FINANCIAL INSTITUTIONS RESTRUCTURING

AND SERVICES ACT OF 1981

MONDAY, OCTOBER 19, 1981

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,

Washington, D.C.

The committee met at 9:05 a.m. in room 5302 of the Dirksen Senate Office Building; Senator Jake Garn, chairman of the committee, presiding.

Present: Senators Garn, Chafee, Schmitt, Proxmire, Cranston, and Dixon.

OPENING STATEMENT OF CHAIRMAN GARN

The CHAIRMAN. The Banking Committee will come to order. This morning marks the opening of the committee consideration of legislation which I am confident will mark the beginning of a new era of growth and stability for the Nation's financial system.

Almost 50 years ago, Congress rejuvenated a financial system suffering from the ravages of the Depression. To protect depositors, the FDIC was established. To promote mortgage financing, the home loan bank system became a reality. To protect the integrity of financial institutions, the business of commercial banking was statutorily separated from other forms of commerce.

What has resulted from such actions is a highly regulated and compartmentalized system, which has served the capital and financial needs of our country for five decades. We are now faced with new challenges brought on by diverse causes, of which we are all well aware, for example, high interest rate and inflation, increased competition among depository and nondepository institutions, development of sophisticated communications and other technical equipment, and the internationalization of financial and economic markets.

What Congress must do now is to revamp the statutory framework established over the past 50 years to insure that the financial system is able to continue to meet the savings and credit needs of the Nation.

The layers of competitive restrictions and regulatory requirements on depository institutions have to be reduced if those institutions are to compete in a changing environment with innovative and aggressive nondepository financial intermediaries. The legislation before the committee today, S. 1703, the administration-Pratt bill; S. 1720, the financial restructuring bill; S. 1721, the insuring agencies consolidation bill; and S. 1686, the local government NOW account bill, represents the first step toward comprehensive restructuring and upgrading of the financial system.

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As I have noted in statements introducing S. 1720, and announcing these hearings, S. 1720 represents the efforts of several committee and former committee members. Senators Heinz, Lugar, Chafee, D'Amato, Tsongas, and Mitchell are responsible for introducing in separate bills parts of S. 1720. Senator Proxmire, the distinguished former chairman of the Banking Committee, is a cosponsor of many of the individual bills. Thus I express my thanks to them and look forward to their continued interest in enacting necessary revisions to the banking statutes.

Pending legislation before the committee will sharpen the focus of the members, resulting in what should be final congressional action this year on a bill that will address some of the fundamental issues facing our financial system. Final legislation may not include all of that which is before the committee now, but I am confident that it will contain most of the major components.

For the past several years, this committee has considered various issues affecting the health and condition of financial institutions. What this legislation and these hearings represent are remedies for the health problems that go far beyond temporary relief.

There can be little doubt that financial market conditions have changed dramatically during the past 10 years. Consumers are interested more than ever in obtaining the market rate on their savings, putting an end to the historical pattern of low-yielding deposits, subsidizing relatively low-cost loans. Corporations, eager to keep their credit costs down, have issued large amounts of commercial paper, thereby bypassing banks as middlemen in the credit process. New financial products and services, such as money market funds and the secondary market for commercial paper have sprung up to serve the needs of the individual and business consumers. Such new developments, often the work of nondepository institutions, have heightened competition within the financial services industry.

By removing the unnecessary competitive restrictions and reducing traditional Government involvement in the operations of depository institutions, the legislation before the committee would allow such institutions the necessary latitude to determine for themselves how best to serve the savings and credit needs of their customers. Congress has considered revisions to existing competitive restrictions on depository institutions for several years. It began the process last year with the Depository Institutions Deregulation Act.

The pending legislation representing ideas and issues that have been before this committee as long, or longer, than I have been a Member of the Senate, represents another step toward a competitive and a stronger financial system.

Let me remind everyone that in preparation for this particular legislation we did hold 7 days of very intensive and detailed hearings this past spring. Those hearings were published in the last couple of weeks, more than 2,000 pages of testimony and information on which to base the direction that we now are going.

To sum up what I have said, it is just simply in my opinion that we have reached a point where we have a revolution going on in the financial services industry. The nondepository institutions that you are all well aware of-the Secretary's former company, Mer

rill, Lynch; American Express buying Shearson; Prudential buying Bache; Sears' getting involved in all of their new types of financial activities outside of the banking laws-we have created a very unfair situation. An unbalanced playing field, with some financial organizations not being able to have to abide by the same rules and regulations as other.

As I said in the hearings last spring, there are two ways you can go. There was a great clamor at that time for imposing reserve requirements on the money market funds and the nondepository type institutions. I reject that idea. It is against my basic philosophy to put more and more Government regulations on business. So the other alternative is to reduce the present rules and regulations on the depository institutions so that Government is not creating an unfair competitive situation. This is the beginning of that effort to restructure and reduce those rules and regulations that have hampered competition, so that the new types of institutions will not have an unfair competitive advantage.

So we are pleased to start these hearings today. And I would first turn to Senator Chafee to see if he has any opening remarks, before we go to the Secretary.

OPENING STATEMENT OF SENATOR CHAFEE

Senator CHAFEE. Well, thank you very much, Mr. Chairman. And I, too, want to welcome Secretary Regan to these hearings. And I also want to commend you, Mr. Chairman, for calling the hearings so swiftly following the introduction of the administration's proposals. The kind of structural changes proposed by the administration and included in title I of S. 1720, I don't believe can be viewed in a vacuum. They affect more than just the industry they are intended to aid. They affect the role of the S. & L.'s relative to the commercial banking, and the financial community in general-relationships which have been established by banking law that, as you know, has existed for decades.

Thus, the remedies for the thrifts, even narrowly drawn, will have a pervasive effect on other financial institutions. Moreover, the problems themselves that have led to the financial difficulties of the thrifts are also experienced by the commercial banking industry. Obviously, the thrifts have been hardest hit by economic conditions and problems in the housing industry. But economic conditions have contributed to increased competition by nondepository institutions, as you mentioned, and this competition has hurt banks along with savings and loan associations.

I agree with the broad approach we are taking, because many of the problems are widely shared and even the narrowest solutions will be widely felt. S. 1720 and S. 1721 will make some very important, valuable reforms that I believe will aid the thrift industry, promote competition, and encourage a broader range of services available to the consumer.

And I am delighted that the proposals I have advanced will allow banks, thrifts, and credit unions to offer commingled account services, including money market mutual funds. I am glad that has been included.

I completely agree with you, rather than imposing the restrictions on those institutions that are currently offering the money

market funds, it is better to free up those who are currently not able to compete because of the restrictions imposed upon them. I think such a measure as the commingling would help the banks and the thrifts by stemming customer outflow. Those institutions that set up their own funds would benefit from the fees generated. The proposal would also benefit the small investor by making available from depository institutions investment services that were previously available only to the wealthy.

We look forward to the distinguished witnesses that will be testifying and submitting their statement over the next few weeks to help us in shaping this legislation. So, Mr. Chairman, I look forward to these hearings. And I am glad the Secretary is here. The CHAIRMAN. Thank you, Senator Chafee.

Mr. Secretary, we would be happy to hear your testimony at this time.

STATEMENT OF DONALD T. REGAN, SECRETARY, DEPARTMENT OF THE TREASURY

Secretary REGAN. Thank you, Mr. Chairman and members of this distinguished committee. I appreciate the opportunity to present to this committee some recommendations developed by the administration to improve the operations of our financial system.

IMPROVING OUR FINANCIAL SYSTEM

I would like to discuss our recommendations in conjunction with your proposals, Mr. Chairman, and with those of other members of this committee, as contained in S. 1720, the Financial Institutions Restructuring and Services Act of 1981. I am delighted to see in the legislation developed by this committee so many ideas for improving our financial system that are shared by those of us in the administration.

As we proceed with our work, we must keep in mind the basic objective of providing the public with the best possible financial system. In recent years, the present system has produced an exceptional number of new products and services, many of them conveniences and benefits for consumers which cannot be offered by traditional depository institutions. Our financial system has evolved with a long history of institutional, product, and geographic restrictions generally for anticompetitive reasons, but in some cases to protect depository institutions themselves against risky ventures which might jeopardize their soundness and require the expenditure of Federal Deposit Insurance Funds.

In order to receive better products and services, or just a better return on their savings, consumers have frequently had to shift their funds from one institution to another, and in many cases outside the banking system itself. To avoid such distortions in the financial system, and the accompanying institutional and consumer inconveniences, we must rely more on deregulated markets and institutions.

With fewer Government restrictions, the financial system should respond more efficiently to changes in the economic and competitive environments for the benefit of everyone. This deregulatory effort is important to the administration, not only because it com

ports so well with the President's regulatory reform program, but because the effort should be especially beneficial to consumers. Those sections of S. 1720 dealing with the expanded powers of thrift institutions, savings and loan associations, and mutual savings banks, are justifiably an important priority of this committee. The thrift industry has always had problems in high interest rate periods, and it will continue to have them in future years, if fundamental changes are not made in the way it does business. Providing thrift institutions with new asset powers need not diminish their contribution to housing finance. Real estate lending is their area of greatest expertise, and they are likely to continue expanding this activity. The ability to make shorter term commercial and consumer loans should supplement their real estate lending and help the industry stabilize its earnings in periods when there is demand for commercial and consumer loans, but very little demand for mortgages. At the same time, more stable deposits, which will occur when thrift institutions are able to pay competitive rates on their deposits, should help ameliorate the cyclical character of the flow of credit to housing.

Moreover, we expect the new alternative mortgage instruments to make real estate lending more attractive to many financial institutions. S. 1720 would give thrift institutions many of the same asset and liability powers that commercial banks now have. We recognize that this legislation would not eliminate all inequalities between thrift institutions and commercial banks. But it would move us a long way in that direction.

Remaining inequalities can be dealt with at a later date, in other legislation, and in that regard we will shortly propose legislation that will address the tax disadvantages that result for commercial banks whose portfolios are configured like those of thrift institutions.

PROVISIONS IN S. 1720

These generally small banks, primarily engaged in housing finance, will be offered the same tax treatment as thrift institutions, which should significantly enhance the equal treatment of all types of small depository institutions. In this regard, Mr. Chairman, I would like to note that S. 1720 contains a number of provisions, which my written statement discusses in more detail, that would ease the burden of certain statutory constraints on small depository institutions.

The administration is especially pleased that steps are being taken to enhance the competitive potential of these institutions. Many other strictures on commercial banks, both small and large, should be alleviated. But until they are, thrift institutions should not be given advantages over commercial banks.

For example, S. 1720 would prohibit interstate branching by federally chartered thrift institutions that take on bank powers as defined in the legislation. We endorse this approach, because we believe it is essential to put thrift institutions doing bank-like business on the same geographic footing as commercial banks, until the ground rules for interstate branching of all kinds of depository institutions can be revised.