Thank you, Mr. Chairman, for providing me this opportunity to discuss HR 10.
HR 10--the so-called financial modernization package--is seriously flawed and clearly lacks the kind of consensus needed if the American public is to have confidence that the Congress is creating a fair and safe financial system.
The deep divisions and uncertainties surrounding this legislation were reflected dramatically in the 214 to 213 vote by which the House of Representatives adopted HR 10 on May 13. The opposition to the bill was bi-partisan. Passage was gained only after a near record "long count" that allowed time for the Republican leadership to twist arms and cajole Members to switch from "no" to "aye."
Unfortunately, much of the debate about HR 10 has been centered on turf battles among regulators, compromises to satisfy competing industry lobbyists and a lot of flimsy dime-store propaganda suggesting that the nation's consumers are clamoring en masse for something called "one-stop shopping" centers and financial "supermarkets" where they can dabble in esoteric financial products.
HR 10 is not a bill for consumers. It is a bill designed to create new profit centers for a relative handful of banking and financial services corporations--corporations that will form combinations which will dominate the delivery of financial products and fuel the already alarming trend toward mega mergers and the concentration of economic power. .
The House of Representatives failed miserably to address key issues in its rush to push the bill through this Congress.
Foremost among these is the question of safety and soundness and the protection of the taxpayer-supported deposit insurance funds.
When it passed financial reform legislation in 1989 and 1991 in the wake of massive savings and loan and bank failures, the Congress--especially its House and Senate Banking Committees--made an implicit promise to the American people that new risks would not be added to deposit insurance and the rest of the federal safety net without commensurate strengthening of regulation.
HR 10 does not keep that promise. Rather than strengthening and rationalizing the disjointed and overlapping financial regulatory system, the legislation makes the system worse by scattering regulation, not only among six federal agencies, but among agencies in the 50 states, the District of Columbia and Puerto Rico.
Regulators, banking officials, financial analysts, key Members of Congress and the General Accounting Office have repeatedly pointed to the inefficiencies, conflicting interpretations of regulations, and the lack of accountability created by the current system. Through the years, bills have been introduced to create a single coordinated agency that would have the sole responsibility of regulation, but the legislation has failed in the face of opposition from segments of the financial community wanting to keep their own agency and by agencies, themselves, seeking to keep their turf.
In 1994, Comptroller of the Currency Eugene Ludwig told the Congress "it is never entirely clear which agency is responsible for problems created by faulty, or overly burdensome, or late regulation."
The last head of the General Accounting Office--Charles Bowsher--often pled with Congress to change and coordinate the system. In 1993, he told the House Banking Committee:
"The current regulatory structure has evolved over more than 60 years as a patchwork of regulators and regulations...we question the ability of the current regulatory structure to effectively function in today's complex banking and thrift environment. We believe the House and Senate Banking Committees, in conjunction with the Administration, should assess the appropriateness of continuing with the present regulatory structure and develop viable alternatives to that structure."
Mr. Chairman, that was five years ago before the Congress contemplated the current legislation to greatly expand the responsibilities of regulatory agencies by combining banks, insurance companies, securities firms and in some cases, non-financial corporations under common ownership. If Comptroller General Bowsher questioned the ability of the system to "effectively function" in handling the less onerous demands circa 1993, what would he say about the ability of the system to meet the much more complex duties imposed by HR 10?
Instead of facing up to the inadequacies of the present system, the House Representatives opted for what it dubbed as "functional regulation"--essentially maintaining the status quo by letting each segment of the industry keep its separate regulatory niche. The Federal Reserve continues as regulator of the holding companies, but HR 10 leaves the Fed's authority over insurance and securities affiliates in a very limited and much muddled state.
Insurance companies will be allowed to become affiliates of federal financial services holding companies without facing federal safety and soundness regulation.
They will continue to be regulated by insurance departments in the 50 states--insurance departments that, for the most part, are woefully underfunded, understaffed and overly dependent on the companies they regulate. Not only will these companies avoid federal safety and soundness examination, but the companies will also escape CRA-like community responsibilities and will not be required to report where they make investments and sell policies as commercial banks are required to report where they make loans under the Home Mortgage Disclosure Act.
In many cases, like pending Travelers Group-Citicorp merger, insurance companies will be the dominant corporate entity in the holding company. Should they fall on bad times or fail, these insurance companies would have the potential to drag down the entire holding company including banks guaranteed by taxpayer-backed insurance funds. The federal safety net--but not the federal regulation--will be extended directly and indirectly to these insurance affiliates.
Under the provisions of HR 10, the Federal Reserve Board, the umbrella regulator of the holding company affiliates, would be subservient to the state insurance regulator. Except under extraordinary circumstances, the Fed would be required to defer to the state insurance departments on examinations, capital requirements, and interpretations and enforcement of regulations.
In 1990, during a period of rising insurance company failures, the House Commerce Committee found "numerous weaknesses and breakdowns in this (state) system, including lack of coordination and cooperation,, infrequent examinations based on outdated information, insufficient capital requirements and licensing procedures, failure to require use of actuaries and incomplete audits, and improper influence on regulators."
Recently, the Wall Street Journal used Indiana as an example in a story on lax state insurance regulation. In that state, the Journal reported, financial examiners--accountants who verify the financial soundness of the companies--make at most $31,980 yearly. The division assigned to investigate consumer complaints has no investigators on its staff, only "consumer consultants" who told the Journal that they do little more than forward complaints to companies. The department does not have a single actuary on staff to examine the fairness of insurance rates..
Even in the handful of states where insurance departments are reasonably funded and staffed, the emergence of thousands of companies that do business across state lines as well as overseas makes it impossible for single state insurance department to monitor and assess risks. Adding to the difficulty of tracking the financial health of the companies is the growing complexity of investments engaged in by these corporations.
The insurance industry has resisted successfully attempts to extend anti-redlining requirements to insurance companies--provisions that would require the companies to report by census tract where they write policies and make investments. They blocked federal legislation in 1993. Similarly, big insurance companies in 1996 maneuvered behind the scenes to scuttle a proposal of the National Association of Insurance Commissioners to conduct an industry-wide study of redlining,.
Not only did the House refuse to extend redlining requirements to insurance companies in HR 10, but it made it easier to for the mutual insurance companies to rip off mutual policy holders--the true owners of the mutual companies. To facilitate this quick grab of the assets of policy holders, the legislation preempts state laws to allow mutual companies to change their domicile to states with laxer laws governing the rights of consumers when a company converts to stock ownership. At stake are tens of billions of dollars worth of assets that belong to the policy holders.
Clearly, HR 10 raises a multitude of questions about the treatment of insurance companies that will become an integral part of the new financial services holding companies, particularly on redlining, safety and soundness regulation and the unconscionable grab of policy holders rights.
The insurance interests are lobbying hard for this legislation. They want to be part of these new financial services holding companies. But they want a free ride. The solution is simple--if they want to play at the federal level--as part of these conglomerates--then require them to accept the federal rules. Left with the weak regulation of state insurance departments, they become an unstable element in the financial services holding company structure.
This Committee and the Congress have a responsibility to determine whether HR 10 does provide proper protection for the safety and soundness of financial institutions and the deposit insurance funds. This cannot not be delegated.
The Office of the Comptroller of the Currency has been forthright in warnings about new risks in a consolidated industry and about the need for better internal controls in banks. But neither the OCC nor the Federal Reserve nor the Federal Deposit Insurance Corporation nor the Office of Thrift Supervision can be expected to suggest that they have any real doubts about the ability to control risks. They feel a need to put up a brave front about whatever the Congress dumps in their laps. Their turfs are at stake.
Similarly, don't expect the representatives of the financial industry, who are salivating over the prospects of new profit centers, to identify safety and soundness problems.
In the 1980s, the Congress depended too long and too much on the rosy scenarios coming from the Federal Home Loan Bank Board and the savings and loan industry and its paid consultant-lobbyists like Alan Greenspan. And that dependence on the self-serving statements of regulators and lobbyists cost the taxpayers tens of billions of dollars.
This Committee needs to undertake an in depth objective study of what HR 10 and the onrushing mergers mean for safety and soundness and the deposit insurance funds. This analysis needs to be in hand before the Committee even thinks about markups of HR 10. Reassuring statements from regulators and lobbyists are not enough.
The answer to regulatory problems is not in adding additional powers to the Federal Reserve Board.
The Federal Reserve's role is monetary policy. This it is where it is held accountable, not on its ability to carry out financial regulation. When this Committee considers nominations to the Board of Governors, few questions are asked about regulatory policy. The concentration is on economic policy.
The argument for the Federal Reserve to be the dominant regulatory agency ignores the fact other countries purposely separate functions of their central banks from financial regulation to avoid a conflict between the two distinct roles .
Hard-nosed objective regulatory decisions that protect safety and soundness of banks and taxpayer-supported deposit insurance funds often do not coincide with a central's bank's concept of what promotes its whims on monetary and economic policy at any given moment.
For example, during the sharp drop in the stock market in 1987, the Federal Reserve was busy filling potholes in the economy. During this period, Continental Illinois exceeded legal limits on extensions of credit to one of its ailing subsidiaries, First Options. Continental's primary regulatory agency--OCC--cited the violation and ordered the bank to cease and desist in further loans to the subsidiary.
But, the Federal Reserve, agonizing over monetary policy and the drop in the stock market, decided that its purposes were best served by propping up the affiliate. As a result, it let the holding company parent--over which it had jurisdiction--extend more credit to First Options, effectively negating what the Comptroller had decided was the proper move to enforce safety and soundness regulations.
Countries that separate their central banks from regulation include Great Britain, Austria, Belgium, Canada, Denmark, Finland, Germany, Japan, Mexico, Norway, Sweden, and Switzerland.
Intertwined with the central bank should "control all" theory is a recurring theme that suggests that the Federal Reserve has a sterling record as a banking regulator. Reports from the General Accounting Office and Congressional investigations of various bank failures raise questions in this area.
A few years ago, the GAO cited a number of problems in the Federal Reserve's regulation of bank holding companies, noting that the Fed's "lack of minimum inspection standards has resulted in a superficial approach to the bank holding company inspection process."
And, of course, this is the Federal Reserve that failed to realize that BCCI, the rogue international bank, was secretly moving into the U. S. banking system --even though BCCI's major takeover--First American Bank--was located only seven blocks from the Federal Reserve in Washington, D. C. It was only after the governments of other nation's uncovered BCCI operations that the Fed learned of the bank's illegal presence in this country.
The Congress needs to take a careful look at the Federal Reserve's regulatory capabilities and record before it adds more power to the Fed.
House Banking Chairman Jim Leach battled against the odds in the House with a successful amendment to strip from HR 10 the ability for financial holding companies to acquire new baskets of commercial (non-financial) activities--the mixing of banking and commerce.
Unfortunately, the Leach amendment didn't solve the whole problem. There remains a huge loophole through a grandfather clause that allows securities and insurance companies which join financial services holding companies to retain the commercial activities engaged in prior to October 1, 1997. The grandfather clause is limited to 10 years, but the Federal Reserve is given the authority to extend this for five additional years.
More important, the history of grandfather clauses is that they often end up as "permanent grandfathers"---through provisions slipped into legislation when no one is paying attention years down the road.
There also remains the fact that unitary thrifts--in existence or applied for by April 1, 1998-- retain authority to engage in commercial activities. These powers would be transferrable when the unitary thrift is acquired or becomes part of a financial services holding company.
It is ironic that these efforts to promote the mixing of banking and commerce remain in the legislation at a time when such combinations of "crony capitalism" are creating so many problems for banks in Japan and Korea and other Asian countries.
The great concern about mixing banking and commerce is the potential for banks to make credit decisions on the basis of incestuous corporate relationships, rather than on credit worthiness. Such combinations ultimately would lead to a concentration of banking and economic resources and a reduction of competition throughout the economy--as well as creating lending decisions that could damage safety and soundness of insured banks and place taxpayer-supported deposit insurance funds at risk.
Proponents of the scheme argue that the limits on non-financial holdings--the so-called baskets--are sufficiently small to protect against these dangers.
But former Federal Reserve Board Chairman Paul Volcker, who has warned repeatedly about the dangers of banking and commerce, derides the claim that "limited baskets" provide any meaningful answer. Here is what he told the House Banking Committee:
Once the foot is in the door, the pressure to ease the necessarily arbitrary 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.
The Committee should finish the job that Jim Leach started in the House by stripping the remaining elements of banking and commerce from the bill.
The changing nature of the financial industry--including the provisions of HR 10--create new dangers for the Community Reinvestment Act.
No longer will community groups be knocking on the doors of just traditional banking corporations. In many communities across the nation, the financial center will no longer be just a bank, but giant conglomerates that may contain a big securities firm, a big insurance company, and possibly, a sizeable industrial corporation along with a bank. Resources, financial and managerial, in many cases, will be shifted from banks to affiliates. All this will mean fewer resources will be available and evaluated for CRA purposes.
Efforts to extend CRA to these affiliates were rejected in the House Banking and Commerce Committees. The Rules Committee blocked efforts to have the full House vote on the issue.
This Committee needs to require that these affiliates meet a CRA-like test. And as I mentioned earlier, the insurance subsidiaries also should be subject to anti-redlining provisions modeled after the Home Mortgage Disclosure Act which the banks are required to follow.
HR 10 makes the problem infinitely worse for communities. It requires non-bank activities to be placed only in Federal Reserve regulated holding company affiliates which are not subject to CRA. This would wipe out OCC's authority to allow banks to set up "operating subsidiaries" in the bank structure.
When OCC evaluates the capacity of the bank to serve its community, it considers the bank's total assets and profitability including earnings that flow to the bank from the operating subsidiaries. In the Federal Reserve structure, the profits of the holding company affiliates accrue to the parent holding company and are not evaluated as part of the bank's ability to meet community needs.
Opponents of requiring that CRA-like responsibilities be extended to holding company affiliates argue that the securities firms and insurance companies do not have deposit insurance and safety net protections of commercial banks and, therefore, there is no rationale to extend a CRA-like responsibility to these firms.
But, this argument ignores the fact the securities and insurance firms--will be wrapped around one or more federally insured banks. It is clear that the subsidy flowing from the federal safety net for banks also benefits non-bank holding company affiliates as well as OCC's operating subsidiaries.
In the real world of bank regulation, the benefits of the links to banking corporations could be sizeable for subsidiaries of a holding company. Invariably, bank regulators are nervous when an affiliate falls on bad times for fear that the public and the markets will perceive that this also means trouble for the insured bank.
It is clear that non-bank affiliates--as well as the banks--will be potential candidates for federal bailouts in order to protect the insured banks in the same holding company.
So there is a clear rationale for non-bank affiliates--as well as banks--to be required to meet a community responsibility test.
HR 10 allows bank affiliations with securities firms and insurance companies without prior regulatory approval--just a simple self certification that they are in compliance with regulatory requirements.
This effectively shuts out public comment on any aspect of the application. This means that efforts to determine whether these combinations meet the "convenience and needs" of communities in their market areas will be short circuited and community input effectively blocked.
As this Committee is well aware, the current wave of coast to coast mergers is raising concerns throughout the nation. This is a time to open the process to the public, not shield corporations within a grip of procedural autocracy.
The Committee should delete the absurd self-certification provisions and allow opportunity for both the public and the agencies to properly consider the applications for cross industry acquisitions.
This Committee announced hearings on HR 10 just eight days after the House of Representatives had struggled to adopt the legislation by a one-vote margin. Hearings have moved rapidly over the past ten days.
Mr. Chairman, I hope that this speed does not suggest that HR 10 has become the priority for the Committee.
From the standpoint of consumers and communities, HR 10 offers little and endangers a great deal. Low, moderate and middle income consumers, who have little surplus cash after meeting their monthly obligations, are not likely customers for HR 10's one-stop shopping centers.. Similarly, consumers are not looking forward to the mergers that will be fueled by the new profit centers created under HR 10.
Mr. Chairman, most consumers--struggling to stretch hard-earned paychecks--are looking for a banking system where they can obtain basic services without being hit with dozens of fees --charges that seem to escalate every time they walk into a bank lobby or access an ATM machine. They are looking not for financial supermarkets, but for banks that are willing to make credit available to all citizens and all neighborhoods on affordable terms.
Fees imposed by banks have become a disgrace. Few, if any, are based on costs. Today there are fees for using a counter deposit slip, for talking to a teller or, for that matter, to an electronic voice. Bounced check charges, running to $30 and more in some banks, have become a big money maker. Consumers who receive and innocently deposit a bad check in their account also get hit with a double-digit charge. No service, from the routine to the complex, escapes these fee factories.
Banks are getting bolder because Congress isn't doing anything to slow down these outrageous grabs of consumers' funds. Inaction by Congress is allowing banks, in effect, to impose a "transaction tax" that raises close to $18 billion from consumers annually.
Mr. Chairman, let me tell you the nation's consumers would cheer an all out assault against these unconscionable charges. HR 10 might make a select few happy. But consumers and communities are looking for basic economic fairness, not frills from Wall Street.
Even for those who believe that major changes in the financial world are inevitable, there clearly is no urgency, no need to rush an ill-considered, patched-together proposal like HR 10.
There will be the well-worn arguments that the regulators are allowing much of the change to take place by administrative fiat. That's a limited argument and certainly does not provide an excuse for passing a bad bill.
There are some who believe that HR 10 is the best Congress can do on this complex set of issues. There are others who suggest that the shortcomings can be fixed in future Congresses and that consumer and community concerns should wait until later.
Such arguments ignore the difficulties that will face reformers once Congress authorizes the formation of big conglomerates with hundreds of billions of dollars of assets. Not only will these conglomerates concentrate economic resources, but they will become immovable political forces.
It is a monumental task now to enact community and consumer protections against the opposition of any one of the three dominant players--banks, securities or insurance. When these three giants are combined under common ownership per HR 10, reforms may be impossible. Now is the time to push for the right kind of regulatory structure and community and consumer protections--while the industry groups are seeking something and are willing to come to the table.
The financial industry--securities, insurance and banks--are awash in profits. Banks, for example, have experienced five straight quarters of record profits. There is no emergency. There is nothing to suggest that this legislation should be a priority in the Senate or placed on a fast track. .
If Congress stampedes this legislation, as the giants in the financial industry demand they do, the day will come when the corruption or speculative risks, facilitated by HR 10, will materialize into gigantic taxpayer obligations to bail out these debacles. It will not go unnoticed who was responsible for laws that, even with the experience of recent bank failures, knowingly failed to foresee and forestall. Is anyone listening?
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