulation mean to NAMIC's members? Most simply, it means that the activity, not the entity, is the focus of regulation. Under a system of functional regulation, insurance activities would be regulated by the States without regard to whether the activities are conducted by a bank, an insurance company affiliated with a bank, or an unaffiliated insurance company.
All State insurance laws, specifically those including financial safety and soundness standards and consumer safeguards, must apply to depository institutions and their affiliates that engage in insurance activities, unless those laws unfairly discriminate against depository institutions. Affiliations must be structured to facilitate functional regulation.
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A primary focus of State insurance regulation is the strength and safety of insurance companies. Another priority of State insurance regulators is consumer protection. This is due in part to the long-term relationship between the consumer and his or her insurance company in which the financial protection afforded under an insurance policy is not realized unless the risk the policy protects against has occurred.
I emphasize the word ''unfairly.'' We believe the imposition of some consumer protection requirements solely on federally insured depository institutions, such as disclosure that insurance products are not FDIC insured, is not only fair but necessary.
NAMIC members believe insurance underwriting activities must be conducted in an entity separate from the bank, duly licensed as an insurance company under State law. The separation of corporate entities facilitates functional regulation, promotes safety and soundness of insurance companies and banks, and maintains the integrity of the State insurance guaranty fund and Federal deposit insurance funds.
The role of the Federal Reserve Board as regulator of the holding company must be minimal. The Fed's regulation of bank holding companies is not an acceptable model for regulation of financial services holding companies' subsidiaries.
For example, imposing the Fed's source-of-strength doctrine on a bank's insurance company affiliates would directly conflict with State regulation of insurance company solvency and the operation of State insurance guaranty funds. Strong functional regulation at the subsidiary level and limitations on transactions with federally insured affiliates are sufficient regulatory measures.
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NAMIC members believe that banks should be allowed to affiliate with all types of commercial entities. Prohibiting or limiting commercial affiliations would preclude many insurance companies from participating in financial services modernization for no clear purpose.
The unitary savings and loan holding company is a model that features in practice the regulatory and structural provisions supported by NAMIC. NAMIC urges its adoption as a model for the new financial services holding company.
Obviously, NAMIC members are concerned that the new holding company structure be accessible to mutual property casualty insurance companies. Several States, including Iowa, have adopted or are considering adopting mutual holding company acts. NAMIC strongly supports this legislation.
However, as a backup to such State legislation, we urge you to expand Section 303 of H.R. 10 which permits redomestication of mutual life insurance companies to include mutual property casualty insurance companies.
While NAMIC generally opposes any Federal legislation directed to the insurance industry, it must respond to the national banks' assault on the insurance business led by the OCC and sanctioned by the Supreme Court in Barnett. Only Congress, through the adoption of Federal legislation, can adequately respond. That Federal legislation should permit banks, insurance companies, and commercial entities to affiliate in a holding company structure that is accessible to mutual property casualty insurance companies. Functional regulation must prevail, including State regulation of insurance. Such a system will permit banks and insurance companies to operate fairly and vigorously in the new financial services marketplace to the ultimate benefit of consumers.
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Thank you for your time this afternoon. I would be pleased to answer any questions.
Chairman LEACH. Thank you very much, Mr. Larsen.
To our last two witnesses, let me say I want to give you full time, but if you could both take about 4 minutes, we would finish this panel from the terms of commentary, and then we will come back to take questions. If you want to take more time, Mr. Grace, we will come back and hear Mr. Booth. It is your option.
Let me recognize Mr. Grace.
STATEMENT OF MR. MICHAEL P. GRACE, AGENT, WRIGHT AND PERCY INSURANCE, ON BEHALF OF THE NATIONAL ASSOCIATION OF PROFESSIONAL INSURANCE AGENTS
Mr. GRACE. Thank you, Chairman Leach and Members of the committee.
My name is Mike Grace, and I serve as President of the National Association of Professional Insurance Agents. PIA is a national trade association representing the interests of 180,000 insurance professionals throughout the country.
I am pleased to have the opportunity to address you today on financial modernization legislation before this committee and, in particular, the issue of functional regulation of insurance by the States.
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For years, PIA opposed affiliation between banking and insurance industries, but given the realities of the financial service marketplace, PIA no longer opposes affiliation, provided that legislation recognizes the full preeminent authority of States to regulate insurance. We firmly believe that a level playing field where a pro-consumer competition exists can only occur when all entities selling insurance can operate under the same rules and regulations. The best way to achieve this is through functional regulation, and that is where I will focus my remarks this afternoon.
Functional regulation has a different meaning to everyone involved in this debate. To PIA, functional regulation means that States have the authority to regulate the insurance sales activities of everyone, irrespective of whether they are independent agents, national banks, or so-called financial institutions. State regulation of bank insurance sales is essential to ensure the integrity of the insurance delivery system and the protection of the insurance-buying public.
Put simply, there is no alternative to State regulation. There is no Federal insurance regulator. And hopefully you will keep it that way. Federal banking regulators simply don't have the years of expertise and/or the resources to match that of the State insurance departments. Even if they did, it wouldn't make sense from a public policy, or just plain practical standpoint to have a dual regulatory scheme.
Unfortunately, national banks and their favorite regulator, the OCC, envision a dual regulatory structure where independent insurance agents toil under vigorous State regulation while national banks sell insurance under favorable Federal regulation by the OCC.
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Some banks even feel that the OCC alone should regulate their activities, including insurance sales. They complain about complying with insurance regulations in 50 different jurisdictions, but that is a reality that insurance companies and agents like myself face every single day. National banks should not have preferential treatment.
On balance, competing on a level playing field is only a very small price to pay for an entry into the insurance sales business. For a long time now, it never occurred to anyone that someone selling insurance might be exempted from State regulation simply because their agency was affiliated with a national bank or because they were employed by a bank. But the OCC took on national banks' agenda, circumventing State and anti-affiliation laws designated to separate banking and insurance.
After years of litigation, the U.S. Supreme Court eventually upheld the OCC's view in the Barnett case, concluding that States cannot prohibit national banks from exercising their Section 92 authority to sell insurance in small towns under 5,000, but the court also made clear that the States otherwise have the authority to regulate national bank sales activities so long as the State regulation does not prevent or significantly interfere with the national banks' ability to sell insurance.
The meaning of that standard has been subject to some dispute. The OCC believes that Barnett never actually said that States cannot discriminate against national banks, evidently meaning that States cannot treat banks differently from non-banks.
This so-called discrimination is the basis for OCC's aggressive efforts, backed by the national banks, to preempt State law aimed at protecting insurance consumers. These laws do impose legitimate limitations on the way that banks sell insurance, but they do not prevent or significantly interfere with the bank's ability to sell. What they really do is interfere with the ability to confuse and coerce customers.
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The State consumer protection laws that PIA and other agent groups are advocating at the State level do not discriminate, they merely draw a legitimate distinction based on the differences between agents, differences such as FDIC insurance and extensive ability to lend money and extend credit.
The OCC itself recognized that there are strong policy reasons for treating banks differently. It told banks as recently as this last October, that in 1996 to take precautions in selling annuities and insurance such as making sure customers understand that the products are not FDIC-insured, separating bank deposit-taking activities from insurance sales activities, and preventing the tying of banks and insurance.
I can see I am out of time, so I am going to cut to the closing paragraph, if you will allow me. PIA fully cements the fact that banks will sell insurance.
The days are gone when trade associations lined up to deny banks access. We know that, and we know it is long gone. Our position of supporting functional State regulation is not a failed effort to keep the banks out, as some would claim. The simple fact is that every consumer, agents, and even banks, will benefit from a level playing field. PIA's position is very clear. Anyone selling insurance, whether they work for an insurance agency, a State bank, or a national bank, should abide by the same set of rules.
Thank you, Chairman Leach and Members, for the opportunity to testify today. We look forward to working with you in the future.
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Chairman LEACH. Thank you for that very reasonable testimony.
I think for fairness' sake to Mr. Booth, we will not hear from you now but will hear from you when we return. That way, you will not be uncomfortably constrained.
The hearing is in adjournment pending what is likely to be three votes, and it may be a time period in the neighborhood of 30 minutes, and maybe 40. Thank you all.
The hearing is in recess.
[Recess.]
Chairman LEACH. The hearing will reconvene and we will begin with where we left off with Mr. Booth.
STATEMENT OF MR. RUSSELL K. BOOTH, PRESIDENT, NATIONAL ASSOCIATION OF REALTORS
Mr. BOOTH. Thank you, Mr. Chairman. We have been able to relax. We doubt that you have been able to do the same. Members of the committee, Mr. Chairman, I am Russell K. Booth, 1997 President of the National Association of Realtors. I am President of Mansell Commercial Real Estate Services in Salt Lake. We are involved in residential and commercial real estate.
On behalf of the more than 730,000 professional members of the realtors, I am pleased to present our association's views on the legislation proposing comprehensive modernization of the Federal banking laws.
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Realtors are naturally concerned about the involvement of financial institutions in the various aspects of the real estate industry. The basic issue of whether, or to what extent, banking and commerce should be mixed is, of course, the prominent question for you and for our association's membership.
As in all dynamic industries, realtors contend daily with change and consolidation within our industry and the expressed desires of non-real estate entities for opportunity to enter this business. We recognize that the impact of technological change and the drive for diversified product lines and income streams in the current markets are lures that argue the Glass-Steagall ban should be reexamined.
Our testimony reviews the implications that the pending bills have on the real estate industry. Specifically, we focus on provisions that permit financial service holding companies via a subsidiary corporation to engage in real estate development, investment, management and brokerage.
The National Association of Realtors strongly opposes the legislative or regulatory definition of real estate as ''banking in nature, or incidental thereto.'' The practical test is clear. Real estate business practices are much more akin to commerce than to banking. The claims to the effect that real estate is banking, or incidental to banking, simply push the broadest interpretation of a legal definition to extremes. Real estate brokerage, development, investment, and management are all commerce, purely and simply.
Indeed, it is the extension of credit, the core business of commercial banking, that makes the real estate industry possible, as with any other business or commercial venture. If legislative action does proceed, realtors believe that H.R. 10, the Financial Services Competitiveness Act, contains the provisions that should be the starting point for this committee. Indeed, we anticipate that the most likely legislative vehicle will be a consensus bill that blends elements of H.R. 10 and H.R. 268, the Depository Institution Affiliation and Thrift Charter Conversion Act.
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We believe reasonable, moderate, Glass-Steagall Act reforms could follow from the more prudent framework envisioned by the elements of these two bills. This is particularly true regarding the real estate provisions of H.R. 10. We strongly support the H.R. 10 prohibition on operating subsidiaries investing in real estate and the limitations on interaffiliate transactions of that bill and H.R. 268. Further, we support the regulatory framework generally proposed by H.R. 10.
The National Association of Realtors does not support unfettered or broadly experimental efforts to modernize the Glass-Steagall Act. For at least a decade now, realtors opposed the direct involvement of financial institutions in real estate activities. We recognize that some States, as part of their dual banking system, have permitted banks and thrifts to engage in some real estate activities, although these activities cannot be undertaken without restrictions because of the risk and potential for conflicts of interest entailed in real estate operations where financial institutions are involved.
The National Association of Realtors opposes the mixture of commerce and banking for the simple reason that economic power will be too concentrated in the financial system and the potential for interference of noncreditworthiness factors and credit decisions is too great. Real estate investment and development are potentially risky ventures that require a level of acumen that may be outside the experience of the newer financial services holding company envisioned by some proposals in Congress this year.
House Resolution 10 basically retains current restrictions on bank and financial services holding companies, involvement in real estate investment,market volatility, inherent business risk and competition required that new entrance into these activities have the capacity and experience to adequately anticipate an account with each risk.
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In summary, Mr. Chairman, our association supports the incorporation of safeguards and firewalls and any Glass-Steagall reforms that protect consumers and taxpayers against conflicts of interest and broadening the Federal safety net for banks to commercial activities. Regulation of banks and their subsidiaries should be comprehensive and coordinated, such that all firewalls and safeguards will not be breached or collapse under financial stresses that will inevitably come. Financial system safety and soundness and assuring that the integrity of the lending decision should be protected are critical. Conflicts of interest obviously should not be permitted.
We are fully willing to work with the committee to devise reasonable, cautious reforms that include firewalls and safeguards that protect the bank from any risks associated with non-banking business ventures, but we respectfully request that any merging of banking and commerce should proceed in a cautious and measured framework.
Thank you, Mr. Chairman, for the opportunity to present our views.
Chairman LEACH. Well, I thank you very much. I thank this entire panel, and there will be a slight difference of opinion on various approaches, but I think this is a signally thoughtful panel. It is also one that has reflected virtually unanimous consent for moving in the direction of reform, with variations from other industry perspectives, and I think that is credible; and I am, in large measure, in general support of the thrust of what you are saying.
There is a point or two that I differ a bit with. One relates, Mr. Berrington, to your source-of-strength concern; that is, if the insurance company owns the bank, the bank starts to fail, should the insurance company have to come to its rescue? You point out that might weaken the insurance company, and then if the insurance company fails, it might go to the general insurance industry. But I would only say to that, if you have a circumstance that an insurance company owns a bank that weakens, and then there is another bank that weakens, and the regulators come into the other bank and force it to raise capital, but they don't come into the insurance company-owned bank, you have disproportionate regulation that implies the possibility, for example, that an insurance company-owned bank might be able to operate at 2 percent of capital, when the rest of the industry might have to operate at 5 percent, or 6 or whatever the State or Federal regulation is at the time, and that is a little unfair competitive landscape.
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In addition, it seems to me not as onerous as it might to you, that an insurance company option, rather than failing, if in providing funds, it goes below its minimum insurance standards, it should be expected, like a bank, to raise more capital; and that might imply some reduction in ownership percentage of the insurance company, but that is not inappropriate.
In addition, it has the option, forgetting raising funds for the insurance company, if it owns a bank that comes down to, let's say, abstractly, 2 percent capital, which might cause an insurance company-owned bank to fail. It would have the option of seeking outside capital simply for the bank, and this might again cause some dilution of insurance company ownership of the bank.
But that is what occurs in the rest of the banking industry, and so I am not convinced that the insurance industry, simply because it owns a bank, should be immune from keeping the bank adequately capitalized.
Could you respond to that?
Mr. BERRINGTON. Yes, thank you very much. This is a difficult and important issue and one that we would want to try to work out to make sure that we understand well what the process is, and so those who are involved on the banking side of the House also understand how the insurance system works. It is not so much whether the insurance company owns the bank or the bank owns the insurance company; it is whether they are in the same corporate family. And it really isn't so much as to whether monies can flow from one to the other, as intracorporate transactions, because under the insurance holding company statutes, money can flow from an insurance company to its holding company, or to an affiliate, if the regulator, the insurance regulator, approves it.
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But the concern that we have, and it is one we need to work on—but the concern that we have is that the Federal Reserve, with its proper concern for banks not failing, might direct that monies be transmitted from the insurance company to the bank to keep the bank from failing.
There are several difficulties with that. One is that looking at insurance companies from the standpoint of assets isn't really very realistic. You must look at insurance companies from the standpoint of risks. And, second, if the insurance company were then to fail after the money was ordered—to use a not very good legal term, but directed by the Federal Reserve to shore up the bank—and the insurance company then went down, the rest of the insurance industry then has to pick up the cost through insurance guaranty funds.
And the guaranty funds have been very important. They were basically established voluntarily by the industry and were incorporated in State law in every State, but both the competitive disadvantage and the threat to the solvency of the system would be pretty dramatic if the insurance companies existed ultimately only to be on call by the Federal Reserve to shore up the bank.
And that is our concern. If there are ways to deal with that, we would like to work with you.
Chairman LEACH. Well, let me think it through, because you provided a slightly different perspective; and let me give an abstract example.
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Let's assume you are head of an insurance company, you buy a bank, and let's say bank capital recedes to 1 percent. From the banking regulators' perspective, that bank should be closed. You would say, that is fine, just close the bank, rather than say that you are liable to assist it.
Now I would give another example that occurred that the banking regulators, as I understand it, have not closed. In my State, we had a major bank holding company that had a couple of weak banks, and they walked away from one. And the banking regulators were furious; frankly, the competitors of that bank were furious that they just allowed it to close, rather than support it. That was a better prudential decision for the holding company, but it was an imperfect one for the system itself.
But are you saying that if you had a 1 percent capitalized insurance company, based on some losses that might occur, that you would rather just have the right to walk away, rather than the obligation to use your insurance funds?
Mr. BERRINGTON. Well, I would hope the banking regulators would have been involved way before the issue became that dramatic. And I think the Fed requiring that, should the bank be further capitalized, in one way or another, that is fine. But directing that the insurance company, especially without the approval of the insurance regulator, to transfer monies over to save the bank just compounds the problem. I mean, I don't disagree there is a big problem in walking away, but I am not sure it is proper to resolve that problem by putting the insurance company at risk.
Chairman LEACH. Luckily, if one is on the side of having a little bit of capital—and given banks today, they are selling usually at about two times book—if they had 1 percent, they are really worth 2 percent, and it is possible to sell capital to raise it to, say, 6 percent, but it dilutes the ownership by the insurance company. That doesn't seem unreasonable to me to stress that that occurs, but you are saying it is unreasonable to extend this to the insurance industry itself.
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It is an interesting point because the chances are, although it could be a localized situation, that if the bank got in trouble, we might be having economic times that would be more likely to lead insurance companies to have more problems than others, and so it would be in the same time that that issue would occur.
That is interesting, and one of the good aspects of modern times is that it is a quicker process by which to go out and seek public help than it was many years ago. By the same token, I think what you are really getting at is, you want the ability to walk away; is that correct? Because if that isn't what you want, you would be saying you want the ability to continue to operate the bank at 2 percent capital, even though your competition has 5 to 8.
Mr. BERRINGTON. What we want is a system in which the financial integrity of the insurance company cannot be put at risk through regulatory fiat to save a bank; and there needs to be, at the very least, a mechanism that gives the insurance regulator veto power over that happening and, perhaps, a strict wall that would——
Chairman LEACH. That is an interesting proposition, but that it wouldn't disallow the bank regulator from closing the bank?
Mr. BERRINGTON. That is absolutely correct, and telling the bank it had to get additional funds. And if the insurance part of the corporate family wanted to transfer the funds and the insurance regulator thought the capitalization of the insurance company would not be in danger by doing so, I think, under the holding company statutes now, that would be approved, that would be an approved arrangement.
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And we would like to sit down with the Fed. I think it is important to get around the table with the folks from the Fed to get their sense of how they would see the system working.
Chairman LEACH. I think that is not unreasonable. I think we will all have to think that through, and I assure you, I will speak to the Fed myself on what are the ways to work this out somewhat differently or not.
Mr. BERRINGTON. Thank you very much.
Chairman LEACH. Thank you. And I appreciate your added clarification; that is an interesting clarification for me.
With regard to functional regulation and State regulation, let me just tell you, I personally think it is only fair that people operate under the same regulation and that it is unfair to have one participant of insurance have a national, perhaps friendly—perhaps inexperienced, at least in insurance regulation—regulator and everybody else to have State.
I think there could be a case in the next generation, or few decades, in which the insurance industry may come to the conclusion that it is better to have a national regulator, in which case that is terribly reasonable if all come under a national regulator. But I have real doubts about one seller of insurance having a national regulator and everybody else having a State regulator; and so unless and until there is a change of McCarran-Ferguson itself, I think it is very unwise to give someone else a leg up on generally considered insurance product.
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Mr. BERRINGTON. Our view would be, in terms of functional regulation, that whatever the insurance regulatory mechanism is—and we live in an era of State regulation that is likely to continue—that the insurance activities be regulated through the traditional insurance mechanism, and that they be regulated through that traditional mechanism, whether they are conducted by bank affiliates or by insurers or agents or otherwise, and that the regulatory warfare which is going on now over Section 92 be ended through putting in the legislation a straightforward standard with regard to insurance sales.
Chairman LEACH. Well, thank you. My sense is that there is a general thrust agreement between various of the agent groups and the companies, but some differentiations; and my sense is that agents are somewhat more concerned for some consumer protection options than the companies, and it is also my understanding, on a historical basis, the agents have objected to commerce and banking.
I would like, first, beginning perhaps with Senator Irons: Would you comment on where you stand on integration of commerce and banking?
Mr. IRONS. Our associations have no official position on this issue. However, I have my own particular belief.
Chairman LEACH. Please.
Mr. IRONS. I would point out our debacle in Rhode Island, the collapse of our banking system, that came about because of the close community banking and business relationship. I believe that it would have occurred even with some of the safeguards discussed by the banking community and Mr. Baker.
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I am only guided by the sad experience in our small State. I don't believe any of this considers the interests of the people. It is a discussion of profit level. The reality is that policymakers should decide the extent of the dangers involved.
Fifteen years ago, the gentleman Fernard St. Germain, whose picture adorns the wall, spoke about firewalls as ''rice paper walls.'' In our State the banks collapsed because the firewalls were, in reality, rice paper walls. And I said at the time, ''A firewall in a car is there to protect the passengers.''
The problem is, you never know the severity of the accident, so you don't know how strong to build the firewall. I personally don't believe it is in the best interest of the American public to travel down the avenues that Chairman Volcker alluded to so well in other countries. I believe as a public official, as I have listened to these debates, it is the right of those who wish to expand their territory to pursue commercial affiliations.
But I do not believe—I have never had, and I would question how many of the Members of this committee have ever had—a constituent come forward to them to ask that banks be permitted to affiliate with commercial entities. Because if we look at the example of Sears, they have tried every financial service, and now they are back to square one—their retail operation, and that tells you what the American public wants. When the American public wants broader affiliations, they will tell us. And we shuld recall the dangers posed by such combinations in the past in our own country that resulted in a Government bail out.
The other witness made an extremely important point, Mr. Chairman, our industry is unique; when we have problems, as we did in the 1990's, not a penny of taxpayer dollars solved the problems in the insurance industry. Our policyholders in the life end had $300,000 worth of protection if a family member died and $100,000 of cash value to protect it, not a penny at taxpayers' expense. That is how we have built our industry.
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The point that was just made is important. To allow the insurance company to be exposed involves much more than the company, it involves the industry; the liability is spread around the country through the State guaranty funds. These tremendous dangers are being exposed in this entire question. That is why we have to have State functional regulation of insurance; we have to have you pass a bill this year.
Will you clarify this confusing, chaotic standard—the Barnett Standard—that now exists, that gives an appointed official, the OCC, the ability to come into my State and second guess our consumer protection laws?
In Rhode Island we passed a law that anyone could objectively say, gave banks broader powers than what were required. We recognized the increased role of banks on insurance in the future. However, it is particularly disturbing that the OCC should decide to question the Rhode Island bill before our regulators even drafted implementing regulations. The question of banking and commerce is, I think, manufactured by those who wish to expand their turf.
They have the right to pose the question; I truly hope the Congress does not endorse it. I champion your legislation, not that of Mrs. Roukema, and surely not that of Mr. Baker.
Chairman LEACH. I appreciate that very much and I will only add, as a fellow elected Representative of the public, the public will express to an elected Representative many angst about the economy and about public policy, but in 20 years in the United States Congress, I have never ever had a constituent come up to me and suggest that what ails America can be solved by Citicorp uniting with GM, or by the local bank owning the local drug store. Never.
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And so when you say—well, Paul Volcker says there is no public support, that is an understatement. Now, frankly, the public has not generally focused on this issue, but what I would suggest to my colleagues is, as soon as it becomes likely that such a thing will be seriously considered, the opposition comes out of the woodwork—and it is coming out today—but for many, many different orders.
Mr. IRONS. Could I follow up on that very quickly?
The public is not asking us to do what is being asked, but they should be protected from the dangers they don't know are developing. They elect you, they elect me, to know where the danger points occur in their daily lives; they cannot be expected to have this responsibility.
In our State, we let the banking system collapse, and we are paying a dear price. What has happened from Congressional inaction is that the dangers are developing week after week, day after day, year after year, in this country because the OCC regulator is able to run rampant for his one constituent—the national banks; and that is the real role that I believe we, as elected officials, must play to serve our constituents.
Chairman LEACH. Thank you, Senator.
Let me ask, on the commerce and banking issue, Mr. Wentzel, if you have any input?
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Mr. WENTZEL. Well, I would think that, of course, our concern with the whole issue of bank powers is the closeness of our industry's products to bank-related lending activities, and to the extent that those relationships get further away, as, say, perhaps a bank holding company in the title business, gets into an unrelated industry through their ability to affiliate with bank and commerce activities; and I think we are less concerned.
Ultimately, I think there are issues—we look at conflict of interest situations and soundness of underwriting. I suppose it is possible to envision an environment where the ties between banking and commerce got so complex and the holding companies got so broad-based and had so many different ties and links into the lending industry that we might encounter those conflicts in two or three different places within the same holding company structure, at that point we would be concerned.
I think the bigger issue is more a sense of timing and whether the legislation being considered is the appropriate vehicle and the appropriate time to cross that bridge.
I think that we view our industry as having made a significant concession in this willingness to now cross the bridge between bank powers and insurance. To the extent there is also a separate bridge being crossed between bank powers and the securities industry, there will be some industry dislocation, some strategic realignments, some corporate repositioning that has to flow out of all of this as our respective industries live in this new environment. I question whether it is time to further complicate the issue by bringing the bank-commerce issue into play and even increase the risks and the complexity of all of our industries going through that process.
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Chairman LEACH. I thank you. I want to ask the two other non-company interests to speak, and then I am going to turn to Mr. Hill. And I want to recognize that the companies may have a different perspective, but I don't want to pretend that all of the current speakers represent the companies.
Mr. Grace, would you like to comment?
Mr. GRACE. Mr. Chairman, our association really does not have a position on the issue, but I would like to go on record as saying that I said it exactly like Senator Irons said it.
Chairman LEACH. Thank you.
Mr. Booth, you represent the realtors.
Mr. BOOTH. Thank you. The basic position is, as you know, we don't think that commerce and banking should be mixed, and support the basic provisions of your bill, H.R. 10, because it does establish the safeguards and keeps the prohibition against the operating subsidiaries. We recognize the world is changing and, if it is going to change, it needs to change in a very careful environment so that all that has made commerce and banking, respectively, successful continues.
Chairman LEACH. I appreciate that, and I frankly think of all the associations that might be perplexed by it, it could be the realtors, because that is the first step. And I just think to myself, if you are a realtor, and you have got a development project, and you were to go to the local bank, what kind of interest would you expect, and would it be in the 8 to 10 percent range today?
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Mr. BOOTH. Ultimately, for a development loan, it would be a little bit higher, for a risky development loan, but as a mortgage, the lower percentage range.
Chairman LEACH. The reason I raise it is, let's say you live in a community and you have got kind of an interesting project in mind. You go to the local bank, and all of a sudden, you realize that he is going to charge you, let's say, 9 percent, and his cost of money is 4. That is a pretty substantial advantage of his.
Second, if you are the developer and let's say I am the banker, you come up with this whiz of an idea, an idea, you know, that it takes a lot of time and thought and experience to put together the numbers. So, you come to me and say, ''I have got this whiz of an idea,'' I have the option not only to say ''it will be 9 percent for you,'' but I have the option of saying, ''No, it doesn't work at that 9 percent; I think I will just take that idea and do it myself.''
And so you have put in what may be tens of thousands of dollars of effort in thinking through this project, you have put in massively sophisticated analyses of demand, of cash flow, and so forth, and you bring it to me. You are bringing it to your potential competitor who has, to boot, an enormous cost of funds advantage. And if I were a realtor, I would say it is a bit unfair. And I may be wrong. And what it would incline me to do, as the local realtor, would be maybe I will shop this with an insurance company that is distant, although they might have the same option.
But one of the functions of real estate that has always impressed me is that as much as there are some major national real estate companies, and people know them, or hotel chains that everybody knows about, I suspect 99 percent of real estate in America is locally owned and that it ends up being an industry that distant actors are not very good at, that—whether it be in the sweat factory, whether it be ''being on top of the local scene'' factor, whether it be knowing how to deal with local ordinances and planning and zoning committees and whatever. It is an industry that is shockingly local, and it just strikes me that this might move it in another direction, which may be, in addition, more imprudential.
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But would you comment on that?
Mr. BOOTH. Thank you, Mr. Chairman.
I agree with your comments, real estate is a local business. A substantial portion of our members are local small businessmen. While there are large chains and franchises and independent companies, and you hear a lot about them, the business even for the large companies is a local business by branch office, by city, by market area, and our business is very local in nature.
And the scenario that you paint of a broker, developer, or a client with the broker going to the bank and having to feel that the bank would be a competitor in the espousal of a development proposal, or something they consider confidential, and are trying to gain a fair market advantage over someone else, and to have that bank or institution representative be a competitor or a potential competitor would have a chilling effect on the relationship and on the potential loan. And if the developer goes ahead and proceeds, they always wonder if they are at risk and those are difficult safeguards to put into place. But we think they surely need to be in place or there would be no measure of that relationship, which is local, which happens tens of thousands of times every day, that would survive.
Chairman LEACH. Well, thank you, Mr. Booth.
Mr. Hill.
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Mr. HILL. Thank you, Mr. Chairman, and I thank all of you for being so patient, and I will try to keep this real, real short because I know you all are probably tired and wanting to get out of here. I know I am.
I was in the insurance business. Many of you might have known that. I had an independent insurance agency. So I have a little bit of experience.
Chairman LEACH. Excuse me, if I can interrupt. And we respect that. I want you to know we are listening to Mr. Hill. Please, go on.
Mr. HILL. Thank you, Mr. Chairman.
And I am sorting through all this, believe me, and I didn't know it was this complicated; all I had to worry about was insurance before.
But, you know, the value of a service industry franchise is the relationship of the customer; that is, independent agents sell customer lists; and it is this value of this relationship with the customer, I think, that is kind of driving the interest of various financial institutions to get in each other's business or each other's traditional business, because they see the value of this relationship, and if they expand that relationship by providing more services, they make more money. There is nothing wrong with that.
The trouble with all this has been, even when I was in the insurance business, I noted this with insurance companies, and that is, the insurance business is extremely competitive, but it was competitive within a very narrow corridor, and insurance companies liked the idea that everybody competed in the same way, used the same rating basis, the same policy forms. As long as everybody was following the same exact rules, then it was OK. But if somebody was creative and wanted to come up with a different way of delivering the services, different policy language or way of rating it, that created a lot of trouble in the insurance industry.
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The reason I bring that up, it seems to me that is a characteristic of this whole area of financial services. We have kind of put everybody into a box and allowed people to be intensely competitive if they want to stay in the box, but if people want to cross out of that box into another one, then we have a problem.
I am not going to go on lecturing about that, but where I am having trouble is a number of areas. Where do we draw lines between the financial services in whatever the new modernization looks like, and where does financial services end, and where does commerce begin? And, most importantly, who is going to make that decision? And that is the question I want to ask all of you; who you think ought to make that decision?
I am just going to give you an example. This is an area I have some familiarity with. Let's take surety bonding and irrevocable letters of credit. Surety bonds have been underwritten by insurance companies for most of a century. Every book that you read about surety bonding says at the beginning that surety bonds aren't insurance. Irrevocable letters of credit, as we know, are instruments issued by banks, but very, very similar instruments, free-form instruments, so it would be very easy to make them the same.
Who is going to determine whether that is a banking function or a financial services function or insurance function? And who is going to regulate it? And why?
Mr. HUGHES. I think, ideally, this ought to be a lot easier than it seems to be, and the analogy we always point to is how the insurance industry and securities industries have interacted over the years. There is no great body of law that says how the two businesses have to interact. There is no body of law that says this is securities, this is insurance, this is how the SEC should regulate, this is how the State insurance regulators should regulate. And yet, you have innovative products, you have variable annuities, which have securities characteristics which are, in fact, Federally regulated by the SEC. The insurance characteristics are regulated by the States. No Federal law had to make a determination there. You have tensions of the margins, and sometimes courts have to resolve these things. But no one has to do this as a matter of law.
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I mean, the examples you have given—and there are certainly others—where there are bank products that replicate to a great extent products in the insurance business. Congress has not had to step in and say, ''You regulate this, and you regulate that.''
Standby letters of credit are generally perceived to be a banking product. They are regulated by bank regulators. Municipal bond guarantee insurance, which is a functional equivalent, has been issued by insurance companies and regulated by the States as insurance.
I guess the question would be, isn't that the way it should take place? Does Congress have to step in and say, ''We are going to figure all of this out for you. We are going to try and draw bright lines between businesses.'' Or can you just say, as long as there are some general rules that are applicable here, that is all that needs to be done, and these things will work themselves out. And your job is largely done as long as you have protected the payment system and as long as you have protected insurance company solvency. Maybe that should be the end of your responsibilities, and you let these other things seek a natural level. And yes, there is going to be some litigation and disagreement between and among regulators, but that is the way it has always been.
Mr. BERRINGTON. Mr. Hill, when I came to the American Insurance Association 11 years ago, the first day I read the McCarran-Ferguson Act which only protects the business of insurance. The second day, my surety lawyer came to me and said surety isn't insurance. And the third day, we said surety is insurance because that is the only way we get protection. So what we talk about is a specialized type of insurance these days, and they even have losses from time to time.
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With regard to your question, which is a very good one, we have some specific ideas to put on the table. The first is that insurance should be that which is defined as insurance in the insurance codes, and that the insurance regulator really should make those decisions, and that idea ought to be encapsulated in the legislation. Where there is a difference of view, there can be appeal to the courts in the State, but the insurance regulator should make that decision.
That approach should have no problems for a bank if you take the view that banks and insurers can affiliate, but that insurance underwriting can only be in a separate corporate entity from the bank, so if the bank wants to underwrite insurance, that is fine, it just can't do it in the bank, it has to do it in its corporate affiliate, which is an insurer or an underwriter.
So the regulatory gains, which the current system encourages, because it is the only way that the bank can get into a competitive product, is by calling something which once was insurance, to call it now ''banking or reasonably related to banking'', no longer exists.
So we would suggest a simple but clear system that what is in the insurance codes is insurance, that insurance underwriting be done in a separate corporate entity, and that the insurance regulator have the authority to determine that a bank product, which is characterized as a banking product, really is insurance, and that if the bank doesn't like it, the bank can sue the regulator in the appropriate court under a statutory standard.
Mr. HILL. So to summarize that, what you are saying is the State insurance regulator is, in essence, going to define insurance?
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Mr. BERRINGTON. The State insurance code and the regulator operating under the code.
Mr. HILL. They can expand that or contract that, if that is what the legislature wanted to do?
Mr. BERRINGTON. I think pursuant to a definition of the statute which pertains to risk transfer, but, again, the fact there can be affiliations between insurers and banks doesn't disadvantage—prevents there from being any disadvantage to the bank. The bank can underwrite insurance whenever it wants. It just has to do it in a separate corporate entity so no one is disadvantaged, but there is a clear delineation between where the underwriting is done for insurance and where banking activities are done, and that is important for the safety and soundness standpoint too with regard to the insurance mechanism.
Mr. HILL. There are a lot of instruments: The instruments we just talked about, the irrevocable letter of credit; and in terms of transfer risks, characteristics of the instruments, there are many instances they have looked exactly alike, functioned exactly alike. So the insurance, the legislature, says, ''Well, from now on, irrevocable letters of credit are going to be surety bonds.''
Mr. BERRINGTON. For those arrangements which exist today, I think, you know, grandfathering is a reasonable way to proceed, but I think a situation that leaves everything up for grabs is not a useful one, and if it is not what I suggested, you should craft something which has some definitiveness to it, so that we can move into business, rather than move into litigation.
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Mr. HILL. Right. And obviously the one thing that is going to happen here is, we are going to select which regulator's decision is going to be supreme in various decisions. That is why I am asking the question.
Mr. Gleason.
Mr. GLEASON. I don't have too much to add. I have been in the business a long time, 32 years. It was simple when I started: Five people made a few calls, built some relationships, and sold insurance. I mean, it was very simple—even today, it can be simple if you are working in a small town or working in some of even the major markets. And safety and soundness are paramount concerns.
The Chairman asked who is looking out for the consumer to make sure that somehow they don't get lost in the shuffle? In Pennsylvania, we had the strongest law separating insurance and banks; banks just couldn't do it. The worry was about coercion. Nobody even talks much about that anymore, but that must remain a concern for the consumer.
I think we make it a lot more complex than it really needs to be. Speaking of safety and soundness, the consumer relies on you, they must accept your judgement that the company is safe, and that is the way it ought to be. And that is, I think, the role here, to make sure that we do have that safety.
As far as who is in the business, I never worried about that; it was never a big problem. Don't we really have to do what is going to be in the best interest of the consumer? That is what we try to do, and that ends up being a judgment call.
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Mr. HILL. But we rely on a regulator to help that occur.
Mr. GLEASON. And I think that is wrong. I mean, a regulator, who is the regulator? What does he know about it that you or I don't know about it? Legislators should make those judgement calls about who is in the business, not regulators.
Mr. HILL. I find your suggestions with regard to this mechanism for licensing particularly interesting. I was licensed in 22 States.
Mr. GLEASON. Wasn't that a bear?
Mr. HILL. Yes, it was, and, I don't know, in five lines in some states. I wrote down, you said ''line by line, class by class, producer by producer, and company by company in many instances.''
Mr. GLEASON. I did it myself with five people and when I sold my first policy in another State, I couldn't believe what I had to do. As we did more States and I did them myself, now I have a person who does this full-time. One of our members pays $500,000 a year to administer licenses. This isn't the fees; this is the administrative component. Nobody is getting any value out of it. And that is why this needs to be streamlined.
So we are not talking about regulation here, what we are talking about is an administrative licensure function so that that money ends up going back to consumers. Money is being wasted right now because nobody is getting any benefit from it, and I think that is one of the main reasons we are advancing this proposal, so that all agencies can be more competitive for the consumer.
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Mr. HILL. So when there is a difference of opinion between the National Association of Registered Agents and Brokers and the State Insurance Commissioner——
Mr. GLEASON. There shouldn't be any, because in our proposal, when you look at it, we think the board should be made up of mainly insurance commissioners, so that, again, we want them to be the regulators, and we feel that those things will be worked out. It is not going to be a problem.
Mr. HILL. I happened to work on passing the NAIC model producer legislation in Montana. It wasn't as easy as that.
Mr. GLEASON. No, and this won't be either.
Mr. HILL. And I don't know very many States followed on after that. But there are a lot of issues there.
Mr. Wentzel, do you have a comment about who ought to be the supreme regulator here on the issue of insurance when we have a crossover of financial services?
Mr. WENTZEL. Sure, and thank you. I think our industry probably has a very unique example of exactly how that issue comes into play.
We have a dispute going where a large bank holding company is in fact issuing a product that is not a title insurance product but it's been determined to not be a title insurance product by about 20 of the different State insurance commissioners. In fact, is being litigated in several States now, and we have that problem of a bank holding company issuing an unregulated product outside the existing regulatory scheme, and our difficulty solving that problem through the State regulatory process. I guess I have several different thoughts on that.
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First of all, I think we have been and can be creative in working outside the box in coming up with new products and services and meeting the challenge of a changing financial services world.
I think, to some extent, the narrowness that people sometimes feel about our industry is the fact that we are subject to State regulation, and the number one concern in that State regulatory environment is consumer protection, and because consumer protection is always at the forefront of State regulators' approach to new products and services, that tends to create, I think, the appearance of the box.
But as I look back at our industry over the number of different products we have come up with in the last even 5 years, with the different changing financial loans available, I think we are pleased with our response. I think we have used State regulation as certainly the initial decisionmaking point for these kinds of differences, and I think how you arrive at a definition for insurance in this bill will certainly have a significant impact on that issue.
We certainly would support looking for the State regulators themselves to define insurance as they view it in each of the respective States, but we are also comfortable with the process of some sort of umbrella regulator when there are differences between the crossover industries that can't be dealt with at the State regulatory level.
Mr. HILL. That would be a Federal regulator.
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Mr. WENTZEL. We feel comfortable with the Federal Reserve, and we are interested in this concept of perhaps a different umbrella regulator, but we think that probably has more unanswered questions at this point than it does solutions, and I think in just our experiences with the Fed, we have been comfortable with the responses we have gotten from them.
Mr. HILL. Your industry is one that particularly interests or concerns me, I guess, with regard to the potential conflict of interest, because I just bought some property. It has been a while since I bought a home. And I bought title insurance. In fact, I bought two title insurance policies; one, the beneficiary was the lender; and the other, I was the beneficiary; and I paid both those premiums.
But the interesting thing that I would see there, if you care to comment on that, is it seems to me there is an inherent conflict of interest if the financial institution making that loan to me had directed me to a title insurance company that they owned when they were going to be the beneficiary of the coverage.
Is it your suggestion that that practice be eliminated or totally prohibited?
Mr. WENTZEL. I think it is our concern that if we have effective State regulation, the States are themselves capable of establishing the different consumer protection devices and controls that would help cure those conflict of interest situations.
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Certainly——
Mr. HILL. So if the State wanted to prohibit that transaction in total——
Mr. WENTZEL. We think it is absolutely within their purview, and we have some examples that we have outlined in the statement being filed with the committee where these conflicts have existed in different States. The ability of a bank lending company, either a bank or its subsidiary, to control product has really been limited on the basis of controlling significant percentages of their lending activity.
We know that when a buyer of a home, a young couple going in for the first time as a home buyer, and their number one focus is qualifying for the loan and purchasing that home. When the couple is steered or directed to a provider that is much smaller in price and cost, they tend to almost totally be swept aside by wanting the loan and be willing to perhaps not ask a lot of questions that they otherwise would if it weren't for that enormous disparity in leverage or position.
So our industry is probably, at least we think, more so than any other in terms of steering in kind because of that issue, but we are again comfortable with the fact that if there is strong State functional regulation, that we will trust the ability of the respective State insurance departments to put in the types of controls that will keep the playing field level for all participants.
Mr. HILL. Would anyone else care to comment on that question of which regulator ought to be supreme?
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Mr. Chairman, I will yield back whatever balance of my 5 minutes there is. Thank you very much.
Chairman LEACH. Well, it has been a long day, and I am sorry to have kept you all so long, but I want to thank you, each of you, for presenting a very interesting perspective. I can't guarantee you exactly that you are going to get precisely what you want, but I think we will try to go in as balanced a way as possible.
We are trying to take each industry group's perspective and place them in balance. So it is my hope that no one is steamrolled. And your industry has some very serious concerns that we will take very seriously into consideration.
Thank you all.
The hearing is adjourned.
[Whereupon, at 4:33 p.m., the hearing was adjourned.]