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OHIO SAVINGS AND LOAN CRISIS AND COLLAPSE OF ESM GOVERNMENT SECURITIES , INC . HEARING BEFORE A SUBCOMMITTEE OF THE COMMITTEE ON GOVERNMENT OPERATIONS HOUSE OF REPRESENTATIVES NINETY-NINTH CONGRESS FIRST SESSION APRIL 3, 1985 Printed for the use of the Committee on Government Operations U.S. GOVERNMENT PRINTING OFFICE 50-923 O 50-923 0-85--1 WASHINGTON : 1985 COMMITTEE ON GOVERNMENT OPERATIONS JACK BROOKS, Texas, Chairman FRANK HORTON, New York DON FUQUA, Florida JOHN CONYERS, JR., Michigan THOMAS N. KINDNESS, Ohio ROBERT S. WALKER, Pennsylvania CARDISS COLLINS, Illinois WILLIAM F. CLINGER, JR., Pennsylvania GLENN ENGLISH, Oklahoma ALFRED A. (AL) MCCANDLESS, California HENRY A. WAXMAN, California LARRY E. CRAIG, Idaho TED WEISS, New York HOWARD C. NIELSON, Utah MIKE SYNAR, Oklahoma JIM SAXTON, New Jersey STEPHEN L. NEAL, North Carolina PATRICK L. SWINDALL, Georgia DOUG BARNARD, JR., Georgia THOMAS D. (TOM) DELAY, Texas BARNEY FRANK, Massachusetts DAVID S. MONSON, Utah TOM LANTOS, California ROBERT E. WISE, JR., West Virginia JOSEPH J. DIOGUARDI, New York BARBARA BOXER, California JOHN G. ROWLAND; Connecticut SANDER M. LEVIN, Michigan RICHARD K. ARMEY, Texas MAJOR R. OWENS, New York JIM LIGHTFOOT, Iowa JOHN R. MILLER, Washington EDOLPHUS TOWNS, New York JOHN M. SPRATT, JR. , South Carolina JOE KOLTER, Pennsylvania BEN ERDREICH, Alabama GERALD D. KLECZKA, Wisconsin ALBERT G. BUSTAMANTE, Texas MATTHEW G. MARTINEZ, California WILLIAM M. JONES, General Counsel JOHN E. MOORE, Staff Administrator STEPHEN M. DANIELS, Minority Staff Director and Counsel COMMERCE, CONSUMER, AND MONETARY AFFAIRS SUBCOMMITTEE DOUG BARNARD, JR., Georgia, Chairman LARRY E. CRAIG, Idaho JOHN M. SPRATT, JR., South Carolina PATRICK L. SWINDALL, Georgia JOE KOLTER, Pennsylvania JIM SAXTON, New Jersey BEN ERDREICH, Alabama ALBERT G. BUSTAMANTE, Texas EX OFFICIO JACK BROOKS, Texas FRANK HORTON, New York PETER S. BARASH, Staff Director DONALD P. TUCKER, Chief Economist STEPHEN R. MCSPADDEN, Counsel JAMES M. PATES, Counsel (II) 7723 CONTENTS Page 1 Hearing held on April 3, 1985 ..... Statement of: Baker, Linda, Schreiber-, finance director, city of Pompano Beach, FL ....... 653 Barnard, Hon. Doug, Jr., a Representative in Congress from the State of Georgia, and chairman, Commerce, Consumer, and Monetary Affairs 1 Subcommittee: Opening statement Batties, Tom, chief deputy superintendent and general counsel, Ohio 174 Division of Savings and Loans Beason, Donald R., president and chief executive officer, Financial Insti332 tutions Assurance Corp. of North Carolina ........... Bulman, Paul E., commissioner of banks, Commonwealth of Massachusetts ......... 422 Brown, Charles H. , Jr., director, Division of Savings and Loan, State of 377 Maryland.............. Burns, James L., Jr., executive vice president, the Co-operative Central 356 Bank, Boston, MA 7 Celeste, Richard F., Governor, State of Ohio 198 Gray, Edwin J., Chairman, Federal Home Loan Bank Board ........ Hathaway, Pamela A., executive vice president, Pennsylvania Savings Association Insurance Corp ..... 312 Hogg, Charles C. , II, president, Maryland Savings-Share Insurance Corp ... 304 240 Horn, Karen N., president, Federal Reserve Bank of Cleveland ...... 55 Hunsche, Donald, executive vice president, Ohio Deposit Guarantee Fund . King, George C., administrator, savings and loan division, North Carolina 383 Department of Commerce .... ......... 347 Lapidus, Leonard, executive vice president, Mutual Savings Central Fund Luken, Hon. Thomas, a Representative in Congress from the State of Ohio ................ 47 McEnteer, Ben, secretary, department of banking, Commonwealth of 403 Pennsylvania ..... Martin, Preston, Vice Chairman, Board of Governors, Federal Reserve 230 System 673 Neild, William E., mayor, city of Beaumont, TX …………………………….. Oakar, Hon. Mary Rose, a Representative in Congress from the State of 49 Ohio .... Selby, H. Joe, Senior Deputy Comptroller for Bank Supervision, Office of 257 ........ the Comptroller of the Currency. Shad, John S.R. , Chairman, Securities and Exchange Commission, accompanied by Charles Harper, associate regional administrator, Miami 438 Branch Office, and Dan Goelzer, general counsel . Tew, Thomas, attorney, Finley, Kumble, Wagner, Heine, Underberg, Manley & Casey, equity receiver over ESM companies, accompanied by 481 Laurie S. Holtz, C.P.A., Holtz & Co. , Miami, FL.. Wylie, Hon. Chalmers P., a Representative in Congress from the State of 32 Ohio ...... Letters, statements, etc., submitted for the record by: Baker, Linda, Schreiber-, finance director, city of Pompano Beach, FL: 660-672 Prepared statement ............ Beason, Donald R., president and chief executive officer, Financial Institutions Assurance Corp. of North Carolina: Prepared statement ........... 334-346 Brown, Charles H., Jr., director, Division of Savings and Loan, State of ............. 379-382 Maryland: Prepared statement ... (III) IV Page Letters, statements, etc., submitted for the record by-Continued Bulman, Paul E., commissioner of banks, Commonwealth of Massachu424-428 setts: Prepared statement ............. Burns, James L., Jr., executive vice president, the Co-operative Central ........... 360-367 Bank, Boston, MA: Prepared statement .. Celeste, Richard F., Governor, State of Ohio: Attachments to prepared 10-17 statement ...... Gray, Edwin J., Chairman, Federal Home Loan Bank Board: 297 Information concerning $8 million loss ... 202-230 Prepared statement ... Hathaway, Pamela A., executive vice president, Pennsylvania Savings .... 317-331 Association Insurance Corp.: Prepared statement Hogg, Charles C. , II, president, Maryland Savings-Share Insurance Corp.: 307-312 Prepared statement . Horn, Karen N., president, Federal Reserve Bank of Cleveland: Prepared 243-257 statement ...... Hunsche, Donald, executive vice president, Ohio Deposit Guarantee Fund: 60-173 Prepared statement ............... King, George C., administrator, savings and loan division, North Carolina 385-402 Department of Commerce: Prepared statement ... Kolter, Hon. Joe, a Representative in Congress from the State of Pennsyl6 vania: Opening statement ............ Lapidus, Leonard, executive vice president, Mutual Savings Central 349-356 Fund: Prepared statement ......... McEnteer, Ben, secretary, department of banking, Commonwealth of .... 406-421 Pennsylvania: Prepared statement ................ Martin, Preston, Vice Chairman, Board of Governors, Federal Reserve 233-239 System: Prepared statement ....... Neild, William E., mayor, city of Beaumont, TX: Prepared statement ..... 677-687 Oakar, Hon. Mary Rose, a Representative in Congress from the State of Ohio: Article from the Wall Street Journal entitled "Bank Board Chairman's Cool Initial Response to Ohio Crisis Linked by Some to GOP Politics" 53 March 18, 1985, letter to Chairman Gray, Federal Home Loan Bank 52 Board, re Federal deposit insurance Selby, H. Joe, Senior Deputy Comptroller for Bank Supervision, Office of .... 261-282 the Comptroller of the Currency: Prepared statement . Shad, John S.R. , Chairman, Securities and Exchange Commission: Pre443-470 pared statement ............ Tew, Thomas, attorney, Finley, Kumble, Wagner, Heine, Underberg, Manley & Casey, equity receiver over ESM companies: Prepared state....... 498-652 ment ..... Wylie, Hon. Chalmers P., a Representative in Congress from the State of ...... 35-42 Ohio: Prepared statement .... APPENDIXES Appendix 1.-Private deposit insurance systems ..... A. Summary chart, characteristics of State/private insurance funds as of April 1, 1985 ......... B. Survey of State/private insurance funds 1. March 20, 1985, questionnaire to State/private deposit insurance funds regarding policies, operations, and powers ....... 2. Questionnaire responses C. June 12, 1985, letter to Subcommittee Chairman Barnard from Federal Reserve Board Chairman Volcker, regarding discount lending to nonfederally insured depository institutions from January 1980 to June 1985 .......... Appendix 2.- National Association of Securities Dealers (NASD) documents concerning ESM Securities, Inc. , and Ronnie R. Ewton ...... A. NASD board of governors decision in re: District Business Conduct Committee v. Hibbard & O'Connor Securities, Inc., dated October 23, 1975 ............ B. ESM's broker-dealer application to NASD (excerpts), dated November 19, 1975 ............. 691 691 696 696 706 1047 1049 1049 1066 V Page Appendix 3.-The SEC investigation of ESM Government Securities, Inc., 1977-81 ............... A. Amended SEC order of investigation, dated January 10, 1978. B. Text of SEC v. ESM Government Securities, Inc., (U.S. Fifth Circuit Court of Appeals), dated May 18, 1981 ...... Appendix 4.-The SEC investigation of American Bancshares, Inc., 1978-81 ..... A. Letter from Daniel L. Goelzer, general counsel, SEC, to Hon. Doug Barnard, Jr., dated June 12, 1985. B. SEC internal memo, "Telephone conversation with Louis Frank, OCC, re American Bancshares," dated July 13, 1978 ........... C. SEC order of investigation, dated November 28, 1978 ........... Appendix 5.-The SEC investigation of Marvin Warner's proxy fight with ....... Century Banks, Inc., 1981-82 ...... A. Letter from Steven W. Arky to Gary Lynch, Assistant Director of Enforcement, SEC, dated October 12, 1981. B. Lynch's response letter, dated October 20, 1981 .......... Appendix 6.-The SEC's investigation of Home State Financial Services, Inc. (HSFS), 1984-85 ......... A. SEC internal memo, "Chronology of Staff Inquiries Concerning Repurchase Transactions Between ESM Government Securities, Inc.,99 and Home State Financial, Inc. (now Home State Savings Bank), undated .......... B. Letter from John F. Murphy, Branch Chief, Division of Corporation Finance, SEC, to HSFS, dated February 27, 1984 ....... C. HSFS internal memo from David J. Schiebel to Marvin L. Warner concerning ESM, dated July 11 , 1984 D. Followup letter from Murphy to HSFS, dated August 7, 1984 ........ ..... E. HSFS internal memo concerning meeting between SEC officials and HSFS, dated August 21, 1984 .... F. Followup letter from Murphy to HSFS, dated August 24, 1983 ....... ..... G. Home State's amendments to SEC form 10-Q for quarter ending June 30, 1984, dated September 28, 1984 ..... H. Followup letter from Murphy to Home State dated December 12, 1984 ....... I. Letter from Home State to SEC, dated December 18, 1984 .. J. Followup letter from Home State to SEC, dated January 3, 1985 .... K. Letter from Home State to Murphy, dated January 21, 1985............... Appendix 7.-Federal Reserve documents ........... A. Letter from H. Terry Smith, vice president, Federal Reserve Bank of Atlanta, to board of directors, American Bancshares, Inc. , dated March 18, 1977 ..... ...... B. Comments of First Marine Bank, Inc., in opposition to ComBanks' application to acquire control of First Marine (excerpts), dated October 31, 1980 Appendix 8.-Federal Home Loan Bank Board documents............... A. Documents relating to the FHLBB's supervision of Unity Savings Association (Chicago, IL) .......... 1. Interim examination report, dated October 10, 1980 2. Unity response to FHLBB, dated November 20, 1980 .... 3. Examination report, dated January 6, 1981 4. Cease-and-desist order, dated February 27, 1981 ......... 5. Special limited examination report, dated March 23, 1981 .............. B. Internal FHLBB memo regarding proper accounting treatment of dollar reverse repos and loans of securities, dated January 29, 1980. C. Internal FHLBB memo regarding over collateralization of reverse repos, dated July 13, 1981 D. Memo from American Savings & Loan official to FHLBB concerning the "unwinding agreement" with ESM, dated March 23, 1985 ........... E. Letter from Marvin L. Warner to FHLBB regarding exam of American, dated November 1 , 1984 ............. F. Letter from Ronnie R. Ewton to FHLBB regarding exam of American, dated November 21 , 1984 ........ 1076 1076 1079 1088 1088 1091 1092 1095 1095 1100 1101 1101 1104 1118 1119 1125 1128 1133 1143 1146 1147 1148 1151 1151 1155 1247 1247 1247 1251 1259 1271 1277 1285 1287 1289 1292 1296 VI Appendix 9.-FDIC documents.......... A. Letter and attachments from William M. Isaac, Chairman, FDIC, to Hon. Doug Barnard, Jr., concerning the Ohio thrift crisis and ESM , dated April 1, 1985.............. B. Letter and attachments from Robert V. Shumway, Director, Division of Bank Supervision, FDIC, to Hon. Doug Barnard, Jr., concerning ESM, dated May 9, 1985 ...... Appendix 10.-Miscellaneous documents .......... A. Letter from Hon. Doug Barnard, Jr., to Steven J. Arky, dated March 27, 1985 ..... B. Letter from Danny O. Crew, assistant city manager, city of Pompano Beach, FL, to Hon. Doug Barnard, Jr., dated April 2, 1985 ....... C. Letter from Hon. Gerald Lewis, comptroller of the State of Florida, to Hon. Doug Barnard, Jr., dated May 15, 1985 .. D. Documents relating to ComBanks' investments with ESM, 1981 E. Letter from Arky, Freed to Alexander Grant & Co., regarding ESM, dated January 31 , 1985............... Appendix 11.-Press materials.... A. "Miami Bank Indicted on Charges of Laundering Illicit Drug Money," the New York Times, December 14, 1982 ........ B. "Marvin Warner: Horse Trader in Florida Banks," Florida Trend, March 1983...... C. "Behind the ESM Collapse," the New York Times, March 14, 1985 ...... D. "The SEC Is Probing Alexander Grant Audits of Collapsed ESM's Books, Sources Say," the Wall Street Journal, March 15, 1985 .......... E. "Home State Chief Put Assets to Work," Cleveland Plain-Dealer, March 17, 1985 F. "Closing of Ohio S&L's After Run on Deposits Is One for the Books ," the Wall Street Journal, March 18, 1985 . G. "Regulatory Failure on ESM," the New York Times, March 30, 1985 .. H. "Founders of ESM Lived High," Miami Herald, March 31, 1985 I. "ESM Doubts Led to Firing, Ex-Banker Said," Cleveland PlainDealer, April 19, 1985 ...... J. "Warner, Pals Undid Life's Work, Angry Miami S&L Founder Says," Cleveland Plain-Dealer, April 21 , 1985. K. "State Can't Keep Up With Securities," Miami Herald, April 28, 1985 L. "Regulator Ignored ESM Warning Signals," Miami Herald, April 28, 1985 ..... M. "How Many Hats Can Steve Arky Wear?", the American Lawyer, May 1985 ..... N. "The Rise and Fall of Marvin Warner," Business Week, May 6, 1985 .. O. "Bank Crisis Figure Shoots Self to Death," Washington Post, July 24, 1985 ........... Page 1299 1299 1305 1332 1332 1333 1334 1338 1347 1350 1350 1351 1358 1361 1362 1364 1368 1370 1372 1373 1375 1378 1380 1387 1391 OHIO SAVINGS · LAPSE OF AND ESM LOAN CRISIS GOVERNMENT AND COL- SECURITIES , INC. WEDNESDAY, APRIL 3, 1985 HOUSE OF REPRESENTATIVES, COMMERCE, CONSUMER, AND MONETARY AFFAIRS SUBCOMMITTEE OF THE COMMITTEE ON GOVERNMENT OPERATIONS, Washington, DC. The subcommittee met, pursuant to notice, at 8:30 a.m., in room 2154, Rayburn House Office Building, Hon. Doug Barnard, Jr. (chairman of the subcommittee ) presiding. Present: Representatives Doug Barnard, Jr., John M. Spratt, Jr., Joe Kolter, Ben Erdreich, Albert G. Bustamante, Larry E. Craig, Patrick L. Swindall, and Jim Saxton. Also present: Representatives Jack Brooks, Thomas N. Kindness, Mary Rose Oakar, Thomas A. Luken, Marcy Kaptur, and Bob McEwen. Staff present: Peter Barash, staff director; James M. Pates, counsel; Stephen R. McSpadden, counsel; Eleanor M. Vanyo, secretary; Faye Ballard, clerk; Scott Fisher, minority professional staff, Committee on Government Operations; and Dean T. Scott, subcommittee staff, on detail from the General Accounting Office . OPENING STATEMENT OF CHAIRMAN BARNARD Mr. BARNARD. The Subcommittee on Commerce, Consumer, and Monetary Affairs will come to order. On March 4, the Securities and Exchange Commission obtained a Federal court order forcing ESM Government Securities of Fort Lauderdale, FL, into receivership. The collapse of this little-known Government securities dealer precipitated a disquieting chain of events unprecedented in the recent history of our Nation's financial markets. The crisis began with the insolvency of Home State Savings Bank of Cincinnati, a $ 1.4 billion thrift institution which had extensive business dealings with ESM; and it ended with nervous international money markets bidding up the price of precious metals and bidding down the price of the dollar. In between these events, the Governor of Ohio ordered a bank holiday of the State's 70 privately insured thrifts; the Ohio Deposit Guarantee Fund, whose entire reserves of $ 127 million may have been exhausted by the Home State failure, was placed under the control of a conservator; hundreds of Federal bank examiners were (1) 2 dispatched to Ohio to prevent the thrift crisis from spreading and to speed the conversion of S&L's from private to Federal deposit insurance; the FSLIC and FDIC were swamped with calls from anxious S&L officials in other States seeking information on how to apply for Federal deposit insurance; and, dozens of municipalities and financial institutions across the country faced the bleak prospect of combined losses totaling $350 million or more. Today, the Commerce, Consumer, and Monetary Affairs Subcommittee of Government Operations begins hearings in an effort to determine whether the Ohio thrift crisis and the events that preceded it were avoidable; whether the major private deposit insurance systems in other States are secure; and, whether the Federal apparatus that supervises our Nation's financial and securities markets is sufficiently competent and aggressive to prevent a repetition of the Ohio situation or at least to minimize the damaging consequences of any repetition . The subcommittee seeks specific answers to the following questions: What did the Federal banking agencies and the SEC each know about the business conduct of ESM Government Securities and the ethics of its principals and when did they know it? Was information developed by one agency regularly shared with other supervisory agencies at the Federal and State levels? Were enforcement responses to ESM's tactics coordinated? If not, why not? What types of changes need to be made in our regulatory structure to assure such cooperative action? Did the Federal Reserve and the Home Loan Bank Board perform adequately in responding to the Ohio emergency? Should the Federal banking agencies establish, on a permanent basis, a standby rescue program for dealing with any similar occurrences in the future? Did the Ohio thrift regulatory officials perform their supervisory responsibilities adequately? Do the major private deposit insurance systems in the various States and elsewhere have the necessary procedures and policies to avoid an Ohio situation? Can these systems, either alone or together with their thrift supervisory agencies, properly monitor and prevent unsafe and unsound banking practices? And do these private systems need to be strengthened, and if so, how? The collapse of ESM Government Securities and the devastating impact of that event on financial institutions and municipalities across the country is a vivid illustration of the fragile interrelationships that exist among providers of our Nation's financial services. A failure on one financial sector can quickly spread to others and the results can be devastating. The failure of a securities dealer or a financial institution because of fraud is not a victimless crime. Just ask the citizens of Ohio, or the taxpayers of Beaumont, TX; Pompano Beach, FL; Toledo, OH, and other cities. Just ask the depositors and the arms-length stockholders of S&L's that did business with ESM. Last October, this subcommittee issued a report entitled "The Federal Response to Criminal Misconduct and Insider Abuse in the Nation's Financial Institutions." It concluded that one-half of all commercial bank failures and one-quarter of all thrift failures are 3 caused by insider criminal misconduct. Within the recent past, fraud also appears to have played an important role in the collapse of a number of nonregistered Government securities dealers like Drysdale, Lion Capital Group, Winters Government Securities, and, of course, ESM . Within the past few weeks , a growing number of major banks have admitted to significant violations of the currency reporting requirements of the Bank Secrecy Act. In combination , these events and these admissions raise understandable concerns about our financial system. While I believe that our Nation's financial markets are vigorous and essentially honest, a repetition of the Ohio episode could deal a crushing blow to the public's confidence in the integrity of those markets. It is essential, therefore, that this hearing lead to a significant strengthening of Federal and State regulatory systems that supervise financial markets. It has been suggested by some that this committee is playing with a political football in this investigation . Well, let me set the record straight. This committee has a long and excellent record of financial institution and regulatory investigations without the least tint of political association . Again, we are dealing here today in risky financial transactions over many years, longer than any period of office of most individuals appearing today. Even more importantly, they involve the loss of hundreds of millions of dollars to financial institutions and municipalities, thereby affecting depositors and taxpaying citizens . Investigations and studies of this committee are independent of any political party or any officeholder. Let me also note at this time that in yesterday's paper, it was announced that Attorney General Meese had outlined a program to better coordinate criminal prosecution of bank crime. I would like to say that this is directly related to the study that was made by this committee last year and is a typical example of the work that this committee aspires to perform. This morning we are very fortunate and pleased to have with us, the Honorable Richard F. Celeste, Governor of the State of Ohio. Governor, at the outset, thank you for taking your time to be with us today. I know it was of some inconvenience to fly in from Ohio today and I know that you are on a limited schedule, but we certainly do appreciate the contribution that you can make to this investigation today. And I would also like to note that there are several distinguished members of the Ohio delegation that are with us today and I want to welcome them to this hearing. Time permitting, I hope that we will be able to accommodate all of you as participants in this hearing. We will ask if any of you would like to make formal statements, and if so, we would welcome those statements. Governor, again we welcome you to be with us today and we will accommodate your entire testimony in the record . Without objection, his entire testimony will be entered into the record. If you care to summarize, you may do so at your own discretion . But before you begin, I would like to ask the distinguished senior minority member of this committee for an opening statement. Mr. CRAIG. Thank you very much , Mr. Chairman . 4 Let me say at the outset a special thanks for the very fair and bipartisan way you have approached this concern and this issue. You are to be commended and your staff is to be commended for the effort you have become involved in. Once again we enter a new chapter in our book of failed financial institutions in America. As in prior cases, we are faced with similar questions. What happened? Why did it happen? And how did it happen? Some of those answers will be forthcoming shortly during today's hearings. But another question needs to be asked. When will it stop? If we fail to address this question and soon, the American people will lose any faith they still have in our very important banking system. I fear the days of hiding one's savings under the mattress or 40 paces due north from the south side of the barn will occur once again and that, of course, cannot be tolerated. Many people would like to point fingers toward deregulation as the reason behind recent bank failures -a notion that I believe is seriously flawed. We are supposed to have a federal system of checks and balances which allows financial institutions to expand in the marketplace while at the same time ensuring stability and public confidence in our banking industry. For some reason, the status quo does not work as well as it should. Unfortunately, the Federal Government's checks and balances is intertwined in a massive layer of bureaucracy. It is this bureaucracy which allows those individuals who want to take advantage of the system to oftentimes do so. It is now known that several Federal agencies were aware of ESM Government Securities, Inc.'s activities years ago, yet failed to communicate their alarm to other Federal agencies. The State of Ohio was well aware of Home State's financial dealings with ESM and failed to stop them. Deregulation did not prevent the Federal and State governments from acting. Last week's committee hearings on Vice President Bush's task group report on regulation of financial services proposed ways to improve Federal regulations of financial institutions. I am going to review that report again to see if it contains a proposal requiring all Federal banking and thrift regulators to sit down together once a month, or once every other month, or once quarterly to discuss problem institutions and/or their investments. If they are not required to meet regularly they should be. If they cannot communicate together voluntarily then they should be legislated to do so. Likewise, the task force report suggests giving States more authority to regulate their State-chartered institutions. Obviously, the State of Ohio will not be used as an example of how well a State can oversee its chartered institutions. Nor should it be said that all State-chartered, private insurance corporations are improperly managed and regulated . Nevertheless, Congress will have to establish stringent guidelines before States take over greater regulatory powers. Finally, Mr. Chairman, Ed Gray, Chairman of the Federal Home Loan Bank Board, has recently received unfair attacks for the role he and the Federal Savings and Loan Insurance Corporation played in assisting the Ohio thrifts. Newspaper headline seekers have suggested that partisan politics were involved in his decision- LO 5 making during the Ohio thrift crisis. I find such remarks incorrect. The members of the subcommittee are well aware of the condition of FSLIC. I believe Chairman Gray acted in a prudent and highly professional manner by not succumbing to the pressures to immediately bring the Ohio thrifts into the FSLIC fund without first doing his required homework on each thrift. His first priority is to ensure financial soundness of FSLIC. Placing more bad apples into a basket that already has its share of bad apples would not be a responsible action. I am sure the thousands of savings and loans associations which are members of the FSLIC also appreciate the manner in which Chairman Gray has responded to this crisis. Let me thank you, Mr. Chairman, and welcome Governor Celeste before our committee. I look forward to hearing from him. Mr. BARNARD. Because of the Governor's schedule this morning, we are going to accommodate him first and then we will have questions from the panel and then we would like to have the testimony of Members of Congress who are here today; specifically, the Honorable Chalmers P. Wylie, the Honorable Thomas A. Luken, the Honorable Mary Rose Oakar, and the Honorable Thomas N. Kindness, if they would so like. Mr. KOLTER. Mr. Chairman. Mr. BARNARD. Yes, Mr. Kolter. Mr. KOLTER. May I submit an opening statement for the record, please? Mr. BARNARD. Without objection, that statement will be entered into the record. [The opening statement of Mr. Kolter follows :] 6 OPENING REMARKS FOR CONGRESSMAN JOSEPH KOLTER BEFORE THE GOVERNMENT OPERATIONS COMMITTEE COMMERCE, CONSUMER AND MONETARY AFFAIRS SUBCOMMITTEE ROOM 2154 RAYBURN HOUSE OFFICE BLDG. APRIL 3, 1985 - 8:30 A.M. Mr. Chairman, the events of the last several weeks, have sensitized the American public to the problems facing the Nation's banking system. The closing of the thrift institutions in Ohio was just another link in what seems to be a long chain of events that have caused the public to ask just what is going on in the Nation's banking system . While I realize that financial deregulation has brought much change for the better, it has also brought much uncertainty. My deep concern is that people with no real idea of what financial deregulation is all about, will feel less secure about their savings in the future. Confidence in the banking system is paramount to maintaining public trust and faith. Mr. Chairman, I would like to thank you for calling this hearing today. It is most timely. I am here to learn more about what occurred in Ohio and for a status report from the witnesses scheduled to testify. Mr. BARNARD. Do any other Members have a statement? Mr. Saxton. Mr. SAXTON. Thank you, Mr. Chairman. I would just like to note for the record and for the interest of those who are here with us this morning and for the public as well, that the perspective from which I believe this committee comes is not one that we wish to express tremendous immediate concern as to the health and welfare of our financial institutions across this country. This is one of a series of hearings that we have held relative to this subject. As the background that we set here in Washington for financial transactions relative to banks and thrift institutions has changed, because of deregulation, because of various changes that have happened on the Federal level, it has changed the financial workings of our financial institutions. And because that has happened, it is necessary for Congress to constantly monitor and watch, not only as the situation has developed in Ohio, but all across the country. And I think it is important to point out to the public and to those who are here today that we are not here because we expect some immediate catastrophe to happen with our banking institutions. It is because we are looking down the road and we are here today in a sense in a preventative way, to take whatever action may be necessary so that in the future we do not have to look at these kinds of situations in retrospect but rather we 7 are here today to look at them in the future in order to prevent these kinds of occurrences from happening again. And once again, if I can just emphasize that we do not expect, we do not think, in fact, we are sure that FSLIC and FDIC are currently able to handle their intended function. And so today we are here to look at the Ohio situation, to try and find out what happened in Ohio, to try and determine whether or not we need to make changes in our system so that these occurrences do not happen in the future. Thank you, Mr. Chairman. Mr. BARNARD. Governor Celeste. STATEMENT OF RICHARD F. CELESTE, GOVERNOR, STATE OF OHIO Mr. CELESTE. Thank you very much, Mr. Chairman, and members of the subcommittee, and particularly Representatives from the State of Ohio. During the past 4 weeks I have become directly and deeply involved in a crisis which threatened the underpinnings of Ohio's thrift industry, and frankly, part of the fabric of our Nation's highly sophisticated financial system. Four weeks ago this morning, Cincinnati's morning newspaper headlined the fact that Home State Savings, Ohio's largest privately insured savings and loan institution, had suffered a severe loss in connection with the massive fraud at ESM Government Securities in Fort Lauderdale, FL, compounded by a false audit report. After 3 days, well over $ 100 million had been withdrawn from Home State by worried depositors, about a third of the assets of the private Ohio Deposit Guarantee Fund were used up to meet the Home State run, and as officers of Home State and ODGF worked to find a buyer, the institution closed its doors. On Sunday, March 10, the superintendent of the Ohio Savings and Loan Division in the Department of Commerce, appointed a conservator to protect the more than 70,000 remaining depositors in Home State and the $520 million they still have on deposit there . The State of Ohio moved as quickly as it could to protect the half million depositors at the 71 remaining privately insured thrifts. By the following Wednesday evening, in record time and with strong bipartisan support, Ohio had passed an emergency appropriation of $50 million as a loan to a new, private insurance fund for those other S&L's, none of which had been tainted with the losses involved in the collapse of ESM . But depositor fears outran legislative efforts. By Thursday, March 15, runs had spread to a growing number of institutions in Cincinnati and elsewhere. Officials of several thrifts had come to Washington and had pronounced private insurance dead, and Federal officials at this stage indicated that this was, in the first instance, a State problem requiring a State remedy. At 5:30 a.m. on Friday, March 25, after reviewing a series of options with affected savings and loan executives, State legislative leaders, key administration personnel, and Federal regulatory officials, I determined that there was a high probability that one or ∞ more of the S&L's would not be able to keep open that day and that additional failures would seriously jeopardize at least 70 other institutions. I ordered a 3-day holiday for the privately insured thrifts so that we could establish an orderly plan for the reopening of all these institutions with sufficient protection to rekindle depositor confidence. I might add that in close cooperation with the Federal Reserve Board and its Chairman, Paul Volcker; and Mrs. Karen Horn, president of the Federal Reserve Bank of Cleveland; the Federal Home Loan Bank Board and its Chairman, Edwin Gray; and Dr. Charles Thiemann, president of the Home Loan Bank of Cincinnati, we are getting these institutions reopened -stronger than ever, and in record time. As of this morning, 10 working days after passage of special legislation requiring Ohio's S&L's to apply for and qualify for FSLIC or FDIC, we have reopened 29 institutions, representing more than 40 percent of the depositors. And these institutions, I might add, are stronger than ever. With this brief summary, let me indicate to you four recommendations, Mr. Chairman, that I would draw as lessons from the past 4 weeks for you and members of the committee. First, the immediate and specific cause of this crisis was largescale fraud in an unregulated Government securities trading company in Florida. If ESM were healthy today, if its audited statements were accurate, we would not be holding this hearing this morning. The Federal Government must provide greater oversight of those who make the market for Government securities, a market which I understand from a recent Wall Street Journal article is trading at $70 billion a day. Second, apparently Ohio's supervision of our privately insured S& L's was sufficient to identify a problem at Home State. "Too many eggs in one basket," according to my commerce director, Ken Cox. But our regulatory process proved insufficient to cure the problem. I am sharing with you-as attachment A to my testimony-several public accounts which highlight this serious concern, going back over two administrations . I have ordered my director of commerce and my superintendent of savings and loans to review both our procedures and our statutory authority and to recommend changes. I have also strongly supported the appointment of a special prosecutor, who is now at work, and asked that his original charge be expanded to include a report "of any deficiencies which may have occurred in the State regulation of Home State Savings Bank and recommendations of any changes which ought to be made in State law, regulations, personnel, and practices in order to protect against a situation such as this ever arising again. " He has agreed to this further assignment . The State of Ohio must provide stronger regulation of our Statechartered thrifts and possibly other financial institutions . That is the second lesson I draw from this experience. Third, despite reassurances by my former superintendent of savings and loans to the contrary, and I have attached as attachment 9 B his memo to me in early January, the Ohio Deposit Guarantee Fund fell short in two important respects. First, relating to public misperception, and the second, relating to private insufficiency. On public misperception- most depositors believe that the "Ohio" in Ohio Deposit Guarantee Fund meant that the State of Ohio stood behind the fund. This misperception was so widespread that in the April 1 issue of Business Week, it is still referred to as a private, State-guaranteed fund . Depositors should know the full and accurate facts about who stands behind such private guarantee funds. Second, in terms of private insufficiency-even though ODGF enjoyed a capital-to-asset ratio of 2.7 percent, roughly $ 138 million of capital to $5 billion of covered assets, the fund proved insufficient to withstand the failure of its largest member. Thus, to my understanding the history of Mississippi and Nebraska was substantially repeated. At a minimum, States with private deposit guarantee funds must assure that their capital and reserves are capable of handling the possibility of failure of their largest member institution . For our part in Ohio, we are insisting on Federal insurance, or an acceptable guarantee from a parent big enough and strong enough to cover every single deposit. Finally, it was apparent in the days immediately preceding my decision to protect depositors in Ohio's thrifts by closing them that there were no well-charted emergency powers by which Federal regulatory agencies could have helped us to head off the crisis. Closing 71 S&L's, most of them healthy but threatened by a growing loss of confidence, meant that our State's problem became part of a larger set of considerations. Such extraordinary State action should be unnecessary in the future. As our national and international financial system grows more complex, more fast paced, and more interdependent, I strongly urge not more day-to-day intervention at the Federal level, but more readily accessible emergency powers to intervene directly and early in situations which could, left to run their course, do damage far beyond one thrift or one State. I want to thank you very much for this opportunity to share the Ohio perspective with you this morning. [Attachments to Mr. Celeste's prepared statement follow: ] 10 The Columbus Dispatch/Tuesday, March 19, 1985 Even though Home State directors pledged in 1983 to lessen the S& L's involvement with E.S.M., the transactions instead increased, reaching more than $600 million that year. Home State had $1.4 billion in net warned in '82 worth and assets. W. Tyler, director of deman said he feared that furc- theWarren Ohio Department of Coming Home State out of the merce By Michael Curtin from January 1983 to Feb. DispatchGeneral AssemblyReporter transactions too quickly would said hewas aware Home Who knew what when? And bring down boththe S&L and the 2,1985, cate had problems, but had no Guarantee Fund. why wasn't something done Ohio Deposit Because Home State was the idea they were solarge. The Diviabout it? sion of Savings and Loan Associr t its fund, the of membe larges Those are the questions state is within the Department Tegislators will ask in an investi- failure would have jeopardized ations ofCommerce. gation of the collapsed Home the fund, Wideman said. "I CAN'T SAY we were State Savings Bank, which trig"It seemed obvious to me that gered a crisis of confidence in, the amount of required assis- unaware there was attention beand the closing of, 69 privately tance would have been fatal to ing paid to Home State," said Tyler, who now is director ofthe the fund," he said. insured savings and loans. "I was prepared to deal with Ohio Environmental Protection When legislators ask their Agency. "But there was attention questions, they will hear Clark the loss of one institution," Wipaid on a regular basis to a W. Wideman, former superinten- deman said. "It was the very being number of companies" in a.vardent ofthe Ohio Division of Sav- significant way the failure of iety of regulated areas. ings and Loan Associations, say Home State would have affected Tyler said he had no direct the guarantee fund" that prethe red flag went up in 1982. knowledge of the communication the intervention, he said. THAT WAS when Wideman's vented "I COULD NOT determine between the Division of Savings examiners reported that Home anything more appropriate to do andLoan Associations and Home State, owned byprominent Dem- than to jawbone and armtwist," State, saying it was "the sole berat Marvin L. Warner, was Wideman said. "We did the best authority of thesuperintendent." dangerously overinvested in we could. So far as I can tell,the Tyler said he was more than E.S.M. Government Securities guys who came in after us did surprised by Home State's faiInc., which failed March 4. lure and the amount and comthe same thing." "There was a tremendous essentially 's Wideman successor, C. Law- plexity of the E.S.M. transac amount of hand-wringing at the rence Huddleston, who served tions. "I thought I understood a top levels" of the division, said from February 1983 to January repurchase agreement," he said. Wideman, who was appointed by 1985, said he could not comment. "It's an amazing story." then-Gov. James A. Rhodes and first order of business is "The served from September 1978 to to get it (the S&L closings) reFebruary 1983. Home State's unusually large solved. I don't want to detract and risky investments in repur- from that effort." However, other sources with chase agreements - in which cash was borrowed in exchange experience in the division confirmed there were continuing effor securities of greater value prompted him "to jawbone and forts by the division and by armtwist" in an attempt to get the ODGF to persuade Home the S&L to reduce its dealings State to reduce its dealings with with E.S.M. of Ft. Lauderdale, E.S.M. "WE ENTERTAINED the Fla., Wideman said in an interless-than-well-placed hope that view. ALTHOUGH THE superin- Home State could wind out of tendent has the authority to or- those transactions," Wideman der divestiture in such cases, Wi- said. Home State 11 THE PLAIN DEALER, SUNDAY, MARCH 31 , 1985. Regulators to propose stricter laws for S& Ls CINCINNATI (AP) — Ohio's savings and loan regulations turnedoutto be inadequate in the wake of the Home State Savings Bank collapse, and politicians and regulators have decided it is time for changes. John Mongeluzzo, state Commerce Department staff lawyer, says talks already have begun within the departmentondrafting new legislation. Lawrence Kane, a Republican special prosecutor appointed by Attorney General Anthony Celebrezze, has been asked to make recommendations for regulatory procedures while investigatingthecase. "One of the problems with the S&L laws as theystand is that wecanbark, but wecannot bite," Mongeluzzo said. "The laws, as stated, ... are very vague. " Two former directors of the loan division agreed on the need to strengthen state enforcement laws. Clark Wideman, superintendent from September 1978 to January 31, 1983, said he and other officials knew years ago that their regulatory powers were not enough. “But at the same time, we were all cognizant that this was the era of deregulation. "Proposing tougher laws with more teeth in them was swimming upstream against the tide," Wideman said Former Assistant Attorney General Roger Sugarman said it has long been clear that judges frowned if the state threatened to issue a " cease and desist" order to stop a state-chartered thrift from engaging in "unsafe and unsound activities. "Youhave to have more than just 'One ofthe problems with the S&L laws as they stand is that we can bark, but we cannot bite' suspicions to convince a judge that a cease and desist order is needed," said Sugarman, who served from 1980 to 1982. Wallace Boesch, S&L superinten dent from 1972 to 1974, said today's regulations are better, but not good enough. "WhenIwasin there, wedidn't even have the cease and desist power. That's only about 4 years old. All I could do was browbeat people, or, if their assets were used upto the point where ...the public's money was becoming endangered, I could go to the attorney general and ask for orders toclose them down. But there was nothing in between." Boesch complained that although state examiners can look at thrift records every 18 months, they cannot examine the books of holding companies that own such thrifts. But state bank examiners can. State Rep. William Batchelder, R4, of Medina, said, "The superintendent of savings and loans has enough power.All he has to do is exercise his muscle. " Rick Spencer, Commerce Depart spokesma ment 31 division n, saidsixtheless examiners, only its than has highest level in recentyears. Salaries range from $ 16,300 to $30,430 a year, Spencer said. Commerce Director Kenneth Cox, formerCommerce Director J. Gordon Peltier and Wideman all said the state knew Home State had invested a dangerously large amount of money with ESM Government Securities Inc., of Fort Lauderdale, Fla., as early as 1982. But state officials under former Gov. James A. Rhodes and Gov. Richard F. Celeste took no legal actions to stop Home State. Celeste has said his administration knew of no problems with Home State before 1983. Wideman said Home State officials promised him in 1983 that they would phase outtheir ESM dealings. Instead, the Cincinnati thrift doubled its stake in ESM. Disaster struck after the U.S. Securities and Exchange Commission closed ESM on March 4. The securities firm owed its creditors $300 million. Home State, which was state-chartered, suffered a $144 million loss from ESM's closing, and a four-day run by depositors in 33 branches removed about $ 154 million more before the thrift closed March 9. On March 15, Celeste closed the other state-chartered thrifts when depositor runs started on some of them. Depositors withdrew an estimated $60 million in one day from the thrifts, which were insured by the privately operated Ohio Deposit GuaranteeFund. Ohio law would have allowed state officials to stop the Home Statedisas ter by ordering directors fired and imposing a cease and desist order after a public hearing,officials said. The superintendent could fine any thrift officer up to $10,000 for ignoring the orders. The superintendent could also close the thrift and appoint a conservator, which was done. BUREAU PO California Nebraska .and 60 two to response "la Minutes ." prophesy COLUMBUS Richard F.Gov. Celeste assured was 7inemo maJan. and Ohio ofSavings Division Ohio the from ." Loan pri Ohio's that Associations vately insured thrifts were safer than insurance deposit state falled in funds SHARKEY By ANNE MANY 198529 MARCH FRIDAY DEALER PLAIN THE Celeste said s week last the memorandum was his first awarenes Ohio dhad guarant fund .Haeposit e ee memora the "afcalled alse ndum -TV CBS on reports the about Nebraska California funds ,tand he Celeste tohe statutory ,"Tmemo sald regulatory and shortcomings that existed inexist those states not lado soundness system ofthe . SavState ,Home later months Two after Cincinnati of Bank Ings Government ESM Securites inclosed Inc. " Florida his 7. .Tled failed toaronun Home State and several other pri- Lawrence ,it. .CIndeed was Hudd leston superintendent ,former of Ohio's memorandum ,sS&Lintheaid s stringent Ohio regulations has and annual Independent ensure to audits After 6TV Jan. the Hudd segment rcalls ,"Ieceived wrote home atleston depositors from institution and managers .This happened never has inmy -ynd ,two atenure suggests ear ." can nervousnessmake damaging potentially received 10 Tmay division . hecalls exist between (a9.m. nd )o9.30 Jan. n Huddleston explained that Califor vately thrifts insured . Ohio in 1956 . state in law ."⚫ tions ." funds ,Hime fund Nebraska uddleston said ,dThe oes full any have -tnot by avand olunteer employees isrun Oboard Deposit ."hio's Guarantee thrifts insures nia Nebraska and ,"both banks industrial insures of something are acwhich of ross between redit sunion aácmall and loan with ,bcompany ut restric fewer tions the on types of investments they Huddleston's January memoranDeposit Ohio stated dum Guarantee thrifts -breacked strin ,“aFund more gently industrial are than regulated assets .The guaranteed .tobanks sav than ishigher fund the of ratio ings federally (the FSLIC insured ),system fund instiand of capital average the than ishigher tutions instituFSLIC memorandum The out point not did are thrifts and banks insured federally backed by federal government .the constitution Ohio prohibits .The pledg ing enterprivate back to money state prises .The by created was ODGF California Huddleston the described "as funds Nebraska and flawed fatally failure ."todoomed and Huddleston : declared accurately depend "All institutions financial on could not confidence ,and depositor depositor ."without confidence exist "60 the said memorandum The deposi revealed "segments Minules Caliand Nebraska in money lost tors ,"but fornia the why explain not did . failed funds insurance Ohio the that regrettable isI"t subject isthe Fund Guarantee Deposit the because concerns depositor of supervision and structure inadequate )and California Nebraska (the of ." basket inone eggs many thas supervisory -afFund ull ime staff and condition the monitors which practices of companies insured ."its State officials admit concern was expressed Home about Savings's State extensive investments ESM in Securi Commerce .Ohio ties Department Director Home said Cox Kenneth State hwarned "was about aying too State & S c L hief ry told Celest e Janua in all was OK 12 Beacon Journal Akron March ,1Friday 29 985 13 gered a statewide closing order ings & Loan and thus will meet by Celeste March 15. the requirement for federal insurCeleste This week, a second savings ance, which Mayflower already and loan was placed temporarily has. East Side was to reopen for under a conservator after reports full services today, McAlister that some of its officers withdrew said. misled their money improperly in the He said East Side will be the wake of Home State's troubles. among the privately insured The conservator was called in 27th S&Ls that now have been given Wednesday. for federal insurance orapproval with have merged Robert B. McAlister , current conditional current McAlisteofr, savings RobertB. by memo state superintendent federal inhave institutions that and loans, said the conservatorIt said Ohio's ship ofthe Oakmont Savings and surance. These have been allowed Loan Co. in Cincinnati ended to- to open their doors for unlimited business, he said. S&Ls were safe day McAlister allowed Oakmont to Meanwhile, the owner of Home reopen Thursday after closing it State, Cincinnati financier MarAssociated Press Wednesday to investigate reports vin L. Warner, 65, has denied any CINCINNATI - A Jan. 7mem- that one or more officers had wrongdoing and claims he is as orandum from a former state drawn their own money out in much a victim as the savings and savings and loan superintendent violation of a March 13 state or loan association's depositors. assured Gov. Richard F. Celeste der. Warner, who has kept his that Ohio's privately insured sav. Oakmont president Howard whereabouts secret since Home ings and loans were safer than Thiemann said the institution has State's closing, made a statement troubled state deposit insurance its application for fed- Thursday through a public relafunds in California and Nebraska. completed eral insurance and would be open tions firm.. The memo, made public Thurs for business today. "For 30 years, I have taken day, was in response to two 66 "My wife, children and I have pride in Home State Savings, the Minutes reports on CBS-TV about our life's savings in Oakmont and service it has rendered to its dethe Nebraska and California we will make no withdrawals ," positors and the community. funds. prepared statement. said he in a regulatory statutory and "The "Now, the bank and its deposishortcomings that existed in Information gathered about the tors, along with my family and those states do not exist in Ohio," incident has been turned over to myself, have become the victims the memo said. the special state-appointed prose of what appears to be a massive Celeste has said the memo was cutor looking into Ohio's savings fraud,” he said. his first indication that Ohio had and loan crisis. "It is my hope that officials in a deposit guarantee fund. He Federal and state bank exam- Ohio will handlethis issue in such called the memo "a false prophe iners and Thomas Batties, the a way that every depositor and sy." superintenddeputy debenture state's chief holder will get every he said. A text ofthe memo was made ent of savings and loans, were penny back,” public Thursday by Celeste at a back at Oakmont on Thursday to conference with newspaper edi- finish reviewing thebank's books. " The bank's doors have been tors in Columbus. Battles declined to say when the locked, and my associates and I investigation completed January would be memo, by C. LawThe have not been given the opportu rence Huddleston, said, "All fi- but said Oakmont would be al nity to help reopen its doors or nancial institutions depend on de- lowed to stay open and that the assist in its sale. I do not know how long this will take, but it is positor confidence, and could not exist without depositor confi- savings and loan is able to meet my prayer that this will be soon, " dence." its money demands. Warner said. The erosion of confidence At his daily news briefing on Warne r is one of 12 Home State caused the collapse of Home the savings and loan situation, officia ls named in a $432 million State Savings Bank in Cincinnati, McAlister announced that East by lawyers on which remains under a conserva- Side Building & Loan of Cincin civil suit filed Home State conservator Arlo tor, and a run on other savings nati has worked out a merger Smith' claimi behalf savs ng the were and loan associations that trig agreement with Mayflower Savings and loan's problems caused by their negligence and reckless mismanagment. Warner did not refer to the suit. 14 A COM STATE OF OHIO Department of Commerce Two Nationwide Plaza Columbus, Ohio 43215 MEMORANDUM January 7, 1985 To: The Honorable Richard F. Celeste Governor of Ohio Speaker Vern Riffe President Paul Gilmore From: C. Lawrence Huddleston, Superintendent Division of Savings and Loan Associations Re: 60 Minutes spots on private insurance of deposit accounts. Each of the past two weeks, CBS has run investigative spots on "60 Minutes" about the failed state deposit insurance funds in California and Nebraska. The California Fund insures "Thrift and Loans," the Nebraska Fund insures "Industrial Banks." Ohio does not have these types of institutions, both of which are something of a cross between a credit union and a small loan company, but with fewer restrictions on the types of investments they can make. Last Monday, after the "60 Minutes" piece on California, two institutions reported significant outflows, although neither could be classified as a "run." • The Division and many institutions received telephone inquiries. After the latest piece, aired January 6 , I received calls at home from depositors and institution managers. This has never happened in my two-year tenure, and suggests a potentially damaging nervousness may exist. The Division received 10 calls between 9 and 9:30 on January 7. In the event that you wish to respond to constituent inquiries, we have attached the statements being made by this office, plus a copy of our special edition Newsletter mailed to the institutions after the December 26 "60 Minutes" broadcast. CLH:gre Attachments cc: Warrem W. Tyler 15 Ohio Savings and Loan Superintendent C. Lawrence Huddleston today issued a statement. in response to recent "60 Minutes" investigative reports on the failures of an Industrial Bank in Nebraska and a Thrift and Loan in California, and the "insurance pools which were to protect depositors. "Both the Nebraska and California insurance corporations have deficiencies not shared by the Ohio Deposit Guarantee Fund: • Ohio - Selective underwriting of savings and loans by Fund Nebraska/California - must insure Industrial Banks and Thrift and Loans · Ohio - Fund has full-time professional staff Nebraska/California - no staff at all, á mere mail order pool of money. · Ohio - Fund exercises supervision over member savings institutions Nebraska/California - no supervision of any kind over activities of insured banks. Ohio - Fund requires monthly report Nebraska/California - No reporting required Ohio - Fund has more than $40 million in reserves and approximately $130 million available to cover losses Nebraska/California - Nebraska fund, according to our information had only $2 million. Ohio - Fund insures only savings and loans Nebraska/California - Funds insured industrial banks The Ohio Deposit Guarantee Fund is a mutual deposit guarantee fund authorized by state law in 1956. The Fund and its member institutions are examined at least every 18 months by the Ohio Division of Savings and Loan Associations. The State has required annual independent audits. Ohio's savings and loans are more stringently regulated than are industrial banks. The assets to guaranteed savings ratio of the Fund is higher than FSLIC, and the average capital of Fund institutions is higher than FSLIC institutions. In short, the Ohio Division of Savings and Loan Associations views the Nebraska and California "insurance funds" as fatally flawed and doomed to failure. The statutory and regulatory shortcomings that existed in those states do not exist in Ohio. All financial institutions depend on depositor confidence, and could not exist . without depositor confidence. "60 Minutes" revealed that citizens lost money in Nebraska and California, but did not explain why the "insurance" funds failed. It is regrettable that the Ohio Deposit Guarantee Fund is the subject of depositor concerns because of the inadequate structure and supervision of the funds. The Ohio Deposit Guarantee Fund meets the requirements of Ohio law and the regulations of the Division of Savings and Loan Associations. 16 The Ohio Deposit Guarantee Fund has been in existence since 1956. It is different from the troubled Industrial Bank Fund in Nebraska in several important respects. The Nebraska fund has no full-time employees and is run only by a volunteer board of directors. Ohio's Deposit Guarantee Fund has a full-time supervisory staff which monitors the condition and practices of its insured companies. Ohio's Deposit Guarantee Fund investigates and qualifies those it insures before insurance of accounts is granted whereas the Nebraska fund is obligated to admit all who apply, irrespective of quality. The Ohio Deposit Guarantee . Fund is chartered and examined by the Superintendent of Savings and Loan Associations of the State of Ohio. No. depositor has ever lost money in any institution with Guarantee Fund coverage. The Ohio Deposit Guarantee Fund has more than $130 million . available to cover depositor losses, and earned more than $ 10 million dollars on its investments in 1984. 17 OM N ME RT A EP ME RC IONS 4 E Rapid OVI ASSO • CIAT D Regulatory SIO NO Review NG AVI FS & LOAN Special Edition ' . Richard F. Celeste Governor WarrenW.Tyler| Director An Equal OpportunityEmployer C.Lawrence Iluc Superintend December 1 On the CBS evening news December 26 there was a news story on the failure of the California Thrift Guarantee Fund. The Division has received inquiries from customers ⚫ of institutions insured by the Ohio Deposit Guarantee Fund, and several Fund-insured companies have also received inquiries about Ohio's Fund as a result of the CBS story. The Superintendent and the Division have worked diligently in both the General Assembly and the Congress to insure the continued right of states to authorize private insurance of accounts. The Ohio Deposit Guarantee Fund - and similar funds in North Carolina, Massachusetts and Maryland -differ dramatically from the failed bank fund in Nebraska and the failed Thrift and Loan fund in California. Lest the Ohio Savings and Loan industry be damaged by unsupportable comparisons, we thought it important to share the differences in protection Ohioans enjoy over funds in other states. The California and Nebraska funds are simply pools of money. We are informed they must insure all who apply, have no full-time employees, exercise no supervision or control over member institutions and have no authority of any kind to take steps to .. prevent or control problems. By contrast, the Ohio Deposit Guarantee Fund exercises discretion over who they do and do not insure (having, refused insurance to applicants in the past 18 months), has a full-time professional staff, exercise comparatively rigid supervisory controls over selected member institutions, and have virtually unlimited contractural authority over those institutions. In addition, the Fund itself is regulated by the Division of Savings and Loan Associations in roughly the same manner as we would regulate a savings and loan association.. The Ohio Deposit Guarantee Fund has 72 member. institutions. The Fund earned in excess of $10 million (net) in the 12 months ended June 30, and now has reserves in excess of $100 million... In summary, the statutory and regulatory shortcomings that permitted the failure of the California and Nebraska Funds do not exist here in Ohio where the Legislature has provided more authority to the regulatory structure. The savings institution community in Ohio can be helpful to depositors by understanding that, compared to nonsupervisory funds in other states, a significantly better operating environment is enjoyed by the Ohio Deposit Guarantee Fund. 18 Mr. BARNARD. Thank you very much, Governor. Governor, it appears that there are 41 savings and loans that still remain closed in Ohio. What are the prospects for those 41? Mr. CELESTE. Mr. Chairman, I believe the prospects for those 41 and particularly for the depositors in those 41 institutions, are very good. Most have made application for FSLIC insurance. And we estimate that a good number of them, 10 to 20, are likely to be processed by the same expeditious processing which the Federal Home Loan Bank has been assuring us in the past 2 weeks. There are a group of them who have indicated the desire to find a strong partner . For them, merger is really important for them to operate safely in the future, and we have retained an investment banker and working with the superintendent of savings and loans to assist in that process and facilitate it. For the remaining group, which really falls in between the first, relatively easy to process, and the latter, who need a strong partner, we are looking at the possibility of some kind of shared entry into the FSLIC in which the State uses what we now have on the table which is about $60 million . I mentioned $50 million- that has been increased to about $60 million-to see if there is not a way in which we can help them meet the capital requirements, help them maintain the standards which FSLIC expects of them properly so that they can qualify. So it is our hope that we can get all of them open reasonably quickly. It is important to the depositors that they have that access to their funds. Mr. BARNARD. Governor, there is substantial evidence that the Ohio Thrift Division knew many years ago about the massive unsafe and unsound financial transactions between Home State and ESM, but failed to do anything about it until it was too late. Do you have any plans to improve your thrift supervisory division so as to minimize the possibility of any future failures? Mr. CELESTE. Mr. Chairman , as I pointed out in my testimony, I think it is vitally important that we do precisely that. I look forward both to the recommendations of my own director of commerce and of the person I have installed who is fresh and from outside is the superintendent of savings and loans , as the changes we should make, both of a statutory nature and of a procedural nature, possibly including the additional personnel. In addition, I think it is very important to take quite seriously the report of the special prosecutor who will be looking at all of the implications of how this matter was handled, and I intend to do so. Mr. BARNARD. Have you gotten any indication from your State supervisor - and you mentioned this in your testimony -why it was difficult to determine this connection between Home State and ESM even though you said that it was acknowledged that they knew about it, but it was difficult to disassociate it? Could you elaborate on that to some degree? Mr. CELESTE. I can tell you what has been reported in the press . I have not had the results of any of the investigative work at this point and in terms of what was reported in the press, on several occasions plans were put in place, and in fact may have been under way to find a way to disinvest in- if that is a proper term - in ESM. The problem was how to manage that in such a fashion that you did not cause a crisis that you sought to avoid. In other words , 19 whether it was by public exposure of a concern that might cause a loss of depositor confidence through the mechanics available to the superintendent and his staff, or whether it was through substantial losses that might be incurred by a plan that required the sale of their investments in an unfavorable situation . Mr. BARNARD. The problem is that first of all we are mindful that the supervisory forces of Ohio did make an attempt to separate the two. In other words, that Home State could buy back their repos. But the irony of it was that while a plan was made to decrease the amount, it actually increased. Mr. CELESTE. You are asking the same questions that I am asking of both my superintendent and of a special prosecutor to examine. am not sure when a plan was put in place. I am not sure what evidence we have of a commitment on both sides to see to it that that plan was implemented . That is part of what we have to determine. I come back to this fact. If ESM had not practiced fraud and if the audited statements were accurate, we would not be confronting this issue in this situation today. Mr. BARNARD. This is what our concern is. Because fraud was evident even back in 1977, and this is where we just―― Mr. CELESTE. There has never been evidence of fraud, Mr. Chairman. Excuse me, Mr. Chairman. There has never been evidence of fraud to my knowledge conveyed to anyone in Ohio's Department of Commerce, Division of Savings and Loan. Mr. BARNARD. We will be coming back to this time and time again today. Because we can trace the knowledge of ESM through many Federal agencies, as well as State agencies. And credit unions. And it is just hard for us to understand why this information was not considered serious. Governor, I believe you announced yesterday that an out-of-State purchaser had been found for Home State . Can you provide us with any of the details of this purchase? Or any further information? Mr. CELESTE. Mr. Chairman I have learned to be very cautious in the last 4 weeks in the matters of banking, as you yourself I am sure are from your own experience in the field . No one is more understandably conservative than are the leaders of the banking community. Let me say this. At the time at which we recognized the dimensions of the crisis at Home State, Home State officers themselves were, and the representatives of the Ohio Deposit Guarantee Fund were in discussions with an Ohio bank about the possibility of a sale. Home State was then also presented to other banks in Ohio and out-of-State banks. In the past week, we have had an indication of substantial interest with the framework for moving forward. For an out-of-State bank to acquire Home State in Ohio and to operate it as a bank would require change in our State law and that matter is now in the hands of more attorneys than I would like to think of this morning to try to work it out. Mr. BARNARD. But you still have a deposit base at Home State of over $500,000. Mr. CELESTE. We have a deposit base of about $520 million , in 34 well-located branches and I am happy to say that. Mr. BARNARD. Are you getting any help in this possible acquisition by the Federal Reserve, the FDIC, or the Home Loan Bank Board? 20 Mr. CELESTE. Yes. I think we have had very close cooperation by all of the Federal regulatory agencies in the effort to consider a buyer, a purchaser, for Home State. Mr. BARNARD. Governor, how would you rate the performance of the Federal Reserve and the Federal Home Loan Bank Board in responding to Ohio's thrift crisis? Mr. CELESTE . Mr. Chairman and members of the committee, I would say that there have been two time periods in which we have dealt. The time period before the declaration of a bank holiday and the time since. I think that the view generally was what we had up until the time I declared the holiday and closed these institutions was a State problem and it required a State remedy. That there was no obvious way in. I think you mentioned some kind of a Federal standby authority. That does not exist today for this kind of a situation. And so I would say as Governor of Ohio I had to seek a remedy on our own terms essentially. Certainly, there was a recognition of the seriousness of the problem at every stage of the way, and willingness to provide advice and support in trying to understand and get our hands around that problem on the part of the Federal Reserve and the Federal Home Loan Bank. Since the declaration of the holiday, we have had extraordinary cooperation. In fact, before that I should say we had Federal Home Loan Bank, or Federal Reserve examiners and others in to help. They came in early to take a look at what might be done in order to assure liquidity at the point at which we reopen institutions. Mr. BARNARD. What has been the response of the financial institutions that were closed in your [bank] holiday? Were they responsive to that affirmatively or did they feel like it was unnecessary? Mr. CELESTE. Mr. Chairman, two institutions chose to remain open in spite of the superintendent's order on Friday morning that the holiday began. One vice president announced that he knew his customers and he was confident that they could continue to be open. By noon, he had closed his institution and said the Governor was right and he would stay closed as long as the Governor required him to be closed. I met with about 130 individuals who represented these 71 institutions the Sunday evening in which the holiday was to come to an end, at that point contemplating emergency legislation to require Federal insurance and to keep them closed until we had secured it. In those conversations which lasted about an hour and a half, there was an opportunity for the executives to speak face to face with me. The vast majority of them expressed appreciation for the fact that they were closed. I said that I would like a written request that I keep them closed . I think understandably they deferred on that matter, but they did offer a rising indication of their opinion. Ninety-five percent of them asked me to keep them closed . But after the meeting about 95 percent of them said that they really would rather be open the next morning. Now, to me that is perfectly understandable. These are individuals whose business is to be there to do business with their depositors and with their customers. And I think it is very difficult for any of them to go out and say on Main Street, " I do not want to be open this morning." But certainly to the Governor, they indicated 21 their desire to stay closed, to have a procedure that would expeditiously get them Federal insurance, either FSLIC or FDIC, depending on the circumstances. And that is what we have achieved. Mr. BARNARD . The fact that so few, comparatively, asked for use of the Fed's discount window, as opposed to the availability of the discount window, does that indicate to you that the management felt confident that they could withstand this crisis? Mr. CELESTE. I think what happened is that the crisis moved selectively from 1 or 2 institutions to 4 or 5 to perhaps 7 of the 71 that were experiencing severe runs on the day before the institutions were closed . Forty of these institutions were concentrated in a media market in southwestern Ohio where they were being belabored by some who urged them that it was time to panic , take your tents, take your cots, lineup in front of the institutions and there were people sleeping overnight in front of a growing number of institutions as Friday dawned. I think it is fair to say that the circumstance was moving very rapidly, and up to that point in time, no one at the Federal Reserve had really had an opportunity to make a judgment about the quality of assets against which these institutions might borrow at the discount window. Mr. BARNARD. Governor, let me ask this question. With all of this experience behind you, will you be proposing that your State deposit insurance fund, as well as your State supervisory agency, be strengthened from the standpoint of what it can require of bank management as to management, capital, and other management practices? Mr. CELESTE. Mr. Chairman, yes, I will. In fact, during the course of this crisis, we issued orders on the kind of trading that could be done, withdrawals, compensation dividends, that might be undertaken by the 71 institutions that were involved. It is my feeling that we have to be more aggressive . I need guidance from those who are investigating exactly what has happened . And the advice of my director of commerce. But I intend to see that strengthened. Mr. BARNARD. You may check a note from the FDIC and the FSLIC. The Congress gave them the power of cease and desist a number of years ago. We certainly would strengthen their hands. Mr. CELESTE. Mr. Chairman , we have a cease and desist power in the State law that requires an opportunity for public hearings shortly after the order is imposed and that problem of public hearing is one that raises often the very difficulty that one is trying to avoid. What I have learned in this is that cash is not the most important ingredient in our banking system. It is confidence. And anything which undermines that confidence is really a greater threat than whether the cash is there at the withdrawal window. And so I am concerned that we reexamine how we strengthen our ability to set standards and enforce them in ways that avoid the danger of undermining confidence. Mr. BARNARD. I have one final question and that is: What is your best estimate as to when the depositors of Home State will be paid off and whether they will recover all of their deposits? Mr. CELESTE. My goal has been from the outset to try to make them whole in the Home State situation . I have been reluctant to make a commitment because it may require standing behind our 22 efforts at sale or something else by the State of Ohio that will be quite likely before the general assembly in the next several days . It is my feeling that we will work urgently in the next few days to have in place a mechanism that gets Home State reopened, gets the depositors protected 100 cents on the dollar, but that is probably a matter of a couple of weeks, not a couple of days, to be done. Mr. BARNARD. How would you recommend, based upon this very difficult episode, that the Federal supervisory agencies can do a better job of protecting those who deal with Government securities dealers? Mr. CELESTE. But surely, Mr. Chairman, if there is information available to Federal regulatory agencies about potential problems at any Government securities dealer, I think that information ought to be available to the State regulatory agencies who deal with financial institutions. I am not familiar enough because my background is not banking and finance to give you a technically strong answer, but as a chief executive officer of a State concerned about a panorama of potential problems, certainly good information about potential difficulties in a timely way is the single most important resource that we can look forward to. Mr. BARNARD . Thank you . Mr. Craig. Mr. CRAIG. Thank you very much, Mr. Chairman . Governor Celeste, we appreciate your openness and frankness about this critical issue. Have any depositors in Ohio lost money yet? Mr. CELESTE. No depositors in Ohio at this point have lost money. Mr. CRAIG. There has been no money lost? Mr. CELESTE. That is right. There may be some, officers and shareholders at Home StateMr. CRAIG. I used the word "depositor." Mr. CELESTE. Who are also depositorsMr. CRAIG. I see. Mr. CELESTE [ continuing]. Who may have money at risk. Mr. CRAIG. Would you tell us the relationship the State government has in Ohio with the Ohio Deposit Guarantee Fund? Mr. CELESTE . Currently, of course, the superintendent has appointed a conservator so that the Ohio Deposit Guarantee Fund is really within the supervision, directly of our division . Mr. CRAIG. Where was it prior to closing—— Mr. CELESTE. It was a private guarantee fund established under a statute passed in the mid-1950's which was subject to some supervision by the division of savings and loans but which operated independently and by virtue of bylaws adopted by the participating institutions. And operated with an assessment from them. I believe that one of its officers will be here shortly and probably could give you a better evaluation or description of that relationship. Mr. CRAIG. There was no State regulatory responsibility or direct oversight of this fund? Mr. CELESTE. I believe that the superintendent could exercise a regulatory authority—— Mr. CRAIG. But I mean there was no quarterly or monthly or Mr. CELESTE. To my knowledge, there was no quarterly or monthly supervisory review of the Ohio Deposit Guarantee Fund. You will see in my testimony a memorandum that was prepared for me 23 and for legislative leaders about the fund by our superintendent of savings and loans back at a time when public questions were raised because of the Nebraska situation. Mr. CRAIG. What type of people then made up the advisory board or the control board or what the proper title is of the fund itself? Mr. CELESTE. You will have to ask the-I apologize. Mr. CRAIG. You are not aware of that? Mr. CELESTE. I am not aware of that. I assume it was the officers of some of the participating institutions. But for accurate information I would defer to the officer of the Ohio Deposit Guarantee Fund. If I may, Mr. Chairman and Mr. Craig, point out again that the "Ohio" in the Ohio Deposit Guarantee Fund was in many respects misleading. Mr. CRAIG. Apparently misunderstood, too . Mr. CELESTE. Of course, misunderstood . Mr. CRAIG. The reason I asked those questions is because our investigation showed the rather notorious dealings of ESM were well known nationwide, in part by a lot of people starting in the late 1970's, by bankers and by savings and loans people. Yet, we seem to have had a phenomenal inability to communicate the Federal involvement and the Federal concern versus knowledge on the part of those who are active at State levels with similar responsibilities to our Federal regulatory groups to understand the magnitude of the problem, and therefore, some continued to do business with this group. Let me then ask the question, Governor, why did you not place the full faith and credit of the State of Ohio behind the Ohio Deposit Guarantee Fund? Mr. CELESTE. Under our constitution, on the advice of the Ohio attorney general, we could not do that. We could make a specific commitment to a private, nonprofit fund of an appropriation . We did that in the case of the second fund. There was no willingness on the part of the members of the general assembly-leadership of the general assembly-to undertake that with respect to Home State. Mr. CRAIG. So in other words, this is why you created the new fund? Mr. CELESTE. That is exactly right. Because it was not subject to the massive hemorrhage caused by the ESM failure and that was the reason for commitment to a new fund. Mr. CRAIG. How many supervisors of the Ohio Division of Savings and Loan Association has there been since 1984? Mr. CELESTE. Since 1984, the superintendent of savings and loan indicated to me his intention to resign in about November 1984, but actually stepped down in mid-January. We appointed an acting superintendent at that time, Thomas Batties, who was a member of the legal staff at the division. He was made superintendent during this crisis because under our law he could not sign any binding document unless he were serving as the superintendent. But the superintendent who I appointed, Robert McAllister, was appointed about 2 weeks ago this time. Mr. CRAIG. So there have been approximately three during that time? 24 Mr. CELESTE. There really have been two and an acting person who was made superintendent in order that his signatures have the full power of the office. Mr. CRAIG. What is the responsibility of that office? Mr. CELESTE. That office has all of the regulatory authority. As a matter of fact, in terms of examination reports, the ability to act on those examination reports, it is in the hands of the superintendent. Even the director of the department in which that division is placed does not have authority under our statute to review examination reports or to act on those examination reports. Mr. CRAIG. He does not have authority? Mr. CELESTE. The director of the department does not have authority. Mr. CRAIG. But this gentleman does? Mr. CELESTE. This individual does have that responsibility. That is exactly right. Mr. CRAIG. Do you know why the first person resigned? Mr. CELESTE. No. I think part of it may have had to do with a quarrel over that authority in which the director chose to exert his leadership as director in terms of all of the divisions in his department. And on that score, I would support the director, let me say, rather than the superintendents. Mr. CRAIG. In October of 1983, the superintendent of the division of savings and loan instructed Home State to wind down its transaction with ESM. In January 1984, all the directors of Home State agreed to a program of winding down ESM's relationship . I understand all directors agreed except one . Do you have any idea who that dissenter was? Mr. CELESTE. No, I do not. The information you are providing me is not information that I have directly. My view, and I would go back to this, is that we must examine every aspect of this transaction to determine what is involved and what the lessons are for our regulatory operations. Mr. CRAIG. And your supervisor or the superintendent of the division of savings and loan did not communicate those transactions to the Office of the Governor? Mr. CELESTE. Absolutely not. The first time that the Office of the Governor became familiar with the problem at Home State was the evening before the article appeared in the Cincinnati Inquirer. Four weeks ago last evening. That was the first evidence, the first expression of concern with respect to Home State and its operations period. Mr. CRAIG. Well, then, who does the superintendent report to? Mr. CELESTE. The superintendent reports to the director of commerce, but the superintendent has the responsibility to deal with those problems and if he does not of his own accord walk forward and say this is a problem, if he believes he is handling the problem , it would be as in any other agency, his responsibility to do that. Mr. CRAIG. And then the director of commerce you say is the title that he reports to? Mr. CELESTE. That is right. Mr. CRAIG. Ultimately then would report to you? Mr. CELESTE. That is right. Mr. CRAIG. And he brought this information to you? 25 Mr. CELESTE. No. No one-but let me go back. No one brought this information. Mr. CRAIG. You read it in the newspaper? Mr. CELESTE. We had a call and I could not tell you exactly from whom-the call to my chief of staff on Tuesday evening, the day after the SEC had closed ESM, saying that there was a serious concern about the impact which the ESM situation would have on Home State Savings because of the extent of Home State's investment. My own personal knowledge of this really began the next morning with the publication of the Cincinnati Inquirer story. Mr. CRAIG. Thank you. Thank you, Governor. Thank you , Mr. Chairman. Mr. BARNARD. Mr. Spratt. Mr. SPRATT. Mr. Chairman, I yield to my distinguished colleague and chairman of the Government Operations Committee, Mr. Brooks, if he would like to proceed ahead of me. Mr. BROOKS. I will let the members go on and question the Governor. We are glad to have you here, Governor. And I will make a brief statement after you leave. Mr. CELESTE. Thank you very much. Mr. BROOKS . I know he has a time problem . Mr. BARNARD. The Governor does have a time problem and I would like to be able to accommodate that time as much as possible. Mr. Spratt. Mr. SPRATT. Governor Celeste, thank you for appearing here on rather short notice. Could you tell us, even though it did not happen on your watch, what motivated the State of Ohio to create the Ohio Deposit Guarantee Fund in 1958? Mr. CELESTE. Mr. Chairman, I cannot tell you. I think it was probably a determination that these that there should at least be an alternative for the State-chartered institutions to Federal insurance, but I was not a member of the general assembly at that time, although I am older than I look, and feel older than I look . And was not-frankly, the first time I heard of the Ohio Deposit Guarantee Fund was when a memo unsolicited came to my office from the superintendent, the January memo which is part of my testimony, saying these are the circumstances involving it. And so I am not familiar with its history. Mr. SPRATT. Do I understand your testimony correctly to mean that the State, the Governor's office, and the State legislative leaders, are now rethinking that decision? It seems to me that you are saying that you are going to require in the future either a big enough parent for a guaranteed fund to assure adequate coverage, or Federal insurance. Are you abandoning the idea of a mutually held State-administered guarantee fund? Mr. CELESTE. Mr. Chairman, Mr. Spratt, we have abandoned it. We have passed legislation that requires that these previously insured ODGF institutions, privately insured institutions, must apply for Federal insurance, must show evidence that they would qualify for Federal insurance or must-and then the superintendent can exercise discretion- or must have a parent who can provide a guarantee in proper form to satisfy the superintendent that all depositors are protected. 26 We, for example, have several loan associations who do not have mortgage portfolios that are not your traditional savings and loan, would not qualify for FSLIC insurance, but have very strong parents and there is a firm guarantee of all of the amounts of the deposits in writing with the superintendents, probably as strong a guarantee as you can get anywhere. But that is the only alternative to Federal insurance as far as this Governor is concerned and as far as our general assembly is concerned for the future, in my judgment. Mr. SPRATT. Fine . I would like to ask more questions, but in light of the time constraints on all of us, I will pass up. Thank you for being here. Mr. CELESTE. Thank you. Mr. BARNARD. Mr. Saxton. Mr. SAXTON. Governor, in previous hearings this committee has had relative to FSLIC and FDIC, one of the considerations that we have taken note of is proposed regulations by those agencies to regulate the amount of direct investment by thrift institutions and banks of various kinds. I am curious to know if you know offhand what percentage of Home State's net worth was invested in ESM? Mr. CELESTE. I think that substantially about half of its assets were in ESM at that time. Its net worth was- or equity was very small. I do not have that information in front of me directly, but I think there are people here who could answer that for you. Mr. SAXTON. Our conversations with FSLIC and FDIC have indicated that a safe level might be 5 or 10 percent of its worth. Mr. CELESTE. I think that is right. Mr. SAXTON. And your indication is that Home State had perhaps 50 percent of its net worth invested in ESM? Mr. CELESTE. Yes, Mr. Chairman. Yes. Of its assets. Actually substantially more than its net worth. Mr. SAXTON. Does the State audit for this type of information? Mr. CELESTE. Yes, we do. And, Mr. Chairman, Mr. Saxton, in my testimony I have shared with you some articles that spell out the concerns that have been expressed over a number of years by those involved. I think our examiners flagged this problem. I think that the question was how do you cure the problem and whatever reasons for the failure to cure that problem are now the matter of investigation, an investigation I strongly support. And we point out also it is not simply Home State that brings us together this morning, but the fact of closing 71 other institutions. None of them invested in ESM. To my knowledge, none of them had this same kind of a problem. And one of the points I would like to emphasize is that unfortunately healthy strong institutions and a very strong thrift industry in Ohio suffered because of the failure at Home State as a result of massive fraud at ESM . Mr. SAXTON. Then if I am hearing you correctly, you are indicating to us that somehow the State had knowledge that this large amount of investment was directly invested in one firm and either could not or did not do anything to remedy the situation? Mr. CELESTE. That is exactly right. I think the second lesson I point out is that we were able to identify the problem, but not cure the problem. And that is a matter of serious concern in terms of our regulatory capabilities. 27 Mr. SAXTON. In light of that, would you say-was anyone in your administration aware of Home State's difficulties before the crisis actually occurred? Mr. CELESTE. Well , I assume that the superintendent of savings and loan was working with them on that. And I think the record will show that and that is part of what will be examined, both by the new superintendent and my director of commerce , new director of commerce, and by a special prosecutor. Mr. SAXTON. One final question, Mr. Chairman. In light of what has happened, do you feel that this subcommittee should make recommendations relative to major changes as they affect private insurance companies? Mr. CELESTE. Yes. Mr. SAXTON. Thank you . Mr. BARNARD. Mr. Kolter. Mr. KOLTER. Thank you , Mr. Chairman. Governor, do you and your banking people in Ohio feel that possibly the Home State Bank problems could have been avoided if the Federal securities regulators had been more vigorous, perhaps strong? Mr. CELESTE. Mr. Chairman, Mr. Kolter, if vigor was the problem, I suppose that will be identified . It may have been communicating information clearly if there were concerns as the chairman and others have indicated about the quality of business practices at ESM . There is no question in my mind that if ESM were healthy today, we would not have had the problem at Home State. Mr. KOLTER. Do you believe the Federal response to the banking crisis in your State was satisfactory? Mr. CELESTE. I am having a very satisfactory relationship with all of the Federal regulatory authorities during the last 2 weeks, and I think there is a real question about-let me take it back. Before the bank holiday, there is a real question about how any of the Federal regulatory authorities stepped in to help. And I am not sure there is a clear path for that to happen. Mr. KOLTER. Thank you, Governor. Mr. CELESTE. Thank you. Mr. BARNARD. Mr. Swindall. Mr. SWINDALL. Governor Celeste, if I understand your testimony correctly, you are stating that in spite of the fact that your capitalto-asset ratio was really not that unlike the capital-to-asset ratio we have with federally insured Mr. CELESTE. Better, as I understand it. Mr. SWINDALL. Better. That the real flaw came in the fact that under your State constitution you are prohibited from really putting the full faith and credit of revenue, tax revenue. Is that essentially correct? Mr. CELESTE. Mr. Chairman, Mr. Swindall, I think there are two aspects of a problem. The first, that even with a well-capitalized fund in relationship to the largest institution, it was not sufficient to meet that. One of the advantages I think of FSLIC and the rest is that though they may not have the same capital-to-assets ratio, there is no single institution that can put the same kind of call on the fund, if it is in trouble. 50-923 0-85--2 28 The other aspect of it, of course, is that the State of Ohio-the legislature of the State of Ohio cannot pass a resolution like the one the Congress passed in 1982 saying that the full faith and credit of the U.S. Government, in this case, the government of the State of Ohio, is behind this institution. We have a debt limitation. We balance our budget and we are required to make specific appropriations for specific purposes. Mr. SWINDALL. But there was no prohibition whatsoever from you as Governor putting into effect some action that would have called on workers' compensation fund, pension funds, revenues from lottery profits, or for that matter any "nontax revenue," to back up and give what was in effect full faith and credit and is it not true that former Gov. Jim Rhodes said that is precisely what he would have done in the same situation? Mr. CELESTE. Mr. Chairman, as all the Members of Congress know, States have only one Governor at a time, and this Governor did talk to the leaders of the general assembly, both parties, who indicated that they were not prepared to recommend the appropriation of any money at that point in time in connection with the situation at Home State. And so a Governor cannot unilaterally commit funds of the State, nor should a Governor be able to, any more than I think that the President could commit funds of this country . Mr. SWINDALL. But, Governor, what you are saying to us is that some other solution for future problems needs to be solved. But my point is that under extraordinary circumstances, extraordinary leadership is necessary and had extraordinary leadership been taken in this situation we might well have avoided the panic that occurred from literally weeks of floundering, rather thanMr. CELESTE. Mr. Chairman, Mr. Swindall, let me make sure the record is correct here. Extraordinary leadership was exercised, both by the Governor and the Ohio General Assembly. Now, there were no weeks involved . There were 3 days involved between the time in which the story broke and the substantial loss at Home State Savings and the time in which the president of Home State closed his doors on a Saturday morning. We placed Home State into a conservatorship on Sunday. That is less than a week. During that time, I met with legislative leaders to propose potential remedies. We had two problems. Home State directly, and 71 other institutions which were part of a private insurance fund threatened themselves because Home State's hole was so big it could absorb all of that fund and leave them, for all practical purposes, uninsured. In that time, the Ohio General Assembly at the request of the Governor prepared legislation and within 3 days passed legislation appropriating $50 million, a step which I am told by Chairman Volcker and others was unprecedented by any State in an effort to protect those other institutions. So I think that before you make a judgment about both the nature of leadership and the causes for panic in Ohio, it would be important to recognize the extraordinary nature of the steps that were taken and the fact that today those depositors are protected and those institutions are reopening stronger than ever. Mr. SWINDALL. In closing, you do, however, concede that in retrospect it might well have been better to have pledged those nontax 29 revenue related assets of the State in support of full faith and credit, rather than Mr. CELESTE. Mr. Chairman, Mr. Swindall, no , I do not concede that at all. Mr. SWINDALL. Thank you. Mr. BARNARD. Time has expired . Mr. Bustamante . Mr. BUSTAMANTE. Mr. Chairman, let me yield some of my time to my colleagues from Ohio. I would like to yield to the gentlelady from the State of Ohio, Mary Rose Oakar. Mr. BARNARD. Ms. Oakar is recognized. Ms. OAKAR. I want to thank the chairman for yielding to me. I want to thank the chairman for allowing us to sit with the committee. The chairman and I serve on the full Banking Committee together and I have great respect for the chairman and my colleagues on this committee. Governor, I just simply want to compliment you on your statement today. I think that your spirit of openness was very, very important and the leadership you provided in those critical days was important. You cannot say it, but I later will, and you have stressed that you have gotten tremendous cooperation in the last 2 weeks and know you got very fine cooperation from the Federal Reserve prior to your decision to close the banks, but I intend to pursue politics involved and I just wanted to make that statement for the record and thank you for being here. Mr. BARNARD. Mr. Kindness . A member of the overall committee. Mr. KINDNESS. Thank you , Mr. Chairman, and Governor Celeste, we welcome you here today, but I think you would agree, Dick, that we have got to stop meeting like this. I am concerned about a phase of the matter that is bound to have been overlooked in the process of quickly responding to the difficult situation with which you and the general assembly were faced, and that is some of the very small savings and loans, to the people who are depositors in those institutions. They have just as much concern about being able to get access to their funds for necessary purposes as do depositors of the larger ones that may qualify for FSLIC coverage, but they are too small . And one of them happens to be the Summerville Savings & Loan in our area, in Preble County, and I believe there may be one or two in that small category. Is it contemplated by the legislation passed by the general assembly that the only out for those small institutions-that one I mentioned happens only to be open 1 day a week. It is a very small operation. Is the only out for them to merge into another savings and loan? Mr. CELESTE. Mr. Chairman, Mr. Kindness, I do not know that the only out is for them to do that. There may be other vehicles under discussion. I might say that one of the things I learned in my conversations with Chairman Gray and his staff was that size in and of itself is not a factor in determining eligibility for Federal insurance. There are others with respect to their providing fulltime service and things of this sort. But our hope would be to work with those small savings and loans. Again, many of them healthy and many of them providing essential services over several genera- 30 tions to a community to ensure that their depositors are protected and that that service continues to be available to them in some fashion. Merger may be the only or the best recourse in some areas, but I do not want to make that judgment at this point in time. Mr. KINDNESS. The door is not closed at any rate to those small ones? Mr. CELESTE. That is right. Mr. KINDNESS. In the functioning of the State of Ohio under chapter 135 of the Ohio Revised Code, there is a State board of deposit whose minutes made by the State treasurer's office, I believe it is, are prima facie evidence in any court of what the transactions were that were dealt with by the State board of deposits . In December, there was a deposit or a purchase of a certificate of deposit by the State of Ohio of a million dollars in a transaction with Home State. At that time, according to press reports at any rate, there was knowledge that ESM and Home State were so intertwined that there was great difficulty to be contemplated there. Do you have any information that you could share with the committee as to why the taxpayers' moneys were put at risk in Home State in that critical period of time? Mr. CELESTE. Mr. Chairman, Mr. Kindness, I do not. No. 1 , I am not sure that-again, we are talking about press reports today about a situation in December where that knowledge may or may not have been communicated either formally or informally to the people who had to make the decision. The Governor does not sit on the board of deposit, as you know, so I have not been involved. I would be happy to try to find out for you what the thinking was in the decision on that deposit, how it was recommended and whether there was any discussion or debate before submitting it to the board of deposit or whatever. Mr. KINDNESS . And if I as a citizen of Ohio were to request a copy of the records relating to that transaction of the State board of deposit, you would have no objection to my obtaining that infor mation? Mr. CELESTE . More than that, I would help you and I would pay the postage . Mr. KINDNESS . I thank you . Thank you , Mr. Chairman. Mr. BARNARD. Governor, I realize that you are on a tight schedule. We have already exceeded it by 15 minutes. And let me say to the committee that as a part of this official record, if you would furnish us any questions that you would like to ask of the Governor or any of these other witnesses, we will see that those questions are answered at your direction and they will be part of the record as a part of your questioning. And so, without objection, we will do that. And I want to say at this time we are delighted to have with us Congresswoman Kaptur and also a very important member of the Banking Committee and we appreciate your being here this morning. Governor, with that we want to again say thank you for being here this morning. Your testimony has been very helpful, and we will very possibly be in touch with your office as to this information. 31 Mr. CELESTE . Thank you very much, Mr. Chairman and members of the committee. I want to express my appreciation for this opportunity to share this experience with you. I want to emphasize again, if I may, that I believe the financial institutions, including those thrift institutions in Ohio that have been affected, are healthy and they are emerging from the closing stronger than ever. But I think all of us can do a better job and look forward to the results of your recommendations. Mr. BARNARD. We can all take some very definite lessons from Ohio, both from the Federal standpoint as well as the State standpoint, as well as Congress . So we hope that we can do something. Thank you very much . Mr. CELESTE. Thank you very much. Mr. BARNARD. Next I would welcome an opening statement from our very, very distinguished chairman of the Government Operations Committee who has permitted us to have this hearing today. I will now recognize the honorable chairman , Mr. Jack Brooks. Mr. BROOKS. Thank you very much, Mr. Chairman . I want to take this opportunity to express my appreciation to you and the very able members of the Commerce, Consumer, and Monetary Affairs Subcommittee for undertaking this timely and much needed investigation into the conditions surrounding the collapse of ESM Government Securities and the financial difficulties ESM's failure has brought to public investors throughout our country. In the past 3 years, six Government securities dealers have failed, costing investors hundreds of millions of dollars. These investors include individuals, municipalities, banks, savings and loan associations , public and private pension funds. My hometown, Beaumont, TX, lost over $20 million when ESM failed. Later this afternoon we will hear from Beaumont mayor, Bill Neild, and other representatives of organizations victimized by ESM's chicanery . While the circumstances surrounding the failures of ESM, Drysdale Government Securities, Cosmark, Inc., Lombard-Wall, R.T.D. Securities and the Lion Capital Group differ from case to case, we can observe certain common characteristics. They were all heavily engaged in the growing National Government securities market. They made extensive use of a relatively new financial instrument called the repurchase agreement. And they were not under the active supervision of any Federal regulatory agency. Taken together their failures have had a far-reaching negative impact on the public's confidence in the stability of our capital markets. It seems to me that part of our job here today is to begin the arduous task of discovering answers to the following questions. What were the causes of ESM's failure? We know they are thieves, but how did we allow them to operate that way? Who is responsible? Who could have avoided with proper Federal regulatory supervision these problems? And what can we do to prevent such failures from occurring in the future, other than everybody being as smart as the Chase National Bank was when they lost their $30 million in one of these same scams? You know, this does not just happen out in the hinterlands, where the unsophisticated people operate. Oh, those big operators right next to Wall Street, deep pocket boys, they dropped about 32 32 in one of these operations. Now, hopefully the answers to these and other questions should give us some factual base upon which to construct the system of governing the operations of both the Government securities market and those who would participate in this market. At the very least, such a system should offer the American people and the public investor a guarantee that their Federal Government is doing what it ought to do to ensure that our country's financial markets are fair and efficient and free of obvious fraudulent activities and operations. Thank you, Mr. Chairman. Mr. BARNARD. Mr. Chairman, you certainly have set the stage for some very interesting inquiries this afternoon and I hope that you will find time to be back with us so you can hear some of the answers. Mr. BROOKS. I will be back with you. Mr. BARNARD . Good. We now have with us Congressman Chalmers Wylie of Ohio. Congressman Wylie is the senior minority member of the Banking Committee and a distinguished member of the Ohio delegation. Chalmers, we are delighted to have you here with us this morning. And we would like to hear your testimony at this time. I understand that you have a lengthy statement, which we will, of course, without objection make part of the official record, and you may summarize as you desire. STATEMENT OF HON. CHALMERS P. WYLIE, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF OHIO Mr. WYLIE. Thank you very much, Mr. Chairman, and members of the Subcommittee on Commerce, Consumer, and Monetary Affairs. I thank you for the opportunity to participate in this important hearing on the collapse of the private deposit insurance fund in Ohio which resulted from the failure of ESM Government Securities, Inc., in Florida, and I appreciate the warm welcome which you have extended to me, Mr. Chairman. The chairman is a very valuable member of our Banking Committee, very knowledgeable on banking matters and what he is doing today is providing an excellent service for all of us. And we thank you for that. I do have a statement which I would ask to be included in the record, and at this point I would summarize the highlights of that statement. Whenever a crisis such as the one which occurred in Ohio in the aftermath of ESM debacle takes place, we are reminded of just how important public confidence in the safety and soundness of depository institutions is to the health of the Nation's economy. The depositors have to come first in this instance and to date we have heard that no depositor in the 71 S&L's which were closed by the Governor has lost any money as a result of the crisis affecting State-chartered savings and loans in Ohio. And I hope the same is true for the depositors of the Home State Bank also. Depositors in institutions insured by the Ohio Deposit Guarantee Fund have suffered great inconvenience as a result of being denied the use of their money for a period of time and some are still re- 33 stricted in the amount they can withdraw even after the institutions have reopened . We have a responsibility, Mr. Chairman, not only to our constituents in this country but to everyone who relies on the stability of our Nation's economy, to learn whatever lessons can be learned from the Home State-ESM fiasco and to take the steps that are necessary to maintain public confidence in insured depository institutions. have During my years of service on the Banking Committee, participated in many inquiries concerning failures of depository institutions. In my experience the causes of these failures tend to fall into three categories: (1) problems associated with deteriorating "spreads" between the cost of funds and the earnings from sound investments; (2) problems associated with the quality of the assets, as has occurred with mortgage loans, business and agricultural loans, and international loans where the value of the property or the earning ability of the borrower were improperly estimated; and (3) where a dominant individual took advantage of weak or nonexistent internal controls or external supervision to impose an imprudent investment policy on the institution . A preliminary conclusion can be drawn that the Home StateESM crisis falls into the third category as have most of the largest failures. To recite the list of large failures which threatened public confidence in depository institutions is also to list those cases in which a dominant individual was able to circumvent internal controls or agency regulations designed to safeguard the assets of the institution. To mention a few, Franklin National, the Texas and Georgia banking scandals, U.S. National Bank of San Diego, Penn Square, Continental, Financial Corp. of America and Empire all fall into this category, Mr. Chairman, and I ultimately suspect that Home State will join them. The Federal Home Loan Bank Board and the Federal Reserve did yeoman service in making their personnel, right up to the chairmen, available to deal with the situation as it was breaking. And may I say that I was in on this from almost the beginning. And I take this opportunity again to express my gratitude to Chairman Gray and Chairman Volcker and to reaffirm my confidence in their dedication to preserving the safety and soundness of the Nation's financial system. You asked the question in your hearing today whether the ESM collapse that triggered Home State's insolvency might have been avoided if Federal securities regulators had been more diligent or whether the SEC should have additional supervisory powers to protect investors. Now, my staff has examined the most recent form 10-Q filed by Home State Savings as a publicly traded company with the Securities and Exchange Commission . It is easy to read this document, Mr. Chairman, and learn that out of $1.4 billion in assets, approximately half were invested in reverse repurchase agreements with a single securities firm and that Home State seemed to have more of the characteristics of a mutual fund than of an institution in the business of making home mortgage loans. It would be interesting to find out how they filed their tax return. 34 I suspect that many deficiencies will be found in the disclosures made by Home State. Yet enough information was provided that one might expect a regulator or a fiduciary to ask further questions . In fact, we have some information provided by the National Credit Union Administration that indicates that some people did take advantage of the information they were able to obtain about Home State and avoided involvement in the transactions that caused so much grief to so many institutions. Moreover, according to last Sunday's Cleveland Plain Dealer, former Ohio State commerce director, Kenneth Cox; former commerce director, J. Gordon Peltier; and former superintendent of savings and loans, Clark Wideman quote "all said the State knew Home State had invested in a dangerously large amount of money with ESM Government Securities , Inc., of Fort Lauderdale, FL, as early as 1982." It is certainly appropriate for this subcommittee to consider whether additional measures are needed, but warning signals were not heeded which could have prevented the failure. With the help of the Federal regulators, the damage was contained. You asked another question. Given the state of the Nation's thrift industry, is there a need to strengthen, modify or replace the current system of State/private deposit insurance? And I think it is fair to say that confidence was restored when FSLIC insurance and FDIC insurance were made available to these institutions in Ohio. But the fact of the matter is, as you know, Chairman Gray, who is here and will testify later, has been saddled with some unprofitable portfolios on residential mortgages vis-a-vis the FSLIC fund. The chairman of the full Banking Committee, Mr. St Germain, and I introduced legislation providing for risk-related insurance to try to assist him in that regard . Congress I think does need to act and act promptly with regard to the situation as we have found it in Ohio. I think, Mr. Chairman, what I would like to do is to close at that point and suggest that if there are any questions that I would be willing to try to answer them. Thank you very much . [Mr. Wylie's prepared statement follows:] 35 Statement of Rep . CHALMERS P. WYLIE , Ohio April 3 , 1985 Subcommittee on Commerce , Consumer and Monetary Affairs Committee on Government Operations Hearings on the collapse of ESM Government Securities , Inc. , and its impact on privately insured Ohio thrifts Mr. Chairman : Thank you for the opportunity to participate in this important hearing on the collapse of the private deposit insurance fund in Ohio which resulted from the failure of ESM Government Securities , Inc. in Florida . My reason for accepting your invitation to appear today , Mr. Chairman , is stated very succinctly in your own remarks as part of the announcement of these hearings : " The public's confidence in the nation's financial markets could be eroded by a repetition of the Ohio-ESM episode . That must not be allowed to happen . " Whenever a crisis such as the one which occurred in Ohio in the aftermath of the ESM debacle takes place , we are reminded of just how important public confidence in the safety and soundness of depository institutions is to the health of the nation's economy . I am pleased to be able to report that to date no depositors have lost any money as a result of the crisis affecting state -chartered savings and loans . .. depositors will be made whole in the very near future . Hopefully, all Governor Celeste , state and federal officials , including Members of the Ohio congressional delegation , have worked long hours in order to speed the arrangements for the reopening of as many of the institutions as possible . At this point I must commend Federal Reserve Board Chairman Paul Volcker , Cleveland 36 Federal Reserve Bank President Karen Horn , Federal Home Loan Bank Board Chairman Ed Gray, for being available and for the long hours they and their able staff put in to contain the Ohio situation . Meanwhile, depositors in institutions insured by the Ohio Deposit Guarantee Fund have suffered great inconvenience as a result of being denied the use of their money for a period of time and restricted in the amount they can withdraw even after the institutions reopen. As the Chairman knows , because we serve together on the Subcommittee on Financial Institutions of the Banking Committee , the Subcommittee held a hearing last week on regulations proposed by the Federal Home Loan Bank Board concerning direct investments by institutions insured by the ' SLIC . Near the conclusion of the hearing Chairman St Germain made a statement that helped to put the Ohio situation in perspective . He noted that fluctuations in the value of the dollar in international money markets have been ascribed to concern over the condition of thrift institutions in Ohio and commercial banks in Texas . Having just returned from Europe I can attest to the fact that people in financial circles there are very much aware of Ohio and Texas . We therefore have a responsibility not only to our constituents in this country but to everyone who relies on the stability of our nation's economy to learn whatever lessons can be learned from the Home State- ESM fiasco and to take the steps that are necessary to maintain public confidence in insured depository institutions . 37 With that introduction , I will proceed to address the specific questions you set forth in your announcement . Circumstances surrounding the Ohio thrift situation , adequacy of federal agency responses . During my years of service on the Banking Committee , I have participated in many inquiries concerning failures of depository institutions . In my experience the causes of these failures tend to fall into three categories : 1 ) problems associated with deteriorating " spreads " between the cost of funds and the earnings from sound investments ; 2 ) problems associated with the quality of the assets , as has occurred with mortgage loans , business and agricultural loans , and international loans , where the value of the property or the earning ability of the borrower were improperly estimated ; and 3 ) where a dominant individual took advantage of weak or nonexistent internal controls or external supervision to impose an imprudent investment policy on the institution . Every day brings new information on the Ohio situation , and it is certainly too soon to pass ultimate judgment . It certainly is not my purpose to pass judgment on other such private insurance funds in other states . In fact , one of the purposes of this hearing is to collect and evaluate the available information . Still , a preliminary conclusion can be drawn that the Home State - ESM crisis falls into the third category , as have most of the largest failures . To recite the list of large failures which threatened public confidence in depository institutions is also to list those cases in which a dominant individual was able to circumvent internal controls or agency regulations designed to safeguard the assets 38 of the institution . Franklin National , the Texas and Georgia banking scandals , United States National Bank of San Diego , Penn Square , Continental , Financial Corporation of America and Empire all fall into this category , and ultimately , I suspect Home State will join them. As for the adequacy of the responses to the crisis by the Federal Home Loan Bank Board and the Federal Reserve , I have already said that these agencies did yeoman work in making their personnel , right up to the chairmen , available to deal with the situation as it was breaking . I take every opportunity to express my gratitude to Chairmen Gray and Volcker and to reaffirm my confidence in their dedication to preserving the safety and soundr.ess of the nation's financial system . Whether the ESM collapse that triggered Home State's insolvency might have been avoided if federal securities regulators had been more diligenti or whether the SEC should have additional supervisory powers to protect investors . My staff has examined the most recent Form 10-Q filed by Home State Savings Bank as a publicly traded company with the Securities and Exchange Commission . Any number of people could look at this filing and get differing insights as to the nature of Home State , but it is remarkable how much of what eventually turned out to be questionable operations of Home State was set forth right in this publicly available filing . It is easy to read this document and learn that out of $ 1.4 billion in assets , approximately half were invested in reverse repurchase agreements with a single securities firm and that Home State seemed to have more of the characteristics of a mutual fund than of an institution in the business of making home mortgage loans . The scheme of the 39 securities regulations has always been based on disclosure and on the assumption that people will have the means to protect themselves if there is adequate disclosure . I suspect that many deficiencies will be found in the disclosures made by Home State . Yet , enough information was provided that one might expect a regulator or a fiduciary to ask further questions . In fact , we have some information provided by the National Credit Union Administration that indicates that some people did take advantage of the information they were able to obtain about Home State and avoided involvement in the transactions that caused so much grief to so many institutions . Moreover , according to last Sunday's Cleveland Plain Dealer , former Ohio State Commerce Director Kenneth Cox , former Commerce Director J. Gordon Peltier, and former Superintendent of Savings and Loans Clark Wideman " all said the state knew Home State had invested a dangerously large amount of money with ESM Government Securities , Inc. , of Fort Lauderdale , Florida , as early as 1982. " It is certainly appropriate for .this Subcommittee to consider whether additional measures are needed , but it has been my experience on the Banking Committee that many failures take place not because there is inadequate regulation or disclosure but because regulators and to a lesser extent investors failed to take advantage of the information systems that are in place . I do not mean to say that these systems will prevent failures , but when properly implemented , they can contain the damage caused by failures , so that they do not threaten the financial system as a whole . Warning signals were not heeded which could have prevented the 40 failure . contained . function . With the help of the federal regulators , the damage was We look to the regulators to perform the information It is our job to oversee their performance on a continuing basis . Given the state of the nation's thrift industry , whether there is a need to strengthen , modify or replace the current system of state/private deposit insurance . Chairman Gray has testified with remarkable candor before both of our Subcommittees concerning the situation that confronts the thrift industry and its regulator . tangible net worth . There is a virtual absence of The size of the FSLIC as a percentage of deposits is near its all -time low. Some institutions are still saddled wich unprofitable portfolios of residential mortgages while others are engaging in new activities and growing at an unmanageable rate . imposed a quarterly assessment of 1 /32% of assets . The Bank Board has It has provided additional support staff to the regional Home Loan Banks and has asked Congress for money for more supervisory staff . The Bank Board has adopted a regulation on net worth and the regulation on direct investment that was the subject of the hearing last week before the Financial Institutions Subcommittee . Chairman Gray has submitted a proposal for risk-based insurance premiums , which Chairman St Germain and I have introduced by request as H.R. 1680 , The Insured Institutions Improvements Act of 1985 . FDIC Chairman Bill Isaac also has devised his own proposal which Chairman St Germain and I introduced at his request as H.R. 1833 , The Federal Deposit Insurance Improvements Act of 1985. doing all they can in my opinion . In short the regulators are Now it's time for Congress to act . 41 The hearing last week , which gave us an opportunity to hear from Chairman Gray , from the S& L Commissioner of Texas , and from representatives of the major trade groups for the thrift industry dramatized the need for Congress to address the issue of deposit insurance reform. We can and should begin by promptly considering the agencies proposals . It is desirable to allow institutions , whether they have state or federal charters , to have enough flexibility to compete in the marketplace . the long run. In fact , this is necessary if they are to remain healthy in It is also desirable for state regulators to have an opportunity to participate in the process of formulating the regulations of the federal agency that insures the deposits of most state- chartered institutions . The crucial issues , however , are who is going to provide the capital to support the portfolios that insured institutions hold and who is going to underwrite insurance to protect the system from the inevitable failures that occur . More than merely desirable , it is necessary , it is imperative , that these issues be resolved , and we never know how much time we have to do it . What I am suggesting is that we.the Congress must ensure that the financial system underlying our Nation's economy is strong and healthy . Public confidence in depository institutions is a key to that strength . Another key is an efficient and smoothly functioning government securities . market which is essential both to the Federal Reserve's implementation of monetary policy and to the U.S. Treasury's financing of the Federal Government . Congress needs to act this year to update our banking and deposit insurance laws , which obviously have not kept pace with the marketplace . The deposit insurance reforms proposals from the FDIC and the FHLBB need to be examined carefully by Congress , just as other 42 modernizing legislation introduced by Chairman Barnard , myself , and many others of our distinguished colleagues ought to be considered fully in this session of the 99th Congress . I would like to address one other issue before concluding . As most of the financial community is aware , I have sponsored a bill , H.R. 15 , which would permit bank and thrift holding companies to underwrite mortgage-backed securities and streamline the procedures for bank holding companies to receive approval to conduct nonbanking activities , within a regulatory framework designed to provide equitable regulation for all financial institutions . I am sometimes asked how I can propose expansion of the range of activities that can be conducted by depository institutions holding companies in light of the ESM incident and the recent disclosure of irregularities in the handling of mortgage -backed securities . The argument is often made that these institutions have enough trouble managing their existing activities that they do not need new powers , and to grant new powers would only be asking for more trouble and more scandals . The point that I want to make today is that no matter what activities financial institutions engage in , problems will inevitably occur from time to time . There will always be people who will try to take advantage of any system, and there will always be people who will make costly mistakes . The rational response is not to shut down every activity in which problems occur . We could shut down the entire economy that way . Rather , the urgent challenge is to require that the institutions be sufficiently capitalized and that they have adequate systems of internal control . Then, there should be effective supervision to discover problems and deal with them in time to safeguard the financial system as a whole . I look forward to working with Members of this Subcommittee , with my colleagues on the Banking Committee , with state and federal regulators , with industry representatives , and with anyone else who can help address the pressing issues facing the banking system today . Thank you again , Mr. Chairman , for the opportunity to testify today . 43 Mr. BARNARD. Thank you very much, Mr. Wylie. You have certainly enumerated many of the things which are certainly on the minds of this committee and which hopefully, with your leadership, will be on the minds of the Banking Committee. I think we definitely need a much more indepth study of the insurance funds and how we can help them, such as the bill that you introduced on variable-rate premiums, and other legislation . So we feel like the work of this committee should be very, very helpful to the Banking Committee and we hope that the Banking Committee will certainly utilize our report when it is developed. And we thank you very much for being here this morning. Mr. WYLIE. You are welcome. Mr. CRAIG. Mr. Chairman, Congressman Wylie, one of the questions that I have asked insurance fund regulators that is of concern to me is the inability of the Ohio Deposit Guarantee Fund to respond accordingly. We hear the argument that simply the money was not there to back it up. And yet I am told that in the situation where there was $130 million in the Ohio Deposit Guarantee Fund , that they could have covered the run on the Home State and then required other members of the fund to borrow from the Federal Reserve System to meet any shortfall caused by deposit demand for cash, and in fact, if that had occurred and the fund had responded as funds are designed to respond, that there would not have had to have been a banking holiday, there would have been no great concern or public outcry or run on the banks, and in large part, even Home State, although it would have been taken over by the fund, could have remained open. Your experience on the Banking Committee-what is your reaction to that general comment? Mr. WYLIE. I do not think that the Ohio Deposit Guarantee Fund could have in fact covered all the possible losses from Home State. I think that a run, a complete run, by Home State would have depleted the fund. As a matter of fact, the fund had $130 million in it 1 day and about 3 days later, after a run, it had about $90 million. Mr. CRAIG. I am talking about prerun. With the knowledge that everyone had as to the situation at Home State, if the fund had acted properly preclosure, could that not have been avoided? Mr. WYLIE. That is hindsight and I do not know. I am not in a position to suggest that something like that could have been done. After it was discovered that ESM Securities in Florida was going belly up, and that most of the assets of Home State were invested in ESM. I think at that point that the fund was clearly inadequate . Now, how you go about shoring up the fund at that point is a question that I am not in a position to answer. Mr. CRAIG. But it is a procedural question . I was curious to see your reaction to it. Mr. WYLIE. But I think after it was discovered that Home State had closed that the fund might not be adequate to meet the cashflow demands of the persons who were insured . And this was a private fund. It was not State administered. It was created by a special statute, passed in Ohio in 1955. After that was discovered, the Chairman of the Federal Reserve Board, and I talked to him twice on March 13 , was very forthcoming in opening the discount window as an emergency situation to all of these 71 State-chartered S& L's. 44 Mr. CRAIG. Thank you. Thank you, Mr. Chairman. Mr. BARNARD. Mr. Spratt. Mr. SPRATT. I have no questions. Mr. BARNARD. Mr. Kolter. Mr. KOLTER. Thank you, Mr. Chairman. Congressman Wylie, following the interrogation of the Governor, do you feel now that the investors have once again their own confidence in the system, in the banking system of Ohio-do you feel the investors are now sure that their money is safe? Mr. WYLIE. The investors are now sure that their money is safe. I feel that since they have been given the opportunity to apply for FSLIC insurance. And may I say that the Federal Home Loan Bank Board put a lot of extra examiners on the job. They worked overtime to try to examine the books of some of the companies. Now, I think that there are now 30 S&L's the Governor said which have qualified for either FSLIC insurance or FDIC insurance. The fact of the matter is that in those institutions it is my information that more money has come in in deposits than has gone out in withdrawals. So this, as far as we in Ohio are concerned, was not as serious as far as the other FSLIC-insured S&L's were concerned. And the assets in these companies represent less than 10 percent of the assets of all of the savings and loans in Ohio. Mr. KOLTER. Thank you. Mr. BARNARD. Mr. Saxton . Mr. SAXTON. Congressmar Wylie, as a member of the Banking Committee, let me ask you a question. I have here a copy of the Ohio Deposit Guarantee Fund constitution, and attached to it are the rules and regulations by which it operates. There is a section that deals with investigative authority of the fund. It says "the fund supervisory staff, at the discretion of the executive vice president of the fund, may at any time enter a member institution for the purpose of conducting an investigation or an audit. The members shall be required to furnish upon request all the company's books, records, securities, moneys, and other property needed to complete investigation of an audit." I guess the question is that it appears to me that the mechanism was set through which the proper types of investigations could have been carried out. The signals were all there to indicate that such an investigation may have been necessary and yet no such investigation seemed to come forward. And I guess my question is from our perspective at the national level, how do we know that private funds carry out those functions? And is there something that we need to do from a legislative point of view to ensure that that happens? Mr. WYLIE. That is a very good question and it may go back to the question that Mr. Craig asked and maybe I did not respond as well to his as I should have. The problem with the Ohio statute and the Ohio Deposit Guarantee Fund, and you have put your finger on it, is that the agreement as to responsibility is not clear. And if you read those rules and regulations you will really not find out what the Ohio Deposit Guarantee Fund is supposed to do for its members in an emergency situation. And I guess that is the point you were trying to make, Larry. 45 But the first response, of course, should have come from the Ohio Deposit Guarantee Funds since they were the insurer. It did not. And it did not come immediately, why I do not know. The Federal Government attempted to intervene through the Federal Reserve 2 years ago to try to find out what the responsibility of the Ohio Deposit Guarantee Fund was to its members, and whether the exposure of the State-chartered S&L's, the 72 State-chartered S& L's, had any impact or effect on the safety and soundness of the banking system. And in the Dimension case, the members of the Ohio Deposit Guarantee Fund filed a law suit in which they got an injunction against the Federal Reserve from becoming involved in any way, and the injunction said that the Federal Government had no nexus, that it could not intervene, and that it could not examine as to safety and soundness. As one of the persons said, I think it was a Mr. Griffith from Molitar, at the meeting with the Federal Reserve Board Chairman , "We are sorry we won that case now. It would have been better if we had had somebody sort of examining it." But the Federal Government at this point, or at that point, had no responsibility, could not have had any responsibility, and it was enjoined from doing anything. think that the Ohio Deposit Guarantee Fund's days are numbered . Or they have ended . And I think maybe we ought to look at some of the other so-called State funds. Not State funds , private funds, which insure these State-chartered S& L's. Mr. BARNARD. Mr. Bustamante. Mr. BUSTAMANTE. Mr. Chairman, thank you . Congressman Wylie, my concern was with the initial reaction of the Federal Reserve to the Ohio bank run. Their initial reaction was that it was a State problem. However, this changed very quickly with the fluctuation of the dollar. Can you tell me why this happened? What caused this reaction or attitude change? Mr. WYLIE. I really do not think it had anything to do with the fluctuation of the dollar, but it is amazing how much of an impact the closing of 72 small State-chartered -well, some of them are rather large- but State-chartered S&L's in Ohio had on the impact of the dollar in Europe. And I had an opportunity to discuss this situation with the editor of the Financial Times and he said there was not any question but that it had an impact because the headlines in Europe were " banks fail in the United States." It did not identify that they were State-chartered savings and loans in Ohio, and so there was a run on the dollar and maybe it is coming down to a little more realistic level and will help the farmers in the process. Maybe there is some good coming from that. But you have to understand that the Federal Home Loan Bank Board operates in a fiduciary capacity. It is their obligation to protect the FSLIC fund, and in that regard, they have to guarantee against loss. Now, if there is a new application, and Chairman Gray can answer this better than I can, but if there is a new application for a new charter, they have to have 52 percent net worth. Most of these State-chartered S&L's did not have 52 percent net worth. It was suggested that they all be brought in and I was at the meeting -that they all be brought in en masse. I do not think 46 that the Federal Home Loan Bank Board could do that legally. I think they had to make some examination up front. Now, after it was determined that some of the State-chartered S&L's had a good asset ratio and had net worth above 5 percent-I think they modified it a little-then they were brought in. But they had an obligation, as I see it, to the other members of the FSLIC fund and they had established rules which provided for a 10day period of comment. If someone wanted to comment about a new application as to whether that would guarantee against loss, they could do that. Now, they have waived in effect the 10-day rule , but at one point during the negotiations the Federal Home Loan Bank Board was willing to bring in all of the 71 State-chartered savings and loans if they could get a guarantee from the State of Ohio that the full faith and credit of the State of Ohio would be pledged against that. And then it was determined that the State of Ohio could not legally do that, or could not constitutionally do that, so they had to back off of that. But I would say that I think the Federal Home Loan Bank Board was very cooperative here and I think the Chairman of the Federal Home Loan Bank Board, Mr. Gray, ought to be complimented for his part in it. Thank you, Mr. Chairman. Mr. BARNARD. Mr. Swindall? Mr. SWINDALL. Yes. Following up with the constitutional constraints, that constitution in no way prohibits pledging of nontax revenues, does it? To your knowledge? Mr. WYLIE. The constitutional provision would not allow the pledging of tax revenues. Is that your question? Mr. SWINDALL . Right. Mr. WYLIE. I do not think it would, no. What the constitutional provision provides is that you cannot pledge the full faith and credit of the State of Ohio against the contingent liability. If the money is there in a separate fund I would assume that perhaps the general assembly could act. Mr. SWINDALL. That is my point. You are a former State legislator. Mr. WYLIE. Yes, sir. Mr. SWINDALL. And I would just like to know your opinion as to whether or not the GovernmentMr. BARNARD. I hate to interrupt but we have got a lot of witnesses today and I want him to answer the question. But he is not an official of the State. Mr. WYLIE. I am glad you added that caveat. That is kind of a 20-20 hindsight call . Mr. SWINDALL. Fine. I yield. He knows the question. Mr. WYLIE. He made the point, yes. Mr. SWINDALL . Thank you. Mr. BARNARD. I am going to defer any further questions of you at this particular time because we do want to hear from other members of the Ohio delegation and we appreciate your being here and we understand that you have got other things to do. Mr. WYLIE. Thank you very much for inviting me. I appreciate it. Mr. BARNARD. We have invited several members of the Ohio delegation to be here this morning, and we certainly welcome them. 47 And we want them to have an opportunity to have something to say. I would like to encourage all of them though, if they would, to submit to us something for the record and then we would like for them to summarize because we have a little scarcity of time. We are delighted now to have the distinguished Congressman from Cincinnati, Mr. Thomas Luken. We would like to hear from you at this time. STATEMENT OF HON. THOMAS LUKEN, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF OHIO Mr. LUKEN. Thank you, Chairman Barnard. I want to sincerely congratulate you in conducting this, calling for this examination, and in the way that the hearing has been conducted. There have been certain issues that have already been raised, but I believe that I have some particular information about the events that have come under question . What I would like to state first, as Congressman Wylie did initially, that the main consideration is depositor confidence. That is the reason, the lack of depositor confidence, the threatened loss to depositors, that our international situation , our currency, has been threatened- has actually fallen . And this has brought involvement from the President, when he was asked at a news conference, and by the highest Federal officials. Now, there is a time for questions, time and a place for questions and finger pointing, and I think this is one of those times. But I would like to take us back to March 13. Those events have been discussed publicly and have been discussed here . And that was when several of us appeared before Chairman Gray, the Federal Home Loan Bank Board, but I will go back the day before. And that was when we appeared before the Federal Reserve and Chairman Volcker. Chairman Volcker at that time told the representatives of the thrifts from Cincinnati that what they were looking for was insurance. That the only thing the Fed could give them was a discount window. And the discount window at that point was like throwing an anchor to a drowning man. Because that would not improve their financial picture, and that is what they would need ultimately to get into FSLIC. So that was not really any kind of a solution . The Fed had no solution and because of the divisions between the Fed responsibility for FDIC and Federal Home Loan Bank responsibility for FSLIC there was that division. And incidentally, Chairman Volcker has publicly recommended a merger of the Federal Home Loan Bank Board and the Fed. Apparently I only read his statement, but I read his statement in the press to the effect that he recommends consideration of a mergerMr. BARNARD. He was talking about the insurance funds, I believe. Mr. LUKEN. All right. That is what I meant . That is the context-Mr. BARNARD. The FDIC and FSLIC. Mr. LUKEN. That is what I was referring to in the context, and that is what I understood, as it has a bearing on this particular situation. 48 So in any event, we did finally meet with Chairman Gray on the following day, which was March 13, and at that time the reaction of Chairman Gray-and I point out, there is a time and I think at this time what should have been the reaction of the Federal authorities was we have a threatened loss of depositor confidence. We had Home State that was closed . And the runs were occurring and this was described to him, it was described on the front pages of the paper. Pictures in the paper. The reaction of Chairman Gray was insensitive. This is not a partisan statement. Mr. Gradison and Mr. Wylie so told the Wall Street Journal . I can quote that, but here is the article . Mr. Wylie admitted that there was a stall at that time on the part of a stall is the way he describes-it on the part of Chairman Gray. We were advised at that time that there was a 10-day waiting period, a 10-day period of notice that could not be waived. We were advised that the Federal Home Loan Bank Board did not have any extra examiners to send in to Cincinnati or to send in to Ohio. We were advised that it was a State problem, that the savings and loans of Ohio had plenty of opportunity and had resisted the opportunity to come into FSLIC, and that the depositors - when we pleaded based upon the depositors potential loss -we were told by Chairman Gray that the depositors knew that they were investing in an institution which did not have Federal insurance and therefore they had made their own bed and they could lie in it also. I think we can learn from history here, and that is the reason I bring it up. We did have the division. We went to two different agencies and the buck was passed. And we went to the one agency who could have done something and I want to emphasize in my opinion, and I am not a banking expert. I am not the kind of an expert that some of you may be, but in my opinion if the Federal Government had responded as it did in the Continental case, it could have folded these in on March 13 and that is what we pleaded for, and then examined them and then weeded them out. Nobody has said that there is any of these 71 institutions that were that much worse. As a matter of fact, on the average they are better than the FSLIC. And when we considered what was at risk, depositor confidence throughout this country, I think that the proper reaction- I still think, I said it then and I still think that the proper reaction which would have avoided any closings was to fold them into FSLIC. They knew basically. When we talked to Mr. Raiden, Mr. Gray's counsel, he knew basically what the financial picture was in these savings and loans, just as he does now. I have told you what the reaction was. I think that in the future we should consider bringing together these two institutions . I think the FDIC and FSLIC-I think as far as the finger pointing is concerned, we had a hearing yesterday in our Energy and Commerce Committee. I am not going to go into the ESM questions. Let me just repeat one of the points though that I made at that time, which has been brought up here, and that is that Mr. Warner was identified by the conservator from Ohio, the conservator of Home State, and by Mr. Tew who is going to testify here today, as the controller of the events at Home State and at ESM . And I think that is very instructive to know that. 49 So if we could back into that, I think the conservator has already filed suit against Mr. Warner. I think that the receiver here, Mr. Tew, should file suit against Mr. Warner. I think he is clearly the responsible party according to these reports, according to the investigation, according to the investigation of those who looked into it. He is one of the responsible parties. We could go into that, but I think my time is about expired. And I wanted to particularly shed what light I could upon what happened with reference to extending this coverage so that in the future in my opinion, my recommendation would be, that we look first, as we did in Continental, to depositor confidence and do whatever is necessary to absolutely avoid-do what is necessary. That is my opinion. Mr. BARNARD. Congressman, you have outlined some of the same concerns that everybody on this committee has, and that is why we are all so anxious to have a very thorough hearing into many of these questions that you have brought out. And hopefully, when this hearing is through and all of our investigations are made, we will be able to answer all of the questions that you have brought up this morning which are very substantive, and I think very appropriate, considering the sequence of events that we have been through since March. So we appreciate your sharing your observations with this committee and I assure you that we are going to look into every aspect of your testimony. Thank you very much. Mr. LUKEN. Thank you , Mr. Chairman. Mr. BARNARD. Again, I want to say I am delighted to have Mrs. Oakar with us this morning, Mary Rose Oakar from Ohio, and also a very prominent member of the Banking Committee and I would like to hear from you at this time. STATEMENT OF HON. MARY ROSE OAKAR, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF OHIO Ms. OAKAR. Thank you, Mr. Chairman, and distinguished members of the committee. I want to first of all say that I am grateful for this hearing. I think it is important. You are a very important subcommittee. You have the role, as you know, of being the chief investigative committee for Congress related to banking issues. And I want you to know, Mr. Chairman, and others, that I am working on legislation related to the ESM crisis so that hopefully there will be more scrutiny in the manner in which S&L's and banks invest with some of these securities companies. I think it is very, very important that we really look into that situation . I also want to say for the record that I believe very strongly as many of us do in Ohio and elsewhere, that anyone who was engaged in any illegal activity whatsoever be prosecuted . And I know that an investigation in my State is going on and I hope it comesto fruition. Mr. Chairman, you know and Congresswoman Kaptur, who is also a member of the Banking Committee, and others know that our Banking Committee has seen unbelievable failures in the last few years. I have been on the committee 8 years and in the last 3 50 or 4 years we have seen enormous failures such as Penn Square. We have seen Continental of Illinois being propped up with billions of dollars and we have seen in the S&L area the federally chartered Financial Corp. of America in California . Their subsidiary American Savings & Loan Co. , was given unprecedented borrowing power exceeding normal capitalization and we saw the potential failure even of our major banks in their foreign investments. So this whole subject of what happens in a crisis transcends whether S&L's are insured federally or nonfederally. I think we really have an obligation to see what is going on in this area in our country. It should be noted for the record that most of the S&L's in Ohio were federally insured. My own county, Cuyahoga County for example, and in Cleveland, OH - had one S&L that was nonfederally insured. It was not a blanket problem in terms of the Federal insurance versus non-Federal insurance. Seventy-one out of about 205 were nonfederally insured . So that most of our institutions are federally insured, and I think that is important to note. Mr. Chairman, I do want to raise this issue because you are the chief investigative committee and I think it is very important to clear the air on this issue and it in no way takes away from the scrutiny of what ought to be going on in the Ohio situation. I believe very strongly that Congress created the Federal Reserve System and the Federal Home Loan Bank Board to function as Federal regulators and to objectively monitor the investments and operation of our financial institutions and to make sure that the actions are in accordance with the principles of safety and soundness . They must protect depositors' moneys: it is extraordinarily important. Board members have long terms and they are appointed and they serve as separate entities from Congress and the administration, that the public perceive them, Chairman Volcker, Chairman Gray, and other members of their respective Boards, to be totally objective. Mr. Chairman, I personally have felt that there were some problems with respect to the manner in which the Ohio S& L's were treated. I think that, and this is just a personal opinion, that Chairman Volcker and Karen Horn of Cleveland's Federal Reserve , acted absolutely expeditiously when they sensed there was an oncoming crisis in Ohio prior to the closing of the privately insured saving and loans. They rolled their sleeves up. They met with various Members of Congress. I was at a meeting that Chalmers Wylie called along with the two Members from Cincinnati, in Chairman Volcker's own boardroom to discuss the S&L's crisis March 13. Mr. Chairman, I have only praise for their actions. They did nothing that was not in accordance with the law. No one wants any regulator to do anything that is not in accordance with the law. We want them to act in accordance with the law. And I want to make that clear. I personally do not feel that Ohio S&L's should have gotten a blanket insurance without scrutinizing first. But our appeal was to have the actions taken in terms of the possibilities of Federal insurance, to have them taken expeditiously. No more, no less. And I felt very strongly that there was stonewalling going on, and for that reason after the Governor closed the privately insured S& L's on the previous Saturday, I circulated a letter, which I 51 would like to submit for the record, that a number of Members of Congress from Ohio signed, both Republicans and Democrats , asking the Chairman of the Federal Home Loan Bank Board to judiciously and expeditiously consider the urgent request of the S & L's in accordance with the law. We felt the need to write this letter because we felt that there was this absolute lack of energy going on within that office. It was not until the following week that the Governor was able to get the appointment with Chairman Gray. Of course, we have all seen the Wall Street Journal article which may or may not be true, but I think it is a very indicting article and I would like to submit that with your permission for the record. The article links our crisis in Ohio with GOP politics. Specifically on Friday, March 8, Treasury Secretary James Baker and other Treasury officials planned a Federal strategy regarding the runs on Ohio thrifts and they decided not to rescue them because we had a Democratic Governor, and informed Chairman Gray of that point . At the Banking Committee the other day, Mr. Chairman, and you were there, Congresswoman Kaptur was there among others, I asked Chairman Gray two very simple questions: Did you, prior to March 13 or any day thereafter, get any advice on how to handle the situation in Ohio from the Secretary of the Treasury or anybody on the staff at the White House? The second question: Did you in any way get advice from the White House on how to act before the Governor closed the S&L's in Ohio that were nonfederally insured? Chairman Gray's answer was that he could not answer it because he did not think they were relevant questions . He refused to answer. Mr. Chairman, I think that the air has to be cleared on this issue one way or another. I do not know whether this article is true or not, but there are some very serious allegations about the integrity of the Federal Home Loan Bank Board, and its ability to act objectively and nonpolitically. For this reason, Mr. Chairman, I am asking your committee, because I think it is the proper committee, to investigate the conduct of the Federal Home Loan Bank Board, its Chairman, and the administration and let the chips fall where they may in terms of how that situation was handled . And I think that you are the proper source to do that, Mr. Chairman . I hope you can respond favorably to do the investigation on this situation and I look forward to a reply to my letter to you, Mr. Chairman, which you will be receiving in about 30 seconds. Thank you, Mr. Chairman. [Letter and article referred to follow: ] 52 Congress of the United States House of Representatives Washington, D.C. 20515 March 18 , 1985 The Honorable Edwin J. Gray Chairman Federal Home Loan Bank Board 1700 G Street , N.W. Washington , D.C. 20552 Dear Mr. Chairman : As you know, some of the state chartered , privately insured Savings and Loans in Ohio have been experiencing a lack of confidence after the failure of Home State Savings Bank. Last week , the Governor declared an emergency bank holiday . It is our understanding that in the interim , some of the affected Ohio Savings and Loans are applying for federal deposit insurance with the Federal Savings and Loan Insurance Corporation . We would appreciate your agency's judicious and expeditious consideration of these urgent requests in accordance with the law . Thank you for your cooperation in this important matter . Sincerely , Ma Rau Name Dahar Mary Rose Dakar Member of Congress ress Hall & Tom Tony HaN Member of Congress Dennis Eckart Member of Congress] Jo Seiberling Member of Congress Mlave Bob McEwen Member of Congress Louis Stokes Member of Congress Tom Hulen Thomas Luken Member of Congress Edward Feighan Member of Congress Bin Pradian Bill Gradison , Jr. Member of Congress 53 BankBoard Chairman's Cool Initial Response To Ohio Crisis Linked by Someto GOP Politics (D., Ohio). "Obviously, it wanted to em- Ohio, according to a Reagan administra By MONICA LANGLEY barrasstheDemocratic governor (Richard tion official. StaffReporterofTHEWALL STREETJOURNAL Celeste) up for reelection soon." A callwasthen made toMr. Grayto ina group of nerWASHINGTON-When Themas Luken (D., Ohio) adds, Treasury officials' conOhio thrift executives flew to Wash- "ItRep. vous took the dollar falling and questions form himthisof the official says, adding, "Ed ington three weeks ago, Federal Reserve asked of President Reagan at his press sensus, agreed with that the Bank Board us Board Chairman Paul Volcker put out the conference before any Bank Board assis- shouldn't save thethrifts; welcome mat. tance was provided. Ohio thrifts hadtobe- what he should do." wedidn't decide comeanational problem before party poliMr. Volcker immediately took time to Thomas Healey, just-departed assistant meet with the executives, whose thrifts tics were removed. " treasury secretary for domestic affairs, were backed by a newly insolvent insurMr. Gray, through a spokesman, re- added, "Of course it (the Treasury and ance fund, and assured them that the Fed fused to comment on administration influ Bank Board decisions) was political . But would provide cash for runs on their de ence on his initial decision not to provide it's the politics of wanting Washington to posits by making loans through the Fed immediate federal insurance to the thrifts. ball the state out,but our sayingno. Ithas discount window. Then he told the execu- But an official involved in the matter in- nothingtodowith Democrats and Republitives to make themselves at home in the siststhe "politics" of itwasn'tpartisanbut cans." board ofgovernors' conference room and federal versus state responsibility. When A Refusal to Meet With Them his own office. asked at a congressional hearing last week executives came totown Mr. Volcker instructed two of his top whether he was told how to react, Mr. theWhenthethrift following Wednesday, Mr. Gray restaffmembersto help the executives plan Gray wouldn't answer the question. fused to them. see On Thursday, when he a strategy to handle the emerging crisis Executives of privately insured Ohio permitted Republican representatives from Ohio to see him, and after some reHow Washington Got Involved sistance, let Democratic Rep. Luken and one thrift executive join them, Mr. Gray's Thursday, March7 first comment was: "Why aren't you guys A run on deposits begins at Home State Savings Bank, which expected up at the state capitol?" heavy losses from its dealings with E.S.M. Government Securities Inc. Mr. Gray then told them he couldn't insure the savings and loans until each instiFriday, March 8. met a 5%% capital-to-assets ratio Treasury SecretaryJames Baker and other Treasury officials plan a federal tution requirement; was individually examined strategy ifruns begin at other Ohio thrifts. Theydecide not to rescuethe by the Bank Board, "which could take S&La, and inform Federal Home Loan Bank Board Chairman Edwin Gray, months," and was subject to a 10-day comwho agrees with the plan. ment period. Saturday, March 9 Upon returning to Ohio empty-handed, the executives privately asked Gov. Ce Home State closes, citing the run. leste to closethe thrifts to stopthe runs on Monday and Tuesday, March 11-12 deposits. Publicly these executives were Ohiothrifts begin experiencing runs and call the Bank Board asking howto stating they could handle the deposit withget federal insurance. They call their congressmen asking for federal help. drawals and wanted to stay open, but Mr. Gray's denial offederal backing terrified Wednesday, March 13 them, say the Ohio lawmakers who met Agroup ofOhio thriftexecutives flies to Washington. Fed Chairman Paul with Mr. Gray. Volcker promises loans through the discount window. Bank Board So when Gov. Celeste, in a closed meetChairman Gray refuses to meetthe executives. ing with the thrift executives, asked who Thursday, March 14 wanted to reopen, only four or me 71 execGrayoutlines to the delegation requirements thrifts must meet before he utives stood up in favor ofreopening, Gov. Celeste told the lawmakers. will consider granting federal insurance, and says it could take months. Even Ohio Republican Rep. Willis Gra Friday, March 15 dison acknowledges that the Bank Board's Ohio Gov. Richard Celeste temporarily closes the thrifts. Initial refusal to aid thethrifts seemed par ticularly harsh, giventhe Fed's immediate Monday, March 18 willingnessto intervene. "I wonder, too, if The dollar begins falling,largely duetothe Ohio crisis. political considerations were placed above Tuesday, March 19 confidence in andthe integrity ofthefinancial system," Rep. Gradison says. The Bank Board agrees to ease requirements for granting insurance. A Reversal by Gray Thursday, March 21 The Ohio Republican notes that Mr. President Reagan, asked about the federal response totheOhio thrift woes, Gray "reversed himself" the next week calls it an isolated problem and says that beyond Fed loans, "there isn't when the Ohio thrift crisis frightened the anything forthe federal government to do.” currency markets, causing the dollar to plunge. At about the same time, Mr. Friday, March 22 Volcker was urging Mr. Gray to expedite The Bank Board begins approving federal insurance for some ofthe thrifts. the insurance process, even offering inforstemming from the collapse ofHome State thrifts wanted federal insurance from the mation from Fed examiners' reports, and Reagan was fielding questions Savings Bank ofCincinnati, and keeptheir Bank Boardtorestore depositor confidence President federal assistance to Ohio thrifts. thrifts open. The executives stayed at the in the wake of the Home State failure, about Mr. Gray suddenly decided that the 10Fed for six hours, using Mr. Volcker'stele- which by itself would wipe out the statephones, typewriters and secretaries. sponsored insurance fund. Home State was day comment period could be waived, that requirement could be A few blocks away, Edwin Gray, chair- closed on Saturday, March 9, following the 5%%tocapital 5%, and that examinations man of the Federal Home Loan Bank runs stemming from heavy losses in its dropped be expedited. Shortly after that, the Board,through whomtheexecutives hoped dealings with the failed E.S.M. Govern- could Bank Board began approving federal into obtain federal insurance, refused to ment Securities Inc., of Fort Lauderdale, surance for two or three Ohio thrifts a meet with them. Fla. The night before, high-level Treasury day."Ed Gray was helpful before it was all The stark difference in the receptions the Ohio thrift executives received in officials, including Secretary James over," says Rep. Chalmers Wylie (R., Washington is being blamed by some here Baker, met for 1% hours to decide what on partisan politics. Democratic represen- the federal response should be if other pri- Ohio), the ranking Republican on the tatives, in particular, argue that Fed vately insured Ohio thrifts began experi- House Banking Committee. "I'm sure his Chairman Volcker understood that a finan- encing runs. The group concluded that if a only motivation in stalling at first was to cial crisis was building and treated the crisis developed, it should remain a prob- guarantee against loss in the insurance executives accordingly. But Bank Board lem of the Democratic administration in Fund." Chairman Gray, a Reagan appointee, was But questions remain asto what extent followingorders from the Reagan adminispolitical factors delayedthe Bank Board's tration not to assist Ohio's Democratic actions, and a House subcommittee hopes governor, these lawmakers assert. to learn more about that at a hearing "The administration must have given scheduled tomorrow. Instructions to Ed Gray not to rescue the Ohio thrifts," says Rep. Mary Rose Oakar 54 Mr. BARNARD. Thank you , Madam Chairman, and let me assure you that we intend to cover every one of the subjects which you have enumerated in your testimony this morning. They have already been a consideration of this committee but we are delighted to have you here to emphasize your concern about this situation . Thank you . Ms. Kaptur, do you have any statement you would like to make at this time? We are delighted to have you with us this morning. Ms. KAPTUR. Thank you, Mr. Chairman. I do not really have a formal statement except to say thank you so much for allowing me the courtesy to sit in on these hearings. And to encourage you to get to the bottom of this entire matter. As you know, one of the municipalities that I represent lost $ 19 million or it appears that it has lost $19 million in this series of events, and there are certainly a lot of unanswered questions on various levels. And I would hope that this committee would use its full powers to bring in the appropriate witnesses and to get the kind of thorough investigation that I think this question needs so we find out who really did what and when. Thank you, Mr. Chairman. Mr. BARNARD. Thank you very much. Congressman Kindness, you are going to be with us today. I did not know whether you wanted to offer any statement at this time. Mr. KINDNESS . Thank you, Mr. Chairman. I had not planned to make a statement, but I would suggest that if newspaper articles are going to be made a part of the record, I have quite a collection of them from around the State of Ohio that reflect concerns about graft and corruption in the political sphere and its influence upon this whole matter, which I had sought not to get into today, but I would urge upon the chairman that if we are to really investigate fully what this matter is all about, we will find a whole lot more meat in the Governor's office, the various departments and agencies that are affected in the State of Ohio than we will find in the Federal Home Loan Bank Board or the Federal Reserve, and I would hope that perhaps we could confine this to those areas that would be productive in terms of finding what the Federal response really should be. Thank you, Mr. Chairman. Mr. BARNARD. Thank you very much. We are also honored today to have with us Congressman Bob McEwen of Ohio and, Congressman, we would be delighted to hear from you if you have a statement at this time. Mr. McEwEN. Mr. Chairman , thank you very much. It is gracious of you to give me this opportunity and I would just quickly say that I join my colleagues in expressing a personal interest in this matter. I too participated in the meetings with the Federal Home Loan Bank Board and I believe that as Congressman Kindness has said that if we can find some way that in the future the Federal Government can participate expeditiously and yet not usurp State authority it would be in the best interests of all of us. And I thank you very much for the generosity. I would be glad to submit a statement. Mr. BARNARD. Thank you very much. 55 Our next witness this morning—our next panel this morning will consist of Mr. Donald R. Hunsche, executive vice president of what was the Ohio Deposit Guarantee Fund, and Mr. Tom Batties, who is chief deputy superintendent and general counsel of the Ohio Division of Savings and Loans. If they would take the podium at this time, the witness stand. We appreciate you gentlemen being with us today and participating in this hearing. And I would first recognize Mr. Donald R. Hunsche and Mr. Hunsche, if you would like to, without objection , we will submit your entire testimony in the record . If you feel like you would like to summarize, that would be at your desire . STATEMENT OF DONALD HUNSCHE , EXECUTIVE VICE PRESIDENT, OHIO DEPOSIT GUARANTEE FUND Mr. HUNSCHE. Thank you, Mr. Chairman. Mr. Chairman, distinguished members of the committee, my name is Donald R. Hunsche. I am the executive vice president of the Ohio Deposit Guarantee Fund. I am accompanied today by David S. Cupps and Roger Yurchuck, my legal counsel . I have been requested to provide the committee with background information on the Ohio Deposit Guarantee Fund and then discuss the Home State Savings Bank situation in three parts. The first part, prior to the ESM collapse; second, the events from Saturday, March 2, 1985, the day the fund became aware of the problem involving ESM, through Sunday, March 10, 1985, the day the conservator was appointed for Home State; and third, the events from March 11 through 20, the date the conservator was appointed for the Ohio Deposit Guarantee Fund. The law authorizing the creation of mutual, nonprofit guarantee associations for Ohio State-chartered savings and loans was passed in 1955. Our fund was incorporated in 1956 and commenced business January 2, 1957 , with 69 original members. The fund was formed because the Federal Savings and Loan Insurance Corporation would not insure companies that were only open for business less than 30 hours a week, did not have ground floor locations, or that had assets of less than $1 million . Many of the initial ODGF members fit into this category. The original amount of the total deposits guaranteed was about $200 million. This has subsequently grown to over $4.3 billion . The fund generally relied on the experience of Massachusetts whose fund predated Federal insurance. The fund's assets include a 2-percent deposit from each member based on savings at that institution. In addition, earnings on those deposits are retained by the fund to further strengthen the fund. Members count this 2 percent as a part of their assets. As of December 31 , 1984, the fund had assets of $ 125,800,000 . The total amount of guaranteed deposits was approximately $4.3 billion. The ratio of assets to guaranteed savings amounted to 2.9 percent. The FSLIC's comparable ratio is approximately three-quarters of 1 percent. The Ohio Deposit Guarantee Fund has cooperated fully with the Ohio Division of Savings and Loans throughout its history. The fund received examination reports of the State as well as quarterly 56 and other reports from all member companies, including Home State. The reports are reviewed by the fund's department of supervision for the purpose of making recommendations to improve operations of the companies and to assist in the correction of unsafe practices. However, the fund does not have legal power to effect compliance. It has no cease-and-desist power. It attempts to achieve compliance by working with State officials and the management of member companies to have the officers and directors of member companies agree to make desirable changes. Beginning on about April 1, 1980, the fund became aware through a review of reports of Home State's involvement with ESM Securities. There were at that time repurchase agreements of about $ 168 million . The situation again came to our attention in March 1981. At that time a report revealed an increase to $232 million. That occurred in July 1980. And there was overcollateralization and too much concentration with one dealer, namely, ESM. As I recall, the State questioned the overcollateralization and claimed there was a violation of borrowing limits; 1982 showed more of the same. The percentage of overcollateralization increased. Letters were written and meetings held expressing our concern, stating that such activities were imprudent. We also told Home State to restructure the transaction. On February 25, 1983, the fund wrote a letter to Home State strongly suggesting that it reduce the overcollateralization with ESM as soon as possible but not later than June 30, 1983, the date by which the transactions would mature. A board resolution of Home State agreed to our directive. Later, the fund was startled to learn that contrary to these directions, the transactions were dramatically increased in May and June 1983 up to $550 million. A meeting was held on October 3 involving representatives of the fund, the superintendent of the division of savings and loans and his staff, officials of Home State, and a representative of ESM . At that point, there was also a significant overcollateralization. We expressed our serious concern . The superintendent, with the fund's full support and concurrence, instructed Home State to wind down the transactions and reduce the substantial overcollateralization . In January 1984, all of the directors with the exception of two agreed to a program of unwinding the ESM relationship. By July 1984, 60 percent of the transactions had been matched and would mature in May and June 1985 and would thereupon cease. At least that is what Home State agreed to. On March 2, 1985, at approximately 4:15 in the afternoon, the fund became aware for the first time of a potential problem at ESM and a potential resultant problem with a loss at Home State. At that time, Mr. Schiebel, president of Home State, advised us that he was concerned because the audit report prepared by Alexander Grant & Co. , the auditors for ESM, had been withdrawn on Friday, March 1 , approximately 24 hours after it was delivered to him. We were advised that Home State still had repurchase relationships with ESM and that they were substantially overcollateral- 57 ized. We responded by requesting that the Ohio Deposit Guarantee Fund be kept fully advised. On Saturday or Sunday, March 2 or 3, I discussed the matter with Thomas Batties, as the acting superintendent of the division of savings and loans. On March the 5th, the depositors of Home State started a run on the institution. On March the 6th, the State of Ohio announced that it was prepared to safeguard the interests of the depositors of Home State and of all depositors whose funds were guaranteed by the Ohio Deposit Guarantee Fund and that the system in place provided adequate safeguards for depositors at its State-chartered savings and loans. The run at Home State continued on Thursday and Friday, March the 7th and 8th, in spite of the State's announcements. By Friday evening, March 8, an estimated $ 154 million had been withdrawn. By the close of business on March 8, the Ohio Deposit Guarantee Fund had advanced $45 million in cash to Home State for the benefit of its depositors. From approximately Wednesday, March 6, through Saturday, March 9, the ODGF was aware of negotiations involving a potential merger or purchase and assumption involving Home State. On Saturday, March 9, the ODGF had representatives present as observers at a meeting in Cleveland where bankers throughout the State of Ohio were informed of the situation and of Home State's availability as a merger partner. On Sunday, March 10, the State of Ohio announced the appointment of a conservator and the closing of Home State. Subsequent to Sunday, March the 10th, the Ohio Deposit Guarantee Fund has not been kept informed of the events surrounding Home State or its potential sale. The fund was not allowed to review the books and records of Home State so as to make its own independent assessment of the parameters of the potential loss. On about March 13, runs began at a few fund-member companies, particularly in the Cincinnati area, creating long lines which were dramatically played up by the media. On or about March 13, the State legislature passed legislation authorizing the creation of a separate deposit guarantee fund and providing for a loan to that fund . The ODGF was not consulted about the content or the advisability of the legislation . On March 15, the Governor visited Cincinnati and announced the closing of all Ohio Deposit Guarantee Fund companies statewide, even though the problem of runs was confined to the general Cincinnati area. Members of the fund were forced to remain closed on March 18 and 19. Institutions which were and are totally uninsured were allowed to remain open throughout this crisis . On Monday, March 21 , the Ohio Deposit Guarantee Fund received notice that the superintendent of savings and loans had appointed or purported to appoint a conservator for it on the evening of March 20. As you might guess, I have not yet had time or sufficiently complete information to reflect thoughtfully on the lessons on the 58 events or to formulate definitive recommendations. Since the appointment of the conservator for Home State on March 10 , the Ohio Deposit Guarantee Fund has been denied access to the records of Home State. Consequently, it is impossible for me to answer certain questions as raised in your letter of March 22. It is impossible to discuss comprehensively the ultimate financial impact of Home State's situation on the Ohio Deposit Guarantee Fund and its members . This is due to the fact that, one, as noted, the Ohio Deposit Guarantee Fund has been denied access to the books and records; second, the ultimate loss of Home State is still not quantified to our knowledge ; third , no buyer has been found for Home State, so the purchase price cannot be determined and thus the impact on the fund cannot be determined; fourth, it is not yet possible to determine either the collectability of Home State's claim against the ESM estate and the likely defendants in ESM litigation or the collectability of claims against directors , officers , controlling persons and other potentially liable persons involved in the Home State situation; and fifth, until Home State is sold we do not know whether it will be sold in such a way as to preserve the ODGF members' 2-percent deposits with the fund . It is also impossible to comment responsibly on the response and assistance from the Federal Home Loan Bank or the Federal Reserve. The ODGF does not know what the response from the Federal Home Loan Bank Board or the Federal Reserve has been since it has not been asked for its advice or assistance nor has it been informed directly as to what steps have been taken. The relationship and interaction with the Ohio Division of Savings and Loans and the Ohio Deposit Guarantee Fund was excellent prior to the Home State Savings Bank closing. Up to March 10, 1985, the fund and the division worked closely to try to resolve problems of Home State. After March 10, when the conservator was appointed for Home State, there has been little if any interaction . Subsequent to March 10, no information has been shared . In summary, as soon as the Ohio Deposit Guarantee Fund became aware of what it considered to be an inadvisable practice at Home State, it attempted to cause Home State to cease the practice. Contrary to those directions, Home State increased the dollar amounts of the transactions and increased the overcollateralization. Finally, Home State and its directors agreed in writing to stop the transactions. The fund has no legal power to author or enforce a cease-and-desist order. It could counsel restraint, but could not compel it. A tragic aspect of the situation which is still unresolved is the fate of the approximately 70 members of the fund . Some are now insured by the FSLIC. Others will be shortly. But there remain a significant number of sound, well-managed companies that have provided good service to their communities and neighborhoods , some for 100 years, whose fate is in doubt. The key to their future is to ensure that the Home State matter is settled promptly and in a way that protects the members' 2-percent deposit in the fund. While I believe that, if handled differently, the Home State situation could have been solved through a quick sale or merger and depositors immediately protected, the problem we now face is to 59 ensure prompt reopening of the remaining fund-guaranteed companies in such a way that they and their depositors are fully protected. To that end, the fund pledges its full support and cooperation. Mr. BARNARD. Thank you very much. Mr. HUNSCHE. Thank you, Mr. Chairman. [Mr. Hunsche's prepared statement follows:] 50-923 0-85--3 60 STATEMENT OF DONALD HUNSCHE , AN OFFICER OF THE OHIO DEPOSIT GUARANTEE FUND , BEFORE SUBCOMMITTEE ON COMMERCE , CONSUMER AND MONETARY AFFAIRS OF THE COMMITTEE ON GOVERNMENT OPERATIONS UNITED STATES HOUSE OF REPRESENTATIVES WASHINGTON , D.C. APRIL 3 , 1985 Chairman Barnard : My name is Donald Hunsche . I am the Executive Vice President of the Ohio Deposit Guarantee Fund ( " ODGF " ) . I would like to provide the Committee with background information on the ODGF and then discuss the Home State Savings Bank (" Home State" ) situation in three parts : ( 1 ) prior to the ESM Securities collapse , ( 2 ) the events from Saturday , March 2 , 1985 , the day the Fund became aware of a problem involving ESM , through Sunday , March 10 , 1985 , the day a conservator was appointed for Home State , and ( 3 ) the events from March 11 , through March 20 , the date a conservator was appointed for ODGF . I will conclude with a summary and some observations . Background The law authorizing the creation of mutual nonprofit guarantee associations for Ohio chartered savings and loans was passed in 1955. The ODGF was incorporated in 1956 and began business on January 2 , 1957. There were 69 original members . The Fund was formed because the Federal Savings and Loan Insurance Corporation ( " FSLIC" ) would not insure companies that were opened for business less than thirty ( 30 ) hours per week , did not have ground- floor office space or had less than 61 $1,000,000 in assets . categories . Many of the initial ODGF members fit those Today , many of those members continue to operate in a similar fashion and serve their neighborhoods , particularly in the Hamilton County area , as well as small towns throughout the State of Ohio . Other original members believed they could jointly do as good a job as the FSLIC in guarding savers deposits . The original amount of total deposits guaranteed was about $200,000,000 . $ 4,300,000,000 . This has subsequently grown to over The fund generally relied upon the experience of Massachusetts , whose fund predated federal insurance , and Connecticut in establishing the rules and operations of the fund . Then and now there are several totally uninsured companies in Ohio . These have not been closed and have not generally , to my knowledge , been adversely affected by the Home State crisis . The Fund's assets include a 2 % deposit from each member , based on savings at that institution , which is adjusted semiannually each year . In addition , earnings on the deposits of members are retained by the Fund to further strengthen the Fund . No dividends have been paid for 25 years . The members count this 2 % deposit as part of their net worth . As of December 31 , 1984 , the Fund had assets of $125,800,000 . The total amount of guaranteed deposits was approximately $ 4,300,000,000 . 2.9 % . This is a ratio of approximately The FSLIC's comparable ratio is approximately 0.75 % . -2- 62 The Home State Situation Prior To ODGF's Knowledge of the Collapse of ESM By way of additional background , ODGF has cooperated fully with the Ohio Division of Savings and Loan Associations throughout its history . ODGF receives examination reports of the State , as well as quarterly and other reports from all fund companies , including Home State . The reports are reviewed by the Fund's Department of Supervision toward the end of making recommendations to improve operations of the companies and to assist in the correction of unsafe practices . legal power to effect compliance . power . However , the Fund has no It has no cease and desist It attempts to achieve compliance by working with the the State and management of insured companies to have the directors of a company agree to make desireable changes . Beginning in about 1980 , the Fund became aware , through its review of reports , of Home State's involvement with ESM Securities . There were at that time repurchase agreements of about $ 100,000,000 . There was also a modest over- collaterali- zation and non-uniform maturities . The situation came to our attention next about March of 1981. At that time a report revealed over- collateralization and we noted that there was too much concentration with one dealer , namely , ESM . tion . There was , however , no explicit lending viola- Letters were written to and meetings held with officers of Home State concerning the problem , particularly the over-collateralization . -3- 63 1982 reports showed more of the same . Although the amounts involved would increase and decrease , the trend was upward . Again , we were concerned with over- collateralization and concentration of activities with ESM . Meetings were held with officials at Home State which were also attended by representatives of the State Superintendents Office . On February 25 , 1983 , the Fund wrote a letter to Home State strongly suggesting that it unwind the transactions with ESM and reduce the over- collateralization as soon as possible , but not later than June 30 , 1983 , the date the transactions would mature . : Later , the Fund was startled to learn that , contrary to these directions , the transactions were dramatically increased in May and June of 1983. A meeting was held in October , 1983 , involving representatives of the Fund , the Superintendent of the Division of Savings and Loans and his staff, officials of Home State and a representative of ESM . significant over-collateralization . At that point there was also The Superintendent , with the Fund's full support and concurrence , instructed Home State to wind down the transactions and reduce the substantial overcollateralizations . In January , 1984 , all the directors of Home State , with one exception , agreed to a program of unwinding the ESM relationship , with a particular emphasis on over-collateralization , and the concentration of transactions with one thinly capitalized dealer . -4- 64 It is our understanding that by July , 1984 , the various transactions had been matched , would mature in June and July of 1985 and would thereupon cease . At least that is what Home State agreed to . The Events of March 2-10 On Saturday , March 2 , 1985 , at approximately 4:15 p.m. , the Fund became aware for the first time of the potential collapse of ESM and the resultant potential loss to Home State . We learned this at a meeting which I and the Fund's counsel attended . Also present were David Schiebel , President of Home State , Nelson Schwab , Jr. , attorney for and a director of Home State , and Marvin Warner . At that time , Mr. Schiebel advised us that he was concerned because an audit report prepared by Alexander Grant & Company , the auditors for ESM , had been withdrawn approximately 24 hours after it was delivered to Mr. Schiebel earlier that week . We were also told that the withdrawal of the auditor's opinion caused Mr. Schiebel to engage legal counsel , whom he authorized to institute an immediate investigation of ESM . We were advised that Home State still had a repurchase relationship with ESM that was substantially over- collateralized . We responded by requesting that ODGF be kept fully advised of the results of the investigation Home State had undertaken in Florida . On Saturday , March 2 or Sunday , March 3 , I discussed the matter with Thomas Batties , at that time acting Superintendent of the Division of Savings and Loans of the State of Ohio . -5- 65 Thereafter , ESM's financial posture became the subject of extensive news coverage in Cincinnati due to the impact it might have on Home State . On March 5 , the depositors of Home State started a run on the institution . On March 6 , the State of Ohio announced that it was prepared to safeguard the interests of the depositors of Home State and of all depositors whose funds were guaranteed by the ODGF and that the system in place provided adequate safeguards for depositors at its State chartered savings and loan associations . The run at Home State continued on Thursday and Friday , March 7 and 8 , in spite of the State's announcements . By Friday evening , March 8 , an estimated $ 154,000,000 had been withdrawn . By the close of business on March 8 , the ODGF had advanced $ 45,000,000 in cash to Home State for the benefit of depositors . On its own initiative , Home State announced that it would not be open for business on Saturday , March 9 , a normal day of business for the Company , pending resolution of its pursuit of a merger . From approximately Wednesday , March 6 through Saturday , March 9 , the ODGF was aware of negotiations involving a potential merger or purchase and assumption involving Home State . The negotiations earlier in the week where with the First National Bank of Cincinnati . On Saturday , March 9 , the ODGF had representatives present as observors at a meeting in Cleveland where bankers from throughout the State of Ohio were informed of the situation and of Home State's availability as a merger partner . Representatives of the Department of Commerce and the -ĥ- 66 Superintendent were also present as were attorneys , for the State and the Superintendent of Banks . Representatives of the Federal Reserve Board were also present . The bankers stated that they were unable to make a rational offer because of the lack of definitive financial information . On Sunday , March 10 , the State of Ohio announced the appointment of a conservator for and the closing of Home State . The Events of March 11 through March 20 Subsequent to Sunday , March 10 , the ODGF has not been kept informed of events surrounding Home State or its potential sale . Even though a request was timely made , the Fund was not allowed to review the books and records of Home State so as to make its own independent assessment of the parameters of the potential problem . On Monday and Tuesday , March 11 and 12 , the media continued to publicize the difficulty Home State was having as a result of the dealings with ESM . On Tuesday , March 12 , 1985 , the Fund retained Mr. John Lyons of a New York firm specializing in sale of troubled financial institutions . The Fund then made the services of Mr. Lyons and his firm available to the State . On Wednesday the Fund was informed that the services of Mr. Lyons were not needed at that time . Later , we learned that on Saturday , March 16 , Mr. Lyons ' firm was retained by the State to assist in the preparation of a bid package . We have not been furnished with a copy of the bid package or bidding instructions , -7- 67 if any , and the Fund has not been involved in any efforts to sell Home State since the Saturday meeting on March 9 in Cleveland . On or about March 13 , runs began at a few Fund member companies , particularly in the Cincinnati area , creating long lines which were dramatically played up by the media . On March 15 , Governor Celeste announced the closing of all ODGF companies statewide , even though the problem of runs was confined generally to the Cincinnati area . On or about March 13 , the State Legislature passed legislation authorizing the creation of a separate deposit guarantee fund and providing for a loan to that fund . The Fund was not consulted about the content or advisability of the legislation . On March 15 , an organization meeting was held for the organization of the new deposit guarantee fund , specifically excluding Home State , based on a deposit of 1 % of member savings and the lending of $ 50,000,000 by the State of Ohio . To this date , to our knowledge , the State of Ohio has not placed its $50,000,000 in the new fund . On March 15 , the Governor visited Cincinnati and announced the closing of all ODGF companies statewide , even though the problem of runs were confined to the general Cincinnati area . Members of the Fund were forced to remain closed on March 18 and 19 . Institutions which were and are totally uninsured were allowed to remain open throughout the crisis . they have had no runs to date . ܘ܂ To our knowledge , 68 On March 19 , the Ohio Legislature passed additional legislation providing for the reopening of ODGF associations on a limited basis in some cases and on a full basis in others . On the morning of March 21 , ODGF received notice that the Superintendent of Savings and Loan Associations had appointed or purported to appoint a conservator for it on the evening of March 20. Summary and Conclusions As you might guess , I have not yet had time or sufficiently complete information to reflect thoughtfully on the lessons of the events or to formulate definitive recommendations . Since the appointment of a conservator for Home State on March 10 , 1985 , the ODGF has been denied access to the books and records of Home State . Consequently , it is impossible for me to answer certain questions as raised in your letter of March 22 . It is impossible to discuss comprehensively the ultimate financial impact of the Home State situation on the ODGF and its members . This is due to the facts that : ( 1 ) as noted ODGF has been denied access to the books and records of Home State , ( 2 ) the ultimate loss at Home State is still not quantified to our knowledge , ( 3 ) no buyer has been found for Home State , so the purchase price cannot be determined , and thus the impact on the Fund cannot be determined , ( 4 ) it is not as yet possible to determine either the collectability of Home State's claims against the ESM estate and the likely defendants in ESM litigation or the collectability of claims against the directors , 69 officers , controlling persons and other potentially liable persons involved in the Home State situation and ( 5 ) until Home State is sold we do not know whether it will be sold in such a way as to preserve the ODGF members ' 2 % deposit ( 2 % of savings ) with the Fund . If a sale can be arranged which protects that deposit , it would be of great benefit to the members of the Fund and their depositors . It is also impossible to comment responsibly on the response and assistance from the Federal Home Loan Bank Board or the Federal Reserve System . Since March 10 , the ODGF has basically been without communications or information relating to Home State . ODGF does not know what the response of the Federal Home Loan Bank Board or the Federal Reserve System has been since it has not been asked for its advice or assistance nor has it been informed directly of what steps have been taken . Therefore any comments would be based on hearsay , and I do not believe such a response would be appropriate . In response to one of your questions in your letter of March 22 , the relationship and interaction with the Ohio Division of Savings and Loan Associations and the ODGF was excellent prior to the Home State Savings Bank closing . Up to March 10 , 1985 , the Fund and the Division worked closely to try to solve the problem of Home State . After March 10 , when the conservator was appointed for Home State , there has been very little , if any , interaction . Pursuant to Section 1155.16 of the Ohio Revised Code , examination reports prepared by the Ohio Division of -10- 70 Savings and Loan Associations were shared with the ODGF . Sub- sequent to March 10 , no information has been shared . Summary In summary , as soon as ODGF became aware of what it considered to be inadvisable practices at Home State , it attempted to cause Home State to cease the practices . Contrary to those directions , Home State apparently increased the dollar amounts of the transactions and increased the over- collateralization . Finally , Home State and its directors agreed in writing to stop the transactions . The transactions still went on . However , the Fund had no legal power to author or enforce a cease-and -desist order . It could counsel restraint , but could not compel it . As soon as the Fund became aware of the ESM collapse , it began working with the State Superintendent . After the March 10 , 1985 appointment of a conservator for Home State , the Fund has been kept out of all negotiations relating to Home State . In fact , even today , it does not know the true financial condition of Home State . A tragic aspect of the situation which is still unresolved is the fate of the other approximately 70 members of the Fund . Some are now insured by the FSLIC . Others will be shortly . But there remain a significant number of sound , well - managed companies that have provided good service to their communities and neighborhoods , some for a 100 years , whose fate is in -11- 71 doubt . The key to their future is to insure that the Home State matter is settled promptly and in a way that protects the members ' 2 % deposit in the Fund . While I believe that , if handled differently , the Home State situation could have been solved through a quick sale or merger and depositors immediately protected , the problem we now face is to insure prompt reopening of the remaining Fund - insured companies in such a way that they and their depositors are fully protected . It will take the cooperation of the State , the FSLIC and the Fund to insure this result . To that end , I am sure the Fund would pledge its support and cooperation . -12- 72 NAME OF DEPOSIT INSURANCE FUND : I. OHIO DEPOSIT GUARANTEE FUND (the "ODGF" ) General Information 1. Type ( s ) of Financial Institution ( s ) whose deposits you insure : Ohio chartered savings and loan associations . 2. In which state ( s ) do you insure : 3. A. B. Annual premium : C. Continuing equity contribution 2% of withdrawal savings , or membership deposit : rounded to the nearest $100 , adjusted semiannually as of June 30 and December 31 of each year . 4. Maximum coverage per account or per depositor : 100% . 5. Do you insure brokered deposits : Yes , but members are controlled by the OGDF Rules and Regulations as to amounts they can take in brokered deposits ( See Item II ( k ) the ODGF Rules and Regulations ( the " Rules " ) . 6. Number of insured institutions , by type : Ohio only . Cost of initial membership 2% of withdrawable in your fund , if any : savings , rounded to the nearest $ 100 , adjusted semiannually as of June 30 and December 31 of each year , plus pro rata share of accumulated earnings at date of acceptance into fund membership . None . 73 A. B. C. D. Under $ 100 million : $ 100 million to $ 500 million : $500 million to $ 1 billion : Over $1 billion : A. B. C. D. December 31 , 1984 Assets Deposits $ 1,833,006,000 $ 1,699,704,000 $ 1,119,130,000 $1,175,396,000 $ 914,551,000 $ 823,675,000 $1,440,608,000 $ 668,005,000 7. II . Aggregate amounts of deposits insured , by type of institution : 61 7 1 1 (Home State ) $ 4,310,514,000 at December 31 , 1984 . 8. Your fund's total usable assets : 9. Ratio of usable insurance fund assets to deposits insured : 2.94% at December 31 , 1984 $ 126,912,430 at December 31 , 1984 (market value ) Background : 1. Are you a governmental or private agency and are you a creation of state law? Please provide a text or description of your basic statutory authority . The ODGF is a non profit , private mutual corporation created pursuant to Ohio Revised Code Section 1151.80-92 , as repealed by Amended Substitute Ohio Senate Bill 119 . 2. Please provide name of the state agency ( ies ) , if any , with supervisory authority over your books , records , operations , etc. Ohio Division of Savings and Loans . 3. If a situation arises where your insurance funds are inadequate to cover deposit losses , do you have , by statute : - 2 - 74 a. Access to the treasuries of the state ( s ) in which you operate ; and/or No b. Authority to assess other insured institutions enough to cover the losses? Not by statute ; however , Article V of the ODGF Constitution and Item III ( A ) of the ODGF Rules provides a method for an assessment . 4. Are you subject to state limitations as to the ratio of insurance fund assets to total deposits insured? No 5. Do you have lines of credit already established by contract on which you can draw at will ? What is the aggregate dollar limit of established lines of credit? With what institution or institutions have these credit lines been established? The ODGF has a $ 1,000,000 line of credit at the Bank for Savings & Loan Associations , Chicago , Illinois 6. Do you reinsure your risks with any other insurance carriers ? Please provide details . $ 2,000,000 Insurance Company of North America . $25,000,000 retention rider 7. Regarding your board of directors : a. How is your board of directors selected : Selected by Nominating Committee and/or representatives or members at ODGF Annual Meeting . See Article VIII of the Constitution . b. What rules govern the size and composition of the board? See Article VIII of the ODGF Constitution . C. Who are the present members of your board? ( Please provide names and principal affiliations . ) - 3 - 75 III . Name Affiliation Charles A. Brigham, Jr. President and Director , Federated Savings Bank , Lockland , Ohio John A. Dreyer Director , Baltimore Savings and Loan Company , Cincinnati , Ohio Richard D. Hoffman Chairman of the Board , The City Loan & Savings Company , Lima , Ohio Vernon W. McDaniel Assistant Treasurer and Director, Anderson Ferry Building and Loan Company , Cincinnati , Ohio John R. Perkins President and Director , The Metropolitan Savings Bank , Youngstown , Ohio Eleanor J. Remke President and Director , Madison Saving Bank , Cincinnati , Ohio Joseph D. Rusnak President and Director , Mentor Savings Bank , Mentor , Ohio David J. Schiebel Chairman of the Board , Home State Savings Bank , Cincinnati , Ohio Harold R. Swope President and Director , Independent Savings Association , Euclid , Ohio Charles F. Tilbury , Sr. Executive Vice - President and Director , The Clermont Savings Association , New Richmond , Ohio Jack R. Wingate Executive Vice -President and Director , Heritage Savings Bank , Cincinnati , Ohio Supervision of insured institutions : 1. Do you impose on the institutions whose deposits you insure , reserve , capital or other safety and - 4 - 76 soundness requirements designed to prevent the likelihood of insolvency? If so , what basic requirements do you impose ? Yes . 2. See Item II of the ODGF Rules . Please respond separately for each state in which you insured deposits : Ohio only a. Do you have authority , either by statute or contract , to discontinue a financial institution's membership in your deposit insurance fund? Yes--See : b. (1 ) Article IX , Section 6 ( a ) of the ODGF Constitution ; (2 ) Item IV ( A ) of the ODGF Rules provides for at least two months of continued insurance ; (3) Item VI of the ODGF Rules requires Notice of Termination to be given to depositors . Under what set of conditions or circumstances would you be authorized to discontinue insurance? By resolution of the Board of Trustees for due cause . See Article IX , Section 6 ( a ) of the ODGF Constitution . C. Since January 1 , 1980 , set forth the number of institutions whose insurance you have discontinued and the reasons for such discontinuance . None . 3. Please respond separately for each state in which you insure deposits : Ohio only a. Do you have authority to examine the books , records , loans and other financial transactions of the institutions you insure ? Is any such authority statutory or by agreement ? Please describe and/or provide a copy of your authority . Yes . See Item VI ( F ) of the ODGF Rules . Also see Article IX , Section 6 ( b ) of the ODGF - 5 - 77 Constitution and Item VI ( C ) of the ODGF Rules concerning additional directors . b. How frequently do you examine the institutions whose deposits you insure? Please describe your examination policies and procedures . How many examiners/auditors do you have? What is your examination operating budget? Member institutions are examined as deemed necessary by the Department of Supervision of the ODGF . Policies and procedures vary with the type of information desired . Department of Supervision consists of three persons capable of examining and auditing with an unlimited budget . c. Whether or not you have independent examination powers , do you have a right of access to the examination reports of the relevant financial institution supervisory authority in your state ? If so , do you receive their examination reports on a regular basis ? Yes , the ODGF receives copies of all examination reports of its member institutions as prepared by the Division of Savings and Loan Associations , State of Ohio . 4. Are the institutions you insure required to have their books audited and their financial statements certified by independent outside accountants? No. 5. If a financial problem is discovered or otherwise becomes apparent in a member financial institution , what authority do you have , short of insurance termination , to force correction of the problem and thereby forestall the necessity for claims against the deposit insurance? The ODGF has no direct authority to correct problems ; however , the ODGF closely supervises problems through the Department of Supervison which works with the member institution to resolve its problems . If the problem cannot be resolved by the Department of Supervision , the ODGF works with the Division of Savings and Loans , State of Ohio , to seek to effect a merger with another financially viable institution . The Advisory Committee of the ODGF can make recommendations to - 6 - 78 the Board of Trustees with respect thereto . IV. Payment of Losses : 1. Do you act as receiver/liquidator for failed institutions you insure? No. By agreement with member institutions , the ODGF has replaced management and directors in the past with ODGF employees and Trustees , corrected problems and then effected a merger with a financially viable association . The ODGF has never been a receiver/ liquidator . 2. If a financial institution whose deposits you insure is closed due to insolvency , do depositors receive their funds immediately or must they await a liquidation process ? The ODGF has never experienced a closing of a financial institution due to insolvency . 3. a. If an institution whose deposits you insure becomes insolvent , is liquidation and a payout of insured deposits your only alternative? No. See Ohio Revise Code $ 1151.87 (H ) . Pursuant to the ODGF Rules and general authority , the ODGF can attempt to effect mergers or provide other assistance . b. Do you have authority to arrange a purchaseand-assumption takeover (purchase of assets and assumption of deposit liabilities ) of a closed institution by another sound institution? No, not without the complete , full knowledge and approval of the Superintendent of the Division of Savings and Loan Associations , State of Ohio , and the ODGF member institutions . c. Do you have authority to keep an insolvent institution open and operating while seeking a merger partner? Yes , but the OGDF needs the approval of the member institution and the Superintendent to provide assistance . 4. Please provide a listing showing , for each insolvency covered by your fund from January 1, -.7 - 79 1980 , to date : The only situation to date is Home State Savings Bank , Cincinnati , Ohio , which is now in the hands of a state appointed conservator . V. Insured Fund Reserves : 1. How much is your total usable insurance reserve ? Provide calendar or fiscal year date for 1981 , 1982 , 1983 , and 1984 . Fiscal Year Ended June 30 1981 $ 50,182,978 1983 $ 88,354,862 2. 1982 $59,269,202 1984 $108,413,800 What is the present composition and market value , by type , of your insurance fund assets ( for example : U.S. Treasury Securities , bank deposits , corporate bonds , mutual fund investments , state/local securities ) ? At March 23 , 1985 U.S. U.S. U.S. Cash Bank 3. Government Securities Government Agency Bonds Government Treasury Bills and Federal Funds Certificate of Deposits $ 33,848,375 39,472,914 2,243,760 2,968,157 450,000 Do you invest any insurance fund assets in deposits , notes , debentures , or other obligations of the institutions you insure ? How much? ODGF deposits are made in member institutions only in the event of an assisted transaction . At present , $ 6,955,311 is on deposit in a savings account at City Loan & Savings Co. pursuant to a contractual agreement arising out of an acquisition of Central Savings Association , Blue Ash, Ohio . 4. In each of the past four calendar or fiscal years , what has been the average yield from interest , dividends , etc. , on your investment portfolio? Fiscal Year Ended June 30 1981 1982 1983 1984 5. 9.98% 11.36% 11.30 % 11.32% Please provide a copy of your latest annuai report . - 8- 80 (Amended Substitute Senate Bill Number 119) AN ACT To ensure the orderly reopening of building and loan associations and to provide for the protection of depositors, to terminate the authority for deposit guaranty associations except for certain functions , to repeal sections 1151.80 , 1151.81 , 1151.82 , 1151.83 , 1151.84 , 1151.85 , 1151.86 , 1151.87, 1151.88, 1151.89, 1151.90, 1151.91 , 1151.92, and 1151.99 of the Revised Code, and to declare an emergency. Be it enacted by the General Assembly ofthe State of Ohio: SECTION 1. (A) No building and loan association the deposits of which on the effective date ofthis act are insured by any deposit guaranty association shall be open for business unless deposits in such association are insured by the Federal Savings and Loan Insurance Corporation (FSLIC) or the Federal Deposit Insurance Corporation (FDIC) , or unless the findings in division (B) , (C) , or (D) of this section have been made. (B) Notwithstanding division (A) of this section , a building and loan association which has made an application for insurance to FSLIC or FDIC that is substantially complete shall be permitted to open for business by the Superintendent of Building and Loan Associations if the Superintendent finds, upon application by such association to the Superintendent, that such association probably should qualify for such insurance under the applicable standards of FSLIC or FDIC, as the case may be. If such association is other than a permanent stock company, and, in addition to an application for insurance to FSLIC or FDIC, it has submitted an application for reorganization under section 1151.61 of the Revised Code, the Superintendent shall include and consider such application in making his finding. (C) Notwithstanding division (A) of this section, if a building and loan association has made application to the Superintendent pursuant to division (B) of this section and such application has been denied or not been approved within fifteen days from the date such application was submitted to the Superintendent , such building and loan association may make application to the Director of Commerce . The Director shall hold a 81 hearing based upon rules promulgated by the Director within fifteen days at which evidence may be presented . A building and loan association shall be permitted to open unless the Director finds, based upon such factors as the liquidity of the building and loan association as demonstrated by its levels of cash, cash items and readily marketable securities , and the ability of such association to immediately preserve or increase the liquidity in response to depositor demands and the net worth of such association, and that such opening is not in the best interests of the depositors of such association or is detrimental to the interests of building and loan associations generally. The procedures provided by this act are not subject to Chapter 119. of the Revised Code. (D) Notwithstanding division (A) of this section, a building and loan association may open if it demonstrates to the satisfaction of the Superintendent one ofthe following: (1) It's deposits are guaranteed by a corporation, organization, or other person, which corporation, organization , or person owns , directly or indirectly, a majority of such association within 120 days of the effective date of this act , and which corporation, organization, or person meets such financial and other qualifications as may be established by the Superintendent; (2) It is owned or controlled, directly or indirectly, by an institution insured by FSLIC or FDIC and such institution guarantees its deposits, or has entered into an agreement to be acquired by or be merged with such institution, or enters into such an agreement within fifteen days of the effective date of this act. (3) The Superintendent determines that the interests ofthe depositors will not be jeopardized. (E) In addition to the causes stated in section 1157.01 of the Revised Code, the Superintendent may order a building and loan association to liquidate its business and property pursuant to section 1157.23 of the Revised Code whenever either: (1) The Superintendent has denied its application to open for business under division (B) of this section and there is no appeal from that denial pending pursuant to division (C) of this section or an appeal has been denied and the Superintendent determines that the interests ofthe depositors will be jeopardized if the association is not liquidated ; (2) After being permitted to open for business under division (B) or (C) of this section, its application for deposit insurance has been denied or the Superintendent finds that any other condition upon which opening was permitted is not in existence and the Superintendent determines that the interests of the depositors will be jeopardized if the association is not liquidated; (3) The association has not qualified to open for business 120 days after the effective date of this act, and the Superintendent determines that the interests of the depositors will be jeopardized ifthe association is not liquidated . (F) . During the period in which a building and loan association is not open for business pursuant to division (A) of this section, such association may set aside and make available in its discretion for withdrawal by all depositors during any period of thirty consecutive days an aggregate amount not exceeding the balance of such depositors' account or accounts, 82 but in no event more than an aggregate of seven hundred fifty dollars in each thirty-day period; provided, however, that such association shall keep an account of the withdrawals made and such withdrawals shall be deemed to be credits against the withdrawing depositor's pro rata dividend in the event such association is liquidated . Such association may receive deposits, but the deposits received during such period are not subject to any limitation as to payment or withdrawal, and such deposits shall be segregated and shall not be used to liquidate any indebtedness of such association existing on the effective date of this act or any subsequent indebtedness. Such deposits received while the association is not open for business shall be kept on hand in cash, invested in the direct obligations ofthe United States or the State of Ohio , or deposited with a financial institution in Ohio designated by the Superintendent . (G) Nothing in this section shall preclude the Superintendent from exercising his powers and discharging his duties and responsibilities as set forth in the Revised Code. (H) The powers of the Superintendent under this act and Sub . S. B. 113 of the 116th General Assembly after December 31 , 1985 , shall be limited to the fulfillment of commitments made under such acts, expressly or by reasonable implication, on or before that date and shall not include the initiation of any additional proceedings not so required . (I) There shall be no liability imposed on the part of, and no cause of action of any nature arises against, the savings association guaranty fund created pursuant to Sub. S. B. 113 of the 116th General Assembly, its board of trustees, officers, agents, or employees , the superintendent of savings and loan associations or his authorized representatives, for any statements made in good faith by them in any reports or communications concerning risks insured or to be insured by the association, or for any administrative actions conducted in connection therewith. SECTION 2. That sections 1151.80 , 1151.81 , 1151.82 , 1151.83 , 1151.84, 1151.85 , 1151.86, 1151.87 , 1151.88 , 1151.89, 1151.90 , 1151.91 , 1151.92, and 1151.99 of the Revised Code are hereby repealed effective sixty days from the effective date of this act . Notwithstanding this section, a deposit guaranty association has all power and authority necessary to accomplish complete winding up of its business, including, but not limited to, the defense to judgment, with right of appeal as in other cases , of any claims asserted against any such deposit guaranty association , and the prosecution to judgment, with right of appeal as in other cases , of claims, whether arising by subrogation or otherwise, presently heid by, or hereafter arising or accruing to, any such deposit guaranty association. SECTION 3. Notwithstanding any other provision of the Revised Code to the contrary, if any such building and loan association or building and loan association or building and loan associations insured by a deposit guaranty association elects to convert to a bank and if following such conversion the institution should be eligible for FDIC insurance, upon application the Superintendent of Banks shall forthwith issue an authorization for the applicant to commence business as a bank and thereafter the institution shall be a bank. SECTION 4. Notwithstanding any other provision of the Revised Code to the contrary, if any such building and loan association or building and loan associations insured by a deposit guaranty association , elects to 83 convert to a bank, the association or associations shall file an application with the Superintendent of Banks. The Superintendent of Banks may, without being subject to the publication, notice and hearing requirements ofsection 1103.07 of the Revised Code, approve such application and may condition such approval to provide for the orderly transition from the business of a building and loan association to the business of the bank. The Superintendent of Banks shall have full authority to enforce compliance with such conditions and to regulate the resulting bank pursuant to Chapters 1101. to 1129. of the Revised Code. Upon receipt of evidence satisfactory to the Superintendent of Banks that the resulting bank will be insured by the Federal Deposit Insurance Corporation at the time it commences business as a bank, the Superintendent shall issue a certificate of authority to commence business as a bank. Notwithstanding any other provision of the Revised Code to the contrary, if any building and loan association or building and loan associations insured by a deposit guaranty association elects to merge or consolidate with a bank or to transfer assets and liabilities to a bank, upon receipt of evidence satisfactory to the Superintendent of Banks that the resulting bank of such reorganization will be insured by the Federal Deposit Insurance Corporation upon consummation of the reorganization, the Superintendent of Banks shall approve the merger, consolidation or transfer of assets and liabilities. The Superintendent of Banks may waive, in whole or in part , fees required by section 1125.16 of the Revised Code for any transaction made pursuant to this section. SECTION 5. A special prosecutor shall be appointed by the attorney general as described in section 2939.10 ofthe Revised Code to investigate and prosecute any criminal violations that may have been committed in connection with any events and circumstances that caused any savings and loan association to be placed in the possession of a conservator as of March 15, 1985, and any criminal activity by any depositor, investor, director, officer, or employee of any savings and loan association, any unlawful activity in the operation of any savings, and loan association, or any unlawful activity by any state officer or employee in connection with the regulation, examination , inspection, or operation of any savings and loan association or any deposit guaranty fund or any person with whom an association had any contractual relationship. SECTION 6. All assets , deposits or loans received by the deposit guaranty fund for state chartered building and loan associations , as created by Sub. S. B. 113 ofthe 116th General Assembly less any deposits by building and loan associations denied membership by the Federal Savings and Loan Insurance Corporation are hereby pledged to indemnify the corporation for any losses incurred by the corporation through defaults through June 30, 1987 of formerly privately insured state chartered associations accepted for membership by the corporation. In addition, the General Assembly shall appropriate $ 10,000,000 , not withstanding the net amount provided by the deposit guaranty fund for these same purposes to the extent these funds are required . SECTION 7. Within two working days of a privately insured state chartered building and loan association receiving notification that it has been denied insurance from the Federal Savings and Loan Insurance Corporation, the deposit guaranty fund as created by Sub. S. B. 113 of 84 the 116th General Assembly, shall pay to the association any funds on deposit by the association to the guaranty fund less any withdrawals by the association and plus interest earned on the net balances by the association on deposit with the guaranty fund. Interest earned shall be calculated on the daily interest received by the guaranty fund as determined by the funds' management. SECTION 8. This act is hereby declared to be an emergency measure necessary for the immediate preservation of the public peace, health, and safety. The reason for such necessity lies in the fact that this action is essential to the best possible conclusion to a serious problem affecting public confidence in building and loan associations whose deposits are insured by deposit guaranty associations. Therefore , this act shall go into immediate effect. Speaker of the House of Representatives. President Passed Approved of the Senate. 19 19 Governor. The section numbering of law of a general and permanent nature is complete and in conformity with the Revised Code. Director, Legislative Service Commission . 85 Filed in the office of the Secretary of State at Columbus , Ohio , on the day of A. D. 19 Secretary of State . File No. Effective Date 86 [DEPOSIT GUARANTY ASSOCIATIONS] 81151.80 Definitions. As used in sections 1151.80 to 1151.92, inclusive, of the Revised Code: (A) "Building and loan association" means a corporation organized for the purpose of raising money to be loaned to its members or to others; and mcludes "savings association"; (B) "Deposit guaranty association" means an association organized under the provisions of sections 1151.81 to 1151.86, inclusive, of the Revised Code; (C) "Superintendent of building and loan associations means the superintendent of building and loan associations in the state of Ohio created 87 1151.81 TITLE 11: BUILDING AND LOAN ASSOCIATIONS by the provisions of section 121.04 of the Revised Code. HISTORY: 126 ▼ 94, § 1. 28 10-11-55. Cross-References to Related Sections FiduciaryDeposit of funds, RC $ 2109.41 Investment by, RC § 2109.37 Investment of funds by trustees of police and firemen's disability and pension fund, RC 1742.11. Investment ofsurplus or reserve of state insurance fund, RC4123.44.2. Investments by domestic life insurance company, RC 3907.14. Investments by public employees retirement board, RC 145.11. Investments by state teachers retirement board, RC $ 3307.15(FX1). See RC $ 1107.18 which refers to RC 1151.80 to 1151.92. CASE NOTES AND OAG 1. A deposit guaranty association organized under RC 1151.80 et seq is not empowered to guar: anty the permanent stock of member building and loan associations: 1956 OAG No.6299. 2. A deposit guaranty association organized under RC 1151.80 et seq is empowered to guaranty withdrawable shares, stock deposit accounts or running stock of member building and loan associations: 1956 OAG No.6299. 3. A deposit guaranty association organized under RC 1151.80 et seq is empowered to guaranty moneys on deposit with member building and loan associations pursuant to the pertinent provisions of RC 1151.19, whether evidenced by passbook o certificate of deposit: 1956 OAG No.6299. 81151.81 Incorporation of mutual deposit guaranty association. Any number of building and loan associations incorporated pursuant to sections 1151.02, 1151.03 and 1151.04 of the Revised Code, not less than twenty-five, may become incorporated under the general corporation laws of this state as a mutual deposit guaranty association without capital stock subject to the limitations prescribed in sections 1151.80 to 1151.92, inclusive, of the Revised Code. Articles of incorporation of a deposit guaranty association shall be filed in the office of the secretary of state. The secretary of state shall, upon receipt of such articles,transmit a copy of them to the superintendent of building and loans and shall not record them until authorized to do so by the superintendent. HISTORY: 125 ▼ 94, § 1. 2E 10-11-55. 188 and substance and the examination shows that such corporation, if formed, would be entitled to commence the business of a deposit guaranty association, the superintendent shall so certify to the secretary of state. The superintendent may refuse to make such certification if upon examination he has reason to believe the proposed corporation is to be formed for any business other than assuring the liquidity of member building and loan associa tions and guarantying deposits therein, if he has reason to believe that the character and general fitness of the incorporators are not such as to command the confidence of the general public or if the best interests of the public will not be promoted by its establishment. HISTORY: 126 ▼ 94, § 1. ZA 10-11-55. CASE NOTES AND OAG 1. The sole purpose of the legislature in making possible a deposit guaranty corporation is to guaranty the liquidity of its member associations: Ohio Deposit Guarantee Fund v. Dziamba, 60 00 428, 137 NE(2d) 905 (CP). 2. The refusal of the superintendent of building and loan associations to certify the articles of incorporation of a deposit guaranty association because of certain provisions or lack of provisions in a proposed constitution and by-laws constitutes an arbitrary and discriminatory act: Ohio Deposit Guarantee Fund v. Dziamba, 60 OO 426, 137 NE(2d) 905 (CP). §1151.83 Recording of articles of incorporation; certified copies. Upon receipt of the certificate provided for in section 1151.82 of the Revised Code, the secretary of state shall record the articles of incorporation of such deposit guaranty association and furnish a certified copy thereof to the incorporators and to the superintendent of building and loan associations. All papers thereafter filed in the office of the secretary of state relating to such corporation shall be recorded as provided by law and a certified copy forwarded to the superintendent. HISTORY: 126 ▼ 04 (95), § 1. ZE 10-11-55. 81151.84 Proposed amendments transmitted to superintendent. When any proposed amendments to the articles of incorporation of a deposit guaranty as sociation are filed in the office of the secretary of state, the secretary of state shall transmit copy thereof to the superintendent of building $ 1151.82 Examination and certification and loan associations and shall not record such by superintendent. amendments until authorized to do so by the Upon receipt from the secretary of state of a superintendent. HISTORY: 125 ▼ 94 (95), § 1. KE 10-11-55. copy of the articles of incorporation of a proposed deposit guaranty association the superin81151.85 Examination and certification examat once shall loans and of tendent building ine into all the facts connected with the forma- of amendments. Upon receipt from the secretary of state of a tion of such proposed corporation. In the event such articles ofincorporation are correct in form copy of proposed amendments to the articles of 88 ticorporation of a deposit guaranty association the superintendent of building and loan associations shall at once examine the proposed amendments to determine their effect on the operation of the deposit guaranty association. In the event such proposed amendments are correct in form and substance and the examination shows that if adopted they would not change the character or principal business of the deposit guaranty association, the superintendent shall so certify to the secretary of state. The superintendent may refuse to make such certification if upon examination he has reason to believe the proposed amendments would change the character of the business of the guaranty deposit association or the best interests of the public will not be promoted by their adoption. HISTORY: 126 ▼ 94 (95), § 1. 28 10-11-55. tion that is subject to inspection by the United States or by this state. (F) Issue its capital notes or debentures to member building and loan associations provided the holders of such capital notes or debentures shall not be individually responsible as such holders for any debts, contracts, or engagements of the deposit guaranty association issuing such notes or deben1 tures; : (G) Borrow money; (H) Exercise any corporate power or powers not inconsistent with, and which may be necessary or convenient to,the accomplishment of its purposes of assuring liquidity of member building and loan associations and guaranteeing deposits therein. *HISTORY: 139 v S 426. Eff 12-9-82. 1151.86 Recording of amendments; certified copies. Upon receipt of the certificate provided for in section 1151.85 of the Revised Code, the secretary ofstate shall record the amendments to the articles of incorporation and furnish a certified copy thereof to the corporation and to the superintendent of building and loan associations. HISTORY: 126 ▼ 94 (95), § 1. ZE 10-11-58. Law Review Developments in Ohio savings and loan law: 1980. Ronald E. Alexander. 17 AkronLRev 357 (1981). Regulating State Chartered Savings Associations: An Introduction to the Ohio Scheme. Ronald E. Alexander. 11 AkronLRev 399 (1978). The Ohio deposit guarantee fund-the Ohio alternative to FSLJC. Ronald Alexander, 15 AkronLRev 431 (1982). § 1151.87 Powers of associations. Adeposit guaranty association incorporated in accordance with sections 1151.81 to 1151.86 of the Revised Code, may: (A) Assure the liquidity of member building and loan associations; (B) Guaranty moneys on deposit, but notthepermanent stock ofassociations; (C) Loan money to a member building and loan association for the purpose of assuring its liquidity and deposits therein; (D) Buy any assets owned by a member building and loan association for the purpose of assuring its liquidity and deposits therein; (E) Invest any of its funds in: (1) Bonds or interest bearing obligations of the UnitedStates orfor which the faith and credit ofthe United States are pledged for the payment of principal and interest; (2) Bonds or interest bearingobligations of the District of Columbia, of this state, of any county, township, school district, or other political subdivision ofthis state, or of any municipal corporation in this state; (3)Farm loan bonds issued under the "Federal Farm Loan Act," 39 Stat. 360, 12 U.S.C. 641 (1916), and amendments thereto; (4)Notes, debentures , and bonds of the federal home loan bank issued under the "Federal Home Loan Bank Act," 47 Stat. 725, 12 U.S.C. 1421 (1932), and any amendments thereto; (5) Bonds or other securities issued under the "Home Owners Loan Act of 1933," 48 Stat. 128, 12 U.S.C. 1461, and any amendments thereto; (6) Securities acceptable to the United States to secure government deposits in national banks; Certificates ofdeposit of any financial institu- Ohio Administrative Code Negotible order of withdrawal account. OBL: OAC 1301: 2-5-21 $ 1151.88 Filing of semiannual financial reports. Each deposit guaranty association shall on the thirtieth day of June and the thirty-first day of December of each year, or within forty days thereafter, file with the superintendent of building and loan associations a report for the preceding half year, showing its financial condition at the end thereof. Such reports shall be in such form and contain such information as prescribed by the superintendent. HISTORY: 126 ▼ 94 (96), 8 1. EN 10-11-55. $1151.89 Annual examination of building and loan associations. At least once each year the superintendent of building and loan associations shall make or cause to be made an examination into the affairs of each deposit guaranty association doing business in this state. The expenses of such yearly examination shall be paid by the state. HISTORY: -126 ▼ 94 (97), § 1. EA 10-11-55. CASE NOTES AND OAG 1. The statute (RC 1151.89 et seq) gives the absolute right of the superintendent to make investigations and examinations and inspections of any 89 § 1151.90 TITLE 11: BUILDING AND LOAN ASSOCIATIONS deposit guaranty company in the same manner as he is empowered to supervise and control the operation of all member building associations. Any abuse of authority, power or discretion on the part of such guaranty association may be dealt with as completely and adequately as with any member building and loan association: Ohio Deposit Guar antee Fund v. Dziamba, 60 00 428, 137 NE(2d) 905 (CP). 188 minister oaths to and examine the officers and agents of such association as to its affairs. HISTORY: 126 ▼ 94 (97), § 1. ZA 10-11-55. § 1151.92 Fees. Each deposit guaranty association doing business in this state shall pay to the superintendent of building and loan associations , at the time offiling $ 1151.90 Special examinations. Whenever the superintendent of building and eachsemiannual report required by section 1151.88 loan associations deems it necessary he may make ofthe Revised Code,five dollars plus a sum equalto or cause to be made a special examination of one one-hundred-sixtieth ofone per cent ofthe assets any deposit guaranty association doing business ofsuch association as shown in such report. All such in this state in addition to the regular examina- fees shall be paid into the state treasury tothe credit tion provided for by section 1151.89 of the Re- of the division of building and loan associations account. vised Code. The expense of a special examina special HISTORY: 136 S 447 (Ef 5-19-76); 137 ▼ S 221. EA tion shall be paid by the association. Such 11-23-77. expenses shall be collected by the superintendThe provisions of § 12 of SB 221 (137 v —) read as ent and paid into the state treasury to the credit follows: of the general revenue fund. SECTION 12. Services rendered by the unclaimed funds HISTORY: 126 ▼ 94 (97), § 1. E# 10-11-85. section ofthe Department of Commerce shall include the costs of making publications required by §1151.91 Right to enter and conduct in- necessary169. Chapter of the Revised Code and of paying other vestigations. operating and administrative expenses. Adjustments tothe The superintendent of building and loan as- Unclaimed Funds rotary fund appropriation shall be made sociations or any examiner appointed by him to cover the actual expenses of this section. The amounts shall have access to and may compel the pro- appropriate tothe Department ofCommerce in Am. Sub. duction of all books, papers, securities, moneys, H.B. 191 ofthe 112th General Assembly for appropriation and other property of a deposit guaranty asso- Item 800-613 Building and Loan Rotary shall be conciation under examination by him. He may ad- 90 Ohio Deposit Guarantee Fund Constitution IO DEPOSIT ALL SAVINGS GUARANTEED D IN FULL UN UARANT F NTEE OH CONSTITUTION OF THE OHIO DEPOSIT GUARANTEE FUND ARTICLE I NAME The name of the corporation shall be : " OHIO DEPOSIT GUARANTEE FUND . " ARTICLE II LOCATION The principal office of the corporation shall be located in Cincinnati , Hamilton County, Ohio . ARTICLE III PURPOSE The purpose of the corporation shall be to use the full extent of it powers , authority and resources to provide for the liquidity of its members and to guarantee the moneys on deposit in member associations , whether evidenced by passbook , or certificates of deposit , withdrawable shares , stock deposit accounts , or running stock of member building and loan associations and savings associations , but not the permanent stock , debentures or similar stock accounts . ARTICLE IV POWERS The corporation shall have all of the powers granted by Sections 1151.80 to 1151.92 inclusive of the Ohio Revised Code to mutual deposit guarantee associations and as may be hereafter provided by law; and shall have the powers granted by the general corporation laws of Ohio to non-profit corporations . - 1 - 91 ARTICLE V DEPOSITS Each member shall maintain a deposit with the corporation in such amount and under such terms and conditions as shall be determined by the Board of Trustees , not to exceed two percent (2 % ) of the deposit liability of such member , which shall be uniformly applied to all members. Such deposit shall be evidenced by certificates of deposit of the corporation . No additional deposit will be required except on an affirmative vote of members having deposit liabilities aggregating more than sixty percent (60 % ) of the total deposit liability of all members at a regular meeting or a special meeting called for the purpose . All deposits and certificates issued therefor shall be rounded off to the nearest Hundred Dollars . Members may carry such certificates on their books as assets and these may be considered as a liquid asset by the member. Members may not , without the consent of the Board of Trustees , use such certificate or certificates as collateral for loans . Deposits of members shall be adjusted semi-annually to conform to changes in deposit liability , as shall be determined by the Board of Trustees . In addition to the above deposit , a new member shall , upon admission , contribute to the accumulated reserves of the corporation a sum equal to the accumulated reserves at the end of the calendar quarter immediately preceding such admission multiplied by the ·- 2 - 50-923 0-85--4 92 ARTICLE V DEPOSITS (continued) fraction whose numerator shall be the required deposit of such new member and the denominator shall be the aggregate of deposits of all members . ARTICLE VI MEMBERS SECTION 1 Only companies organized under Sections 1151.02 , 1151.03 and 1151.04 of the Ohio Revised Code may be members of the corporation . On or before the 31st day of July each year , each member , by action of its Board of Directors , shall appoint one of its officers or directors to be its Representative , and one of its officers or directors to be its Alternate Representative who shall serve in the absence of the Representative , and shall thereafter notify the corporation of its appointment . On October first of each year following such notification, each Representative and Alternate Representative shall be the Representative and Alternate Representative of the member appointing them until October first of the following year or until their successors are chosen and qualified . At all meetings of members , the vote of each Representative or Alternate Representative shall be the vote of the member association which appointed him. - 3- 93 ARTICLE VI MEMBERS (continued) SECTION 2. Vacancies Whenever a vacancy occurs in the office of Representative or Alternate Representative of any member, by reason of death , resignation or failure to continue in office as an officer or director , such member , by action of its Board of Directors , shall appoint a successor to fill such vacancy for the unexpired term and shall notify the corporation of its appointment . ARTICLE VII MEETINGS AND NOTICES SECTION 1. Annual Meeting of Members The Annual Meeting of members shall be held in October of each year , not earlier than the fifteenth (15th ) day thereof , for the purpose of electing the Trustees and conducting such other business as may properly come before the meeting . The Board of Trustees shall designate the time and the place of said meeting and the Secretary shall notify the Representatives at least fourteen (14 ) days in advance of said meeting by mail . notice shall contain the time , place and purpose of the meeting . Section 2. Special Meetings of Members Special meetings of members shall be held whenever called by the Board of Trustees , the President , or by at least five ( 5 ) Representatives or 94 ARTICLE VII MEETINGS AND NOTICES (continued) twenty percent (20% ) of the Representatives , whichever , is larger, joined together for such purpose . The President , or such group of Representatives , shall notify the Secretary of the purpose of the meeting in writing . The Secretary shall notify all the Representatives of the call , time , place and purpose of said meeting , in writing , at least fourteen ( 14 ) days in advance of said meeting. Section 3. Notices All notices for Annual or Special Meetings shall be mailed to the address given by the member in its notice of appointment or such other address as the Representatives or Alternate Representatives shall designate . Section 4. Quorum Fifteen ( 15 ) Representatives or twenty percent (20%) of the Representatives , whichever is larger , shall constitute a quorum of members , and at each meeting of members , whether Annual or Special , said quorum may act by and through a majority of Representatives in attendance , and the act and deed of such majority shall be binding and conclusive as the action of all of the members in all respects . - 5 - 95 ARTICLE VIII BOARD OF TRUSTEES Section 1. Number of Trustees The Board of Trustees shall consist of not less than nine (9) nor more than fifteen ( 15 ) Trustees . Only an officer or a director of a member shall be eligible to serve as a Trustee . The terms of office of elected Trustees shall not be less than one (1 ) year nor more than three (3 ) years . Repre- sentatives may increase or decrease the number of Trustees , within the limits herein prescribed , at any Annual or Special Meeting called for that purpose . A decrease will not affect the term of a Trustee then in office . Trustees shall be elected by the Representatives at the Annual Meeting in such numbers and to serve for such terms that an equal number of Trustees , as nearly as possible , will expire each year . Elections shall be by ballot if more candidates are nominated than number of Trustees to be elected . Trustees shall be limited to two ( 2 ) consecutive terms of office , but may be eligible to serve after one (1 ) full year's absence on the Board . The Board of Trustees may make recommendations to the membership as to the number of Trustees and may nominate a duly qualified person as Trustee . Any five ( 5 ) Representatives may also nominate a Trustee by written nomination , provided such nomina- - 6 - 96 ARTICLE VIII BOARD OF TRUSTEES (continued) tion is made in writing and addressed to the Executive Vice-President and received by him at least five ( 5) days prior to the Annual Meeting . Section 2. Compensation The Trustees shall serve without compensation as Trustees , but may be reimbursed for expenses as may be required from time to time in the performance of their duties as Trustees . Section 3. Termination of Office and Vacancies The office of a Trustee shall be terminated by reason of death , resignation , failure to continue in office as an officer or director of a member or failure to attend three (3 ) consecutive meetings . Whenever such vacancy occurs , the remaining members of the Board of Trustees shall appoint a successor to fill such vacancy for the unexpired term. Section 4. Meetings of Board of Trustees The Board of Trustees shall meet at least once every three ( 3 ) months , and may , from time to time , by action of the Board of Trustees , establish additional regular meetings of the Board of Trustees . The President may call a special meeting of the Board of Trustees at any time and the Executive VicePresident shall notify the members of the Board of 7.- 97 ARTICLE VIII BOARD OF TRUSTEES (continued) Trustees by notice , in writing , at least five (5 ) days prior to said meeting . Section 5. Quorum A majority of the Board of Trustees shall constitute a quorum at any meeting of the Board of Trustees . At any meeting of said Board , at which a quorum is present , said Board may act by and through a majority of the Trustees in attendance and the act and deed of such majority shall , in all respects , be binding and conclusive as the action of the whole Board . ARTICLE IX OFFICERS AND COMMITTEES Section 1 . The officers of the corporation shall be elected annually by the Board of Trustees at an organizational meeting to be held following the Annual Meeting of the corporation or at a regular or special meeting of the Board , if necessary , and shall consist of the following: President , and a Vice- President , all from its own number ; one or more Vice-Presidents ; a Secretary and a Treasurer . The Board shall elect an Executive Vice-President who shall not be an officer or director of any building and loan association , who shall administer the policies of the Board . The Board will appoint 98 ARTICLE IX OFFICERS AND COMMITTEES (continued) an attorney or attorneys and an auditor or firm of auditors , who shall be certified public accountants . The Executive Vice-President , attorney or attorneys , and auditor or firm of auditors , will all serve at the pleasure of the Board . The Board may employ such other persons as it deems necessary . No full time employee may be a director or officer of any building and loan association . Officers so elected shall take office immediately and shall hold office for a term of one year or until their successors are elected and qualified . The office of President shall not be held for more than two ( 2 ) consecutive terms by the same person . Section 2 . The President shall appoint an Executive Committee of five ( 5 ) , with the approval of the Board of Trustees , all of whom shall be Trustees , who shall act for the Trustees of the corporation in the interim between the meetings of the Board of Trustees and have 1 such duties and powers as is delegated to them by the Board of Trustees . The President shall appoint an Advisory Committee of seven (7 ) , with the approval of the Board of Trustees , all of whom shall be officers or directors of members , who shall have such duties and - 9. 1 99 ARTICLE IX OFFICERS AND COMMITTEES (continued) authority as shall be delegated to them by the Board of Trustees . The Executive Vice- President shall be the Executive Secretary of both committees without vote . Section 3. The Board of Trustees shall have the power to adopt , amend , repeal and enforce such By-Laws , resolutions , rules and regulations and orders as they may deem necessary to enable them to properly manage and control all the business , property and rights of the corporation . Section 4. The officers shall have the powers and duties as may be prescribed by the By-Laws . Section 5. The Board of Trustees may elect such other officers and provide for such committees , either temporary or permanent , as it deems necessary . Section 6. In addition to the powers granted heretofore , the Board of Trustees is charged with the following specific responsibilities : - 10 - 100 ARTICLE IX OFFICERS AND COMMITTEES (continued) (a) The Board of Trustees shall have the sole right to admit additional members to membership in the corporation on such terms and conditions as the Board may prescribe , and for due cause shall have the sole right to revoke membership in the corporation . (b) The Board of Trustees may require regular and special reports , statements and audits of its members . Section 7 . Any rule and regulation or order may be amended or repealed by a vote of the members at a duly constituted meeting called for that purpose . ARTICLE X AMENDMENTS The Charter and Constitution of the corporation may be altered , amended , repealed , or superseded either in whole or in part by the affirmative action of a majority of the members , at any meeting of members called for that purpose . - 11 - 101 ARTICLE XI DISSOLUTION The corporation may be merged or dissolved or otherwise terminate its existence , in accordance with the General Corporation Act of Ohio , with the provision that any action of the members to bring about a dissolution or termination of the existence of the corporation shall require the affirmative vote of not less than eighty percent ( 80% ) of the members . Notwithstanding the provisions of Article X of this Constitution , this Article XI may be amended only by the affirmative vote of not less than eighty percent (80 % ) of the members . ·- 12 - 102 Ohio Deposit Guarantee Fund By- Laws O DEPOSI T ALL SAVINGS GUARANTEED D IN FULL FUN ARANTEE FU OHI BY - LAWS OF THE OHIO DEPOSIT GUARANTEE FUND SECTION I DUTIES OF OFFICERS A. President The President shall preside at all meetings of the corporation , and of the Board , and shall have such authority and perform the duties as they pertain to said office as may be required of him. B. First Vice- President The First Vice-President , who is a Trustee , shall perform the duties of the President in the event of his absence . C. Secretary The Secretary shall keep a complete record of all the proceedings of all meetings of members and of the Board and shall perform the duties as shall pertain to said office and such other duties as may be required of him. D. Treasurer The Treasurer shall perform the duties usually incident to the office of the Treasurer and such other duties as may be required of him. E. Executive Vice- President The Executive Vice-President shall be a salaried officer who shall devote his entire business -- 1 - 103 SECTION I DUTIES OF OFFICERS (continued) time to the affairs of the corporation . He shall administer the policies of the Board , and , as such , he shall be the general receiving , disbursing , and managing officer of the corporation under the Board and the Executive Committee , and , with the assistance of such employees as the Board may provide , shall have the care and management of all the corporation's business , rights , and affairs for which there is no other provision in the Constitution or By-Laws of the corporation . In the performance of his duties , he shall exercise such authority over the subordinate officers and employees as shall be necessary or appropriate . He shall receive notice of and attend all meetings of the members of the corporation , of the Board , of the Executive Committee , and of the Advisory Committee , and may act , if chosen , as secretary of any committee . SECTION II ATTORNEY The Attorney shall represent the corporation in all legal proceedings ; he shall draw all necessary legal papers , give his advice and counsel whenever requested , and render such other services as may be required by the Board . SECTION III AUDITOR The Auditor shall annually examine the books and records of the corporation and render an opinion of same and perform such other duties as are required by the Board . - 2 - 104 SECTION IV COMMITTEES A. Executive Committee The President shall appoint the Chairman of the Executive Committee who shall preside at all meetings of the Committee . The Executive Vice- President shall be ex -officio the secretary of the Committee without vote . Members of the Committee shall hold office until the next Annual Meeting following their appointment and until their successors are appointed and qualified . A majority of members of the Committee shall constitute a quorum for the transaction of business . The Committee shall establish the policy for investment of funds within the limitations prescribed by Section 1151.87 of the Revised Code and shall establish the policy regarding the sale of investments or other assets , real or personal , of the corporation . The Committee may borrow money and secure loans so made by a pledge or mortgage of any of the property , real or personal , of the corporation . If, in the opinion of the President , or of the Vice-President acting in the capacity of President , an emergency exists and it is impossible to get a quorum to act at once , he may appoint one or more members of the Board to act temporarily as a - 3 105 SECTION IV COMMITTEES (continued) member of the Executive Committee to provide a quorum so that the Committee may function during the emergency . Minutes of meetings of the Execu- tive Committee shall be submitted to the Board at its next regular meeting . B. Advisory Committee The Committee shall , at its first meeting , organize by electing one of its members as its Chairman who shall preside at all meetings of the Committee . The Executive Vice -President shall be exofficio a member of said Committee without the power to vote . The Advisory Committee may inquire into the financial condition and management policies of each member of the corporation and shall recommend to any member actions or policies it considers necessary or advisable for such member to take to adopt in order to place or preserve such member in a condition to safeguard properly the interests of its depositors . If its recommendations are not complied with within a reasonable time to the complete satisfaction of the Committee , it shall so report to the Board at its next meeting , including in its report its recommendations with respect to the action to be taken by the Board . 4 106 SECTION IV COMMITTEES (continued ) Said Committee shall have authority to counsel with the Board of Directors of members . All applications for membership in the corporation shall be submitted to the Advisory Committee for its review and recommendation to the Board . The Ad- visory Committee shall meet at least quarterly and special meetings may be called at any time by the Executive Vice - President or the Chairman of the Commit- tee . Minutes of all meetings of the Advisory Committee shall be submitted to the Board . SECTION V WAIVER Members of the Board may waive notice of a meeting required to be given by law or by the Constitution of the corporation , and, by attendance at a meeting , shall be deemed to have waived such notice . SECTION VI AUTHORIZED SIGNATURES All certificates of deposit , notes , deeds , mortgages , contracts , and all instruments in writing not herein specifically enumerated other than checks for the disbursement of money , shall be signed by any two (2 ) of the following officers : President ; First Vice- President ; Executive Vice- President ; Secretary or Treasurer , or such officers as shall be designated by - 5- 107 SECTION VI AUTHORIZED SIGNATURES (continued) the Board of Trustees to sign on behalf of the corporation . No officer shall sign in more than one capacity . SECTION VII DEPOSITORIES AND DISBURSEMENTS All funds shall be under the control of the Board of Trustees , who shall cause them to be deposited in the name of the corporation with its designated depository or depositories , and such funds shall be withdrawn from such depository only on check of such depository or depositories , to be signed by such officer or officers as designated by resolution of the Board . SECTION VIII INDEMNITY BOND All officers and employees of the corporation , before entering upon the discharge of their duties , shall be covered by an individual , schedule or blanket fidelity bond in favor of the corporation in an amount required by , and with the terms and surety approved by , the Board . The Trustees , as such , shall not be required to give bond . -- 6 - 108 SECTION IX PARTICIPATION BY TRUSTEES IN MATTERS BEFORE BOARD Any member of the Board of Trustees who represents , as counsel , director or other officer , a member of the Fund which has a matter before the Trustees , which may require action by the Trustees , may present to the Trustees the case of the member which he represents , but such member of the Trustees shall not participate any further in the deliberation of the Trustees or the action of the Trustees with respect to such matter . SECTION X PARTICIPATION BY ADVISORY COMMITTEE MEMBERS IN MATTERS BEFORE COMMITTEE Any member of the Advisory Committee who represents , as counsel , director or other officer , a member of the Fund which has a matter before the Committee which may require a recommendation by the Committee , may present to the Committee the case of the member which he represents , but such member of the Committee shall not participate , any further , in the deliberation of the Committee of the recommendation of the Committee with respect to such matter . --7- 109 SECTION XI AMENDMENTS These By-Laws may be altered , amended , repealed , or superseded either in whole or in part by the affirmative action of a majority of members of the Board at any meeting of the Board called for that purpose . A proposal to amend shall be filed with the Executive Vice-President at least two (2 ) weeks prior to the meeting at which said amendment is to be considered , and the Executive Vice-President shall include said proposal with the notice of the meeting. Any amendment so adopted must be substantially the same as proposed . - 8 - 110 Ohio Deposit Guarantee Fund Rules and Regulations O DEPOS IT ALL SAVINGS GUARANTEED QUARAINNFULL FUND TEE OHI INDEX TO RULES AND OF REGULATIONS THE OHIO DEPOSIT GUARANTEE FUND ITEM I. APPLICATION FOR MEMBERSHIP A. Eligible B. Records and Files C. Advertising Membership ITEM II . STANDARDS AND QUALIFICATIONS A. Liquidity B. Required Reserve C. Real Estate Owned D. Slow Loans E. Taxes and Insurance F. Shareholders ' Approval of Membership G. Holding Companies H. Test Appraisals I. Deferred Charges & Income J. Service Corporation Activities ITEM III . DEPOSITS AND PENALTIES A. Deposits B. Penalties ITEM IV . WITHDRAWAL FROM MEMBERSHIP A. Notice B. Amount Entitled To C. Merger D. Reorganization E. Dissolution 111 ITEM V. NOTICE OF TERMINATION OF MEMBERSHIP ITEM VI . POWERS DEFINED A. Loans to Members B. Purchase of Member's Assets . C. Authority to Fill Vacancies on Board D. Liquidation by Superintendent E. Trustee's Authority to Require Amendments F. Investigative Authority ITEM VII . INTEREST AND RETURN ON DEPOSITS ITEM VIII . INFORMATION AND STATISTICS OF MEMBERS ITEM IX . REQUIRED NOTIFICATION ITEM X. INCREASE IN INTEREST OR DIVIDENDS ITEM XI . ADVERTISING RATES OF RETURN ITEM XII . PROMOTIONAL OPERATIONS ITEM XIII . AMENDMENTS 112 RULES AND REGULATIONS OF THE OHIO DEPOSIT GUARANTEE FUND ITEM I. (A) ELIGIBLE APPLICATION FOR MEMBERSHIP state which is not a member of the Fund may , upon Any building and loan association of this compliance with such conditions as may be prescribed by the Board , become a member of the Fund . (B) RECORDS AND FILES Applicants for membership in the Fund and mem- bers of the Fund agree to authorize the Superintendent to make available to the Fund the records and files in his office as to the management and condition of each member . Said authorization shall be in the form agreed upon by the Fund or the Superintendent . (C) ADVERTISING MEMBERSHIP A member may advertise itself as a member of the Fund and may use the symbol in its advertising as long as it is a member . to prescribe the form may be advertised . - 1 - The Fund reserves the right in which the guarantee of deposits 113 ITEM 11 . STANDARDS AND QUALIFICATIONS The following standards and qualifications shall be required of all members of the Fund and their maintenance shall be a condition of continuous membership or admittance to membership in the Fund . (A) LIQUIDITY Each member shall establish and maintain unpledged liquid assets equivalent to 7% (or such other percentage as determined by the Board of Trustees ) of its net deposit liability and borrowed money . However , a member shall not be required to maintain the required percentage on borrowed money that is collateralized by a liquid asset as hereafter defined . For purposes of this regulation , the following items shall be considered as liquid assets : 1 ) Cash . 2 ) U.S. Treasury Bonds , Notes or Bills . 3) Municipal obligations and federal funds , as prescribed in Section 1151.34 (B ) , Ohio Revised Code . 4) Investments in any of the following : a) Stock in Federal Home Loan Bank . b) Deposit in Ohio Deposit Guarantee Fund . c) Bank for Cooperatives Bonds . d) Federal Land Bank Bonds . e) Federal Intermediate Credit Bank . f) Federal International Credit Banks Consolidated Systemwide Bonds . · la - 114 ITEM II (A) LIQUIDITY (continued ) STANDARDS AND QUALIFICATIONS g ) Federal Home Loan Bank Bonds . h ) Federal National Mortgage Association Bonds . i ) Government National Mortgage Association Bonds . j ) Bankers acceptances of a bank insured by Federal Deposit Insurance Corporation . 5) Deposits in Federal Home Loan Bank both demand and time . 6) Deposits in Bank for Savings & Loan Associations . 7) Certificates of Deposit in any financial institution subject to inspection by the United States or by the State of Ohio . 8) Any other type of investment similar to those listed that may be approved from time to time by the Board of Trustees . That portion of any liquid asset that is pledged or used as collateral for public deposits or used in reverse repo transactions cannot , at the same time , be construed as a liquid asset . In the event that liquid assets are used as collateral for borrowed money , public deposits , or reverse repo transactions , only the amount of the liquid assets equal to the amount of the borrowed money , public deposit or reverse repo transaction need be deducted from the book value of the liquid assets in determining the 7 % liquidity requirement . However , in the event the lender , etc. specifically requires liquid collateralization on a greater basis than one for one , the additional amount required shall also be deducted . - 2 - 115 ITEM LI STANDARDS AND QUALIFICATIONS (A) LIQUIDITY (continued ) Specifically excluded as liquid assets are all mortgage backed securities and revenue bonds . If, for any consecutive seven (7 ) business days , the liquid assets of the member remain less than the fixed requirement and , during that period , the member makes loans , the member may be assessed a fine of not more than $ 500.00 for each day when loans were made . The amount of the fine shall be determined by the Board of Trustees , upon reviewing the facts disclosed to them by the Supervisory Section of the Fund . At its discretion , the Board of Trustees may waive any fine or penalty assessed . # # # · 2a - 116 ITÉM II . STANDARDS AND QUALIFICATIONS (continued) (B ) LOSS RESERVE AND OTHER NET WORTH ACCOUNTS Each member or applicant for membership shall maintain or show reasonable ability to maintain , a Loss Reserve and other net worth accounts in accordance with the requirements of the Ohio Revised Code and the Superintendent , Division of Building and Loan Associations , State of Ohio . (C) REAL ESTATE OWNED No member or applicant for membership shall hold real estate , acquired through mortgage foreclosure or deed in lieu thereof , the aggregate value of which is in excess of three percent ( 3 % ) of its total assets . (D) SLOW LOANS No member or applicant for membership shall permit the aggregate of its slow loans , as defined by the Division of Building and Loan Associations , to exceed a sum equal to two percent (2 % ) of its total assets . (E) TAXES AND INSURANCE Each member or applicant for membership shall maintain office records which show payment or nonpayment of taxes and insurance premiums upon all property upon which the member or applicant holds -3- 117 ITEM II . a mortgage , and upon real estate owned . STANDARDS AND QUALIFICACATIONS (continued) (F ) SHAREHOLDERS ' APPROVAL Each member or applicant for membership shall obtain the approval by its shareholders of its membership or application for. membership in the Fund , and shall , within sixty (60 ) days following its admittance to membership , present to the Fund a certified copy of minutes of the meeting at which such approval was given . (G) HOLDING COMPANIES Each member , the records of which disclose that more than twenty percent ( 20 % ) of its voting stock is owned by a person or corporation not organized under Chapter 1151 of the Ohio Revised Code , shall report this fact promptly to the Fund . The Fund, upon receipt of such notice , or within six (6) months thereafter , may then declare the member to be not eligible for continued membership in the Fund . In such event , said member shall withdraw from the Fund within two (2 ) months after the Fund has declared it to be not eligible for continued membership . Such member shall be entitled to withdraw from the Fund , in the manner provided in these Rules and Regulations . 4 118 ITEM II . STANDARDS AND QUALIFICATIONS (continued) The Fund may reject any application made for membership in the Fund , if it finds that more than twenty percent ( 20 % ) of the voting stock of the applicant is owned by a person or corporation not organized under Chapter 1151 of the Ohio Revised Code . If , after the receipt of notice that more than twenty percent (20 % ) of the voting stock of a member or applicant for membership is owned by a person or corporation not organized under Chapter 1151 of the Ohio Revised Code , and the Fund decides to retain such member or admit such applicant for membership , such member and the person or corporation owning in excess of twenty percent ( 20 % ) of the voting stock may , at the discretion of the Board of Trustees , be required to comply with the following regulations : 1. No dividends may be declared or paid when the aggregate of the subject member's statutory reserves and undivided profits are less than five percent ( 5 % ) of its withdrawable money . -5- 119 ITEM II . STANDARDS AND QUALIFICATIONS (continued) 2. The Fund shall have the right to audit or review the records of the person or corporation owning in excess of twenty percent ( 20% ) of the voting stock of a member and any other subsidiary owned or controlled by such person or corporation whenever the Fund considers such audit or review necessary for its best interest . 3. A member whose voting stock is owned , as stated above , shall have its stockholder or corporation , at its expense , submit copies of all reports requested by the Fund which it considers necessary for the protection of its interest . Such reports shall include , but not be limited to , copies of annual audits performed by certified public accountants and copies of reports filed annually with the Securities and Exchange Commission . 4. Transactions and dealings between a member and any person owning more than twenty percent ( 20 % ) of the voting stock of such member , and any other corporations , partnerships , trusts , or similar organizations in which said person or his family has an interest , is prohibited , without the prior approval of the Fund . 6 120 ITEM II . STANDARDS AND QUALIFICATIONS (continued) 5. Transactions and dealings between a member and its parent corporation , or any subsidiaries of the parent corporation or major stockholder of the parent or any of the subsidiaries , wherein the proceeds of any transaction or dealing made by such member inure to the benefit of any of the above , is strictly prohibited without the prior approval of the Fund . (H) TEST APPRAISALS Whenever a member is in violation of Sub- sections (C ) or (D ) of this section and an examination made by the Division of Building and Loan Associations , or an audit conducted by the Fund's staff discloses that the member company is or has been engaged in unsound , unsafe or imprudent lending practices , it shall be reported to the Board of Trustees . Under such circumstances , the Board of Trus- tees has the authority to cause test appraisals to be made of the real estate owned by such member and the real estate securing its loans , by an independent appraiser selected by the Fund . The cost of such test appraisals will be borne equally by the member and the Fund . In the event the test appraisals indicate that the member is or has been engaged in unsound , unsafe or imprudent lending practices , the Board of Trustees - 7 - 121 ITEM II . may require the member to set up a Specific Reserve STANDARDS AND QUALIFICATIONS (continued) in the amount by which the balance of the loan exceeds the appraised value of the real estate security and also , to have all future real estate offered as security for loans appraised by an independent appraiser selected by the Fund for such period as the Board may determine . (I) DEFERRED CHARGES AND INCOME Each member or applicant for membership shall charge off premiums , on mortgage loans purchased when paid, or may capitalize them. If capitalized , a pro- portionate amount of the premium shall be charged to expense , at least semi -annually, over the remaining term of the loans or over a period not exceeding the average remaining term of the loans , or seven (7) years , whichever is less . Each member or applicant for membership shall defer discounts on loans purchased over a period of not less than seven ( 7 ) years ; the discount shall be credited to income at least semi -annually . Any charge made by the purchaser in connection with the purchase of a loan shall be deducted from the purchase price to determine the amount of the discount . 122 ITEM II . STANDARDS AND QUALIFICATIONS (continued) (Rev. 2/80 ) (Rev. 4/25/84) All charges for finder's fees , buying commission , attorney's fees , and brokerage fees in connection with the making or acquisition of a mortgage loan or contract , shall be treated as an expense in the accounting period in which such charges are incurred . Each member shall credit to an account descriptive of deferred income any amounts charged in connection with making a loan or contract (other than average interest provided by the loan contract ) all amounts in excess of the greater of $ 50.00 , or four and one - half percent ( 4-1 % ) of the amount of the loan , if the loan is for the purpose of construction, or four percent ( 48 ) of the loan or contract , if the loan is for any other purpose , plus $ 400.00 for either type of loan or contract when members utilize employees of the institution to perform appraisal , attorney or loan closing functions . A proportionate amount of this deferred income shall be credited to income , at least semiannually over a period of not less than seven ( 7 ) years . Amounts collected from the borrower and paid out to third parties for necessary initial charges in connection with the mortgage loan or contract transaction are excluded from computing deferred income . - 9 123 ITEM II . STANDARDS AND QUALIFICATIONS (continued ) On loans sold, by participation or otherwise , capitalized premiums and/or deferred credits or discounts applicable to such loans as of the sale date shall be added to or deducted from (as appropriate ) the book value , and the profit or loss thereon shall be recognized as of that date . On loans paid in full , the above may apply; however , it is not mandatory , as it is on loans sold . (J) . SERVICE CORPORATION ACTIVITIES A service corporation in which any member has an interest or any subsidiary of a service corporation is prohibited from entering into any transaction wherein a director , officer , employee of the member or corporation , or person or corporation owning or controlling 20% or more of the member's stock has a direct or indirect interest without the prior written approval of the Ohio Deposit Guarantee Fund . · 10 50-923 0-85--5 124 ITEM II . STANDARDS AND ALIFICATIONS (continued ) (K) BROKERED DEPOSITS AND JUMBO CERTIFICATES OF DEPOSIT Brokered Deposits are defined as funds received , in which a third party intermediary, acting as a broker, comes between the owner of (Approved by Board of Trustees 9/26/84) the money and the depository. This broker repre- sents either party for a fee --- or other consideration -- usually paid to the broker by the depository. A savings promotion by a member , in which the employee receives a bonus for bringing savings into the Association, is not considered brokered savings , provided no one other than the employee is involved in obtaining the savings deposits... Jumbo Certificates of Deposit are defined as Certificates of Deposit in an amount of $100,000 or more or a combination of amounts exceeding $100,000 , which are controlled by the same account holder , and which are specially negotiated as to rate and/or duration . With respect to the above , a member or applicant for membership shall comply with the following : 1) Brokered Deposits and Jumbo Certificates , in the aggregate , shall not exceed five percent (5% ) of a member's current total deposit liability. · 10a - 125 ITEM II . However , Brokered Deposits and /or STANDARDS D QUALIFICATIONS (continued) Jumbo Certificates may be accepted in excess of the 5 % limit , if such excess is invested in a liquid instrument that matures within seven (7 ) days of the maturity date of the Brokered Deposit or Jumbo Certificate . Mortgage loans , construction loans , and other forms of loans will not be considered as liquid investments . 2) Any tie- in of Brokered Deposits or Jumbo Certificates to the granting of credit is prohibited . 3) In the event the Board of Trustees determines that a member is a supervisory problem, it may, by action taken at any regular or special meeting , prohibit any future acceptance of Brokered Deposits or Jumbo Certificates by said member until such time as the Board of Trustees , in its opinion , no longer considers said member to be a supervisory problem. 4) A member shall have the right to submit to the Board of Trustees a written request for authorization to exceed the percentage .- 10b - 126 Such request ITEM II. limitation in 1 ) above . STANDARDS A. QUALIFICATIONS (continued) shall set forth the reasons for additional authorization, together with supporting documentation. The Board of Trustees shall have the sole right to approve or disappprove such request . 5) Brokered Deposits and Jumbo Certificates , held as of May 31 , 1984 , that exceed the percentage limit in 1 ) , may not be renewed without the specific approval of the Fund, except that Jumbo Certificates existing in member institutions as of May 31 , 1984 , are " grandfathered " and may be continuously renewed . · 10c 127 ITEM III . DEPOSITS AND PENALTIES (A) DEPOSITS 1. If additional deposits are voted , in accordance with Article V of the Constitution , any member not voting in favor of such call may resign from membership by filing with the Fund , within thirty ( 30) days after such a vote is taken , a written notice of its intention to resign . Such resignation shall become effective upon compliance with and in accordance with the provisions of the Rules and Regulations . The member so resigning shall be entitled to receive from the Fund the same : portion of its assets , and in the same manner , as it would be entitled to receive under Item IV , Section B, of these Rules and Regulations . No member which has filed a notice with the Fund of its intention to resign under this SubSection shall be required to make any additional deposits , required by the Fund of its members pursuant to Article V of the Constitution , after receipt by the Fund of such notice . The assent of each member to the vote for additional deposits shall be conclusively presumed to have been given unless a member , within thirty ( 30 ) days after the vote thereon was taken , files a notice with the Fund of its intention to resign . -- 11 - 128 ITEM III . DEPOSITS AND PENALTIES (continued) Any member, having given notice of its intention to resign, may withdraw such notice by written request , at any time before its effective date . Upon payment to the Fund of its full share of the additional deposit required , such notice of intention to resign shall be void . 2. Upon admission to the Fund , the amount required to be contributed to the accumulated reserves and to the deposit of the Fund , required by Article V of the Constitution , may be paid at once , or in such manner as may be determined by the Board of Trustees . 3. Deposits with the Fund , prescribed by Article V of the Constitution , and the amount required to be paid pursuant to Sub-Section 2 of this section , are prerequisite to membership . 4. "Deposit liability , " as used in this section , means the deposit liability of a member as of December 31st or June 30th, immediately preceding the date of the action taken or required to be taken . 5. There shall be an adjustment of the deposit requirements of members semi-annually , beginning · January 1st and July 1st , based upon the increase or the decrease of the deposit liability of each member . - 12 - 129 ITEM III . For each semi -annual period beginning January 1st , DEPOSITS AND PENALTIES (continued ) of the member's deposit liability as reported on the deposit of each member shall equal that portion December 31st , immediately preceding and for each semi -annual period beginning July 1st , the deposit of each member shall equal that portion of the member's deposit liability as reported on June 30th immediately preceding , as prescribed in percentage by Article V of the Constitution . If the required deposit of a member is thus found to have increased over the preceding semi -annual period , it may deposit the difference due from time to time , provided the entire difference shall be paid in full not later than February 10th and August 10th of the period for which the adjustment was made . Refund due to members on decrease shall be made by February 10th and August 10th of the period for which the adjustment is made , provided the Certificate of Deposit is presented for such change . At the time of each semi- annual adjustment of deposits , and after payments in accordance with such adjustments have been made , the Fund shall enter on each of the Certificates of Deposit the amount then on deposit . All deposits made with the Fund pursuant to this Sub-Section shall be rounded off to the nearest hundred dollars . ·- 13 -- 130 ITEM III . DEPOSITS AND PENALTIES (continued) (B) PENALTIES Each member accepts the obligation to make all payments due pursuant to Sub- Section 5 of Section A of this Item , on or before the date due . Failure to do so on the part of any member renders such member subject to suspension or expulsion . While under suspension , or after expulsion , for failure to make deposits when due , the Fund recognizes no obligations to such member to exercise any of the powers set forth in Item VI hereof , and such member is not entitled to any of the benefits of membership in the Fund , including display of the symbol , other than those granted by Item IV , Section B, with respect to withdrawal of assets . Failure to make deposits on or before the date due shall subject the member to a penalty . The penalty shall not exceed ten percent ( 10 % ) of the amount due . The Fund may institute an action at law for the collection of the deposits or the penalty or 1 both . · 14 - 131 ITEM IV . (A) WITHDRAWAL FROM MEMBERSHIP time of giving notice of intention to withdraw or NOTICE Any member which is not , either at the at the time of withdrawal , in default in any of its obligations to the Fund , including calls made before the date of withdrawal , or which has repaid any advance or loan made to it by the Fund , and has carried out the terms of any repurchase agreement made with the Fund , may withdraw from membership in the Fund upon giving to it twelve ( 12 ) months ' notice in writing , of its intention to withdraw. The Fund may , upon a vote of two-thirds ( 2/3 ) of its Board of Trustees , at a meeting called to consider such notice , or upon a vote of the members whose deposit liabilities aggregate not less than seventy-five percent (75 % ) of the total deposit liabilities of all members (including those of the withdrawing member) at a meeting of the members called to consider such notice , permit such member to withdraw at the end of two (2 ) months from the date of giving such notice or at the end of such period less than twelve ( 12 ) months from the date of giving of such notice as may be approved by the Board, if no meeting of the members is called to consider such notice . Upon the written request of the withdrawing member, the meeting of the Board to consider the notice as above provided shall be held - 15 - 132 ITEM IV. within five (5 ) weeks from the date such notice was WI RAWAL FROM MEMBERSHIP (continued) given. If the Board , at such meeting , has fixed the effective date of withdrawal at a date more than two (2 ) months from the date the notice was given , then, upon the written request of the withdrawing member , the meeting of members to consider such notice , as above provided , shall be held within eight ( 8 ) weeks from the date B) (Approved by Board of Trustees 9/26/84) such notice was given. AMOUNT ENTITLED TO Any member withdrawing from the Fund pursuant to the provisions of Section A above shall be entitled to withdraw from the Fund's assets only in the manner hereinafter stated , its proportionate share of the Fund's net assets on the date its withdrawal becomes effective . Such proportionate share shall be calculated in the following manner: 1) The amount of the deposit in the Fund by the member, (representing the percentage of the deposit liability of the member ) ; plus ... 2) the amount of the payment , if any, made by the member upon admission to the Fund, representing its proportionate interest in the accumulated reserves of the Fund (the equalization payment ) ; plus or minus -16- 133 ITEM IV. 3) WITHDRAWAL FF MEMBERSHIP (continued) The member's proportionate interest in the net earnings or losses of the Fund between the date such member was admitted to membership and the date of such member's withdrawal , calculated as hereinafter stated . A member's proportionate interest in the earned reserves or losses of the Fund will be calculated in the following manner: . For each six-month period , or fraction thereof , (January to June , and July to December) , of membership , the net earnings or losses of the Fund less any dividends paid to members shall be allocated to each member based upon the ratio of each member's deposit in the Fund to the total deposits in the Fund of all members , based upon the deposits required at the beginning of each period . 2) As of the withdrawal date , the withdrawing member shall be charged with its propor- ~ tionate interest (based upon the ratio of the withdrawing member's deposit in the Fund to the total deposits in the Fund of all members at that date ) in the following manner : -17- 134 ITEM IV. a) WITHDRAWAL FR MEMBERSHIP (continued) the amount , if any, by which the market value of the Fund's assets is less than their amortized cost (book value); b) the amount of any reserve , as determined by the Board of Trustees but not recorded in the financial statements of the Fund , to provide for existing or potential losses existing at the withdrawal date . 3) If the total of the amounts calculated in 1 ) and 2 ) above shall be an increase in the amount due to the withdrawing member, there shall be deducted from such amount , twentyfive percent (25% ) of such amount to be retained by the Fund . The amount due to a withdrawing member shall normally be paid in cash. However , in the event that the Board of Trustees , in its judgment , determines that certain assets of the Fund are not readily marketable, then a percentage of such amount shall be paid by the issuance of a certificate or certificates of fractional participation.. Such certificate or certificates of fractional participation shall entitle the holder thereof to its proportionate share of any proceeds resulting from the liquidation of such remaining assets as they are liquidated by the Fund. -18- Such certificates 135 ITEM IV. WITHDRAWAL ROM MEMBERSHIP (continued) shall describe the assets to which it relates only by symbols , and the Fund shall , after the issuance of such certificate or certificates , designate such assets on its records , by like symbols . Such certi- ficate or certificates shall not entitle the holder thereof to any control over the manner , amounts , or time of liquidation of any of such assets . The Fund shall not reveal any information related to such remaining assets other than the extent of liquidation of the assets to which such certificate or certificates relate . The Fund , in final settlement of such member's proportionate share , either may pay to the withdrawing member, in lieu of such certificate or certificates , such sum in cash as may be agreed upon as the reasonable value thereof, or at any time after the issuance of such certificate or certificates , may purchase the same for such sum in cash as may be then agreed upon as the reasonable value thereof. In the event that a withdrawing member's proportionate interest in the earned reserves or losses of the Fund was reduced by a reserve as provided in 2 ) b) , the following shall apply. If the ultimate aggregate loss incurred by the Fund is less than the amount of the reserves provided at the withdrawal date , then the withdrawing member shall be entitled to its propor-18a- 136 ITEM IV. tionate share of any such amount ( less the 25 % WITHDRAWAL FI I MEMBERSHIP (continued ) to be retained by the Fund , if applicable ) . In this event , the determination of any amounts due to withdrawn members , as well as the time and method of payment , shall be made by the Board of Trustees , in their judgment , based upon a review of all the facts and circumstances relating to the loss or potential loss . -18b- 137 ITEM IV . WITHDRAWAL J FROM MEMBERSHIP (continued) (C) MERGER Any member, or members , proposing to merge with any other association or associations , shall immediately upon adoption of a plan of merger by the Board of Directors of such member , or members , notify the Fund of such action and provide the Fund with a detailed copy of the proposed merger . Such proposal ' shall include a proposed adjustment of its deposit and premium payment with the Fund based upon its deposit liabilities after such merger . The Fund may approve such proposal with or without modification or it may disapprove if the merged association fails to meet the standards adopted by the Fund . A decision to approve with or without modification or disapprove shall be made within sixty ( 60 ) days after receipt of the copy of the proposal . Upon request of the member , the Board of Trustees shall extend the sixty-day ( 60 ) period . Upon the final disapproval by the Fund of such merger , the membership of such member , or members , shall terminate upon the effective date of such merger . Any such member , or members , thus terminating membership shall be entitled to withdraw from the Fund's assets , in the same manner provided in Section B of this Item; its proportionate share of the Fund's net assets on the effective date of such merger . · 19 - 138 REORGANIZATION ITEM IV. (D) WITHDRAWAL FROM MEMBERSHIP (continued) to Section 1151.61 of the Ohio Revised Code shall Any member proposing to reorganize pursuant notify the Fund immediately upon adoption by its Board of Directors of a plan of reorganization . The Fund may approve such plan with or without modification or it may disapprove , if the reorganized association fails to meet the standards adopted by the Fund . A decision to approve with or without modification or disapprove shall be made within sixty (60) days after receipt of the copy of the · proposal . Upon request of the member , the Board of Trustees shall extend the sixty-day (60 ) period . Upon the final disapproval.by the Fund of such plan, the membership of such member shall terminate upon the adoption of the plan by the shareholders and such member shall be entitled to withdraw from the Fund's assets , in the same manner provided in Section B of this Item, its proportionate share of the Fund's net assets on the date of the adoption of such plan by the shareholders . 20 - 139 ITEM IV. (E) WITHDRAWAL FROM MEMBERSHIP (continued) to dissolve with the Superintendent of Building DISSOLUTION Any member which has filed an application and Loan Associations and received his consent in writing to such dissolution , pursuant to Section 1151.45 of the Ohio Revised Code , shall be entitled to withdraw from the Fund's assets , in the same manner provided in Section B of this Item , its proportionate share of the Fund's net assets on the date such consent of the Superintendent is given . The Fund shall deduct from the proportionate share of such member any obligation of such member to the Fund and may require the fulfillment of any repurchase agreement made with the Fund . Such member shall keep on deposit with the Fund such percentage of its current deposit liabilities as is required of members pursuant to Article V of the Constitution , until such time as such member shall have paid all of its depositors and the guarantee by the Fund of the deposits of such member's depositors shall have terminated . - 21 - 140 ITEM V. NOTICE OF TERMINATION OF MEMBERSHIP Any member , whose membership in the Fund is terminated at any time , shall notify each of its depositors of such termination of membership , and shall set forth in the notice the date upon which the Fund will cease to guarantee such deposits . The Fund shall determine the date upon which it will cease to guarantee such deposits and the time and manner of giving and content of such notice . In no event shall the Fund permit the withdrawal of any assets of the Fund by such member until such member has delivered to the Fund proof of the giving of such notice . ITEM VI . POWERS DEFINED For the purpose of guaranteeing the deposits and assuring the liquidity of its members , the Fund shall have the following powers : (A) LOANS TO MEMBERS The Fund may loan money to members with or without security . Such loans shall bear such rate or rates of interest and be on such terms as the Board of Trustees may determine . ·- 22 - If and when bonds, 141 ITEM VI . mortgages or mortgage notes secured by mortgages POWERS DEFINED (continued) on real estate shall be taken as security for any such loan , the value of the bonds , mortgages or mortgage notes and the title of the mortgagor may be ascertained at such time and in such manner as shall be satisfactory to the Board , and it shall not be necessary to record the assignment of any such bonds , mortgages , or mortgage notes to the Fund . (B) PURCHASE OF MEMBER'S ASSETS The Fund may buy any assets owned by any member at the book value thereof , or at such other value as the Board of Trustees may determine , notwithstanding that such value may exceed the market value thereof , either with or without an agreement providing for the repurchase of such assets , or any of them, at such price or prices , and at such time or times , and subject to such conditions , as are determined by the Board . (C) AUTHORITY TO FILL VACANCIES ON BOARD Whenever the Superintendent of the Division of Building and Loan Associations shall notify the Fund that any member has committed such an act or acts or is in such condition that he might take possession of the business of such member , pursuant · 23 - 142 ITEM VI . to law or when the Superintendent shall so request , POWERS DEFINED (continued) the Fund may require the Board of Directors of such member to appoint one or more persons , recommended to it by the Board of Trustees , to attend all meetings of the Board of Directors and such committee meetings as the Fund shall deem necessary and also to fill any vacancy or vacancies on the Board of Directors , to remain and retain such rights until such conditions shall have been corrected to the satisfaction of the Superintendent and/or the Fund . Each building and loan association , upon becoming a member , agrees , under the foregoing circumstances , to make such changes in its condition or in its Constitution or By-Laws or in the membership of its Board of Directors as may be required of it by the Fund and to retain such changes in the Constitution and By-Laws for the duration of its membership or until authorized by the Fund to do otherwise . - 24- 143 ITEM VI . (D) POWERS DEFINED (continued) mine that a member is in such condition that he LIQUIDATION BY SUPERINTENDENT Whenever the Superintendent shall deter- may be required to exercise any of his statutory powers to restrict such member in the carrying on of its business , or whenever he has , in fact , exercised any of such statutory powers , the Superintendent may notify the Fund . The Fund shall there- upon , or within a reasonable time , either restore such member to a financial condition satisfactory to the Superintendent , or it shall make available to the Superintendent , as receiver or liquidating agent , such funds as may be necessary to pay each of the depositors in such member the full amount of his deposit as credited to his account on the books of the member , and such funds shall be used only for the purpose of paying the depositors of such member . The Fund shall thereupon be subrogated to the rights of such depositors against such member . (E) TRUSTEES ' AUTHORITY TO REQUIRE AMENDMENTS The Board of Trustees may require the Constitu- tion and By-Laws of members and of applicants for membership to be amended for the sole purpose of providing uniformity of the provisions affecting the liability to their depositors and , consequently , the - 25 - 144 ITEM VI . liability and responsibility of the Fund to its POWERS DEFINED (continued) of each state examination which is made from time members , and may require members to supply a copy to time. The Board may supply personnel to assist the Superintendent of Building and Loan Associations to make special examinations of its members . (F ) INVESTIGATIVE AUTHORITY The Fund's Supervisory staff, at the direction of the Executive Vice- President of the Fund , may, at any time , enter a member institution for the purpose of conducting an investigation or audit . The member shall be required to furnish, upon request , all of the company's books , records , securities , monies , and other property, needed to complete the investigation or audit . 26- 145 ITEM VII. INTEREST AND RETURN OF DEPOSITS (A) At the discretion of the Board of Trus- tees , the Fund may pay interest when the deposit liability ratio exceeds one and one-quarter percent (1-1/4% ) and may return deposits to members , to the extent of the excess , when the deposit liability ratio exceeds two percent ( 2 % ) . (B) The Fund shall pay interest or return deposits to members when the deposit liability ratio exceeds three percent (38) to the extent of such excess . (C) The interest paid to any member shall be computed upon its deposits with the Fund , at the immediate preceding adjustment date or in such other manner as may be determined by the Board of Trustees . (D) Any interest or return deposits may , at the discretion of the Board of Trustees , be paid to a member by applying such interest or return of deposits to the reduction of any advance made to such member by the Fund or any other liability of such member to the Fund , including any amounts due to the Fund as an adjustment of deposit requirements pursuant to Item III , Section A, Sub-Section 5 , hereof. 1 ·- 27 146 ITEM VII . INTEREST AND RETURN OF DEPOSITS (continued) ITEM VIII . INFORMATION AND STATISTICS OF MEMBERS (E) Whenever the Fund returns deposits to members pursuant to Sections A, B , or D of this Item, the Fund shall enter on each of the certificates of deposit the amount then on deposit . The Fund may require from its members information and statistics , in addition to information which it may have received from the Superintendent , Division of Building and Loan Associations , or otherwise , with respect to their condition and investments , and upon consideration thereof may make such written recommendations as , in the judgment of the Board of Trustees , shall tend to place or preserve members in condition to properly safeguard their depositors . If a member to which such a recommendation has been made refuses to comply therewith , within a reasonable time , then the Board may , after hearing the member at a meeting of the Board called for that purpose , and upon the affirmative vote of three-fourths (3/4 ) of the entire Board , expel or suspend such member from membership in the Fund . Such member shall thereupon have , pursuant to Item IV (B) , the same rights with reference to withdrawal of assets as a member which has withdrawn from the Fund , except that the Fund may set off against the member's proportionate share of the assets any obligation of the member to the Fund , including advances , loans or repurchase agreements . ·- 28 - 147 ITEM IX. REQUIRED NOTIFICATION Any member proposing to take any action for which statutes require that application be filed with or notice be given to the Superintendent of Building and Loan Associations , shall , at the time of filing such application or giving such notice , transmit a copy thereof to the Fund . ITEM X. INCREASE IN INTEREST OR DIVIDEND Any member intending to increase its rates of interest to be paid on deposits , or its dividend rates to be paid its withdrawable shareholders , shall immediately notify the Executive Vice- President of the Fund of such increase ." ITEM XI . ADVERTISING RATES OF RETURNS Every advertisement , announcement or solicitation relating to the interest or dividends paid on savings accounts in member institutions shall be governed by the following rules : (a) Annual rate of simple interest . Interest or dividend rates shall be stated in terms of annual rates of simple interest or dividends . OHIO DEPOSIT GUARANTEE FUND 1001 TRI STATE BLDG . CINCINNATI , OHIO 45202 - 29-· 148 ITEM XI . ADVERTISING RATES OF RETURN (continued) (b) Percentage yields based on one year . Where a percentage yield achieved by compounding interest or dividends during one year is advertised , the annual rate of simple interest shall be stated with equal prominence , together with a reference to the basis of compounding . No member shall advertise a percentage yield based on the effect of grace periods permitted such members . (c) Percentage yields based on periods in excess of one year . No advertisement shall include any indication of a total percentage yield , com-` pounded or simple , based on a period in excess of a year , or an average annual percentage yield achieved by compounding during a period in excess of a year . (d) Time or amount requirements . If an advertised rate is payable only on savings accounts that meet time or amount requirements , such requirements shall be clearly and conspicuously stated . Where the time requirement for an advertised rate is in excess of a year, the required number of years for the rate shall be stated with equal prominence , together with an indication of any lower rate or rates that will apply if the savings account is withdrawn at an earlier maturity . 9 30 -· 149 ITEM XI . ADVERTISING RATES OF RETURN (continued) The term "profit " shall not (e) Profit . be used in referring to interest or dividends paid on savings accounts . (f) Accuracy of advertising . No member shall make any advertisement , announcement , or solicitation, which is inaccurate or misleading or which misrepresents its savings accounts contract . (g) Solicitation of savings accounts for member institution. Any person or organization which solicits savings accounts for a member shall be bound by the rules contained in this section with respect to any advertisement , announcement , or solicitation. No such person or organization shall advertise a percent yield on any savings account it solicits for a member institution which is not authorized to be paid and advertised by such member . (h) "Savings Accounts , " as aforementioned , are defined as all types of savings accounts , whether evidenced by passbooks or certificates . ·- 31 - 150 ITEM XII . PROMOTIONAL OPERATIONS A member may use give -aways in connection with a promotional campaign to increase savings accounts . The value of the give -away (any premium whether in the form of merchandise , credit , or cash ) shall be its cost to member institution (excluding shipping and packaging costs , if applicable ) , and shall not exceed : 1. $ 10.00 for the opening of a new account , or for an addition to an existing account of less than $ 1,000.00 . 2. $ 20.00 for the opening of a new account , or for an addition to an existing account of $ 1,000.00 or more . · 32 - 151 ITEM XIII . AMENDMENTS These Rules and Regulations may be altered , amended , · repealed , or superseded , either in whole or in part , by the affirmative action of a majority of members of the Board at any meeting of the Board . . A proposal by the Board to amend shall be submitted to the membership for review and comment thirty (30 ) days prior to final adoption by the Board of Trustees , except that , in any emergency , as determined by the Board of Trustees , temporary action , not to exceed ninety (90) days , may be taken to alter , amend , repeal or supersede the above regulations pending final adoption . -- 33 - 152 OHIO DEPOSIT GUARANTEE FUND DEFINITIONS AS USED IN THE CONSTITUTION , BY- LAWS AND RULES AND REGULATIONS 1. "Fund" means the Ohio Deposit Guarantee Fund , a corporation organized under the provisions of Section 1151.80 to 1151.92 , inclusive , of the Revised Code of Ohio. 2. "Superintendent" means the Superintendent of the Division of Building and Loan Associations , office created by Section 121.04 of the Revised Code. 3. " Building and loan association " means a corporation organized under Sections 1151.02 , 1151.03 and 1151.04 of the Revised Code , for the purpose of raising money to be loaned to its members or to others , and " building and loan association" includes savings association . 4. "Member" means a building and loan association which has become a member of the Fund . 5. "Depositor" means any person , firm or corporation who has placed withdrawable funds in a member . 6. "Deposit liability" means the aggregate of all withdrawable funds credited to the accounts of all depositors of a member . (more) 153 DEFINITIONS (CONTINUED ) 7. "Certificate of deposit" means the capital note which the Fund is authorized to issue to its members pursuant to Section 1151.87 , subsection (F ) , of the Revised Code . 8. "Deposit" means the money which a members has deposited with the Fund as a capital asset for which the Fund has issued a certificate of deposit. … 9. "Deposit ratio" means , expressed in percentage, the deposit liability of a member divided into the face value of the certificates of deposit of a member. 10. "Deposit liability ratio" means , expressed in percentage , the aggregate deposit liability of all members divided into the aggregate of all cash and the value of marketable securities of the Fund: 154 OHIO DEPOSIT GUARANTEE FUND 1001 Tri-State Building Cincinnati, Ohio 45202 DEPO SIT IO ALL SAVINGS EED GUARANT D QUAR IN FULL FUN ANTE R OH STATEMENT OF CONDITION June 30, 1984 155 TWENTY- EIGHTH ANNUAL REPORT of the OHIO DEPOSIT GUARANTEE FUND A mutual deposit guaranty association of state- chartered savings and loan companies organized under the laws of the State of Ohio . Report For The Fiscal Year Ended June 30, 1984 Submitted To The Members October 18, 1984 50-923 0-85--6 156 OHIO DEPOSIT GUARANTEE FUND BOARD OF TRUSTEES THREE YEARS Charles A. Brigham , Jr. President and Director, Federated Savings Bank, Lockland Eleanor J. Remke President and Director, Madison Saving Bank, Cincinnati John R. Perkins President and Director, The Metropolitan Savings Bank, Youngstown Joseph D. Rusnak President and Director, Mentor Savings Bank, Mentor TWO YEARS John A. Dreyer Director, Baltimore Savings and Loan Company, Cincinnati David J. Schiebel Chairman of the Board, Home State Savings Bank, Cincinnati Harold R. Swope President and Director, Independent Savings Association , Euclid ONE YEAR Robert D. Maher Secretary and Director , The Ottawa Home and Savings Association , Ottawa Vernon W. McDaniel Assistant Treasurer and Director, Anderson Ferry Building and Loan Company, Cincinnati Charles F. Tilbury, Sr. Executive Vice- President and Director, The Clermont Savings Association , New Richmond Jack R. Wingate Executive Vice-President and Director, Heritage Savings Bank, Cincinnati 157 OFFICERS AND COMMITTEES OFFICERS President Charles F. Tilbury, Sr. Donald R. Hunsche Executive Vice-President Vernon W. McDaniel Vice-President. David J. Schiebel Secretary Treasurer Joseph D. Rusnak EXECUTIVE COMMITTEE Joseph D. Rusnak Vernon W. McDaniel John R. Perkins Charles F. Tilbury, Sr. Jack R. Wingate ADVISORY COMMITTEE Wallace E. Evans Executive Vice- President, American Savings Bank Upper Sandusky Richard D. Hoffmann Chairman ofthe Board , The City Loan & Savings Company, Lima August Hoffman Executive Vice- President , Midwest Savings Association , Silverton Michael O. Roark President, Scioto Savings Association , Columbus Arthur W. Wendel , Jr. Executive Vice- President, Seven Hills Savings Association , Cincinnati Jerry D. Williams Secretary, People's Building , Loan and Savings Company, Lebanon Robert M. Williams President, Union Savings , Building and Loan Company , Loveland 158 ANNUAL REPORT OF THE PRESIDENT Members of the Ohio Deposit Guarantee Fund : Your Fund concluded a very successful twenty-eighth year of operation . The performance of your Fund is noteworthy in that new highs have once again been achieved . These achievements include topping $100 million in Assets and $ 10 million in Earnings . Also an achievement, during the fiscal year , is our losses , due to default prevention activities , which were less than one quarter of a million dollars . Your Fund had some other noteworthy achievements during the fiscal year, which were related indirectly to its financial success : 1 ) The filing of a successful lawsuit against the Federal Reserve Board, challenging the Board's redefinition of Regulation Y. If the Fund had not been successful in winning this case, twelve of our members , with Assets aggregating $ 2,854,000,000 , would have been forced to terminate their membership in the Fund and apply for FSLIC or FDIC coverage . 2) NASSALS , on behalf of your Fund and the Superintendent , was also successful in Washington , D. C. in lobbying amendments to Senate and House Bills which would have given the federal government considerable control over state- chartered privately- insured savings and loans . However, it is imperative that , in the future , constant vigilance be exercised . We owe a debt of gratitude to a number of enlightened United State Senators , Congressmen and Congresswomen . We also owe a debt of gratitude to the Division of Savings and Loan Associations and its able Superintendent , C. Lawrence Huddleston , for having the State of Ohio join us in our suit against the Federal Reserve Board , as well as their efforts in Washington , D.C. in protecting the dual system of chartering . This fiscal year has seen the savings and loan industry in Ohio emerging from the chaos of 1981 and 1982 with many additional powers . These powers are designed to enhance the profitability of the industry to enable it to better withstand the economic instability in which it has been forced to operate . If used properly, these new powers should increase profitability and enable all of us to better serve the housing needs of Ohioans . I would like to extend my gratitude to the Board of Trustees , members of the various committees , management and staff for their cooperation . The Ohio Deposit Guarantee Fund has enjoyed another very successful year due to their dedication and unselfish service. Sincerely, Charles ILicy Charles F. Tilbury President 159 OHIO DEPOSIT GUARANTEE FUND Consolidated Financial Statements of Membership Adjusted to Reflect Current Membership Growth (000 OMITTED ) ASSETS Increase or June 30, 1984 June 30, 1983 Decrease Cash $ 67,607. $ 78,180. $ 10,573. U. S. Govt. Obligations 782,184. 216,936. 565,248. 514,068. Other Investments 427,076. (86,992.) 18,231. 73,808. 55,577. Ohio Deposit Guarantee Fund Federal Home Loan Bank Stock 2,474. 2,981. (507.) 2,875,435. 2,545,573. 329,862. First Mortgage Loans Other Loans 707,028. 472,672. 234,356. Real Estate Owned 21,486. 12,385. 9,101. Office Bldg., Leasehold 2 38,46 . 8,624. 47,086. Improvements & Equipment 37,337. 110,709. 73,372. Other Assets TOTAL ASSETS: $5,125,466. $777,521 $4,347,945. Withdrawable Savings ⚫ Borrowed Money Other Liabilities Permanent Stock General Reserves Undivided Profits ; LIABILITIES AND NET WORTH $4,103,030. $3,373,350. 728,578. 717,116. 42,090. 81,020. 22,766. 20,664. 76,599. 77,145. 118,126. 112,927. TOTAL LIABILITIES AND NET WORTH: $5,125,466. $4,347,945. 14.11% 12.61% 5.19% 6.39% includes $5,541,000 in 1983 insured by FSLIC. Liquidity Ratio: Net Worth to Savings Ratio: $729,680. 11,462. 38,930. 2,102. 546. (5,199.) $777,521. 160 PEAT. MARWICK Peat. Marwick, Mitchell & Co. Certified Public Accountants 580 WalnutStreet memnati Ohio 45202 The Board of Trustees and Members Ohio Deposit Guarantee Fund Cincinnati , Ohio: We have examined the statements of financial condition of the Ohio Deposit Guarantee Fund as of June 30, 1984 and 1983 and the related statements of operations, changes in deposits and reserve fund and changes in financial position for the years then ended and the schedule of investments at June 30, 1984. Our examinations were made in accordance with generally accepted auditing standards and, accordingly, included such tests of the accounting records and such other auditing procedures as we considered necessary in the circumstances. In our opinion , the aforementioned financial statements present fairly the financial position of the Ohio Deposit Guarantee Fund at June 30, 1984 and 1983 and the results of its operations and the changes in its financial position for the years then ended, in conformity with generally accepted accounting principles applied on a consistent basis; and the schedule of investments at June 30, 1984, in our opinion , presents fairly the information set forth therein . Pest , Marwick,Mitchell + Co. July 27, 1984 161 OHIO DEPOSIT GUARANTEE FUND Statements of Financial Condition June 30, 1984 and 1983 1984 ASSETS Cash 1983 122,064 75,920 2,968,904 3,400,000 and $74,961,000 in 1983 99,580,636 74,088,089 Accrued interest receivable 3,112,322 1,884,169 Note receivable from member, net (note 3) 6,955,311 7,225,581 $ Time and overnight deposits U. S. Government and agency obligations, approximate market $96,387,000 in 1984 Equalization contributions due from new members (note 2) Prepaid insurance and other assets 6,700 362,900 13,989 11,821 $ 112,759,926 86,968,460 LIABILITIES, DEPOSITS AND RESERVE FUND Allowance for estimated losses (note 3) 150,000 120,000 Accrued expenses and other liabilities 33,182 34,708 Members' deposits 74,778,500 57,952,000 Reserve fund 37,798,244 28,861,752 112,576,744 86,813,752 $ 112,759,926 86,968,460 Deposits and reserve fund (note 2): Total deposits and reserve fund Contingencies (note 4) See accompanying notes to financial statements. 162 OHIO DEPOSIT GUARANTEE FUND 1 Statements of Operations Years ended June 30, 1984 and 1983 1984 1983 10,116,338 409,310 765,115 11,953 11,302,716 6,938,012 521,806 913,648 12,202 8,385,668 Office operating expenses Operating income 754,947 10,547,769 481,097 7,904,571 Other income (expense): Provision for losses-member associations (note 3) Other, net Other income (expense), net Net income (225,269) 34,976 (190,293) 10,357,476 (176,369) 6,072 (170,297) 7,734,274 Interest income: U. S. Government and agency obligations Time and overnight deposits Notes receivable from members Other $ Total interest income See accompanying notes to financial statements. $ 163 OHIO DEPOSIT GUARANTEE FUND Statements of Changes in Deposits and Reserve Fund Years ended June 30, 1984 and 1983 Members Deposits Balance at June 30, 1982 Net income for the year ended June 30, 1983 Increase in members' deposits (note 2) Payments to withdrawing members Balance at June 30, 1983 Net income for the year ended June 30, 1984 Increase in members' deposits, including equalization contributions (note 2) Payments to withdrawing members Balance at June 30, 1984 See accompanying notes to financial statements. $ 45,986,300 12,475,700 (510,000) 57,952,000 19,371,200 (2,544,700) $ 74,778,500 Reserve Fund 21,312,956 7,734,274 (185,478) 28,861,752 10,357,476 14,718 ( 1,435,702) 37,798,244 164 OHIO DEPOSIT GUARANTEE FUND Statements of Changes in Financial Position Years ended June 30, 1984 and 1983 1984 Sources of funds: Net income Increase in accrued interest receivable Funds provided from operations Decrease in cash and time and overnight Deposits Decrease in notes receivable from members Increase in members' deposits, including equalization contributions Other, net Use of funds: Increase in U. S. Government and agency obligations Payments to withdrawing members See accompanying notes to financial statements. $ 10,357,476 (1,228,153) 9,129,323 1983 7,734,274 (710,810) 7,023,464 384,952 270,270 2,075,433 5,396,381 19,385,918 382,506 $ 29,552,969 12,475,700 606,546 27,577,524 25,572,567 3,980,402 $ 29,552,969 26,882,046 695,478 27,577,524 165 OHIO DEPOSIT GUARANTEE FUND Notes to Financial Statements June 30, 1984 and 1983 (1 ) Summary of Significant Accounting Policies The Following items comprise the significant accounting policies which the Ohio Deposit Guarantee Fund (Fund ) follows in preparing and presenting its financial statements : U. S. Government and agency obligations are recorded at amortized cost. The obligations are not carried at the lower of cost or market because they are generally held until maturity . Gains or losses on the sale of securities are recognized upon realization and are included in the statements of operations. Where the Fund anticipates losses will be incurred in fulfilling its guarantee of deposits in certain members, the Fund's policy is to provide allowances for losses and for liquidation expenses by charging operations for all anticipated losses in the period in which the losses become evident and can be reasonably estimated . Such allowances are recorded as asset valuation accounts where the Fund acquires assets at costs in excess of appraised values and where the Fund pledges certain assets to guarantee against losses to other parties. The costs of these assets which , in management's opinion, have no value are written down to a nominal value of $1 . When losses and liquidation expenses are anticipated , but do not relate to specific assets of the Fund , the allowances are shown as liabilities. Income is credited for the reduction of estimated loss provisions when losses realized in the period are less than the allowances provided. In the opinion of management, adequate provision has been made for all known or probable losses and expenses of liquidation to be incurred. (2) Description of the Fund The Fund, a corporation exempt from Federal income taxes , was incorporated under Ohio law as a mutual deposit guaranty association for the purpose of assuring the liquidity of and guaranteeing the deposits of its members. 166 OHIO DEPOSIT GUARANTEE FUND Notes to Financial Statements, Continued Each member maintains on deposit with the Fund 2% of its savings balances, adjusted semi-annually. Based on net growth in savings deposits of members during the six months ended June 30, 1984, the Fund expects to receive approximately $7,283,000 in additional members ' deposits . Members joining since the inception of the Fund are required to make an equalization contribution , which is credited to the reserve fund , to establish their interest in the fund balance at the date of entry on a par with other members. These deposits are invested primarily in United States Government and agency obligations and serve as the central fund to fulfill the guarantee of the Ohio Deposit Guarantee Fund. (3) Provision for Losses During the year ended June 30, 1983, the Fund , in its default prevention activities, assisted the merger of a member institution into another member institution by placing a deposit with the acquiring institution at a below market interest rate and by agreeing to indemnify the acquiring institution for losses on certain mortgage assets . The Fund previously recorded a provision of $720,000 for estimated loss based upon management's evaluation of this situation and the status of negotiations at June 30, 1982. In the years ended June 30, 1983 and 1984, the Fund recorded additional provisions for estimated loss based upon management's continuing evaluation of the provisions of the assistance agreement. The note receivable is due in annual installments of $ 250,000, with the balance due in December, 1986. The balance at June 30, 1984 has been reduced by approximately $425,000 ($600,000 at June 30, 1983) , representing the difference between imputed interest at the rate of 10.5% and the stated interest rate of 7.713% over the term of the note. (4) Contingencies The savings and loan industry in general (including many members of the Fund) is experiencing unfavorable operating results and declining net worth as a result of high and volatile rates. This operating 167 OHIO DEPOSIT GUARANTEE FUND Notes to Financial Statements, Continued environment has affected savings and loans more severely than many other sectors of the economy because of the mismatch between the yield and maturities of their assets and liabilities. Given the state of the economy and present condition of the industry, it is possible that the Fund could sustain additional losses in subsequent accounting periods due to its default.prevention actions . Because many of the causes for default are beyond management's control, the amount of these losses cannot be determined . However, the Fund believes that its resources are sufficient to absorb any such losses over the foreseeable future. 168 Schedule OHIO DEPOSIT GUARANTEE FUND Investments June 30, 1984 U. S. TREASURY BILLS I Maturity 7/05/84 7/12/84 7/19/84 7/26/84 8/02/84 8/09/84 8/16/84 8/23/84 8/30/84 9/06/84 9/13/84 9/20/84 9/27/84 10/04/84 10/11/84 10/18/84 11/01/84 11/23/84 11/29/84 12/06/84 12/13/84 12/20/84 12/27/84 Discount Equivalent Rate Bond Yield 9.19% 9.80% 9.10 9.67 8.92 9.50 9.60 9.01 9.55 8.97 9.71 9.11 9.16 9.77 9.28 9.90 9.93 9.33 9.37 9.97 9.51 10.14 9.79 10.44 9.88 10.54 9.83 10.49 9.82 10.48 9.92 10.59 9.88 10.54 10.38 11.11 10.62 11.38 10.57 11.32 10.66 11.42 10.49 11.23 10.49 11.23 Par Value $ 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 $ 2,300,000 Amortized Cost 99,877 99,686 99,522 99,362 99,155 98,940 98,755 98,569 98,387 98,156 97,960 97,770 97,548 97,320 97.116 96,932 96,490 95,794 95,613 95,416 95,181 94,959 94,770 2,243,278 Approximate Market Value 99,877 99,686 99,522 99,362 99,155 98,940 98,755 98,569 98,387 98,156 97,960 97,770 97,548 97,320 97,116 96,932 96,490 95,794 95,613 95,416 95,181 94,959 94,770 2,243,278 U.S. TREASURY BONDS AND NOTES Maturity 7/31/84 10/31/84 11/30/84 12/31/84 12/31/84 1/31/85 2/28/85 Interest Approx. yield Rate To Maturity Par Value 13%% 11.78% $ 2,500,000 9% 1,500,000 9.52 9% 9.58 2,000,000 14 14.03 1,000,000 9% 9.48 1,500,000 9¼ 9.67 1,000,000 9% 9.71 1,000,000 Amortized Cost 2,514,062 1,501,339 2,002,589 999,887 1,499,297 996,916 999.300 Approximate Market Value 2,504,687 1,492,969 1,988,125 1,011,875 1,484,531 986,250 985,625 169 Schedule, Continued OHIO DEPOSIT GUARANTEE FUND Investments U. S. TREASURY BONDS AND NOTES, Continued Maturity 5/15/85 6/30/85 7/31/85 8/15/85 11/15/85 11/30/85 2/15/86 2/28/86 3/31/86 3/31/86 4/30/86 8/15/86 9/30/86 12/31/86 2/15/87 2/15/87 3/31/87 5/15/87 5/15/87 5/15/87 6/30/87 12/31/87 3/31/88' 8/15/88 11/15/88 Par Value 9.85% $ 1,000,000 10.24 1,000,000 11.19 2,750,000 8.37 1,500,000 9.82 2,750,000 10.57 3,000,000 9.80 1,400,000 10.96 3,000,000 14.03 1,500,000 11.55 1,000,000 12.27 2,000,000 11.42 3,600,000 11.48 3,000,000 10.00 2,000,000 9.03 1,500,000 11.10 3,000,000 10.26 4,000,000 12.02 1,000,000 12.62 2,000,000 14.08 1,500,000 10.95 1,000,000 11.35 1,000,000 12.21 2,000,000 11.16 3,000,000 11.61 3,000,000 Amortized Cost 1,005,250 996,719 2,731,309 1,498,268 2,747,852 2,997,124 1,401,854 2,995,312 1,499,496 999,130 1,983,437 3,596,892 3,045,912 2,000,000 1,499,028 2,982,880 3,998,792 998,932 1.995.270 1,497,967 989,219 997,252 1,986,875 2,933,234 3,009,407 $ 63,000,000 62,900,801 60,768,746 1,000,000 746,625 1,018,750 998,389 1,861,524 996,766 6,622,054 999,375 726,562 997,812 931,562 1,730,859 925,000 6,311,170 Interest Approx. Yield To Maturity Rate 10%% 10 10% 84 934 10/2 9% 10% 14 11/2 11 % 11 % 12¼ 10 9 10% 10% 12 122 14 10½ 11 % 12 10½ 11 % Approximate Market Value 987,500 978,437 2,699,297 1,441,875 2,647,734 2,913,750 1,337,000 2,909,062 1,521,094 975,312 1,955,000 3,483,000 2,945,625 1,863,750 1,360,312 2,840,625 3,715,000 970,312 1.956.250 1,519,687 928,125 938,750 1,908,125 2,705,625 2,813,437 AGENCY BONDS Federal Farm Credit Bank 3/04/85 1/20/86 9/02/86 12/01/86 1/20/87 10/20/88 11.95% 10.90 13.35 10.00 9.90 11.50 11.95% $ 11.20 12.36 10.08 10.31 11.60 $ 1,000,000 750,000 1,000,000 1,000,000 1,875,000 1,000,000 6,625,000 (Continued) 170 Schedule, Continued OHIO DEPOSIT GUARANTEE FUND Investments U.S. TREASURY BONDS AND NOTES, Continued Maturity Interest Approx. Yield To Maturity Rate Par Value Amortized Cost Approximate Market Value Federal Home Loan Bank 1/25/85 7/25/85 8/26/85 9/25/85 12/26/85 2/25/86 4/25/86 8/25/86 11/25/86 2/25/87 3/25/87 6/25/87 7/27/87 11/25/87 10/25/88 13.55% 12.80 9.35 14.15 14.70 15.30 10.25 14.60 11.30 10.45 11.10 10.30 11.35 10.65 11.40 Total U.S. Government and agency obligations 12.20% $ 2,500,000 13.34 2,000,000 9.35 1,000,000 14.15 3,000,000 14.70 1,500,000 15.30 2,000,000 10.13 2,750,000 14.60 1,000,000 12.30 1,000,000 10.22 1,000,000 10.25 1,875,000 11.13 2,000,000 3,500,000 11.72 10.51 1,700,000 11.53 1,000,000 27,825,000 2,527,155 1,989,955 1,000,000 3,000,000 1,500,000 2,000,000 2,755,402 1,000,000 983,333 1,006,211 1,913,672 1,967,946 3,469,648 1,704,836 996,345 27,814,503 2,521,094 2,004,375 964,062 3,045,937 1,533,750 2,061,250 2,612,500 1,021,250 958,125 933,125 1,774,219 1,841,250 3,308,594 1,562,937 921,562 27,064,030 $ 99,750,000 99,580,636 96,387,224 171 ROSTER OF MEMBERS BELLAIRE Buckeye Savings and Loan Company BETHEL Bethel Building and Loan Company BLANCHESTER Peoples Building and Loan Company CINCINNATI Addison Savings and Loan Company American Savings and Loan Company Anderson Ferry Building and Loan Company Baltimore Savings and Loan Company Century Savings Bank Charter Oak Savings Association Cherry Grove Savings and Loan Company Columbia Savings and Loan Company Delta Savings and Loan Association East Side Building and Loan Company First North West Savings and Loan Company Heritage Savings Bank Home State Savings Bank Madison Savings Bank Molitor Loan and Building Company New Foundation Loan and Building Company The Oakley Improved Building and Loan Company Oakmont Savings and Loan Company Seven Hills Savings Association Sycamore Savings and Loan Company The Tri-State Savings and Loan Company West Northside Loan and Savings Company Woodward Savings and Loan Company COLDWATER Home Building and Loan Company COLUMBIANA Home Savings & Loan Company COLUMBUS Scioto Savings Association DAYTON Home State Savings Bank of Dayton DEGRAFF People's Building and Loan Company DOVER Surety Savings and Loan Company DRESDEN Savings One Association ELMWOOD PLACE Inter-Valley Savings Association 172 EUCLID Independent Savings Association FRANKLIN Miami Valley Building and Loan Association GALION Galion Building and Loan Company GALLIPOLIS Buckeye Building and Loan Company Gallipolis Savings and Loan Company GEAUGA Geauga Savings Association GREENFIELD Home Building and Loan Company HAMILTON Permanent Savings and Loan Association HILLSBORO Anchor Savings Association LEBANON People's Building, Loan and Savings Company LIMA The City Loan and Savings Company LOCKLAND Federated Savings Bank LONDON Home Savings Bank LOVELAND Union Savings , Building and Loan Company MAINEVILLE Cardinal Savings Bank MENTOR Mentor Savings Bank MIAMITOWN Miami Savings and Loan Company MONTGOMERY Unity Loan and Building Company MT. HEALTHY Mt. Healthy Savings and Loan Company MT. VERNON The Citizens Building, Loan and Savings Association NEW ALBANY Investor Savings Bank NEW PARIS New Paris Loan and Building Company 173 NEW RICHMOND The Clermont Savings Association OTTAWA The Ottawa Home and Savings Association OXFORD Oxford Savings Association SABINA Sabina Building and Loan Company ST. BERNARD Southern Ohio Savings Association ST. MARY'S The Community Savings and Loan Company SILVERTON Midwest Savings Association SOMERVILLE Somerville Building , Loan and Savings Association Co. STEUBENVILLE Jefferson Building and Savings Company UPPER SANDUSKY American Savings Bank VERSAILLES Versailles Savings and Loan Company WEST UNION Adams County Building and Loan Company WHITEHALL First State Savings and Loan Association WILLIAMSBURG Williamsburg Building and Loan Company WOODSFIELD Woodsfield Savings and Loan Company YOUNGSTOWN The Metropolitan Savings Bank 174 Mr. BARNARD. We will now hear from Mr. Tom Batties, chief deputy superintendent and general counsel of the Ohio Division of Savings and Loans. Mr. Batties. STATEMENT OF TOM BATTIES, CHIEF DEPUTY SUPERINTENDENT AND GENERAL COUNSEL, OHIO DIVISION OF SAVINGS AND LOANS Mr. BATTIES. Thank you, Mr. Chairman. I am here at the invitation of Chairman Barnard . I am pleased to be here to have the opportunity to answer the questions of the committee regarding the impact of the closing of Home State Savings Bank and what we are doing in Ohio to resolve this problem. Unfortunately, I learned late afternoon of yesterday that I would be appearing before the committee to testify, so I do not have a prepared text. However, I was in receipt of a letter approximately March 22 or 23 by the chairman which listed a number of questions that would possibly be asked of me. And I have had an opportunity since yesterday afternoon to basically review those questions and prepare some answers. I think it is important at this time for me to fill the committee in on my background and my relationship with the division . I joined the division on April 23, 1984, as counsel to the superintendent and chief of supervision. On January 19, 1985, Mr. Larry Huddleston, who had been the superintendent, resigned on that day and I assumed the role as acting superintendent. On March 8, 1985, I assumed the role or was appointed to the role as superintendent of the division of savings and loan, and on March 22 I resigned this position and Mr. Robert McAllister was appointed the position of superintendent. I guess in lieu of a prepared text, as I mention again, I have answered basically or reviewed the questions that were submitted to me and would like to share my comments with you now, Mr. Chairman. In question No. 1 through 2, there are various informational data that was requested . I do have that information. I do not know whether you want me to recite that information now. Mr. BARNARD. If you could just furnish it and we will, without objection, include it in the record, but if you will give us the bare statistics that would be fine. Mr. BATTIES. Do you want me to recite that now, sir? Mr. BARNARD. No. Let us skip over that. We might need to come back to it, butMr. BATTIES. OK. Fine. I think one of the most important things is to note here in question 2A is how many Ohio federally insured and nonfederally insured thrifts were on your problem list prior to the insolvency of Home State? And I would like to answer that question by stating that there was actually no problem or watch list maintained by the Ohio Division of Savings and Loan. However, different types of lists were maintained for a variety of reasons. Some of these lists were to more closely supervise institutions as a result of their various violations of statutory laws. Other lists were kept for supervisory concerns as a result of operating losses sus- 175 tained by the institutions. Other lists were kept because of the high level of scheduled items incurred by an institution or delinquency rates. Also by management weakness and/or underwriting practices or a lack of continuity of management and other areas such as the amount or level of real estate owned by an institution and other related problems. Mr. BARNARD. Can you tell us whether or not Home State was on that list? Mr. BATTIES. Yes, sir. Mr. BARNARD. It was on the list? Mr. BATTIES. Yes, sir. Mr. BARNARD. For any particular reason? Mr. BATTIES . Yes, sir. It was on that list as a result of a low net worth with respect to its asset size. Mr. BARNARD. How long had it been on that list? Mr. BATTIES. My personal knowledge of that list was created once I had arrived at the division . Mr. BARNARD . Which was-Mr. BATTIES . In April 1984. Mr. BARNARD. April 1984? Mr. BATTIES . Yes, sir. Mr. BARNARD. But it was on the list since April 1984? Mr. BATTIES. Yes, sir. Mr. BARNARD. Thank you. Mr. BATTIES. Question 3A asks to describe as completely as possible the results of the last two examinations of Home State Savings Bank. "In your response, include specifically the supervisory rating accorded Home State, any examination, criticism, or mention of Home State's financial dealings with ESM Government Securities and any other unsafe or unsound conditions or operations at the association." My answer to this is that I respectfully decline to answer on the basis that to provide any of the requested information would require me to violate the provisions of section 1155.16 of the Ohio Revised Code, which states, in part, "The Superintendent of Building and Loan Associations and its deputies, assistants, clerks and examiners shall keep secret the information obtained in an examination or by reason of their official position except in connection with criminal proceedings or when it is necessary for them to take official action regarding the affairs of the Building and Loan Association and examine ." I might add that a violation of this statute would result in a fourth degree felony for anyone who violates this. Mr. BARNARD. Does your department have any intention at this time to file any criminal actions? Mr. BATTIES . Sir, the Governor in recent legislation has appointed a special prosecutor to investigate wholly the transactions of Home State Savings Bank as well as the operations of the division prior to this situation. And we are working in cooperation with them and have submitted all our records to the special prosecutor. Mr. BARNARD. When do you think there will be a report from the prosecutor? Mr. BATTIES. Mr. Chairman, I believe that as expeditiously as possible. I could not give a date certain at this time, but as a result 176 of the public interest that I would believe that that would be done as expeditiously as possible. Question 3B asks : Whether or not related to the examination findings on what date did the Savings and Loan Division first become aware of Home State's financial relationship with ESM? Please describe the formal and informal supervisory actions, if any, taken by your division with respect to Home State's financial dealings with ESM . In this connection, please provide copies of any supervisory letters or memorandums involving Home State and ESM and describe all meetings with Home State and/or ESM employees. My answer to this question is to the extent that I am required to examine the records of the division, in order to answer this question, I have not done so because of section 1155.16 of the Ohio Revised Code. I have no personal knowledge of any action taken by any former superintendent in connection with prior examinations . To my personal knowledge, no actions not within the scope of section 1155.16 of the Ohio Revised Code were taken concerning Home State's dealings with ESM since I was employed by the division in April 1984. Mr. BARNARD . Mr. Batties, is there any possibility that this information could be furnished to us privately? Mr. BATTIES. I am sorry. Someone is coughing behind me. Mr. BARNARD. Is there any possibility that we could get this information privately? You know, we could get it by subpoena. Mr. BATTIES. I am well aware of that, sir. I would be more than happy to discuss that with the attorney general on what information we could disclose, and I would work with full cooperation to provide you with whatever we could under the law. Mr. BARNARD. If you would look into that, because we think that this information is very important to our ongoing study of this problem. Mr. BATTIES. Yes, sir. Question 4AAt what point did the Ohio Savings and Loan Division first make known to, one, the Federal Home Loan Bank Board, and two, the Federal Reserve System the situation at Home State and its potential impact on Ohio Deposit Guarantee Fund? My answer-I first learned of the potential problems at ESM and the consequences of those problems for Home State from Mr. Don Hunsche of the ODGF on Sunday, March 3, 1985. After stories concerning ESM appeared in the Cincinnati newspapers on Tuesday, March 5, 1985 , I contacted the Federal Home Loan Bank at its Cincinnati office that same day to discuss the impact that this might have on Home State, on the ODGF funds, and for verification of the Cincinnati reports. To the best of my recollection, my first discussions with the representatives of the Federal Reserve bank were on a Wednesday, March 6, 1985. Those discussions were confined primarily to the questions concerning the liquidity of Home State and the Federal Reserve Board's ability to help Home State respond to depositors' demands . Question 4BWere copies of or information from your Division's examinations of Home State made available to the Federal Home Loan Bank Board prior to the events of last week? If so, when? Please enumerate. Section 1155.16 of the Ohio Revised Code permits reports of examinations to be shared with representatives of the Federal Home 177 Loan Bank Board . A copy of the 1983 report of examination of Home State Savings Bank was provided to the Federal Home Loan Bank Board at its request on or about March 13, 1985. Question 5Describe your Division's dealings with the Federal Home Loan Bank Board and the Federal Reserve System once it was determined that Home State would have to be closed because of insolvency. Were these dealings satisfactory? If not, why not? How could they have been improved? First of all I would like to note that the division did not close Home State Savings Bank. Home State Savings Bank officers closed Home State effective Saturday, March 9, 1985. I appointed a conservator on Sunday, March 10, and the conservator decided not to reopen Home State in light of the depositor run which Home State had experienced from the previous week and the illiquidity of the institution. The Federal Reserve Bank of Cleveland attempted to provide assistance to the division and to the conservator based upon past experiences including suggestions as to the solutions for Home State and the use of the discount window. The Federal Home Loan Bank Board's fifth district's office in Cincinnati attempted to respond to inquiries and provide suggestions as to the Home State situation . I had no direct contact with the Federal Home Loan Bank Board of Washington and therefore am not in the position to comment on any dealings with them. Obviously, in hindsight, I wish that it had been possible to find a way to reopen Home State with Federal insurance and adequate liquidity on Monday, March 11, 1985, with the assistance of the Federal Reserve Board and the Federal Home Loan Bank Board. Unfortunately, it was not possible to do so. Both institutions have been extremely helpful in assisting the State of Ohio with solutions and potential solutions for Home State and the other ODGF-insured institutions since that time. As to the question of how the system could have been improved-obviously time was a crucial factor for us. I would like to suggest that there needs to be some sort of expedited process to get to the decisionmakers at the Federal Reserve Board and also the Federal Home Loan Bank Board. Procedures which lie outside of the normal operating channels. I also believe that there needs to be a greater cooperation among financial institution regulators on both the State and Federal levels, and that there possibly is a centralized crisis center or something established so that situations that occur that we have the opportunity to deal with them directly and immediately. And to operate in a more coordinated fashion. Question 6On what date did your Division first notify the Ohio Deposit Guarantee Fund of; one, the financial relationship between Home State and ESM, and two, your conclusion that Home State would have to be closed? Please elaborate. My answer is that if your question goes to the losses actually suffered by Home State as a result of its dealing with ESM, I did not notify the Ohio Deposit Guarantee Fund. Don Hunsche, the executive director of the ODGF, called me late on Sunday night, March 3, 1985, to advise me that there was a concern that substantial 178 losses could be incurred by Home State as a result of an alleged fraud at ESM. I have no personal knowledge concerning discussions by prior superintendents with representatives of the Ohio Deposit Guarantee Fund as to the relationship between Home State and ESM other than those within the scope of section 1155.16 of the Ohio Revised Code. As to question B, as I indicated earlier, the division did not close Home State Savings Bank. The officers of Home State made that decision to close its doors on Saturday, March 9, 1985. The conservator and the superintendent since that time have explored a variety of alternatives which would permit the reopening of Home State on a safe and sound basis, including the purchase of assets and the assumption of liabilities as well as other alternatives. But as of this date, no successful result has been concluded . Question 7What specific lessons have been learned and what recommendations are you prepared to make to Congress regarding recent events in Ohio, including the relationship between Home State and out-of-State Government securities dealers and the financial crisis that developed therefrom? I respectfully suggest that is more appropriate for the Governor of Ohio and the present superintendent to respond to this question with specificity. Since March 4 my activities have been solely centered around finding solutions to the problems of Home State and the other 71 savings and loan associations. My concern at this point is directed primarily to needed changes in Ohio law concerning the powers of the superintendent to regulate financial institutions and the creation of more effective powers for the superintendent to utilize. Obviously, I have not had time to focus upon Federal solutions or alternatives in the midst of this crisis and therefore have only a limited number of recommendations to offer at this time. Once again, I would like to refer back to an answer to a previous question that I think there needs to be some sort of centralized crisis clearing house involving all the Federal financial institution regulators. The second recommendation is that I think that the Government securities area obviously needs to be highly regulated by the Securities and Exchange Commission, and I would like to defer any other recommendations until I have had a time to reflect upon the events that have taken place in the last month or so. I had some other comments that I would like to make right now, Mr. Chairman, if I could . I would like to applaud the efforts of the Federal Reserve Bank which has been helpful from the very beginning throughout this process not only in dealing with Home State but in dealing with the other 71 institutions as runs occurred throughout the State. They have provided examiners to ascertain the liquidity position and open the discount window to the various institutions and I think that they have been involved in an unrelentless effort in providing assistance. think that with respect to the Federal Home Loan Bank Board, once Chairman Gray made a decision to be of assistance in this problem that the fifth district of the Federal Home Loan Bank Board as well as Chairman Gray has acted in an expeditious 179 manner in providing assistance in getting these institutions open on a timely basis. And I would like to take this opportunity to pay special attention to the president of the Federal Reserve Bank of Cleveland and to President Chuck Thiemann of the fifth district of the Federal Home Loan Bank Board and of Mr. Larry Muldoon for their assistance throughout this crisis. And that is the end of my testimony, Mr. Chairman . Mr. BARNARD. Thank you very much. Mr. Hunsche, what is your official status at this particular time? I mean, the Ohio Insurance Fund is no longer a fact of life, is that Mr. HUNSCHE. It has been taken over by conservators, so I have no status. Mr. BARNARD. But are there any funds left in the deposit fund at all? Mr. HUNSCHE. Yes. There is about $87 million. Mr. BARNARD. $87 million . What will happen to that? Mr. HUNSCHE. That is a question only the conservator can answer, since he has total power over it. Mr. BARNARD. But there is a new fund that the State legislature has appropriated . Is that true? Mr. HUNSCHE. To the best of my knowledge, it has never got off the ground . Mr. BARNARD. I thought the Governor said that the State legislature had started a new fund with about $50 million or $60 million. Mr. HUNSCHE. To the best of my knowledge, they have not placed one penny in any new fund as yet. Mr. BARNARD. Mr. Hunsche, you stated in your testimony on page 6 that on March 6 the State of Ohio announced that it was prepared to safeguard the interests of the depositors of Home State and of all the depositors whose funds were guaranteed by the ODGF and that the system in place provided adequate safeguards for depositors at its State-chartered savings and loan associations. What does that mean? Mr. HUNSCHE. I was under the impression that the $50 million that they were talking about was going to be put into the Ohio Deposit Guarantee Fund. And that we would then go to our members for an additional 1 percent on top of that, which would have given us approximately $220 million at which time we could have gone into the newspaper and said that no matter what the loss is at Home State, it can be covered. Mr. BARNARD. Well, why was that not done? Mr. HUNSCHE. That I have to defer to the State legislature and the Governor. I do not know why it was not done. Mr. BARNARD. Mr. Batties, can you answer that question? I mean, I was under the impression this morning that there had been an additional fund created for this purpose. Mr. BATTIES. Mr. Chairman, there has been legislation providing for a new fund, a new position guarantee fund. The moneys have been appropriated for that fund and the attorneys of the State are working on the mechanics in terms of opening up that fund . The moneys have been appropriated andMr. BARNARD. But it is not operational? 180 Mr. BATTIES. No. It is not operational at this time. It has been incorporated if that answers your question. It has been incorporated, and the moneys have been appropriated for it. Mr. BARNARD. But does that mean that the State of Ohio plans to stand behind that new fund? Mr. BATTIES. Mr. Chairman, they have appropriated $ 50 million to inject on a loan basis to be repaid back over a period of a number of years for the new fund. Mr. BARNARD. What happens to the reserve in the present fund? Mr. BATTIES. I can only speculate on that. And I might have to defer to the Governor to provide that answer for you. I believe the funds of the Ohio Deposit Guarantee Fund are frozen as they have been basically placed on call by the result of the losses at Home State. Mr. BARNARD. Mr. Batties, it is obvious from the information available to the subcommittee that beginning in 1980 the Ohio Thrift Division and the Deposit Guarantee Fund had serious concerns about Home State's exposure with ESM. Why did the thrift division not take more aggressive action to force an unwinding of that relationship? Mr. BATTIES. Mr. Chairman, I have to defer to the fact that I arrived at the division in 1984. It is my understanding as a result of hearing testimony today and reading certain things in the papers that there had been agreements made between the Ohio Division of Savings and Loan and the Ohio Deposit Guarantee Fund with respect to Home State and its dealings with ESM and that there was an agreement to unwind those transactions on a timely basis to be completed I believe some time in 1985. Mr. BARNARD. Can you answer that question , Mr. Hunsche? Mr. HUNSCHE. Yes. In January, I believe, of 1984 or so. Mr. BARNARD. What about 1983? Mr. HUNSCHE. I believe it was 1984. The board had gone into an agreement, a drafted agreement, whereby the-Mr. BARNARD. Now, this is a supervisory board, not the insurance fund? Mr. HUNSCHE. No. This was Home State's board. Mr. BARNARD. Home State's board and who? Mr. HUNSCHE. Had entered into an agreement that it was going to wind down the reverse repo transaction. Mr. BARNARD. Was that agreement with the Ohio Thrift Division or was it with the Deposit Guarantee Fund? Well, it must have been with the Ohio Thrift Division, because you had no jurisdiction evidently to supervise Home State, right? Mr. HUNSCHE. Right. We have no cease-and -desist powers . Mr. BARNARD. OK. Mr. HUNSCHE. And that was being done, Mr. Chairman. In fact, in July 1984, $400 million of the $670 million became Treasury bills that were going to mature in May and June 1985. I think both the division and the fund felt a sigh of relief knowing that 60 percent of the transaction was going to be completed by May and June 1985. Mr. BARNARD . Your testimony indicated that these transactions would have actually matured on June 30, 1983. The question is if they had matured, all these transactions, why did not Home State 181 at that time—when they could have very appropriately disassociated themselves from ESM-did they not do that? And instead, it looks like to me that they increased the fund from $200 million to $700 million. Mr. HUNSCHE. We were astonished at it. Why that was not done, we do not really know. Mr. BARNARD. Now, Mr. Batties, surely your acquaintances in the department would give you some information about that, would they not? Mr. BATTIES. Please? Mr. BARNARD. I mean, would not your experience in this division , would you not have some knowledge of why this was not done? Mr. BATTIES. When I arrived at the division of savings and loanMr. BARNARD. Now, when was that? Mr. BATTIES. I arrived, Mr. Chairman, on April 23, 1984. Mr. BARNARD. OK. Mr. BATTIES. As counsel to the superintendent and chief of supervision-prior to that time, there had not been a separate division or separate section within the division for supervisory matters. As providing a dual role within the division as counsel to the superintendent and chief of supervision, I was stepping up my activities in the supervisory area. During the course of my tenure there with the division, the superintendent himself dealt with supervisory matters as it related to Home State. Mr. BARNARD. But would not the records that you have assumed since taking on your new role, would they not give you the benefit of this information? Mr. BATTIES . Yes. Mr. BARNARD. This has been over nearly a year ago and of course this subject has been, you know-I know that this has been a matter of concern with the State of Ohio. Mr. BATTIES. Right. When I assumed the duties of acting superintendent on January 19, those records would have come under my control. On that particular date, I was closing up an institution in eastern Ohio and involved in various runs since that time on some of the other institutions. To answer your question, once again I would have to defer to 1155.16 in terms of providing that information for you, and would like to talk with my attorney general on what information I could provide for you. Mr. BARNARD. Mr. Batties , the subcommittee has been told informally that your department felt that their hands were tied because the sale of securities in 1983 would have resulted in a $45 million loss to Home State and would have caused its insolvency. Did the department not ask Mr. Marvin Warner, the owner of Home State, to infuse more capital at that time? Mr. BATTIES. Mr. Chairman, I was not a member of the division at that time and I have no personal knowledge as to whether or not the superintendent or anyone asked Mr. Warner to infuse capital. Mr. BARNARD. Mr. Batties, when we asked you and Mr. McAllister to testify, we expected that you were going to bring us information from the department which we could use in this hearing. And obviously, you know, we are not getting that information . I mean, 182 information which we have been able to get from other sources. Surely we feel like you, as a representative of the Office of Ohio Division of Savings and Loan, would have the availability of that information. And you have given us nothing. Mr. BATTIES. Mr. Chairman, I am not— Mr. BARNARD . I respectfully appreciate the fact that you got a new position and that you have only been in this position for nearly a year. But a year, considering this transaction, is a long, long, long time. I mean, because we have learned more than we thought we would learn in the last 30 days. So I am just saying that the information- we are not getting the information we need to really find out what your department did, what you felt your responsibilities were, and whether you took just normal appropriate action toward offsetting this calamity which developed between Home State and ESM . I guess the word is " stonewalling," but hopefully we need to get this information. Mr. BATTIES . Mr. Chairman, once again I defer to section 1155.16 and I would like to cooperate with you and provide that informationMr. BARNARD. That does not protect you from just telling us what you know. We are not asking for the availability of information in examination forms . We are not asking for that. We respect that. Mr. BATTIES. Yes, sir. Mr. BARNARD. But on the other hand, we feel that you, as a representative of this department, should tell us what we are trying to find out. In fact, I guess let me clarify. We are trying to ask you what you did. What was done? And that is all we are trying to find out. Mr. BATTIES. Right. Mr. Chairman , I understand that. And I am trying to cooperate. The confusion is that many of the questions that you are asking me are the information that I would have would be as a result of my official position. AndMr. BARNARD. That is exactly why we have you here. Mr. BATTIES. Right. And so thereforeMr. BARNARD. I mean, we like you , but we are here because of the fact that you represent the Ohio Thrift Division. Mr. BATTIES. Exactly. And as a result, I am constrained by the section of the Ohio State Code and am personally liable for a fourth-degree felony for exposing some of the information. Mr. BARNARD. Do you think that the Ohio Thrift Division was negligent in their handling of the connection between Home State and ESM? Mr. BATTIES . No, sir. Mr. BARNARD. You do not? Why not? Mr. BATTIES. Based upon the statutory restrictions that the superintendent had-this is my own opinion. You are asking me for my opinion. Mr. BARNARD. We are getting somewhere now. Mr. BATTIES. Right. Based upon my personal opinion, I do not believe that the superintendent was negligent based upon the knowledge that I personally have and his restrictions under the statute as provided by the Ohio Code. 183 Mr. BARNARD. In your examination of Home State, in just your normal routine examination and what you expect of sound, wellmanaged financial institutions, you found nothing amiss between Home State and ESM? Mr. BATTIES . There was concern within the division as to the level of involvement of transactions with Home State and ESM Government Securities . There was no statutory provision that caused a violation of law with respect to those except for the discretion of the superintendent with respect to those transactions. Mr. BARNARD. In other words, the fact that they had more securities pledged than their loan would require was a discretionary type of decision? Mr. BATTIES . There was no direct violation of law for their involvement with ESM . Mr. BARNARD. But it was obvious that that was not very good management. Mr. BATTIES. Business practice. Mr. BARNARD. The fact that there were obviously no receipts of safekeeping from a third party with responsibility for these securities. How do you react to that? Mr. BATTIES. Mr. Chairman, I have no personal knowledge that there were no receipts provided Home State for its transaction with ESM . Mr. BARNARD. Let me quote from your October 1983 examination: The failure to record in the corporate minutes the approvals for security transactions in the millions of dollars the various security brokerage firms used, having a total of $390 million of open contracts in the futures market, and the repeated failure to properly prepare financial reports to the State of Ohio and to the Ohio Deposit Guarantee Fund, indicates a reluctance by management to document and report its actions. It should also be mentioned in this report summary that many of the areas of concern that are included in this examination report were also the subject of comments in previous examination reports. So here the examination report that your department conducted brings forth the fact that there were real questions as to the management practice of Home State. So what did the department do about that? Mr. BATTIES. Mr. Chairman, as to my personal knowledge of what the division did, my knowledge is scant. The proper person to ask with respect to that would be the former superintendent . It is my understanding in conversations recently and in testimony provided today as well as in the newspapers , is that there was an agreement struck between the division and Home State, that they were to unwind their transactions—they had matched their transactions is a term in the investment field, as Mr. Hunsche said, with T-bills, which are of a sounder nature than possibly previous investment transactions and that they were to unwind these beginning in May and June 1985. Mr. BARNARD. Mr. Batties, I hope you can answer this question. That is, when the Home State conservator recently filed a law suit against Marvin Warner and other officers of Home State, the new thrift superintendent, Mr. McAllister, was quoted as saying that "ugly acts by Mr. Warner and others caused the Home State collapse." 184 Are you familiar with that statement? Mr. BATTIES . Yes, sir. Mr. BARNARD. What were those ugly acts? Mr. BATTIES. I personally do not know what Mr. McAllister totally meant by those ugly acts by Mr. Warner. I can only give you my personal opinion as to what they possibly could have been. Mr. BARNARD. And what is your association with Mr. McAllister? Mr. BATTIES. I am his employee. I work for Mr. McAllister. He is superintendent of the division of savings and loan and I am chief deputy superintendent. Mr. BARNARD. And general counsel . Mr. BATTIES. And chief counsel, yes, sir. Mr. BARNARD. So you are speaking from some authority? Mr. BATTIES . Yes, sir. Mr. BARNARD . Good. Mr. BATTIES. I would say that there is some concern. Mr. Warner's obvious involvement with Home State and his control position as being the sole shareholder of Home State, plus being possibly in a control position with American Savings of-I believe it is Miami or Fort Lauderdale-and his obvious personal relationship with Mr. Ewton of ESM, and that there might have been some collusive or alledged misconduct on the part of Mr. Warner with respect to Mr. Ewton and ESM. Mr. BARNARD. Do you think some of that will be a part of the— will some of this information or your feelings be relayed to the special prosecutor that has been selected? Mr. BATTIES . Yes, sir. Mr. BARNARD. Mr. Craig. Mr. CRAIG. Thank you very much, Mr. Chairman. Mr. Batties, you came to the division when? Mr. BATTIES. April 23, 1984, Mr. Representative. Mr. CRAIG. Who hired you? Mr. BATTIES. Mr. Chairman, Mr. Craig, the superintendent at that time, C. Lawrence Huddleston . Mr. CRAIG. Is the superintendent's position of that division an appointed position? Mr. BATTIES. Mr. Chairman , Mr. Craig, yes, sir. Mr. CRAIG. Who appoints that person? Mr. BATTIES. Mr. Chairman and Mr. Representative , the Governor. Mr. CRAIG. Why did that person resign? Mr. BATTIES . Mr. Chairman and Mr. Representative, I do not have any personal knowledge as to why he resigned, and possibly the Governor might be the best person to answer that question for you. Or Mr. Huddleston . Mr. CRAIG. Your current boss is whom? Mr. BATTIES. Robert McAllister, sir. Mr. CRAIG. And he was appointed by the Governor also? Mr. BATTIES . Mr. Chairman and Mr. Representative, yes, sir. Mr. CRAIG. Thank you very much. I have some questions of Mr. Hunsche. I have before me, sir, the constitution of the Ohio Deposit Guarantee Fund. And on the face of that constitution is a-I assume-a decal or a logo of the fund itself. It says "Ohio Deposit Guarantee 185 Fund, all savings guaranteed in full. " And embossed on the face of that is an outline of the State of Ohio . How is this decal used? Mr. HUNSCHE. Just as it is presented there. Mr. CRAIG. Could you come closer to the mike. I could not hear you . Mr. HUNSCHE. Just as it is presented . It is Mr. CRAIG. And how is it presented to the public of Ohio? Does it appear on the windows or doors of the-Mr. HUNSCHE. It appears on the doors and the windows of the member companies . Mr. CRAIG. Are there brochures available in eachMr. HUNSCHE. There are brochures available in each member institution Mr. CRAIG. And what do they say? Mr. HUNSCHE [continuing]. And Mr. CRAIG. Could you come closer to the mike, sir? Mr. HUNSCHE. The topics first start out with "What is the Ohio Deposit Guarantee Fund? How does the fund operate to protect depositors? Who owns and manages the fund?” Mr. CRAIG. And what does it say about that? Mr. HUNSCHE. It says "The Ohio Deposit Guarantee Fund is owned entirely by its member associations which maintain a percentage of their savings deposits adjusted semiannually in the form of cash deposits with the fund ." Mr. CRAIG. Now could you tell me Mr. HUNSCHE. There is no indication that it is owned by the State or anything of that nature. Mr. CRAIG. In other words, it is " depositor beware, do not look at the decal that shows the State of Ohio. Read the brochure." Mr. HUNSCHE. Right. They should read the brochure. Mr. CRAIG. OK. Can you tell me who the current board of trustees of that Fund are? Who the board is? Mr. HUNSCHE. Yes. Mr. CRAIG. It is a board of trustees, I believe your constitution calls it. Mr. HUNSCHE. Yes. Charles A. Brigham. Do you want their affiliation as well? Mr. CRAIG. Yes, please. Mr. HUNSCHE. Who is also the president and director of Federated Savings Bank of Lockland. John A. Dreyer, director of Baltimore Savings & Loan Co. of Cincinnati. Richard D. Hoffmann, chairman of the board, City Loan & Savings Co. , Lima. Vernon W. McDaniel, assistant treasurer and director, Anderson Ferry Building & Loan Co. , Cincinnati. John R. Perkins, president and director of the Metropolitan Savings Bank, Youngstown, OH. Eleanor J. Remke, president and director of Madison Savings Bank, Cincinnati, OH. Joseph D. Rusnak, president and director of Mentor Savings Bank, Mentor. David J. Schiebel, chairman of the board, Home State Savings Bank, Cincinnati. Harold R. Swope, president and director, Independent Savings Bank, Euclid, OH. Charles F. Tilbury, Sr., executive vice president and director of the Clermont Savings Association, New Richmond, OH. Jack R. Wingate, executive vice president and director, Heritage Savings Bank, Cincinnati, OH. 186 Mr. CRAIG. This group, in its overall examination of Home State, had made some determinations as to Home State's relationship with ESM . In that determination , what authority does the guarantee fund have over a member institution? Can it only make recommendations? Mr. HUNSCHE. To the best of my knowledge, it can only make recommendations. Mr. CRAIG. It cannot withdraw guarantee? Mr. HUNSCHE. It can withdraw the guarantee of the member. But then, you know, it is like taking an elephant gun to shoot a flea. Mr. CRAIG. So it has little to no authority over supervision of a member bank's activity? Mr. HUNSCHE. No. We can counsel, but we cannot compel . And we have found over the years that normally we have been able to counsel very effectively. Mr. CRAIG. Were you able to counsel very effectively with Home Savings? Mr. HUNSCHE. Initially I would say we ran into a problem. Towards the end of the situation, when in July 1984, 60 percent of the ESM transaction was put into Treasury bills that matured in May and June 1985, we felt that we had done an excellent job because they would have rolled out. And there would have only been about $270 million left on some Ginnys that they had at that time. Our position would have been at that time, depending on market, if there were not an enormous loss in the Ginnys, that they roll out of those as well. And that is what we would have tried to get them to do. Mr. CRAIG. Of the member institutions of the fund, where did Home Savings rank in size and premium payment? Mr. HUNSCHE. In size it ranked as first; in premium payment, second . Mr. CRAIG. So in other words, a substantial portion of the fund's assets were derived from Home Savings? Mr. HUNSCHE. I believe they amounted to approximately 15 percent of the fund. Mr. CRAIG. Fifteen percent of the total. On January 4, all of the directors of Home State, and I am quoting your testimony, "with the exception of one, agreed to a program of unwinding from ESM's relationship. " With a particular emphasis on overcollateralization, and a concentration of transactions with one thinly capitalized dealer, who was the one exception to that board decision? Do you know? Mr. HUNSCHE. Now, which date were you referring to, Mr. Craig? Mr. CRAIG. I am referring to page 4, I believe , of your statement. Last paragraph on the bottom of the page. Mr. HUNSCHE. I believe that one was Nelson Schwab, the company's attorney. Mr. CRAIG. We were informed otherwise. Do you know that to be a fact? Mr. HUNSCHE. I am not sure. There are two of these. One of them-both of them have somebody missing. One of them was Stan Brock and the other was the attorney. 187 Mr. CRAIG. Do you know for a fact or is it a fact that Mr. Warner did not sign the agreement and objected to that decision? Mr. HUNSCHE. Oh, Mr. Warner, Jr.? I believe this is the one- oh, five out of the seven. This is the one that Mr. Warner, Jr., and Nelson Schwab did not sign . Mr. CRAIG. Do you know their reason for not signing? Mr. HUNSCHE. No, we do not . I believe they did not show as being in attendance at the meeting. Mr. CRAIG. What is your relationship to the State supervisor's office in the collection of information and reports? Mr. HUNSCHE. Over the years we have worked very effectively together. Anything that comes out of our office, a transmittal copy goes to the division of savings and loans, and conversely, what comes out of their office normally we get a copy of it. Mr. CRAIG. Is it made available to the fund, to you, all of the supervisorial reports that the supervisor conducts of your member group? Mr. HUNSCHE . The examination reports? Mr. CRAIG. The examinations. Mr. HUNSCHE . Yes. Mr. CRAIG. Are they adequate reports, do you feel? Mr. HUNSCHE. Yes. Mr. CRAIG. Do you base your entire decisions on those reports, or do you do an investigative process yourself? Mr. HUNSCHE. Sometimes we do. Other times, if we feel something should be expanded, our own people will go out and expand on it. Mr. CRAIG. You seem to demonstrate a vagueness in knowledge as to the activities of the supervisor's office in your testimony or the division, of at least a knowledgeable relationship through this whole episode. How was the line of communication from the time it became knowledgeable that Home State was in trouble? Mr. HUNSCHE. Can you repeat that, please? I did not grasp what you were saying. Mr. CRAIG. You seem to, in your testimony, demonstrate, or at least in the cross examination of the chairman, some lack of knowledge as to the activities of the supervisor's office or the division and so I was curious as to what your relationship with them has been through this whole episode. Mr. HUNSCHE. That has only taken place since the conservator was placed in Home State . Prior to that, we had a very workable relationship. I think we almost lived together for a solid week in trying to get this thing resolved . Once the conservator was appointed in Home State, we were taken out of the picture totally. Mr. CRAIG. Do you believe that that is the proper process to go through? Mr. HUNSCHE. Personally, no. Mr. CRAIG. Why not? Mr. HUNSCHE. We felt that we could be helpful. Mr. CRAIG. In what way? Mr. HUNSCHE. Well, in one way we brought in a thrift consulting firm out of New York early on to get a bid package together for Home State. Sent them over to counsel's office for the department 50-923 0-85--7 188 of commerce and they were turned away. Then I think that following Saturday we found out-Mr. CRAIG. Who was turned away from the department of commerce? Mr. HUNSCHE. The people we brought in from New York, to prepare a bid package. Mr. CRAIG. In other words, in an attempt to sell Home State? Mr. HUNSCHE. Right. Mr. CRAIG. What was the reason for turning them away? Mr. HUNSCHE. That I do not really know. Mr. CRAIG. You were not given a reason. Mr. Batties, could you give us a reason? Mr. BATTIES. Mr. Chairman, Mr. Representative, on the eve that the conservator was appointed and subsequent days thereafter, the conservator was trying to gain control of the Home State Savings Bank situation- books , records. I had enlisted probably 20 to 22 State examiners to provide assistance in gaining control over the institution at that time. We had already gone through some sales activity with respect to Home State in the previous weekend . To answer your question, it was just not in the best interests of having the conservator gain control over the books and records of Home State to have an additional party or parties clamoring around the books and records at that time. Mr. CRAIG. If I remember Mr. Hunsche's, either testimony or cross examination, there was a concern though in the capability of the fund to be able to present a valid image that Home State could have been acquired, that the fund could properly have assisted, and that the doors might have remained open in that transaction -or in that period of time. Mr. HUNSCHE. Well, it is just my personal opinion. Mr. CRAIG. Well, as the administrator of the fund, your personal opinion ought to have some value. Mr. HUNSCHE. That had the loan been given to the fund, given to the Ohio Deposit Guarantee Fund, and had we gone to our members for an additional 1 percent, which many of them were agreeable to, it would have increased our assets substantially. So that we could have gone into the newspapers and then made the statement that regardless of how large Home State's loss is, the Ohio Deposit Guarantee Fund can cover it. We had 30 years of credibility in the Hamilton County area. And I think it would have worked. Mr. CRAIG. But you were denied that opportunity? Mr. HUNSCHE. A separate fund was set up. Mr. CRAIG. All right. Mr. Chairman, thank you . Mr. BARNARD. Mr. Spratt? Mr. SPRATT. Thank you , Mr. Chairman. It would be helpful to me, since we do not have balance sheets before us or attached as any of the exhibits to any of your testimony, if you could just walk us, Mr. Hunsche, through the years and examinations that passed from the time you first detected a problem at Home State in 1980, at which time your statement says there were repurchase agreements of about $ 100 million and overconcentration with ESM, and an overcollateralization in nonuniform maturities. 189 Could you first of all tell us what you mean by overcollateralization? Mr. HUNSCHE. By overcollateralization is when the securities put up with the broker/dealer exceed the amount of the loan against their securities . Mr. SPRATT. Do you know what the margin on those deals was? The amount of excess collateralization? In rough percentage terms. Mr. HUNSCHE. There were some of them as high as 25 to 30 percent, as I recall . One of our objectives was to get them down within national ranges of 103 to 105 percent total collateralization. Mr. SPRATT. Would that not strike an average examiner as an extraordinary situation? Mr. HUNSCHE. Right. It did and, you know, the examiners did an excellent job on this. The thing that we were told is that the excess overcollateralization enabled them to borrow even at a cheaper rate, initially. Mr. SPRATT. Did the rate of borrowing-did the rate which they were paying ESM validate that representation? Mr. HUNSCHE . Yes . Mr. SPRATT. It was a below-market rate of interest? Mr. HUNSCHE. Compared to what you would borrow in other areas. To the best of my knowledge. Mr. SPRATT. And did the Ohio Savings and Loan Department and the guarantee fund accept that explanation at that time? Mr. HUNSCHE. Yes, I believe we did. However, we still felt that there was too much of a concentration. Our main objective- we had two objectives really-to get the collateralization down within realistic percentages, and second, to reduce the amount of funds that the company had with one securities dealer. In July 1984, when we were advised that the $400 million of the $670 million loan was covered by Treasury bills that matured in May and June 1985, we felt we had won the war. That over 60 percent of this thing would have been washed out come May and June of this year. And then all we would have had to contend with was the remaining $270 million based on their Ginny Mae loans that they had out. And our theory was that if the loss was not substantial, then we would urge them to get out of that as well . Mr. SPRATT. In July 1984 , what did the Home State balance sheet look like? What was on the asset side? Mr. HUNSCHE. I do not have it with me. Mr. SPRATT. Was there still an overcollateralization . Did these Tbills belong to Home State? Had they been transferred as collateralization for a loan from ESM? Mr. HUNSCHE. I believe somehow back then, as I recall, they were switched. They had some Treasury bonds due in 1988, and somehow or another, they managed a switch out of the Treasury bonds and into the Treasury bills, which would have matured then on the year- what they done, their reverse repos were done basically for a year at a time. By switching out of the bonds and into the Treasury bills, it gave us a definite maturity date , when 60 percent of the transaction would have just been paid off. Mr. SPRATT. What was the net worth, the parent book net worth, of ESM at this time? Excuse me-of Home State at this time? 190 Mr. HUNSCHE. Probably somewhere in the vicinity of $13 to $15 million. I am not totally sure. Mr. SPRATT. $ 13 to $ 14 million? Mr. HUNSCHE. I really do not have those figures with me. Mr. SPRATT. So many times its net worth was in effect being held by a third party well beyond the jurisdiction of the State of Ohio in Fort Lauderdale. What efforts did the Ohio State Savings and Loan Division and the guarantee fund make to determine the validity, the security, of this institution that was holding several times the net worth of the largest institution that they insured? Mr. HUNSCHE. We insisted on an audit report by Arthur Anderson. We also insisted on an audit report of ESM Government Securities and an attachment on that audit report showing where all of their securities were supposed to be placed. Mr. SPRATT. And so the audit report you-was the audit report of ESM made by Arthur Anderson? Mr. HUNSCHE. No. The audit report made on ESM was made by Alexander Grant. But was accepted by Arthur Anderson who is the C.P.A. firm that does the auditing of Home State. And it was accepted by us as well. We did not have any idea that it was an invalid audit report. Mr. SPRATT. Who was the audit firm for ESM? I am sorry. I did not hear your answer. Mr. HUNSCHE. Alexander Grant. Mr. SPRATT. Alexander Grant. What happened to them? Not what is going to happen to them, but what happened to them in their audit practice? Mr. HUNSCHE. What happened to them? I think they would like to find that out themselves. From what I have read, apparently they had a partner who was taking kickbacks or something. Mr. SPRATT. It was not a typographical error, was it? Mr. HUNSCHE. I hope not. Mr. SPRATT. I am sorry to ask you these elementary questions , and maybe if I had been following the press accounts closely enough I would know this myself. I am just trying to put together a picture of the situation. Were there custodial receipts? Were there documents, safekeeping receipts, indicating these securities were in the hands of a third party somewhere? The T-bills that are the subject of the reverse repo-were these certificates in these vaults? Mr. HUNSCHE. I cannot answer that totally. At the one meeting I attended where there was a gentleman up from ESM, the story we were given is that the collateral is turned over to the communities that put up the money. The physical collateral. It was always our understanding that ESM was nothing more than a middleman . It went to Toledo and various communities, got the money in, then the institutions would pledge their governments, or Ginnys or whatever it would be, and then those would then be taken and pledged to the communities. Mr. SPRATT. I see. What in fact happened? Do you know what in fact happened to the securities? Mr. HUNSCHE. Please? Mr. SPRATT. Do you know what in fact happened to these securities? 191 Mr. HUNSCHE. You idea is as good as mine. I have been waiting with baited breath to find out from Florida exactly what happened to the securities. Now, we do know that something like $300 million in Ginnys apparently are still in Home State's name because Home State is getting the interest on them. Mr. SPRATT. Let me ask you a couple of questions about your insurance fund. One of the reasons for our holding this hearing is that we also have oversight jurisdiction of the FSLIC and the FDIC and there has recently been a proposal made for the reorganization and consolidation of banking agencies. Basically it proposes that the FDIC sort of back out of its examination process and only come into dealing directly with its insured member banks at a time of crisis. It seems to me that you have been in something of that situation yourself. Would you recommend that other insurance funds operate in the same manner you have with only moral suasion at your disposal? Mr. HUNSCHE. No. You would be better off to have as much power as you can possibly get. But most of that emanates out of the State law and it is awfully difficult for a private organization to have it. The ultimate weapon that we have naturally is the expulsion , but when you go through the expulsion, then you have the situation that was initially created by ESM, where you would have a run on it. So-Mr. SPRATT. Were you hampered by the fact that you did not have routine access to the books of Home State? Mr. HUNSCHE. No. We always had routine access to the books of Home State. Mr. SPRATT. Oh, you did have access to the books. Mr. HUNSCHE. That only stopped after the conservator was appointed. Mr. SPRATT. I beg your pardon. OK. How have the member institutions of your deposit guarantee fund booked their 2-percent deposit? Mr. HUNSCHE. They keep it on their books as an asset. Mr. SPRATT. As an asset? Mr. HUNSCHE. Yes. That is why it is imperative in the sale of Home State to try and preserve that 2 percent so it does not have to be wiped out against their net worth which will make less of them qualified for Federal insurance. Mr. SPRATT. I notice in the responses to interrogatories we put to you that you indicated you had $2 million of reinsurance and a $1 million line of credit. In light of your exposure, do you think that is adequate backup liquidity? Mr. HUNSCHE. Definitely not, although after the Garn-St Germain Act, when the Federal Reserve was made available, it did seem to be adequate. Mr. SPRATT. You also guarantee deposits over $ 100,000 - all deposits, rather; 100-percent guaranteed . If it were not for that inclusive guarantee, would you still have the same insolvent situation? Would you still have the same problem you have with Home State? Mr. HUNSCHE. Yes. 192 Mr. SPRATT. That does not make any difference in terms of exhausting your assets? Mr. HUNSCHE. The guarantee in full really does not change the portfolio all that much. I mean, you know, under the FSLIC and FDIC, they have a number of ways that you can get up to- I forget how much it is , a quarter of a million or better-guaranteed under their insurance program . Mr. SPRATT. Thank you. Mr. BARNARD. Mr. Kolter? Mr. KOLTER. Thank you, Mr. Chairman. According to your statement, as early as 1980 and 1981 , there was overconcentration with one dealer as you mentioned. And you did have contact with the Home State Bank. Did you in fact also have contact with say the Governor's office, the responsible members of the legislature, the superintendent of banking for the State, and State people? Or were they not notified? Mr. HUNSCHE. No. Mr. KOLTER. The reason I ask this question, the Governor today was interrogated as to why he did not move faster. And how could he move faster if he was not notified by somebody? Mr. HUNSCHE. The information contained in those reports would have been strictly shared between the Ohio Division of Savings and Loans and the Ohio Deposit Guarantee Fund. Now, I cannot speak for Tom. I do not know if he reports to the Governor or not. Mr. KOLTER. Do you feel if in fact you did notify responsible people at that time at the State level that action could have been taken to avert this crisis? Mr. HUNSCHE. Back then it really was not all that much of a crisis. A lot of them were matched. They might have been overcollateralized, but they were matched, and they were rolled off every 6 months. There are tremendous numbers of financial institutions who use reverse repos as a borrowing type of instrument. I think the situation involving Home State here was using it on a too large a scale and with a too thinly capitalized dealer. Mr. KOLTER. Mr. Batties, as regulator, if you would have contacted responsible people at the State level, do you feel this could be averted? Or is this not your responsibility? Mr. BATTIES. Mr. Chairman , Mr. Representative, no. I do not think that it could have been averted. One thing, I do not think that there is any way that the State in and of itself could have averted the type of alleged fraud activity that took place at ESM. If your question is to the level of involvement of Home State with ESM, in terms of its level of activity, there was concerted effort being taken at that time pursuant to the statutory authority to have them unwind their situation, hopefully without a loss to the institution that would possibly impair the Ohio Deposit Guarantee Fund. Mr. KOLTER. Thank you . Mr. Mr. the Mr. Mr. BARNARD. In other words, your authority is very limited? BATTIES. Mr. Chairman, I might just go through some of BARNARD. Do you have cease-and-desist powers? BATTIES . Yes, sir. 193 Mr. BARNARD. So in other words, the Ohio Thrift Department could-even as far back as 1977 or 1978, knowing of this involvement with ESM-they could have, at that time, taken regulatory action? Mr. BATTIES. The Ohio Division of Savings and Loan does possess cease-and-desist powers . Mr. BARNARD. And they could have taken action to remedy this association if they thought it was unwise banking practices? Mr. BATTIES. Mr. Chairman, if the superintendent at his discretion thought they were involved in unsafe and unsound practices, he could have instituted a cease-and-desist order. Mr. BARNARD. Who is the present superintendent? Mr. BATTIES. Robert McAllister. Mr. BARNARD. And who was the previous superintendent? Mr. BATTIES. Myself, for a period of— Mr. BARNARD. You were the acting superintendent. Mr. BATTIES. Acting Superintendent. Mr. BARNARD. But who was your predecessor? Mr. BATTIES. C. Lawrence Huddleston . Mr. Mr. Mr. Mr. man . Mr. BARNARD. How long had he been in that job? BATTIES . Mr. Chairman, roughly 2 years or more. BARNARD. And what is he doing today? BATTIES. He is in the investment banking field, Mr. ChairBARNARD. Mr. Erdreich? Mr. ERDREICH. Thank you, Mr. Chairman . I am trying to get a separation between the sharks and the victims. And I think we are all victims here . I think the State of Ohio is obviously a victim. The depositors who are more than inconvenienced and in jeopardy of losing their deposits are victims. But it seems to me we are losing sight of the shark and I am shocked by the memorandum, Mr. Chairman , that I looked at. A 1977 memo— it talks about ESM and the principals and it says and I quote: Everyone seems aware of their names and they are known as suede shoe typesslickers, high-pressure salesmen. The usual high-pressure bond salesmen. They are known and feared because they once operated in Memphis and Little Rock as well as Houston, TX, prior to coming to Fort Lauderdale, and are branded as the Memphis bond bandits. I mean, it sounds like we are dealing with the Bonnie and Clyde of the bond selling business, and this is 1977 when the Comptroller of Currency is telling, at least in a memo that went to all national bank presidents, about ESM. That ESM is a little problem, and is a danger indeed, as this says, is feared by folks in the business. I am just curious to hear that you folks in Ohio, and, yes, you saw that this ESM situation was a problem, but I do not get the impression that either of you, from each agency, had any sense that ESM was some real danger, that you were aware of ESM being a real difficulty or a real financial problem. Did you have any, Mr. Hunsche, of that? Mr. HUNSCHE. No , sir. I wish that would have been shared with us. I am sure we would have got them out of that ESM in 1977. Mr. ERDREICH . Mr. Batties? 194 Mr. BATTIES. Mr. Chairman, Mr. Representative, we were not aware and to my knowledge any other superintendent or myself was aware that ESM, quote unquote, was a bad actor. Mr. ERDREICH. It just amazes me, and I think, Mr. Chairman, the further hearings today, what you are doing, is excellent because the obvious lack of communication between all the agencies involved, whether it is at the Federal level or State level, contributed to more victims piling up, and from what I am hearing I see what Ohio had in the level of authority that you had, Mr. Hunsche, what you all could do and where you moved in on the problems at Home State, but looking overall, it just bothers me that an actor like this and more than a bad actor, I would say, could be one of those sharks out there and institutions have not really any sense of it and the State agencies have very little sense of it. What sort of information beyond an audit, that you said you required, Mr. Hunsche, I believe, received an audit on ESM? Anything beyond that is information or disclosure about this particular entity and what it was doing? Mr. HUNSCHE. As far as ESM is concerned? Mr. ERDREICH. Yes. As far as ESM? Mr. HUNSCHE. I think they also required the ESM auditor to indicate where Home State's securities were located . Against which transactions. And they used to compile a list of that every year as well. Mr. ERDREICH. But no further additional information about ESM itself? And from the State's side-Mr. HUNSCHE. And the financial statements, you know, made it look like it was making money tremendously. Very profitable corporation. Mr. ERDREICH. The first that you had- that is, that the State had information, your organization did, your agency, was prior to 1982 the involvement with ESM. Do you have any sense now of the size of ESM , its operations? Mr. HUNSCHE. Do I have any sense of the size? Mr. ERDREICH. Have you any further information beyond an audit report on ESM? Mr. HUNSCHE. I have seen the 1984 audit report. Mr. Scheibel had it. Apparently it was given to him on a Thursday and was asked to be taken back on a Friday, but he kept it. I cannot quote you from it, because I really do not have it. But he did have a physical audit report issued by Alexander Grant & Co. , for the year 1984 in his hand and he still has that. Mr. ERDREICH . And the audit report, you and your agency were satisfied with the audit report on the face of it, I take it? Mr. HUNSCHE. Right. Mr. ERDREICH. Thank you, Mr. Hunsche. Mr. BARNARD. Mr. Batties, one of the strongest- well, excuse me. Let me ask this to Mr. Hunsche . One of the strongest State private insurance funds that we know about indicates that under their system a reverse repurchase borrowing is a separate item on a monthly report, which is flagged on a computer printout, and if it appears like this situation between Home State and ESM , it results in an automatic special inquiry. Now, I will ask both Mr. BattiesOhio does not have a system like that? 1 195 Mr. HUNSCHE. No, sir. We did not. Mr. BARNARD. From your standpoint, the Ohio Insurance Fund has no system like that. So you do not get these monthly reports? Mr. HUNSCHE. Yes, sir. We get monthly reports . But I do not believe there is a definitive enough breakdown on that monthly report to show any increase in collateral . Now, it would show an increase in the borrowing, but it does not break down the collateral as to what is truly available right now for liquidity and what is assigned to the other side of the reverse repo transaction. Mr. BARNARD. Mr. Batties, what type of reports do you get from these institutions? You do not get a monthly report, you get a quarterly report? Mr. BATTIES. Mr. Chairman, we do receive a monthly report that itemizes the assets and liabilities of the institution. In that monthly report, and I am not an examiner, but in my memory, my recollection of reviewing the reports, that it might take the examiner just a few seconds to figure out that there is an item there that he needs to inquire about, and then he would necessarily phone the institution to determine exactly what that involved . So I believe it is my understanding that that had been tracked on a continual basis about their involvement, their assets and the liabilities . And their relationship . Mr. BARNARD. But nothing was done about it? Mr. BATTIES. No, sir. Mr. BARNARD . Mr. Kindness? Mr. KINDNESS . Thank you , Mr. Chairman . I will be very quick here. Mr. Batties, does your division have any cease-and-desist powers to in effect order a savings and loan to change their investment pattern or to take particular actions in order to bring them into compliance with sound practice? Mr. BATTIES. Mr. Chairman, Mr. Representative, we had ceaseand-desist powers to in essence order an institution to cease and desist the activity of which we felt was in violation of either law or safe and sound business practices . Mr. KINDNESS. Was that used? Mr. BATTIES. With respect to Home State? No, sir. Mr. KINDNESS. Is there a reason that is on the record why it was not used? Mr. BATTIES. I personally have no knowledge as to why it was not used. I can only maybe offer an opinion, but I do not know specifically why it was not used by a previous superintendent. Mr. KINDNESS. This was in a period of time when the superintendent himself was exercising the supervisory function although your designated responsibility was supervisory as well as being chief counsel; is that correct? Mr. BATTIES. Mr. Chairman, Mr. Representative, that is correct. Mr. KINDNESS . So Home State was a special case then aside from your usual caseload, I take it . Mr. BATTIES. Mr. Chairman, Mr. Representative , correct. Mr. KINDNESS. And where is Mr. Huddleston now? Mr. BATTIES. Mr. Chairman, Mr. Representative, he is still in Columbus, if that is your question, working in the investment banking field. 196 Mr. KINDNESS . Mr. Hunsche, is it your understanding that the Ohio Deposit Guarantee Fund is a corporation? Incorporated under the laws of the State of Ohio? Mr. HUNSCHE. Right. Mr. KINDNESS . And it is a separate legal entity and might conceivably have a right to recover from the State of Ohio its losses because of the interference with the ability of the ODGF to minimize or prevent loss of the funds that belonged to its members? Do you have a right to sue as an association? Mr. HUNSCHE. I would assume we would have a right to sue. Mr. KINDNESS. And you have indicated to the committee that there were actions taken by the State of Ohio which precluded ODGF from pursuing actions it would normally pursue in a case like Home State in trying to get another purchaser to acquire Home State, and you were precluded from having information and access to the books and records; is that correct? Mr. HUNSCHE. That is correct. Mr. KINDNESS . And as a result of that, has ODGF in your opinion suffered any financial loss? Mr. HUNSCHE. We do not know at this time. We do not know what deal has been put together for Home State. All we have tried to impress upon everybody concerned with it was the extreme importance of saving the 2 percent of the members' deposits. Mr. KINDNESS. But the members ' deposits that were in the ODGFMr. HUNSCHE. That are still in the ODGF . Mr. KINDNESS [continuing]. Are under the control of a conservator appointed by the superintendent? Mr. HUNSCHE. The superintendent. Mr. KINDNESS. And as a result of that conservator's function, the ODGF cannot function at all with respect to its own fund; is that right? Mr. HUNSCHE. Yes. You are right. Mr. KINDNESS . And under what authority was the conservator appointed? Mr. HUNSCHE. Under a bill that was just passed about 2 weeks ago. About 2 weeks ago, they amended the statutes and provided for a conservator over guarantee-fund companies. Mr. KINDNESS. That was the taking of property without compensation, was it not? Well, that asks for a conclusion. It sounds like a taking of private property without compensation. Mr. HUNSCHE. I am no lawyer, but I have heard those words used before. Mr. KINDNESS. Has there been a meeting of the board of trustees of ODGF since the conservator was appointed? Mr. HUNSCHE. There is no board of trustees. Now we are nothing more than individuals. Mr. KINDNESS . Did the legislation passed by the general assembly revoke the charter, the corporation papers? Mr. HUNSCHE. They revoked all the statutes under which we were chartered. And then put us under a conservatorship. Mr. KINDNESS . The articles of incorporation are still on file in the secretary of state's office? Mr. HUNSCHE . To the best of my knowledge. 197 Mr. KINDNESS. But it has been confiscated by the State. Is there any action that you know of personally whereby the State of Ohio has said "You no longer have these assets that belong to private individuals or companies, savings and loans, that are members?" Mr. HUNSCHE. I would say that that is a question that the conservator has to ask. You know, at this point in time he is the possessor of all the assets of the Ohio Deposit Guarantee Fund. Mr. KINDNESS . Is the conservator appointed by a court or by the supervisor? Mr. HUNSCHE. He is appointed by the superintendent. Mr. KINDNESS . Is there any court proceeding involved? Mr. HUNSCHE. Not to the best of my knowledge. Mr. KINDNESS . It sounds as though there ought to be. Thank you, Mr. Chairman. Mr. BARNARD. Ms. Oakar, do you and Mr. Luken have any brief questions for this panel? Ms. OAKAR. No, I think you have dealt with that thoroughly. Mr. BARNARD. Gentlemen, we appreciate both of you being here today, and offering the testimony. Mr. Batties, it would be helpful to us if you could, while we have the testimony, you know, the answers to your questions, it might be helpful to us if you could go back and restructure some of those answers now that you have been here today, and if you can fill in some of the vacant aspects after conferring with Mr. McAllister or whoever else you need to confer with . It would be very helpful to us, because at this particular time we feel like we are somewhat lacking as to the intricacies of your examination process. We know that 148 examiners went into Ohio at the direction of the Federal Reserve, and I guess the reason they did that, they had to find out the stability of the institutions themselves because your records probably did not-I am not saying that, but from what we have learned this morning-that maybe the Ohio Thrift Division was inadequate to give them information as to the strength of these 71 institutions. But if you can fill in the blanks , we would be very appreciative and likewise, we would like to have the opportunity to ask for further information from the Ohio Department of Thrifts and Supervision. And with that, we thank you very much for being with us today. Mr. BATTIES. Mr. Chairman, thank you very much. Mr. HUNSCHE. Thank you, Mr. Chairman. Mr. BARNARD. Our next panel consists of the Honorable Edwin J. Gray, Chairman of the Federal Home Loan Bank Board; the Honorable Preston Martin, Vice Chairman of the Federal Reserve Board; Mrs. Karen N. Horn, president of the Cleveland Federal Reserve Bank; and the Honorable H. Joe Selby, Senior Deputy Controller of the Currency. Would you gentlemen please take your positions at the witness stand? Gentlemen, we certainly appreciate your being with us today and we also appreciate your patience. We are a little bit behind in schedule, but because of the very importance of this subject in this hearing and in this investigation, we certainly do not make any apologies. We feel like all the time that we have used up to now 198 has been very valuably spent. We appreciate, however, your indulgence with us up to this point. At this time I would just like to have the testimony of each of you and then we will ask that you respond to questions from the panel. We will begin with Mr. Gray and then Mr. Martin, Mrs. Horn, and Mr. Selby. And the committee will be advised that from this point on, because of the time, we will be imposing the 5-minute rule, including the chairman, and hopefully we will have several rounds of questioning. But we would like for everybody to have an opportunity to offer questions . So with that, Mr. Gray, we will hear from you, and thank you for being with us today. STATEMENT OF EDWIN J. GRAY, CHAIRMAN, FEDERAL HOME LOAN BANK BOARD Mr. GRAY. Thank you very much, Mr. Chairman, and distinguished members of the subcommittee. I appear before you today in my capacity as Chairman of the Federal Home Loan Bank Board and as Chief Executive Officer of the Federal Savings and Loan Insurance Corporation . We are here to discuss the nature of the response by the Federal Home Loan Bank Board to the crisis in Ohio which was precipitated by the failure of Home State Savings Bank. I am pleased to report today that the Federal Home Loan Bank Board has conditionally approved applications for insurance of accounts by the FSLIC from 24 former member institutions of the Ohio Deposit Guarantee Fund-applications which were processed in an historically unprecedented period of time. In addition, two institutions have acquired FSLIC insurance of accounts through merger into already insured institutions. We understand five other institutions intend to apply for FDIC insurance. As you know, Home State Savings Bank was closed on March 10 1985 , following a run on the institution by its depositors. The Home State run spread quickly to other State-chartered institutions insured by the private but State-chartered Ohio Deposit Guarantee Fund, threatening these institutions and the fund that insured them . Faced with this crisis, Governor Celeste declared a bank holiday for the 71 privately insured Ohio thrifts on March 15. I mention these dates because I think they are of interest to you . On Wednesday evening, March 13, representatives of the Federal Home Loan Bank of Cincinnati examined State reports on Ohio Fund members to make a preliminary estimate of their eligibility for FSLIC insurance . On that same evening, at my request, Bank Board General Counsel Norman Raiden explained the FSLIC's requirements for insurance of accounts at a meeting at the Federal Reserve Board attended by several representatives of a number of Ohio institutions and certain members of the Ohio congressional delegation. Mr. Raiden extended an invitation at that time to the Members of Congress who were present to meet with me the following day in my office to review the problem. At that time I took the initiative to commit the FSLIC to expeditious processing of applications for FSLIC insurance by members of the Ohio Deposit Guarantee Fund. 199 Over the next 3 days, from Friday, March 15 through Sunday, March 17, members of the staff of the Federal Home Loan Bank Board had numerous conversations with Ohio officials to discuss related issues. On Sunday evening, March 17, I and members of my staff met with Federal Reserve Board Chairman Paul Volcker in his office to discuss means of assisting Ohio institutions which the State had closed . I told Chairman Volcker that I had pledged to expedite the processing of applications for FSLIC insurance as quickly as possible. I further explained that because the Bank Board's examination force is severely understaffed -by some 750 positions nationwide-I simply did not have the examination staff required to complete necessary examinations nearly as quickly as I would like . Chairman Volcker responded that evening with a pledge to provide as many Federal Reserve examiners as needed to help the Bank Board fulfill its commitment of rapid processing of insurance of accounts applications. The following morning I dispatched the Director of the Bank Board's Office of Examinations and Supervision to Cleveland to meet with the staff of the Federal Reserve Bank there to coordinate the deployment of examiners. Over Monday, March 18, and Tuesday, March 19, telephone calls were made to all Ohio institutions insured by the Ohio Deposit Guarantee Fund requesting them to advise the Federal Home Loan Bank of Cincinnati as to whether they intended to seek FSLIC insurance. In addition, advance application packages were specially mailed to all those institutions so they would be in hand on Tuesday. On Tuesday evening, March 19, examiners were deployed to all those institutions which had indicated their intention to apply for FSLIC insurance of accounts. On Wednesday, March 20 , I met with Governor Celeste in my office at his request. In that meeting I again reiterated my pledge to mount an extraordinary effort to expedite processing of applications for FSLIC insurance by Ohio institutions . Following that meeting I also dispatched the Bank Board's Director of the Office of District Banks to Cincinnati to coordinate the applications process . Indeed, the Bank Board deployed 71 of its own examiners and, in addition, used some 140 Federal Reserve examiners for the sole purpose of helping to expedite FSLIC insurance of accounts applications by Ohio Deposit Guarantee Fund members. Examination of the applicant institutions was necessary because the National Housing Act requires that the FSLIC "shall reject the application of any applicant if it finds the capital of the applicant is impaired or that its financial policies or management are unsafe." Indeed, the act requires the FSLIC to quote " give full consideration to all factors in connection with the financial condition of applicants ." I had been advised by staff that a 10-day notice period was required by Bank Board regulations in order to approve applications. The Bank Board's General Counsel explained this during his meeting with the members of the Ohio congressional delegation . Later, after Chairman Volcker pledged examiner support, the staff advised me that the notice period could be waived under the circum- 200 stances. The Bank Board immediately waived the 10-day notice requirement in order to expedite the applications process. Frankly, in light of this extraordinary and unprecedented effort and the results it has so far achieved, I am not only pleased by the dedicated work of our staff and the Federal Reserve examiners, but I also cannot be apologetic to those who have chosen to find fault with our effort. There are several other matters, if time permits, which I would like to address. Considerable confusion has been generated by some as to the contrasting roles of the Federal Reserve and the Federal Home Loan Bank Board . Under Federal law-specifically the Monetary Control Act of 1980-the Federal Reserve is given specific responsibilities as lender of last resort to depository institutions of any kind. That act requires the Federal Reserve to provide " the same discount and borrowing privileges as members banks" to any "depository institution in which transaction accounts or nonpersonal time deposits are held." This is why the Federal Reserve was directly involved in providing collateralized credit to member institutions of the Ohio Deposit Guarantee Fund from the earliest beginnings of the Ohio thrift crisis. On the other hand, the Federal Home Loan Bank Board was not involved in any way with the regulation , examination, supervision , or insuring of member institutions of the Ohio Deposit Guarantee Fund. Our only legal responsibility in this matter was, and is, to deal with applications for FSLIC insurance of accounts and to provide collateralized credit to Federal Home Loan Banks System member institutions. There were 14 non-FSLIC-insured Ohio members of the Federal Home Loan Bank System at the outset of the Ohio thrift crisis. None of them requested Federal Home Loan Bank credit. Those who have chosen to misconstrue the contrasting nature of the legal responsibilities of the Federal Reserve compared to the Federal Home Loan Bank Board, and have sought to leave the impression, false as it is, that the Bank Board moved slowly or had any role to play other than to deal with applications for insurance of accounts do a disservice to the men and women of the Federal Home Loan Bank System who have acted well above and beyond the call of duty in this matter. For my part, Mr. Chairman and members of the subcommittee, I am very pleased with the Bank Board's historically unprecedented and extremely swift response to the Ohio thrift crisis. As you know, the Bank Board has the clear duty under the law to protect the safety and soundness of the Federal Savings and Loan Insurance Corporation. Consistent with that solemn responsibility, the Bank Board has chosen as a matter of policy to act prudently and carefully to assess applications for insurance of accounts from uninsured depository institutions . This we have done, and this we intend to continue to do , given the fact that it is the 201 full faith and credit of the United States which ultimately is called upon to back insured accounts in FSLIC member institutions. Thank you very much. I will be pleased at the proper time to answer any questions the subcommittee may have. [Mr. Gray's prepared statement follows :] 202 STATEMENT OF EDWIN J. GRAY CHAIRMAN OF THE FEDERAL HOME LOAN BANK BOARD Mr. Chairman and distinguished members of the Subcommittee . I appear before you today in my capacity as Chairman of the Federal Home Loan Bank Board ( " Bank Board " ) , and Chief Executive Officer of the Federal Savings and Loan Insurance Corporation ( " Corporation " or " FSLIC " ) . You have asked me to discuss the nature of the response by the Federal Home Loan Bank Board to the crisis in Ohio precipitated by the failure of Home State Savings Bank , and to share my thoughts concerning what Congressional response might be appropriate to prevent history from repeating itself . Home State Savings Bank was closed on March 10 , 1985 , following a run on the institution by its depositors . That run resulted from a lack of depositor confidence in the institution due to large losses Home State sustained as a result of the collapse of E.S.M. Government Securities , Inc. , with which it had a number of complex , and ultimately catastrophic , financial arrangements . The Home State run spread quickly to other state-chartered institutions insured by the private Ohio Deposit Guarantee Fund , threatening both these institutions and the fund that insured them . Faced with this crisis , Ohio Governor Richard Celeste declared a " bank holiday " for these seventy-one privately insured Ohio thrifts on March 15 , 1985 . As early as 1982 , the Federal Home Loan Bank of Cincinnati was aware of rumors of Home State's massive dealings with E.S.M. The Cincinnati Bank heard that Home State's September 1983 examination report disclosed substantial problems , but 203 staff at the Bank did not see a copy of that report until the Ohio Division of Savings and Loan Associations made it available to staff on March 8 , 1985 , after E.S.M.'s collapse . Prior conversations with officials of the Ohio Division and the Federal Reserve Bank of Cleveland during the week of March 4th had confirmed the distinct possibility that E.S.M.'s collapse had not only impaired Home State , but threatened to exhaust the resources of the Ohio Deposit Guarantee Fund as well . On Tuesday , March 5th , my office received a telephone call from Chairman Volcker's office alerting us to reports that American Savings and Loan Association , based in Miami , Florida , had suffered a major loss in the collapse of E.S.M. On Wednesday , March 6th , the Bank Board's general counsel received a telephone call from the Securities and Exchange Commission noting that public disclosure of the loss would probably be required . At the request of the Federal Reserve Bank of Cleveland , the Federal Home Loan Bank of Cincinnati sent three experienced senior supervisory staff members to Cleveland over the weekend of March 9th and 10th to assist the Federal Reserve in assessing the financial condition of the state- chartered Ohio thrifts that might need to borrow from the Federal Reserve Bank's discount window. 204 Following this review , details of the potential loss to Home State were discussed at a meeting on Sunday , March 10th, in Florida among officials of the Securities and Exchange Commission , the Federal Reserve Bank of Cleveland , and the Federal Home Loan Bank of Cincinnati , as well as other Federal Home Loan Bank district officials . At that time it was evident that the Ohio Fund itself was threatened . On March 12th , copies of certain information obtained at the March 10th meeting were sent to the Washington office of the Federal Home Loan Bank Board . On Wednesday evening , March 13th , representatives of the Federal Home Loan Bank of Cincinnati examined State reports on Ohio Fund members to make a preliminary estimate of their eligibility for FSLIC insurance . That same evening the Bank Board's general counsel explained the FSLIC's requirements for insurance of accounts at a meeting at the Federal Reserve Board attended by several representatives of a number of Ohio institutions and members of Ohio's Congressional delegation . The next day , Thursday , March 14th , I met with four members from Ohio's Congressional delegation to review the problem . At that time I took the initiative to commit expeditious processing on our part of applications for FSLIC insurance by Ohio institutions formerly insured by the Ohio Fund . Over the next three days , from Friday , March 15th , through Sunday , March 205 17th , officials of the Federal Home Loan Bank Board had numerous telephone conversations with Ohio officials to discuss related issues . On Sunday , March 17th , my staff and I met with Chairman Volcker to discuss means of assisting the Ohio institutions which had been closed by the State . I indicated that , while the Bank Board would make every possible effort to expedite the processing of FSLIC insurance applications , it did not have the examination staff available to complete the necessary examinations in as short a time as I would like . Chairman Volcker indicated that the Federal Reserve Board had over 100 examiners already in the Ohio institutions for the purpose of reviewing the creditworthiness of those institutions . He pledged to me the use of these Federal Reserve examiners by our staff to assist in expediting the examinations of Ohio institutions applying for FSLIC insurance . On Monday morning , March 18th , I dispatched the director of the Bank Board's Office of Examinations and Supervision to Cleveland to meet with the staff of the Federal Reserve Bank to coordinate the deployment of examiners . Over Monday , March 18th , and Tuesday , March 19th , telephone calls were made to all Ohio institutions insured by the Ohio Deposit Guarantee Fund , requesting them to advise the Federal Home Loan Bank of Cincinnati whether they intended to seek FSLIC insurance . In addition , advance application packages were specially mailed to 206 all those institutions so that they would be in hand on Tuesday . On Tuesday evening , March 19th , examiners were deployed to all those institutions which had indicated their intention to apply for FSLIC insurance . On Wednesday , March 20th , I met with Governor Celeste in my office in Washington . At that meeting , I reiterated my prior commitment directly to the Governor to mount an extraordinary effort to expedite processing of applications for FSLIC insurance by Ohio institutions . I assured Governor Celeste in the strongest possible terms that nothing was more important to me and to the Bank Board than rendering every assistance possible to Ohio institutions seeking FSLIC insurance . Giving this assistance was our number- one priority . To meet that commitment , I dispatched the director of the Bank Board's Office of District Banks to Cincinnati to coordinate the applications process . I am pleased to report that the staff has performed in an extraordinary manner and , as of April 1 , 1985 , 60 Ohio institutions applied for FSLIC insurance : 23 of these institutions have been conditionally approved , 2 additional institutions have acquired FSLIC insurance through merger into already insured institutions , and 5 institutions intend to apply for FDIC insurance . 207 The Ohio crisis shows clearly that persons who place money in a depository institution ought to know the true nature of the insurance backing that institution . That is , disclosure should be made to savers as to whether their deposits are backed by a federal agency , a state agency , or a private company or association . You have asked whether a standby rescue plan for state or private deposit insurance funds should be put in place . In my opinion , the public would be better protected by requiring federal insurance for all depository institutions . This is so simply because , as the events in Ohio have all too recently reminded us , there appears to be no adequate substitute in the minds of depositors for federal deposit insurance . Nothing gives depositors the same amount of confidence that FSLIC and FDIC insurance do . Universal federal deposit insurance is preferable to a rescue plan for a number of reasons . We are generally aware of some financial statistics behind the state authorized private deposit insurance funds , but we do not know the true financial condition of the thrift institutions insured by these funds . Privately insured thrift institutions are totally exempted from all federal regulations , and , consequently , they are not required to report their financial condition to federal regulators nor to subject their books and operations to the scrutiny of federal savings institution bank examiners . In 208 short , these institutions have no connection with the Federal Government , and the Federal Government in turn has no means of assessing the financial viability of these institutions . I should add that even a formal report on the financial condition of these institutions might not prove sufficient to assess their long- term economic viability . Analyzing financial institutions depends not only on the conditions reflected in pro forma financial statements , but also on the quality of examination and supervision those institutions receive . On a straight accounting basis , Home State Savings Bank appeared to be adequately capitalized . On the other hand , due to what may have been lax supervision , that institution was allowed to take tremendous risk by borrowing almost 50 percent of its funds through a single government securities dealer E.S.M. Without our being able to scrutinize the adequacy of the examination and supervision process in states permitting private deposit insurance funds , we have no way at all of determining the soundness or financial integrity of these funds , nor can we vouch for the accuracy of the financial statistics provided by the affected institutions . H.R. 1564 , which Congressman Leach introduced on March 19 , 1985 , represents an approach for attempting to deal with some of the problems that caused the Ohio crisis . That bill would require all privately insured depository institutions to apply for federal insurance . If they did not qualify , they 209 would receive interim insurance of individual accounts up to a maximum of $ 10,000 per account . Institutions insured on an interim basis would have five years to become insurable . Federally insurable institutions could elect to be insured by a state- level program meeting standards set by federal regulators . This proposal is under study by the Bank Board . Rather than prematurely commenting on this legislation at this time , however , I think it might be more helpful if I were to discuss what needs to be done to strengthen the FSLIC so that the FSLIC's survival is assured . I believe that there are eight general goals whose achievement would significantly strengthen the FSLIC Fund . I must note , parenthetically , that the achievement of these goals would not necessarily permit the forgiveness of the recent special premium assessment imposed on institutions currently insured by the FSLIC . However , these goals are highly relevant to the formulation of any federal legislation intended to avoid a repetition of the Ohio crisis in another state at some future date . First , long- term capital adequacy of the FSLIC Fund should be achieved to ensure public confidence in the Corporation's ability to meet present and future obligations . 210 Second , capital should be infused from insured institutions to the FSLIC to provide it with assets sufficient to resolve problem cases in an expeditious manner . Third , the FSLIC should be able to require additional deposits or premium assessments from insured institutions in order to replenish the reserves of the Corporation to the extent they fall below acceptable levels . Fourth , the additional capital infusion from insured institutions to the FSLIC Fund should be structured so that it primarily will be treated as a deposit , or investment in the FSLIC , to be " expensed " when the deposit or investment is paid out by the Corporation or depleted by losses incurred by the Corporation . Fifth, costs of the risk to the FSLIC should be allocated fairly by requiring those institutions which choose to engage in certain risky activities to bear a higher proportion of FSLIC premiums than institutions not engaging in such activities . Sixth , the FSLIC should be given explicit statutory authority to limit , on a regulatory basis , losses from excessive risk - taking by the industry . 211 Seventh , FSLIC insurance should be limited to those institutions that are principally engaged in housing finance and housing - related activities . The FSLIC should not be required to insure all the activities of other companies that choose to designate themselves as savings institutions institutions which choose to use the FSLIC seal to attract funds and Federal Home Loan Bank credit to expedite investments which are not reasonably related to economical home financing , including practices by arbitrageurs engaged in greenmail or corporate takeover attempts . Eighth , the FSLIC should have the authority to classify accounts and to insure only those that are appropriate for insurance by a federal agency , because deposits that are really equity investments should not be federally insured . Through its special insurance premium assessment and the recent introduction of H.R. 1680 , the Bank Board has already begun to move toward the goals I have outlined . I continue to believe strongly that the most important of these goals is the amendment of the National Housing Act to create a " supplementary premium" plan requiring those institutions which choose to engage in activities which go beyond those found suitable for federal deposit insurance for thrifts by the Congress in the Garn- St Germain Depository Institutions Act of 1982 to bear a higher proportion of FSLIC assessments than those institutions 212 which do not choose to engage in such higher risk activities . The Bank Board included this approach in H.R. 1680 , as well as in legislation proposed to the Congress last year . In Mississippi in 1976 and now in Ohio the FSLIC has responded to a private insurance crisis by making extraordinary efforts to expedite the examination of privately insured thrift institutions and the processing of their applications for insurance . I believe that such efforts are in the public interest . However , they do impose very heavy strains on an already over taxed examining and regulatory staff . I have repeatedly stressed that the Examinations staff and the FSLIC are severely understaffed , and thus cannot adequately shoulder the monumental burdens being placed on them . Indeed , we have been able to deal with the Ohio situation in an expeditious manner only because of the virtually unlimited staffing assistance provided to us by the Federal Reserve Board . In my opinion , the Bank Board has moved swiftly and in an historically unprecedented manner to expedite applications for FSLIC insurance from institutions which were formerly members of the Ohio Deposit Guarantee Fund . this regard . I am proud of our efforts in I will be happy to try to answer any questions the Subcommittee may have . Thank you for your thoughtful attention . 213 1700 G Street, N.W. Washington, D.C. 20552 Federal Home Loan Bank System Federal Home Loan Mortgage Corporation Federal Savings and Loan Insurance Corporation Federal Home Loan Bank Board OFFICE OF CONGRESSIONAL RELATIONS July 25, 1985 RECEIVED Mr. Peter S. Barash Staff Director Commerce, Consumer, and Monetary Affairs Subcommittee Committee on Government Operations House of Representatives Washington, D.C. 20515 AUG 2 1985 COMMERCE , CONSUMER AND MONETARY AFFAIRS SUBCOMMITTEE Dear Peter: In response to your letter of July 17 , the Bank Board staff has reviewed the confidential submission in question and finds that we have no objection to any or all of this material being made part of the public hearing record . If I may be of further assistance please feel free to call me . Sincerely, حال L. Arlen Withers Director 214 APPENDIX Question 1 Set forth , as comprehensively as possible and in chronological order , the FHLBB's response to the collapse of Home State and its impact on the Ohio Deposit Guarantee Fund and on Ohio's other state - insured thrifts . In this regard , on what date and by whom was the FHLBB first made aware of Home State's financial difficulties ( including its dealings with ESM ) and their likely impact on the Ohio Deposit Guarantee Fund? Answer The Federal Home Loan Bank of Cincinnati was aware of rumors of Home State's heavy dealings with ESM dating back to 1982. ( Attached is a copy of Home State's December 1984 , December 1983 , December 1982 balance sheets from the Annual Reports of the Ohio Division of Savings and Loan Associations . ) The Cincinnati Bank heard from various sources that the September 1983 examination report disclosed substantial problems , but it did not obtain a copy of that report until March 8 , 1985 , after ESM's collapse surfaced . The report came to the Bank from the Ohio Division subsequent to the run on Home State starting on March 5 , 1985. Various conversations with Ohio Division and Federal Reserve Bank of Cleveland officials during the week of March 4 , 1985 , confirmed the distinct possibility that ESM's collapse had not only impaired Home State but that it also could easily exhaust the resources of the Ohio Deposit Guarantee Fund . On Tuesday , March 5 , Chairman Gray's office received a telephone call from Chairman Volcker's office alerting the Chairman that American Savings and Loan Association , based in Miami , Florida , had suffered a major loss in the collapse of ESM . On Wednesday , the Bank Board's general counsel received a telephone call from the Securities and Exchange Commission noting that public disclosure of the loss probably would be required . At the request of the Federal Reserve Bank of Cleveland , the Federal Home Loan Bank of Cincinnati arranged to send three experienced senior supervisory staff members to Cleveland over the weekend of March 9 and 10 to assist the Federal Reserve Bank in assessing financial conditions and trends of Ohio Fund thrifts that might need to borrow from the Federal Reserve Bank's discount window. On Sunday , March 10the president and vice president of the Federal Home Loan Bank of Cincinnati attended a meeting in Florida with SEC , Federal Reserve Bank , and other Federal Home Loan Bank 215 district officials at which more details of ESM and the potential loss to Home State were discussed , and where it become more evident that the Ohio Fund itself was threatened . On March 12 copies of certain information obtained at the March 10 meeting were sent to the Bank Board . On Wednesday evening , March 13 , representatives of the Federal Home Loan Bank examined Ohio Division reports on members of the Ohio Fund in order to make a preliminary estimate of their eligibility for FSLIC insurance . On Wednesday evening , March 13 , the Bank Board's general counsel explained the FSLIC's requirements for insurance of accounts at a meeting at the Federal Reserve Board attended by representatives of a number of Ohio institutions and members from Ohio's Congressional delegation . The next day , Thursday , March 14 , Chairman Gray met with four members of Ohio's Congressional delegation and agreed to expedite FSLIC action on applications for insurance by Ohio institutions formerly insured by the Ohio Fund . Over the next three days , from Friday , March 15 , through Sunday , March 17 , officials of the Bank Board had numerous telephone conversations with Ohio officials . On Sunday , March 17 , Chairman Gray and his staff met with Chairman Volcker . At this meeting , Chairman Volcker agreed to provide and Chairman Gray agreed to use Federal Reserve examiners to assist in expediting the examinations of Ohio institutions applying for FSLIC insurance . On Monday morning , March 18 , the director of the Bank Board's Office of Examinations and Supervision was dispatched to Cleveland to meet with staff of the Federal Reserve Bank to coordinate the deployment of examiners . Over Monday , March 18 , and Tuesday , March 19 , telephone calls were made to all 71 Ohio institutions requesting them to indicate whether they intended to seek FSLIC insurance . In addition , advance application packages were specially mailed to all institutions so that they would be in hand on Tuesday . On Tuesday evening , March 19 , examiners were deployed to all institutions indicating their intention to apply for FSLIC insurance . On Wednesday , March 20 , Chairman Gray met with Ohio Governor Celeste . At that meeting , Chairman Gray confirmed his commitment to mount an extraordinary effort to expedite processing of applications for FSLIC insurance by Ohio institutions . On Friday , March 22 , the director of the Bank Board's Office of District Banks was dispatched to Cincinnati to coordinate the applications process . As of April 1 , 1985 , 60 Ohio institutions have applied for FSLIC insurance : 23 of these institutions have been 216 conditionally approved , 2 additional institutions have acquired FSLIC insurance through merger into already insured institutions , and 5 institutions intend to apply for FDIC insurance . 1. b . Does the FHLBB/FSLIC have copies of the Ohio Division of Savings and Loan's examination reports or other supervisory documents regarding Home State? What do these documents indicate about Home State's dealings with ESM from a safety and soundness point of view? When were these examination reports made available to the Bank Board? Answer The Bank Board has a copy of the latest completed examination report ( 10/15/83 ) for Home State Savings Bank . The examination report , which was made available to the Federal Home Loan Bank of Cincinnati on March 8 , 1985 , describes in detail the institution's dealings with ESM . The examiner concluded that management's actions placed the thrift " in a position of possible serious financial loss that could create an extreme indemnification obligation on behalf of the Ohio Deposit Guarantee Fund . " The potential loss exposure at September 30 , 1983 , was estimated to be $158 million if the brokerage firm failed for any reason to perform . Question 2 2. a . Please describe fully the normal procedures followed and the operating condition required of thrift institutions that seek FSLIC insurance of their accounts . Please provide copies of relevant regulations , statements of policy , or written guidelines applicable to the standards for granting insurance coverage . Answer On December 15 , 1983 , the Bank Board adopted procedures and criteria for evaluating applications for FSLIC insurance by depository institutions currently insured by the FDIC . The Bank Board's procedures for uninsured associations applying for FSLIC insurance have incorporated the same criteria mentioned above ( see attached memo dated March 14 , 1985 ) . In the case of institutions formerly insured by the Ohio Fund , the Bank Board is using the following three -pronged test : ( 1 ) the institution must have net worth of at least 5 percent of liabilities calculated on a regulatory basis and excluding deferred loan losses ; ( 2 ) the results of a viability analysis run for the institution over a five -year period using the Bank Board standard market rate scenario must show that the institution does not fall below existing regulatory net worth requirements over this period of time ; and ( 3 ) the institution must pass a standard eligibility examination . 217 If an Ohio association passes this three - pronged test , it is granted conditional approval subject to an ongoing minimum net worth requirement of 5 percent of liabilities . 2. b . How many of Ohio's nonfederally insured thrifts have applied to date for FSLIC admission ? How many do you expect to apply? Answer As of April 1 , 1985 , 60 Ohio institutions have applied for FSLIC insurance : 23 of these institutions have been conditionally approved , 2 additional institutions have acquired FSLIC insurance through merger into already insured institutions , and 5 institutions intend to apply for FDIC insurance . Has it been or will it be the Bank Board's policy to expedite the application process or to modify in any way the substantive operating condition or performance requirements necessary for membership in FSLIC ? If so , how? Answer The Bank Board has committed to expedite the processing of Ohio state -chartered institutions for FSLIC insurance . Through Monday , April 1 , 1985 , the Bank Board conditionally approved 25 applications for FSLIC insurance ( including 2 mergers ) . To qualify for insurance , all Ohio state - chartered institutions must meet the requirements described in the answer to question 2.a. 2. d . What is the average net worth ratio of federally insured thrifts ( i ) in Ohio and ( ii ) nationwide? Answer The net worth ratio of FSLIC - insured thrifts in Ohio is identical to the national ratio . The following shows regulatory net worth as a percent of both assets and liabilities for all FSLIC - insured institutions in Ohio and nationwide for December 31 , 1984: Regulatory Net Worth : Amount (millions ) Percent of Net Assets Percent of Liabilities Ohio U.S. $1,843 3.87% 4.03% $37,895 3.87% 4.03% 218 2. e . How many FSLIC insured thrifts in Ohio ( i ) are presently on your problem list , ( ii ) could qualify for new admission to FSLIC insurance at this time? Answer (i) Ohio . The Cincinnati Bank has 11 significant supervisory cases in ( ii ) Ninety - six of the 217 FSLIC - insured institutions in Ohio have a net worth ratio to assets of 5 percent or more . 2. f . In what respects ( if any ) do the insurance approval standards currently being applied to the Ohio thrifts differ from the standards applied in the past to similarly situated applicants ( i.e. , nonfederally insured or uninsured applicants already in operation ) ? Answer The Bank Board has reviewed such applications on a case - by - case basis . In all cases , however , the applicant was required to pass an eligibility examination and , if approved , was required to maintain net worth at regulatory levels . Recent cases have applied the formula applicable to FDIC - insured applicants . The most recent case of privately insured applicants similar to the Ohio situation was the failure of the private insurance fund in Mississippi in 1976. Institutions affected by that failure were required to undergo a standard eligibility examination . Those institutions that passed the eligibility examination were required to maintain net worth and reserves at regulatory levels ( 5 percent at that time ) . At the time of the closing of Home State Savings Bank , several insurance of accounts applications were pending from members of the Ohio Deposit Guarantee Fund . The same criteria were being applied to those applications as are now being applied to the other Ohio applicants . Question 3 Without identifying associations by name , please provide the following information about the 10 similarly situated institutions ( i.e. , nonfederally insured or uninsured institutions that have been open and in operation for a significant period of time before making application for Federal insurance ) that have most recently applied for and been granted FSLIC insurance : state in which located ; year of application ; and ( as of date of insurance application ) ( i ) 219 CORRECTED regulatory capital ratio , ( ii ) ratios of scheduled items to capital and to assets , and ( iii ) any other financial ratios and statistics that are being assigned prime importance in evaluating the current. application's of the Ohio applicants . Answer Applicant's Scheduled Scheduled Application Approval Net Worth to Items to Items to Net Worth Filed Liabilities Net Worth Assets Date to Assets State Assets (millions ) Conn . 11/4/82 9/29/83 6.10 24.40 1.4 5.70 2,100.4 Ind. 1/22/82 4/8/82 14.90 19.90 2.6 13.00 3.2 Mass . 9.40 17.00 0.5 7.00 39.2 7/28/83 4/30/84 Maine 3/17/78- 2/3/83 6.90 15.50 1.0 6.40 59.3 Ohio 6/13/82 : 4/6/83 12.90 58.70 6.4 10.90 65.1 N. C. 3/15/83 5/29/84 4.42 42.90 1.8 4.19 38.4 N. Y. 11/1/82 5/14/84 5.36 6.70 0.4 5.00 71.0 N. Y. 3/9/82 2/3/83 13.00 7.58 0.8 11.00 1,319.2 N. Y. 6/2/82 5/20/83 6.78 2.50 0.2 6.35 163.2 N. Y. 2/4/82 Question 4 11/24/82 6.85 20.85 1.3 6.41 1,209.8 To what extent have the Home Loan Bank Board and the Federal Reserve System coordinated their responses to the Ohio situation? Please provide specific information on the dates and the substance of communications between the FHLBB and the Federal Reserve System . Answer The Bank Board and the Federal Reserve Board coordinated their response to the Ohio situation soon after the problem came to light . The FHLBank of Cincinnati furnished three supervisory agents to the Federal Reserve Bank of Cleveland on March 9 to assist in evaluating the credit of the uninsured institutions . There has been close cooperation between these agencies since that time . Presently about 100 Federal Reserve examiners are assisting Bank Board examiners in conducting eligibility examinations of uninsured Ohio institutions that have applied for FSLIC insurance . 50-923 0-85--8 220 Question 5 5. a . It is the subcommittee's understanding that a number of federally chartered and FSLIC - insured thrift institutions had financial dealings with ESM Government Securities , Inc. , including American Savings and Loan Association of Florida , Home Savings Association of Florida , Baraboo Federal Savings and Loan , Sun Federal Savings and Loan . Since 1980 , how many FSLIC - insured associations had funds loaned to or invested with ESM? What is the total dollar value of these funds? What is the current FHLBB/FSLIC estimate as to the likely loss to FSLIC - insured institutions from these loans and/or investments ? Could there be any FSLIC losses as a result ?. Answer As of December 31 , 1984 , we know of six FSLIC - insured institutions that had financial dealings totaling about $758.3 million with ESM . Losses are estimated to be $66.8 million , including possible FSLIC losses of $ 8.0 million . In addition , one institution borrowed $8 million from ESM. 5. b . Please provide the dates of the two most recent FHLBB/FSLIC examinations of each federally chartered or insured thrifts that conducted business with ESM? Did any ofthe reports of these examinations criticize or mention in any way the dealings between these institutions and ESM? Please be specific . If so , were any formal or informal supervisory actions taken against these institutions ? Please enumerate . Answer The following summary describes any comments concerning dealings between the institutions and ESM for the two most recent examinations and any supervisory action taken . INSTITUTION A 5/21/82 Exam : 11/30/83 Exam: No report comment . No report comment . INSTITUTION B 3/18/83 Exam : No report comment . 9/14/84 Exam : The examiner noted that Ronnie Ewton , a director of American , owned a controlling interest in ESM Group , Inc. , the parent company of ESM Government Securities , Inc. The association 221 engaged in a number of securities transactions with ESM , the largest being a $ 1 billion leveraged arbitrage transaction . Mr. Ewton presented this transaction to the institution's board and participated in the approval process . A substantial portion of the funds for this transaction were borrowed from various lenders . ESM was responsible for obtaining the borrowings through third parties . association had no control over who the borrowers were or of any review of their financial strength . ESM refused to provide the institution with information on the commissions involved . The supervisory letter was written after the demise of ESM . special examination was ordered to determine the extent of the institution's involvement . The results of that examination have not been received . The Board will conduct an investigation using its powers under the National Housing Act . INSTITUTION C 10/14/83 Exam : No report comment . 10/15/84 Exam : No report comment . INSTITUTION D 7/8/83 Exam: Exam report criticized over - collateralization of reverse repos . Supervisory agent requested corrective action . Management agreed to take such action . 9/18/84 Exam : Exam report criticized over - collateralization of reverse repos . Supervisory agent has not yet sent his supervisory letter . INSTITUTION E 11/21/81 Exam : 5/21/83 Exam : No report comment . No report comment . INSTITUTION F 7/2/82 Exam: 8/16/84 Exam : No report comment . No report comment . 222 Question 6 Based on its experience to date with the Ohio crisis , does the FHLBB have any recommendations to Congress regarding the need for strengthening or modifying state/private deposit funds ? For example , is there a need to put in place a permanent " standby" rescue plan for state/private deposit insurance funds that may experience extreme difficulty? Any other recommendations? Answer Any legislation establishing some sort of " standby" rescue plan for state -authorized private deposit insurance funds could significantly reduce the incentive for a state to responsibly regulate and supervise its insured thrifts . The linkage of responsibility and accountability is essential to the effectiveness of any supervisory program. Even in the absence of any federal " standby " plan , the Ohio events provide evidence that at least some Ohio authorities thought that at the eleventh hour the federal umbrella would be extended to shelter the state - authorized private fund's inadequacies . 223 CONFIDENTIAL HOME STATE BANK Since1840 Statement of Condition December 31 , 1984 Assets As we begin our 95th year, Home State's Statement ofCondition represents a financial institution with over 65% of its assets invested in cash, U.S. Government securities, short term time deposits and mortgages guaranteed byagencies of the federal government. As ofDecember 31 , 1984 total deposits were $667,804,694, which is an increase of $83,952,651, or 14.4% over the preceding year. Total loans grew approximately $38,000,000 to $670.358.560 and total assets reached $1,448,621,505 asof December 31, 1984. With 33 offices covering Cincinnati, Middletown, Dayton and Columbus and with Home State Savings Bank offering increasing services to our customers, we look forward in 1985 to continued progress and growth. Sincerely. Mortgage Loans Government Insured Privately Insured . Other ... Commercial and Consumer Loans.. Savings Account Loans ... Real Estate Owned .... Cash, Government Securities and Other Investments.... Ohio Deposit Guarantee Fund Investment in Real Estate Rental Property-Depreciated . Office Buiklings-Depreciated Furniture and Equipment –Pepreciated Investment In and Advances to Subsidiaries Other Assets... $365,185,204 115,911,399 160,019,046 26,601,881 • 2.641,030 2,445,243 620,097,603 12,238,300 28,298,315 6.466.296 1.981,416 32,927,030 73.808,742 $1,448,621.505 President& Chestmenof the ProN Directors David J. Schiebel Robert J. Weeder Marvin L. Warner, Jr. ( Wrvian Farm Irangan Menhirby Nelson Schwab, Jr. Porters Crapbor Head & Restry Stanton G. Brock Predini. Aparan Management, the Robert (Bob) Braun TV 1. Arthur C. Elliott Amany -Officers David J. Schiebel Prodrm & (herman of the Anand Robert J. Weeder Savare Vice Pendent & Tratow Gerald L. Stephens Severe Vue Prenderi Richard J. Macke Sem Ver Pendent Charles D. Steinau VarPrades Barry M. Ross You twarded Ronald F. Boatman VerIwata Charles S. Stroup Barry I. Randman V...Instal Liabilities and Capital Deposits.. $ 67.0-9.09-1 Securities Sold Under Repurchase Agreements ... 670,356.908 Debentures Payable 26.921.463Other Borrowed Money 12.064.083 Mortgage Escrow Deposits Other Liabilities ..... 50.012.013 Income Applicable to Future Operations ..... 506.180 Stock Statury Reserwes and Undivickel Profits ... 19,745,0: 0 $1.448,621,505 224 CONFIDENTIAL HERITAGE SAVINGS BANK 3316 GLENMORE AVENUE HAMILTON COUNTY CINCINNATI 45211 BRANCH OFFICES: 1 Telephone: 513-481-2481 Incorporated: 1883 PRESIDENT: WILLIAM T. SHEFFIELD EXEC. VICE PRES: JACK R. WINGATE (MO) SECRETARY:STANLEY C. MEININGER, JR. ATTORNEY: WILLIAM T. SHEFFIELD ASSETS Conventional Mtg. Loans …………………………… . Non Mortgage Loans.................. Cash..... Investment Securities Fixed Assets-Net OtherAssets Total.............. LIABILITIES AND CAPITAL Withdrawable Savings. $25,676.573 84,829 Other Liabilities . Reserves ............ ..930,395 Undivided Profits 1.217.237 $22,446,931 410,587 .394,412 .3.304,341 ..848.627 .504,136 $27,909,034 Total.. $27,909,034 O.D.G.F. 12/31/88 HOME STATE SAVINGS BANK 2727 MADISON RD CINCINNATI 45209 HAMILTON COUNTY BRANCH OFFICES: 24 Incorporated: 1890 Telephone: 513-871-3400 PRESIDENT: BURTON M. BONGARD EXEC. VICE PRES: DAVID J. SCHIEBEL (MO) SECRETARY: DAVID J. SCHIEBEL ATTORNEY: NELSON SCHWAB, JR. ASSETS Insured & Guaranteed Loans ...... $17,022,062 470,798,769 Conventional Mig. Loans.. Non Mortgage Loans.....……………………………………………….....12,282,689 Real Estate Owned.........................………………..……………. 2,751,137 Cash..... 8,863,216 Investment Securitios 596,226,323 Fixed Assets-Net 6,921,917 Other Assets ..............…………... ..26,818,513 Total......... $1,141,684.626 LIABILITIES AND CAPITAL Withdrawable Savings $498,870,739 Borrowed Money 610,051,957 Other Liabilities......... ..16,691,757 1,185,000 Permanent Stock Reserves 2,727.461 Undivided Profits . 12,157,712 Total O.D.G.F. 68. $1.141,684,626 225 CONFIDENTIAL HERITAGE SAVINGS AND JUAN ASSOCIATION NE 3316 GLENMORE AVENUE CINCINNATI 45211 HAMILTON BRANCH OFFICEL Telephone: 513-401-2481 PRESIDENT: WILLIAM T. SHEFFIELD EXEC. VICE PRES: JACK R. WINGATE (RIO) BECH RIV: JACK AL WINGATE ATTOLET: WILLIAM T. SHEFFIEL ASSETS PABILITIES AND CAPITAL $14.313.0 Conventional Mig. Loans $20,015,783 Within i40 Sesings. 355,520 Other Non Mortgage Loans.......... Real Estate Owned............................... 39,547 Ruser : Cash ..... 1,198,629 3,809,824 Undlyk! Profis . Investment Securities .. 100,780 Fixed Assets- Not ............................ 873,992 ..600,601 Other Assets ............. To ! $28,60132 Totul........... $26,596,122 O.D.G.F. 12/31/87 HOME STATE SAVINGS ABSOCIATION 2727 MADISON R CINCINNATI 45209 HAMILTON COUNTY BRANCH OFFICES: 21 Telephone: 513-871-3400 Incorporis : 139. PRESIDENT: BURTON M. BONGARD EXEC. VICE PRES: DAVID J. SCHIEBEL (MO) SECRETARY: DAVID J. SCHIEBEL ATTORNEY: NEI RON SCHWAR, J. ASSETS Insured & Guaranteed Loans . $17,837,319 Conventional Mtg. Loans. 277,299,699 Loans..............................3.424,792 Non Mortgage ................... .................... 2,445,888 Real Estate Own Cash. 4,011,315 Investment Securities 236,142,211 Fixed Assets-Ne:............................. 4,789,207. OtherAssets 32,363,886 Tow .................. #578,414,117 LIABILITIES AND CAPITAL Withdraws !! Savings. $485.182,079 Borrowed honey. 86,014,092 Other Liabilities...... 10,877,874 Permanent Stock. 1,185,000 Reserver.... 2,727,461 Undivided ofits ...... -------------------- 12,427,611 ODGF Tetal...... .4678,414,117 226 CONFIDENTIAL Federal Home Loan Memo Bank Board FROM: S. G. Frank Haas, II Director TO : Chairman Gray OFFICE OF DISTRICT BANKS INTER-OFFICE COMMUNICATION DATE March14.1985 : February 21, 1985 SUBJECT: Ohio Deposit Guarantee Fund Attached is a copy of the procedures adopted by the Board on December 15, 1983 , for evaluating applications for FSLIC insurance by depository institutions insured by FDIC. The Board does not have any procedures for uninsured associations , but we have typically used the same criteria. An application would have to pass each part of the " three-prong" test before coming to the Board for final action . If an applicant failed a part of the test, it would not go any further in the process . The three-prong test is as follows: 1. 5% snapshot net worth. 2. Viability analysis applicant required to meet regulatory net worth requirements over a five year period using the Bank Board's standard market rate scenario . 3. Eligibility examination . As explained in the June 29, 1984 memo, an exception would be granted on the first prong of the test for associations with net worth of between 4% and 5%, provided that their operating results reflected increasing net worth over the prior two semi -annual periods. Based on discussions with the Cincinnati Bank, it is estimated that 30 associations with assets of $1.4 billion would meet the first prong of the three-prong test . (Of these 30 associations , the largest is a $ 914 million consumer loan company with 6% net worth. It has $515 million in consumer loans and as such would not meet a thriftness test. ) Assuming that there would be a 50% fallout rate between the next two stages , I would estimate that no more than 15 associations would qualify for FSLIC insurance if we applied the existing FDIC test. 227 Federal Home Loan Memo Bank Board FROM : ΤΟ : CONFIDENTIAL OFFICE OF DISTRICT BANKS INTER-OFFICE COMMUNICATION S. G. Frank Haas , III , Director , ODB David W. Glenn, Director, FSLIC Eric I. Hemel , Director , OPER All Bank Presidents DATE : January 12 , 1984 SUBJECT: Procedures and Criteria for Evaluating Applications for FSLIC Insurance by Depository Institutions Insured by the FDIC On Thursday, December 15 , 1983 , the Board formally adopted procedures and criteria for evaluating applications for FSLIC Insurance by depository institutions insured by the FDIC . The Board considered a memorandum (copy attached ) from the Directors of the Office of District Banks , Federal Savings and Loan Insurance Corporation and the Office of Policy and Economic Research, recommending a " three-prong" test as part of the overall evaluation process . The development and formal adoption of this procedure will provide guidance to potential applicants as well as provide the applicant with a realistic indication of whether it can expect favorable action at each stage of the process . The first step of the " three-prong" test would be to determine whether the applicant had net worth to liabilities equal to or greater than 5%. If the applicant met the first test , it would move to the second step whereby the District Bank would conduct a viability analysis over a 5 year horizon, based upon data obtained from FDIC examination reports and the Board's standard market rate scenario viability test . If the applicant maintains its regulatory net worth (currently 3.0%) during the entire simulation period , it would qualify for the eligibility examination. Upon completion of the eligibility examination the District Banks ' digest and recommendation would be prepared and forwarded to Washington , D.C. for review and submission to the Board for action. It is the opinion of the Board that the adopted procedure will be in the best interest of both the applicant and Insurance Corporation . The procedure will ensure that the corporation will not be exposed to unnecessary risk as well as provide potential applicants with formal procedures . If there are any questions regarding the above procedures feel free to give any one of us a call . Patrick G Berbakos of the Office of District Banks ( 202-377-6712) is also available to answer any specific operational questions. S. G. Frank Haas , III Director , ODB David W. Glenn Director, /FSLIC Went Enid . Eric 1. Hemel Director, OPER 228 Federal Home Loan Bank Board MEMORANDUM FOR: FROM: SUBJECT: CONFIDENTIAL 1700 G Street, N.W. Washington, D.C. 20552 Federal Home Loan Bank System Federal Home Loan Mortgage Corporation Federal Savings and Loan Insurance Corporation Federal Home Loan Bank Board S. G. Frank Haas , III , Director , ODB David W. Glenn , Director , FSLIC Eric T. Hemel , Director , OPER Proposed Procedures and Criteria for Evaluating Applications for FSLIC Insurance by Depository Institutions Insured by the FDIC DATE : ISSUE: Establishment of appropriate criteria for evaluating applications for FSLIC insurance submitted by other depository institutions currently insured by the FDIC . PREVIOUS AND CURRENT PROCEDURES By law, the FSLIC must consider the safety and soundness of each applicant when granting insurance of deposits . The exact criteria for judging safety and soundness , however , is a matter over which the Board can exercise wide discretion . Historically, the determination of an institution's safety and soundness was generally made in OES and ODB . However , in December 1982 the Board reviewed the existing approach for evaluating applications and decided that the FSLIC should also have an integral role in the evaluation of an applicant's viability according to a standard set of criteria . Although no formal procedures were developed or issued by the Board , there is general staff agreement that then Chairman Pratt informally directed OPER and FSLIC to apply strict standards for the initial FSLIC evaluation of applicants . This reflected a policy that stressed the minimization of additional risk exposure to the Insurance Corporation . The standard which governed the initial evaluation of an applicant for conversion to FSLIC insurance required that the institution demonstrate an expected financial performance which would place it in the top 33% of all thrift institutions already insured by the FSLIC. Upon receiving an application for insurance of accounts , the FSLIC would analyze whether the applicant would survive an interest rate scenario that would cause two-thirds of the thrift industry insured by the FSLIC to be insolvent . Only those institutions which remained viable under this scenario were deemed eligible for FSLIC insurance of accounts . While this standard minimized the risk of insuring new members , it was clearly not a realistic scenario nor one which the insurance fund would be likely to survive . 1 229 Since January 1983 , 15 institutions have applied to convert to FSLIC insurance . Of these applications , 5 were approved , 4 withdrawn , and 6 are currently pending . This past Spring , OPER and FSLIC were asked to reevaluate the criteria under which applications are considered for FSLIC insurance . Since that time, the Bank Board's core staff has met several times to discuss possible alternatives to the two- thirds rule. RECOMMENDATIONS We recommend the adoption of a " three- prong " test as part of the overall evaluation process for institutions currently insured by the FDIC. The initial stage of this test would be the determination of whether the applicant had net worth to assets or net worth to liabilities equal to or greater than the FDIC's current reserve requirement of 5%. If the applicant met the 5% reserve requirement , it would move to the second stage of the test during which the District Banks would conduct a viability analysis , over a 5 year horizon , based upon data obtained from FDIC examination reports and the Board's standard market rate scenario viability test . If the applicant meets its regulatory net worth requirements during the entire simulation period of the standard market rate scenario , it would qualify for the eligibility examination . An advantage of this system is that applicants would be " pre- screened " at the District Bank level prior to the eligibility examination ; if an applicant is unable to pass the first two stages of the "three- prong " test , it would not qualify for FSLIC insurance and would not incur the expense of the eligibility examination which can be very costly ( $ 304 per day per examiner) . If the applicant passes all three stages of the test , the application would be forwarded to Washington D. C. for review and submission to the Board for action .. To ensure that the principal role of FSLIC - insured institutions continues to be that of home finance , it was also recommended that applicants be required to invest a substantial percentage of their assets in mortgage and mortgage- related securities . However , the Office of General Counsel recommended against trying to impose a housing commitment percentage test . In 1978 , the Bank Board attempted to impose a 60% housing commitment test as part of the Committee on Banking , Finance and Urban Affairs , Financial Institutions Regulatory Act ( H.R.13471 ) . The Act authorized Federal charters for mutual savings banks . At that time , the Board wanted to ensure that mutual savings banks investments reflected the fact that the Federal Home Loan Bank System remained firmly committed to the housing needs of the country. Although the Board urged the committee to statutorily require a percentage test , it was explicitly rejected by Congress . 230 CONCLUSION It is the finding of FSLIC, OPER and ODB that the " three-prong" test is in the best interest of both the applicant and the Insurance Corporation. The procedure is strict enough to ensure that the insurance corporation will not be exposed to unnecessary risk and it also gives the applicant a realistic indication of whether it can expect approval at each stage of the review process. Adoption of formal insurance criteria will provide guidance to potential applicants and should help to expedite the processing time. Shtim S. G. Frank Haas , III Director , ODB David W. Glenn Director , FSLIC السوله است Eric 1. Heme Director ,. OPER Mr. BARNARD. Thank you, Mr. Gray. We will now hear from Vice Chairman of the Federal Reserve Board, Mr. Preston Martin. STATEMENT OF PRESTON MARTIN, VICE CHAIRMAN, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM Mr. MARTIN. Thank you, Mr. Chairman. We appreciate the opportunity, President Horn and myself, to appear before the subcommittee and briefly to summarize the contribution of the Federal Reserve System to the amelioration of the Ohio privately insured thrift institution situation. You have already been reminded that the Central Bank has the authority under the Monetary Control Act of 1980 to lend under normal circumstances to nonmember depository institutions, and throughout the Ohio crisis, we have stood ready so to lend, and we have extended credit during the course of events there. The Federal Reserve has further, as has been indicated , played a role in monitoring events in Ohio, in facilitating cooperative efforts, in counseling the various parties involved to resolve the situation, to reestablish public confidence and to promote the safety of depositors ' funds. In this capacity, as President Horn will detail with you, Federal Reserve officials from the Cleveland Fed and from Washington have held and have participated in numerous meetings with governmental supervisory officials from the State of Ohio, officials from the Federal Home Loan Bank System, Federal Home Loan Bank of Cincinnati, and other Federal regulatory agencies. As the primary supervisor of bank holding companies, and in response to a request by Governor Celeste, the Federal Reserve, both from the Board and through the efforts of officials of the several Federal Reserve banks, have also been in contact with banking organizations , both from within and from without Ohio, to determine their interest if any in acquiring or merging with ODGF institutions, including those which may be unable to qualify on their own 231 for Federal insurance or to reopen without additional external support. To facilitate the Federal insurance requirement of the State government, we have expedited arrangements for review of applications by the Bank Board, as has been commented here, the FDIC , and within our own organization. And in this process, the Federal Reserve will continue to make field examination personnel available to the Bank Board and to Ohio authorities to assist in examinations and to expedite the process of qualifying for Federal deposit insurance. While a longer range solution with respect to all of the affected thrifts remains to be worked out, we believe the Ohio events underscore the importance of full cooperation among appropriate Federal and State supervisory authorities. And with regard to State banking authorities, the Federal Reserve is well into a new program to work with those State officials and their staffs as they see fit to increase their technical and examinational abilities. One of your questions of us raised by the recent events in Ohio relates to the role of private deposit insurance funds . Clearly deposit insurance is an important factor in maintaining public confidence in deposit institutions . I believe it is too early to make a definitive judgment about the role of sole- insurer private insurance funds and even of possible State-sponsored funds in our financial system . But you have asked for comments and we appreciate the opportunity to do so. There may be industry structures which could be adequately supported by private arrangements as sole insurers, structures involving large numbers of small institutions, a substantial reserve fund not dependent upon deposits in a mutual basis by the insured institutions, and featuring adequately strong examination and auditing procedures . And I would add to that the desirability of geographic dispersion of risk and the further desirability of an independent board, independent of representatives of the mutually insured institutions . Such an industry structure of small institutions could consist, say, of the smaller credit unions. Any such arrangements suffer from a certain degree of confusion as to whether and to what extent the resources of State government are behind the private sole-insurer's reserves. However, industry structures consisting in part or in whole of sizable depository institutions, reserve funds dependent upon the deposits of the members exclusively, and with an examination and regulatory procedure, in part justified to its membership as less rigorous than Federal procedures . These raise substantial questions as to whether the public interest is served thereby. And thus the Board supports the movement of several State legislatures away from the presently constituted private insurance funds . Whatever approaches may ultimately prove feasible, the events in Ohio do serve to remind us of the potential consequences of the loss of public confidence in individual depository institutions , and of the celerity with which that loss can spread to other institutions. In view of these concerns, the Federal Reserve System will continue to cooperate fully with the State and Federal authorities 232 seeking a longrun solution to thrift industry liquidity problems in Ohio. Thank you, Mr. Chairman. Mr. BARNARD. Thank you, Mr. Vice Chairman. [Mr. Martin's prepared statement follows:] 233 Statement by Preston Martin Vice Chairman , Board of Governors of the Federal Reserve System I am pleased to appear before this Subcommittee to discuss the Federal Reserve's contribution to efforts to ameliorate the problems of the state-chartered, privately insured thrift institutions in Ohio. The situation in Ohio was touched off by reported losses suffered by Home State Savings Bank (Home State) as a result of transactions with E.S.M. Government Securities, Inc. (ESM ), a broker-dealer in government securities, but also was related to more systemic weaknesses in the supervision and insurance of some Ohio savings and loan associations. A detailed chronology of the Federal Reserve System's response to events in Ohio is attached to the statement of President Karen Horn of the Federal Reserve Bank of Cleveland. As this Subcommittee is aware , reports of losses at E.S.M. precipitated a run on Home State that led to its closing. This development subsequently contributed to more generalized deposit outflows at other ODGF savings and loan associations and savings banks in Ohio, and a number of these institutions experienced heavy depositor withdrawals. Faced with this situation , Governor Celeste of Ohio closed, on a temporary basis, all 70 of the remaining ODGF thrift institutions. Subsequently, the State of Ohio adopted a plan that allows certain institutions found to qualify for federal insurance to reopen on a full service basis. Ohio authorities are pursuing other remedial steps, including the potential merger of weak thrifts with stronger federally insured institutions, designed to resolve the situation and promote the safety of depositor funds. At the present time , all but one of the ODGF thrifts have reopened on either a full or limited service basis; although a permanent solution involving the remaining closed thrift, Home State, and those thrifts that cannot qualify for federal insurance remains to be worked out. The limited service reopenings permit withdrawals of $750 per account per month. The Federal Reserve is lending to the reopened thrift institutions where necessary. 234 In reviewing this situation, it is helpful at the outset to clarify the Federal Reserve's specific regulatory responsibilities for various types of banking institutions as well as its broader responsibilities as the nation's central bank. The Federal Reserve has primary supervisory responsibility at the federal level for state-chartered banks that are members of the Federal Reserve System and for all bank holding companies. Commercial banks that are members of the Federal Reserve System are FDIC- insured, and commercial banks that are subsidiaries of bank holding companies, regardless of membership status, must by law be federally insured. Of course, the Federal Reserve does not have supervisory responsibility for thrift institutions, and the federal regulatory agencies, including the Federal Reserve, generally do not have direct supervisory or regulatory responsibility for state-chartered, nonfederally insured depository institutions, such as the affected ODGF thrift institutions in Ohio. Normally, such institutions are supervised and regulated by state authorities. It should also be pointed out that the Federal Reserve is not an insuring agency and does not have authority to make direct equity investments in depository institutions. However, the Federal Reserve does have authority to lend through the discount window and, in its role as the nation's central bank, has a fundamental responsibility to foster the stability and orderly functioning of the nation's banking and financial system . Nonmember depository institutions, including the state-chartered thrift institutions in Ohio, became generally eligible for discount window borrowing in 1980 as a result of the enactment in that year of the Monetary Control Act. Under this legislation, the discount window facilities of the Federal Reserve System were made available to all insured or uninsured depository institutions, throughout the nation , which offer transaction accounts or hold nonpersonal time accounts. 235 In its capacity as the central bank, the Federal Reserve may assist in efforts to deal with financial disturbances in order to prevent them from becoming generalized financial crises or causing systemic dislocations. An important policy tool to achieve these ends is the discount window through which the Federal Reserve serves as the ultimate source of liquidity. Throughout this difficult period in Ohio, the Federal Reserve Bank of Cleveland has been prepared to lend and has loaned through the discount window to the affected thrift institutions under terms and conditions established by law for such borrowing. Indeed, on March 6, one day after the public disclosure of possible Home State losses, Federal Reserve examiners were dispatched to Cincinnati to meet with Home State officials, explain borrowing procedures, and begin to review potential collateral. chartered In addition , the eligibility of state- depository institutions, including thrifts, for discount window assistance was stressed in a public statement by the Federal Reserve Bank of Cleveland on March 10. Prior to the temporary ODGF closings, the Federal Reserve Bank of Cleveland provided discount window credit to certain affected institutions, and as the institutions have reopened, they have been eligible for liquidity assistance. The availability of this discount window assistance to reopened institutions was stated publicly by President Horn on March 15 and reiterated by Chairman Volcker on March 20, 1985. In carrying out its responsibilities as lender of last resort, Federal Reserve System supervisory and examination personnel have worked closely with the affected institutions to inform them of collateral and documentation requirements and to assist them in understanding fully and meeting these requirements. Discount window loans to affected institutions have been made at the regular discount rate, currently 8 percent, and, as required by the Federal 236 Reserve Act, have been secured by adequate collateral . As is usually the case, this collateral has consisted of government and agency securities, commercial loans, one-to-four family residential mortgage loans, and other loans, and the collateral has been evaluated within normal guidelines. The Federal Reserve has, however, acted in a expeditious manner to facilitate the access of these institutions to the discount window under normal terms and conditions. In addition to these lender of last resort responsibilities, the Federal Reserve has also played an important role in monitoring events in Ohio and in facilitating cooperative efforts among the various parties involved to resolve the situation, to reestablish public confidence and to promote the safety of depositors' funds. In this capacity, Federal Reserve officials have held or participated in numerous meetings with governmental and supervisory officials from the State of Ohio as well as with officials from the Federal Home Loan Bank Board (FHLBB), the Federal Home Loan Bank of Cincinnati , and other federal regulatory agencies. In order to enhance our understanding of the financial condition of the affected thrifts and to assist the State of Ohio and the FHLBB, the Federal Reserve , within a few days of the temporary closings, provided examiners to participate in on-site examinations and asset evaluations of the ODGF institutions. These examinations have helped to determine the availability of collateral for facilitating access to the discount window and, equally important, they have played a critical role in the process of reopening those institutions found to qualify for federal insurance. The information developed in our on-site visits and otherwise has been made available promptly to other federal and state authorities. We hope these actions have supported and complemented the steps taken by Governor Celeste , the Ohio legislature , and the federal insurance agencies to reopen the affected thrift institutions. 237 As the primary supervisor of bank holding companies and in response to a request by the State, the Federal Reserve has also been in contact with banking organizations, from both within and outside of Ohio, to determine their interest, if any, in acquiring or merging with ODGF institutions, including those which may be unable to qualify for federal insurance or to reopen without additional external support. The day after the temporary closings, Reserve Bank officials telephoned the senior managements of bank holding companies throughout the country to inform them of imminent State plans to hold meetings to discuss the possible sale or acquisitions of certain thrift institutions. As the Subcommittee is aware , the State of Ohio has adopted a plan requiring federal insurance for essentially all savings and loans, building and loan associations, and all savings banks in the state. The State has also implemented arrangements to provide ODGF thrift institution depositors limited access to their funds. Further, the Ohio legislature acted promptly to advance $ 50 million in state funds to shore up the remaining ODGF institutions other than Home State. To facilitate the federal insurance requirement, expedited arrangements have been made for review of applications by the FHLBB, the FDIC, and the Federal Reserve. In this process, the Federal Reserve will continue to make field examination personnel available to the FHLBB and to Ohio authorities to assist in examinations and to expedite the process of qualifying for federal deposit insurance. We have been informed that as of March 29, 1985, the State of Ohio had authorized 26 institutions to reopen on a full service basis. Included in this number is a former thrift institution that has converted to commercial bank status and has reopened with FDIC insurance after our Board acted on a bank holding company application . Also included in this figure is a thrift institution acquired by a bank holding company in a transaction approved on an expedited basis by the Federal Reserve Board. 238 It may take some time for the thrift situation to return to normal in Ohio. A number of ODGF institutions have obtained federal deposit insurance. Others will , apparently, need an injection of capital from present owners or new investors, and still others may need to be acquired by stronger depository institutions. I assure you that the Federal Reserve will continue to provide assistance through the discount window, the provision of examination personnel to assist the FHLBB and State authorities, and the expeditious review and action on applications for mergers or acquisitions that require our approval. While a longer range solution with respect to all of the affected thrifts remains to be worked out, the Ohio events underscore the importance of full cooperation among appropriate federal and state supervisory authorities in dealing with any strains or pressures involving depository institutions that could have adverse systemic implications for the banking or financial system . Such adverse developments must be met with timely and effective action to restore confidence and maintain the stability of the financial system . In the case of the thrifts in Ohio, I believe that , in general , the remedial procedures that have been taken should significantly reduce any lasting impacts on financial markets. One of the questions raised by the recent events in Ohio relates to the role of private deposit insurance funds. Clearly, deposit insurance is an important factor in maintaining public confidence in depository institutions. Indeed, as I have noted, commercial banks that are members of the Federal Reserve System are FDIC-insured, and all commercial banks that are subsidiaries of bank holding companies are required by law to be federally insured. I believe that it is too early to make a definitive judgment about the role of sole insurer private insurance funds and even state sponsored funds in our financial system . 239 There may be industry structures which could be adequately supported by private arrangements as sole insurers, structures involving large numbers of small institutions , a substantial reserve fund not dependent upon deposits by the insured institutions, and featuring adequately strong examinations and auditing procedures. Such a structure might consist of a large number of smaller credit unions. Any such arrangements suffer from a certain degree of confusion as to whether and to what extent the resources of state government are behind the private sole insurers' reserves. However, industry structures consisting in part or in whole of sizable depository institutions, reserve funds dependent upon the deposits of its members, and with an examination and regulatory procedure in part justified to its membership as less rigorous than federal procedures , raise substantial questions as to whether the public interest is served thereby. The Board supports the movement of several state legislatures away from private insurance funds. Whatever approaches may ultimately prove feasible , the events in Ohio do serve to remind us of the potential consequences of the loss of public confidence in individual depository institutions and of the celerity with which that loss can spread to other institutions. In view of these concerns, the Federal Reserve System will continue to cooperate fully with the State and federal authorities seeking a long run solution to thrift institution liquidity problems in Ohio. 240 Mr. BARNARD. Ms. Horn, we are delighted to have you with us today, and as president of the Federal Reserve Bank of Cleveland, and we would like to hear from you at this time. Ms. HORN. Thank you, Mr. Chairman . I would like to submit my full statement for the record. Mr. BARNARD . Without objection , your full statement will be included . STATEMENT OF KAREN N. HORN, PRESIDENT, FEDERAL RESERVE BANK OF CLEVELAND Ms. HORN. I am pleased to appear before the Commerce, Consumer, and Monetary Affairs Subcommittee to discuss the Federal Reserve's response to the recent problems experienced by thrifts insured by the Ohio Deposit Guarantee Fund. This morning I will be reviewing for you the response of the Federal Reserve Bank of Cleveland . Attached to my statement is a chronology that sets forth the Federal Reserve System's response to the recent events in Ohio. I would like to begin by stating that the role of the Federal Reserve Bank of Cleveland throughout this period has been to assist the State of Ohio and other Federal regulators in fashioning a solution . Our initial involvement was to ensure that we could act quickly to provide liquidity assistance at the discount window and to make currency shipments-first, to Home State and subsequently, to the other institutions insured by the Ohio Deposit Guarantee Fund. We have acted at the request of the State of Ohio, and throughout this period, the Federal Reserve Bank of Cleveland and the Federal Home Loan Bank of Cincinnati have shared information and staff in a cooperative effort to deal with the problems and to fashion solutions . I would also like to recognize the substantial and supportive role of the correspondent banks, the commercial banks, in Cincinnati . I believe the Federal Reserve has been helpful , and we will continue to assist the State of Ohio and other Federal regulators until the problem is solved. The Federal Reserve Bank of Cleveland first became aware of possible financial difficulties at Home State Savings Bank of Cincinnati on Monday, March 4, 1985, when an official of Home State telephoned the Federal Reserve Bank of Cleveland to inquire about procedures that Home State should follow if it needed to borrow at the discount window. Although the problems at Home State were triggered by unique events growing out of its transactions with ESM, the severity of public reaction made us concerned about possible deposit withdrawals at other ODGF-insured institutions . As I mentioned earlier, deposits at Home State were insured by the ODGF, a private fund that also insured 70 other State-chartered thrift institutions in Ohio. According to State officials , the insurance fund had assets of about $ 130 million prior to the run on Home State . Uncertainty regarding other ODGF-insured institutions was increased by reports on the use of ODGF funds to deal with Home State's heavy deposit withdrawals. 241 Growing concern that other ODGF institutions might confront problems on Monday, led us on Saturday, March 9, to develop a plan to monitor and deal with deposit withdrawals at other ODGF institutions, should they occur. The plan had several dimensions. One, having a timely and effective mechanism for sensing unusually heavy deposit withdrawals. Two, informing ODGF institutions of collateral and other requirements for borrowing at the discount window. And three, planning and putting into place the logistics necessary to deliver currency, evaluate collateral, and obtain documents for borrowing at the discount window. The large number of ODGF institutions and the need for prompt and effective action, if action were to be required-at this point we were still in the contingency planning stage- made it imperative that we be prepared to deal with the problem by Monday, March 11, when the ŌDGF institutions opened. We were fortunate in being able to draw upon the staff from other Federal Reserve banks to assist us in contingency planning and logistics. The weekend planning effort concluded with meetings at 10 p.m. on Sunday, March 10, in both Cleveland and Cincinnati to brief Federal Reserve examiners on their role in the contingency plans. These plans called for examiners to be strategically placed near ODGF institutions throughout the State prepared to deliver borrowing documents upon request. Our weekend efforts had made it possible to monitor deposit outflows, to lend at the discount window, and to ship cash throughout the weeks that followed to a large number of institutions, most of which had not dealt at our discount window and which normally received their currency from other sources. Public confidence in ODGF institutions continued to decline . As the financial institutions opened on Monday, March 11 , there was evidence of loss of depositor confidence. At first this loss of confidence was largely confined to Cincinnati, where Home State is located. As the week progressed, the number of ODGF institutions suffering heavy cash strains increased and the volume of withdrawals rose sharply. On Thursday, March 15, for example, the seven most affected institutions in the Cincinnati area lost more than $60 million in deposits, almost triple the amount withdrawn on Wednesday, the day before. Several institutions had lost one-fifth of their deposits between Monday morning and Thursday night, and there was clear evidence that the crisis was spreading to ODGF-insured institutions in other cities as well. The more public confidence fell, the more serious the problem became. Federal Reserve examiners were sent upon request to many institutions to begin reviewing their collateral as their deposit withdrawals increased and the potential for borrowing at the discount window increased . The Federal Reserve and other commercial banks shipped currency to institutions that were experiencing heavy withdrawals, but cash alone was not enough to restore confidence . Without confidence, even the strongest financial institution can be severely impacted. Our active and visible role was to provide liquidity assistance to ODGF institutions at the discount window. In performing this function, the Federal Reserve Bank of Cleveland has not modified its 242 normal eligibility requirements for discount window assistance . The Monetary Control Act of 1980, which has already been referred to, made the discount window of the Federal Reserve Bank available to any depository institution that holds transaction accounts for nonpersonal time deposits . This so-called adjustment credit is available on a short-term basis to assist borrowers in meeting temporary requirements for funds while they engage in an orderly adjustment in their asset and deposit liabilities. We set up field warehouses in most of the ODGF institutions where collateral was identified, evaluated, and earmarked for possible use in securing discount window borrowings. That is our statutory and traditional role. The Federal Reserve played another very important role during the ODGF Savings and Loan problem. We served as a facilitator. During the early morning hours of Friday, March 15, when the full dimensions of the problem became clear, Governor Celeste decided to close all ODGFmember institutions for a 3-day period. Following that decision, the Governor requested that the Federal Reserve assist him in calling a meeting of large Ohio banking and thrift institutions to discuss the situation with them and propose a solution to the problem. The State subsequently decided it would be useful to discuss the situation with out-of-State banks, and two meetings were held with outof-State institutions at the Federal Reserve Bank of Cleveland . In the past 2 weeks , some elements of a solution have fallen into place . Each ODGF institution was examined on a case-by-case basis to determine its financial condition and the likelihood of its qualifying for Federal insurance . The Ohio State Superintendent of Savings and Loan Associations requested assistance from the Federal Reserve, the Federal Deposit Insurance Corporation [ FDIC], and the Ohio Division of Banks in conducting these examinations. The results of the preliminary examinations made it clear that a large number of these institutions were well managed, in sound financial condition, and consequently viable candidates for Federal insurance . Others, for a variety of reasons, would have difficulty in qualifying for Federal Deposit Insurance. As of Tuesday, April 2, according to the State of Ohio, 28 of the former ODGF institutions have been reopened for the full range of banking functions , most with Federal insurance. Confidence in these institutions seems to be restored. And among those fully opened, there has not been evidence of unusual withdrawals or need for assistance through either the credit facilities of the Federal Home Loan Bank in Cincinnati or the Federal Reserve discount window. The Federal Deposit Insurance applications of some ODGF institutions are still being considered , and other ODGF institutions have been informed of the changes and improvements that will be necessary in order for them to be able to obtain Federal insurance . Mr. BARNARD . Thank you very much. [Ms. Horn's prepared statement follows:] 243 Statement by Karen N. Horn President , Federal Reserve Bank of Cleveland I am pleased to appear before the Commerce , Consumer , and Monetary Affairs Subcommittee to discuss the Federal Reserve's response to the recent problems experienced by thrifts insured by the Ohio Deposit Guarantee Fund . This morning I will be reviewing for you the response of the Federal Reserve Bank of Cleveland . Attached to my statement is a chronology that sets forth the Federal Reserve System's response to recent events in Ohio. I would like to begin by stating that the role of the Federal Reserve Bank of Cleveland throughout this period has been to assist the State of Ohio and other Federal regulators in fashioning a solution . Our initial involvement was to insure that we could act quickly to provide liquidity assistance at the discount window and to make currency shipments 19 first to Home State and subsequently to other institutions insured by the Ohio Deposit Guarantee Fund ( ODGF ) . We have acted at the request of the State of Ohio, and throughout this period the Federal Reserve Bank of Cleveland and the Federal Home Loan Bank ( FHLB) of Cincinnati have shared information and staff in a cooperative effort to deal with the problems and to fashion solutions . I would also like to recognize the substantial and supportive role of the correspondent banks in Cincinnati . I believe the Federal Reserve has been helpful , and we will continue to assist the State of Ohio and other Federal regulators until the problem is solved . The Federal Reserve Bank of Cleveland first became aware of possible financial difficulties at Home State Savings Bank of Cincinnati , Ohio on March 4 , 1985, when an official of Home State telephoned the Federal Reserve Bank of Cleveland to inquire about the procedures Home State should follow if it needed to borrow at the discount window . The Federal Reserve Bank of Cleveland did not have any financial information on Home 244 State . It is a state- chartered savings and loan association , regulated and examined by the Ohio Division of Savings and Loan Associations , and prior to this time it had never borrowed at the discount window . know that Home State's deposits were insured by the ODGF , but we did not have access to any financial reports on Home State . On March 5 , the press reported that Home State might suffer a large loss in connection with the failure of E.S.M. Government Securities , Inc. ( E.S.M. ) , a Florida-based broker-dealer in government securities . The Federal Reserve began an effort to gather information on Home State's situation . Discussions with the FHLB of Cincinnati confirmed that Home State was not a member of the FHLB and that the FHLB also had little financial information on Home State . Reports from Cincinnati on Wednesday , March 6 , indicated a large volume of depositor withdrawals at Home State . On that same day , Federal Reserve examiners entered Home State to examine available collateral in the event that it became necessary for Home State to borrow at the discount window. Depositor withdrawals on Wednesday and Thursday were funded with Home State's own liquidity and lending by the ODGF. withdrawals on March 6 totaled $ 55 million . On March 7 , a meeting was held at the Cincinnati Branch of the Federal Reserve Bank of Cleveland with representatives from the State of Ohio, ODGF , and Home State to discuss liquidity assistance for Home State from the Federal Reserve Bank of Cleveland. Based on collateral judged to be acceptable by the Federal Reserve Bank , credit was extended on Friday , March 8, and arrangements were put in place to extend further credit . Depositor withdrawals had continued on March 7 and 8, reaching approximately $ 100 million for those two days . On Saturday , March 9 , Home State did not open for business . 245 Governor Celeste appointed a conservator for Home State and announced on Sunday night , March 10 , that Home State would not reopen for business on Monday. Although the problems at Home State were triggered by unique events growing out of its transactions with E.S.M. , the severity of the public reaction made us concerned about possible deposit withdrawals at other ODGF insured institutions . As I mentioned earlier , deposits at Home State were insured by the ODGF , a private fund that also insured 70 other State-chartered thrift institutions in Ohio . According to State officials , the insurance fund had assets of about $ 130 million prior to the run on Home State . Uncertainty regarding other ODGF insured institutions was increased by reports on the use of ODGF funds to deal with Home State's heavy deposit withdrawals . Financial information on all ODGF insured institutions was made available to the Federal Reserve Bank of Cleveland late Friday , March 8. Federal Reserve examiners and discount window staff reviewed and analyzed this information on Saturday and Sunday , March 9 and 10 , with the assistance of senior examination personnel from the FHLB of Cincinnati . Growing concern that other ODGF institutions might confront problems on Monday led us on Saturday , March 9 , to develop a plan to monitor and deal with deposit withdrawals at other ODGF institutions , should they occur. The plan had several dimensions : 1 ) having a timely and effective mechanism for sensing unusually heavy deposit withdrawals ; 2 ) informing ODGF institutions of collateral and other requirements for borrowing at. the discount window; and 3 ) planning and putting into place the logistics necessary to deliver currency, evaluate collateral , and obtain documents for borrowing at the discount window . The large number of ODGF 246 institutions and the need for prompt and effective action , if action were required , made it imperative that we be prepared to deal with the problem by Monday , March 11 , when the ODGF institutions opened . We were fortunate in being able to draw upon staff from other Federal Reserve Banks to assist in the contingency planning and logistics . The weekend planning effort concluded with meetings at 10:00 p.m. on Sunday , March 10 , in both Cleveland and Cincinnati to brief Federal Reserve examiners on their role in the contingency plans . These plans called for examiners to be strategically placed near ODGF institutions throughout the State prepared to deliver borrowing documents upon request . Also , late Sunday evening , March 10 , following the Governor's announcement that Home State would not reopen on Monday , the Cleveland Federal Reserve Bank publicly restated its discount window policy: "State-chartered savings and loans and savings banks , like all depository institutions , are eligible for liquidity assistance through the discount window...under normal terms and conditions . " Our weekend efforts had made it possible to implement the policy , to monitor deposit flows , to lend at the discount window , and to ship cash throughout the weeks that followed to a large number of institutions , most of which had not dealt with our discount window and which normally received their currency from other sources . Public confidence in ODGF institutions continued to decline . As financial institutions opened on Monday , March 11 , the evidence of the loss in depositors ' confidence was almost immediate . At first the loss of confidence was largely confined to Cincinnati , where Home State is located. As the week progressed , the number of ODGF institutions suffering heavy cash drains increased , and the volume of withdrawals rose 247 sharply. On Thursday, March 14 , for example , the seven most affected institutions in the Cincinnati area lost more than $60 million in deposits -- almost triple the amount withdrawn on Wednesday. Several institutions had lost one-fifth of their deposits between Monday morning and Thursday night , and there was clear evidence that the crisis was spreading to ODGF insured institutions in other cities . confidence fell , the more serious the problem became . The more public Federal Reserve examiners were sent upon request to many institutions to begin reviewing collateral as deposit withdrawals and the potential for borrowing at the discount window increased . The Federal Reserve and other commercial banks shipped currency to institutions that were experiencing heavy withdrawals , but cash alone was not enough to restore confidence ; without confidence even the strongest financial institution can be severely impacted . Our active and visible role was to provide liquidity assistance to ODGF institutions at the discount window . In performing this function , the Federal Reserve Bank of Cleveland has not modified the normal eligibility requirements for discount window assistance in any way . Monetary Control Act of 1980 made the discount window of the Federal Reserve Bank available to any depository institution that holds transactions accounts or nonpersonal time deposits . Regulation A of the Board of Governors , which prescribes standards for the operation of the discount window, provides for lending to eligible depository institutions under two basic programs . One is the adjustment credit program; the other supplies credit for seasonal and other limited purposes for more extended periods . Adjustment credit is available on a short- term basis to assist 248 borrowers in meeting temporary requirements for funds while an orderly adjustment is being made in their assets and deposit liabilities. All Federal Reserve advances must be secured to the satisfaction of the Reserve Bank providing the credit . Satisfactory collateral includes securities of the U.S. government and of federal agencies , and , if of acceptable quality , residential mortgage notes and other assets . Although collateral is generally held in safekeeping at the Federal Reserve Banks or acceptable third- party custodians , in this instance , field warehouses were set up in most ODGF institutions where collateral was identified , evaluated , and earmarked for possible use in securing discount window borrowings . The Federal Reserve played another very important role during the ODGF savings and loan problem -- we served as a facilitator . During the early morning hours of Friday , March 15 , when the full dimensions of the problem became clear , Governor Celeste decided to close all ODGF member institutions for a three-day period . Following that decision , the Governor requested that the Federal Reserve assist him in calling a meeting of large Ohio banking and thrift institutions to discuss the situation with them and propose a solution to the problem . A meeting with representatives of thirteen Ohio depository institutions and S&Ls -- was convened that morning at the Federal Reserve Bank of Cleveland . At that meeting Governor Celeste explained his decision to close the ODGF institutions and discussed a legislative proposal that would require the ODGF institutions to obtain federal insurance before reopening . He also presented a proposal for dealing with the ODGF institutions that would not qualify for federal insurance . The State subsequently decided it would be useful to discuss the situation with 249 out-of-state banks , and two meetings were held with out- of- state institutions at the Federal Reserve Bank of Cleveland --one on Saturday , March 16 , at 9:00 p.m. and another on Sunday , March 17 , at 11:00 a.m. In the past two weeks , some elements of a solution have fallen into place . Each ODGF institution was examined on a case-by- case basis to determine its financial condition and the likelihood of its qualifying for federal insurance . The State Superintendent of Savings and Loan Associations requested assistance from the Federal Reserve , the Federal Deposit Insurance Corporation ( FDIC ) , and the Ohio Division of Banks in conducting these examinations . This process began on Saturday , March 16 , with examiners provided by the Federal Reserve Bank of Cleveland and , eventually , by every other Federal Reserve Bank . to each of the ODGF institutions . Examiners were assigned Virtually all examinations were completed on Sunday , March 17 , enabling us to conduct a preliminary review of the condition of each institution to supplement and update the information obtained the previous Friday from the State . The results of the preliminary examinations made it clear that a large number of these institutions were well -managed , in sound financial condition , and , consequently , viable candidates for federal deposit insurance . Others , for a variety of reasons , would have difficulty qualifying for federal deposit insurance . The FHLB Board agreed to review on an expedited basis the Federal Savings and Loan Insurance Corporation ( FSLIC ) insurance applications of ODGF member institutions . Under this arrangement , FSLIC qualification examinations were expedited , using the resources of the FHLB System and the Federal Reserve . The Federal Reserve offered its assistance to help complete the FSLIC examinations as rapidly as possible. We believed we could facilitate this process because our 250 examiners were already in place at the ODGF institutions and had gained familiarity with these institutions through the just completed examinations conducted on March 16 and 17. As of Friday , March 29 , according to the State of Ohio , 26 of the former ODGF institutions have been reopened for the full range of banking functions , most with federal insurance . seems to have been fully restored . Confidence in these institutions There has been no evidence of unusual withdrawals or need for assistance through either the credit facilities of the FHLB of Cincinnati or the Federal Reserve discount window . The federal deposit insurance applications of some ODGF institutions are still being considered . Other ODGF institutions have been informed of the changes and improvements that will be necessary to enable them to obtain federal insurance . The State of Ohio is making intense efforts to develop an orderly plan for those institutions that might not qualify for federal insurance . It is my understanding that a final outline of such a plan is not yet complete . A solution may have to involve the sale of some ODGF institutions to other Ohio financial institutions and , perhaps , also to out-of-state institutions . The Federal Reserve Bank of Cleveland has not participated in the discussions involving plans for any single institution except those for which Federal Reserve regulatory approval was required , such as the sale of Metropolitan Savings Bank of Youngstown to FNB Corporation , a Pennsylvania bank holding company , and the conversion of Scioto Savings Association into a state- chartered FDIC insured commercial bank under the continuing ownership of its parent company , Society Corporation , an Ohio bank holding company . 251 While this process is underway , the State has authorized the CDGF institutions not yet qualified to reopen for full business to open for the limited purposes of giving each depositor access to a maximum of $750 per month and pledging assets to and borrowing from correspondent banks or the Federal Reserve discount window to fund the limited deposit withdrawals . Complete confidence in the ODGF institutions has not been restored , but the atmosphere is much calmer than it was two weeks ago . 50-923 0-85--9 252 CHRONOLOGY OF FEDERAL RESERVE RESPONSE TO OHIO S & L SITUATION (* indicates events not part of the Federal Reserve response but which are important to that day's chronology . ) Monday, March 4 * A receiver is appointed for ESM at the request of the S.E.C. The Cleveland Reserve Bank's Loan and Discount Department receives what appears to be a routine telephone call from Home State inquiring whether its borrowing documents were in order . Tuesday, March 5 Cleveland Reserve Bank makes initial inquiries about Home State to the Federal Home Loan Bank of Cincinnati ( "FHLB Cincinnati ") and the Ohio Deposit Guarantee Fund ( " ODGF" ) . Home State's correspondent bank meets with Cincinnati branch of the Cleveland Reserve Bank ( "Cincinnati branch " ) to discuss Home State situation. Cincinnati branch Home State . makes arrangements for emergency cash shipments to Wednesday, March 6 Cleveland Reserve Bank sends examination personnel to Home State and they begin to review collateral . Home State has estimated deposit outflows of $ 55 million . Cincinnati offices . branch makes 39 special cash shipments to various Home State Thursday , March 7 Meeting at Cincinnati branch is held with representatives of the State , ODGF , Home State , and the Cleveland Reserve Bank to discuss possible discount window loan. Examiners continue reviewing collateral . Governor Richard Celeste telephones President Karen Horn to discuss Home State matter and to learn what assistance might be available from Federal Reserve . Cincinnati branch makes 59 special cash shipments to various Home State offices . Home State has estimated deposit outflows of $45 million . Friday, March 8 Home State's liquidity position declines throughout the day . Cleveland Reserve Bank monitors the situation with Home State's correspondent bank . Frequent discussions are held by Federal Reserve officials in Cincinnati , Cleveland , and Washington regarding liquidity needs of Home State. A Cleveland Reserve Bank official attends a meeting in Columbus called by the Superintendent to discuss possible solutions to Home State situation . -- 1 - 253 Friday, March 8 (Continued) In late afternoon , Home State directors sign a note to borrow from the Cleveland Reserve Bank . Collateral is segregated by examiners and shipped to the Cincinnati branch . At 4:00 p.m. , a discount window loan is made to Home State . Cincinnati branch makes 76 separate cash shipments to various Home State offices . Home State has estimated deposit outflows of $54.2 million . At the Cleveland Reserve Bank's request , the Superintendent agrees to provide financial information for all ODGF institutions in anticipation of borrowing requests from these institutions . * In late evening , Home State management announces that Home State will be closed on Saturday . Saturday, March 9 Concerned about the potential spillover effects of the Home State closing , Cleveland Reserve Bank officials begin internal logistical planning for possible cash deliveries and borrowing arrangements for other ODGF institutions . Cleveland Reserve Bank examination personnel begin analyzing the financial data of all ODGF member institutions for possible borrowings at the discount window . Three representatives from the FHLB Cincinnati assist in this process . * A conservator , Arlo Smith , is appointed by Governor Celeste to direct the affairs of Home State . The Superintendent convenes a meeting at a Cleveland bank at 6:00 p.m. with several large bank holding companies in Ohio to discuss the proposed sale of Home State . Representatives from the Federal Reserve are in attendance as observers . Sunday, March 10 * Governor Celeste announces that Home State will not open on Monday . Cleveland Reserve Bank issues a statement to the press indicating that state-chartered savings and loans , like all depository institutions , are eligible for liquidity assistance through the discount window under normal terms and conditions . At the Cleveland Reserve Bank , contingency planning continues and officials from other Reserve Banks arrive to assist . Monday, March 11 Cleveland Reserve Bank examiners are placed strategically throughout the state and are prepared to deliver borrowing documents to any ODGF institution that requests such information . Cincinnati Branch officials discuss the Home State situation with local banks . Estimated net deposit outflows of $6.0 million at ODGF institutions . - 2- 254 Tuesday, March 12 Conservator Smith repays loan from Cleveland Reserve Bank . Activity at ODGF institutions remains relatively calm. Estimated net deposit outflows for the day approximate $ 13.4 million at ODGF institutions . Borrowing documents are delivered by Cleveland Reserve Bank examiners upon request . Wednesday , March 13 Estimated net institutions . deposit outflows for the day of $23.4 million at ODGF Officials from four ODGF institutions experiencing heavy deposit withdrawals go to Washington , D.C. , to meet with members of Congress and officials of the Federal Reserve and the FHLBB . Several meetings are held at the Cincinnati institutions to discuss borrowing documents . Branch Thursday, March 14 and cash Major runs occur at six ODGF institutions institutions accelerate . Estimated net deposit outflows approximate $63.9 million . of all open ODGF with shipments institutions individual to for these day Seven special cash shipments to five different ODGF institutions by the Cleveland Reserve Bank . Friday, March 15 At 7:30 a.m. in Cincinnati , Governor Celeste holds a press conference to declare a three-day holiday for the ODGF institutions . President Horn indicates that the Cleveland Reserve Bank stands ready to supply liquidity through the discount window under normal conditions when the institutions reopen. At 11:45 a.m. , a meeting at the Cleveland Reserve Bank is convened at the request of the Governor with representatives of 13 Ohio financial institutions . The Governor requests the institutions to join together to develop a rescue package for those ODGF institutions that would not qualify for federal insurance . Fifteen special cash shipments are made to 12 institutions . Saturday , March 16 At 9:00 a.m. , a second meeting is held at the Cleveland Reserve Bank with the Ohio financial institutions . The State also requests Federal Reserve assistance in discussing this situation with out-of-state financial institutions . Two meetings with out-of-state institutions are then scheduled at the Cleveland Reserve Bank--one on Saturday night at 9:00 p.m. and another for Sunday at 11:00 a.m. Representatives from the State requested out-of-state banks to consider acquiring some or all of those ODGF institutions that would not qualify for federal insurance . - 3- 255 Saturday, March 16 (Continued ) Examiners are present at every ODGF institution to review collateral . Examiners from other Reserve Banks arrive to assist . The Superintendent of Savings and Loan Associations requests the Federal Reserve , the FDIC , and the Ohio Division of Banks to assist in learning the current financial condition of all the ODGF institutions . Examinations are then commenced for this purpose . Fifteen special cash shipments are made to 11 ODGF institutions . Sunday, March 17 A meeting is held at 11:00 a.m. at the Cleveland Reserve Bank with a second group of eleven out-of-state bank holding companies . (This meeting is also attended by some representatives from the previous meeting . ) Examinations conducted at the State's request are concluded at virtually all ODGF institutions by examiners from the Federal Reserve . Summary results from these examinations are compiled and reviewed . Monday, March 18 * Governor Celeste signs an executive order requiring ODGF institutions to remain closed for an additional 48 hours . Examiners insure execution of borrowing documents and control of adequate collateral for all ODGF institutions . An evening meeting is held at the Cleveland Reserve Bank with officials from the Federal Home Loan Bank System to discuss possible assistance by the Federal Reserve with FSLIC qualification insurance examinations for ODGF institutions . Eight special cash shipments are made to 7 institutions . Tuesday, March 19 A second meeting is held at the Cleveland Reserve Bank with officials from the Federal Home Loan Bank System. The Federal Home Loan Bank Board officials accept an offer from the Federal Reserve to assist in qualification examinations . Governor Celeste meets separately in Washington , D.C. , with Chairman Volcker and Chairman Gray. Governor Celeste is assured of expedited processing by FHLBB of FSLIC insurance applications . As provided in the Cleveland Reserve Bank's check collection operating letter , the Bank sends notice and begins returning checks drawn on the closed ODGF institutions with the stamp " not presentable at this time . " FSLIC qualification examinations begin at ODGF institutions with the assistance of Federal Reserve examiners already present at these institutions . Two special cash shipments are made to 2 institutions . Wednesday , March 20 * The State of Ohio legislature approves legislation requiring federal insurance and permitting partial withdrawals ($750 per depositor each 30 day period) for ODGF institutions . 256 Wednesday, March 20 (Continued) The availability of discount window assistance to reopened ODGF institutions was restated by Chairman Volcker . Two special cash shipments are made to 2 institutions . Thursday , March 21 The conversion of Scioto Savings Association into a commercial bank is approved by the State of Ohio, the FDIC , and the Board of Governors of the Federal Reserve System. Friday, March 22 A task force is established in Columbus at the office of the Superintendent of Savings and Loan Associations to coordinate communications between the Superintendent , Cleveland Reserve Bank , and the FHLB-Cincinnati . An application by F.N.B. Corporation in Hermitage , Pa., to acquire Metropolitan Savings Bank in Youngstown , Ohio , is processed and approved on an emergency basis by the Board of Governors of the Federal Reserve System. Saturday , March 23 As ODGF institutions reopen for limited withdrawal purposes , cash demands are placed on the Cleveland Federal Reserve Bank . FSLIC qualification examinations continue . In addition , Federal Reserve examiners continue their presence in ODGF institutions to monitor cash situations , and to secure collateral for borrowings where necessary. Staff remains on duty at the Cleveland Reserve Bank to provide assistance and discount window borrowings , answering questions regarding check collection and manage the large numbers of examiners from outside the Fourth Federal Reserve District . Seven special cash shipments are made to 4 institutions . Estimated net deposit outflows (aggregate ) · $5.4 million . Sunday, March 24 FSLIC qualification examinations continue . Monday, March 25 The Cleveland Reserve Bank issues notice that it is presenting checks to those institutions that are fully open . Six special cash shipments are made to 5 institutions . Estimated net deposit outflows (aggregate) - $7.7 million . Tuesday, March 26 Eighteen institutions are now open on a full-service basis . Liquidity and cash situations in these institutions continue to be monitored by Federal Reserve examiners in the field as well as the Cleveland Reserve Bank staff in Cleveland , Cincinnati , and Columbus .. - 5- 257 Tuesday, March 26 (Continued ) Five special cash shipments to 2 institutions . Estimated net deposit outflows (aggregate ) - $3.9 million . Wednesday, March 27 Six special cash shipments to 4 institutions . Estimated net deposit outflows (aggregate ) - $ 2.9 million . Thursday , March 28 One special cash shipment . Estimated net deposit outflows ( aggregate ) - $4.4 million . Friday , March 29 Twenty- six institutions are now open on a full- service basis . FSLIC qualification examinations continue . Three special cash shipments to 3 institutions . Estimated net deposit outflows (aggregate ) - $2.8 million . Saturday, March 30 Estimated net deposit outflows (aggregate ) - $1.3 million . Mr. BARNARD. Mr. Selby, we will hear your testimony at this time. STATEMENT OF H. JOE SELBY, SENIOR DEPUTY COMPTROLLER FOR BANK SUPERVISION, OFFICE OF THE COMPTROLLER OF THE CURRENCY Mr. SELBY. Thank you, Mr. Chairman , for inviting me, and members of the committee. On the shortness of the time that I knew I was coming up, I do not have a prepared statement, but if it is appropriate I would ask that my letter to you of March 29 be entered into the record . Mr. BARNARD. Without objection . Mr. SELBY. And I will summarize it very briefly. You requested information from us concerning national bank involvement with ESM Government Securities of Ft. Lauderdale, FL. National bank examiners first encountered ESM in late 1976 during the examination of the National Bank of South Florida in Hialeah. Our examiners at that time reviewed the bank's new relationship established with ESM Government Securities and reviewed the securities transactions arising out of this relationship. Our examiners determined that the type of securities trading and the methods of financing provided by ESM were unsuitable for a national bank primarily because they were clearly speculative and the financing arrangement of the equivalent of margin financing. 258 We also concluded that the securities transactions may have been executed at prices above the prevailing market price . We directed bank management to stop the securities trading activity with ESM, to properly record and unwind outstanding repurchase agreements and to sever their relationship at that time with ESM. During the examination bank management did follow the examiners' recommendations. They completely unwound the trades and reclaimed the money that had already been sent to ESM. As a result, the bank suffered no loss on the transactions with ESM. During this examination, it was also evident that there was some massive self-dealing, numerous violation of bank laws as well as possible criminal violations in concentrations of credit which appeared to us to propose a threat to the solvency of the bank. On February 8, 1977, the bank's directors were served with a notice of charges and a temporary cease-and-desist order. Due to our imposed pressures and limitations particularly through the cease-and-desist order, the controlling shareholder of the bank sought purchasers for the bank and eventually sold it in August 1977. The examination that we had conducted did result in a number of criminal referrals made to the Department of Justice and Treasury, dealing with a substantial number of banking laws and I might add particularly the Bank Secrecy Act, which did result in some prosecution, but I think it was not a successful prosecution at that time on the bank secrecy. Information on the dealings between ESM and the bank were first communicated by us to the Office of the State of Florida, that State's securities regulator, in a February 16, 1977 , letter, and subsequently referred on April 27 , 1977, to the Miami office of the Securities and Exchange Commission. During this same period of time, we became aware that Robert Seneca and Ronnie Ewton, principals of ESM Government Securities, Inc., were interested in acquiring control of the bank holding company in Florida called the American Bankshares, Inc. [ABI ] . I believe at that time we had six national banks under ABI and there were three State banks, also members of the holding company. To our knowledge, Ewton and Seneca's involvement with ABI had no connection to the situation encountered at the National Bank of South Florida. However, because of our experiences with ESM and their dealings with the National Bank of South Florida, we did deem it appropriate to enter into voluntary written agreements with each of ABI's six national bank subsidiaries which would preclude any business dealings directly or indirectly between ABI's subsidiary national banks and ESM Securities, Inc. , its affiliates, its principals, any relative, whether by blood or by marriage of the principals of ESM or any corporation, partnership, or other type of enterprise controlled by these persons. After Messrs . Ewton and Seneca acquired controlled of American Bankshares, we resisted several attempts by these individuals to subvert the voluntary agreements on the banks. During 1978 , national bank subsidiaries of ABI were converted to State-chartered banks . Eventually Mr. Seneca and Ewton sold their interests in ABI, I believe , to Mr. Marvin Warner. 259 Prior to the conversion of the banks from national to State, we informed the Florida State banking regulator of our outstanding agreements and concerns. We also met with representatives of the FDIC to provide them background information and assistance with respect to the information . And it is my knowledge that since it was a holding company, we also discussed our agreements with the Federal Reserve. Contemporaneous with this office's direct dealings with banks doing business with or controlled by ESM and its principals, we published a warning notice to all national banks which contained descriptions of the types of transactions and financing arrangements being offered at that time by ESM as well as by other bond dealers. That was contained in a banking circular dated July 26, 1977 . In your March 22, 1985, letter, you requested information with respect to how many national banks have had dealings with ESM Securities from 1980 to date. At the time of ESM's demise, we have knowledge only of one national bank that had moneys loaned via repurchase agreements collateralized by U.S. Government securities and that bank suffered minimal losses of approximately $250,000. Mr. BARNARD . Was this account segregated? Mr. SELBY. I do not know. Yes, it was. Mr. BARNARD. Did you show any evidence of the securities? Mr. SELBY. Yes. We have no other evidence of national banks dealing with ESM during the period of your inquiry although I must presume that some national banks did conduct business with ESM during this period. I must also presume absent any indication to the contrary that no national banks suffered significant losses in connection with its dealings with ESM. Certainly it had not been reported to us by our examiners or by the banks. Our examiners are well trained in these areas and are extremely sensitive to the unsavory reputations of a number of security dealers doing business with depository institutions. And basically, since 1977, Mr. Chairman, we have intensified our training in the securities dealing practices and have given a great number of training sessions to our examiners as well as other examiners and I am told my staff member that in fact one of the lesson plans contains an example using ESM as the type of example that we teach our examiners . We are not aware at this time of any other examination criticisms or formal or informal enforcement actions taken against any national bank because of their business dealing with ESM . Because of the corporate structure of dealer firms trading U.S. Government securities, we must presume each Government or Federal agency securities transaction entered into between a national bank and a dealer involves an unregistered U.S. Government securities dealer. The full extent of those transactions in terms of dollar value or number of transactions is unknown. But as I indicated previously, our supervisory reviews, which are attuned to precisely the kind of transactions undertaken by ESM, disclose very few irregularities . Those irregularities that are disclosed are routinely communicated to the Securities and Exchange Commis- 260 sion, the National Association of Securities Dealers, and the appropriate State securities regulator. It is my understanding that these referrals have been the basis for a number of enforcement actions taken by the Securities and Exchange Commission. Thank you very much. [Mr. Selby's prepared statement follows: ] 261 Comptroller ofthe Currency Administrator of National Banks Washington, D. C. 20219 March 29 , 1985 The Honorable Doug Barnard , Jr. Chairman Commerce , Consumer , and Monetary Affairs Subcommittee Committee on Government Operations U. S. House of Representatives Washington , D.C. 20515 Dear Mr. Chairman : This is in response to your March 22 , 1985 letter requesting information concerning national bank involvement with ESM Government Securities , Inc. , of Fort Lauderdale , Florida ( ESM ) . National Bank Examiners first encountered ESM in late 1976 during an examination of the National Bank of South Florida , Hialeah , Florida ( the Bank ) . Our examiners reviewed the Bank's new relationship established with ESM and securities transactions arising out of this relationship . The examiners determined that the type of securities trading and the methods of financing provided by ESM were unsuitable for a national bank because the trades were clearly speculative and the financing arrangement was the equivalent of margin financing . We also concluded that the securities transactions may have been executed at prices above the prevailing market price . Bank management was directed to stop the securities trading activity , to properly record and unwind outstanding repurchase agreements and to sever the relationship with ESM . During the examination , bank management followed the examiners ' recommendations , completely unwound the trades and reclaimed the money already sent to ESM . The Bank suffered no loss on the ESM transactions . During this examination it also became evident that there was massive self dealing , numerous violations of bank laws as well as possible criminal violations , and concentrations of credit which appeared to pose a threat to the solvency of the Bank . On February 8 , 1977 the Bank's directors were served with a Notice of Charges and Temporary Cease and Desist Order . Bank was ordered to remove the self dealing transactions and to halt further dealings with insiders . The directors were informed that several senior officers of the Bank should be removed . In the days following , the Bank received the 262 resignations of a number of senior officers and directors . Due to our imposed pressures and limitations , the controlling shareholder of the Bank sought purchasers for the Bank and eventually sold the Bank in August , 1977. The examination resulted in a number of criminal referrals made to the Departments of Justice and Treasury dealing with a substantial number of banking laws and the Bank Secrecy Act . The specific securities transactions encountered in this examination are detailed in the enclosed February 16 , 1977 memorandum authored by Mr. Lou Frank , who was then Deputy Regional Administrator for National Banks in our Atlanta regional office . Information on the dealings between ESM and the Bank was first communicated to the Office of the Comptroller of the State of Florida , that state's securities regulator , in a February 16 , 1977 letter and subsequently. referred on April 27 , 1977 ( see enclosures ) to the Miami office of the Securities and Exchange Commission . During this same period of time , we became aware that Robert Seneca and Ronnie Ewton , principals of ESM Government Securities , Inc. , were interested in acquiring control of a bank holding company , American Bankshares , Inc. ( ABI ) . knowledge , Ewton and Seneca's involvement with ABI had no connection to the situation encountered in National Bank of South Florida . However , because of our experiences with ESM in their dealings with that bank , we deemed it appropriate to enter into voluntary written agreements with each of ABI's six national bank subsidiaries which would preclude any business dealings , directly or indirectly , between ABI's subsidiary national banks and ESM Securities , Inc. , its affiliates , its principals , any relative , whether by blood or by marriage , of the principals of ESM or any corporation , partnership or other type of enterprise controlled by these persons . A copy of one of these agreements , dated February 23 , 1977 , is enclosed . After Messrs . Ewton and Seneca acquired control of American Bankshares , we resisted attempts by these individuals to subvert the voluntary agreements ( see attached correspondence dated September 30 , 1977 ) . During 1978 , national bank subsidiaries of ABI were converted to state chartered institutions , and Messrs . Seneca and Ewton eventually sold their interest in ABI to Mr. Marvin Warner . Prior to the conversion , we informed the state banking regulator of the outstanding Agreements . Subsequent to the conversion to state charters , we met with representatives of the FDIC to provide them with background and assistance with respect to this matter . Contemporaneous with this office's direct dealings with banks doing business with or controlled by ESM and its principals , we published a warning notice to all national banks which contained descriptions of the types of transactions and financing arrangements being offered by ESM ( see the enclosed Banking Circular No. 2 , Supplement No. 4 , dated July 26 , 1977 ) . 263 In your March 22 , 1985 letter you requested information , from 1980 to date , with respect to how many national banks have had dealings with ESM securities , the total dollar value of these dealings , and if any national bank suffered losses in connection with ESM . At the time of ESM's demise , only one national bank had monies loaned via repurchase agreements collateralized by U. S. government securities . Bank South ; Atlanta , Georgia , a relatively large regional bank , had repurchase agreements of $38 million and suffered losses approximating $ 250 thousand in liquidating these positions . Two regional national banks have reported small gains and losses in closing out forward contracts in GNMA securities against ESM's Memphis , Tennessee , branch office . We have no other records of national banks dealing with ESM during the period of your inquiry although I must presume that some national banks did conduct business with ESM during this period . I must also presume , absent any indications to the contrary, that no national bank suffered significant losses in connection with its dealings with ESM . Our examiners are well trained in these areas and are extremely sensitive to the unsavory reputations of a number of securities dealers doing business with depository institutions . It is my understanding that examiner criticisms of bank dealings with ESM would be brought to the attention of our Investment Securities Division . No significant criticisms were brought to that division's attention since the original 1977 transaction noted in the National Bank of South Florida examination . We are not aware of any other examination criticisms or formal or informal enforcement actions taken against national banks because of their business dealings with ESM . Presently , and also during the period covered by your inquiry , our field examiners routinely review transactions between national banks and unregistered government securities dealers . Our examination reviews disclose that the vast majority of such transactions are conducted in a manner which does not expose national banks to losses . In each financial collapse of an unregistered U. S. government securities dealer , apart from the Drysdale Government Securities , Inc. situation , national banks lost very little money because they followed the procedures articulated in supervisory notices of the type previously referred to ( see Banking Circular No. 2 ) and because they exercised banking prudence . Because of the corporate structure of dealer firms trading U.S. government securities , we must presume each government or federal agency securities transaction entered into between a national bank and a dealer involves an unregistered U. s . government securities dealer . The full extent of those . transactions , in terms of dollar value or number of transactions , is unknown . But , as I indicated previously , our supervisory reviews , which are attuned to precisely the kinds 264 of transactions undertaken by ESM , disclose very few irregularities . Those irregularities that are disclosed are routinely communicated to the Securities and Exchange Commission , the National Association of Securities Dealers , and . the appropriate state securities regulator . understanding that these referrals have been the basis for a number of enforcement actions taken by the Securities and Exchange Commission . I hope this information is useful to the Subcommittee in its investigation . Please let me know if you have further questions in this area . Sincerely , HrsSech H. Joe Selby Senior Deputy Comptroller for Bank Supervision 265 Comptroller ofthe Currency Administrator of National Banks Sixth National Bank Region Suite 2700, Peachtree Čain Tower 229 Peachtree Street, N.E. Atlanta, Georgia 30303 404-221-4926 February 16 , 1977 PR IU Mr. Tim Rigsby General Counsel Office of the Comptroller State of Florida Tallahassee , Florida TM A Dear Mr. Rigsby : We are investigating a bond transaction involving E.S.M. Government Securities , Inc. This security transaction originated on December 1 and 2 , 1976 . We have previously been advised that E.S.M. Government Securities Corporation was not authorized to engage in securities transactions until December 23 , 1976. If our information is correct , E.S.M. Securities Corporation was engaged in an unauthorized and prohibited transaction with one of the banks that we regulate . Our Regional Counsel , H. Gary Pannell , informed me that you intend to investigate the matter and advise us of the results of your investigation . Very truly yours , Low Frank Lou Frank Deputy Regional Administrator . of National Banks Sixth National Bank Region cc: Leomptroller - Attn : Mr. Dunham Reading File Priority File American Bancshares Holding Co. File LFrank : np 266 "E.S.M. Government Securities , Inc. INVESTME::T BANKERS SUITE 1710, ONE FINANCIAL PLAZA, FORT LAUDERDALE, FLORIDA 33394 (305) 764-2600 Corrected from SG1952 as to Price & Figures SALE DATE SETTLEMENT REP. D. Fromhoff 12/1 /767% 12/7/76 SOLDTO CONFIRMATION SUBJECTTO CORRECTION NO. SG National Bank of South Florida 1001 E. 9th Street Hialeah, Florida 33011' Att : Henry Heitman, Chairman of Board PAR AMOUNT $500,000.00 . PRINCIPAL PRICE DESCRIPTION OF SECURITIES 5 7/8 Treasury Notes : Due 12/31/80 Dated 12/7/76 . INTEREST PERIOD INTEREST 99.902 TOTAL AMOUNT $499,510.00 $499,510.00 DELIVER TO Manufacturers Hanover Trust NY F/A National Bank of South Florida WE CONFIRM SALE AS PRINCIPAL OF THE SECURITIES DESCRIBED ABOVE WITH ACCRUED INTEREST TO BE ADDED. WEAPPRECIATE YOUR BY 200 267 E.& M. Government SecuriųE: Im . INVESTMENT BANKERS SUITE 1710, ONE FINANCIAL PLAZA, FORT LAUDERDALE, FLORIDA 33394 (305) 764-2600 SALE DATE 12/2/16 CUSTOMER FILE COPY SUBJECTTO CORRECTION SETTLEMENT 12/9/76 REP. B. Trabeff NO. C 105 S SOLDTO ר Parfemel bank of South Florids 1001 . " fireet Melea , Merida 3211 L Att: Heary Hartmas, Chalınan of kard . PAR AMOUNT $1,000,000.00 DESCRIPTION OF SECURITIES CENA. Fart. Cert. iry 2/1/03 Date: 8/1/12 PRICE 4.:.5 3. ! PRINCIPAL INTEREST PERIOD $600,000.00 INTEREST $21,548.00 TOTAL AMOUNT 1, DELIVER TO THIS IS YOUR AUTHORIZATION TO ACCEPT DELIVERY OF THE ABOVE BONDS, AND CHARGE OUR ACCOUNG Authorized Signature SIGN AND FORWARD TO BANK ACCEPTING DELIVERY 268 April 27, 1977 PRISTAA A Mr. Charles Harper Securities and Exchange Commission Dupont Plaza Center, Suite 1114 300 Biscayne Boulevard Way Miami , Florida 33131 Dear Mr. Harper: During the course of an examination of the National Bank of South Florida in Hialeah, Florida, our examiners uncovered information indicating potential violations of federal laws and regulations coming under the jurisdiction of the Securities and Exchange Commission. Enclosed herewith is a factual memorandum prepared by Deputy Regional Administrator Lou Frank detailing the transactions which indicate the subject bank may have been defrauded by E.S.M. Government Securities , Inc. Because of the firm's activities , it appears that substantial damage would have been perpetrated on the bank. Subsequent to our axamination , the attorneys for the bank notified E.S.M. Government Securities , Inc., to cancel the transaction. The securities firm complied resulting in no ultimate loss to the bank. Notwithstanding the lack of loss, it is clear from the facts in the attached memorandum that an intent of fraud was perpetrated by the E.S.K. Government Securities, Inc. and, but for the fact that we intervened, substantial loss could have occurred . Very truly yours, Donald L. Tarleton Regional Administrator of National Banks Sixth National Bank Region Enclosures CC: Comptroller - Attn : Mr. Dunham Loomptroller - Attn : Mr. Serino Reading File Priority File (National Bank of South Florida) American Bancshares Holding Company File RS :LF:np 269 MEMORANDOM Comptroller oftheCurrency Administrator of National Banks Sixth National Bank Region Suite 2700, Peachtree Cain Tower 229 Peachtree Street, N.E. Atlanta, Georgia 30303 To Mr. Donald L. Tarleton From Lou Frank Date February 16 , 1977 g Subject Your Request to Investigate Messrs . Ewton and Senaca E.S.M. Government Securities , Inc. was chartered in the state of Florida September 26 , 1975 and licensed to do business effective December 23 , 1976. Records indicate a technical suspension with reinstatement January 21, 1977 for some type of infraction . Reportedly, this bond broker operates out of One Financial Plaza , Fort Lauderdale , Florida . A parallel company , E.S.M. Securities , Inc. , apparently did business prior to the current corporate activities . "E " stands for Ronnie R. Ewton , 7421 S.W. 14th Street , Plantation , Florida ; " S" stands for Robert C. Senaca , 3999 Bayview Drive , Fort Lauderdale , Florida ; "M" stands for George G. Mead , 2717 NE 35th Drive , Fort Lauderdale , Florida . Only Ewton and Senaca have stated an interest in purchasing stock in American Bancshares , Inc. Complete financial and biographical forms have been furnished to these individuals ; however , because Mr. Slobusky claims the sale transaction will be consummated by Friday, we will have no time prior to their acquisition of the stock to investigate their background . I have therefore made a concerted effort to check their background without source documents . No record exists with the Justice Department , State of Florida , the SEC, FDIC , FRB or our office . Everyone seems aware of their names and they are known as suede- shoe types , slickers , high pressure salesmen , i.e. , the usual high pressure bond salesmen . They are known and feared because they once operated in Memphis and Little Rock , as well as Ilouston , Texas prior to coming to Fort Lauderdale and are branded as "Memphis Bond Bandits " . While no actual criminal wrongdoing in their past has been found , the relationship of E.S.M. Government Securities , Inc. , with the National Bank of South Florida , Hialeah , Florida appears to be a clear case of unsafe and unsound bond transactions . A high pressure bond salesman from the company , Don Fromhoff, duped former Chairman of the Board, Henry Heitman , into taking part in speculative 270 trading transactions . Mr. Heitman was lured by E.S.M. into various flip- flop bond trades (1) with promises of profits of $ 150M per year, (2) without use of bank funds , and (3) promises to complete the trades before the settlement date . Beginning with a " sucker transaction" (see Transaction "A" ) E.S.M. allowed the bank to make a quick one- day profit of $ 1,583.75 . Greatly impressed by the fast profit , possibly a "set up" transaction involving only $500M, Mr. Heitman apparently authorized two transactions the following day, each for $ 1MM . E.S.M. "boxed" the bank on these two transactions , artificially overstating the price of the GNMA PC issue by about three points on the buy side , while buying br reporting to buy $ 1MM in FNMA's at the same time . The next day the FNMA's were sold with a point profit . A one point spread was reported as a profit of $10,000 to Mr. Heitman , who must at this point , have been ecstatic about the bank's good fortune . (See Transaction " B" ) . The one point profit is possible but since the securities were not delivered or settled for we may assume that the figures were "matched" to provide a profit of $ 10M. The GNMA's were quoted by Soloman Brothers on December 2 , 1976 at 89% to 91 with the 93 price paid through E.S.M. appearing to be several points above the spread . With each point representing $ 10M , it is easy to speculate that the two to three points or $20M to $30M paid over the probable price of the GNMA PC's security included the $ 10M profit they allowed him to take on the FNMA's transaction . Another transaction begun December 3, 1976 ended December 7 , 1976 resulting in a small profit of $ 1,562.50 . By the settlement date , Mr. Heitman faced a problem, although he must have felt reasonably comfortable with his profits to date . He must come up with $ 930,000 plus accrued interest of $21,343.06 or book a $30M loss and report it to his board making his $13,146.25 profits prior to this time look small . The net loss after eight days of trading with E.S.M. would have been $ 16,853.75 . To make matters worse , the bank did not have the ready cash available to pay for the GNMA participation certificates . Also , Mr. Heitman had been speculating with these E.S.M. bond transactions without Board approval or their knowledge ; a fact he did not want to report to them because of the loss he would have to tell them about . Mr. Heitman was apparently offered a repo deal which meant that he had to in effect enter into a loan transaction with E.S.M. who in effect lent the money to purchase the bond to the bank, a violation of 12 U.S.C. 82. E.S.M. apparently asked for a $30M " haircut" or made a "margin" call on the bank in order to make their so - called loan secure . This occurred December 8 , 1976 and all of these transactions should have been booked at this time . None were booked which resulted in a possible violation of 18 U.S.C. 656 and 1005 by former Chairman of the Board Henry Heitman . Possibly a violation of 18 U.S.C. 1001 as well . E.S.M. might possibly be engaging in a conspiracy to defraud the bank . 271 !" rad Wran J The very sad part about the trap is that a very careful check of the prices of the GNMA's on December 2 , 1976 showed they were quoted at 89 1/2-91 1/2 while on December 8 , 1976 they were roughly 91 If he had not been " sandwiched" by E.S.M. and the transaction was clean , he could have gotten out about even because some brokers even indi -- uk ? cated a one point profit . Instead E.S.M. shuffled him into a repo transaction . Then the market really did drop to where the bonds are now worth about 87 giving the bank a $60,000 loss if they sell or a $60,000 depreciation in the issue if they take delivery on the February 18 , 1977 settlement date . Several points should be made : the bank had no business engaging in trading activities . They had neither the knowledge or experience but probably the most disgusting fact about E.S.M. involvement is the fact that they put the bank in a GNMA PC which is not a type of security normally used in trading activities for the following reasons : (1 ) it is thinly traded with very little volume , (2 ) prices are hard to determine , but probably the most serious reason why GNMA PC's are not traded is that the spreads between bid and asked are usually too large for traders to overcome in a short period of time . Of course , GNMA PC's are U. S. guaranteed obligations and represent good long-term bank investments . However , only a very inexperienced and unlearned banker coerced by an unscrupulous and unethical bond broker would try to trade such issues . 9 There has arisen the possibility that E.S.M. Government Securities , Inc. , was not licensed to do business until December 23 , 1976 and yet the invoices indicate that they were doing business with the bank on December 2 , 1976 prior to the date they would have been authorized . Today , I am notifying in writing Mr. Tim Rigsby , General Counsel , Office of the Comptroller , State of Florida , Tallahassee , Florida , who has advised telephonically that he will investigate the matter . Through Mr. Slobusky , I requested an explanation from Messrs . Ewton and Senaca of how they could do business when they were not authorized . He reported that they claimed that they did business as E.S.M. Securities , Inc. , prior to December 23 , 1976. The advices attached clearly state E.S.M. Government Securities , Inc. , and cast serious questions in regard to their personal integrity , not to mention their moral and business ethics in these unsavory bond transactions . Their actions contributed to Mr. Heitman's loss of his position and the possibility of a substantial loss if the bank should sell the GNMA PC's in the near future . I trust this material is sufficient to provide you with the grounds necessary to protect the banking subsidiaries of American Bancshares , Inc. , from Mr. Ewton and Mr. Senaca . cc: Comptroller - Attn: Mr. Dunian Comptroller - Attn: Mr. Serino Reading File Priority File LNBE Owen Carney CC: BC James Jones iami Subregion BC- 5 LFrank: 272 AGREEMENT BY AND BETWEEN THE SECOND NATIONAL BANK OF NORTH MIAMI NORTH MIAMI , FLORIDA AND THE OFFICE OF THE COMPTROLLER OF THE CURRENCY WHEREAS , The Second National Bank of North Miami , North Miami , Florida (hereinafter the " BANK " ) , and the Comptroller of the Currency (hereinafter the " COMPTROLLER" ) , wish to protect the interests of the depositors , other customers , and shareholders of the BANK, and , toward that end , wish the BANK to operate safely and soundly, and in accordance with all applicable law; NOW THEREFORE , IT IS HEREBY AGREED , between the BANK , through its duly elected and acting Board of Directors , and the COMPTROLLER, through his duly authorized and acting Representative , that commencing no later than the effective date of this Agreement , or as shall otherwise specified within the Articles of this Agreement , the BANK shall operate in compliance with the Articles of this Agreement . ARTICLE I (1) This Agreement shall be construed to be a "written agreement entered into with the agency " , within the meaning of the Financial Institutions Supervisory Act of 1966 , 12 U.S.C. $ 1818 ( b ) ( 1 ) . ARTICLE II (2) As of and after the date of this AGREEMENT , the knowingly BANK shall not purchase , assume , or acquire in any manner, directly or indirectly , in its own capacity or as a fiduciary or nominee , or through its subsidiaries or affiliates , any loan , loan participation , or any other obligation or asset Knowingly in any form whatsoever , FROM : nor shall the BANK extend , endorse , guarantee, or in any manner provide any extension of credit whatsoever , TO cr FOR, any of the following : 273 (a) E.S.M. Securities , Incorporated , Fort Lauderdale , Florida ; (b) any affiliate , as that term is defined in the Banking Act of 1933 [ 12 U.S.C. $ 221a (b) ) , of E.S.. Securities , Incorporated , Fort Lauderdale, Florida; (c) Robert Charles Seneca ; (d) Ronnie Restine Ewton; (e) George Gordon lead ; Alan Richard Novick ; (f) (g) any relative , whether by blood or by marriage , of the above named individuals , including , but not limited to , spouse , sons , daughters , sons-in-law, daughters- in-law, and parents ; (h) any corporation , partnership, joint endeavor, or other enterprise or undertaking whatsoever, controlled by or operated substantially in the interest of any of the above named individuals ; where " control " shall be defined as ownership, whether direct or indirect , of ten percentum ( 10 % ) or more of the stock or other evidence of capital or equity ownership of any such organization; and where " substantial interest" shall be defined as derivation , in any manner whatsoever, of income amounting to ($13,000) more than ten thousand dollars ($10,006,006) per annum as a result of the operation of any 的 Brid such organization . ARTICLE III (3) As of and after the effective date of this Agreement , the Board of Directors of the BANK shall not pay any sum as management fees or other charges whatsoever to its parent holding company, American Bancshares , Incorporated , North Miami , Florida , without the prior written approval of the <. 274 Regional Administrator of National Banks for the Sixth National Bank Region , Atlanta , Georgia (hereinafter the "REGIONAL ADMINISTRATOR" ) . It is expressly understood that no contemplated payment of such management fees or charges shall be approved by the REGIONAL ADMINISTRATOR , unless same shall represent payment for services actually performed , or for goods actually provided , in the calendar year for which payment is sought . ARTICLE IV (4) Within five ( 5) days of the effective date of this Agreement , the Board of Directors of the BANK shall appoint a committee to supervise the BANK's investment portfolio . No person shall be appointed to that committee who shall not have been a Director of the BANK on or before February 23, 1977, and no officer or director of the BANK's parent holding company, American Bancshares , Incorporated , North Miami , Florida , shall be elligible to serve on the committee . (5) The committee , acting for the Board of Directors of the BANK, shall review any existing investment policy of the BANK , and shall , within fifteen ( 15) days of the effective date of this Agreement , adopt a written resolution incorporating a written investment policy of a safe and sound nature , to which the BANK shall strictly adhere . Such resolution shall be submitted to the REGIONAL ADMINISTRATOR for approval , prior to adoption . (6) Said written investment policy shall include , but not necessarily be limited to , the following : (a) a strict definition of the type or kind of security to be purchased and held ; (b) limits upon the concentration of credit in the investment portfolio; (c) (d) a schedule of desired maturities ; specification of the minimum quality of security to be purchased and held . 275 ARTICLE V whose employment or appointment as S.fin (7) No officer of the BANK who shall be employed, an officer shall Commence appointed or otherwise retained after February 23 , 1977 , Band shall be vested with any authority to : (a) loan money or otherwise extend the credit of the BANK ; (b) authorize or otherwise approve or supervise loans or other extensions of credit ; (c) purchase or sell any security or other instrument of investment on behalf of the BANK ; or (a) authorize or otherwise approve or supervise the purchase or sale of any security or other instrument of investment on behalf of the BANK ; UNLESS the prior approval of the REGIONAL ADMINISTRATOR shall have been first obtained . When the BANK shali seek such approval , a written request shall be submitted to the PEGIONAL ADMINISTRATOR , which request shali particularly name the officer , his rank, and the authority for which such approval is sought , including a specification of any lending limits and/or investment restrictions intended to be imposed upon such officer ( s ) . ARTICLE VI (8) It is expressly and clearly understood that if, at any time , the COMPTROLLER , in his sole discretion , deems it appropriate in fulfilling the responsibilities placed upon the COMPTROLLER by the several laws of the United States of America, to undertake any action affecting the BANK, nothing in this Agreement shall in any way inhibit , estop , waive , bar or otherwise impede or prevent the COMPTROLLER from so doing . ARTICLE VII (9) The provisions of this Agreement shall continue in full force and effect until , unless , or inasmuch as such 276 provisions shall be modified , suspended , excepted , waived or terminated by mutual consent of the parties of this Agreement . IN TESTIMONY WHEREOF , the undersigned , designated by the Comptroller of the Currency as his representative , has hereunto set his hand on behalf of the COMPTROLLER. Danel& l Kliter Donald L. Tarleton Regional Administrator of National Banks Sixth National Bank Region Atlanta , Georgia -2-23-77 Date/ 277 IN TESTIMONY WHEREOF , the undersigned , as the duly elected and acting Board of Directors of the BANK , have hereunto set their hands on behalf of the BANK. Benak, Then Thomas C. Bennett 2/27/27 2-23·77 Date limenthal & Blumenghal William H. Çatr' 2.23.77 Date Anthony P Cassinelli -23-72 2-2 Date James D. Evans Date chilis . Halline 1ph D. Hollander 2-23-77 Date David Buge Julian lineetDAVID BERGER -73.7 Date David M. Starke Date 42-23-77 Date Deze In PerfoN Beth M. Thompson Budwig M. Ungaro Date L. G. Whatley Date Page 6 of 6 pages 278 Comptroller ofthe Currency Administrator of National Banks Washington , D. C. 20219 September 30. 1977 Mr. Ronnie R. Ewton Mr. Robert C. Seneca c/o E.S.M. Securities , Inc. One Financial Plaza , Suite 1710 Fort Lauderdale , Florida 33394 Dear Messrs . Ewton and Seneca : I am writing this letter in response to your letter of September 19, 1977 , to Regional Administrator Donald Tarleton in our Atlanta office . Shortly after receiving your letter Mr. Tarleton transmitted it and its attachments to our Washington office for an appropriate response . I am advised that while your letter was undergoing review in our Law Department Mr. Tarleton received a telegram stating that you intended to pursue the matter with his Washington superiors if he did not respond to your demand by a date specified . I believe it appropriate , therefore , that I personally respond to your letter of September 19 , since , as First Deputy Comptroller for Operations , I am Mr. Tarleton's Washington superior. In February of this year , information came to our attention which we believe to be relevant to the performance of our statutorily mandated duties and responsibilities . In one instance , the information came to our attention in the course of a general examination of a national bank . In another , it was derived through confidential communications with another federal regulatory agency . Our review ofthe information thus elicited was conducted both in Washington as well as in Atlanta . On the basis of our evaluation of the information confidentially derived , we considered it appropriate to advise the boards of directors of the six national bank subsidiaries of American Bancshares , Inc. , of such of the information as we properly could . At that time , we requested those banks to agree to certain precautionary measures on a voluntary basis . The directors of the six banks deemed it appropriate to enter into the voluntary Agreements we proposed and with which we have reason to believe you are familiar . Please be advised that we approached the involved banks with the opportunity to enter into voluntary agreements in the exercise of our statutorily mandated responsibility to ensure their safe and sound operation . The action taken by this Office in executing its statutory responsibilities was fully considered and authorized both by myself and the then Acting Comptroller of the Currency . 279 As we advised the subject national banks at the time the voluntary agreements were executed , we neither intend nor anticipate that the agreements will remain effective in perpetuity . In this regard , any national bank with whom we have an agreement is free at any time to request the modification or termination of the agreement should the board of directors believe it unduly burdensome or otherwise inappropriate . You realize , of course , that such matters are properly conducted between the parties to the agreement , and not their affiliates . Please be advised that we shall devote our most careful consideration to any modification of an existing agreement which the involved board of directors may propose . Sincerely, H. Joe Selby First Deputy Comptroller for Operations 280 Comptroller ofthe Currency Administrator of National Banks Washington, D. C. 20219 Banking Circular No. 2 Supplement No. 4 To : Presidents of All National Banks Subject : Improper Securities Practices July 26 , 1977 The unusually high proportions of liquid assets held by banks in recent times have provided a tempting target for high- pressure salesmen offering questionable securities transactions . circular contains examples of transactions which our examiners have found in increasing numbers in recent months . The list is not all - inclusive , but merely representative of high risk situations which have resulted in significant losses or illiquid situations for the banks involved . The list includes offers of : Municipal bonds having partial federal subsidies as fully U. S. Government guaranteed issues . Thinly traded federal agency and government guaranteed issues at prices in excess of current market prices . Informal repurchase arrangements as a price guarantee mechanism used to promote the sale of thinly traded securities or as a means of financing the dealer's securities inventory . Repurchase agreements which do not require proper evidence of collateral securities or which do not specifically identify the security held as collateral thus making it possible for the dealer to obtain funds without adequate collateral support and impossible for the bank to perfect a collateral lien . To purchase a bank's existing portfolio securities under a reverse repurchase agreement ( securities purchased under an agreement to resell ) if the banker is willing to reinvest the cash proceeds in long term government or municipal securities purchased from the dealer , thus transfering the more pronounced long term interest rate risk from the dealer to the bank . If interest rates rise during the term of the repurchase agreement , the longer term securities or other holdings must be liquidated in declining market to refund the maturing repurchase i agreement . is 281 Reverse repurchase or securities borrowed agreements with inadequate collateral . The dealer will price collateral securities in excess of their current market values , often pricing issues at par when they are selling at a discount . "When issued " , " forward placement " and " delayed delivery " securities contracts to prospective purchasers with the verbal assurance that a buyer would not have to accept delivery of the securities . These types of commitments require no investment on the part of a purchaser . In a rising market the commitment can generally be sold at a profit . However , in a declining market banks acquiring such open contractual commitments have in several instances become liable for the purchase of considerable amounts of securities at prices substantially in excess of prevailing market value at settlement date . To arrange reverse repurchase agreements to finance payment for securities delivered under the types of contractual commitments referred to above . This procedure allows the dealer to convert an unsettled sale transaction to a secured receivable due from a bank . The dealer will require cash and delivery prices , plus a comfortable collateral margin . This type of re- po financing generally creates immediate liquidity problems for a bank by having volatile short term source funds support long maturity securities with significant market depreciation . Stand - by or optional delivery forward placements or delayed delivery contracts covering GNMAS with the option to deliver being at the dealer's discretion . The dealer pays the bank a stand - by fee for the privilege of delivering the securities at a fixed price and future date ; if prices go up the option is not exercised , if prices go down the securities are delivered at the original price . In this manner the dealer can hedge the possibility of loss by paying a modest fee . The most an investor can gain is the amount of the fee , while simultaneously incurring a substantial exposure to loss in a declining market . To place the proceeds of a municipal advance refunding issue , which the dealer had underwritten or served as the issuer's financial advisor , on deposit with a bank if the bank agrees to purchase the government securities to be pledged against the escrowed deposit at prices in excess of current market . 282 To guarantee a certain level of income if the banker will grant the dealer blanket or discretionary authority to execute trades on behalf of the bank . Transactions executed under such agreements are seldom in the bank's best interest . Investment officers are advised that good professional practice in connection with all securities transactions demands that they fully educate themselves to the nature of the risk exposures involved both in form of transactions and the underlying securities . It is also fundamental that the financial standing and professional qualifications of the persons or firms soliciting business should be checked out carefully before commitments are made . Transactions should be consistent with the bank's preplanned investment strategy . The following general investment guidelines are recommended for all transactions : Analyze the financial statements of securities firms you do not customarily purchase securities from , prior to transacting business with the firm . Never give a blanket or discretionary investment authority to exercise security transactions on your behalf to any securities dealer . Do not enter into a transaction the terms of which you do not completely understand . • Do not purchase an option or security which you cannot comfortably afford to pay for in full . . Do not advance payment for purchased or resale agreement securities until you are certain the securities have been delivered or until you have obtained proper evidence that the securities exist . Test prices of unusually attractive securities offerings by obtaining substantiating quotes from a reputable local or regional dealer . JACHE John G. Heimann Comptroller of the Currency 283 Mr. BARNARD . Thank you , Mr. Selby. Mr. Gray, in the procedure of bank examinations, does the Home Loan Bank Board or the FSLIC, do they get the benefit of examinations of State-chartered institutions that are not insured by the FSLIC, such as the 71 banks in Ohio? Mr. GRAY. No. Mr. BARNARD. You have no information from them whatsoever? Mr. GRAY. No. Mr. BARNARD. So on the occasion then of this situation, your files, of course, were empty as far as financial statements of these institutions? Mr. GRAY. That is correct. Mr. BARNARD. Mr. Mr. GRAY. Pardon me. That is not correct with respect to those 11 institutions which are members of the Federal Home Loan Bank of Cincinnati which were also members of the ODGF. There are another three which have no insurance whatsoever which are members of the Federal Home Loan BankMr. BARNARD. In other words, you had some that were members of both? The FSLIC and the Ohio-Mr. GRAY. No. In this caseMr. BARNARD. No, I realize there were three that had no insurance whatsoever. Mr. GRAY. Right. That is correct . And still have none. Mr. BARNARD. And the laws of Ohio permit them to operate without any insurance. Mr. GRAY. Yes. Mr. BARNARD. But you indicated there was another exception . What was that exception? Mr. GRAY. No; in this case, we do receive quarterly financial statements from and State examination reports on members of the Federal Home Loan Bank of Cincinnati. Mr. BARNARD. But they are not federally insured? Mr. GRAY. No; they are not federally insured . But they are members of the bankMr. BARNARD. They are Federal savings and loan associations but are not federally insured? Mr. GRAY. They are not Federal savings and loans. They are members of the Federal Home Loan Bank of Cincinnati for credit purposes only. Mr. BARNARD. Oh, for credit purposes . OK. Has the FSLIC been weakened at all because of these new memberships in the fund? Mr. GRAY. No; I am pleased to say no. Mr. BARNARD. Mr. Martin and Ms. Horn, were either of you consulted and counseled by the Governor as far as the bank holiday was concerned? Mr. MARTIN. Yes; I spoke to the Governor on one occasion and I know that President Horn was consulted several times. Mr. BARNARD. Did you concur in his decision that this was the most expeditious decision to make in view of the circumstances? Mr. MARTIN. Mr. Chairman, it is not our role to transgress in this area. This is a State-regulated and chartered institution. We provided the counsel from our experience. In my own case as 50-923 0-85--10 284 former Chairman of the Federal Home Loan Bank Board in other States and other situations we had no time attempted to make the decision or to be compelling in the decision▬▬ Mr. BARNARD. Did you advise him of any precedent, as far as a situation like this was concerned? Ms. HORN. We discussed a number of alternatives over a number of telephone calls, and as the Vice Chairman has indicated, we never recommended a decision since that was not our role in this situation. Among the alternatives that were discussed was a historical situation, and if my memory serves me right it was in the State of Mississippi. That is the one historical situation I remember entering the conversation . Mr. BARNARD . Yes; I understand that there was a precedent for a bank holiday in the State of Mississippi . I do not know how many institutions were involved or how long it occurred, but that was the purpose of my question: Had the Mississippi situation entered into the decision of Governor Celeste? Ms. HORN. It had entered into our discussions . Mr. BARNARD. There was some indication today by some that the Federal Reserve initially-I think we need to clarify this-say, on the first or second day of the crisis, there was not as much interest on the part of the Federal Reserve to get involved as it was after the money market-after the value of the dollar did a somersault. Would you like to address that? Was there any-did that have anything to do to speed up your concern? Mr. MARTIN. No, sir, the concern arose as soon as there was information with regard to Home State, the implications of other ODGF institutions was patent, and our interest was, let us say, stimulated immediately that there was trading in the dollar, there was trading in the dollar of $50 to $70 billion in foreign exchange trading most days. And that traders may have alluded to Ohio to justify some directional movement in the dollar is neither here nor there. Mr. BARNARD. My time has expired on this first round, but we shall return . Mr. Craig . Mr. CRAIG. Thank you very much, Mr. Chairman. I appreciate the testimony of all of the members of the panel. Mr. Gray, in your experience with the Home Loan Bank Board and the FSLIC, have you ever had a situation which you had to utilize a procedure because a member institution was having a run on it? Mr. GRAY. Not out of the ordinary. What we have done in one particular case was to establish a limit of credit available at the Federal Home Loan Bank for regulatory purposes. But that is the only case I am aware of. Mr. CRAIG. So you could not refer to a procedure or a plan of action that you would utilize in the case of a member institution getting into this kind of trouble? Mr. GRAY. Well, we certainly would, as a collateral lender, desire to provide credit for liquidity purposes to such an institution , to the extent that collateral was available. Mr. CRAIG. Have you ever closed one down? 285 Mr. GRAY. That was experiencing a run? No; I do not believe so. Fortunately. Mr. CRAIG. In your ability to approve institutions coming into the FSLIC, do you have carte blanche authority there? Mr. GRAY. In our ability to what? Mr. CRAIG. Do you do carte blanche approval? Mr. GRAY. The Federal Home Loan Bank Board approves all applications for insurance of accounts. Mr. CRAIG . Were you asked during this time to accept all members? Mr. GRAY. Yes; I was. By a Member of the Congress. Mr. CRAIG. And because of the Federal law that regulates you and the procedure involved under that law, you did not have carte blanche-you could not offer carte blanche authority or approval? Mr. GRAY. As I noted in my opening statement, this would contravene both the spirit and the letter of the National Housing Act. Mr. CRAIG. Mr. Selby, in the narrative you gave us of the episodes in Florida involving principals in ESM and also some of their banking efforts and at a time when two principals , particularly offered to and a Mr. Warner purchased I believe it was American Bancshares , which is a holding company with six nationals? Mr. SELBY. That is correct. Mr. CRAIG . And they were then converted to State banks? Mr. SELBY. Correct. Mr. CRAIG. In your opinion, why did that conversion take place from Federal to State? Mr. SELBY. I do not have any definitive answer. Mr. CRAIG. In your opinion. Mr. SELBY. My opinion- one reason generally is they did not want to live under our agreements, possibly. Mr. CRAIG . Your agreements differingMr. SELBY. That limited the national banks from dealing specifically with ESM and the principals and relatives and affiliates of ESM. Now, that is only presumption on my part. I do not know that. Mr. CRAIG. In your Federal relationship or as the Comptroller of the Currency and a regulator versus State regulation, where would you say the level of scrutiny differs and the thoroughness of investigation? Mr. SELBY. At the State level versus▬▬ Mr. CRAIG. The State versus Federal in this particular situation? Mr. SELBY. I just cannot answer that. I know that we scrutinize it and I also know that the other Federal agencies scrutinize it . I cannot speak for the States . My guess is that certainly not in 1977. I think now we have in place better mechanisms where not only the Federal but the State authorities are privy to shared information, mainly through the Federal Financial Institutions Examination Counsel. We routinely now share this information and indeed with the State authorities if they want the information . Mr. CRAIG. In other words, what you are saying then, a move from national to State could be a result of the ownership of a holding company not wanting to play by one set of rules, therefore moving to play by another set? 286 Mr. SELBY. Well, the holding company is the Federal Reserve , and obviouslyMr. CRAIG. I understand that. Mr. SELBY [ continuing]. Has the authority under change of control. The banks converting to a State oftentimes their business plan calls for them to convert. It is cheaper maybe. They have different plans. In this particular instance, I do not know other than we put the agreements on these banks to insulate them against Mr. CRAIG . Down to and including any relative? Mr. SELBY. That is correct. To insulate them and they attempted to get out from under those agreements and we were unrelenting and so I assume their business plan called for them to convert. Mr. CRAIG. Thank you . My time is up. Mr. BARNARD. Mr. Spratt? Mr. SPRATT. Mr. Selby, it seems that the Comptroller's Office by fortune and chance found out about ESM in time to alert your member banks, national banks, and avert substantial losses on the part of these national banks. Mr. SELBY. Hopefully, by deliberate chance. Mr. SPRATT. By deliberate chance? Mr. SELBY. Through the offices of our examiners . Mr. SPRATT. We will not pursue that. OK. In any event, you found out about it. Mr. SELBY. Yes. Mr. SPRATT. Do you think that your office should continue to rely upon chance discoveries of this kind, or fortunate deliberate opportunities of this kind , or should have a regular mechanism by which these other ESM's presumably out there in the securities markets are ferreted out and attention is relayed to your member institutions to be on the alert? Mr. SELBY. Well, I think there should be a mechanism to perhaps share information such as ESM when one agency finds it, which I think we did, maybe not as well as we would do it now. But, yes, there should be sharing of that information, and I think we do it, quite frankly. Mr. SPRATT. And with the StateMr. SELBY. With the States . Mr. SPRATT. With the State funds? Mr. SELBY. Yes. Mr. SPRATT. In this particular case, however, no similar bulletin or alert went out to the State funds? Mr. SELBY. No. Mr. SPRATT. Is it institutionalized now that an alert would go out to State funds? Mr. SELBY. Not to the State funds. It would go out through the Federal mechanism to not only Federal institutions, that is, savings and loans and banks, through the FFIEC but it would alsowe would afford the States the opportunity to have that information and do the same things with the State institutions. So I would assume whatever funds are there we would also be aware of. As a matter of fact, we are working right now through the-Mr. SPRATT. Do you have a list , are there other memoranda like the suede shoe memorandum about ESM that has gone out. Do you 287 have a list of suspects, securities dealers with whom national banks and others should not deal? Mr. SELBY. I imagine that our staff could put together a list of the ones that we are most suspicious of. Mr. SPRATT. But is there such a list in circulation now? Mr. SELBY. No, no. Mr. SPRATT. If you do not advocate regulation or periodic audit, do you not think that information should be compiled and made available? Mr. SELBY. Not if you go under the premise that our examiners are trained sufficiently and understand the transactions sufficiently and go in and examine the banks and institutions sufficiently to ensure that the banks are not transacting in speculative ventures and are covering their position with collateral. Mr. SPRATT. But there are other examiners. There are State regulatory examiners. There are Fed examiners . There are FDIC examiners. Why not share your information with them in a systematic way? Mr. SELBY. Well, I think we do now, was my point. Mr. SPRATT. I am pursuing that still. If there is no compilation, how are you-you have got a body of information, a data bank of suspect securities dealers, but it is not compiled and it is not being, as I understand it, routinely sent out to other regulatory agencies by way of bulletin or some similar form of contact. Mr. SELBY. Well, it gets a little iffy, if you ask us to take a suspected bond dealer or securities dealer, and send out a mass mailing that says: " Don't trust this guy." I am not a lawyer, but I do not think I would want to sign that myself. Mr. SPRATT. Do not sign it. Just send it out under the name of— you have got better immunity than the Ohio State Guarnatee Fund which isMr. SELBY. I do not think my liability insurance covers me that much. Mr. SPRATT. I think you have got sovereign immunity possibly. I understand, and there may be privileged communications withbut if that is true, if we have legal liable barriers, then maybe we ought to consider some way to remove the barriers, mitigate the barriers, in order to encourage to disseminate this needed information. Mr. SELBY. I agree with your theory that we should share what we find with other regulators as they examine their institutions and supervise them. I agree with that. Mr. SPRATT. Am I out of time? Mr. BARNARD. No. Mr. SPRATT. If I understand the testimony-I believe it is Mr. Gray who implies that the examination performed by the Ohio Savings and Loan Division was quote " less rigorous than Federal procedures ," and in fact, the lessened rigor was held out as an inducement to membership in Ohio Guarantee. Your statement says "that the Ohio Guarantee Fund justified itself to its membership by offering less rigorous procedures than federally required . " Is that your empirical observation having dealt with them and looked back at what was happening in Ohio? 288 Mr. GRAY. In all candor; yes. There are apparently other historic reasons why institutions chose to be members: that is to say, they were not held to the same constraints on interest that could be paid on passbook accounts, and so forth . I reached this conclusion on the basis of conversations with experienced staff that has been around for some time. Certainly long before I came to the Bank Board. Mr. SPRATT. Out of time? Thank you, Mr. Chairman. Mr. BARNARD. Thank you. Mr. Saxton. Mr. SAXTON. Mr. Gray, this morning when Mr. Hunsche was testifying, I think he testified that the Ohio Deposit Guarantee Fund had in its fund a percentage of about 2.9 percent of the gross holdings of its member banks. Does that sound right? I believe that is the figure that he gave us this morning. Mr. GRAY. I have to take his word for that. Mr. SAXTON. And he contrasted that in the same light to about one-half of 1 percent figure for the FSLIC . Mr. GRAY. That would not be correct. I think the closest, the most recent figure would be about 0.76 percent, as a ratio of FSLIC reserves to deposits at our insured institutions. Mr. SAXTON. In any event, 0.76 percent. Why is it that the FSLIC is able to conduct its business with that kind of reserve while at 2.9 percent or almost 3 percent, the Ohio Deposit Guarantee Fund was not? Mr. GRAY. Well, obviously we would like to strengthen the reserves of the Federal Savings and Loan Insurance Corporation, as you know, and one of the reasons why that ratio has developed as it has is because of the frankly excessive growth in liabilities and assets at our FSLIC-insured institutions over the last several years under liability deregulation. We have taken actions now through an additional special premium to increase the reserves of the fund. But to answer you specifically, I think it is the full faith and credit of the United States which at least implicitly stands behind both the FSLIC and the FDIC. Mr. SAXTON. Would you also say that in insurance language we often talk about the spread of risk? And with the FSLIC there are many more member banks, member institutions? Is that an important factor in contrasting the Ohio Deposit Guarantee Fund with the FSLIC? Mr. GRAY. Well, in all honesty I do not necessarily think that that in itself would represent an advantage as such. Obviously, the reserves of the fund depend on real dollars, real assets . I am not suggesting this would happen but I suppose you could say that with as many members as we have we could, particularly if the law were changed, raise greater amounts of funds through special premiums. But essentially it is full faith and credit of the United States itself which provides public confidence in our institutions. Mr. SAXTON. The trustees in the Ohio Deposit Guarantee Fund who administered it or who were the backbone organization of it are appointed, were appointed, by member banks; is that correct? Member thrift institutions? Mr. GRAY. I gather that is correct. At least that is what the gentleman previously testified to. 289 Mr. SAXTON. Is there any danger in having member institutions actually represent themselves and control themselves? Is that a built-in problem with private insurance funds? Mr. GRAY. There is always the potential for conflict of interest, although I say that generically, without any great knowledge of the Ohio Deposit Guarantee Fund. And in our efforts to protect the FSLIC, of course, we do have conflict-of-interest regulations which are intended to deal with that problem. Mr. SAXTON. I am not so concerned perhaps about actual conflict of interest. I am just concerned about who watches the henhouse better, someone who is completely disassociated with an organization or someone who has a rather close association with member institutions. Mr. GRAY. I think as a general proposition it would be better to have independent governors for that kind of system . Mr. SAXTON. Thank you, Mr. Chairman. Mr. BARNARD. Mr. Kindness. Mr. KINDNESs. Thank you , Mr. Chairman. I will not impose on the time of the subcommittee further with regard to this panel. Thank you. Mr. BARNARD. Ms. Oakar. Ms. OAKAR. Thank you , Mr. Chairman. Ms. Horn, you testified that on March 9 you took action and made some initiations with respect to the impending crisis in Ohio. I want to congratulate you and the Fed on that. You did it under the spirit of the law. But you took that initiation , and I think that it did play a role, at least temporarily, in giving some element of confidence to the situation . I just wanted to congratulate you on that. Mr. Gray, Mr. Craig asked a very important question which is why I am so interested in potential conflicts of interest. I think what the distinguished minority leader asked was has the Federal Home Loan Bank Board acted or ever had a situation that was extraordinary in which they really took the bull by the horns and acted. I think you answered, not to your knowledge. I am concerned about some of the transactions . For instance I look at the situation with the Financial Corp. of America and its subsidiary in California that had a run on it . I think that was fairly extraordinary. Their subsidiary had some real problems. What the Federal Home Loan Bank Board did, and I realize they were federally insured, but you did extraordinary things . The institution was given unlimited borrowing rights exceeding normal collateralization Mr. GRAY. That is not correct. MS. OAKAR. Well, how much of the borrowing—— Mr. GRAY. That is absolutely not correct. Ms. OAKAR. How much has the Home Loan Bank Board lent this institution since October? Mr. GRAY. From October 31 , 1984, to March 31 , 1985, the Federal Home Loan Bank of San Francisco advanced $5.6 billion to American Savings & Loan Association in California. During that same period, American repaid $6.5 billion, for a reduction in its net outstanding advances from the San Francisco Bank of about $900 million. I would also note that in every instance, Congresswoman Oakar, the only credit that has been provided to any of our institu- 290 tions, including American, has been under the collateralization requirements that are imposed by the individual Federal Home Loan Banks. MS . OAKAR. Let me just say this. Mr. Chairman, it is my understanding that they have lent at least $4 billion which is no small amount of money. By the way, that approximates the total assets of all 72 institutions that were nonfederally insured, so that was a pretty extraordinary undertaking . I point that out because there have been extraordinary situations. And you may have been right about it, but if I can pursue this. That is why I am concerned about the rumors, and innuendos, concerning your actions or nonactions related to the Ohio situation . I asked you two questions before the full Banking Committee and I asked you very specifically did you , prior to March 13 or any day thereafter, get any advice on how to handle the situation from the Secretary of Treasury or anybody from the White House. You answered that was not relevant. You would not answer it. Then we have a situation whether it is accurate or not, in which the Wall Street Journal publishes an article that says, indeed, Secretary Baker discussed this issue with you after having a meeting in terms of how to decide what the Federal response should be. They concluded that if the crisis developed it should remain a problem of the Democratic administration in Ohio. The role that the Federal regulators should play, whether it is the Federal Home Loan Bank Board or the Federal Reserve Board, should be above politics . I do not understand why you would not answer the questions during the Banking Committee hearing, but I will give you another chance now. Mr. GRAY. I have been waiting for your question which I am happy to answer. Ms. OAKAR. Good. I think you could have solved a lot of problems on March 27 if you had answered my two questions. Mr. GRAY. Well, let me just say, with all due respect to you as a Member of the Congress of the United States, any innuendo, any discussion of partisan politics, was raised by you and certainly not by me. For example, and the record will show this, you referred to the upcoming Governor's race in Ohio. Ms. OAKAR. That is right. Mr. GRAY. You referred to my failure to meet with members of both sides of the aisle , Democrats as well as Republicans. Now, you know full well that an invitation was extended to you and Congressman Luken and to others, to come to my officeMs. OAKAR. That is right. Mr. GRAY [continuing]. To meet with me—— MS . OAKAR. And you know full well why I did not attend. Mr. GRAY. Well , no, I do not. Ms. OAKAR. Because you chose to meet with Congressman Wylie privately after we had all agreed on an 11:30 meeting, you chose to meet him for breakfast and my colleague from Ohio can verify that. Mr. LUKEN. If the gentlelady will yield . Ms. OAKAR. I will be happy to yield. Mr. LUKEN. That is exactly what happened . We have the floor. We will ask you the questions. 291 Mr. GRAY. Well, just a minute. She just made an observation and I am going to answer it. Mr. LUKEN. Are you running this, Mr. Chairman . Mr. GRAY. Let me just say, Congresswoman Oakar, that the meeting I had with Congressman Wylie had been set on my calendar 3 weeks before and it was to deal specifically with legislation which was introduced by request by Congressman Wylie and by Chairman St Germain of the House Banking Committee. That was the purpose of that meeting . MS. OAKAR. Let me yield to my colleague. Mr. LUKEN. As the gentlelady has said, at extensive meetings on March 13, with your counsel, we attempted to get a meeting with you that night. Sixteen or more representatives of savings and loans of Ohio were present pleading to meet with you . You were unavailable we were told until 11:30 the following morning. That is what we were told by your counsel seated here today. You were not available until 11:30 . Mr. Wylie was there. At 9:30 the following morning Mr. Wylie called me and said he had had breakfast with you, had discussed these issues , and told me what your decisions were. Those are the facts. I repeat, he called me at 9:30, said he had breakfast with you. I was shocked. And he had discussed these issues and he laid out what the decisions were which you later confirmed. I yield back to the gentlelady. Mr. GRAY. Well, I cannot speak for Congressman Wylie, but I did tell him at breakfast, which began at 8 , that the Bank Board was going to make a very strong effort to expedite applications as soon and as quickly as possible . Mr. BARNARD. Just a second. Let me advise that we owe Mr. Luken time now. Ms. Oakar's time has expired. Mr. GRAY. I did not answer, her question which I thinkMr. BARNARD. I mean I think they are participating together on that. Mr. LUKEN. I will proceed. Mr. Gray, we did meet with you on March 13, and I will say right now that if you had taken action at that time as we requested, that the closings of Friday, March 15, would not have occurred. Now, I want to say exactly why I say that. First of all, your statements are inconsistent with those of Congressman Gradison and Congressman Wylie, as indicated in the Wall Street Journal. Mr. Wylie said that you did stall at that time. Mr. Gradison states that you have reversed yourself since . Now, I want to ask you -on March 13 did we ask you to waive the 10-day waiting period? The 10-day notice period? And what was your answer? Mr. GRAY. Counsel advised me, and you were there, that there was a 10-day notice period which had to be observed. Mr. LUKEN. And we pleaded with you to waive it and you said, "no way," did you not? Mr. GRAY. Well , I take the advice of my lawyer, who probably knows more about these things than I do. Mr. LUKEN. Did you take it a week later when you did waive it? Mr. GRAY. Yes, I did. Mr. LUKEN. Oh. Mr. GRAY. On the advice of counsel. 292 Mr. LUKEN. It is his fault. And at that we asked you to apply extra help to get other examiners in, and did you not tell us that you were stretched so thinMr. GRAY. That is right. Mr. LUKEN. That you could not possibly get any more help. Mr. GRAY. That is essentially correct. Mr. LUKEN. And a week later you found all that help that you have just been describing. Mr. GRAY. Well, you know, on Sunday evening, as my testimony indicates, I met with Chairman Volcker in his office and at that time Chairman Volcker pledged to the Federal Home Loan Bank Board as many examiners as we would need to bring about the expeditious processing of these applications . Mr. LUKEN. You had Chairman Volcker's people with you on March 13, and did you or did you not tell us that it was an Ohio problem, quote "You are in the wrong city. You should be in Columbus"? Did you say that, Mr. Gray? Mr. GRAY. I said I thought that individuals should be at the State capital talking about this problem. Mr. LUKEN. And when we pleaded on behalf of the depositors, did you or did you not say that the depositors should have known that they were not federally insured when they deposited in the State institutions? Mr. GRAY. You know, I do not recall that statement, but I did Mr. LUKEN. Well, I will refresh your recollection . You did. Mr. GRAY. WellMr. LUKEN. And when we talked about the savings and loans and helping the depositors, you said "After all, the savings and loans had the opportunity previously to join FSLIC and they had refused it." You did not say that once. I bet you said that at least six times in our brief meeting. Mr. GRAY. That is a historical fact. Mr. LUKEN. And then you would characterize that as cooperative, that you were going to extend yourself? Those reactions that you were extending yourself for the depositors? Mr. GRAY. You know, I said repeatedly, Congressman, that the Federal Home Loan Bank Board and the FSLIC were committing to do everything possible to expedite applications for insurance of accounts as quickly as possible. Mr. LUKEN. But you said you had no help. You had no legal authority. How were you going to expedite it if you did not have anybody to apply to processing the applications. And if you had to follow the law, which you said could not allow you to expedite it. And finally, I want to ask one more question. When the representative of the S&L, his last question to you was, "Give us 30 days. We will close for 30 days and can you examine these in 30 days," and you said you would not even consider it . Is that not true? Mr. GRAY. I said that with a very severe shortage of 750 examiners around the country that would not be possible, and that was in specific response-Mr. LUKEN. But you have managed to do it in the last 2 weeks. 293 Mr. GRAY. But let me finish what I am saying . That was in specific response to a suggestion that all of our examiners be deployed summarily to the State of Ohio. Mr. LUKEN. No. That was not the―― Mr. GRAY. Well, it certainly was. Mr. LUKEN. The suggestion was-would you at leastMr. GRAY. Congressman Gradison made that suggestion. Mr. LUKEN. It was not Congressman Gradison. It was the representative of the thrift, and he said that if we close for 30 days- he said he recognized it that you were not going to help, so he said if we close for 30 days will you at least examine them within that 30 days. And you said, "No way." You would not even consider it. And now you are saying that you have already done it in less than 30 days. Mr. GRAY. Well, now, I have tried to explain to you that on the following Sunday evening, Chairman Volcker pledged the full support of the Federal Reserve and as a matter of fact, has provided 140 examiners - 140-to help the Bank Board in this process. Ms. OAKAR. Chairman Volcker has been great. Will the gentleman yield? I just have to ask you the question . Did Secretary Baker ever call you and tell you to stall and stonewall the Ohio crisis? Mr. GRAY. I am glad I get a chance to answer your question . Ms. OAKAR. Mr. Chairman, I think he should answer. Whatever you want to do. You are investigating it, so maybe you can get it in writing. Mr. GRAY. I am glad I get a chance to answer that question . I would like to do it briefly. First of all, the Federal Home Loan Bank Board has traditionally, over many, many years, exchanged information with the Treasury, which is under the Chief Fiscal Officer of the United States , with other regulatory agencies, including the Federal Reserve. And we have continued to do that . Particularly in extraordinary situations. Now, I want to assure you that I have never taken instructions from anyone, anyone, whether in the White House or Treasury or anywhere else, nor has any other member of the Federal Home Loan Bank Board because, in all honesty, we are an independent agency. Ms. OAKAR. But did you discuss the politics in Ohio? Mr. GRAY. I absolutely never discussed any kind of politics in the State of Ohio. Ms. OAKAR. Well, it is referred to in the Wall Street Journal article. Mr. GRAY. Well, that is pure unadulterated fiction. Because no one ever called me to talk about politics in Ohio. The first time I ever became aware of the plan alleged in the Wall Street Journal was when I read it in the Wall Street Journal. MS. OAKAR. I do not think the question has been answered specifically, but I will leave that to the committee to investigate. Mr. BARNARD. Thank you very much . Ms. Horn, how much did the Federal Reserve Bank lend out of its discount window to these Ohio institutions? Ms. HORN . Altogether―― 294 Mr. BARNARD. I am not asking you individually, but cumulatively? Ms. HORN. Altogether, throughout this whole period, we have lent in the range of $70 million . Mr. BARNARD. $70 million. Ms. HORN . That is a cumulative figure . Of course, it has been paid back. Mr. BARNARD. For the uninformed, all of that had to be secured . Ms. HORN. Yes, it was secured . Mr. BARNARD. And what maturities are you working on for those loans? Ms. HORN. They are relatively short-term loans. Mr. BARNARD. Two weeks? Four weeks? Ms. HORN. We do not have a designated maturity, but we have overall guidelines limiting the frequency that an institution can obtain adjustment credit. I cannot answer your question with a specific number of days, but we are talking about short periods of time. Mr. BARNARD. Do you think that in some of these more troubled institutions that-even though you are secured-you will be a little bit more liberal in renewing these discount notes? Ms. HORN. There is no question about it . The guidelines are in place so that we can use judgment in respect to them. As we review the needs of the institutions, we will be adhering to the guidelines-Mr. BARNARD. And you are not setting precedent here? This precedent is already established? Ms. HORN . I do not quite understand the question . Mr. BARNARD. Is this the same practice that you use with other member banks? Ms. HORN . Absolutely. Mr. BARNARD . Mr. Gray, did any of the 14 Ohio institutions involved, which were members of the Cincinnati Home Loan Bank, apply formally or informally for credit? Mr. GRAY. No, they did not. Mr. BARNARD. Now, we want to get-well, one other question, Mr. Gray. Because of this situation in Ohio, do you recommend a more formal association with State savings and loan agencies or even State private insurance funds, such as the exchange of examinations and so forth? Especially since you are subject to be called on to either- no, you are not necessarily, but Mr. Martin is, the Federal Reserve is subject to be called on as far as the discount window is concerned . Of course, you are not eligible to loan to these State-chartered institutions. Am I correct? Mr. GRAY. That is correct Mr. BARNARD . The Home Loan Bank BoardMr. GRAY [continuing]. As to Ohio institutions that were not members of the Federal Home Loan Bank of Cincinnati. Mr. BARNARD. Mr. Martin? Mr. MARTIN. Mr. Chairman, I would assure you that the results of the Ohio experience, since it is the most recent of its type, will be communicated in our training sessions with the various officers , discount officers, and others within the whole Federal Reserve System, and will be communicated to those State officials who are 295 working with our Federal Reserve bank presidents and officials in the so-called training and orientation to improve both their and our operations. This experience will not go on the shelf. Mr. GRAY. Incidentally, Mr. Chairman, we do exchange information of a supervisory nature with other State savings institutions regulatory agencies. Mr. BARNARD. Including Ohio? Mr. GRAY. With the State regulatory agencies. Mr. BARNARD. Do they exchange information with you though? That is the question. Now, I mean, are they furnishing you a copy of their examinations? Mr. GRAY. Well, we are really talking here about FSLIC-insured institutions. Mr. BARNARD. OK, yes. We need to, at this point in time, move our discussion to some of the practices- policies and practice of supervisory agencies, especially as it is associated with ESM . And I will ask all of you this. What procedures-Home Loan Bank Board, Comptroller, and the Federal Reserve-are your examiners supposed to follow, during the examination process, to verify that an institution which has entered into a repo agreement has actual possession of those securities? Mr. GRAY. Well, in the case of the Federal Home Loan Bank Board, repos and reverse repos are subject to two levels of review. The first is the required annual audit by an accounting firm . Audit procedures require verifications . The second level of review would be during an actual examination of the institution . Examinations procedures would require verification that the association's records of the transaction were complete, adequately maintained, and they would further require a review of such transactions to see if they were in keeping with the Bank Board's regulations and guidelines . Unusual positions or violations such as excess collateralization which we have dealt with in guidelines which were issued on July 13, 1981 , would warrant comment and further investigation by our supervisory personnel. Mr. BARNARD. Mr. Martin? Mr. MARTIN. Our examiners, according to a series of instructions, written instructions, they have in these matters, check on the documentation, check on the credit worthiness of the institutions with which the banker is dealing, check on the internal auditing procedures within that bank with regard to documentation, location of collateral and so forth, and on and on. We have a rather elaborate system of checking in it. Mr. SELBY. Well, our examiners' handbook requires that our examiners verify that the banks have taken possession of the securities period. Mr. BARNARD. In that event then, Mr. Gray, were these procedures followed in the September 1984 examination of the American Savings and Loan? Mr. GRAY. Yes, I believe they were. Mr. BARNARD. Did you know that American's securities were mixed in with everybody else's in ESM's account at Bradford Trust? Mr. GRAY. Yes, yes . Bradford Trust? Let me say, that I am a bit hesitant, in all candor, to talk about it. 296 Mr. BARNARD. I beg your pardon? Mr. GRAY. I am a bit reluctant in all candor to talk in this public forum about an ongoing institution where confidence is important and certainly we would be pleased to provide members of the subcommittee with this information privately. I really am reluctant to get into great detail publicly because of the possible harm it could cause to any individual institution. Mr. BARNARD. I can understand that, Mr. Gray, and we certainly do concur with you in that particular situation . Mr. Gray, the subcommittee has information that on a number of occasions between 1980 and 1985, the Federal Home Loan Bank Board in its examination supervisory capacities came across unsafe and unsound transactions involving ESM. For example, in 1980 and 1981 , the Bank Board participated in a joint examination of Unity Savings Association of Chicago and the issuance of a cease-anddesist order involving Unity's $200 million transaction with ESM. You have advised the subcommittee that in 1982, the Federal Home Loan Bank of Cincinnati was aware of rumors of Home State's dealings with ESM. And yet these rumors were not investigated. In 1983 and in 1984, immediately after ESM's principal founder, Ronnie Ewton, was made a board member and put on the executive committee of American Savings and Loan of Florida, an FSLIC institution , American entered into a large and unsafe transaction with ESM . You advised the subcommittee that the FSLIC insurance fund is likely to sustain an $8 million loss because of the dealings of federally insured thrifts with ESM. Could you provide us with more details as to that loss? Mr. GRAY. I will be happy to provide information for the record. [The information referred to follows: ] 297 1700 G Street, N.W. Washington, D.C. 20552 Federal Home Loan Bank System Federal Home Loan Mortgage Corporation ||||| Federal Savings and Loan Insurance Corporation Federal Home Loan Bank Board OFFICE OF EXAMINATIONS AND SUPERVISION April 11 , 1985 RECEIVED 121985 Mr. Peter S. Barash Staff Director Commerce , Consumer , and Monetary Affairs Subcommittee of the Committee on Government Operations Rayburn House Office Building , Room B-377 Washington, DC 20515 COMMERCE, CONSUMER AND MONETARY AFFAIRS SUBCOMMITTEE Dear Mr. Barash : During the April 3 , 1985 hearing concerning Ohio privately insured savings and loans, several matters were discussed regarding which we agreed to provide you with additional information . Our estimate of an $8 million dollar potential loss to the FSLIC was based upon the situation of two institutions which are now in the hands of the FSLIC. This estimate is based upon the assumption that liquidation will be necessary in these two cases and represents a worst-case scenario. The actual loss may be considerably less depending on numerous other factors. I have enclosed for your information a copy of our memorandum R 6-2 which discusses over-collateralization of reverse repurchase agreements and provides guidelines for appropriate collateralization levels . This memorandum was referred to by Chairman Gray during the course of the hearing . Finally, I am enclosing for your information a copy of a phone log from the Federal Home Loan Bank of Cincinnati for the period from March 11 through April 4 , 1985. (This is a log of their on-going monitoring of the situation . ) Please let me know if I can be of any further assistance . Very truly yours, Willi am Shilling William J. Schilling Director Enclosures CC: Chairman Gray 298 Mr. BARNARD. Evidently, we have lost our records of that, Mr. Chairman, but we will find them. Mr. Chairman, based on your supervisory knowledge of ESM's speculative and dangerous transactions with financial institutions, did youoppose in any way the placing of Ronnie Ewton on the board and the executive committee of American Savings and Loan? Mr. GRAY. American Savings-Mr. BARNARD. Or to the Home Loan Bank Board? Mr. GRAY. I do not believe we had anything to say about that in particular. Counsel advises that this is a State-chartered institution. Mr. BARNARD . Beg your pardon? Mr. GRAY. Counsel advises that this is a State-chartered institution and, frankly, apparently we do not have jurisdiction-Mr. BARNARD. It was FSLIC-insured, though? Mr. GRAY. Yes. It is FSLIC-insured . Mr. BARNARD . But would not your authority run to that because of that? Because of FSLIC's insurance, would you not have the jurisdiction to make a determination there? Mr. GRAY. We can only remove a director if there are grounds based on a violation of rules and regulations of the Federal Savings and Loan Insurance Corporation. Mr. BARNARD . In other words, there was no objection to Mr. Ewton then being on the board of American Savings and Loan? Mr. GRAY. Not on the basis of our discretionary authority, I gather from counsel. Mr. BARNARD. Given the large exposure of American Savings and Loan and its ESM transaction and the involvement of Marvin Warner in initiating those transactions, can you give us an explanation why the Home Loan Bank Board permitted the institution to spend $26 million of its precious capital to buy back Mr. Warner's 50-percent ownership in American? Again, because of FSLIC. Mr. GRAY. The principal supervisory agent of the Federal Home Loan Bank of Atlanta approved this transaction in which American purchased the Warner stock from Shepard Broad. The purchase price was to be replaced either by the association reselling the stock or by the sales of subordinated debt. The principal supervisory agent in this connection, urged by the State of Florida, as I understand, felt that it would be in the best interests of the association for this transaction to take place. Mr. BARNARD. Was that capital replaced? Did they sell the stock subsequent to that? Mr. GRAY. Well, it is in the process of being replaced. I think they have a commitment to do so within 18 to 24 months. Mr. BARNARD. Let me get back to the six FSLIC- insured institutions that had financial dealings with ESM. We ask whether the latest two examinations of those institutions- if those examinations mentioned or criticized their dealings with ESM? Mr. GRAY. As I recall - and you are talking about the six-there were comments on several of them . On others apparently there was not. Mr. BARNARD. I think there was a mention of it on two of the examinations but not the other four. Mr. GRAY. That is right. 299 Mr. BARNARD. Is there any reason why it would not have been uniform ? Mr. GRAY. Well, apparently the reason that there was no comment is because their position could have been de minimis or could have been closed out in these instances. Mr. BARNARD. As you can see all the members of the panel - we are concerned about security dealers, and what it has done, especially as far as this particular situation in Ohio is concerned. And frankly, I guess that is much of the reason why we are having these unfortunate hearings today. I guess it is unfortunate, likewise, that the Federal Reserve has not anticipated this sort of event coming for a long time. And I would just like to quote from some testimony given by Mr. Tony Solomon, who was president of the New York Fed back in May 1982. When he testified before the Senate Banking Committee concerning the Drysdale collapse he said, and I quote, [I]n today's situation, with everybody traumatized by what has happened [ in the Drysdale situation ] and looking very carefully and reviewing their situation, I would say it was extremely unlikely that there is another Drysdale around. Now, Mr. Martin, in view of that, and we have had since Drysdale, Lombard-Wall, the Lion Capital, and now ESM . How manywhat is the attitude now of the Fed regarding these nonregistered security dealers? Mr. MARTIN. Mr. Chairman, as my colleague, the new President of the Federal Reserve of New York, has this week testified before another committee of the House of Representatives, we are aware that the volume of trading in these markets is enormous, as I alluded to before. We are aware that there may be need for additional flows of information, additional analysis, even additional supervision. We are going to go ahead, as of May 1 , and initiate a reporting-voluntary admittedly-reporting process for the secondary dealers in this market. We are gathering information and reviewing the situation given ESM and just the volume of trading there. Mr. BARNARD. You would not agree then with the statement that [your supervision of] the Government securities market is really aimed at the maintenance of an orderly market for U.S. debt securities and not at the detection of fraudulent practices or protecting investors? Mr. MARTIN. Well, the market has of course a whole series of purposes. As a market it is a way of financing our very, very large deficit and the turnover of that deficit. In terms of our responsibility we have not been accorded the specifics in a complete way of protecting depositors or holders of securities, although we make every effort to maintain an orderly market and the sound group of institutions, particularly the primary dealers, because they are the big volume operators. Mr. BARNARD . In other words, are you saying that if the normal bank examination and supervisory procedures are carried out- so far as banks are concerned and savings and loans-the institutions do not need any more protection, from the standpoint of registering all security dealers? Mr. MARTIN. I think that every involved agency, State or Federal, can afford to sharpen its procedures in reviewing these kinds of 300 relationships, to see how adequate they are given today's markets. But I am not here to advocate additional regulations. Mr. BARNARD. Mr. Martin, in 1980, the Federal Reserve participated with the Treasury and the SEC in a study of fraudulent practices in the Government securities market. What steps has the Federal Reserve taken as a result of that study? Mr. MARTIN. We have enhanced our examination procedures and instructions to our examiners. We have stepped up our surveillance of the primary dealers in New York through a kind of a suboffice headed by Edward Ging of the Fed of New York, so that we get more information more regularly, do more analyses, have more people, person hours devoted to that process at the Fed in New York. Mr. BARNARD. Do you feel like that is a satisfactory solution to the present problem? Mr. MARTIN. I think, sir, that we-I am sorry to be repetitive. I believe that our present review of those procedures will lead us to an answer which we do not have at this moment. I would say it warrants restudy and reappraisal which we are in the process of doing. Mr. BARNARD. Mr. Martin , I think that, in my own opinion, and I will speak for myself personally, I think the Fed acted very responsibly in this situation. And I think that we probably set some precedent in the involvement of the Fed in these State-chartered institutions, which were also privately insured . I think the question which everyone has on his mind now is whether the Federal Reserve stands ready to act promptly to supply liquidity to prevent the type of mass closings of even healthy institutions which occurred in Ohio. Mr. MARTIN. I can only say, Mr. Chairman, that we have learned from this experience. We appreciate the various comments the committee members and the chairman have made with regard to our performance here. We have learned from it. And there is no question of our commitment to you and to the public to act promptly. I think somebody, some official in the Bank of England 100 and some years ago, said in these situations you lend, you lend boldly, and you keep on lending. Ms. HORN. And I would just add, if I might, Mr. Chairman, that in the Ohio case we did not refuse a single request for liquidity. Mr. BARNARD. It is interesting, Ms. Horn, though, that in view of all the needs that were developed- in Ohio-was the Fed not surprised by the small amount of requests that they had? Ms. HORN. Yes, I think that is a fair statement. In fact, we were prepared for more than a week for the requests to come in. We communicated with the institutions about their possible needs . The requests were slow in starting up, as confidence deteriorated, the situation became more severe. Mr. BARNARD. Do you think this came about because of the wide publicity that was given to the fact that the Fed was involved and that the Home Loan Bank Board was doing all they could to bring other institutions-do you think that that sort of stemmed the need for this additional borrowing? Ms. HORN. There is no question about it; these institutions run on confidence, even more than they run on cash. And we tried to 301 make public statements occasionally, when it seemed appropriate, to indicate the Federal Reserve's participation in the situation, and we believe that added to the public confidence . Mr. BARNARD . One last question I would like to ask of Mr. Selby. In 1977, the Office of the Comptroller of the Currency had substantial supervisory experience involving ESM Government Securities that painted the firm in a highly damaging light. I think you have pretty well testified that your concerns ran so deep that some criminal referrals were made involving the National Bank of South Florida's dealings with ESM. Agreements were entered into with six national banks in Florida prohibiting them from doing any business with ESM. And you wrote the presidents of all national banks warning against the types of securities transactions that ESM regularly offered . You did alert the SEC as to your concerns and you did provide some information to the FDIC and the Florida comptroller. You did not, I presume, communicate it at all with your State counterparts. I think we are repeating testimony here but I want to get it for the record. And there was no attempt to sit down and coordinate with the other Federal banking agencies in a concerted enforcement actions against ESM. Knowing what you know now, do you not think that ESM could have been stopped or its tactics exposed years ago, if Federal and State banking and securities agencies had acted together? Mr. SELBY. Well, I do not know that we could have stopped ESM . I do not think that was our responsibility to say, to make a determination whether ESM was performing illegal transactions . Our responsibilities were to see that the banks were operating in a safe and sound manner. And to avoid having the banks, the national banks particularly, participate in any kind of transactions that might accrue loss to them. And I am not terribly sure I would know how the Federal banking agencies could say to the world at large that an ESM is not-you do not do business with an ESM. We referred it to the SEC. And I think that was our obligation . I do think in retrospect maybe that we could have, among the Federal agencies, and perhaps even the State agencies, done a better job in talking about an ESM, and all we could do is to share our experiences with ESM. I do not think we could tell the Federal Reserve or the FDIC or the Federal Home Loan Bank Board , "Here is a firm that we suspect of doing illegal things ." Mr. BARNARD . Well, you know, I understand that. And of course, it is very obvious that everybody dealing with ESM did not have losses. Mr. SELBY. That is right. Mr. BARNARD. It is very obvious that somewhere along the regulatory process there was some slippage here . Those who did not have segregated accounts, and who did not have trust receipts, they seem to be operating with some regularMr. SELBY. I think we could do a better job, and I think we are doing a better job in disseminating information to the industry. We all along have issued these banking circulars and assurances on the securities transactions. The 1977 was not the only one. We have done it all along, and as a matter of fact, right now I am chairman of the task force on bank supervision under the FFIEC, 302 and the counsel has approved a drafting of a new circular that will be sent out by all five agencies, talking about these very same things . This was started back in the fall of last year . Mr. BARNARD. That is the Federal-Mr. SELBY. The Federal Financial Institutions Examination Council . Mr. BARNARD. Mr. Gray is Chairman of that. Mr. SELBY. Mr. Gray is now Chairman of it, that is correct. Mr. GRAY. I am the Chairman, and we will be looking into this very carefully and closely in the future. Mr. BARNARD. Mr. Craig. Mr. CRAIG. Two last questions. First of Mr. Martin and Ms. Horn . Your activity and the method by which you approached the problem in Ohio and the ability that you could move in was entirely within the law and you were responding to the law as it currently is? Mr. MARTIN. Yes, sir. We have alluded several times to the Monetary Control Act of 1980 and that is exactly what you all intended us to do-Mr. CRAIG. That is correct. Mr. MARTIN. For depository institutions . Mr. CRAIG. And because of that law you were able to respond in a timely and necessary fashion to the needs of those institutions? Mr. MARTIN. Yes, sir. Ms. HORN . That law, and our general approach of wanting to be cooperative with everybody in trying to fashion a solution enabled us to respond in a timely and necessary fashion. Mr. CRAIG. Thank you. Mr. Gray, I may make the mistake of quoting from the Wall Street Journal in light of concern about its reporting today, I have here a March 18 Wall Street Journal page with a listing of the activities on a day-by-day basis of the Ohio S&L crisis. I see that on March 9-10, Home State closes. In your testimony, you say on Wednesday evening, March 13, representatives of the Federal Home Loan Bank of Cincinnati examined State reports on Ohio Fund members to make a preliminary estimate of their eligibility for FSLIC insurance. Why did that Home Loan Bank move at that time? Mr. GRAY. I think we wanted to move as quickly as we could and we employed the information which we had at that early date to try to get a fix on the situation to the extent we could. I think much of the information we had at that time was relatively cursory. But we were at least trying to get a feel. Mr. CRAIG. The Cincinnati board moved on your instruction? Mr. GRAY. Yes. Mr. CRAIG. That was how many working days from the time of the public-announced closure of Home State? Mr. GRAY. Two days. Mr. CRAIG. Thank you very much. I have no further questions at this time, Mr. Chairman .. Mr. BARNARD. Mr. Kindness. Mr. KINDNESS. Thank you , Mr. Chairman. Just one quick question for Chairman Gray. There was some questioning a little while ago which had to do with whom you had 303 breakfast with on what day, and that sort of thing. And regrettably it is the sort of thing that happens around here once in a while, and you were interrupted constantly. Is there anything else you wanted to say on that subject? Mr. GRAY. I certainly would. Mr. KINDNESS . I regret that Representatives Oakar and Luken could not stay, butMr. GRAY. Thank you very much . Well, I appreciate the opportunity. I read with considerable interest the article in the Wall Street Journal. Frankly, substantial portions of that article were inaccurate, misleading, distorted, and just plain wrong. It is interesting to note that the author of the article made no attempt at all to solicit my views or my account of our involvement and the efforts which we made . I note that a substantial portion of the article is given to the comments of at least two Members of Congress who have had a disagreement with me over the way we have handled this situation . I want to point out again that I wanted to send the general counsel to the meeting at the Federal Reserve because I felt that he could provide the kind of information that the Members of Congress and the members of the Ohio thrifts could use. And I felt that at that time it was more appropriate for me to meet with Members of the Congress as soon as possible. And in that evening meeting we extended the invitation through the general counsel to meet in my office the following morning at 11:30. There was no mention of that in the article that Congresswoman Oakar chose not to come to that meeting. And I regret of that. Mr. Luken did. Another part of the article says that only after some resistance did I let Democratic Representative Luken and one thrift executive join a meeting with Republican Representatives from Ohio . The fact is that Mr. Luken was invited and was obviously a part of the group that came. We did not show any resistance to let him in at all. Mr. Gradison, one of your colleagues , a Representative from the State of Ohio, told me yesterday that he was not completely quoted in his remarks. In fact, he told me that when he was quoted as saying, "I wonder, too, if political considerations were placed above confidence in and the integrity of the financial system," as is written in the article, the Wall Street Journal left out another part of his statement which clarified it substantially. What he furthermore said was, "There is no indication that that happened." There is also a suggestion that Mr. Volcker was urging me to expedite the insurance process. Well, you know, as I have already discussed before, I met with Chairman Volcker on the final evening of the bank holiday. I have talked with him for more than 2 years now and he has never called to question, or asked about, a course of action taken by the Federal Home Loan Bank Board - ever! And I have had some differences, as you may know, with the Treasury from time to time on particular matters. They have been expressed. We do share information with the Department of the Treasury, because after all that is headed by the Chief Fiscal Officer of the United States, just as we share information with the Chairman of the Federal Reserve Board and members of the Feder- 304 al Reserve Board because it is their responsibility to maintain the integrity and financial stability of this country. Such communications are a responsible course of action . And we also exchange information with our fellow financial regulators in all of the Federal financial regulatory agencies. That is also a prudent, long established practice. So I thank you for the opportunity to make my comments, Congressman. Mr. KINDNESS . Thank you . I am sorry it was necessary. Mr. BARNARD. Gentlemen, we thank you, and, lady, very much for being with us today. And you certainly have contributed tremendously to this. I just want to say in closing, we all are concerned about maintaining the confidence in our financial institutions. And certainly I do not have to preach to you about how much we are indebted to you and your organizations in helping us maintain that confidence in the public sector for our financial institutions . And I sincerely hope that you will continue . We have had some traumatic experiences in the last 4 or 5 years . We have had Penn Square . We have had United American . We had Empire . No regulatory agency has been left out of this, possibly except for the Fed, and you have been lucky. But we need your continual vigilance in what you are doing in order to help us maintain the confidence in our financial institutions. Thank you very much. Mr. GRAY. Thank you. Mr. BARNARD. Our next panel consists of Charles C. Hogg II, who is president of the Maryland Savings-Share Insurance Corp .; Ms. Pamela A. Hathaway, executive vice president of the Pennsylvania Savings Association Insurance Corp.; Donald R. Beason, president of the Financial Institutions Assurance Corp. of North Carolina; Leonard Lapidus, executive vice president, Mutual Savings Central Fund of Massachusetts; and James L. Burns, Jr., executive vice president of the Cooperative Central Bank of Massachusetts. We will begin with Mr. Hogg and then go with Ms. Hathaway on across the table and following that, we will have our questions . Mr. Hogg. STATEMENT OF CHARLES C. HOGG II , PRESIDENT, MARYLAND SAVINGS-SHARE INSURANCE CORP. Mr. HOGG. Mr. Chairman, members of the subcommittee , it is my pleasure to be here and to address you on this very important issue that is being discussed this morning. I have submitted complete testimony and a very complete questionnaire. I would request that that be entered into the record . Mr. BARNARD. Without objection , your entire testimony will be in the record and you may summarize at your convenience. Mr. HOGG. I will do that, sir. My name is Charles Hogg. I am president and chief operating officer of the Maryland Savings-Share Insurance Corp. , referred to as MSSIC. 305 MSSIC was created in 1962 by a special act of the Maryland General Assembly for the purpose of providing a viable form of deposit insurance for State-chartered savings and loans. Our purpose is, in addition to insuring accounts are to facilitate the flexibility of our industry and to provide liquidity. Currently MSSIC insures 102 State-chartered savings and loans, all of whom have their principal offices in Maryland. These members have assets of about $8.9 billion and savings of $7.2 billion. The figures I will give you for MSSIC are as of December 31 , 1984. They were audited with an unqualified opinion by Touche Ross & Co. We had total assets at that period of $204 million . Our reserves are $ 166.8 million . The components of the reserves, as we calculate them , are the capital deposits from our members of about $ 144.3 million, retained earnings over the 23 years of operation of $17.5 million and a reserve for insurance losses of $5 million, therefore totally $ 166.8 million. In addition MSSIC maintains a central reserve fund, which has as its primary purpose liquidity, of $80.8 million . We maintain, with a group of five banks, a line of credit equal to $60 million . The most important point in my testimony to you today will cover the highly sophisticated regulatory and supervisory system that we have in Maryland in dealing with the State-chartered, MSSIC-insured industry. This regulatory system includes a very complete monthly report submitted to us by each member whose assets exceed $ 3 million . The data on the reports gives us complete knowledge of compliance or noncompliance of members with our regulations. We have a sophisticated data processing system into which the monthly reports are input against the programming of that data. Our highly qualified staff then follows up on exceptions and trends and highlights that the computer output gives us. An important aspect of our operation in Maryland is close coordination with the State through the division of savings and loan associations which is an agency of the department of licensing and regulation and the true State regulator of the industry. This coordination includes both exchanging of exams and reports, and cross attendance at board meetings. By that I mean I attend meetings of the board of commissioners. Mr. Brown, from whom you will hear later, attends the MSSIC board meetings . We hold joint supervisory conferences . My staff attends the exit interviews of the division . When they complete an examination of an institution, we get a copy of that examination and we get a copy of the institution's reponse to the comments in the examination . So, while there is total coordination of our effort, there is independent analysis. The coordination then has to do with dealing with potential problem situations. We believe that in the insurance company, that we are managing risk through the monitoring of our institutions and through quick, effective response to potential problems . Both the State and MSSIC are active in our role in dealing with our members, both in examination and in taking corrective action . It has been said today here, many times, that the key to any depos- 306 it insurance system is confidence . We believe that, obviously. We also think liquidity being strong is also important. Liquidity in the MSSIC system at yearend was over 16 percent among our members. In addition our members maintain lines of credit with commercial banks . We have proven access, and this topic has been talked about many times this morning, to the Federal Reserve Bank discount window. MSSIC sources such as its central reserve fund and its own line of credit are also important, so we think both cash and confidence are important in dealing with these problems . In summary, we know our industry, we respond quickly to problems . We know our jobs and we do them well. At the appropriate time I would be delighted to answer your questions. Thank you , sir. [Mr. Hogg's prepared statement follows: ] 307 Testimony of Charles C. Hogg, II before Commerce, Consumer and Monetary Affairs Subcommittee of the Committee on Government Operations April 3, 1984 I am pleased to appear before the Subcommittee to present my views on the state/private deposit insurance systems and to discuss in particular the Maryland Savings-Share Insurance Corporation (MSSIC). My testimony will provide brief background on MSSIC and respond to the four topics listed in Chairman Barnard's letter of March 22, 1985. MSSIC was created in 1962 by a special act of the Maryland General Assembly for the purpose of providing a viable alternative for deposit insurance for state-chartered savings and loan associations. In the early 1970's Maryland law was changed to require deposit insurance for all savings and loans in the state, and MSSIC and the Federal Savings and Loan Insurance Corporation (FSLIC) were the only providers authorized. The Charter of MSSIC appears at Title 10, Financial Institutions Article, Annotated Code of Maryland. The stated purposes of the Corporation are listed there as follows: "(1) Promote the elasticity and flexibility of the resources of members ; (2) Provide for the liquidity of members through a central reserve fund; and (3) Insure the savings accounts of members." The operations of MSSIC are directed by a Board of Directors comprised of three members appointed by the Governor of Maryland and eight members elected from among representatives of member associations . The Board of Directors employs a staff of financial professionals to implement Board policies. I am President and Chief Operating Officer. In addition to the Board of Directors, we have a Membership Committee which meets monthly to review the operations of the member associations and to determine the eligibility of new associations for membership. Our analysis of the operations and financial condition of member associations is an 308 active, not a passive, one. Each member whose assets exceed $3 million is required to submit monthly a complete financial report which includes a balance sheet, income statement and supplemental data. This information is entered into an IBM 34 computer which is programmed to point out exceptions to all of our rules, regulations, guidelines and policy statements. In addition the computer provides reports on trend analysis, margin analysis and any change beyond established parameters. These reports are reviewed by our financial analysts , and presented to the Membership Committee and Board. Most importantly, our staff follows up on the reports by on-site visits to and review of the operations of selected institutions high-lighted by the reports. These visits and reviews may include checking on securities portfolios, loan files, operating expenses and other specifics areas of interest, or they may entail a complete review of the operations of the institution. In addition to our major data processing efforts, our staff uses an IBM Personal Computer to perform selected analysis on member associations as well as for internal uses. To supplement the analysis and review conducted by my staff, we have complete access to the examinations and files of the Division of Savings and Loan Associations (the Division), the state agency with regulatory responsibilities for the state chartered industry. Members of my staff attend the Exit Interviews conducted by the state upon completion of an examination of an institution , and we receive at the same time as the institution a copy of the Examination Report, and subsequently, a copy of the institutions response to comments in that examination . Coordination between MSSIC and the Division is further enhanced by the Director's attendance at MSSIC Board meetings,and my attendance at meetings of the Board of Commissioners. Our staffs and senior officials meet frequently to coordinate our efforts in dealing with potential problem associations and to insure that total, complete and free lines of communications exist . Copies of correspondence between our offices and member institutions are regularly 289 Mr. SAXTON. Is there any danger in having member institutions actually represent themselves and control themselves? Is that a built-in problem with private insurance funds? Mr. GRAY. There is always the potential for conflict of interest, although I say that generically, without any great knowledge of the Ohio Deposit Guarantee Fund. And in our efforts to protect the FSLIC, of course, we do have conflict-of-interest regulations which are intended to deal with that problem. Mr. SAXTON. I am not so concerned perhaps about actual conflict of interest. I am just concerned about who watches the henhouse better, someone who is completely disassociated with an organization or someone who has a rather close association with member institutions. Mr. GRAY. I think as a general proposition it would be better to have independent governors for that kind of system. Mr. SAXTON. Thank you, Mr. Chairman. Mr. BARNARD. Mr. Kindness . Mr. KINDNESS . Thank you, Mr. Chairman. I will not impose on the time of the subcommittee further with regard to this panel. Thank you . Mr. BARNARD. Ms. Oakar. MS . OAKAR. Thank you , Mr. Chairman. Ms. Horn, you testified that on March 9 you took action and made some initiations with respect to the impending crisis in Ohio. I want to congratulate you and the Fed on that. You did it under the spirit of the law. But you took that initiation , and I think that it did play a role, at least temporarily, in giving some element of confidence to the situation . I just wanted to congratulate you on that. Mr. Gray, Mr. Craig asked a very important question which is why I am so interested in potential conflicts of interest. I think what the distinguished minority leader asked was has the Federal Home Loan Bank Board acted or ever had a situation that was extraordinary in which they really took the bull by the horns and acted. I think you answered, not to your knowledge. I am concerned about some of the transactions. For instance I look at the situation with the Financial Corp. of America and its subsidiary in California that had a run on it. I think that was fairly extraordinary. Their subsidiary had some real problems. What the Federal Home Loan Bank Board did, and I realize they were federally insured, but you did extraordinary things. The institution was given unlimited borrowing rights exceeding normal collateralizationMr. GRAY. That is not correct. MS. OAKAR. Well, how much of the borrowing—— Mr. GRAY. That is absolutely not correct. MS. OAKAR. How much has the Home Loan Bank Board lent this institution since October? Mr. GRAY. From October 31 , 1984, to March 31 , 1985, the Federal Home Loan Bank of San Francisco advanced $5.6 billion to American Savings & Loan Association in California. During that same period, American repaid $6.5 billion, for a reduction in its net outstanding advances from the San Francisco Bank of about $ 900 million . I would also note that in every instance, Congresswoman Oakar, the only credit that has been provided to any of our institu- 290 tions , including American, has been under the collateralization requirements that are imposed by the individual Federal Home Loan Banks. Ms. OAKAR. Let me just say this. Mr. Chairman, it is my understanding that they have lent at least $4 billion which is no small amount of money. By the way, that approximates the total assets of all 72 institutions that were nonfederally insured, so that was a pretty extraordinary undertaking. I point that out because there have been extraordinary situations. And you may have been right about it, but if I can pursue this. That is why I am concerned about the rumors, and innuendos, concerning your actions or nonactions related to the Ohio situation . I asked you two questions before the full Banking Committee and I asked you very specifically did you , prior to March 13 or any day thereafter, get any advice on how to handle the situation from the Secretary of Treasury or anybody from the White House. You answered that was not relevant. You would not answer it. Then we have a situation whether it is accurate or not, in which the Wall Street Journal publishes an article that says, indeed, Secretary Baker discussed this issue with you after having a meeting in terms of how to decide what the Federal response should be. They concluded that if the crisis developed it should remain a problem of the Democratic administration in Ohio. The role that the Federal regulators should play, whether it is the Federal Home Loan Bank Board or the Federal Reserve Board, should be above politics. I do not understand why you would not answer the questions during the Banking Committee hearing, but I will give you another chance now. Mr. GRAY. I have been waiting for your question which I am happy to answer. Ms. OAKAR. Good . I think you could have solved a lot of problems on March 27 if you had answered my two questions . Mr. GRAY. Well, let me just say, with all due respect to you as a Member of the Congress of the United States, any innuendo, any discussion of partisan politics, was raised by you and certainly not by me. For example, and the record will show this, you referred to the upcoming Governor's race in Ohio. Ms. OAKAR. That is right. Mr. GRAY. You referred to my failure to meet with members of both sides of the aisle , Democrats as well as Republicans . Now, you know full well that an invitation was extended to you and Congressman Luken and to others, to come to my officeMs. OAKAR. That is right. Mr. GRAY [continuing]. To meet with me-— Ms. OAKAR. And you know full well why I did not attend . Mr. GRAY. Well, no, I do not. Ms. OAKAR. Because you chose to meet with Congressman Wylie privately after we had all agreed on an 11:30 meeting, you chose to meet him for breakfast and my colleague from Ohio can verify that. Mr. LUKEN. If the gentlelady will yield. Ms. OAKAR. I will be happy to yield. Mr. LUKEN. That is exactly what happened . We have the floor. We will ask you the questions . 291 Mr. GRAY. Well, just a minute. She just made an observation and I am going to answer it. Mr. LUKEN . Are you running this , Mr. Chairman . Mr. GRAY. Let me just say, Congresswoman Oakar, that the meeting I had with Congressman Wylie had been set on my calendar 3 weeks before and it was to deal specifically with legislation which was introduced by request by Congressman Wylie and by Chairman St Germain of the House Banking Committee. That was the purpose of that meeting . MS . OAKAR. Let me yield to my colleague . Mr. LUKEN. As the gentlelady has said, at extensive meetings on March 13, with your counsel, we attempted to get a meeting with you that night. Sixteen or more representatives of savings and loans of Ohio were present pleading to meet with you. You were unavailable we were told until 11:30 the following morning. That is what we were told by your counsel seated here today. You were not available until 11:30 . Mr. Wylie was there. At 9:30 the following morning Mr. Wylie called me and said he had had breakfast with you , had discussed these issues, and told me what your decisions were. Those are the facts. I repeat, he called me at 9:30, said he had breakfast with you. I was shocked. And he had discussed these issues and he laid out what the decisions were which you later confirmed. I yield back to the gentlelady. Mr. GRAY. Well, I cannot speak for Congressman Wylie, but I did tell him at breakfast, which began at 8, that the Bank Board was going to make a very strong effort to expedite applications as soon and as quickly as possible. Mr. BARNARD. Just a second . Let me advise that we owe Mr. Luken time now. Ms. Oakar's time has expired. Mr. GRAY. I did not answer, her question which I thinkMr. BARNARD. I mean I think they are participating together on that. Mr. LUKEN. I will proceed . Mr. Gray, we did meet with you on March 13, and I will say right now that if you had taken action at that time as we requested, that the closings of Friday, March 15, would not have occurred . Now, I want to say exactly why I say that. First of all, your statements are inconsistent with those of Congressman Gradison and Congressman Wylie , as indicated in the Wall Street Journal. Mr. Wylie said that you did stall at that time. Mr. Gradison states that you have reversed yourself since. Now, I want to ask you-on March 13 did we ask you to waive the 10-day waiting period? The 10-day notice period? And what was your answer? Mr. GRAY. Counsel advised me, and you were there, that there was a 10-day notice period which had to be observed . Mr. LUKEN. And we pleaded with you to waive it and you said, "no way," did you not? Mr. GRAY. Well, I take the advice of my lawyer, who probably knows more about these things than I do. Mr. LUKEN. Did you take it a week later when you did waive it? Mr. GRAY. Yes, I did. Mr. LUKEN . Oh. Mr. GRAY. On the advice of counsel . 292 Mr. LUKEN. It is his fault. And at that we asked you to apply extra help to get other examiners in, and did you not tell us that you were stretched so thin- Mr. GRAY. That is right. Mr. LUKEN. That you could not possibly get any more help. Mr. GRAY. That is essentially correct. Mr. LUKEN. And a week later you found all that help that you have just been describing. Mr. GRAY. Well, you know, on Sunday evening, as my testimony indicates, I met with Chairman Volcker in his office and at that time Chairman Volcker pledged to the Federal Home Loan Bank Board as many examiners as we would need to bring about the expeditious processing of these applications. Mr. LUKEN. You had Chairman Volcker's people with you on March 13, and did you or did you not tell us that it was an Ohio problem, quote "You are in the wrong city. You should be in Columbus"? Did you say that, Mr. Gray? Mr. GRAY. I said I thought that individuals should be at the State capital talking about this problem. Mr. LUKEN. And when we pleaded on behalf of the depositors, did you or did you not say that the depositors should have known that they were not federally insured when they deposited in the State institutions? Mr. GRAY. You know, I do not recall that statement, but I didMr. LUKEN. Well, I will refresh your recollection. You did. Mr. GRAY. Well--Mr. LUKEN. And when we talked about the savings and loans and helping the depositors, you said "After all, the savings and loans had the opportunity previously to join FSLIC and they had refused it." You did not say that once. I bet you said that at least six times in our brief meeting. Mr. GRAY. That is a historical fact. Mr. LUKEN. And then you would characterize that as cooperative, that you were going to extend yourself? Those reactions that you were extending yourself for the depositors? Mr. GRAY. You know, I said repeatedly, Congressman, that the Federal Home Loan Bank Board and the FSLIC were committing to do everything possible to expedite applications for insurance of accounts as quickly as possible. Mr. LUKEN. But you said you had no help. You had no legal authority. How were you going to expedite it if you did not have anybody to apply to processing the applications. And if you had to follow the law, which you said could not allow you to expedite it . And finally, I want to ask one more question. When the representative of the S&L, his last question to you was, " Give us 30 days . We will close for 30 days and can you examine these in 30 days," and you said you would not even consider it. Is that not true? Mr. GRAY. I said that with a very severe shortage of 750 examiners around the country that would not be possible, and that was in specific response-Mr. LUKEN. But you have managed to do it in the last 2 weeks. 293 Mr. GRAY. But let me finish what I am saying. That was in specific response to a suggestion that all of our examiners be deployed summarily to the State of Ohio. Mr. LUKEN. No. That was not theMr. GRAY. Well, it certainly was. Mr. LUKEN. The suggestion was -would you at leastMr. GRAY. Congressman Gradison made that suggestion . Mr. LUKEN . It was not Congressman Gradison. It was the representative of the thrift, and he said that if we close for 30 days- he said he recognized it that you were not going to help, so he said if we close for 30 days will you at least examine them within that 30 days. And you said, "No way." You would not even consider it . And now you are saying that you have already done it in less than 30 days. Mr. GRAY. Well , now, I have tried to explain to you that on the following Sunday evening, Chairman Volcker pledged the full support of the Federal Reserve and as a matter of fact, has provided 140 examiners- 140-to help the Bank Board in this process . Ms. OAKAR. Chairman Volcker has been great . Will the gentleman yield? I just have to ask you the question . Did Secretary Baker ever call you and tell you to stall and stonewall the Ohio crisis? Mr. GRAY. I am glad I get a chance to answer your question. Ms. OAKAR. Mr. Chairman, I think he should answer. Whatever you want to do. You are investigating it, so maybe you can get it in writing. Mr. GRAY. I am glad I get a chance to answer that question . I would like to do it briefly. First of all, the Federal Home Loan Bank Board has traditionally, over many, many years, exchanged information with the Treasury, which is under the Chief Fiscal Officer of the United States, with other regulatory agencies, including the Federal Reserve. And we have continued to do that. Particularly in extraordinary situations. Now, I want to assure you that I have never taken instructions from anyone, anyone, whether in the White House or Treasury or anywhere else, nor has any other member of the Federal Home Loan Bank Board because, in all honesty, we are an independent agency. MS. OAKAR. But did you discuss the politics in Ohio? Mr. GRAY. I absolutely never discussed any kind of politics in the State of Ohio. Ms. OAKAR. Well, it is referred to in the Wall Street Journal article. Mr. GRAY. Well, that is pure unadulterated fiction . Because no one ever called me to talk about politics in Ohio. The first time I ever became aware of the plan alleged in the Wall Street Journal was when I read it in the Wall Street Journal . Ms. OAKAR. I do not think the question has been answered specifically, but I will leave that to the committee to investigate. Mr. BARNARD . Thank you very much. Ms. Horn, how much did the Federal Reserve Bank lend out of its discount window to these Ohio institutions? Ms. HORN. Altogether-- 294 Mr. BARNARD. I am not asking you individually, but cumulatively? Ms. HORN. Altogether, throughout this whole period, we have lent in the range of $70 million . Mr. BARNARD. $70 million. Ms. HORN . That is a cumulative figure. Of course, it has been paid back. Mr. BARNARD. For the uninformed, all of that had to be secured. Ms. HORN. Yes, it was secured . Mr. BARNARD. And what maturities are you working on for those loans? Ms. HORN . They are relatively short-term loans. Mr. BARNARD . Two weeks? Four weeks? Ms. HORN. We do not have a designated maturity, but we have overall guidelines limiting the frequency that an institution can obtain adjustment credit . I cannot answer your question with a specific number of days, but we are talking about short periods of time. Mr. BARNARD. Do you think that in some of these more troubled institutions that-even though you are secured-you will be a little bit more liberal in renewing these discount notes? Ms. HORN. There is no question about it. The guidelines are in place so that we can use judgment in respect to them. As we review the needs of the institutions, we will be adhering to the guidelines―― Mr. BARNARD. And you are not setting precedent here? This precedent is already established? Ms. HORN. I do not quite understand the question. Mr. BARNARD. Is this the same practice that you use with other member banks? Ms. HORN. Absolutely. Mr. BARNARD. Mr. Gray, did any of the 14 Ohio institutions involved, which were members of the Cincinnati Home Loan Bank, apply formally or informally for credit? Mr. GRAY. No, they did not. Mr. BARNARD. Now, we want to get -well, one other question, Mr. Gray. Because of this situation in Ohio, do you recommend a more formal association with State savings and loan agencies or even State private insurance funds, such as the exchange of examinations and so forth? Especially since you are subject to be called on to either- no, you are not necessarily, but Mr. Martin is, the Federal Reserve is subject to be called on as far as the discount window is concerned . Of course, you are not eligible to loan to these State-chartered institutions. Am I correct? Mr. GRAY. That is correct-Mr. BARNARD. The Home Loan Bank BoardMr. GRAY [continuing]. As to Ohio institutions that were not members of the Federal Home Loan Bank of Cincinnati. Mr. BARNARD . Mr. Martin? Mr. MARTIN. Mr. Chairman, I would assure you that the results of the Ohio experience, since it is the most recent of its type, will be communicated in our training sessions with the various officers , discount officers, and others within the whole Federal Reserve System , and will be communicated to those State officials who are 295 working with our Federal Reserve bank presidents and officials in the so-called training and orientation to improve both their and our operations . This experience will not go on the shelf. Mr. GRAY. Incidentally, Mr. Chairman, we do exchange information of a supervisory nature with other State savings institutions regulatory agencies. Mr. BARNARD. Including Ohio? Mr. GRAY. With the State regulatory agencies . Mr. BARNARD. Do they exchange information with you though? That is the question. Now, I mean, are they furnishing you a copy of their examinations? Mr. GRAY. Well, we are really talking here about FSLIC-insured institutions . Mr. BARNARD. OK, yes. We need to, at this point in time, move our discussion to some of the practices- policies and practice of supervisory agencies, especially as it is associated with ESM . And I will ask all of you this. What procedures-Home Loan Bank Board, Comptroller, and the Federal Reserve-are your examiners supposed to follow, during the examination process, to verify that an institution which has entered into a repo agreement has actual possession of those securities? Mr. GRAY. Well, in the case of the Federal Home Loan Bank Board, repos and reverse repos are subject to two levels of review. The first is the required annual audit by an accounting firm . Audit procedures require verifications. The second level of review would be during an actual examination of the institution . Examinations procedures would require verification that the association's records of the transaction were complete, adequately maintained, and they would further require a review of such transactions to see if they were in keeping with the Bank Board's regulations and guidelines . Unusual positions or violations such as excess collateralization which we have dealt with in guidelines which were issued on July 13, 1981 , would warrant comment and further investigation by our supervisory personnel. Mr. BARNARD. Mr. Martin? Mr. MARTIN. Our examiners , according to a series of instructions, written instructions, they have in these matters, check on the documentation, check on the credit worthiness of the institutions with which the banker is dealing, check on the internal auditing procedures within that bank with regard to documentation , location of collateral and so forth, and on and on. We have a rather elaborate system of checking in it. Mr. SELBY. Well, our examiners' handbook requires that our examiners verify that the banks have taken possession of the securities period. Mr. BARNARD. In that event then, Mr. Gray, were these procedures followed in the September 1984 examination of the American Savings and Loan? Mr. GRAY. Yes, I believe they were. Mr. BARNARD. Did you know that American's securities were mixed in with everybody else's in ESM's account at Bradford Trust? Mr. GRAY. Yes, yes. Bradford Trust? Let me say, that I am a bit hesitant, in all candor , to talk about it. 296 Mr. BARNARD. I beg your pardon? Mr. GRAY. I am a bit reluctant in all candor to talk in this public forum about an ongoing institution where confidence is important and certainly we would be pleased to provide members of the subcommittee with this information privately. I really am reluctant to get into great detail publicly because of the possible harm it could cause to any individual institution . Mr. BARNARD. I can understand that, Mr. Gray, and we certainly do concur with you in that particular situation . Mr. Gray, the subcommittee has information that on a number of occasions between 1980 and 1985, the Federal Home Loan Bank Board in its examination supervisory capacities came across unsafe and unsound transactions involving ESM. For example, in 1980 and 1981, the Bank Board participated in a joint examination of Unity Savings Association of Chicago and the issuance of a cease-anddesist order involving Unity's $200 million transaction with ESM . You have advised the subcommittee that in 1982, the Federal Home Loan Bank of Cincinnati was aware of rumors of Home State's dealings with ESM. And yet these rumors were not investigated. In 1983 and in 1984, immediately after ESM's principal founder, Ronnie Ewton, was made a board member and put on the executive committee of American Savings and Loan of Florida, an FSLIC institution , American entered into a large and unsafe transaction with ESM . You advised the subcommittee that the FSLIC insurance fund is likely to sustain an $8 million loss because of the dealings of federally insured thrifts with ESM. Could you provide us with more details as to that loss? Mr. GRAY. I will be happy to provide information for the record. [The information referred to follows :] 297 1700 G Street, N.W. Washington, D.C. 20552 Federal Home Loan Bank System Federal Home Loan Mortgage Corporation Federal Savings and Loan Insurance Corporation Federal Home Loan Bank Board OFFICE OF EXAMINATIONS AND SUPERVISION April 11 , 1985 RECEIVED 121985 Mr. Peter S. Barash Staff Director Commerce , Consumer , and Monetary Affairs Subcommittee of the Committee on Government Operations Rayburn House Office Building , Room B-377 Washington, DC 20515 COMMERCE, CONSUMER AND MONETARY AFFAIRS SUBCOMMITTEE Dear Mr. Barash : During the April 3 , 1985 hearing concerning Ohio privately insured savings and loans , several matters were discussed regarding which we agreed to provide you with additional information . Our estimate of an $8 million dollar potential loss to the FSLIC was based upon the situation of two institutions which are now in the hands of the FSLIC. This estimate is based upon the assumption that liquidation will be necessary in these two cases and represents a worst-case scenario . The actual loss may be considerably less depending on numerous other factors. I have enclosed for your information a copy of our memorandum R 6-2 which discusses over- collateralization of reverse repurchase agreements and provides guidelines for appropriate collateralization levels . This memorandum was referred to by Chairman Gray during the course of the hearing . Finally, I am enclosing for your information a copy of a phone log from the Federal Home Loan Bank of Cincinnati for the period from March 11 through April 4 , 1985. (This is a log of their on-going monitoring of the situation . ) Please let me know if I can be of any further assistance . Very truly yours, Willi am Chilling William J. Schilling Director Enclosures CC: Chairman Gray 298 Mr. BARNARD. Evidently, we have lost our records of that, Mr. Chairman, but we will find them. Mr. Chairman, based on your supervisory knowledge of ESM's speculative and dangerous transactions with financial institutions, did youoppose in any way the placing of Ronnie Ewton on the board and the executive committee of American Savings and Loan? Mr. GRAY. American Savings▬▬ Mr. BARNARD. Or to the Home Loan Bank Board? Mr. GRAY. I do not believe we had anything to say about that in particular. Counsel advises that this is a State-chartered institution. Mr. BARNARD . Beg your pardon? Mr. GRAY. Counsel advises that this is a State-chartered institution and, frankly, apparently we do not have jurisdiction-Mr. BARNARD. It was FSLIC- insured , though? Mr. GRAY. Yes. It is FSLIC- insured . Mr. BARNARD. But would not your authority run to that because of that? Because of FSLIC's insurance , would you not have the jurisdiction to make a determination there? Mr. GRAY. We can only remove a director if there are grounds based on a violation of rules and regulations of the Federal Savings and Loan Insurance Corporation . Mr. BARNARD. In other words, there was no objection to Mr. Ewton then being on the board of American Savings and Loan? Mr. GRAY. Not on the basis of our discretionary authority, I gather from counsel . Mr. BARNARD. Given the large exposure of American Savings and Loan and its ESM transaction and the involvement of Marvin Warner in initiating those transactions, can you give us an explanation why the Home Loan Bank Board permitted the institution to spend $26 million of its precious capital to buy back Mr. Warner's 50-percent ownership in American? Again, because of FSLIC. Mr. GRAY. The principal supervisory agent of the Federal Home Loan Bank of Atlanta approved this transaction in which American purchased the Warner stock from Shepard Broad. The purchase price was to be replaced either by the association reselling the stock or by the sales of subordinated debt. The principal supervisory agent in this connection, urged by the State of Florida, as I understand, felt that it would be in the best interests of the association for this transaction to take place. Mr. BARNARD . Was that capital replaced? Did they sell the stock subsequent to that? Mr. GRAY. Well, it is in the process of being replaced . I think they have a commitment to do so within 18 to 24 months. Mr. BARNARD. Let me get back to the six FSLIC-insured institutions that had financial dealings with ESM. We ask whether the latest two examinations of those institutions- if those examinations mentioned or criticized their dealings with ESM? Mr. GRAY. As I recall - and you are talking about the six-there were comments on several of them. On others apparently there was not. Mr. BARNARD . I think there was a mention of it on two of the examinations but not the other four. Mr. GRAY. That is right. 299 Mr. BARNARD. Is there any reason why it would not have been uniform? Mr. GRAY. Well, apparently the reason that there was no comment is because their position could have been de minimis or could have been closed out in these instances. Mr. BARNARD. As you can see-all the members of the panel -we are concerned about security dealers, and what it has done, especially as far as this particular situation in Ohio is concerned. And frankly, I guess that is much of the reason why we are having these unfortunate hearings today. I guess it is unfortunate, likewise, that the Federal Reserve has not anticipated this sort of event coming for a long time. And I would just like to quote from some testimony given by Mr. Tony Solomon, who was president of the New York Fed back in May 1982. When he testified before the Senate Banking Committee con66 cerning the Drysdale collapse he said, and I quote, [I]n today's situation, with everybody traumatized by what has happened [in the Drysdale situation ] and looking very carefully and reviewing their situation, I would say 99 it was extremely unlikely that there is another Drysdale around. Now, Mr. Martin, in view of that, and we have had since Drysdale, Lombard-Wall, the Lion Capital, and now ESM. How manywhat is the attitude now of the Fed regarding these nonregistered security dealers? Mr. MARTIN. Mr. Chairman, as my colleague, the new President of the Federal Reserve of New York, has this week testified before another committee of the House of Representatives, we are aware that the volume of trading in these markets is enormous, as I alluded to before. We are aware that there may be need for additional flows of information, additional analysis, even additional supervision . We are going to go ahead, as of May 1 , and initiate a reporting-voluntary admittedly-reporting process for the secondary dealers in this market. We are gathering information and reviewing the situation given ESM and just the volume of trading there. Mr. BARNARD. You would not agree then with the statement that [your supervision of] the Government securities market is really aimed at the maintenance of an orderly market for U.S. debt securities and not at the detection of fraudulent practices or protecting investors? Mr. MARTIN . Well, the market has of course a whole series of purposes. As a market it is a way of financing our very, very large deficit and the turnover of that deficit. In terms of our responsibility we have not been accorded the specifics in a complete way of protecting depositors or holders of securities, although we make every effort to maintain an orderly market and the sound group of institutions, particularly the primary dealers, because they are the big volume operators . Mr. BARNARD. In other words , are you saying that if the normal bank examination and supervisory procedures are carried out - so far as banks are concerned and savings and loans-the institutions do not need any more protection, from the standpoint of registering all security dealers? Mr. MARTIN. I think that every involved agency, State or Federal, can afford to sharpen its procedures in reviewing these kinds of 300 relationships , to see how adequate they are given today's markets. But I am not here to advocate additional regulations. Mr. BARNARD. Mr. Martin, in 1980, the Federal Reserve participated with the Treasury and the SEC in a study of fraudulent practices in the Government securities market. What steps has the Federal Reserve taken as a result of that study? Mr. MARTIN. We have enhanced our examination procedures and instructions to our examiners. We have stepped up our surveillance of the primary dealers in New York through a kind of a suboffice headed by Edward Ging of the Fed of New York, so that we get more information more regularly, do more analyses, have more people, person hours devoted to that process at the Fed in New York. Mr. BARNARD. Do you feel like that is a satisfactory solution to the present problem? Mr. MARTIN. I think, sir, that we-I am sorry to be repetitive. I believe that our present review of those procedures will lead us to an answer which we do not have at this moment. I would say it warrants restudy and reappraisal which we are in the process of doing. Mr. BARNARD. Mr. Martin , I think that, in my own opinion, and I will speak for myself personally, I think the Fed acted very responsibly in this situation . And I think that we probably set some precedent in the involvement of the Fed in these State-chartered institutions, which were also privately insured. I think the question which everyone has on his mind now is whether the Federal Reserve stands ready to act promptly to supply liquidity to prevent the type of mass closings of even healthy institutions which occurred in Ohio. Mr. MARTIN. I can only say, Mr. Chairman , that we have learned from this experience. We appreciate the various comments the committee members and the chairman have made with regard to our performance here. We have learned from it. And there is no question of our commitment to you and to the public to act promptly. I think somebody, some official in the Bank of England 100 and some years ago, said in these situations you lend, you lend boldly, and you keep on lending. Ms. HORN. And I would just add, if I might, Mr. Chairman , that in the Ohio case we did not refuse a single request for liquidity. Mr. BARNARD. It is interesting, Ms. Horn, though, that in view of all the needs that were developed - in Ohio- was the Fed not surprised by the small amount of requests that they had? Ms. HORN. Yes, I think that is a fair statement. In fact, we were prepared for more than a week for the requests to come in. We communicated with the institutions about their possible needs. The requests were slow in starting up, as confidence deteriorated, the situation became more severe. Mr. BARNARD. Do you think this came about because of the wide publicity that was given to the fact that the Fed was involved and that the Home Loan Bank Board was doing all they could to bring other institutions- do you think that that sort of stemmed the need for this additional borrowing? Ms. HORN. There is no question about it; these institutions run on confidence, even more than they run on cash . And we tried to 301 make public statements occasionally, when it seemed appropriate, to indicate the Federal Reserve's participation in the situation , and we believe that added to the public confidence . Mr. BARNARD. One last question I would like to ask of Mr. Selby. In 1977, the Office of the Comptroller of the Currency had substantial supervisory experience involving ESM Government Securities that painted the firm in a highly damaging light. I think you have pretty well testified that your concerns ran so deep that some criminal referrals were made involving the National Bank of South Florida's dealings with ESM. Agreements were entered into with six national banks in Florida prohibiting them from doing any business with ESM. And you wrote the presidents of all national banks warning against the types of securities transactions that ESM regularly offered . You did alert the SEC as to your concerns and you did provide some information to the FDIC and the Florida comptroller. You did not, I presume, communicate it at all with your State counterparts . I think we are repeating testimony here but I want to get it for the record. And there was no attempt to sit down and coordinate with the other Federal banking agencies in a concerted enforcement actions against ESM. Knowing what you know now, do you not think that ESM could have been stopped or its tactics exposed years ago, if Federal and State banking and securities agencies had acted together? Mr. SELBY. Well, I do not know that we could have stopped ESM . I do not think that was our responsibility to say, to make a determination whether ESM was performing illegal transactions . Our responsibilities were to see that the banks were operating in a safe and sound manner. And to avoid having the banks, the national banks particularly, participate in any kind of transactions that might accrue loss to them. And I am not terribly sure I would know how the Federal banking agencies could say to the world at large that an ESM is not-you do not do business with an ESM . We referred it to the SEC. And I think that was our obligation. I do think in retrospect maybe that we could have, among the Federal agencies, and perhaps even the State agencies, done a better job in talking about an ESM, and all we could do is to share our experiences with ESM. I do not think we could tell the Federal Reserve or the FDIC or the Federal Home Loan Bank Board, "Here is a firm that we suspect of doing illegal things." Mr. BARNARD. Well, you know, I understand that. And of course, it is very obvious that everybody dealing with ESM did not have losses. Mr. SELBY. That is right. Mr. BARNARD. It is very obvious that somewhere along the regulatory process there was some slippage here. Those who did not have segregated accounts, and who did not have trust receipts, they -seem to be operating with some regular-Mr. SELBY. I think we could do a better job, and I think we are doing a better job in disseminating information to the industry. We all along have issued these banking circulars and assurances on the securities transactions . The 1977 was not the only one. We have done it all along, and as a matter of fact, right now I am chairman of the task force on bank supervision under the FFIEC, 302 and the counsel has approved a drafting of a new circular that will be sent out by all five agencies, talking about these very same things. This was started back in the fall of last year. Mr. BARNARD. That is the Federal-— Mr. SELBY. The Federal Financial Institutions Examination Council. Mr. BARNARD. Mr. Gray is Chairman of that. Mr. SELBY. Mr. Gray is now Chairman of it, that is correct. Mr. GRAY. I am the Chairman, and we will be looking into this very carefully and closely in the future. Mr. BARNARD. Mr. Craig. Mr. CRAIG. Two last questions. First of Mr. Martin and Ms. Horn . Your activity and the method by which you approached the problem in Ohio and the ability that you could move in was entirely within the law and you were responding to the law as it currently is? Mr. MARTIN. Yes, sir. We have alluded several times to the Monetary Control Act of 1980 and that is exactly what you all intended us to do-Mr. CRAIG. That is correct. Mr. MARTIN. For depository institutions. Mr. CRAIG. And because of that law you were able to respond in a timely and necessary fashion to the needs of those institutions? Mr. MARTIN . Yes, sir. Ms. HORN. That law, and our general approach of wanting to be cooperative with everybody in trying to fashion a solution enabled us to respond in a timely and necessary fashion. Mr. CRAIG. Thank you. Mr. Gray, I may make the mistake of quoting from the Wall Street Journal in light of concern about its reporting today, I have here a March 18 Wall Street Journal page with a listing of the activities on a day-by-day basis of the Ohio S&L crisis. I see that on March 9-10, Home State closes. In your testimony, you say on Wednesday evening, March 13, representatives of the Federal Home Loan Bank of Cincinnati examined State reports on Ohio Fund members to make a preliminary estimate of their eligibility for FSLIC insurance. Why did that Home Loan Bank move at that time? Mr. GRAY. I think we wanted to move as quickly as we could and we employed the information which we had at that early date to try to get a fix on the situation to the extent we could. I think much of the information we had at that time was relatively cursory. But we were at least trying to get a feel. Mr. CRAIG . The Cincinnati board moved on your instruction? Mr. GRAY. Yes. Mr. CRAIG. That was how many working days from the time of the public-announced closure of Home State? Mr. GRAY. Two days. Mr. CRAIG. Thank you very much. I have no further questions at this time, Mr. Chairman. Mr. BARNARD. Mr. Kindness . Mr. KINDNESS. Thank you, Mr. Chairman. Just one quick question for Chairman Gray. There was some questioning a little while ago which had to do with whom you had 303 breakfast with on what day, and that sort of thing. And regrettably it is the sort of thing that happens around here once in a while , and you were interrupted constantly. Is there anything else you wanted to say on that subject? Mr. GRAY. I certainly would . Mr. KINDNESS . I regret that Representatives Oakar and Luken could not stay, but Mr. GRAY. Thank you very much . Well, I appreciate the opportunity. I read with considerable interest the article in the Wall Street Journal. Frankly, substantial portions of that article were inaccurate, misleading, distorted, and just plain wrong. It is interesting to note that the author of the article made no attempt at all to solicit my views or my account of our involvement and the efforts which we made. I note that a substantial portion of the article is given to the comments of at least two Members of Congress who have had a disagreement with me over the way we have handled this situation . I want to point out again that I wanted to send the general counsel to the meeting at the Federal Reserve because I felt that he could provide the kind of information that the Members of Congress and the members of the Ohio thrifts could use. And I felt that at that time it was more appropriate for me to meet with Members of the Congress as soon as possible. And in that evening meeting we extended the invitation through the general counsel to meet in my office the following morning at 11:30. There was no mention of that in the article that Congresswoman Oakar chose not to come to that meeting. And I regret of that. Mr. Luken did. Another part of the article says that only after some resistance did I let Democratic Representative Luken and one thrift executive join a meeting with Republican Representatives from Ohio. The fact is that Mr. Luken was invited and was obviously a part of the group that came . We did not show any resistance to let him in at all . Mr. Gradison, one of your colleagues, a Representative from the State of Ohio, told me yesterday that he was not completely quoted in his remarks. In fact, he told me that when he was quoted as saying, "I wonder, too, if political considerations were placed above confidence in and the integrity of the financial system," as is written in the article, the Wall Street Journal left out another part of his statement which clarified it substantially. What he furthermore said was, "There is no indication that that happened." There is also a suggestion that Mr. Volcker was urging me to expedite the insurance process . Well, you know, as I have already discussed before, I met with Chairman Volcker on the final evening of the bank holiday. I have talked with him for more than 2 years now and he has never called to question , or asked about, a course of action taken by the Federal Home Loan Bank Board- ever! And I have had some differences, as you may know, with the Treasury from time to time on particular matters. They have been expressed. We do share information with the Department of the Treasury, because after all that is headed by the Chief Fiscal Officer of the United States, just as we share information with the Chairman of the Federal Reserve Board and members of the Feder- 304 al Reserve Board because it is their responsibility to maintain the integrity and financial stability of this country. Such communications are a responsible course of action . And we also exchange information with our fellow financial regulators in all of the Federal financial regulatory agencies. That is also a prudent, long established practice. So I thank you for the opportunity to make my comments, Congressman. Mr. KINDNESS . Thank you. I am sorry it was necessary. Mr. BARNARD. Gentlemen, we thank you, and, lady, very much for being with us today. And you certainly have contributed tremendously to this. I just want to say in closing, we all are concerned about maintaining the confidence in our financial institutions. And certainly I do not have to preach to you about how much we are indebted to you and your organizations in helping us maintain that confidence in the public sector for our financial institutions . And I sincerely hope that you will continue. We have had some traumatic experiences in the last 4 or 5 years. We have had Penn Square . We have had United American. We had Empire. No regulatory agency has been left out of this, possibly except for the Fed, and you have been lucky. But we need your continual vigilance in what you are doing in order to help us maintain the confidence in our financial institutions. Thank you very much. Mr. GRAY. Thank you. Mr. BARNARD. Our next panel consists of Charles C. Hogg II, who is president of the Maryland Savings-Share Insurance Corp .; Ms. Pamela A. Hathaway, executive vice president of the Pennsylvania Savings Association Insurance Corp .; Donald R. Beason, president of the Financial Institutions Assurance Corp. of North Carolina; Leonard Lapidus , executive vice president, Mutual Savings Central Fund of Massachusetts; and James L. Burns, Jr., executive vice president of the Cooperative Central Bank of Massachusetts . We will begin with Mr. Hogg and then go with Ms. Hathaway on across the table and following that, we will have our questions. Mr. Hogg. STATEMENT OF CHARLES C. HOGG II, PRESIDENT, MARYLAND SAVINGS -SHARE INSURANCE CORP. Mr. HOGG . Mr. Chairman, members of the subcommittee, it is my pleasure to be here and to address you on this very important issue that is being discussed this morning. I have submitted complete testimony and a very complete questionnaire. I would request that that be entered into the record . Mr. BARNARD . Without objection, your entire testimony will be in the record and you may summarize at your convenience. Mr. HOGG. I will do that, sir. My name is Charles Hogg. I am president and chief operating officer of the Maryland Savings-Share Insurance Corp. , referred to as MSSIC. 305 MSSIC was created in 1962 by a special act of the Maryland General Assembly for the purpose of providing a viable form of deposit insurance for State-chartered savings and loans. Our purpose is , in addition to insuring accounts are to facilitate the flexibility of our industry and to provide liquidity. Currently MSSIC insures 102 State-chartered savings and loans, all of whom have their principal offices in Maryland . These members have assets of about $8.9 billion and savings of $7.2 billion . The figures I will give you for MSSIC are as of December 31 , 1984. They were audited with an unqualified opinion by Touche Ross & Co. We had total assets at that period of $204 million . Our reserves are $ 166.8 million. The components of the reserves, as we calculate them, are the capital deposits from our members of about $ 144.3 million, retained earnings over the 23 years of operation of $17.5 million and a reserve for insurance losses of $5 million, therefore totally $166.8 million . In addition MSSIC maintains a central reserve fund, which has as its primary purpose liquidity, of $80.8 million. We maintain , with a group of five banks, a line of credit equal to $60 million . The most important point in my testimony to you today will cover the highly sophisticated regulatory and supervisory system that we have in Maryland in dealing with the State-chartered , MSSIC-insured industry. This regulatory system includes a very complete monthly report submitted to us by each member whose assets exceed $3 million. The data on the reports gives us complete knowledge of compliance or noncompliance of members with our regulations. We have a sophisticated data processing system into which the monthly reports are input against the programming of that data. Our highly qualified staff then follows up on exceptions and trends and highlights that the computer output gives us. An important aspect of our operation in Maryland is close coordination with the State through the division of savings and loan associations which is an agency of the department of licensing and regulation and the true State regulator of the industry. This coordination includes both exchanging of exams and reports, and cross attendance at board meetings. By that I mean I attend meetings of the board of commissioners. Mr. Brown, from whom you will hear later, attends the MSSIC board meetings . We hold joint supervisory conferences . My staff attends the exit interviews of the division . When they complete an examination of an institution, we get a copy of that examination and we get a copy of the institution's reponse to the comments in the examination . So, while there is total coordination of our effort, there is independent analysis. The coordination then has to do with dealing with potential problem situations . We believe that in the insurance company, that we are managing risk through the monitoring of our institutions and through quick, effective response to potential problems. Both the State and MSSIC are active in our role in dealing with our members, both in examination and in taking corrective action. It has been said today here, many times, that the key to any depos- 306 it insurance system is confidence . We believe that, obviously. We also think liquidity being strong is also important. Liquidity in the MSSIC system at yearend was over 16 percent among our members. In addition our members maintain lines of credit with commercial banks . We have proven access, and this topic has been talked about many times this morning, to the Federal Reserve Bank discount window. MSSIC sources such as its central reserve fund and its own line of credit are also important, so we think both cash and confidence are important in dealing with these problems. In summary, we know our industry, we respond quickly to problems. We know our jobs and we do them well. At the appropriate time I would be delighted to answer your questions. Thank you, sir. [Mr. Hogg's prepared statement follows: ] 307 Testimony of Charles C. Hogg, II before Commerce, Consumer and Monetary Affairs Subcommittee of the Committee on Government Operations April 3, 1984 I am pleased to appear before the Subcommittee to present my views on the state/private deposit insurance systems and to discuss in particular the Maryland Savings-Share Insurance Corporation (MSSIC). My testimony will provide brief background on MSSIC and respond to the four topics listed in Chairman Barnard's letter of March 22, 1985. MSSIC was created in 1962 by a special act of the Maryland General Assembly for the purpose of providing a viable alternative for deposit insurance for state-chartered savings and loan associations. In the early 1970's Maryland law was changed to require deposit insurance for all savings and loans in the state, and MSSIC and the Federal Savings and Loan Insurance Corporation (FSLIC) were the only providers authorized . The Charter of MSSIC appears at Title 10, Financial Institutions Article, Annotated Code of Maryland. The stated purposes of the Corporation are listed there as follows: "(1) Promote the elasticity and flexibility of the resources of members ; (2) Provide for the liquidity of members through a central reserve fund ; and (3) Insure the savings accounts of members." The operations of MSSIC are directed by a Board of Directors comprised of three members appointed by the Governor of Maryland and eight members elected from among representatives of member associations. The Board of Directors employs a staff of financial professionals to implement Board policies . I am President and Chief Operating Officer. In addition to the Board of Directors, we have a Membership Committee which meets monthly to review the operations of the member associations and to determine the eligibility of new associations for membership. Our analysis of the operations and financial condition of member associations is an 308 active, not a passive, one . Each member whose assets exceed $3 million is required to submit monthly a complete financial report which includes a balance sheet, income statement and supplemental data. This information is entered into an IBM 34 computer which is programmed to point out exceptions to all of our rules, regulations, guidelines and policy statements. In addition the computer provides reports on trend analysis, margin analysis and any change beyond established parameters. These reports are reviewed by our financial analysts, and presented to the Membership Committee and Board. Most importantly, our staff follows up on the reports by on-site visits to and review of the operations of selected institutions high-lighted by the reports. These visits and reviews may include checking on securities portfolios , loan files, operating expenses and other specifics areas of interest, or they may entail a complete review of the operations of the institution. In addition to our major data processing efforts, our staff uses an IBM Personal Computer to perform selected analysis on member associations as well as for internal uses. To supplement the analysis and review conducted by my staff, we have complete access to the examinations and files of the Division of Savings and Loan Associations (the Division), the state agency with regulatory responsibilities for the state chartered industry. Members of my staff attend the Exit Interviews conducted by the state upon completion of an examination of an institution, and we receive at the same time as the institution a copy of the Examination Report, and subsequently, a copy of the institutions response to comments in that examination . Coordination between MSSIC and the Division is further enhanced by the Director's attendance at MSSIC Board meetings,and my attendance at meetings of the Board of Commissioners. Our staffs and senior officials meet frequently to coordinate our efforts in dealing with potential problem associations and to insure that total, complete and free lines of communications exist . Copies of correspondence between our offices and member institutions are regularly 309 exchanged. Our coordination and cooperation with the Federal Home Loan Bank Board (FHLBB) is naturally more limited, although we do attend seminars and meetings where representatives of the FHLBB participate. In addition, I have recently held meetings with the Director of the Insurance Section of the FSLIC on methods of planning for and executing institution closings or other supervisory actions. We retain as a consultant the firm of the former Director of Insurance of the FSLIC. The financial data I will provide today is as of December 31 , 1984 to give a good comparative basis, although our data processing capabilities allow us to provide monthly data. We will be pleased to provide any data the committee wants. At December 31 , 1984 the 101 members of MSSIC (now 102) had total assets of $8.9 billion and total savings deposits of $7.2 billion . Included in the assets are mortgage loans of $5.8 billion and Investments and Securities of $ 1.6 billion. Our largest member had total assets of $1.6 billion and our smallest member had assets of $ 152,968. At the same date, MSSIC had total asets of $204.8 million , which included highly liquid investments, primarily U.S. Government or Agency securities of $ 132.2 million . In addition, the Central Reserve Fund, used for liquidity, had assets of $80.8 million , also invested in liquid securities. Our premium structure consists of a 2% Capital Deposit maintained by member associations with MSSIC . These deposits are adjusted semi- annually as of June 30 and December 31 of each year. We calculate our reserves or net worth to be $166.8 million . The components of this reserve position are Capital Deposits ($144.3 million), Retained Earnings ($ 17.5 million) and a Reserve for Insurance Losses ($5.0). All of the MSSIC figures are audited as of December 31 , 1984 and Touche Ross & Co. has given an unqualified opinion on our financial statements . At this point in my testimony , I would like to digress to introduce a topic that has significant meaning to MSSIC and which could add over $ 15 million to our retained earnings and reserve position. 310 This Subcommittee has asked us to make recommendations to Congress on measures which could be taken to strengthen the private deposit insurance system. Mr. Chairman, MSSIC is proud of its record. We feel depositors in members of MSSIC are thoroughly protected by our continuing to operate as we have since we were established in 1962. There is one area, however, where a change in the law would allow MSSIC to increase insurance reserves , which would add further protection to our members. As the Committee is aware, the federal deposit insurance agencies, the FDIC and FSLIC and the central liquidity facility of the National Credit Union Administration, are statutorily exempt from federal income taxes. MSSIC is statutorily exempt from Maryland state taxes. MSSIC, however, is not exempt from federal taxes, although several state organizations which perform functions similar to those of MSSIC are exempt from federal taxes. This disparity in treatment results from the fact that the section of the Internal Revenue Code which provides the federal exemption for deposit insurers, section 501 (c)( 14)( B), applies only to organizations created before September 1 , 1957. MSSIC is excluded by virtue of having been established in 1962. There is no logical reason for this discrimation . A federal tax exemption for MSSIC would permit us to add approximately fifteen million dollars to our insurance reserve fund, that figure representing taxes owed to the federal government, but not yet paid to the government. If MSSIC were operating under a federal exemption, we would be fifteen million dollars stronger, yet there would be no revenue loss to the federal Treasury. More importantly, we would operate in the same federal tax position as the federal deposit insurance agencies and those private insurers established before September 1 , 1957. A bill H.R. 6199, was introduced last Congress to eliminate entirely the cut-off date in Section 501 (c)( 14)(B) of the Code. We understand that a similar bill will be 311 reintroduced this session. We hope it will be enacted into law. In light of Congress' concerns over the ability of federal and state deposit insurers to do their jobs well, all deposit insurers should have the same federal tax treatment, particularly when they ' perform as well as MSSIC. As we have pointed out, our exacting procedures for membership in MSSIC, and the careful ongoing scrutiny that we make of our state's savings and loan industry, are a depositor's best protection against loss. No depositor in Maryland has lost even a single penny since MSSIC was organized in 1962, and we intend to continue this fine record. A federal tax exemption would help us perform the job of assuring the maximum protection available under law to depositors with members of MSSIC. A proper and appropriate early-warning and regulatory/supervisory system such as is in place in Maryland and at MSSIC should preclude the failure of one or more large insured thrifts from occurrring suddenly or as a suprise to regulators and insurers. Careful and constant monitoring must be used to detect potential problems before they become serious, and enforcement and corrective action must be taken quickly and effectively. Should a significant failure occur, however, several options are available to the regulator and insurer. These options, exercised early and decisively , include voluntary merger, assisted merger or acquisition, conservatorship or receivership , assumption of management and control, sale of branches or other assets and controlled liquidiation. Obviously all sources of liquidity, including the Federal Reserve Bank Discount Window, bank lines and other sources must be activated. Communications among all parties concerned must be open and effective. Several lessons have been learned from the events in Ohio. These deal primarily with communications , liquidity sources, and regulatory response. As a result of the Ohio situation, we have reviewed our methods of communications with our members, and with the executive and legislative branches of our State government. We are capable of disseminating quickly critical information to 102 savings and loans, and of getting from 312 these institutions, and their branches, fast and accurate information . We have reviewed and are assured that those institutions who are eligible are properly filed and prepared to utilize their access to the Federal Reserve Bank Discount Window. We have instructed our members to reconfirm the terms and conditions of borrowing under bank lines of credit. MSSIC's own liquidity position has been temporarily increased We have the systems in place to deal with an unfortunate event. All the parties involved, including the Federal Reserve Bank, are prepared to do our jobs,quickly and effectively. It has been my pleasure to appear before you. I would be happy to answer any questions. Thank you for your time and interest. STATEMENT OF PAMELA A. HATHAWAY, EXECUTIVE VICE PRESIDENT, PENNSYLVANIA SAVINGS ASSOCIATION INSURANCE CORP. Ms. HATHAWAY. Thank you, Mr. Chairman . Mr. Chairman and distinguished members of the subcommittee , I am pleased to be able to appear before you today on behalf of the Pennsylvania Savings Association Insurance Corp. I am Pamela Hathaway and I am the executive vice president of the corporation. The Pennsylvania Savings Association Insurance Corp. was created by act 5 of 1979 of the general assembly of the Commonwealth of Pennsylvania as a nonstock, nonprofit corporation and I quote, "to promote the elasticity and flexibility of the resources of member associations , to provide for the liquidity of such associations through a central reserve fund and to insure the savings accounts in such association ." The general assembly created the corporation at the same time it passed a law mandating insurance of accounts in Pennsylvania. At that time there were 139 State-chartered, uninsured savings and loan associations in that State. The majority of these institutions were small, neighborhood , traditional building and loan associations , many of which had been serving the thrift and mortgage needs in their local communities since before the turn of the century. The general assembly had attempted to pass legislation requiring Federal insurance of accounts but realized that the majority of these associations would not qualify for Federal insurance because of their small size and lack of full-time offices . The creation of the PSAIC allowed the continued existence of these small, but otherwise viable and well-run neighborhood associations . After commencing business in November 1979, the corporation approved its first group of associations for insurance of accounts on August 13 , 1980. Of 102 applications submitted to the corporation, 89 associations were approved for insurance of accounts . As of Jan- 313 uary 31 , 1985, the corporation insured accounts in 69 associations ranging in asset size from $ 128,700 to $89 million. That asset range is broken down as follows: We have 14 associations under $500,000 . Between $500,000 and $ 1 million- 16 associations; $ 1 to $ 3 million- 19 associations; $3 to $5 million - 10 associations; $5 to $10 million-7 associations; $ 10 to $15 million - 2 associations and over $15 million- 1 association. The median asset size of all of our insured institutions is $2.2 million. Net worth at our insured institutions averages a strong 13 percent as a ratio to total deposits and our institutions maintain average liquidity of approximately 15 percent. Any building, savings or savings and loan association organized under the laws of Pennsylvania may become a member of the corporation so long as its fiscal affairs, solvency, management and directorship have been certified as approved for insurance of accounts by the secretary of banking. Act 5 also provides that the central insurance fund shall consist of capital contributions by each member in an amount equal to not less than 2 percent of total savings on deposit. Each member institution is presently assessed a membership or what we call a capital deposit, of 2 percent of total savings liabilities. This deposit is adjusted at least semiannually for each institution but is adjusted on a monthly basis for those institutions which experience net savings activity greater than $ 100,000 per month. The corporation also has the authority to assess additional capital deposits against member associations upon 75-percent membership approval of such action . As of January 31, 1985, capital deposits by members stood at $4,040,000 . This figure, when added to the fund balance or our retained earnings, gives the corporation insurance reserves of $5.1 million which translates to a reserve-tomember savings ratio of 2.46 percent. The board of directors of the corporation exercises the corporate powers of PSAIC and the size and composition of the board is set by law at 11 members, 3 of whom are appointed by the Governor and 8 of whom are elected representatives of member institutions. The corporation's monitoring system is geared to early detection of problems and is carried out in very close cooperation with the department of banking. Each of our insured institutions is required to submit to the corporation, monthly financial data consisting of a balance sheet, income statement and information regarding slow loans, mortgage commitments, lines of credit and savings activity. Our associations are also required to submit a complete copy of their annual independent audit report to the corporation and the department of banking provides the corporation with a copy of its examination report and supervisory letter and all subsequent correspondence and information. The corporation has the authority to assess penalties and fines against member institutions for failure to comply with reporting requirements. The corporation's staff reviews all financial reports and information and prepares the data for review by the membership committee which meets on a regular bimonthly schedule to discharge its duties of making recommendations to the board with respect to the admission of new members, the withdrawal of members and the standing of members which continue in the corpora- 314 tion. Any action deemed necessary by the staff or committee is reviewed with the department of banking and carried out jointly. The corporation does have the authority to examine the books and records of member institutions at anytime and to terminate the insurance of any member upon good cause shown. The corporation may issue cease-and-desist orders; appoint a "supervisor in charge" at an institution; remove officers, directors and employees for violations of the law or the bylaws and rules and regulations and enter into written agreements with member institutions to avert default and lend money to or purchase assets from institutions. All member associations are required to abide by the regulations of the Savings Association Code of Pennsylvania as well as our bylaws and rules and regulations. These regulations include but are not limited to a loans-to-one borrower limit of 10 percent of total savings and maintenance of at least 8 percent reserves and 10-percent total net worth as a ratio to total savings. Borrowings are limited to 50 percent of total savings deposits and although none of our institutions approaches this limit, the corporation monitors any borrowed money at an institution very closely. Our regulations require an institution to maintain at least 7-percent liquidity. As stated earlier, the majority of our members maintain liquidity well in excess of that requirement and the corporation can, from time to time, require that associations maintain additional liquidity in accordance with guidelines set by the board to assure prudent management. Although we have never had any payouts from the fund, our bylaws do outline the procedures for such claims. The corporation maintains a very close working relationship with the savings association bureau of the department of banking. A representative of the bureau attends all of our board and membership committee meetings and as noted previously, we regularly receive all examination reports for our insured members and the bureau keeps us informed of their actions in regard to our members at all times and, in fact, no supervisory action would be taken by the bureau without first discussing the matter with the corporation. If supervisory action is deemed to be necessary and appropriate, we would act jointly with the bureau in that regard. The department of banking and the corporation share the same goal of maintenance of a strong, viable and well-run State-chartered, privately-insured system of savings institutions. It is in the best interests of not only the department and the corporation but also our savings institutions and their depositors to fully coordinate our efforts to monitor and supervise our institutions . In addition to those aspects of the relationship which I previously outlined, the secretary of banking must approve any amendments to the bylaws and rules and regulations of the corporation prior to final adoption. The secretary of banking has the statutory authority to examine the corporation's books and records and the corporation is required by statute to provide the secretary with an annual report of our activities and financial condition as examined and certified to by an independent public accountant after the 315 close of each fiscal year. The secretary of banking also has statutory authority to require the corporation to discharge its obligation to act for the protection of depositors of member institutions. Thirteen of our institutions are also members of the Federal Home Loan Bank System and although we do not have the same extensive relationship with the Federal Home Loan Bank that we do with the department of banking, we do receive copies of their mailings to our members and we have always had ready access to the officials at the Federal Home Loan Bank. We do not receive any examination reports from the Federal Home Loan Bank Board because the Board does not examine any of our institutions or exercise supervisory authority over them. With regard to precautions which have been taken to prevent or minimize dissipation of the assets of the insurance fund, the regulations which are in place to assure adequate liquidity and reserves and limits on borrowing and lending at member institutions ensure prudent management of our insured member associations. We believe that closely monitoring and supervising our institutions in close cooperation with the department of banking to insure and enforce such prudent management allows the corporation to identify potential problems and act to solve them before they reach the point where the assets of the fund could be jeopardized. The corporation also can work with the department of banking to arrange mergers, capital infusions and underwriting agreements, and as noted earlier, we do have supervisory powers to appoint a new manager, remove officers, directors and employees, issue cease-and-desist orders and terminate insurance of accounts. In addition, the corporation can make mandatory the purchase of debentures, notes or other evidence of indebtedness in an amount not to exceed 2 percent of a member's total assets and we can increase the 2-percent membership deposit upon the affirmative vote of 75 percent of all members entitled to vote. We would also point out that the number of insured institutions which are larger than the fund are not in the majority as evidenced by the member asset ranges provided earlier in this statement and our largest member has filed a written agreement with the corporation and with the department of banking to maintain capital and net worth levels in excess of the 10-percent requirement. Prior to the recent events in Ohio, the corporation was already looking at various ways in which the fund could be strengthened. Specific options being considered were establishing lines of credit, reinsurance, assessing member associations a nonrefundable annual fee in addition to the 2-percent capital deposit and establishment of a central reserve fund to provide for members' liquidity. When we have more complete information available to us, other than what has been reported in the news media regarding recent events in Ohio, we will carefully review that data with a view toward making any changes we might consider necessary to further improve and strengthen our fund. As explained in this statement, we do maintain close coordination and cooperation with the department of banking which is the principal thrift supervisory agency for our member associations. 50-923 0-85--11 316 After working so closely with the savings association bureau since our inception, we would stress that State supervision of our thrift institutions is first rate. We feel that the State examiners are well qualified to supervise our institutions and the management of the bureau has, as its foremost concern, the protection of member associations and their depositors and the Pennsylvania Savings Association Insurance Corp. The bureau staff's experience and knowledge of the savings industry, in general, and of our members, in particular, contributes to a strong State-chartered , privately insured savings and loan system in Pennsylvania. This system has served the citizens of Pennsylvania well and should continue to do so in the future. Mr. Chairman and distinguished members of the subcommittee, I thank you for your attention and for the opportunity to make this statement today. [Ms. Hathaway's prepared statement follows:] C 317 STATEMENT OF PAMELA A. HATHAWAY, EXECUTIVE VICE PRESIDENT PENNSYLVANIA SAVINGS ASSOCIATION INSURANCE CORPORATION Mr. Chairman and distinguished members of the Commerce , Consumer , and Monetary Affairs Subcommittee of the House of Representatives Committee on Government Operations , I am pleased to be able to appear before you today on behalf of the Pennsylvania Savings Association Insurance Corporation . The Pennsylvania Savings Association Insurance Corporation was created by Act 1979-5 of the General Assembly of the Commonwealth of Pennsylvania as a nonstock, nonprofit corporation " to promote the elasticity and flexibility of the resources of member associations , to provide for the liquidity of such associations through a central reserve fund and to insure the savings accounts in such associations" . The General Assembly created the Corporation at the same time it passed a law mandating insurance of accounts in Pennsylvania. At that time there were 139 state-chartered , uninsured savings and loan associations in the state . The majority of these institutions were small , neighborhood , traditional building and loan associations, many of which had been serving the thrift and mortgage needs in their local communities since before the turn of the century. The General Assembly had attempted to pass legislation requiring federal insurance of accounts but realized that the majority of these associations would not qualify for federal insurance because of their small size and lack of fulltime offices ; the creation of PSAIC allowed the continued existence of these small , but otherwise viable and well-run neighborhood associations . After commencing business in November, 1979, the Corporation approved its first group of associations for insurance of accounts on August 13 , 1980 .. Of 102 applications submitted to the Corporation , 89 associations were approved for insurance of accounts . As of January 31 , 1985 the Corporation insured accounts in 69 associations ranging in ' asset size from $ 128,700 to $ 89,089,000. 318 That asset range is broken down as follows : under $500,000 - 14 associations , $500,000 to 1 million - 16 associations , 1 to 3 million - 19 associations , 3 to 5 million - 10 associations , 5 to 10 million - 7 associations , 10 to 15 million - 2 associations and over 15 million - 1 association. The median asset size of PSAIC-insured institutions is $2,280,500 . Net worth at our insured institutions averages a strong thirteen ( 13) percent as a ratio to total deposits and our institutions maintain average liquidity of approximately 15%. Any building, savings or savings and loan association organized under the laws of Pennsylvania may become a member of the Corporation so long as its fiscal affairs , solvency, management and directorship have been certified as approved for insurance of accounts by the Secretary of Banking. Act 1979-5 provides that the central insurance fund " shall consist of capital contributions by each member in an amount equal to not less than 2% of total savings on deposit" . Each member institution is presently assessed a membership (capital) deposit of two (2 ) percent of total savings liabilities ; this capital deposit is adjusted at least semi-annually for each institution but is adjusted on a monthly basis for those institutions which experience net savings activity of $100,000 or more monthly. The Corporation has the authority to assess additional capital deposits against member associations upon 75 percent membership approval of such action. As of January 31 , 1985 capital deposits by members stood at $4,040,000; this figure when added to the fund balance gives the Corporation insurance reserves of $5,120,000 which translates to a reserve-to-member savings ratio of 2.46% based on total member savings liabilities of $208,502,800 . The Board of Directors of the Corporation exercises the corporate powers of PSAIC and the size and composition of the Board is set by law at eleven (11) members , three (3) of whom are appointed by the Governor and eight (8) of whom are elected representatives of member institutions . The bylaws require the Board to meet at least once every two months. 319 The Corporation's monitoring system is geared to early detection of problems and is carried out in close cooperation with the Department of Banking. Each of our insured institutions is required to submit to the Corporation monthly financial data consisting of a balance sheet , income statement and information regarding slow loans , mortgage commitments , lines of credit and savings activity . Associations are also required to submit a complete copy of their annual independent audit report to the Corporation and the Department of Banking provides PSAIC with a copy of its examination report and supervisory letter and all subsequent correspondence and information. The Corporation has authority to assess penalties and fines against member institutions for failure to comply with reporting requirements . The Corporation's staff reviews all financial reports and information and prepares the data for review by the Membership Committee which meets on a regular bimonthly schedule to discharge its duty of making recommendations to the Board with respect to the admission of new members , the withdrawal of members and the standing of members which continue in the Corporation . Any action deemed necessary by the staff or committee is reviewed with the Department of Banking and carried out jointly. The Corporation has the authority to examine the books and records of member institutions at any time and to terminate the insurance of any member upon good cause shown. The Corporation may issue cease-and-desist orders ; appoint a " supervisor in charge" at an institution ; remove officers , directors and employees for violations of the law or bylaws , rules and regulations and enter into written agreements with member institutions to avert default and lend money to or purchase assets from institutions . All member associations are required to abide by the regulations of the Savings Association Code of Pennsylvania as well as our bylaws , rules and 320 regulations . These regulations include but are not limited to a loans-to-one borrower limit of 10% of total savings and maintenance of at least 8% reserves and 10% total net worth as a ratio to total savings . Borrowings are limited to 50% of total savings deposits and although none of our institutions approaches this limit , the Corporation monitors any borrowed money at an institution very closely. Our regulations require an institution to maintain at least 7% liquidity; the majority of our members maintain liquidity well in excess of that requirement and the Corporation can, from time to time , require that associations maintain additional liquidity in accordance with guidelines set by the Board to assure prudent management . Although we have never had any payouts from the fund , our bylaws outline the procedures for such claims . These procedures are as follows : (1) The Secretary of Banking declares an institution in default , takes possession and values the assets pursuant to the Department of Banking Code . (2) The Corporation calculates the net insurable loss in accordance with its bylaws . (3) The Corporation then pays such net insurable loss in cash to the Secretary of Banking or to the owner of the account , or makes available a transferred , unrestricted savings account in another PSAIC-insured institution. The Corporation maintains a very close working relationship with the Savings Association Bureau of the Department of Banking. A representative of the Bureau attends all of our Board and Membership Committee meetings and as noted previously, we regularly receive all examination reports for our insured members and the Bureau keeps us informed of their actions in regard to our members at all times . In fact , no supervisory action would be taken by the Bureau without 321 first discussing the matter with PSAIC ; if supervisory action is deemed to be necessary and appropriate we would act jointly with the Bureau in that regard. The Department of Banking and the Corporation share the same goal of maintenance of a strong, viable and well-run state-chartered , privately-insured system of savings institutions . It is in the best interests of not only the Department and the Corporation but also the member savings institutions and their depositors to fully coordinate our efforts to monitor and supervise our institutions . In addition to those aspects of the relationship outlined above , the Secretary of Banking must approve any amendments to the bylaws , rules and regulations of the Corporation prior to final adoption . The Secretary of Banking has statutory authority to examine the Corporation's books and records and the Corporation is required by statute to provide the Secretary with an annual report of our activities and financial condition as examined and certified to by an independent public accountant after the close of each fiscal year. The Secretary of Banking also has statutory authority to require the Corporation to discharge its obligation to act for the protection of depositors of member institutions . Thirteen (13 ) of our insured institutions are also members of the Federal Home Loan Bank system and although we do not have the same extensive relationship with the FHLBB that we do with the Department of Banking, we do receive copies of the general mailings which are sent out to FHLB member associations and we have always had ready access to the FHLBB officials who work with our FHLB system members . We do not receive examination reports from the Federal Home Loan Bank Board because the Board does not examine any of our institutions or exercise supervisory authority over them. 322 With regard to precautions which have been taken to prevent or minimize dissipation of the assets of the insurance fund , the regulations which are in place to assure adequate liquidity and reserves and limits on borrowing and lending at member institutions ensure prudent management of our insured member associations . We believe that closely monitoring and supervising our institutions in close cooperation with the Department of Banking to ensure and enforce such prudent management allows the Corporation to identify potential problems and act to solve them before they reach the point where the assets of the fund could be jeopardized . The Corporation also can work with the Department of Banking to arrange mergers , capital infusions and underwriting agreements , and as noted earlier, the Corporation has the supervisory powers to appoint a new manager at an institution , remove officers , directors and employees , issue cease-and-desist orders and terminate insurance of accounts . In addition, the Corporation can make mandatory the purchase of debentures , notes or other evidence of indebtedness in an amount not to exceed two (2) percent of a member's total assets and can increase the 2% membership deposit upon the affirmative vote of 75 percent of all members entitled to vote at a meeting called for that purpose . We would also point out that the number of insured institutions which are larger than the fund are not in the majority as evidenced by the member asset ranges provided earlier in this statement and our largest member has filed a written agreement with the Corporation and the Department of Banking to maintain capital and net worth levels in excess of the ten (10) percent requirement. Prior to recent events in Ohio , the Corporation was already looking at various ways in which the funds could be strengthened . Specific options being considered were establishing lines of credit , reinsurance , assessing member 323 institutions a nonrefundable annual fee in addition to the two ( 2) percent capital deposit and establishment of a central reserve fund to provide for members ' liquidity. At a recent directors ' meeting , the PSAIC Board passed a resolution to require all member associations which have not already done so to establish a relationship with the Federal Reserve Bank to allow access to the discount window and also voted to amend the PSAIC rule which requires an affirmative vote of 75% of the membership to allow the Corporation to assess a capital deposit in excess of two (2) percent of total savings . When we have more complete information available to us other than what has been reported in the news media regarding recent events in Ohio, we will carefully review that data with a view toward making any changes we might consider necessary to further improve and strengthen our fund . As explained in this statement , we maintain close coordination and cooperation with the Department of Banking which is the principal thrift supervisory agency for our member associations . After working so closely with the Savings Association Bureau since our inception, we would stress that state supervision of our thrift institutions is first-rate ; we feel that the state examiners are well-qualified to supervise our institutions and the management of the Bureau has as its foremost concern the protection of member associations and their depositors and the Pennsylvania Savings Association Insurance Corporation . The Bureau staff's experience and knowledge of the savings industry in general and of our members in particular contributes to a strong state-chartered , privatelyinsured savings and loan system in Pennsylvania . This system has served the citizens of Pennsylvania well and should continue to do so in the future . Mr. Chairman and distinguished members of the Commerce , Consumer, and Monetary Affairs Subcommittee of the House of Representatives Committee on Government Operations , I thank you for your attention and for the opportunity to make this statement before you today. 324 NAME OF DEPOSIT INSURANCE FUND Pennsylvania Savings Association Insurance Corporation 1. i. General Information: 1. Type(s) of Financial Institution(s) whose deposits you insure: Savings & loan associations 2. In which state(s) do you insure: Pennsylvania 3. A. Cost of initial membership in your fund, if any: Non-refuxlable filing fee - $1,250.00 B. Annual premium: C. Continuing equity contribution or Two (2) per cent of savings membership deposit membership deposit: None 4. Maximum coverage per account or per depositor: $100,000 per account 5. Do you insure brokered deposits: brokered deposits 6. Number of insured institutions, by type: Yes , however our institutions do not use B. $100 million to $500 million: None Sixty-eight (68) C. $500 million to $1 billion: None D. Over $1 billion: None M¡. Under $100 million: jå A. 7. Aggregate amount of deposits insured, by type of institution: $208,502,800 (Jan. 31 , 1985) 8. Your fund's total useable assets: 9. Ratio of usable insurance fund assets to deposits insured: 2.46% $5,120,000 (Jan. 31 , 1985) (Jan. 31 , 1985). 325 II. Background: 1. Are you a governmental or private agency and are you a creation of State law? Please provide a text or description of your basic statutory authority. We are a private agency created by State law (P.L. 17 , No. 5 - April 6 , 1979 ) as a nonstock, nonprofit corporation, the purpose of which is " to promote the elasticity and flexibility of the resources of member associations , to provide for the liquidity of such associations through a central reserve fund and to insure the savings accounts in such associationsany, . " with supervisory authority 2. Please provide name of the state agency(ies), if over your books, records, operations, etc. By statute , the Secretary of Banking "may make such examinations and inspections of the corporation and require the corporation to furnish him with such reports and records or copies thereof as the Secretary of Banking may consider necessary or appropriate in the public interest or to effectuate the purposes of this act . " In addition the Secretary of Banking must approve any amendment to the bylaws , rules and regulations (attached 3. If a situation arises where your insurance funds are inadequate to cover sheet ) . deposit losses, do you have, by statute, a. access to the treasuries of the state(s) in which you operate; and/or No. authority to assess other insured institutions enough to cover the losses? b. The Corporation can make mandatory the purchase of debentures , notes or other evidence of indebtedness , in an amount not to exceed two (2) percent of a member's total assets . We also can increase the 2% membership deposit but only upon the affirmative vote of 75 percent of all members entitled to vote at a meeting called for that purpose . The Board is , however, presently considering (attached Are you subject to state limitations as to the ratio of insurance fund assets sheet) 4. to total deposits insured? Act 5-1979 provides that the " fund shall consist of capital contributions by each member in an amount equal to not less than 2% of the total savings on deposit with each member." 5. Do you have lines of credit already established by contract on which you can draw at will? What is the aggregate dollar limit of established lines of credit? With what institution or institutions have these credit lines been established? No. 326 II. Background : 2. (cont'd . ) of the Corporation prior to final adoption. We are also required to make an annual report of our financial condition and activities to the Secretary of Banking after the close of our fiscal year. 3. (cont'd . ) b. language to remove the need for approval of the membership to increase the assessment . 327 6. Do you reinsure your risks with any other insurance carriers? Please provide details . No. 7. Regarding your board of directors : a. How is your board of directors selected? We have an eleven (11 ) member Board of Directors - eight (8) are elected by the membership from the representatives of insured associations and three (3) are appointed by the Governor of Pennsylvania upon the advice of the Secretary of Banking. b. What rules govern the size and composition of the board? Section 4 of Act 5-1979 and Article II , Section 2 of the Bylaws require that eight of the directors be selected from among the insured institutions and three be appointed by the Governor to comprise the required board membership of eleven. c. Who are the present members of your board? (Please provide names and principal affiliations . ) Edward J. Bartosiewicz - Metropolitan Savings & Loan Assn. , Secretary-Treasurer Walter A. Benfield - Bally Building & Loan Assn. , President Herbert J. Blair - Tioga-Franklin Savings Assn. , Secretary Shirley C. Chiesa - Carnegie Savings , Building & Loan Assn. , President J. Richard Eshleman - public director appointed by the Governor John J. Kelly, Jr. - public director appointed by the Governor Anthony V. Miscavige , Jr. , - Sobieski Building & Loan ." Assn. , Secretary Edward B. Servov - public director appointed by the Governor Gregory L. Walker - Huntingdon Savings & Loan Assn. , EVP Fred J. Wiest - Union Savings & Loan Assn. , Solicitor John M. Zdanowicz - Windthorst Warsaw Savings Assn. , Secretary 328 III. Supervision of insured institutions: Do you impose on the institutions whose deposits you insure, reserve, capital or other safety and soundness requirements designed to prevent the likelihood of insolvency? If so, what basic requirements do you impose? All institutions must abide by the provisions of the Savings Association Code of Pennsylvania, as per reserve and capital requirements , as well as lending limits , borrowing limits and investment authority. Our associations must maintain at least 8% reserves and 10% total net worth, loans to one borrower are limited to 10% of total savings , associations are permitted to borrow only up to 50% of total savings and we require associations to maintain at least 7% liquidity at all times . 1. 2. Please respond separately for each state in which you insure deposits: Do you have authority, either by statute or contract, to discontinue a financial institution's membership in your deposit insurance fund? Yes Our rules and regulations provide for termination of insurance and expulsion from membership in the Corporation . a. Under what set of conditions or circumstances would you be authorized to discontinue insurance? We may expel an association and terminate its insurance if: (1) The member is violating any provisions of the laws of the Commonwealth . (2) The member is conducting unsafe or unsound practices in the conduct of business . (3) The member is in violation of any of the bylaws , rules and regulations of the Corporation. b. C. Since January 1 , 1980, set forth the number of institutions whose insurance you have discontinued and the reasons for such discontinuance . None .. 329 3. Please respond separately for each state in which you insure deposits: Do you have authority to examine the books, records, loans and other financial transactions of the institutions you insure? Is any such authority statutory or by agreement? Please describe and/or provide a copy of your authority. Yes - The rules and regulations provide that an association must " provide and permit examination of any and all books , papers and records of the member as may be requested by the Board of Directors of the Corporation. " 8. b. How frequently do you examine the institutions whose deposits you insure? Please describe your examination policies and procedures. How many examiners/auditors do you have. What is your examination operating budget? We presently employ no examiners or auditors . The Department of Banking provides us with a complete copy of the examination which they conduct once a year at each of our institutions . We also receive monthly financial data from each of our insured members as well as a copy of the annual audit report as conducted by an independent accountant . With regard to any special examinations we might request, we can employ an outside auditor for that purpose or request that the Department of Banking conduct a special examination . C. Whether or not you have independent examination powers, do you have a right of access to the examination reports of the relevant financial institution supervisory authority in your state? If so, do you receive their examination reports on a regular basis? Yes we have a right of access to the examination reports and we do receive them on a regular basis. In addition , we are a part of any subsequent correspondence or action in regard to the examination . 4. Are the institutions you insure required to have their books audited and their financial statements certified by independent outside accountants? Yes - at least annually at the close of their fiscal year . 5. If a financial problem is discovered or otherwise becomes apparent in a member financial institution, what authority do you have, short of insurance termination, to force correction of the problem and thereby forestall the necessity for claims against the deposit insurance? We have the authority to issue cease-and-desist orders and temporary cease-and-desist orders which are effective immediately upon service upon the institution. If such orders are violated we have the authority to appoint a " Supervisor in Charge" of the institution. We also have authority to remove from participation in the conduct of business of the association any officer, director or employee who has violated the law, rules and regulations or cease-and-desist order. We are authorized to enter into written agreements with members for the purpose of averting an event of default this can include lending money, purchasing assets , endorsing or acting as surety on obligations of the member. In conjunction with the Department of Banking we can also arrange mergers , require infusion of capital or require other underwriting . 330 IV. Payment of Losses: 1. Do you act as receiver/liquidator for failed institutions you insure? No. The Secretary of Banking would declare an association " in default" and become receiver. After depositors are paid off, the Secretary would turn over the assets of the failed institution to the Corporation for liquidation. 2. If a financial institution whose deposits you insure is closed due to insolvency, do depositors receive their funds immediately or must they await a liquidation process? Depositors would receive their funds immediately upon determination of the net insurable loss . 3. a. If an institution whose deposits you insure becomes insolvent, is liquidation and a payout of insured deposits your only alternative? No. Do you have authority to arrange a purchase-and-assumption takeover (purchase of assets and assumption of deposit liabilities) of a closed institution by another sound institution? Yes - we would work with the Department of Banking to arrange such a takeover. C. Do you have authority to keep an insolvent institution open and operating while seeking a merger partner? Yes as long as an institution has not been declared " in default" and closed we can keep it operating while we work with the Department to find a merger partner. 4. Please provide a listing showing, for each insolvency covered by your fund from January 1, 1980, to date: a. The name, location, and size of the institution; b. The total dollar cost of the insolvency to your fund; C. The dollar amount of insured deposits in the institution at time of closing; d. The dollar amount of uninsured deposits in the institution; e. The percentage recovery to date to depositors on uninsured deposits; f. The gross dollar amount of outstanding unpaid depositor claims; and g. The length of time between the closing of the institution and the completion of all payouts or transfers of insured deposits. No insolvencies covered , to date . 331 V. Insurance Fund Reserves: 1. How year 1981 1982 1983 1984 2. What is the present composition and market value, by type, of your insurance fund assets (for example: U.S. Treasury securities, bank deposits, corporate bonds, mutual fund investments, state/local securities)? As of February 28, 1985: Bank Deposits - $2,596,531 U. S. Treasury Securities - $2,275,852 U. S. Agency Bonds - $125,000 Money Market Fund - $26,573 3. Do you invest any insurance fund assets in deposits, notes, debentures, or other obligations of the institutions you insure? How much? No 4. In each of the past four calendar or fiscal years, what has been the average yield from interest, dividends, etc., on your investment portfolio? 1981- 13.71% 1982 - 14.30% 1983 · 13.23% 1984 · 12.20% 5. Please provide a copy of your latest annual report. much is your total usable insurance reserve? Provide calendar or fiscal data for 1981 , 1982, 1983, and 1984. - $2,094,634 - $2,386,713 $2,792,376 - $4,612,357 2 332 Mr. BARNARD. Thank you very much. STATEMENT OF DONALD R. BEASON, PRESIDENT AND CHIEF EXECUTIVE OFFICER, FINANCIAL INSTITUTIONS ASSURANCE CORP. OF NORTH CAROLINA Mr. BEASON . Thank you, sir. My name is Donald R. Beason and I am president and chief executive officer of the Financial Institutions Assurance Corp. of North Carolina. I have previously submitted testimony and information which I would request be included in the record. Mr. BARNARD. Without objection, it will so be. You may summarize, it's your decision. Mr. BEASON. To quickly summarize, I want to emphasize a few points and then I will be available for any questions that you may have. It is important to point out that we are strongly regulated and supervised by State government. We fully cooperate with them and the statutes give them authority over our operations including the ability to remove officers and directors of the insurance company. The majority of our board of directors is independent of the insured institutions and has no relationship with them at all . Our company has clear authority to take any actions we deem appropriate for the protection of the depositors . That action does include the removal of officers and directors of insured institutions and other areas that we would feel appropriate at any time. We don't operate a fund, we run a risk management insurance company. To do that, we have a financial analysis system which assists us in identifying risk and we have a trained professional staff to help manage those risks once they are identified. All the conversation today is about losses and risk and I think risk in financial institutions and their regulators, by the way, can be defined in five broad areas: Management, capital, liquidity, credit risk, and interest rate risk. We audit management which many people, including some on the national level say is impossible to do, but it is absolutely necessary because management controls the other four areas of risk. We perform operational audits and diagnostic reviews on our institutions to identify potential risks so that we have the time to work with them before they become losses . We also impose a risk-related cost factor on individual institutions. If the risk is more than we perceive to be normal, institutions are charged a higher cost for the insurance coverage. We have, in the past, and will in the future, take whatever action is appropriate under our contracts and our statutory authority to protect the depositors. That includes not closing an institution, but maintaining them as an ongoing entity should that need ever occur. I would also like to say that we have in the past, do today, and will in the future support strong standards for private deposit insurance. 333 Thank you, sir, for the time to be here and I will answer questions when it is appropriate . Mr. BARNARD. Thank you, Mr. Beason. [The prepared statement of Mr. Beason follows: ] 334 Statement of Donald R. Beason President , Financial Institutions Assurance Corporation Before the Commerce , Consumer , and Monetary Affairs Subcommittee House Committee on Government Operations April 3, 1985 Mr. Chairman and members of the Subcommittee , my name is Donald R. Beason . I am President of Financial Institutions Assurance Corporation ( " FIAC " ) of Raleigh , North Carolina . FIAC , established in 1967 as a mutual deposit guaranty insurance association under North Carolina law, operates in four states and insures the deposits of savings and loan associations , credit unions , and industrial loan companies . Under North Carolina law , FIAC is supervised and examined (on an annual basis ) by the State Secretary of Commerce . FIAC appreciates this opportunity to provide the Subcommittee with information about its deposit insurance program and related matters . Pursuant to the Subcommittee's request , this statement includes a discussion of the purposes , operations and financial resources of FIAC , the supervision of its insured institutions , and its recommendations to maintain the soundness of the deposit insurance system. 335 FIAC Deposit Insurance System Through effective financial management and growth of FIAC's capital and reserve accounts and close supervision of its member institutions , FIAC has developed a strong deposit insurance system over the past 17 years . As such , it has consistently met the following North Carolina statutory standards governing its existence : 1. Assure the liquidity of insured institutions ; 2. Guarantee the withdrawable accounts , shares of deposits of insured institutions ; and 3. Serve as receiver , when appointed , of an insured institution . Since its organization in 1967 , FIAC has never suffered a loss and none of its members has failed . FIAC's ratio of reserves to insured deposits ( 2.24% , including reinsurance contracts , as of Dec. 31 , 1984 ) exceeds those of the federal deposit insurance funds and the aggregate net worth to savings ratio of its member institutions (6.7% as of Dec. 31 , 1984 ) exceeds the regulatory requirements of state and federal authorities . FIAC insures individual accounts up to $ 100,000 and IRA accounts up to $ 250,000 . FIAC funds its operations and reserves by requiring each member to place with it a non- interest bearing deposit equal to 1.25 % of such member's savings accounts . This is supplemented by statutory authority to impose additional , riskrelated capital assessments and/or annual premiums . For 336 example , FIAC may require an institution to increase its capital deposit to 2 % of savings or pay an annual premium of up to 1/12 of 1 % of savings . These additional risk- related premiums may be assessed when FIAC determines that an institution poses more than a " normal " risk to the system . FIAC's funding system assures the maintenance of a sufficient capital base and provides flexibility to assess risk- based fees in individual circumstances . Although none of the federal funds have such capital deposit and risk- related assessment authority, Congress enacted legislation last year as part of the Deficit Reduction Act of 1984 to provide the National Credit Union Share Insurance Fund with capital deposit maintenance authority . This year , the Federal Home Loan Bank Board has proposed a FSLIC recapitalization plan which closely resembles the Share Insurance Fund capital deposit program. The operations and activities of FIAC are devoted to the active and ongoing identification and management of risk entailed in the operations of its member institutions . To that end , FIAC has developed an extensive financial analysis system to monitor such risk and has retained staff with the requisite skills , background and experience to implement this risk management function . This is in addition to state supervisory examination and independent audit requirements applicable to FIAC insured institutions . Details of the numbers and asset range of FIAC insured institutions are included in the preliminary material made available to the Subcommittee on March 25 , 1985. To 337 summarize those figures , FIAC insures 34 savings and loan associations with total deposits of $ 2,071,789,000 ; 25 credit unions with total deposits of $ 1,092,946,000 ; and 8 industrial thrift and loans with total deposits of $ 382,945,000 . The majority of FIAC's 68 insured institutions have assets of less than $ 100 million and only one institution has assets exceeding $500 million . Our Corporation employs a number of systems and procedures to assure the safety and soundness of insured thrifts . A sophisticated , computer - based financial analysis system tracks financial information on a monthly basis to provide us with an historical perspective on our members ' performance and insight into the future direction of their operations . These financial reports are checked against the institutions ' independent audits and state examinations for accuracy . This system also " flags " those items which we believe represent danger signals so that we can identify and act on potential problems before they become so acute as to pose a risk of loss . For example , under our system, a reverse repurchase borrowing , which is a separate line item on our monthly report from members , is " flagged " on a computer printout and the analyst primarily responsible for that institution must obtain detailed information on such a transaction . Copies of some reports generated by this system were included in the preliminary materials sent to the Subcommittee . In addition to the information provided us by our monthly reports , FIAC has a procedure under which periodic 338 visits are made to member institutions for the purpose of obtaining information about developments or trends which do not necessarily appear on the monthly reports . Interviews with management provide us with knowledge of new products or services , changes in operating policies or strategic plans , and give us a basis for assessing the degree of management risk of a given institution . FIAC believes that part of its role as a risk manager includes taking positive steps to improve the profitability of its insureds . Diagnostic reviews and opera- tional audits designed to pinpoint operating deficiencies and make constructive suggestions are among these positive steps . Through these processes , FIAC works to ensure that its members continue to be financially sound . Even the systems and procedures we have in place could not be effective without qualified and capable staff to perform the analysis and follow-up on identified problems . FIAC has attracted qualified personnel from a number of disciplines to carry out this critical aspect of our operations . In addition , outside professional help is engaged , when needed, to supplement the activities of staff . Liquidity and Funding With respect to FIAC's procedures for paying potential claims , we are not constrained under any statutory limitation trom using our funds to pay depositors upon demand . Accordingly , in the unlikely event of a liquidation of 339 a member institution , depositors would not have to wait for the liquidation of an institution's assets before they could receive their funds . In that respect , our response to demands for withdrawals would be similar to that of the FSLIC or FDIC . Of course , while we have effected a number of sales and merger transactions in dealing with supervisory cases , no FIACinsured institution has been liquidated since FIAC's organization in 1967 . FIAC has assets which provide sufficient funding to handle foreseeable problems . Its assets of $49.8 million are heavily liquid , with approximately $ 30.3 million invested in U.S. Treasury and Agency securities , $9.5 million in other intermediate investments , and $ 9.4 million in interest bearing cash accounts . The average maturity of the investment port- folio is less than one year . FIAC's investment philosophy of safety and liquidity has provided it with a steady income stream and asset growth . The combination of regulatory powers and financial oversight minimize the risk that any of our institutions will fail and cause FIAC to suffer a loss . On the other hand , extra attention is focused on any institution deemed to require special supervisory attention . Moreover , as any insurer would , we pay close attention to the larger FIAC insured institutions . Even with the oversight and funding systems we have in place , we have to consider the possibility that one of our insureds could fail and we have adopted measures to further protect our assets . I 340 Such measures include our reinsurance policies (which aggregate $ 27 million and for which we commit a substantial portion of our annual budget ) and our authority to increase member deposits from 1.25% to 2% of deposits . However , based on our experience , we are confident that FIAC can react to any foreseeable problem in such a manner as to prevent any serious dissipation of its own assets . The fact that we have never suffered a loss does not mean that we are inexperienced in finding solutions to problem cases . We have in the past exercised our broad powers to solve these situations . This has included the removal, for good cause, of officers and directors from problem institutions and arranging the merger or sale of troubled instituions . With regard to liquidity needs of FIAC members , the following are several of the available sources : 1. Member institution liquidity , which FIAC constantly monitors for adequacy . (At December 31 , 1984 , FIAC insured institutions had liquid assets equal to 30% of withdrawable savings . ) 2. Member institution lines of credit . FIAC- insured institutions are required to maintain independent lines of credit with reputable lenders . December 31 , 1984 , these lines aggregated some $139 million . 3. Federal Reserve discount window . All FIAC members have access to the Federal Reserve's discount window . Such access , mandated by the Monetary Control Act of 341 1980 for all depository institutions which are required to maintain non- interest bearing reserves at the Federal Reserve Banks , is provided to all such institutions on a fully secured basis . As was stated in the House Banking Committee's Report on the Monetary Control Act legislation , such access to this liquidity source " enhances the safety and soundness of the banking system" . House Report No. 263 , 96th Cong . , 1st Sess . , p . 5 . 4. FIAC's liquidity . Our investment portfolio's average maturity is presently less than one year and can be converted to cash in a very short time . 5. FIAC's lines of credit . FIAC maintains a $ 75 million line of credit with two large commercial banks . This facility is tested periodically to ensure that funds can be mobilized within a matter of hours . These funding procedures underscore FIAC's belief that an institution should not be closed to the public unless all other efforts have been expended . To do otherwise would not only create a possible lack of confidence in the financial system, but more importantly it would destroy any remaining franchise value of the closed institution. It is public confidence that maintains the franchise value which is so important to a financial institution and is a valuable asset for an insurer seeking a merger or sale solution to a supervisory problem . 342 Supervisory Responsibility Under North Carolina law , FIAC's primary regulator is the North Carolina Department of Commerce , which has broad regulatory powers over FIAC's operation . Those regulatory powers extend from performing annual safety and soundness examinations to removing any officer or Trustee of FIAC . The state's annual examination evaluates the ability of FIAC's systems and personnel to identify and act on insured institution risk within FIAC's system . This examination program was developed by a former Federal Reserve System official who is presently a staff advisor to the North Carolina Department of Commerce assigned to the Savings and Loan Division . Besides the regulatory link between the Department of Commerce and FIAC , there is a close working relationship between the two entities regarding the insured institutions . Because FIAC and the state regulator share responsibility to the depositors of the insured institutions , we have developed a system of communication that each party uses to keep the other fully posted on current developments which affect those institutions . For example , if a state examiner should become aware of a problem, we are immediately notitied instead of waiting until the final report is published . Of course , all examina- tion reports covering institutions insured by FIAC are made available to us on a routine basis , just as the results of any 343 examination or study we conduct are shared with the state regulator of the insured institution. In addition , representatives from the state regulator's office have a standing invitation to attend all of the meetings of the underwriting committee of FIAC's board of trustees . This board committee , composed entirely of public members, regularly meets to discuss the financial condition of FIAC insured institutions and to make formal recommendations to staff regarding supervisory matters . Finally, the monthly report we use to monitor the condition of members is the same one that our regulators use . Any modifications to the reporting form are approved by both parties before implementation . We work with state regulators to insure that safety and soundness is maintained through teamwork between our offices rather than through duplication of effort . This unique combination of regulatory oversight and communication has contributed greatly to FIAC's success in acting quickly and effectively to solve problems before they become crises . While no formal link exists between our Corporation and the Federal Home Loan Bank Board, we do maintain close contact with that supervisory body to stay abreast of current developments affecting federally chartered institutions . We have participated jointly in special investigations and have shared information which might have an impact on our respective insured institutions . 344 Overview of the Deposit Insurance System FIAC believes that its capital deposit and riskrelated assessment funding powers provide it with innovative tools necessary to maintain a strong and sound deposit insurance system . The events in Ohio during the past few weeks have focused attention on both federal and state deposit insurance systems , and FIAC believes that Congress should consider the flexible and effective funding methods of FIAC and other state funds in its current review of the federal funds . The federal deposit insurance funds for banks (FDIC ) and thrift institutions ( FSLIC) require each institution to pay the same annual assessment percentage . Unlike FIAC , these funds receive no capital deposits from insured institutions nor are the funds authorized to impose risk- related assessments . This has resulted in lower ratios of reserves to insured deposits for the federal funds , premium subsidies for institutions with more portfolio risk , and greater potential exposure on the U. S. Treasury . FIAC's risk management funding and oversight program is one example of an alternative to the present federal system . Besides considering ways in which to strengthen that system, FIAC believes that the federal government should spread its potential liability to a larger financial base than the federal insurance funds . Thus , state and private insurers such as FIAC increase the alternatives , both as to types of insurance systems and additional financial · 345 resources, available to the existing federal deposit insurance We believe that these alternatives should be programs . examined as part of a comprehensive review of all deposit insurance . Whether the underlying cause of the Ohio situation is ultimately determined to be inadequate supervision of a thrift institution , lack of a monitoring framework over government securities dealers , premature closure of all institutions , inadequate cooperation with the Federal Reserve Bank to assure liquidity , or some other reason , regulators and insurers must redouble their efforts to provide a safe and sound financial system. On the state level , FIAC has been active in promoting the development of standards for all deposit insurance funds and is continuing its efforts to achieve that goal . Examples of such standards which FIAC supports include , but are not limited to: 1. A requirement that a majority of the insurer's board of trustees be independent of the insured institutions ; 2. Enforcement powers for the insurer including cease and desist orders and the power to remove officers and directors ; 3. An adequate system to gather data and analyze financial condition of insureds on an ongoing and timely basis; 346 4. Procedures to ascertain that the insurer has qualified and competent staff to carry out the risk management function; 5. Access to examination reports of insured institutions ; 6. A strong working relationship with the primary regulator of its insured institutions and the Federal Reserve ; 7. Adequate external funding sources ; 8. Risk related premium or assessment powers ; and 9. Well developed contingency procedures . I expect that state and private insurers will continue to pursue such matters and assist one another in developing standards and operations best suited for their insured institutions . Conclusion The dual banking system has been an historical bedrock of our financial system . State and private deposit insurance programs have become a more visible part of this dual system. FIAC believes that its operations add to the strengths of the financial system and is an example of why private deposit insurance works . FIAC appreciates having been invited to participate in this hearing in order to highlight the positive aspects of a private deposit insurer . 347 STATEMENT OF LEONARD LAPIDUS, EXECUTIVE VICE PRESIDENT, MUTUAL SAVINGS CENTRAL FUND Mr. LAPIDUS. My name Leonard Lapidus . I am executive vice president of the Mutual Savings Central Fund. I have prepared written testimony and have answered the questions of the committee which have been submitted before this and ask that it be put in the record. Mr. BARNARD. Without objection, your entire testimony will be included in the record. Mr. LAPIDUS. The central fund was created by State law in 1932 as a liquidity facility and undertook deposit insurance services for State-chartered savings banks in 1934 and actually began insuring savings banks in the State of Massachusetts before the FDIC began insuring savings banks elsewhere. All State-chartered savings banks must be members of the fund and by State law, all deposits must be insured in full . The central fund is supervised and examined by the banking division of the State. We have 145 member banks. They have about $25 billion of deposits but they may also be insured by the FDIC and 49 of them are. The FDIC has about half the deposit liability and the central fund has the other half, so we insure roughly $ 12 billion of deposits. We have a fund of $400 million in assets available to meet our insurance responsibility and that gives us a so-called coverage ratio of 3.2 percent which is among the highest of any deposit insurer in the country, including the Federal agencies. The fund may also draw 1 percent of deposits of members which would give us access to an additional $250 million of funds if that became necessary. We have a liquidity backup of $40 million of contractural lines and we have a standby liquidity program with $40 million of lines with two investment banks which are noncontractural. As I have indicated , we have been in business over 50 years. No depositor has ever lost money in those 50 years and no bank has ever been closed to the inconvenience of depositors and borrowers. I think our success is based upon three factors . We have a very strong conservative industry and, in fact, even though we're called thrifts, the condition of the State-chartered savings banks in Massachusetts bear hardly any resemblence to thrifts elsewhere in the country. The average capital ratio of our institutions is 7.5 percent. They have a strong earnings base. During the hard times of 1980, 1981 , and 1982, we had to provide assistance to only one of our banks and in the 50-year history, we have provided assistance only to about a dozen banks. The second reason is that we have had the resolute and conscientious supervision by the banking department. There is a long tradition of good banking regulation in Massachusetts. Third, there is very close cooperation between the banking department and the central fund in monitoring banks and effecting solutions of problems as they arise. The surveillance techniques that the banking department and the central fund use include examination reports which we receive 50-923 0-85--12 348 from the banking department on the basis of statutory authority. The banks also provide us with quarterly financial reports that we transform into what we call the performance measurement system, a comprehensive detailed ratio analysis, and we get monthly reports on deposits, on delinquencies, and special reports and analysis as needed. Many of these reports are required by regulations approved by the banking commissioner and have the same force as the regulations of the banking commissioner. The information is effective , not simply because it's information , but because of the readiness to act when the information indicates that we have a problem. The committee in its request of us asked what did we learn from the Ohio situation. I think the record that we have shaped in Massachusetts indicates that what we are doing seems to make sense. The only thing I would add is that we probably need more Federal and State cooperation than we have had in the past. I think that might be more formalized, as many speakers this morning, many witnesses this morning indicated. In fact, in Massachusetts, there has been a very good, close informal relationship but, perhaps some of that has to be made more concrete. Thank you very much. [The prepared statement of Mr. Lapidus follows: ] 349 Testimony of Leonard Lapidus Executive Vice President Mutual Savings Central Fund before Commerce , Consumer and Monetary Affairs Subcommittee of the House Committee on Government Operations April 3 , 1985 My name is Leonard Lapidus . I am the Executive Vice President of the Mutual Savings Central Fund , Inc. , which insures Our deposits in state - chartered savings banks in Massachusetts . deposit insurance fund was established in 1934 , and actually began operating before the FDIC . The Central Fund is one of three private deposit insurers in Massachusetts , the others being deposit insurers for the state's cooperative banks and credit unions . The Central Fund insures the full amount of deposits in Massachusetts savings banks . All of the state's 145 savings banks are required by law to be members of the Fund . These banks range in asset size from $ 9.4 million to $ 1.2 billion , although most of them have less than $ 200 million in assets . Members have the option of joining the FDIC , in which case the Central Fund insures only those amounts over $ 100,000 that are not covered by FDIC insurance . Forty-nine of our members , including 13 of the state's 15 largest savings banks , are members of the FDIC . The Fund has $ 401 million in assets available to meet its insurance obligations and insures approximately $ 12.3 billion of deposits . Its coverage ratio is over 3.2 percent . The Fund is backed only 350 by its own assets and does not have any statutory backing of the State Treasury . Members pay an annual insurance premium set by the Central Fund Board with the approval of the Commissioner of Banks . The maximum premium is 1/16 of one percent of insured deposits , and the premium is currently set at 1/24 of one percent . The Board , with the Commissioner's approval , can levy additional assessments up to a total of one percent of each bank's deposits , or about $ 250 million . The Fund also has $40 million in contractual lines of credit with five different commercial banks , and has another $ 40 million of non-contractual lines of credit with two investment banks . Regular surveillance of members is accomplished primarily through a system of monthly , quarterly, and semi - annual reports that are required to be submitted to the Fund by regulations approved by the Commissioner of Banks . The Central Fund compiles the information received and develops a quarterly performance measurement report on each member bank . These reports , which are also sent to each member bank , provide the Central Fund with a great deal of information about its members and are a very effective monitoring tool as well as an important management tool for the member banks . The Fund has also developed a savings bank simulation model that enables it to project future balance sheet and income data under different interest - rate and 351 operational scenarios , and we are in the process of developing an interest-rate - gap-measurement report . Officials of the Fund also have regular meetings with State Banking Division staff . Our extensive reporting and monitoring system and cooperative efforts with the Banking Division enable the Central Fund to maintain close surveillance of its members and to detect problems before they become unmanageable . In over 50 years of operation , the Central Fund has never had to liquidate a bank , and pay off depositors . It has been the policy of the Fund to solve problem bank situations by providing direct assistance or by arranging a merger , and that is how we envision solving any problems in the future . In the event of a liquidation , we would expect to pay off all depositors in the bank immediately and to take over the bank's assets and proceed to liquidate them in an orderly fashion . I have already touched on the nature and extent of the Central Fund's coordination and cooperation with the Massachusetts Banking Division in discussing our monitoring efforts . In general , the Banking Division and the Central Fund work closely and exchange information to assist each other in monitoring savings bank performance . At least quarterly , Central Fund and Banking Division staff meet to discuss and compare notes on general industry conditions and specific banks that may be experiencing problems . By law , the Central Fund receives a copy 352 of each member's examination report from the Commissioner , and the Commissioner is also authorized by law to provide , in his discretion , any information that may be useful when problems are suspected . Because the Central Fund was created by an act of the legislature , its role is formally recognized in Massachusetts This is an advantage because it assures coordination and cooperation between the Fund and the Banking Division . While no formal arrangements exist between the Central Fund and the Federal Home Loan Bank System, on various occasions Central Fund officials meet or exchange information with Home Loan Bank and Bank Board officials . Although the Bank Board has no supervisory role with regard to our members , many of them are members of the Federal Home Loan Bank of Boston , and in light of the Ohio situation , we plan to explore the possibility of developing closer ties with the Home Loan Bank in the future . The Subcommittee has posed the question of what special precautions the Central Fund has taken to minimize the likelihood of the occurrence of a problem like that which arose in Ohio . The Central Fund's membership is much more evenly distributed than was the case in Ohio . Taken together , the sum of the two largest non-FDIC banks aggregates only 10 percent of the Central Fund's deposit liability , and if these two banks were to suffer the same relative losses as Home State , the Central Fund could handle the situation without any difficulty . 353 We are , of course , concerned about problems that may arise at our larger banks , and greater attention is paid to these banks than to smaller ones in our surveillance program . We have a very strong surveillance program based on regular reporting requirements , detailed performance measurement reports generated by the Fund , our simulation model , access to examination and independent audit reports of each member , and a continuing exchange of information with the Banking Division . The Subcommittee has also sought our views as to the lessons that have been learned from the recent events in Ohio , and any specific recommendations that we may have . In this connection , we offer the following thoughts : 1. Deposit insurers must have the powers and authorities necessary to meet their responsibilities . on its face , but is not always the case . This is obvious The funds must have the authority to get information to monitor on a continuing basis the financial , condition of the banks that they insure . First , the insurer must have examination authority or the authority to receive examination reports of the bank regulatory agency . It must also be able to get standard and special financial reports appropriate to its responsibilities . Its authority may rest on law or regula- tion or contract . Second , when potential problems are detected , the insurers must have the necessary powers to 354 occurs to make the necessary contacts and arrangements . Development of contingency plans should be encouraged by the Federal Reserve and Home Loan Bank Systems , and the necessary documents , collateral arrangements , etc. put in place for prompt access to the Federal liquidity facilities . Despite enactment of the Monetary Control Act of 1980 , there sometimes is a tendency on the part of the federal regulators to view privately insured institutions and their insurers as outside the system and to place legal or policy impediments in the way that make it difficult to effect the necessary coordination . This must be recognized and every effort made to encourage working relationships between federal authorities and private deposit insurers , whether by statute , regulation or policy . 4. Deposit insurance funds must be adequately capitalized . What constitutes adequate capitalization is , of course , relative and depends on other factors such as the degree of risk diversification . Obviously , funds like the failed fund in Nebraska , which was largely a sham, should not be permitted to operate . A fund like the Ohio fund , whose capitaliza- tion appeared credible on its face but which had structural problems that ultimately caused its downfall , poses more difficult problems . Nevertheless , realistic standards can and should be developed . 355 deal effectively with them before they become unmanageable . The authorities should be broad to provide direct assistance in many different ways ; to facilitate mergers and purchase and assumption transactions ; to conserve and , if necessary , to liquidate . This authority need not be independent of state supervision -- for example , in Massachusetts , all Central Fund actions with respect to troubled banks require the approval of the Commissioner , but our close relationship to the Banking Division and parallel interests have assured the effective superintendence of our members . 2. Coordination and cooperation between state supervisory officials and the insurance funds is a must . Private deposit insurers are generally not agencies of the state governments , and there can be barriers , whether legal or political , to the sharing of information and cooperation in the decision-making process . Every effort should be made to ensure that state agencies and private insurers act as allies in monitoring the banks and developing solutions to problems . Recognition of the deposit insurer's role in state statutes probably contributes to greater cooperation between state supervisory authorities and private insurers . 3. Deposit insurance funds must also have the cooperation of federal banking authorities . This cooperation must be continuing; we cannot afford to wait until an emergency 356 5. There is no substitute for strong financial institutions and vigilant supervision . Massachusetts savings banks have an average capital - to -assets ratio of nearly 7.5 percent . Their health and the effective supervision by the Massachusetts Banking Division are significant factors that contribute to the strength of the Central Fund . Deposit insurance is a valuable protection and contributes to the public's confidence in the system, but the success of both private and federal deposit insurers depends ultimately on the strength of the institutions they insure . Thank you for the opportunity to testify before the Subcommittee . I would be pleased to answer any questions . STATEMENT OF JAMES L. BURNS, JR, EXECUTIVE VICE PRESIDENT, THE CO-OPERATIVE CENTRAL BANK, BOSTON, MA Mr. BURNS. Initially I would like to express to you our appreciation for the opportunity to address this committee relative to the function and capability of the Co-operative Central Bank. The Co-operative Central Bank is a source of liquidity and is the deposit insurer for the 100 co-operative banks in the Commonwealth of Massachusetts. The Central Bank's reserve fund was founded in 1932 to be utilized as a source of liquidity by our member banks. As you well know, liquidity is normally the first need to be satisfied in the event difficulty occurs within any banking system . The reserve fund has been maintained and increased since its inception in 1932 and has continued to be utilized by our member banks to meet their occasional liquidity needs. The leaders of our industry recognized, at that time, the need for the existence of a deposit insurance fund in addition to the liquidity fund. Our industry implemented the share insurance fund in 1934 at a time when no other deposit insurance funds existed in the country. This fund is a prime example of the banking community, the banking department and our legislature acting in conjunction with one another in our Commonwealth . As a result of these two funds, a very strong, confident, conservative and well-regulated industry evolved . Our depositors have never lost any money nor ever had any difficulty in obtaining their funds at any of our co-operative banks, even during the depths of the Depression. This service to our customers continues to exist. At this time our industry consists of 100 co-operative banks with total assets of $5.25 billion. There are 220 co-operative bank offices throughout our Commonwealth. The principal activity within our 357 system for well over 100 years has been the granting of home mortgages. These mortgages comprise nearly 70 percent of our total asset base. With the changes which have occurred in banking over the past two decades, our member banks have provided additional service to their depositors such as NOW accounts, auto loans, personal, student and home modernization loans, ATM's, Keough retirement accounts and IRA's, and so forth. The net worth of our industry is about 7.3 percent of deposits. At the Central Bank we have $ 170 million in fund reserves, should the need arise. We also have over $60 million in lines of credit with commercial banks in Boston, New York and Washington, DC. One additional strength within our system is our size. The average size of our member banks is approximately $ 50 million in assets . Only 12 are over $ 100 million and none have deposits in excess of $300 million. The methods of obtaining moneys for our reserve fund and insurance fund differ somewhat. In our reserve liquidity fund, deposits are adjusted annually as the result of the vote of the board of the Central Bank. A dividend is paid on these moneys. Because of the good earnings of the fund, that dividend has been at the rate of 12 percent for a number of years. It acts as a source of liquidity for member banks, as well as an additional income stream. The share insurance fund was initially funded by an original assessment in 1934 and special assessment in the mid-1940's . Each year the banks are assessed-for many years that assessment has been at a reduced rate of one-twenty-seventh of 1 percent of deposits and notes payable. This assessment is determined by a vote of the board of the Central Bank and is subject to the approval of the commissioner of banks. By statute, the assessment could be increased to one-twelfth of 1 percent of deposits and notes payable. Once the coverage factor of the share insurance fund alone, is 3 percent of deposits, no further assessments would be made unless the coverage factor fell below 3 percent. Each member bank, including the Central Bank, is subject each year to regular recurring field examinations by the State banking department and an audit by independent public accountants. All examination reports and audits are required to be sent to the Central Bank for review. In addition, monthly reports are required by law, with fines, if late, to be sent to the Central Bank. These reports include balance sheet items, income statement items, along with delinquency reporting, commitments outstanding, liquidity, and other selected important data. Our monitoring system would recognize any significant change occurring in these figures. Immediate telephone inquiry and/or visitation by our staff, and possibly banking department staff would soon occur. In Massachusetts, the banking department has maintained a very conservative philosophy in its supervision and regulation of State-chartered banks. This supervisory approach has resulted in one of the strongest banking communities in America. The following capital guidelines have been established for a number of years by the State banking department and we adhere to them : 358 If any bank's capital ratio falls below 5 percent of assets, the bank is placed on a supervisory concern list. When the ratio falls below 4 percent, the Board is directed to formulate and implement immediately a course of action which should include, but not be limited to, seeking a merger or raising additional capital. When the ratio falls below 3 percent, the certification of the bank as unsafe and unsound would be imminent. In addition to these capital requirements , we also monitor variations in any of the classifications in our early warning system. There have been instances where we have taken action with banks of relatively high net worth when a deterioration trend has been diagnosed in one of these other categories. This policy of early remedial action has been successful in preventing deterioration of the bank's financials and for the maintenance of a very important item, public confidence. We have been able to assist some 15 banks over the recent past utilizing our ability to restructure, merge, provide income streams along with administrative assistance and financial assistance purely from the income of the insurance fund. The principal of the fund has not been used and through the 1930's and the difficult period of high interest rates and deregulation in the early 1980's , the fund has continued to successfully grow each year. It should be noted that since 1980, the Central Bank has furnished financial assistance to insured members to facilitate mergers, or to assist in asset restructure . None of these cases involved insolvency but were cases of early detection and prompt remedial action to maintain the banking system's safety and soundness. I won't bother you with the amount of funds which have been injected or loaned to our member banks. It's included in my testimony. Ninety percent of the assisted cases are now in a repayment mode. In order to attain this enviable record, it is of the utmost necessity that the regulator and insurer work together. Since assuming my responsibilities at the Central Bank some 12 years ago, I have worked with four State banking commissioners in Massachusetts and, am very proud to say, have worked well with each and every one, enabling us to fulfill our duties as the watchdog and the insurer of our industry. Forty-two of our member banks are also members of the Federal Home Loan Bank System and, as such, have access to that discount window. We in the Massachusetts thrift business have been very reluctant in the past to borrow. However, the opportunity is still there should we need it. The average borrowing, in the recent past, for our over $ 5 billion industry has averaged out to approximately $50 million. We work in conjunction with the Federal Home Loan Bank of Boston insofar as supplying monthly information to them relative to our 42 member banks who are also members of that system. The examination, audit and reporting process, together with visitations by personnel of the Central Bank, enable us to keep a very close scrutiny of our banks' performance, thus ensuring the safety and soundness of our industry. 359 Our two largest institutions each represent only 6 percent of the total assets of our industry. We monitor all our institutions on a very thorough basis. Our industry is a very stable one-community banks serving community needs. They are not involved with brokered CD's or out-of-State repurchase agreements . Your letter of invitation to appear before this committee requested specifically that I make comment as to the lessons learned and specific recommendations to the Congress regarding the events in Ohio in terms of strengthening our system, State supervision and improving the Federal response to the strains on our industry. Situations such as that which occurred in Ohio would not be permitted to exist in our Commonwealth for a number of reasons. Such a rapid increase in asset size over a short period of time would immediately trigger an investigation . In addition, the resultant gross deterioration of net worth would violate ours and the banking department's net worth requirements which I discussed previously. Upon audit review, the holding of collateral by a nonregulated Government securities dealer would be detected and would not be permitted to continue. The situation in Ohio appears to me to have been a regulatory problem which, when ignored and not acted upon, became an insurance problem. Our banks' own strong liquidity positions, substantial lines of credit, the membership in our own reserve/liquidity fund, the Monetary Control Act of 1980, which would allow their access to the Federal Reserve discount window, the overall strength of our industry and what we consider to be a very strong Co-operative Central Bank-all of these would prevent anything so traumatic as the Ohio situation from occurring in our Commonwealth . We also have in Massachusetts a very conservative State legislature which has wisely placed limitations on the amount of borrowing and also the total amount of any one particular loan or investment to any one individual. You can see that these checks and balances would prevent a situation similar to Ohio from occurring in our Commonwealth. While the situation has been a major item in the media, by and large depositor confidence has been maintained and through our tracking process, it appears to us that we are still experiencing deposit in-flows. I would like to stress to the committee, once again, that not even during the traumatic experience of the 1930's and the early 1980's , not one co-operative bank has ever failed, not one depositor has ever lost a dollar in our system, liquidity has always been maintained and all deposits have been insured in full . Thank you very much. [The prepared statement of Mr. Burns follows: ] 360 DANK THE L TRA CEN EN COP TheCO- OPERATIVE CENTRAL BANK 225 FRANKLIN STREET BOSTON • MASSACHUSETTS 02110 INSURED TUL (617) 542-3093 JAMES L BURNS, EXECUTIVE VICEJR.PRESIDENT ANE TREASURE MARCH 28 , 1985 TO MEMBERS OF THE COMMERCE , CONSUMER , AND MONETARY AFFAIRS SUBCOMMITTEE GENTLEMEN : INITIALLY I WOULD LIKE TO EXPRESS TO YOU OUR APPRECIATION FOR THE OPPORTUNITY TO ADDRESS THIS COMMITTEE RELATIVE TO THE FUNCTION AND CAPABILITY OF THE CO-OPERATIVE CENTRAL BANK . THE CO-OPERATIVE CENTRAL BANK IS A SOURCE OF LIQUIDITY AND IS THE DEPOSIT INSURER FOR THE 100 CO- OPERATIVE BANKS IN THE COMMONWEALTH OF MASSACHUSETTS . THE CO- OPERATIVE CENTRAL BANK'S RESERVE FUND WAS FOUNDED IN 1932 TO BE UTILIZED AS A SOURCE OF LIQUIDITY BY OUR MEMBER BANKS . AS YOU WELL KNOW , LIQUIDITY IS NORMALLY THE FIRST NEED TO BE SATISFIED IN THE EVENT DIFFICULTY OCCURS WITHIN ANY BANKING SYSTEM . THE RESERVE FUND HAS BEEN MAINTAINED AND INCREASED SINCE INCEPTION IN 1932 AND HAS CONTINUED TO BE UTILIZED BY OUR MEMBER BANKS TO MEET THEIR OCCASIONAL LIQUIDITY NEEDS . THE LEADERS OF OUR INDUSTRY RECOGNIZED AT THAT TIME THE NEED FOR THE EXISTENCE OF A DEPOSIT INSURANCE FUND IN ADDITION TO THE LIQUIDITY FUND . OUR INDUSTRY IMPLEMENTED THE SHARE INSURANCE FUND IN 1934 AT A TIME WHEN NO OTHER DEPOSIT INSURANCE FUNDS EXISTED IN THE COUNTRY . THIS FUND IS A PRIME EXAMPLE OF THE BANKING COMMUNITY, THE BANKING DEPARTMENT AND THE LEGISLATURE ACTING IN CONJUNCTION WITH ONE ANOTHER IN THE COMMONWEALTH OF MASSACHUSETTS . 361 AS A RESULT OF THESE TWO FUNDS , A VERY STRONG , CONFIDENT, CONSERVATIVE AND WELL - REGULATED INDUSTRY EVOLVED . OUR DEPOSITORS HAVE NEVER LOST ANY MONEY NOR EVER HAD ANY DIFFICULTY IN OBTAINING THEIR FUNDS AT ANY OF OUR CO- OPERATIVE BANKS , EVEN DURING THE DEPTHS OF THE DEPRESSION . THIS SERVICE TO OUR CUSTOMERS CONTINUES TO EXIST . AT THIS TIME OUR INDUSTRY CONSISTS OF 100 CO - OPERATIVE BANKS WITH TOTAL ASSETS OF $ 5 1/4 BILLION . THERE ARE 220 CO-OPERATIVE BANK OFFICES THROUGHOUT THE COMMONWEALTH . THE PRINCIPAL ACTIVITY WITHIN OUR SYSTEM FOR WELL OVER 100 YEARS HAS BEEN THE GRANTING OF HOME MORTGAGES . ASSET BASE . THESE MORTGAGES COMPRISE NEARLY 70% OF OUR TOTAL WITH THE CHANGES WHICH HAVE OCCURRED IN BANKING OVER THE PAST TWO DECADES , OUR MEMBER BANKS HAVE PROVIDED ADDITIONAL SERVICE TO THEIR DEPOSITORS SUCH AS NOW ACCOUNTS , AUTO LOANS , PERSONAL , STUDENT AND HOME MODERNIZATION LOANS , ATM'S, KEOUGH AND IRA RETIREMENT ACCOUNTS , ETC. THE NET WORTH OF OUR INDUSTRY IS OVER 7.3% OF DEPOSITS . AT THE CO-OPERATIVE CENTRAL BANK WE HAVE $ 170 MILLION IN THE FUNDS ' RESERVES , SHOULD THE NEED ARISE . WE ALSO HAVE OVER $60 MILLION IN LINES OF CREDIT WITH BOSTON , NEW YORK AND WASHINGTON , D.C. COMMERCIAL BANKS . OUR SIZE . ONE ADDITIONAL STRENGTH WITHIN OUR SYSTEM IS THE AVERAGE SIZE OF OUR MEMBER BANKS IS APPROXIMATELY $50 MILLION IN ASSETS . ONLY TWELVE ARE OVER $ 100 MILLION AND NONE HAVE DEPOSITS IN EXCESS OF $ 300 MILLION . 362 THE METHODS OF OBTAINING MONEYS FOR OUR RESERVE FUND AND INSURANCE FUND DIFFER SOMEWHAT . IN OUR RESERVE /LIQUIDITY FUND , DEPOSITS ARE ADJUSTED ANNUALLY AS THE RESULT OF A VOTE OF THE BOARD OF THE CO - OPERATIVE CENTRAL BANK . THESE MONEYS . A DIVIDEND IS PAID ON BECAUSE OF THE GOOD EARNINGS OF THE FUND , THAT DIVIDEND HAS BEEN AT THE RATE OF 12% FOR THE PAST NUMBER OF YEARS . IT ACTS AS A SOURCE OF LIQUIDITY FOR MEMBER BANKS , AS WELL AS AN ADDITIONAL INCOME STREAM . THE SHARE INSURANCE FUND WAS INITIALLY FUNDED BY AN ORIGINAL ASSESSMENT IN 1934 AND A SPECIAL ASSESSMENT IN THE MID - 1940S . EACH YEAR THE BANKS ARE ASSESSED -- FOR MANY YEARS THAT ASSESSMENT HAS BEEN AT A REDUCED RATE OF 1/27TH OF 1% OF DEPOSITS AND NOTES PAYABLE . THIS ASSESSMENT IS DETERMINED BY A VOTE OF THE BOARD OF THE CO-OPERATIVE CENTRAL BANK AND IS SUBJECT TO THE APPROVAL OF THE COMMISSIONER OF BANKS . BY STATUTE THE ASSESSMENT COULD BE INCREASED TO 1 / 12TH OF 1 % OF DEPOSITS AND NOTES PAYABLE . ONCE THE COVERAGE FACTOR OF THE SHARE INSURANCE FUND ALONE IS 3% OF DEPOSITS , NO FURTHER ASSESSMENTS WOULD BE MADE UNLESS THE COVERAGE FACTOR FELL BELOW 3%. 1 EACH MEMBER BANK , INCLUDING THE CENTRAL BANK , IS SUBJECT EACH YEAR TO REGULAR RECURRING FIELD EXAMINATIONS BY THE STATE BANKING DEPARTMENT AND AN AUDIT BY INDEPENDENT PUBLIC ACCOUNTANTS . ALL EXAMINATION REPORTS AND AUDITS ARE REQUIRED TO BE SENT TO THE CO-OPERATIVE CENTRAL BANK FOR REVIEW . IN ADDITION , MONTHLY REPORTS ARE REQUIRED BY LAW TO BE SENT TO THE CO - OPERATIVE CENTRAL BANK . THESE REPORTS INCLUDE BALANCE SHEET AND INCOME STATEMENT 363 ITEMS TOGETHER WITH DELINQUENCY REPORTING , COMMITMENTS OUTSTANDING , LIQUIDITY DATA AND OTHER SELECTED IMPORTANT DATA . OUR MONITORING SYSTEM WOULD RECOGNIZE ANY SIGNIFICANT CHANGE OCCURRING IN THESE BANK FIGURES . IMMEDIATE TELEPHONE INQUIRY AND/OR VISITATION BY CENTRAL BANK STAFF , AND POSSIBLY BANKING DEPARTMENT STAFF , WOULD OCCUR . IN MASSACHUSETTS , THE BANKING DEPARTMENT HAS MAINTAINED A VERY CONSERVATIVE PHILOSOPHY IN ITS SUPERVISION AND REGULATION OF STATE CHARTERED BANKS . THIS SUPERVISORY APPROACH HAS RESULTED IN ONE OF THE STRONGEST BANKING COMMUNITIES IN AMERICA . THE FOLLOWING CAPITAL GUIDELINES , ESTABLISHED FOR A NUMBER OF YEARS BY THE COMMISSIONER OF BANKS , SERVES AS A GOOD EXAMPLE OF A STRONG , CONSERVATIVE APPROACH : " IF ANY BANK'S CAPITAL RATIO FALLS BELOW 5% OF ASSETS THE BANK IS PLACED ON A SUPERVISORY CONCERN LIST , WHEN THE RATIO FALLS BELOW 4% THE BOARD IS DIRECTED TO FORMULATE AND IMPLEMENT IMMEDIATELY A COURSE OF ACTION WHICH SHOULD INCLUDE , BUT NOT BE LIMITED TO , SEEKING A MERGER OR RAISE ADDITIONAL CAPITAL . WHEN THE RATIO FALLS BELOW 3% THE CERTIFICATION OF THE BANK AS UNSAFE AND UNSOUND WOULD BE IMMINENT . " IN ADDITION TO THESE CAPITAL REQUIREMENTS , WE ALSO MONITOR VARIATIONS IN ANY OF THE CLASSIFICATIONS IN OUR EARLY WARNING SYSTEM . THERE HAVE BEEN INSTANCES WHERE WE HAVE TAKEN ACTION WITH BANKS OF RELATIVELY HIGH NET WORTH WHEN A DETERIORATION TREND HAS BEEN DIAGNOSED IN ONE OF THESE OTHER CATEGORIES . THIS POLICY OF EARLY REMEDIAL ACTION HAS BEEN SUCCESSFUL IN PREVENTING 364 DETERIORATION OF THE BANK'S FINANCIALS AND FOR THE MAINTENANCE OF A VERY IMPORTANT ITEM -- PUBLIC CONFIDENCE . WE HAVE BEEN ABLE TO ASSIST SOME FIFTEEN BANKS OVER THE RECENT PAST UTILIZING OUR ABILITY TO RESTRUCTURE , MERGE , PROVIDE INCOME STREAMS ALONG WITH ADMINISTRATIVE ASSISTANCE AND FINANCIAL ASSISTANCE PURELY FROM THE INCOME FROM THE INSURANCE FUND . THE PRINCIPAL OF THE FUND HAS NOT BEEN USED , AND THROUGH THE 1930S AND DIFFICULT PERIOD OF HIGH INTEREST RATES AND DEREGULATION IN THE 1980S , THE FUND HAS CONTINUED TO SUCCESSFULLY GROW EACH YEAR . IT SHOULD BE NOTED THAT SINCE 1980 THE CO - OPERATIVE CENTRAL BANK HAS FURNISHED FINANCIAL ASSISTANCE TO INSURED MEMBERS TO FACILITATE MERGERS , OR TO ASSIST IN ASSET RESTRUCTURE . NONE OF THESE CASES INVOLVED INSOLVENCY BUT WERE CASES OF EARLY DETECTION AND PROMPT REMEDIAL ACTION TO MAINTAIN BANKING SYSTEM SAFETY AND SOUNDNESS . (A) PERMANENT CAPITAL OF $ 1,950,000 WAS DISBURSED TO TWO INSTITUTIONS .. ( B ) INTEREST BEARING LOANS OF $ 3,529,670 WERE ADVANCED TO THREE INSTITUTIONS . CURRENT OUTSTANDING BALANCE OF $899,670 EXISTS . ( C ) CAPITAL CERTIFICATES OF $ 16,724,000 WERE ISSUED TO FOUR INSTITUTIONS . $ 13,819,700 REMAINS OUTSTANDING PRESENTLY . ( D ) SECURITIES OF $ 10,065,000 WERE ACQUIRED FROM ONE INSTITUTION AT BOOK VALUE . $ 8,731,700 REMAINS OUTSTANDING SUBJECT TO RESALE ON 4/21/87 . 365 IN ORDER TO ATTAIN THIS ENVIABLE RECORD IT IS OF THE UTMOST NECESSITY THAT THE REGULATOR AND THE INSURER WORK TOGETHER . SINCE ASSUMING MY RESPONSIBILITIES AT THE CO - OPERATIVE CENTRAL BANK SOME TWELVE YEARS AGO I HAVE WORKED WITH FOUR STATE BANKING COMMISSIONERS IN MASSACHUSETTS AND , AM VERY PROUD TO SAY, HAVE WORKED WELL WITH EACH AND EVERY ONE , ENABLING US TO FULFILL OUR DUTIES AS THE WATCHDOG AND INSURER OF OUR INDUSTRY . FORTY -TWO OF OUR MEMBER BANKS ARE ALSO MEMBERS OF THE FEDERAL HOME LOAN BANK SYSTEM AND , AS SUCH , HAVE ACCESS TO THEIR DISCOUNT WINDOW . WE IN THE MASSACHUSETTS THRIFT BUSINESS HAVE BEEN VERY RELUCTANT IN THE PAST TO BORROW . STILL THERE SHOULD WE NEED IT . HOWEVER , THE OPPORTUNITY IS THE AVERAGE BORROWING IN THE RECENT PAST FOR OUR OVER $ 5 BILLION INDUSTRY HAS BEEN APPROXIMATELY $ 50 MILLION . WE WORK IN CONJUNCTION WITH THE FEDERAL HOME LOAN BANK OF BOSTON INSOFAR AS SUPPLYING MONTHLY INFORMATION TO THE HOME LOAN BANK RELATIVE TO OUR 42 MEMBER BANKS WHO ARE ALSO MEMBERS OF THAT SYSTEM . THE EXAMINATION , AUDIT AND REPORTING PROCESS , TOGETHER WITH VISITATIONS BY PERSONNEL OF THE CENTRAL BANK , ENABLE US TO KEEP A VERY CLOSE SCRUTINY OF OUR BANKS ' PERFORMANCE , THUS ENSURING THE SAFETY AND SOUNDNESS OF OUR INDUSTRY . OUR TWO LARGEST INSTITUTIONS EACH REPRESENT ONLY 6% OF THE TOTAL ASSETS OF THE INDUSTRY . A VERY THOROUGH BASIS . WE MONITOR ALL OUR INSTITUTIONS ON 366 OUR INDUSTRY IS A STABLE ONE COMMUNITY NEEDS . COMMUNITY BANKS SERVING THEY ARE NOT INVOLVED WITH BROKERED CD'S OR OUT -OF -STATE REPURCHASE AGREEMENTS . YOUR LETTER OF INVITATION TO APPEAR BEFORE THIS COMMITTEE REQUESTED SPECIFICALLY THAT I MAKE COMMENT AS TO THE LESSONS LEARNED AND SPECIFIC RECOMMENDATIONS TO THE CONGRESS REGARDING THE EVENTS IN OHIO IN TERMS OF STRENGTHENING OUR SYSTEM , STATE SUPERVISION AND IMPROVING THE FEDERAL RESPONSE TO STRAINS ON THE THRIFT INDUSTRY . SITUATIONS SUCH AS THAT WHICH OCCURRED IN OHIO WOULD NOT BE PERMITTED TO EXIST IN THE COMMONWEALTH OF MASSACHUSETTS FOR A NUMBER OF REASONS . SUCH A RAPID INCREASE IN ASSET SIZE OVER A SHORT PERIOD OF TIME WOULD IMMEDIATELY TRIGGER AN INVESTIGATION . IN ADDITION , THE RESULTANT GROSS DETERIORATION OF NET WORTH WOULD VIOLATE OURS AND THE BANKING DEPARTMENT'S NET WORTH REQUIREMENTS WHICH I DISCUSSED PREVIOUSLY . UPON AUDIT REVIEW , THE HOLDING OF COLLATERAL BY A NON - REGULATED GOVERNMENT SECURITIES DEALER WOULD BE DETECTED AND WOULD NOT BE PERMITTED TO CONTINUE . THE SITUATION IN OHIO APPEARS TO ME TO HAVE BEEN A REGULATORY PROBLEM AND WHEN IGNORED AND NOT ACTED UPON BECAME AN INSURANCE PROBLEM . OUR BANKS ' OWN STRONG LIQUIDITY POSITIONS , SUBSTANTIAL LINES OF CREDIT , THE MEMBERSHIP IN OUR OWN RESERVE /LIQUIDITY FUND , THE MONETARY CONTROL ACT OF 1980 WHICH WOULD ALLOW THEIR ACCESS TO THE FEDERAL RESERVE DISCOUNT WINDOW , THE OVERALL STRENGTH OF OUR INDUSTRY AND WHAT WE CONSIDER TO BE A VERY STRONG CO - OPERATIVE 367 CENTRAL BANK ALL OF THESE WOULD PREVENT ANYTHING SO TRAUMATIC AS THE OHIO SITUATION FROM OCCURRING WITHIN OUR COMMONWEALTH . WE ALSO HAVE IN MASSACHUSETTS A CONSERVATIVE STATE LEGISLATURE WHICH HAS WISELY PLACED LIMITATIONS ON THE AMOUNT OF BORROWING AND ALSO ON THE TOTAL AMOUNT OF ANY ONE PARTICULAR LOAN OR INVESTMENT TO ANY ONE INDIVIDUAL . YOU CAN SEE THAT THESE CHECKS AMD BALANCES WOULD PREVENT A SITUATION SIMILAR TO OHIO FROM EVER OCCURRING IN MASSACHUSETTS . WHILE THE SITUATION HAS BEEN A MAJOR ITEM IN THE MEDIA , BY AND LARGE DEPOSITOR CONFIDENCE HAS BEEN MAINTAINED AND THROUGH OUR TRACKING PROCESS IT APPEARS THAT WE ARE STILL EXPERIENCING DEPOSIT IN-FLOWS . I WOULD LIKE TO STRESS TO THE COMMITTEE ONCE AGAIN THAT EVEN THROUGH THE TRAUMATIC EXPERIENCE OF THE ' 30S AND EARLY ' 80S NOT ONE CO-OPERATIVE BANK HAS EVER FAILED , NOT ONE DEPOSITOR HAS EVER LOST A DOLLAR IN OUR SYSTEM , LIQUIDITY HAS ALWAYS BEEN MAINTAINED AND ALL DEPOSITS HAVE BEEN INSURED IN FULL . RESPECTFULLY SUBMITTED , JAMES L. BURNS , JR . EXECUTIVE VICE PRESIDENT 368 Mr. BARNARD. I thank all of you for very, very splendid testimony. One of the thrusts of our hearing and investigation has been to look into the adequacy of what we term the "State private insurance funds" and certainly all of you have brought testimony which is, at this point in the hearing, a breath of fresh air as to what you are doing to offset things that we have seen happen in Ohio. And, I certainly want to commend you and say that it certainly gives this member of the committee a lot more confidence in the experience of funds such as you have. Mr. Burns, I was intrigued by your statement that upon an audit review, the holding of collateral by a nonregulated Government securities dealer would be detected and would not be permitted to continue. I would just like to ask, briefly, all the members of the panel : How would you have responded if you had been confronted several months ago by a situation like Home State? You have listened to the testimony this morning and I would be interested to know what would you have done in a situation such as this. We'll begin with Mr. Hogg. Mr. HOGG. Mr. Chairman, in Maryland , we have had on the books of MSSIC since 1976, a regulation which would prohibit a borrowing position of that level . We limit all borrowing of our member institutions to 15 percent of their savings, not anywhere near the Ohio situation. In addition, we have loan concentration limits which would limit the involvement with one institution. Mr. BARNARD. Ms. Hathaway . Ms. HATHAWAY. Yes , Mr. Chairman. I think we have basically the same setup in Pennsylvania in that, as I stated in my testimony, we do have a law on the books of Pennsylvania that no institution may borrow more than 50 percent of its total savings. However, right now I know that at all of my institutions, most do not have borrowings and of those that do, the highest percentage is 3 percent. Although we don't have a formal written guideline or written policy on that issue, I think we would start to very closely look at the borrowed money if it got to be 10 percent. Mr. BARNARD. Both you and Mr. Hogg would have gotten this information, then, from the monthly reports furnished to you by your membership? Ms. HATHAWAY. That's correct, I would and I think Mr. Hogg also would . Mr. BARNARD. Mr. Beason . Mr. BEASON. Yes, thank you, Mr. Chairman . Our regulations and, I think, State regulation limits a concentration of borrowings or lendings to 10 percent of assets or less than capital of some figure. The financial analysis system we have has a flag system that kicks out items that are outside the norm and it just so happens that reverse repurchase agreements are a flag within our system and anytime those were to develop, it would be kicked out. Such a concentration would be found within a 45-day period from the time it took place. 369 Mr. BARNARD. Do your examinations come only through sharing of examination reports from the North Carolina State Department of Banking or Savings and Loan? Mr. BEASON. No, sir. Mr. BARNARD. You do your own examinations? Mr. BEASON. Not examination, no, sir. The State does an annual examination as we would normally think of a bank examination . We perform operational audits or diagnostic reviews, more of the operational audit concept. Our primary source of information is a monthly financial analysis system that is performed. Mr. BARNARD. Mr. Lapidus? Mr. LAPIDUS. The savings banks in Massachusetts are not limited in the amount of borrowing they can do, but the level of borrowing that was engaged in by Home State would have been considered to be an unsafe and unsound practice, we would have picked that up as, in fact, the Ohio Division of Savings and Loan picked it up. The issue was once you get the information , what do you do with it? I think that was where the difference would be. I think in Massachusetts something would have been done, something on the basis of the way the banking department has handled its responsibilities in the past . Mr. BARNARD. Mr. Burns. Mr. BURNS. Thank you . Our early warning system would have detected this immediately. We are informed on a monthly basis now as to the source of loans in terms of the loans. Of our $50 million outstanding at the moment, 45 is on a matched basis from the Federal Home Loan Bank, 3 from our own liquidity fund, and 2 from the commercial banking system. Anything above 10 percent would kick out a flag. Mr. BARNARD. Mr. Beason, I believe that your insurance fund is the only one that has directors outside of your membership . Am I correct there? Mr. BEASON. We have that. I don't know about the others. Mr. BARNARD. Mr. Lapidus? Mr. LAPIDUS. We have a board of 25 members, 21 are bankers and 4 are outside directors. Mr. BARNARD. Mr. Beason, yours is exclusively outside directors; is that it? Mr. BEASON. No, sir. The statute requires that a majority of the nine-member board be outsiders and independent. Mr. BARNARD. Outside and independent. How do you feel this strengthens your fund or your organization? Mr. BEASON. It gives us the quality of people who can look at what we do on a subjective basis without any personal feelings or motivations being involved. Mr. BARNARD. How are they selected? Mr. BEASON. They are nominated by a nominating committee made up for public directors. Mr. BARNARD. Not from any supervisory agency or political entity? Mr. BEASON. That's correct. Mr. HOGG. Mr. Chairman, in Maryland, the Governor appoints three members of our board of directors . 370 Mr. BARNARD. Which are outside of your membership? Mr. HOGG. Yes, sir. Mr. BARNARD. Pennsylvania? Ms. HATHAWAY. Pennsylvania has the same set up, eight are elected from the membership and three are appointed by the Governor as public interest directors. Mr. BARNARD. Mr. Burns, what about your organization? Mr. BURNS. Yes, sir. Soon our board will be made up of 15 elected from the officers and directors of the industry and 4 public interest directors nominated by nominating committee and elected by the corporate membership. Mr. BARNARD. Mr. Lapidus, in your statement today, I believe you said there sometimes is a tendency on the part of the Federal regulators to view privately insured institutions and their insurers as outside of the system and that they put into place legal and policy impediments that make it difficult to effect the necessary coordination. Would you care to elaborate on that? Mr. LAPIDUS. I don't mean to point fingers unnecessarily. I think it's a matter that the private insurance funds don't have a governmental nexus so there is a tendency to think of them as simply outsiders. I think it is something that is remediable. I have the good fortune of having worked within the Federal regulatory system for a large part of my career and have very good relationships with Federal supervisors . I haven't had any problem making those connections on my own, but I think in other States, it might be more difficult. Mr. BARNARD. Mr. Beason, in your testimony, you said that we have fought within the private deposit insurance industry to establish national standards and a certification body for deposit insurers. What type of certification body would you like to see established? Mr. BEASON. I'm not sure I have the answer to that yet. We have been working first, to try to set the parameters of what the standards ought to be. Obviously the first reaction would be an independent body, independent of us and independent of Government, if you will, but I don't think that we are opposed to that body having Government representation or being Government controlled though . Mr. BARNARD. In other words, you see a body made up of representatives from the FSLIC, the FDIC, the Federal Reserve, or who are you talking about? Mr. BEASON. Certainly not the FDIC or the FSLIC. I would have full faith in that body being under the jurisdiction of the Federal Reserve System. Mr. BARNARD. From what membership would you obtain this certification group? Mr. BEASON. Maybe it ought to be under the Federal Reserve System and that body appoint the other members and they could come from government or business and industry for that matter. Mr. BARNARD. Why do you object to the FSLIC or FDIC? Mr. BEASON. Well, quite frankly, I think the standards that we have set are clear and stand on their own and I would personally object to that situation. 371 Mr. BARNARD. In other words, in your valuation, you've got a better system than the Federal system? Mr. BEASON. I was trying not to say that. Mr. BARNARD. I think it's obvious you said that. That's a very interesting approach. Do you foresee that in this situation that there would be a mandatory membership or would it be a voluntary membership, as far as the State insurance funds are concerned? Mr. BEASON. I think being from North Carolina, you have to recognize that I am a States Righter without any reservation. But, at the same time, I think national public policy does come into play and has to override some things. With the depositors in Ohio suffering as they have, regardless of whose responsibility it is or how it developed . Nebraska and California are having the same situation . That's where we come down and think that something has to be done for the national policy aspect of this and yes, I think that overrides and is effective. Mr. LAPIDUS. Mr. Chairman, may I comment on that question as well? Mr. BARNARD. Sure. Mr. LAPIDUS. Mr. Beason and I and a number of people at the table have spent sometime over the past year discussing regulatory standards. As far as the State funds go, we're not making a circle with the wagons, but if we are making a circle with the wagons, we only want the good guys inside. We have been injured by funds such as the Ohio fund and Nebraska fund which went under. What we want to do is distinguish ourselves from the funds that are weak and, in fact, in discussing these standards, all of us admitted, very clearly that if we have real standards, appropriate standards, some people are going to be left out and that's exactly what should happen. Mr. BARNARD. You know, I was interested in-and I am going to finish so I can let my colleagues finish this questioning-the percentage of reserves to total assets insured. Mr. Hogg, did I understand you to say that your ratio is 16 percent? Mr. HOGG. No, sir. That 16 percent was the liquidity level of our member institutions . Our reserves to savings insured at yearend was 2.31 percent. Mr. BARNARD. Your's was 2.31 . Mr. HOGG. Yes, sir. Mr. BARNARD. What about Pennsylvania, Ms. Hathaway? Ms. HATHAWAY. Pennsylvania's, at the end of January, were 2.46 percent . Mr. BARNARD. Well, since we're on that subject▬▬ Mr. BEASON. Our reserves to savings, I think are 2.4 and the liquidity position of our institutions is over 30 percent. The net worth position of the institutions is over 6 percent. Mr. BARNARD . Mr. Lapidus? Mr. LAPIDUS . Ours is 3.2 percent. Mr. BURNS. Our coverage factor, including the reserve liquidity fund, are about 3.6 percent. Liquidity is about 28 percent and the 372 net worth of the industry is about 7.2 percent of deposits and 6.8 percent of assets. Mr. BARNARD. In Ohio, we have a situation which I might describe as a catastrophic loss. I mean, here's a $ 1.5 billion institution, the largest institution insured . Is there some danger in any of these funds that an institution , the largest that you have, could cripple your fund? Mr. BEASON. Mr. Chairman, that's always a possibility, but a $50 million total asset savings and loan association could suffer a $ 150 million loss if they engaged in the kind of concentration that you have been talking about in Ohio. Mr. BARNARD. Would anyone else like to respond to that? Mr. LAPIDUS. Yes. Our largest institution-our largest fully insured institution is about $800 million in assets. If it suffered the same relative loss as Home State had suffered , the loss would be $120 million and we could easily cover that. Our two largest institutions don't constitute more than 10 percent of our liabilities so we could cover that as well. Mr. BARNARD. Mr. Burns? Mr. BURNS. Our four largest institutions were among the 15 we assisted in the early 1980's, primarily because they are located in metropolitan areas and were losing money to the money market funds. They are all about 5 percent in assets now and most are paying us back. Mr. BARNARD. Mr. Burns , are the institutions in your fund, do they have access to the discount window? Mr. BURNS. Under the Monetary Control Act of 1980, they would, sir, and out of that 100, 42 would be members of the Federal Home Loan Bank System and would have access to that window as well. Mr. BARNARD. Were you encouraged this morning-I presume you were here-by what you heard from the Federal Reserve as to the so-called precedent it established here with Ohio? Are you encouraged by that? What is your general feeling about that? Mr. HOGG. Well, we've known, sir, since 1980 the Monetary Control Act, that the Fed had the requirement to lend to our institutions. There has not been opportunity for the thrift industry to really exercise that until the Ohio situation , but it did not surprise us because the Fed is very good at what it does and it has been authorized and required to do that since 1980. Mr. BARNARD. You didn't learn anything new from that? Mr. HOGG. No, but we were pleased with their response. Ms. HATHAWAY. I would just add too that we in Pennsylvania were pleased with the Fed's response . The Federal Reserve Bank of Philadelphia was in immediate contact with me regarding whether or not our members were experiencing any troubles and giving me the information to disseminate to our members immediately that if they did start to have liquidity problems, we had a certain set of guidelines in place that they should follow and our institutions do have the same access to the Federal Reserve . The one thing I would stress, that I think I skipped over inadvertently in my testimony was that one of the lessons we did learn from the Ohio situation is that we are requiring our member institutions, at this point, to establish a borrowing relationship with a Federal Reserve bank. Some of them do not now have that. 373 Mr. BEASON. After the act of 1980, we immediately required all of our institutions to file and maintain borrowing agreements with the Fed. They have been in place since that time. We have had no reason to believe that the Fed would act in any other way than to honor this. I might point out that we have read that the institutions in Ohio did not have those borrowing agreements in place. Mr. LAPIDUS. As Ms. Hathaway indicated, we are not only encouraged by the testimony this morning, but by the actions of the Federal Reserve after the Ohio situation broke. The commissioner of banks, Paul Bulman, who will be on the next panel, and I chatted about that. I got in touch with the Federal Reserve and they indicated they were prepared to meet their responsibilities under the Monetary Control Act. They subsequently sent in a group of examiners to take a look at our reports. We filled them full of information and Girl Scout cookies, which had just come in, and I think they left happy on both counts. Mr. BURNS. The Fed did its job and it did it very well. We appreciate that very much. We have been in daily contact with the Boston Fed and as Len has said, we have had their examiners contact our office and they have been very cooperative. We appreciate it. Mr. BARNARD . Mr. Craig. Mr. CRAIG. Thank you very much, Mr. Chairman. I appreciate the extent and depth of your testimony this morning and the obvious confidence you do display and the ability of your individual funds to handle crisis and the method by which you operate. That is, as the chairman reflected, very gratifying to all of us. A couple of questions and I would ask them somewhat generically so if you would all like to respond as you have to the chairman, I would appreciate that. Are your respective States allowed to, or have they, by law, placed their full faith and credit behind your deposit insurance funds? Mr. HOGG. In Maryland specifically, no, sir. Our charter, which is title 10 of the Financial Institutions Article of the Maryland Code does not place the full faith and credit of Maryland. Mr. CRAIG. Do you feel that is necessary? Mr. HOGG. No, sir. Ms. HATHAWAY. In Pennsylvania, our statute, the statute that created the corporation, does state that the faith and credit of the Commonwealth is not pledged in any way. Mr. CRAIG. Is not? Ms. HATHAWAY. Is not pledged and we do not feel that that is necessary. Mr. BEASON. The answer to the question is no, and it's one reason we have a name that does not have the name of the State within in. Mr. LAPIDUS . The same is true of Massachusetts. I'll answer for both Mr. Burns and me. Full faith and credit is not dedicated to the fund. Mr. CRAIG. You have, in large part, responded . Would either or any of you like to respond in any additional way as to how you might handle in your own States, based on your own experience, a 374 situation somewhat like the Home State situation in Ohio and how you might deal with that if that were to occur? Mr. Burns. Mr. BURNS. On a for-instance basis, if that reverse had gone to $60 million, we would have staff at that particular institution finding out the terms, conditions, collateral, requirements, and so forth and then would work with the banking department and get that reversed. Mr. LAPIDUS. I'll respond to that with the luxury of not having faced the situation, and not having all the facts, so I can work out a nice solution. First, I would draw a distinction between solvency problems and liquidity problems. And, Ohio is interesting because there were both of them, the solvency problem was with the Home State Savings Bank and solvency problems are handled by insurers. Liquidity problems are handled, partly out of one's own resources, partly out of lines that you might have with commercial banks or investment banks or what have you. From the Home Loan Bank, if you're a member, and ultimately from the Federal Reserve which has the authority to lend to any depository institution under the Monetary Control Act. In order to keep Home State open, and perhaps also in order to stop the runs that occurred, the insurance entity would have had to have made up the loss. If the insurance company didn't have the resources to make up the loss, then it has to come from someone else and in the typical circumstance, there would have been some additional assessment from members to make up the loss. The difference between the resources of the Ohio Fund and, at least, the indicated loss at the time, did not seem to be very great. It would seem to me that there should have been a possibility of assessing the membership and effectively making up the difference. With respect to the liquidity problem, to the extent that there weren't lines available or resources available within the institution, one would have hoped that the Federal Reserve could have done the job as they appeared to be ready to do. Now, there are gaps in this scenario of mine because I am not familiar with all of the facts of the situation except what was testified to this morning. Mr. CRAIG. Mr. Beason. Mr. BEASON. Not to repeat what they have said, but maybe go back to an earlier date, I understand from what I have heard and read that the State and the fund had agreements from the institution to back out of these investments. The first time they found a failure to follow those agreements, I think we would have replaced officers and directors of that institution and caused a change of control which would have then effected those changes . Mr. CRAIG. Do you have cease-and-desist authority? Mr. BEASON. We do not use the words, "cease-and-desist ." We. have the authority to take any action we deem appropriate for the protection of the depositors and then we have a list in our standards and procedures of what those include but not a limit, that would include removing officers and directors if they do not take the actions we request them to take . Mr. CRAIG. Ms. Hathaway. 375 Ms. HATHAWAY. Yes. I think that in that regard, and I don't want to echo what everyone else has said, but I think we, in Pennsylvania, do have requirements and regulations in place that would prevent that same kind of scenario, in the first place, and we do have the supervisory powers to issue cease-and-desist orders, replace management, remove officers and directors and certainly we would be enforcing those kinds of things. Mr. HOGG. I would just add, sir, that to be in this business, you need regulations. You need an early warning system, but neither of those works unless you enforce violations of your regulations and bring about compliance through the cease-and-desist order, removal power or whatever authority you need to correct the problem. Mr. CRAIG. I appreciate those comments . One last question and then I am going to have to run and vote. Mr. Lapidus, the State and private funds like yours have been a part of a dual banking system for quite some time. There are some that are now arguing that all regulations should be done at the Federal level, that there is no longer a need or an advantage to a dual system of chartering regulation and insurance . What are your views on this and the reasons for your position and, of course, if any of you would like to comment on that question, we would be more than happy to hear it. Mr. LAPIDUS. Yes, I would like to comment on that. I have served both as regulator in State systems and in the Federal system. I worked for the Federal Reserve for 13 years in New York. I was in the New York State Banking Department for 2 years as first deputy superintendent and later as acting superintendent and was assistant to the chairman of the FDIC for a few years and I headed the Central Liquidity Facility of the National Credit Union Administration and was director of the National Credit Union Share Insurance Fund. So, I have spent most of my career in banking and bank regulations on both the State side and the Federal side. I think there is a significant underappreciation of the importance of the dual banking system despite the fact that we very often salute it. If you take a look at the kinds of initiatives that have developed at the State level and the richness that it provided to the banking industry, I think you have to recognize how important it is that it not be destroyed in times of crisis through the overreaching at the Federal level. Just to tick off some of the important things, the NOW account was developed in Massachusetts at a time when we did not have Federal insurance, at the time that Federal insurance was not imposed upon Massachusetts banks, and it would not have otherwise developed. The NOW account was the seed that led to the development of the financial reform on the national level. Variable rate mortgages developed in the States long before it was made possible for federally chartered institutions to offer VRM's. Now, as you know, probably 70 percent of the mortgages are issued in VRM form and everybody is pushing institutions to match their asset and liability maturities by use of VRM's. Financial reform of the Garn-St Germain type was first passed in the State of Maine. 376 Competitive standards, of the kind that were developed in the 1960's, probably were developed in New York State before they were developed here. Those are only examples . Mr. SPRATT. There will be a short recess while the members go to the floor to vote. [Recess taken . ] Mr. BARNARD. We apologize for the process, but we will be underway like this now for the rest of the afternoon . Were any of you notified by any Federal agency or otherwise as to the situation at ESM in Florida? Mr. HOGG. No, sir, we were not. Ms. HATHAWAY. No, in Pennsylvania we weren't. Mr. BEASON. Not to my knowledge by a Federal agency, but by some means our people determined that what was happening there was not an appropriate investment for our institutions to make and we were able to put that word out ourselves sometime back. Mr. BARNARD. You don't insure credit unions, do you? Mr. BEASON. Yes, sir, I do. Mr. BARNARD. You do? Mr. BEASON. Yes, sir. Mr. BARNARD. Did you get information from the National Credit Union Administration? Mr. BEASON. Not to my knowledge. We may have, but I don't know that for a fact . Some of my supervisory people may have. Mr. BARNARD. Mr. Lapidus? Mr. LAPIDUS. No, we were not. Mr. BARNARD. Mr. Burns? Mr. BURNS. No, sir, we were not, but we conduct regular seminars for our people, instructions on how to safeguard the purchase and sale of securities. Mr. BARNARD. We want to thank all of you for your very valuable testimony today and it is encouraging that these organizations which you represent are as strong as they are. I am sure it is of confidence, as well, for the public and we appreciate your testimony. Thank you very much. The next panel will represent the supervisors of the State savings and loan organizations. I would like to ask at this time if Mr. Charles H. Brown would take the witness stand, Mr. George C. King, Mr. Ben McEnteer, and Mr. Paul E. Bulman. Gentlemen, we appreciate very much your being here today and helping us with this testimony as to the operation of your supervisory agencies and we would certainly entertain your testimony at this time. I would like to say that we would be more than pleased to include your entire statement in the record without objection and if you care to summarize, it would certainly be up to your own decision . And, we will begin with Mr. Brown. 377 STATEMENT OF CHARLES H. BROWN, JR., DIRECTOR, DIVISION OF SAVINGS AND LOAN ASSOCIATIONS, STATE OF MARYLAND Mr. BROWN. Mr. Chairman, members of the committee, I am Charlie Brown, director of the division of savings and loan associations for the State of Maryland. I think, Mr. Hogg, from the Maryland Savings-Share Insurance Corp., when he addressed you, stole some of my thunder. A lot of my testimony he has already given you, but I will say that the division regulates 115 associations, 13 of which are insured by the Federal Savings and Loan Insurance Corporation and has assets of $1.6 billion. We have 102 State-chartered associations insured by the Maryland Savings-Share Insurance Corp. with assets of $8.9 billion, so we have a $10.5 billion industry on the State-chartered side. Additionally in the State of Maryland, just for informational purposes, there are 44 federally-chartered associations with $9.5 billion in assets so we have a $20 billion industry in the State of Maryland. The assets of the 102 MSSIC-insured institutions range from $ 1.6 billion downward to our smallest association of $ 152,000 . We have 18 associations with assets in excess of $ 100 million and 58 associations with assets under $10 million. We have many small neighborhood ethnic associations, many of which are open to the public only 1 or 2 evenings a week. Under Maryland law, the division is required to examine our associations at least once every 2 years. At the present time, examinations are made approximately every 14 to 15 months. If need be, an association could be examined more frequently if the division director considers it necessary. Additionally both the division and the insurer, MSSIC, require that our institutions submit a monthly operating report so that we can keep abreast of the operations between examination periods . Associations with assets of $5 million or more are required to have an annual audit done by an independent C.P.A. That annual audit goes to MSSIC, the insurer, and to the division. The division works very closely with the insurer, MSSIC, in the supervision of the State-chartered industry. MSSIC receives copies of the examinations made by the division . MSSIC attends the exit conference that we have with management after the examination is completed. Both agencies receive copies of the independent audit. Information is exchanged by the agencies so that we are kept fully aware of the operations of each and every institution. If a supervisory conference, with any institution, is necessary, both agencies are involved. Additionally the division director, myself, attends the monthly meeting of the board of directors of the insurer and Mr. Hogg, president of MSSIC, attends the meetings of the board of savings and loan association commissioners. There is full cooperation between the two agencies in the supervision of our industry. One of the questions that I was asked in that letter that was sent me was, "Comment on the Ohio Deposit Insurance situation and the adequacy of responses by State and Federal officials." 378 I would like to state that the regulator and the insurer in Maryland took steps to insure that our institutions were fully informed of the situation, that our associations were prepared to meet unusual withdrawals resulting from publicity from the failure of Home State and the Ohio fund. Our insurer, MSSIC, was very liquid and was prepared to render whatever assistance that might be needed by the membership. On learning of this situation, Mr. Hogg and myself met with the Governor's staff within a day or two. We met with the president of the senate in Maryland, the speaker of the house to apprise them what was going on and that it could have some effect on Maryland associations. We met with the larger commercial banks in Maryland and the head of the Baltimore office of the Federal Reserve Bank of Richmond. We had full cooperation from the banks. The Federal Reserve bank was outstanding. They moved fast to render whatever assistance they could give to us. A lot of our associations had already given the necessary documentation to the Federal Reserve bank years ago when the opportunity presented itself. The Federal Reserve bank was there when they were needed . The Federal Home Loan bank in Atlanta kept in touch with me twice a day to see what was going on in Maryland, anticipating that there might be a lot of applications for conversion . As late as yesterday, I talked with them, yesterday afternoon . I would just like to say that the Government agencies, both on the Federal level and the State level reacted promptly for the protection of the industry and the public in the State of Maryland. That's all I have to say, Mr. Chairman. [Mr. Brown's prepared statement follows: ] 379 STATE OF MARYLAND PAR TME NT CEN SI & NG MARYLA ND AB ON LATI E R GU HARRY HUGHES GOVERNOR SECRETARY OF FREDERICK L. DEWBERRY SECRETARY CHARLES H. BROWN, JR. DIRECTOR DEPARTMENT OF LICENSING AND REGULATION DIVISION OF SAVINGS AND LOAN ASSOCIATIONS THE BROKERAGE - SUITE 800 34 MARKET PLACE BALTIMORE , MARYLAND 21202-4078 301 659-6330 WILLIAM S. LECOMPTE, JR. DEPUTY DIRECTOR March 29 , 1985 Representative Doug Barnard , Jr. , Chairman Commerce , Consumer and Monetary Affairs Subcommittee Rayburn House Office Building , Room B-377 Washington , D. C. 20515 Dear Representative Barnard : In response to your letter of March 22 , 1985 , I would be pleased. to appear at the subcommittee's hearings on the Ohio deposit insurance situation which will be held on Wednesday , April 3 , 1985. I am enclosing herewith the data requested in your letter and which will be included in any testimony that I might give during the hearings . Very truly yours , CharlesH.Nor Charles H. Brown, Director CHB: kg Enclosure 50-923 0-85--13 380 ON REGUATLAI HARRY HUGHES GOVERNOR SECRETARY MARYLAND NG DEPARTMEN NSI E LIC NT OF STATE OF MARYLAND CHARLES H. BROWN, JR. DIRECTOR DEPARTMENT OF LICENSING AND REGULATION DIVISION OF SAVINGS AND LOAN ASSOCIATIONS THE BROKERAGE - SUITE 800 34 MARKET PLACE BALTIMORE, MARYLAND 21202-4078 301659-6330 FREDERICK L. DEWBERRY SECRETARY WILLIAM S. LECOMPTE, JR. DEPUTY DIRECTOR The Division of Savings and Loan Associations was created by the State Legislature in 1961 for the purpose of regulating the State-chartered savings and loan industry in Maryland . The insurer , more popularly referred to as MSSIC , was created by the Maryland State Legislature in 1962 for the purpose of insuring savings accounts of State-chartered savings and loan associations which were not federally insured by the Federal Savings and Loan Insurance Corporation (F.S.L.I.C. ) . The corporation , although created by the State Legislature , is not a State agency nor is the insurance of savings accounts backed or guaranteed by the State of Maryland . However , under Maryland Law the Governor of the State of Maryland does appoint three public interest or consumer members to the Board of Directors of the corporation . The remaining eight directors are elected by the membership consisting of the 101 institutions insured by it. The Savings and Loan Division for the State of Maryland has a staff of 30 individuals of which 18 are field examiners , 2 examiner-supervisors and a chief examiner . Additionally , there is the Director of the agency , Charles H. Brown, and the Deputy Director , William S. LeCompte , plus clerical employees . Since 1982 the Division has operated on the budgets as set forth below: 1982 Actual $ 674,125 1983 Actual 708,387 1984 Actual 734,015 1985 Appropriated 960,785 1,020,604 1986 Proposed The Division of Savings and Loan Associations , for the State of Maryland , regulates 114 State-chartered associations as follows : Assets December 31 , 1984 in Billions 13 State-chartered with insurance of savings accounts by the Federal Savings and Loan Insurance Corporation (FSLIC) $ 1.6 101 State-chartered with insurance of savings accounts by the Maryland Savings-Share Insurance Corporation (MSSIC) Total State-chartered industry 8.9 $10.5 381 The 13 associations insured by the FSLIC have assets ranging from $495 million downward to $ 21 million . The assets of the 101 MSSIC insured institutions range from $ 1.6 billion downward to our smallest association of $152,968 . We have 18 associations with assets in excess of $ 100 million and 58 associations with assets under $ 10 million . We have many small , neighborhood associations , some of which are open to the public only one or two evenings per week. Under Maryland law the Division is required to examine our associations at least once every two years . At the present time examinations are made approximately every 14 to 15 months . If need be an association could be examined more frequently if the Division Director considers it necessary . Additionally , both the Division and the insurer , MSSIC , require that our institutions submit a monthly operating report so that we can keep abreast of the operations between examination periods . Associations with assets of $5 million or more are required to have an annual independent audit by a Certified Public Accountant . Presently , the Division has limited enforcement authority . However , as a result of a 1984 Maryland legislative summer task force study of the savings and loan industry , several bills were introduced in the State legislature this year which will give the Division greater authority to regulate the industry. These bills cover the following : 1. The authority to issue a Cease and Desist Order for any violations of Maryland law or regulations of the Division . 2. Would allow the removal of any officer or director found to be operating in an unsafe and unsound manner . 3. Clarification of the regulatory authority of the Board of Savings and Loan Commissioners over State-chartered associations . 4. Requirement that an association must have available for the public an annual financial statement . The Division Director and the Board of Savings and Loan Association Commissioners are satisfied that these new powers will give the Division the authority to regulate the State- chartered industry . These bills are awaiting passage in the Senate and the House and when passed and signed by the Governor will become law effective July 1 , 1985. By regulations of the Board of Commissioners , our institutions are required to maintain a net worth of at least 3% of the savings deposits . Additionally , the insurer , MSSIC , also has its own net worth requirements which I am sure will be included in the presentation by Charles Hogg , President of MSSIC. - 2 - 382 Presently we do operating problems . need to monitor more associations in this not have any associations that we feel have severe There are always some associations which we feel we closely than others and at this time we have three category. The Division works very closely with the insurer , MSSIC , in the supervision of the State-chartered industry . MSSIC receives copies of the examinations made by the Division . Both the Division and the insurer receive the monthly operating report of each association . Both agencies receive copies of the annual independent audit . Information is exchanged by the agencies so that we are both kept fully aware of the operations of each and every institution. If a supervisory conference with any institution is necessary , both agencies are involved . Additionally , the Division Director attends the Board of Directors meetings of the insurer and Mr. Hogg , President of MSSIC , attends the meetings of the Board of Savings and Loan Commissioners . There is full cooperation between the two agencies in the supervision of our industry . Maryland Law requires that any institution operating within the State must have insurance of savings accounts by either the Maryland Savings -Share Insurance Corporation or the Federal Savings and Loan Insurance Corporation . Although the Division does not have the authority to terminate the insurance , the insurer , MSSIC , does have such authority . The termination of the insurance , however , would probably result in a supervisory merger of an institution with a stronger association or the appointment of a conservator or a receiver for liquidation purposes . In that respect , under Maryland law the Federal Savings and Loan Insurance Corporation or the Maryland Savings - Share Insurance Corporation has an absolute right to be appointed conservator or receiver of a savings and loan insured by it. With regards to the Ohio situation it is felt the regulator and insurer here in Maryland took steps to assure that our institutions were fully informed of the situation and that our associations were prepared to meet unusual withdrawals resulting from publicity from the failure of the Home State Savings and Loan Association and the Ohio Deposit Guaranty Fund . Our insurer , MSSIC , was very liquid and was prepared to render whatever assistance that might be needed by the membership . It is felt other government agencies , in particular the Federal Reserve Bank , moved promptly to render any needed assistance for institutions which qualified . The Federal Home Loan Bank of Atlanta kept in constant touch with the Division to determine whether Maryland was having any savings losses which could result in a large number of applications for federal insurance of savings accounts . In conclusion I would say that all government agencies on both the state and federal level reacted promptly for the protection of the industry and , more in particular , the public . Charles1. Submitted by Charles H. Brown , Director - Division of Savings and Loan Associations , State of Maryland March 29, 1985 - 3- 383 Mr. BARNARD. Thank you very much, Mr. Brown. STATEMENT OF GEORGE C. KING, ADMINISTRATOR, SAVINGS AND LOAN DIVISION, NORTH CAROLINA DEPARTMENT OF COMMERCE Mr. KING. I am happy to respond to your recent inquiry concerning the manner in which State/private insurance funds interact with their supervisory agencies. The savings and loan division presently has a very competent 13-member professional staff that is responsible for supervising 81 State-chartered savings and loans representing a total of approximately $6.5 billion in assets. Thirty-four of the 81 institutions have their deposits insured by the Financial Institution Assurance Corp. [FIAC] and they have about $2 billion in deposits. We have very broad supervisory and enforcement powers provided in our State statutes. We examine all institutions at least annually. We monitor the associations based on monthly information submitted to us and, if adverse trends are detected, take appropriate action to make necessary corrections. It is my opinion that present powers vested in me by State statutes are adequate to address any foreseeable adverse situations. Our statutes and regulations do require that our State-chartered associations maintain reserves and liquidity and minimum limits are established for these purposes. Minimum reserves are based on perceived risk of the association's assets . Liquidity investments are limited to cash and unpledged short-term securities with maturities of 5 years or less . Although the minimum liquidity requirement is 5 percent of net deposits, the average liquidity of all State-chartered shops is approximately 12 percent and the average liquidity of FIAC-insured associations is almost 20 percent. I feel that the cooperation between the division and FIAC is most satisfactory. All of our examination information is provided to the fund on a timely basis. Because of the very close working relationship that exists between the division and the fund, any supervisory actions taken are carefully coordinated. We examine FIAC on an annual basis as well as maintain a continuing dialog throughout the course of the year. Accordingly, we feel adequately qualified to address this area. Basically, we are very pleased with the operation and approach utilized by FIAC in keeping abreast of its insured institutions on an ongoing basis. Moreover, we are of the opinion that necessary coordination and full cooperation between FIAC and ourselves is fully in place at the present time. We are entirely satisfied that FIAC is adequately carrying out its responsibilities in a competent manner and, cooperation with our division is more than satisfactory. In regards to the recent situation in Ohio, the following remarks /observations are predicated entirely on media articles that have been released to date. Accordingly, the following comments are offered in that context. The most disturbing aspect of the Ohio deposit insurance situation is that the State and the fund apparently did not have adequate plans in place for dealing with a major crisis or default. 384 It also appears that the State had very little supervisor oversight over the Ohio Deposit Guarantee Fund [ ODGF] and little direction as to how the fund could or would respond to a major crisis. Significant questions surround this situation but apparently both the State regulator of savings and loans and the ODGF were either not aware or not capable of acting to correct serious deficiencies in the financial condition of a large supervised institution . As a State regulator working in a State with State/private insurance fund, I cannot understand how the situation in Ohio got to the position it did without the State and the ODGF taking action to defuse the problem. I feel that our system in North Carolina is sound . We closely monitor all State-chartered associations and endeavor to work closely with our Federal and private insurance counterparts to see that the deposit of funds in our institutions are safe. Moreover, we supervise and annually examine the private insurance fund and monitor its operation . We communicate with FIAC on a continuous ongoing basis as to the condition of our privatelyinsured institutions and I am fully confident that we have adequate contingency plans in place to deal with potential problems. The lesson we have learned from the recent debacle in Ohio is that situations and actions in other geographic locations over which we have no input or control can have an effect on us in North Carolina. We would like to see strong, minimum standards be put into place that would have to be met by any entity that wishes to provide deposit insurance for financial institutions. These standards should include: (1) capable fund management; (2) minimum reserve requirements; (3) strong monitoring capabilities; (4) adequate enforcement powers; (5) independent directorate; (6) qualified State regulators; (7) liquidity capabilities, and (8) underwriting standards. Mr. Chairman, at the appropriate time, I will be glad to respond to any questions the committee may have. Mr. SAXON. Mr. Chairman, the gentleman, when his microphone was turned off, I heard him say, I believe the primary problem in Ohio or the most important problem in Ohio is, and I couldn't understand where you went from there. Mr. BARNARD. We heard a lot of words today. I didn't know if our ears were playing out or not. Mr. KING. I'm sorry, Mr. Chairman . I just thought that it was on. What I had said, sir, was, "The most disturbing aspect of the Ohio deposit situation is that the State and the fund, apparently did not have adequate plans in place for dealing with a major crisis or default." This is something that, from our standpoint, we do on an ongoing basis to try to determine what a worse-case-type situation would be and how we would deal with it, both from a safety and soundness standpoint and from a liquidity situation. [Mr. King's prepared statement follows :] 385 NOR STATE9 TH CAROU SEAL 198 CREAM North Carolina Department of Commerce 430 North Salisbury Street Raleigh, North Carolina 27611 Howard H. Haworth, Secretary James G... March 29 , 1985 Martin, Governor The Honorable Doug Barnard , Jr. United States House of Representatives Washington , D.C. 20515 Dear Mr. Barnard : This is in response to your letter of March 22 , 1985 in which you request specific information in anticipation of my appearance before your Subcommittee on April 3 , 1985. The response follows the same chronological order as outlined in your letter . Also enclosed are exhibits which we concluded would provide additional pertinent information to assist the Subcommittee in their deliberations . la. Professional Staff Examination Supervisory Budget Fiscal Year End 6-30 3355 1982 $580,000 1983 . $523,000 1984 $616,000 1985 $780,000 (Projected) 1b. Asset Size (Millions of Dollars ) 0-25 25-50 .. 50-100 100+ lc. 8 10 9 8 3 3 5 5 FIAC Insured Number Avg . Size 8 12 7 7 $16,540,811 $33,873,275 $65,576,672 $221,537,769 FSLIC Insured Number Avg. Size 13 11 11 12 $17,904,453 $38,294,918 $71,405,151 $202,848,806 Under the North Carolina General Statutes the Administrator may examine savings and loan associations any time he " deems it prudent " . In actual practice , every association is examined within twelve calendar months from the date of the previous examination . Moreover , if any adverse trend is discernible from our review of the required associations ' monthly monitoring reports , the examination process is accelerated to determine what , if any , problems may be developing . This could include a full scope examination or a modified examination specifically geared to address the perceived problem area . Also , in instances of known problem institutions , the examining cycle is shortened . An Equal Opportunity /Affirmative Action Employer 386 The Administrator is vested with considerable power to maintain safety and soundness in the institutions for which he is responsible . These powers cover the whole range of supervisory prerogatives from the issuance of cease and desist orders , civil and criminal sanctions and removal of officers and directors . Enclosed under Exhibit 1 are the applicable statutes that address the remedies that are available to the Administrator to affect correction of unsafe and unsound practices or procedures by an association and its officers and/or directors . Since my employment with the Division in 1976 , in two instances it was considered necessary to resort to a written supervisory agreement to affect correction , while in five other situations it proved necessary to arrange a supervisory acquisition action . The other remedial options available to the Administrator have not proved necessary to utilize up to the present time . We have found that moral suasion has been an effective tool to correct most association problems . However, in direct response to your question , we opine that the present powers vested in the Administrator are adequate to address any foreseeable adverse situations . Further, because of our close supervisory working relationship with the Financial Institutions Assurance Corporation and FSLIC respectively , which obviously share our common goals of assuring the safety and soundness of our supervised institutions , their additional powers such as termination of deposit insurance further assists in assuring the ongoing viability of our savings associations . ld . We impose both a General Reserve Requirement (adequacy of net worth/capital ) and a Liquidity Requirement as provided under North Carolina Administrative Code , Title 4, Chapter 16D.0701 , .0601 , and .0602 , respectively. See Exhibit 2. Under the General Reserve Requirements , varying percentages of net worth are applied against an association's assets based on the perceived risk inherent in a particular type/class of asset . Accordingly , investments in the insurer's fund are considered riskless , while assets classified loss are considered a 100% risk , with various other graduations between these two extremes as indicated under Exhibit 3. This form was recently upgraded to more adequately reflect the present composition of an association's assets (under deregulation ) as well as the perceived risk associated with such assets . Basically the Liquidity Analysis ( See Exhibit 4) format is designed to identify those assets that are considered reasonably liquid and that can be sold (with minimal loss potential ) to augment possible liquidity demands such as unexpected deposit withdrawals , etc. Assets that are considered liquid include cash, deposits with other institutions and unpledged securities with maturities of five years or less . The minimum requirement is equal to 5% of the association's net deposits . 387 le . We do not maintain a "problem" list , per se . However , we have adopted an adaptation of the interagency rating system used by the Federal agencies known as the CAMEL rating system. We are reluctant to disclose any additional information because of the obvious sensitivities of the situation. 2a. All of our examination reports on FIAC insured institutions are provided to the insurance fund in a timely manner ; usually within 30 days after the close of the examination . In addition , copies of all correspondence between the Savings and Loan Division and FIAC insured associations are provided to the insuring corporation. Because we work closely with the insurance fund, any supervisory actions taken by the Savings and Loan Division involving FIAC insured associations are carefully coordinated between the fund and the Division . All related information and documents are also provided by us to the insurance fund . 2b. North Carolina statute requires that all savings and loans have insurance of accounts . The termination of this insurance , if the need for such action should arise , would be initiated by FIAC . Specific authority for taking this action is not vested in the Administrator of the Savings and Loan Division nor in the Savings and Loan Commission . There has never been an insurance of accounts termination in North Carolina . Because of the close ongoing working relationship that exists between the Division and FIAC, we cannot envision that an insurance of accounts termination could occur without the full knowledge and concurrence of the Savings and Loan Division. 3. We examine FIAC on an annual basis as well as maintain a continuing dialogue throughout the course of the year . Accordingly , we feel adequately qualified to address this area . Basically , we are very pleased with the operation and approach utilized by FIAC in keeping abreast of its insured institutions on an ongoing basis . Moreover , we are of the opinion that necessary coordination and full cooperation between FIAC and ourselves is fully in place at the present time . In summation, we are entirely satisfied that FIAC is adequately carrying out its responsibilities in a competent manner and , cooperation with our Division is more than satisfactory . 4. The following remarks/observations are predicated entirely on media articles that have been released to date . Accordingly , the following comments are offered in that context . The most disturbing aspect of the Ohio deposit insurance situation is that the state apparently did not have adequate plans in place for dealing with a major crisis or default . It also appears that the state had very little supervisory oversight over the Ohio Deposit Guaranty Fund (ODGF) and little direction as to how the fund could or would respond to a major crisis . Significant questions surround this situation but apparently both the state regulator of savings and loans and the ODGF were either not aware or not capable of acting to correct serious deficiencies in the financial condition of a large supervised institution . As a state regulator working in a state with a state/private insurance fund , I cannot understand how the situation in Ohio got to the position it did without the state and the ODGF taking action to either prevent or defuse the problem. 388 I feel that our system in North Carolina is sound . We closely monitor all state chartered associations and endeavor to work closely with our federal and private insurance counterparts to see that the deposit funds in our institutions are safe . Moreover , we supervise and annually examine the private insurance fund and monitor its operation . We communicate with FIAC on a continuous ongoing basis as to the condition of our privately insured institutions and I am fully confident that we have adequate contingency plans in place to deal with potential problems . The lesson we have learned from the recent debacle in Ohio is that situations and actions in other geographic locations over which we have no input or control can have an effect on us in North Carolina . We would recommend that strong, minimum standards be put into place that would have to be met by any entity that wishes to provide deposit insurance for financial institutions . These standards should include 1 ) capable fund management , 2) minimum reserve requirements , 3) strong monitoring capabilities , 4) adequate enforcement powers , 5) independent directorate , 6) qualified state regulators , 7 ) liquidity capabilities and 8) underwriting standards . 6. We are forwarding to Mr. McSpadden a blank copy of our examination report used in conjunction with examining a privately insured savings and loan association as well as a blank copy of the examination report used in connection with our annual examination of FIAC . The purpose in forwarding these two examination reports is to provide the Subcommittee with some indication of the overall scope and depth of the respective examinations that we undertake in North Carolina . Each examiner is also furnished a comprehensive manual of instructions to assist in the examination of both federal and nonfederal savings and loan associations . I trust the foregoing is fully responsive to your request . Sincerely, George C. King, Administrator Savings and Loan Division GCK/pr 389 § 548-43 CH. 54B. SAVINGS AND LOAN ASSOCIATIONS (3) Notice to file claims; (4) Claims of members; (5) Payments of claims and distribution; and (6) Final distribution and liquidation. (b) Upon completion of liquidation, the liquidators shall file with the Administrator a final report and accounting of the liquidation. The approval ofthe report by the Administrator shall operate as a complete and final discharge of the liquidators, the board of directors, and each member or stockholder in connection with the liquidation of such association. Upon approval ofthe report, the Administrator shall issue a certificate of dissolution of the association and shall record same in the manner required by this Chapter for the recording of certificates of incorporation; and upon such recording, the dissolution shall be effective. (1981, c. 282, s. 3.) a short form conversion, ifthe finding is made with regardto a mutual association, or a merger or consolidation of the State association as to whichthe finding was made, with any other State association" at the end of the first sentence and added the second sentence. In subsection (b), the amendment substituted "consolidations, conversions, and combination mergers and conversions" for "consolidations and conversions." §§ 54B-45 to 54B-51: Reserved for future codification purposes. ARTICLE 4. Supervision and Regulation. § 54B-52. Administrator of Savings and Loan § 54B-43. Stock dividends. Division. No dividend on stock shall be paid unless the The Administrator of the Savings and Loan association has the approval of the Administra- Division of the State is hereby empowered and tor. ( 1981 , c. 282, s. 3; 1983, c. 144, s. 7.) directed to perform all the duties and exercise Effect ofAmendments. The 1983 amendment, all the powers as to savings and loan associaeffective April 6, 1983, rewrote this section, which tions organized or operated under this Chapter, formerly referred to stock ownership and dividends. unless herein otherwise provided. ( 1981 , c . 282 , s. 3.) § 54B-44. Supervisory mergers, consolidations, conversions, and combination mergers and conversions. (a) Notwithstanding any other provision of this Chapter, in order to protect the public, including members, depositors and stockholders of a State association, the Administrator, upon making a finding that a State association is unable to operate in a safe and sound manner, may authorize or require a short form merger, consolidation, conversion, or combination merger and conversion ofthe State association as to which the finding is made. The resulting association may be a mutual association or a stock association. (b) The Administrator shall promulgate rules and regulations to govern supervisory mergers, consolidations, conversions, and combination mergers and conversions authorized by this section. ( 1981 , c. 670, s. 2 ; 1981 (Reg. Sess. , 1982), c. 1238, s. 11.) Editor's Note. Session Laws 1981 , c. 670, s . 3, provides: "This act is effective upon ratification but shall not apply to any savings and loan association chartered, but not yet operating, prior to said effective date." The act was ratified June 24, 1981. Effect of Amendments. - The 1981 (Reg. Sess. , 1982) amendment, in subsection (a), substituted "stockholders" for "shareholders" near the beginning ofthe first sentence, substituted "authorize or require a short form merger, consolidation, conversion, or combination merger and conversion ofthe State association as to which the finding is made" for "authorize § 54B-53. Savings and Loan Commission. (a) The Savings and Loan Commission, which has heretofore been created, shall continue to exist and the seven members ofthe Savings and Loan Commission who have heretofore been appointed by the Governor shall continue to serve their full terms and their successors shall be appointed by the Governor as required by this section. The Governor shall on July 1 , 1981, appoint three persons to the Commission for four-year terms. On July 1, 1983, he shall appoint two persons to the Commission for three-year terms, and two persons for four-year terms. All appointments to the Commission thereafter shall be for four-year terms. Any vacancy on the Commission shall be filled by the Governor for the unexpired term. A newly appointed commissioner shall assume office at the first regular or special meeting subsequent to his appointment. (b) The members of the Commission shall elect one of their number to serve as chairman of the Commission for such term as set forth in rules adopted by the Commission. A vice-chairman and other officers may be elected as specified by the Commission. (c) The term of a commissioner shall be four years, or until his successor is appointed and qualified. (d) At least two members of the Commission shall be persons who are currently serving as managing officers of State associations. Four members of the Commission shall be appointed as representatives of the borrowing public and shall not be employees of or directors of any 100 390 CH . 54B. SAVINGS AND LOAN ASSOCIATIONS financial institution or have an interest in any financial institution other than as a result of being a depositor or borrower. (e) Meetings of the Commission shall be held regularly as provided in rules adopted by the Commission but no less than once each calendar quarter. Special meetings shall be held at any time upon the call of the chairman, or upon the call of any three commissioners. The Administrator shall call meetings when consideration by the Commission is required by law for contemplated action of the Administrator. Members of the Commission shall be reimbursed as prescribed by law for expenses incurred in the performance of their duties under this section. (f) The relationship between the Secretary of Commerce and the Savings and Loan Commission shall be as defined for a Type II transfer under Article [ Chapter] 143A of the General Statutes. (g) The Savings and Loan Commission is hereby vested with full power and authority to review, approve, disapprove, or modify any action taken by the Administrator in the exercise ofall powers, duties and functions vested in or exercised by the Administrator under the savings and loan laws ofthis State. ( 1981 , c. 282, s. 3.) § 54B-54. Deputy administrator of Savings and Loan Division. (a) There shall be a deputy administrator of the Savings and Loan Division who, in the event of the absence, death. resignation, disability or disqualification of the Administrator, or in case the office of Administrator shall for any reason become vacant, shall have and exercise all the powers and duties vested by law in the Administrator. (b) The deputy administrator is authorized and empowered at any and all times to perform such duties and exercise such powers of the Administrator as the Administrator may direct. (1981, c. 282, s. 3.) 54B-55. Power of Administrator to promulgate rules and regulations; reproduction of records. (a) The Administrator shall have the right, and is empowered , to promulgate rules, instructions and regulations as may be necessary to the discharge of his duties and powers as to savings and loan associations for the supervision and regulation of said associations , and for the protection of the public investing in said savings and loan associations. (b) Without limiting the generality of the foregoing paragraph, rules, instructions, and regulations may be promulgated with respect to: (1) Reserve requirements; § 548-55 (2) Stock ownership and dividends; (3) Stock transfers; (4) Incorporators, stockholders, directors, officers and employees of an association; (5) Bylaws; (6) The Savings and Loan Commission; (7) The structure of the office ofthe Administrator; (8) The operation of associations; (9) Withdrawable accounts. bonus plans, and contracts for savings programs; (10) Loans and loan expenses; (11) Investments; (12) Forms and definitions; (13) Types of financial records to be maintained by associations; (14) Retention periods of various financial records; ( 15) Internal control procedures of associations; (16) Conduct and management of associations: (17) Chartering and branching; (18) Liquidations; ( 19) Mergers: (20) Conversions; (21) Reports which may be required by the Administrator; (22) Conflicts of interest; (23) Collection of State savings and loan taxes; (24) Service corporations; and (25) Savings and loan holding companies. (c) Repealed by Session Laws 1983, c. 144, s. 14, effective April 6, 1983. (d) Any association may cause any or all records by it to be recorded, copied or reproduced by any photographic, photostatic or miniature photographic process which correctly, accurately, permanently copies, reproduces or forms a medium for copying or reproducing the original record on a film or other durable material. (e) Any such photographic. photostatic or miniature photographic copy or reproduction shall be deemed to be an original record in all courts and administrative agencies for the purpose of its admissibility in evidence. A facsimile, exemplification or certified copy of any such photographic copy or reproduction shall, for all purposes, be deemed a facsimile, exemplification or certified copy ofthe original record. (f) The provisions of this section with reference to the retention and disposition of records shall apply to any federal savings and loan association operating in North Carolina unless in conflict with regulations prescribed by its supervisory authority. (1981, c. 282, s. 3; 1983, c. 144, s. 14.) Effect of Amendments. The 1983 amendment, effective April 6, 1983, deleted subsection (c), which read, "In order to supervise the continuing operation ofstock associations, the Administrator shall promulgate rules to ensure the compliance by such associations." 101 391 § 548-56 CH. 54B. SAVINGS AND LOAN ASSOCIATIONS § 54B-56. Examinations by Administrator; report. (a) If at any time the Administrator deems it prudent, it shall be his duty to examine and investigate everything relating to the business of a State association or a savings and loan holding company, and to appoint a suitable and competent person to make such investigation, who shall file with the Administrator a full report of his finding in such case, including in - his report any violation of law or any unauthorized or unsafe practices of the association disclosed by his examination. (b) The Administrator shall furnish a copy of the report to the association examined and may, upon request, furnish a copy ofor excerpts from the report to the Federal Home Loan Bank Board, a Federal Home Loan Bank, any mutual deposit guaranty association organized and operated under the provisions of Article 12 of this Chapter, or the Federal Savings and Loan Insurance Corporation or its successor. (c) No association may willfully delay or willfully obstruct an examination in any fashion. Any person failing to comply with this subsection shall be guilty of a misdemeanor. (d) No person having in his possession or control any books, accounts or papers of any State association shall refuse to exhibit same to the Administrator or his agents on demand , or shall knowingly or willingly make any false statement in regard to the same. Any person failing to comply with this subsection shall be guilty of a misdemeanor. ( 1981 , c. 282, s . 3. ) solely to defray expenses incurred by the office ofthe Administrator in carrying out its supervisory and auditing functions. (c) Notwithstanding any of the provisions of subsections (a) and (b) of this section, whenever the Administrator under the provisions of G.S. 54B-56 appoints a suitable and competent person, other than a person employed by the Administrator's office, to make an examination and investigation of the business ofa State association, all costs and expenses relative to such examination and investigation shall be paid by such association. (1981 , c. 282, s. 3; 1983, c. 144, s. 15.) Effect of Amendments. — The 1983 amendment, effective April 6, 1983, inserted " savings and loan holding company acquisition" in subdivision (a)( 2). § 54B-58. Prolonged audit, examination or revaluation; payment of ccsts. (a) If, in the opinion ofthe Administrator, an examination conducted under the provisions of G.S. 54B-57 fails to disclose the complete financial condition of an association , he may in order to ascertain its complete financial condition: (1) Make an extended audit or examination ofthe association or cause such an audit or examination to be made by an independent auditor; (2) Make an extended revaluation of any of the assets or liabilities ofthe association § 54B-57. Supervision and or cause an independent appraiser to make such revaluation. examination fees. (b) The Administrator shall collect from the (a) Every State association, including asso- association a reasonable sum for actual or necesciations in process of voluntary liquidation or sary expenses of such an audit, examination or savings and loan holding company, shall pay revaluation. ( 1981 , c. 282, s. 3.) into the office of the Administrator each July a supervisory fee. Examination fees shall be paid $ 54B-59. Cease and desist orders . promptly upon an association's receipt of the examination billing. The Administrator, subject (a) Ifany person or association is engaging in, to the advice and consent of the Commission, or has engaged in, any unsafe or unsound pracshall, on or before June 1 of each year: tice or unfair and discriminatory practice in con(1 ) Determine and fix the scale of supervi- ducting the association's business, or of any sory and examination fees to be assessed other law, rule, regulation, order or condition and collected during the next fiscal year; imposed in writing by the Administrator, the (2) Determine and fix the amount ofthe fee Administrator issue a notice of charges to and set the fee collection.schedule for such person or may A notice of charges the fees to be assessed to and collected shall specify theassociation. acts alleged to sustain a cease from applicants to defray the cost ofpro- and desist order, and state the time and place at cessing their charter, branch, merger, which a hearing shall be held. A hearing before conversion, location change, savings the Commission on the charges shall be held no and loan holding company acquisition, earlier than seven days, and no later than 14 and name change applications and all days after issuance of the notice. The charged fees associated with foreign associa- institution is entitled to a further extension of tions . days upon filing a request with the (b) All funds and revenue collected by the seven Administrator. The Administrator may also Division under the provisions of this section and issue a notice of charges if he has reasonable the provisions of all other sections of this Chap- grounds to believe that any person or associater which authorize the collection of fees and tion is about to engage in any unsafe or unsound other funds shall be deposited with the State business practice, or any violation of this ChapTreasurer of North Carolina and expended ter, or any other law, rule, regulation or order. under the terms of the Executive Budget Act, If, by a preponderance of the evidence, it is 102 392 CH. 54B. SAVINGS AND LOAN ASSOCIATIONS shownthat any person or association is engaged in, or has been engaged in, or is about to engage in, any unsafe or unsound business practice, or unfair and discriminatory practice or any violation ofthis Chapter, or any other law, rule, regulation, or order, a cease and desist order shall be issued. The Commission may issue a temporary cease and desist order to be effective for 14 days and may be extended once for a period of 14 days. (b) If any person or State association is engaging in, has engaged in, or is about to engage in any unsafe or unsound practice in conducting the association's business, or any violation of this Chapter or of any other law, rules, regulation, order, or condition imposed in writing by the Administrator, and the Administrator has determined that immediate corrective action is required, the Administrator may issue a temporary cease and desist order. A temporary cease and desist order shall be effective immediately upon issuance for a period of 14 days, and may be extended once for a period of 14 days. Such an order shall state its duration on its face and the words. "Temporary Cease and Desist Order. " A hearing before the Commission shall be held within such time as such an order remains effective, at which time a temporary order may be dissolved or made permanent . ( 1981 , c. 282, s. 3.) § 54B-60. Administrator to have right of access to books and records of association; right to issue subpoenas, administer oaths, examine witnesses. (a) The Administrator and his agents: (1 ) Shall have free access to all books and records of an association , or a service corporation thereof, that relate to its business, and the books and records kept by an officer, agent or employee relating to or upon which any record is kept; (2 ) May subpoena witnesses and administer oaths or affirmations in the examination of any director, officer, agent, or employee of an association , or a service corporation thereof or of any other person in relation to its affairs, transactions and conditions; (3) May require the production of records, books, papers, contracts and other documents; and (4) May order that improper entries be corrected on the books and records of an association. (b) The Administrator may issue subpoenas duces tecum . (c) If a person fails to comply with a subpoena so issued or a party or witness refuses to testify on any matters, a court of competent jurisdiction, on the application of the Administrator, shall compel compliance by proceedings for contempt as in the case of disobedience of the § 548-62 requirements of a subpoena issued from such court or a refusal to testify in such court. ( 1981 , c. 282, s. 3.) § 54B-61 . Test appraisals of collateral for loans; expense paid. (a) The Administrator may direct the making of test appraisals of real estate and other collateral securing loans made by associations doing business in this State, employ competent appraisers, or prescribe a list from which competent appraisers may be selected, for the making of such appraisals by the Administrator, and do any and all other acts incident to the making of such test appraisals. (b) In lieu of causing such appraisals to be made, the Administrator may accept an appraisal caused to be made by a Federal Home Loan Bank, the Federal Home Loan Bank Board or by the Federal Savings and Loan Insurance Corporation or any mutual deposit guaranty association organized and operating under the provisions of Article 12 of this Chapter. (c) The expense and cost of test appraisals made pursuant to this section shall be defrayed by the association subjected to such test appraisals, and each association doing business in this State shall pay all reasonable costs and expenses ofsuch test appraisals when it shall be directed. ( 1981 , c. 282 , s. 3.) § 54B-62. Relationship of savings and loan associations with the Savings and Loan Division. (a) Except as provided by subsection (b) ofthis section, a savings and loan association or any director, officer. employee, or representative thereof shall not grant or give to the Administrator or to any employee of the Administrator's office, or to their spouses, any loan or gratuity, directly or indirectly. (b) Neither the Administrator nor any person on the staff of the Savings and Loan Division shall: ( 1) Hold an office or position in any State association or exercise any right to vote on any State association matter by reason ofbeing a member ofthe association; (2) Be interested, directly or indirectly in any savings and loan association organized under the laws of this State; or (3) Undertake any indebtedness, as a borrower directly or indirectly or endorser, surety or guarantor, or sell or otherwise dispose of any loan or investment to any savings and loan association organized under the laws of this State. (c) Notwithstanding subsection (b) ofthis section, the Administrator or any other person employed in or by his office may be a withdrawable account holder and receive earnings on such account . 103 393 $ 548-63 CH. 54B. SAVINGS AND LOAN ASSOCIATIONS (d) If the Administrator or other person has any prohibited right or interest in a savings and loan association, either directly or indirectly, at the time ofhis appointment or employment, he shall dispose of it within 60 days after the date of his appointment, or employment. If the Administrator or other such person is indebted as borrower directly or indirectly, or is an endorser, surety or guarantor on a note, at the time ofhis appointment or employment, he may continue in such capacity until such loan is paid off. ( 1981 , c. 282, s. 3.) § 54B-63. Confidential information. (a) The following records or information ofthe Commission, the Administrator or the agent(s) of either shall be confidential and shall not be disclosed: (1) Information obtained or compiled in preparation of or anticipation of, or during an examination, audit or investigation of any association: (2) Information reflecting the specific collateral given by a named borrower, the specific amount of stock owned by a named stockholder, or specific with drawable accounts held by a named member or customer; (3) Information obtained, prepared or compiled during or as a result of an examination, audit or investigation of any association by an agency of the United States, ifthe records would be confidential under federal law or regulation: (4) Information and reports submitted by associations to federal regulatory agencies, if the records or information would be confidential under federal law or regulation; (5) Information and records regarding complaints from the public received by the Division which concern associations when the complaint would or could result in an investigation, except to the management of those associations; (6) Any other letters, reports, memoranda, recordings, charts or other documents or records which would disclose any information ofwhich disclosure is prohibited in this subsection. (b) A court of competent jurisdiction may order the disclosure of specific information. (c) The information contained in an application shall be deemed to be public information. Disclosure shall not extend to the financial statement of the incorporators nor to any further information deemed by the Administrator to be confidential. (d) Nothing in this section shall prevent the exchange ofinformation relating to associations and the business thereof with the representatives of the agencies of this State, other states, or ofthe United States, or with reserve or insuring agencies for associations. The private business and affairs ofan individual or company shall not be disclosed by any person employed by the Savings and Loan Division, any member of the Commission, or by any person with whom information is exchanged under the authority of this subsection. (e) Any official or employee violating this section shall be liable to any person injured by disclosure of such confidential information for all damages sustained thereby. Penalties provided shall not be exclusive of other penalties. (1981 , c. 282, s. 3.) § 54B-64. Civil penalties; State associations. (a) Except as otherwise provided in this Article, any association which is found to have violated any provision of this Article may be ordered to forfeit and pay a civil penalty ofup to twenty thousand dollars ($20.000). Any association which is found to have violated or failed to comply with any cease and desist order issued under the authority of this Article may be ordered to forfeit or pay a civil penalty of up to twenty thousand dollars ($20,000) for each day that the violation or failure to comply continues. (b) To enforce the provisions of this section, the Administrator is authorized to assess such a penalty and to appear in a court of competent jurisdiction and to move the court to order payment ofthe penalty. Prior to the assessment of the penalty. a hearing shall be held by the Administrator which shall comply with the provisions of Article 3 of Chapter 150A of the General Statutes. (c) Ifthe Administrator determines that, as a result of a violation of any provision of this Article, or of a failure to comply with any cease and desist order issued under the authority of this Article, a situation exists requiring immediate corrective action, the Administrator may impose the civil penalty in this section on the association without a prior hearing, and said penalty shall be effective as of the date of notice to the association. Imposition of such penalty may be directly appealed to the Wake County Superior Court. (d) Nothing in this section shall prevent anyone damaged by a State association from bringing a separate cause of action in a court of competent jurisdiction. ( 1981 , c. 282, s . 3.) § 54B-65. Civil penalties; directors, officers and employees. (a) Any person, whether a director, officer or employee, who is found to have violated any provision of this Article, whether willfully or as a result of gross negligence, gross incompetency, or recklessness, may be ordered to forfeit and pay a civil penalty of up to five thousand dollars ($5,000) per violation. Any person who is found to have violated or failed to comply with any cease and desist order issued under the authority of this Article, may be ordered to forfeit and pay a civil penalty of up to five thousand dollars ($5,000) per violation for each day that the vio lation or failure to comply continues. 104 394 CH. 54B. SAVINGS AND LOAN ASSOCIATIONS (b) To enforce the provisions of this section, the Administrator is authorized to assess such a penalty and to appear in a court of competent jurisdiction and to move the court to order payment ofthe penalty. Prior to the assessment of the penalty, a hearing shall be held by the Administrator which shall comply with the provisions of Article 3 of Chapter 150A of the General Statutes. (c) Whenever the Administrator shall determine that an emergency exists which requires immediate corrective action, the Administrator, either before or after instituting any other action or proceeding authorized by this Article, may request the Attorney General to institute a civil action in a court of competent jurisdiction, in the name ofthe State upon the relation ofthe Administrator seeking injunctive relief to restrain or enjoin the violation or threatened violation of this Article and for such other and further relief as the court may deem proper. Instituting an action for injunctive relief shall not relieve any party to such proceedings from any civil or criminal penalty prescribed for violation of this Article. (d) Nothing in this section shall prevent anyone damaged by a director, officer or employee of a State association from bringing a separate cause of action in a court of competent jurisdiction. (1981 , c. 282, s . 3.) § 54B-66. Criminal penalties. (a) The provisions of this section shall in no event extend to persons who are found to have acted only with gross negligence, simple negligence, recklessness or incompetence. (b) In addition to any of the other penalties or remedies provided by this Article, the following shall be deemed to be misdemeanors and shall be punishable as provided in Chapter 14 of the North Carolina General Statutes: (1) The willful or knowing violation of the provisions of this Article by any employee ofthe Savings and Loan Division. (2) The willful or knowing violation of a cease and desist order which has become final in that no further administrative orjudicial appeal is available. (c) In addition to any ofthe other penalties or remedies provided by this Article, the willful omission, making, or concurrence in making or publishing a written report, exhibit, or entry in a financial statement on the books of the association, which contains a material statement known to be false shall be deemed to be a misdemeanor and shall be punishable as provided in Chapter 14 ofthe North Carolina General Statutes . For purposes of this section, " material" shall mean "so substantial and important as to influence a reasonable and prudent businessman or investor." (d) The Administrator is authorized to enforce this section in a court of competentjurisdiction. (1981, c. 282, s. 3.) § 548-68 § 54B-67. Primary jurisdiction. Whenever an agency ofthe United States government shall defer to the Administrator, or notify the Administrator of pending_action against an association chartered bythis State or fail to exercise its authority over any State- or federally-chartered association doing business in this State, the Administrator shall have the authority to exercise jurisdiction over such association. (1981 , c. 282, s. 3.) § 54B-68. Supervisory control. (a) Whenever the Administrator determines that an association is conducting its business in an unsafe or unsound manner or in any fashion which threatens the financial integrity or sound operation of the association, the Administrator may serve a notice ofcharges on the association, requiring it to show cause why it should not be placed under supervisory control. Such notice of charges shall specify the grounds for supervisory control, and set the time and place for a hearing. A hearing before the Commission pursuant to such notice shall be held within 15 days after issuance of the notice of charges, and shall comply with the provisions of Article 3 of Chapter 150A of the General Statutes. (b) If, after the hearing provided above, Commission determines that supervisory control of the association is necessary to protect the association's members, customers, stockholders or creditors, or the general public, the Administrator shall issue an order taking supervisory control of the association . An appeal may be filed in the Wake County Superior Court. (c) If the order taking supervisory control becomes final, the Administrator may appoint an agent to supervise and monitor the operations of the association during the period of supervisory control . During the period of supervisory control, the association shall act in accordance with such instructions and directions as may be given by the Administrator directly or through his supervisory agent and shall not act or fail to act except when to do so would violate an outstanding cease and desist order. (d) Within 180 days of the date the order taking supervisory control becomes final, the Administrator shall issue an order approving a plan for the termination of supervisory control. The plan may provide for: (1 ) The issuance by the association of capital stock; (2) The appointment of one or more officers and/or directors; (3) The reorganization, merger, or consolidation of the association; (4) The dissolution and liquidation of the association. The order approving the plan shall not take effect for 30 days during which time period an appeal may be filed in the Wake County Superior Court. (e) The costs incident to this proceeding shall be paid by the association, provided such costs are found to be reasonable. 105 395 § 548-69 CH. 54B. SAVINGS AND LOAN ASSOCIATIONS (f) For the purposes of this section, an order appointed to any position as a director, officer or shall be deemed final if: employee of that association, nor shall such a (1) No appeal is filed within the specific director, officer or employee be eligible to be elected to or retain a position as a director, offitime allowed for the appeal, or (2) After all judicial appeals are exhausted. cer or employee of any other State association. (1981, c. 282, s. 3.) (1981, c. 282, s. 3.) § 54B-69. Removal of directors , officers and employees. (a) If, in the Administrator's opinion, one or more directors, officers or employees ofany association has participated in or consented to any violation ofthis Chapter, or any other law, rule. regulation or order, or any unsafe or unsound business practice in the operation of any association; or any insider loan not specifically authorized by or pursuant to this Chapter; or any repeated violation of or failure to comply with any association's bylaws, the Administrator may serve a written notice of charges upon the director. officer or employee in question, and the association, stating his intent to remove said director, officer or employee. Such notice shall specify the conduct and place for the hearing before the Commission to be held. A hearing shall be held no earlier than 15 days and no later than 30 days after the notice of charges is served, and it shall comply with the provisions ofArticle 3 ofChapter 150A ofthe General Statutes. If, after the hearing, the Commission determines that the charges asserted have been proven by a preponderance of the evidence, the Administrator may issue an order removing the director. officer or employee in question . Such an order shall be effective upon issuance and may include the entire board of directors or all of the officers of the association. (b) Ifit is determined that any director, officer or employee of any association has knowingly participated in or consented to any violation of this Chapter, or any other law, rule, regulation or order, or engaged in any unsafe or unsound business practice in the operation of any association, or any repeated violation of or failure to comply with any association's bylaws, and that as a result, a situation exists requiring immediate corrective action, the Administrator may issue an order temporarily removing such person or persons pending a hearing. Such an order shall state its duration on its face and the words, "Temporary Order of Removal." and shall be effective upon issuance, for a period of 15 days. and may be extended once for a period of 15 days. A hearing must be held within 10 days of the expiration of a temporary order, or any extension thereof, at which time a temporary order may be dissolved or converted to a permanent order. (c) Any removal pursuant to subsections (a) or (b) ofthis section shall be effective in all respects as ifsuch removal had been made by the board of directors, the members or the stockholders of the association in question. (d) Without the prior written approval of the Administrator, no director, officer or employee permanently removed pursuant to this section shall be eligible to be elected, reelected or § 54B-70. Involuntary liquidation. (a) The Administrator with prior approval of the Commission may take custody ofthe books, records and assets of every kind and character of any association organized and operated under the provisions of this Chapter for any of the purposes hereinafter enumerated, if it reasonably appears from examinations or from reports made to the Administrator that: (1) The directors, officers, or liquidators have neglected, failed or refused to take such action which the Administrator may deem necessary for the protection of the association, or have impeded or obstructed an examination; or (2) The withdrawable capital ofthe association is impaired to the extent that the realizable value of its assets is insufficient to pay in full its creditors and holders of withdrawable accounts; or its liquidity fund or general reserve account is impaired; or (3) The business of the association is being conducted in a fraudulent, illegal or unsafe manner, or that the association is in an unsafe or unsound condition to transact business; (any association which, except as authorized in writing by the Administrator, fails to make full payment ofany withdrawal when due is in an unsafe or unsound condition to transact business, notwithstanding such provisions of the certificate of incorporation or such statutes or regulations with respect to payment of withdrawals in event an association does not pay all withdrawals in full); or (4) The officers, directors, or employees have assumed duties or performed acts in excess of those authorized by statute or regulation or charter, or without supplying the required bond; or, (5) The association has experienced a substantial dissipation of assets or earnings due to any violation or violations of statute or regulation, or due to any unsafe or unsound practice or practices; or (6) The association is insolvent, or is in imminent danger of insolvency or has suspended its ordinary business transactions due to insufficient funds; or (7) The association is unable to continue operations. (b) Unless the Administrator finds that such an emergency exists which may result in loss to members, withdrawable account holders, stockholders, or creditors, and which requires that he take custody immediately, he shall first give written notice to the directors and officers specifying the conditions criticized and allowing a reasonable time in which corrections may be 106 396 CH. 54B. SAVINGS AND LOAN ASSOCIATIONS made before a receiver shall be appointed as outlined in subsection (d) below. (c) The purposes for which the Administrator may take custody of an association include examination or further examination; conservation ofits assets; restoration ofimpaired capital; the making of any reasonable or equitable adjustment deemed necessary by the Administrator under any plan of reorganization. (d) If the Administrator after taking custody of an association, finds that one or more of the reasons for having taken custody continue to exist through the period of his custody, with little or no likelihood of amelioration ofthe situation, then he shall appoint as receiver or co-receiver any qualified person, firm or corporation for the purpose of liquidation of the association, which receiver shall furnish bond in form, amount and with surety as the Administrator may require. The Administrator may appoint the association's withdrawable account insurance corporation or its nominee as the receiver, and such insuring corporation shall be permitted to serve without posting bond. (e) In the event the Administrator appoints a receiver for an association, he shall mail a certified copy of the appointment order by certified mail to the address ofthe association as it shall appear on the records of the Division, and to any previous receiver or other legal custodian of the association, and to any court or other authority to which such previous receiver orother legal custodian is subject. Notice of such appointment shall be published in a newspaper of general circulation in the county where such association has its principal office. (f) Whenever a receiver for an association is appointed pursuant to subsection (d) above the association may within 30 days thereafter bring an action in the Superior Court ofWake County, for an order requiring the Administrator to remove such receiver. (g) The duly appointed and qualified receiver shall take possession promptly ofthe association for which he or it has been so appointed, in accordance with the terms of such appointment, by service of a certified copy of the Administrator's appointment order upon the association at its principal office through the officer or employee who is present and appears to be in charge. Immediately upon taking possession of the association, the receiver shall take possession and title to books, records and assets of every description of such association. The receiver, by operation of law and without any conveyance or other instrument, act or deed. shall succeed to all the rights, titles, powers and privileges of the association, its members or stockholders, holders ofwithdrawable accounts. its officers and directors or any of them: and to the titles to the books, records and assets of every description of any previous receiver or other legal custodian of such association. Such members, stockholders, holders ofwithdrawable accounts, officers or directors, or any of them , shall not thereafter, except as hereinafter expressly provided, have or exercise any such rights, powers or privileges or act in connection with any assets or property of any nature ofthe § 548-70 association in receivership: Provided however, that any officer, director, member, stockholder, withdrawable account holder, or borrower of such association shall have the right to communicate with the Administrator with respect to such receivership. The Administrator, with the approval of the Commission, may at any time, direct the receiver to return the association to its previous or a newly constituted management. The Administrator may provide for a meeting or meetings of the members or stockholders for any purpose, including, without any limitation on the generality of the foregoing, the election ofdirectors or an increase in the number of directors, or both, or the election ofan entire newboard ofdirectors; and may provide for a meeting or meetings of the directors for any purpose including, without any limitation on the generality ofthe foregoing, the filling of vacancies on the board, the removal of officers and the election of new officers, or for any ofsuch purposes. Any such meeting ofmembers or stockholders, or of directors, shall be supervised or conducted by a representative of the Administrator. (h) A duly appointed and qualified receiver shall have power and authority to: (1) Demand, sue for, collect, receive and take into his possession all the goods and chattels, rights and credits, moneys and effects, lands and tenements, books, papers. choses in action, bills, notes, and property ofevery description ofthe association; (2) Foreclose mortgages, deeds oftrust, and other liens executed to the association to the extent the association would have had such right; (3) Institute suits for the recovery of any estate, property, damages, or demands existing in favor of the association, and he shall, upon his own application, be -substituted as party plaintiff in the place of the association in any suit or proceeding pending at the time of his appointment; (4) Sell, convey, and assign all the property rights and interest owned by the association: (5) Appoint agents to serve at his pleasure; (6) Examine and investigate papers and persons, and pass on claims as provided in the regulations as prescribed by the Administrator; (7) Make and carry out agreements with the insuring corporation or with any other financial institution for the payment or assumption ofthe association liabilities, in whole or in part, and to sell, convey, transfer, pledge, or assign assets as security or otherwise and to make guarantees in connection therewith; and (8) Perform all other acts which might be done by the employees, officers and directors. Such powers shall be continued in effect until liquidation and dissolution or until return ofthe association to its prior or newly constituted management. 107 397 § 548-71 CH . 54B. SAVINGS AND LOAN ASSOCIATIONS (i) A receiver may at any time during the receivership and prior to final liquidation be removed and a replacement appointed by the . Administrator. 6) The Administrator may determine that such liquidation proceedings should be discontinued. He shall then remove the receiver and restore all the rights, powers, and privileges of its members and stockholders, customers, employees, officers and directors, or restore such rights, powers, and privileges to its members, stockholders and customers, and grant such rights, powers and privileges to a newly constituted management, all as of the time of such restoration ofthe association to its management unless another time for such restoration shall be specified by the Administrator. The return ofan association to its management or to a newly constituted management from the possession of a receiver shall, by operation of law and without any conveyance or other instrument, act or deed, vest in such association the title to all property held by the receiver in his capacity as receiver for such association. (k) A receiver may also be appointed under the authority of G.S. 1-502. No judge or court, however, shall appoint a receiver for any State association unless five days' advance notice of the motion, petition or application for appointment ofa receiver shall have been given to such association and to the Administrator. (1) Following the appointment of a receiver, the Administrator shall request the Attorney General to institute an action in the name ofthe Administrator in the superior court against the association for the orderly liquidation and dissolution ofthe association, and for an injunction to restrain the officers, directors and employees from continuing the operation ofthe association. (m) Claims against a State association in receivership shall have the following order of priority for payment: (1) Costs, expenses and debts of the association incurred on or after the date of the appointment of the receiver, including compensation for the receiver; (2) Claims of general creditors; (3) Claims of holders of special purpose or thrift accounts; (4) Claims of holders of withdrawable accounts; (5) Claims of stockholders of a stock associa tion; (6) All remaining assets to members and stockholders in an amount proportionate to their holdings as ofthe date of the appointment of the receiver. (n) All claims of each class described within subsection (m) above shall be paid in full so long as sufficient assets remain. Members ofthe class for which the receiver cannot make payment in full because assets will be depleted during payment to such class shall be paid an amount proportionate to their total claims. (0) The Administrator shall have the authority to direct the payment of claims for which no provision is herein made, and may direct the payment of claims within a class . The Administrator shall have the authority to promulgate rules and regulations governing the payment of claims by an association in receivership. (p) When all assets of the association have been fully liquidated, and all claims and expenses have been paid or settled, and the receiver shall recommend a final distribution, the dissolution ofthe association in receivership shall be accomplished in the following manner: (1) The receiver shall file with the Administrator a detailed report, in a form tobe prescribed by the Administrator, of his acts and proposed final distribution, and dissolution. (2) Upon the Administrator's approval of the final report of the receiver, the receiver shall provide such notice and thereafter shall make such final distribution, in such manner as the Administrator may direct. (3) When afinal distribution has been made except as to any unclaimed funds, the receiver shall deposit such unclaimed funds with the Administrator and shall deliver to the Administrator all books and records of the dissolved association. (4) Upon completion ofthe foregoing procedure, and upon the joint petition ofthe Administrator and receiver to the superior court, the court may find that the association should be dissolved, and following such publication of notice of dissolution as the court may direct, the court may enter a decree offinal resolution and the association shall thereby be dissolved. (5) Upon final dissolution of the association in receivership or at such time as the receiver shall be otherwise relieved of his duties, the Administrator shall cause an audit to be conducted, during which the receiver shall be available to assist in such. The accounts of the receiver shall then be ruled upon by the Administrator and Commission and if approved, the receiver shall thereupon be given a final and complete discharge and release. ( 1981 , c. 282, s. 3.) § 54B-71 . Judicial review. Any person or State association against whom a cease and desist order is issued or a fine is imposed may have such order or fine reviewed by a court of competent jurisdiction . Except as otherwise provided, an appeal may be made only within 30 days ofthe issuance ofthe order orthe imposition of the fine, whichever is later. (1981 , c. 282, s. 3.) § 54B-72. Indemnity. No person who is fined or penalized for a violation of any criminal provision of this Article shall be reimbursed or indemnified in any fashion by the association for such fine or penalty. (1981 , c. 282 , s. 3.) 108 398 Exhibit 2 COMMERCE - SAVINGS AND LOAN DIVISION T04 : 16D .0600 25.16 SECTION .0600 - LIQUIDITY FUND 25.18 .0601 LIQUIDITY FUND REQUIREMENT (a) Each association shall maintain a liquidity fund as 25.20 defined in G.S. 54B - 210 for the sole purpose of assuring the 25.21 liquidity of the association . (b) The liquidity fund required by this Section shall be 25.22 deemed identical with and not supplementary to the liquidity fund required to be maintained by associations insured by the Federal 25.24 Savings and Loan Insurance Corporation . (c) Reserves required to be maintained pursuant to Title I of 25.25 the Depository Institutions Deregulation and Monetary Control Act of 1980 and established pursuant to 12 C.F.R. 204 may be used to 25.27 satisfy the liquidity fund requirements of this Section. (d) In addition to those investments set forth in G. S. 54B- 25.30 210 (a ) , a state association's liquidity fund may also include securities which are hedged , subject to options, or 25.31 debt redeemable , in the manner allowed to members of the Federal Hone Loan Bank Board , by the board's regulations , as amended from time 25.32 to time ; the limitations regarding amounts of investments , investments in, or hedged by, a single source , and other similar 25.33 limitations set forth in the bank board's regulations , which 25.34 apply to members of the Federal Home Loan Bank Board , shall also 25.35 apply to state associations . Statutory Authority G.S. 54B -55; 54 B- 210; 54B- 211 ; Bff. August 31 , 1981 ; Amended Eff . July 1 , 1983. 25.38 25.39 25.40 25.41 .0602 AMOUNT OF LIQUIDITY FUND The liquidity fund shall be maintained in an amount equal to at least the greater of: percent of the net withdrawal value of the (1) five association's withdrawable accounts ; or (2) two hundred fifty thousand dollars ($250,000) . 25.43 25.45 25.46 25.48 25.49 25.51 History Note : History Note : 25.54 25.55 25.56 Statutory Authority G.S. 54B- 55; 54E- 210 ; 5& B- 211 ; Eff. August 31 , 1981 . NORTH CAROLINA ADMINISTRATIVE CODE 12/05/84 16-37 399 COMMERCE · SAVINGS AND LOAN DIVISION SECTION .0700 T04 : 16D .0700 GENERAL RESERVE ACCOUNT 26.6 .0701 GENERAL RESERVE REQUIREMENTS Ja) Each association shall establish and maintain a general reserve account for the sole purpose of covering losses. The general reserve account shall be established and maintained separately from any specific loss reserve accounts established and maintained at the election of the association. (b) Any state association which has insurance of withdrawable accounts with the Federal Savings and Loan Insurance Corporation and meets the statutory reserve requirement of the Federal Savings and Loan Insurance Corporation need not comply with the general reserve requirement of this Rule. level of the general reserve account shall be (c) The calculated at the end of each fiscal year using the percentages set forth in Paragraph ( d ) of this Rule , and shall be based on Bach the amount of assets at the end of each fiscal year. association shall make such transfers as may be necessary to reach the calculated level no later than 90 days after the end of the fiscal year . (d) The level of the general reserve account which shall be established and maintained against assets is fixed at the following percentages : (1 ) zero percent for the following "Group One" assets: (A) Stock in the Federal Home Loan Bank of Atlanta ; (B) PSLIC secondary reserve ; (C) Deposits in the North Carolina Savings Guaranty Corporation; and (D) Unencumbered land and fixed assets used in course of the association's business. (2) two percent for the following " Group Two " assets : (A) investments eligible for liquidity under G.S. 54B210, except stock in the Federal Home Loan Bank of Atlanta and deposits in the North Carolina Savings Guaranty Corporation ; and (B) encumbered land and fixed assets used in course of the association's business. (3 ) three percent for the following " Group Three" assets: JA) residential mortgage loans and mortgaged - backed securities ; (B) loans on withdrawable accounts ; (C) premiums or discounts on mortgage loans to be amortized ; and (D) other assets not listed under this Paragraph (d ) . (4) five percent for the following " Group Four" assets: (A) commercial loans ; NORTH CAROLINA ADMINISTRATIVE CODE 12/05/84 16-38 26.8 26.10 26.11 26.12 26.13 26.14 26.15 26.16 26.17 26.18 26.19 26.20 26.21 26.22 26.23 26.24 26.25 26.27 26.28 26.29 26.30 26.31 26.33 26.34 26.36 26.38 26.39 26.40 26.41 26.42 26.44 26.46 26.47 26.49 26.51 26.52 26.54 26.55 26.56 400 COMMERCE SAVINGS AND LOAN DIVISION T04 : 16D .0700 (B) secured consumer loans ; (C) loans to facilitate ; and (D) investment in service corporation. (5) eight percent for the following " Group Five " assets: (A) unsecured loans ; (B) real estate owned ; JC) standby, fixed-rate , Long terna commitments in excess of six months at time of issuance ; and (D) loans in bankruptcy. je) Upon a review of an association's assets and for just cause, the administrator may require an amount to be reserved in addition to the amounts prescribed in Paragraph (d) of this Rule. (E) For the purposes of meeting the required level of the general reserve account, any account which is a part of the association's net worth as defined in G.S. 54B-4 ( b) ( 38 ) shall be considered a part of the association's general reserve account. History Note: .0702 Statutory Authority G.S. 54B- 216 ; Eff. December 1 , 1981 ; Amended Eff. November 1 , 1982 ; October 1 , 1982 . REQUIREMENTS FOR NEWLY- CHARTERED STOCK ASSOCIATIONS History Note: Statutory Authority G.S. 54B- 216 ; Eff. December 1 , 1981 ; Repealed Eff. November 1 , 1982 . 26.57 27.1 27.2 27.3 27.4 27.5 27.7 27.8 27.10 27.12 27.13 27.14 27.15 27.16 27.17 27.18 27.21 27.22 27.23 27.25 27.28 27.29 27.30 401 Exhibit 3 GENERAL RESERVE REQUIREMENT (ADEQUACY OF NET WORTH/CAPITAL ) Description of Assets GROUP I Stock in FHLB-Atlanta FSLIC Secondary Reserve Deposits with FIAC Unencumbered Land and Fixed Assets Used in the Course of Assn. Business Total Group I. GROUP II Investments Eligible for Liquidity (Exclude FHLB-Atlanta Stock and Deposits with FIAC ) Encumbered Land and Fixed Assets Used in the Course of Assn . Business Total Group II GROUP III Residential Mortgage Loans and Mortgage Backed Securities Loans in Withdrawable Accounts Premiums/Discounts on Mortgage Loans to be Amortized Assets not Otherwise Listed Total Group III GROUP IV Commercial Loans Unsecured Loans Consumer Loans Loans to Facilitate Investment in Service Corporation Special Mention Assets Total Group IV GROUP V Real Estate Owned Assets Classified Substandard Total Group V GROUP VI Assets Classified Doubtful GROUP VII Assets Classified Loss Amount Requirement X 2% = X 5% = X 10% = X 20% = X 50% = × 100% = Reference 4 NCAC 16D.0701 ||| Total Assets Total General Reserve Requirement General Reserve on Exam Date Excess (Deficiency) 402 Exhibit 4. LIQUIDITY ANALYSIS Cash on Hand Bank Deposits (Checking Accounts ) Federal Funds and Overnight Deposits Stock in Federal Home Loan Bank Deposit with Financial Institutions Assurance Corporation U. S. Governments and Agency Obligations Certificates of Deposit (Banks and S&Ls) Bankers Acceptances Corporate Debt/Commercial Paper Repurchase Agreements Debt Securities Hedged Other Investments Accrued Interest on Above Less Total Amount Pledged Actual Liquidity (A) $ $ Total Savings Less: Share Loans Pledged Collateral on Other Loans Net Savings Required Liquidity Ratio x Required Liquidity ( B ) Excess (Deficiency) (A) Should Exceed (B) Comments: References: NC General Statute 548-210- Components of Liquidity Fund 4 NCAC 16D.0601 - Liquidity Fund Requirement 4 NCAC 16D.0602 Amount of Liquidity Fund Section 523.10 - Liquidity Definitions Bank System Regs 12 5% 403 Mr. BARNARD. Mr. McEnteer, before you begin, I would like to ask, as Pennsylvania's secretary of banking, do you have the joint supervisory control of banks and savings and loans? Mr. McENTEER. Yes, sir. Mr. BARNARD. You have both under your jurisdiction? Mr. MCENTEER. Yes, sir. Mr. BARNARD. Not divided in other words? Mr. MCENTEER. Yes, sir. Mr. BARNARD. What about credit unions? Mr. MCENTEER . We have them also. State-chartered credit unions also. Mr. BARNARD. You have all three under your jurisdiction ? Mr. McENTEER. And consumer credit companies also, and pawn brokers too. Mr. BARNARD. Well, now we're getting to the important aspects now. [Laughter. ] Mr. McENTEER. All State-chartered financial institutions that comes under the purview of the department of banking. Mr. BARNARD . The other 2 witnesses, you just have savings and loans, correct? Mr. BROWN. The State of Maryland's Savings and Loan Division is a separate agency. Credit unions come under the bank commissioner's office which is a separate agency. Mr. KING. Yes, sir, that's correct. Mr. BARNARD. Mr. McEnteer, we will hear from you at this time. STATEMENT OF BEN MCENTEER, SECRETARY, DEPARTMENT OF BANKING, COMMONWEALTH OF PENNSYLVANIA Mr. MCENTEER. Thank you, Mr. Chairman, distinguished members of the subcommittee. I am Ben McEnteer, secretary of banking of the Pennsylvania Department of Banking. We have submitted detailed testimony, as requested by the committee and I appreciate the opportunity to highlight this testimony. Mr. BARNARD. Without objection , your entire testimony will be entered in the record. Mr. MCENTEER. The Pennsylvania Savings Association Bureau is the division within the department of banking charged with the examination and supervision of savings associations and directly responsible to the secretary of banking of Pennsylvania. Under the Savings Association Code, the department of banking is vested with the authority to annually or more frequently examine or investigate any State-chartered association . Along with the power to investigate and examine is the power to issue orders to discontinue any violation of law or any unsafe or unsound business practice. The department is authorized to take possession of an association, and either liquidate the association or appoint a deputy receiver for that purpose in the event the institution is in an unsafe or unsound condition. The savings association bureau presently supervises 104 Statechartered, federally insured savings associations with assets ranging from $4 million to $2.019 million and 68 State-chartered asso- 404 ciations insured by the Pennsylvania Savings Association Insurance Corp. with assets ranging from $ 125,000 to $82.9 million. The largest association insured by PSAIC is $82.9 million. The remaining 67 associations have assets of between $ 125,000 and $ 13.5 million. These associations have been in business for a period of up to a 117 years. The average net worth of these associations equals 13 percent of total savings on a GAAP accounting basis . I think that is very important, that the average net worth of these associations amounts to 13 percent. This has been an historical pattern for a considerable portion of the Commonwealth's associations. Pennsylvania is the home of this country's first building and loan association. Associations insured by the Pennsylvania Savings Association Insurance Corp. are normally examined by the examing staff of the bureau on an annual basis . The department has the authority to examine and conduct investigations whenever it deems appropriate. The department of banking may, by written order, direct an association to discontinue any violation of law or any unsafe or unsound business practice. Any director, officer, attorney, or employee of an association who, after the department orders it to cease and desist from any violation of law or any unsafe and unsound business practice, continues such violation or practice, may be removed from office. Based upon our experience, we are confident the enforcement powers provided the department by law are sufficient to monitor the safety and soundness of Pennsylvania's associations. The Savings Association Code provides that whenever the general reserves of an association are not equal to at least 8 percent of the savings accounts or whenever the net worth of the association is not equal to at least 10 percent of the savings accounts, it shall credit annually to its general reserves an amount equal to not less than 5 percent of its net income before payment of interest on savings accounts. The State's capital requirements then are significantly higher than those required by the Federal Savings and Loan Insurance Corporation. Even with the recently adopted FSLIC capital requirements imposing higher capital, the Pennsylvania State requirements are still higher. After the Commonwealth amended its law in 1979 to require that all State-chartered associations obtain account insurance, the department had the task of reviewing the financial status of every association applying for insurance from the Pennsylvania Savings Association Insurance Corp. If the financial status of an association did not support a department certification for PSAIC insurance, the department would first condition its certification upon the pledging of accounts by officers or directors. The second method of certification would be the traditional method of arranging for a supervisory merger and the third method is a relatively new procedure of recapitalizing an association by a supervisory conversion to stock form. Based upon our continuous monitoring of both federally insured and nonfederally-insured thrifts, we report that at the present time we have no problem associations within the Pennsylvania State system . 405 The statute establishing the Pennsylvania Savings Association Insurance Corp. provides that the department of banking shall monitor the operations of the PSAIC and require the corporation to furnish reports or records as deemed necessary or appropriate in the public interest. Since the PSAIC has been in operation , the department has provided the PSAIC with copies of reports of examinations, supervisory letters and related correspondence between the bureau and the insured members. Accordingly, our supervisory letters require that the member associations provide copies of all their responses to the savings association bureau for the PSAIC. Since the inception of the PSAIC, a representative from the savings association bureau has attended all board of director's meetings, and membership committee meetings as well as annual meetings of the insurance corporation . This provides for continuous dialog and a most effective joint supervisory program for all the State-chartered associations insured by PSAIC. It is appropriate, in our opinion, to emphasize that the safety of a savings association primarily comes from (1) sound management; (2) blue-chip home mortgage and investment portfolios; (3) strong supervisory-enforced reserve position; (4) adequate liquidity for meeting withdrawals; (5) the ability of the savings association to secure funds in time of need from the Federal Home Loan Bank's system, or the Federal Reserve Bank's discount window, or other reliable sources; and (6) in addition, the insurance of savings accounts . As the department's line of communication between itself and the Pennsylvania Savings Association Insurance Corp. is operating effectively, the department is not aware of any method that would materially improve that relationship. One important lesson to be learned from the Ohio situation is that the well-being of any financial institution depends ultimately on public confidence. The privately-insured institutions in Pennsylvania have been in business for a long time. They are strong, well managed, and well regulated. These are the key features to insure that any type of financial institution remains fiscally sound. Again, Mr. Chairman, I appreciate the opportunity to appear before the subcommittee today and I will be pleased to take any questions you may have. Thank you. [ The prepared statement of Mr. McEnteer follows:] 406 TESTIMONY BY BEN MCENTEER SECRETARY , DEPARTMENT OF BANKING COMMONWEALTH OF PENNSYLVANIA Mr. Chairman and Distinguished Members of the Subcommittee : I am Ben McEnteer , Secretary of Banking of the Pennsylvania Department of Banking . I appreciate the opportunity to come before you today to review the operation of the Pennsylvania Savings Association Insurance Corporation , (a deposit insurance fund created by the Pennsylvania Legislature ) and to discuss the manner in which the Corporation interacts with the Department of Banking of the Commonwealth of Pennsylvania . The Pennsylvania Savings Association Bureau is the division within the Department of Banking charged with the examination and supervision of savings associations (hereinafter associations ) and directly responsible to the Secretary of Banking of Pennsylvania . The department enforces and administers all laws of the Commonwealth relating to any statechartered financial institutions . The department exercises general supervision over institutions in order to afford the greatest possible safety to depositors , other creditors , and shareholders thereof . It also acts to insure the safe conduct of the business of such institutions , conserve their assets , maintain the public confidence in such institutions , and protect the public interest . Under the Savings Association Code of 1967 and the Department of Banking Code , the department is vested with the authority to annually or more frequently examine or investigate any state -chartered association . Along with the power to investigate and examine is the power to issue orders to discontinue any violation of law or any unsafe or unsound business practice . Under the Department of Banking Code , the Department is authorized to take possession of an association , and either liquidate the association or appoint a deputy receiver for that purpose in the event the 407 institution is in an unsafe or unsound condition . In response to the request of this committee , as contained in the communication of March 22 , 1985 , I submit the following : The budget of the Pennsylvania Savings Association Bureau for the fiscal year ended June 30 , 1983 was $ 1,008,000 ; for the year ended June 30 , 1984 , $ 1,004,400 ; and for the current fiscal year , $ 1,033,000 . The professional staff of the Bureau consists of 12 field examiners , 3 supervisory examiners , an assistant director and a director . The Savings Association Bureau presently supervises 104 statechartered , federally - insured savings associations with assets ranging from $4,000,000 to $ 2,219,000,000 ; and 68 state - chartered associations insured by the Pennsylvania Savings Association Insurance Corporation with assets ranging from $125,000 to $ 82,900,000 . A further breakdown of the state- chartered associations insured by the Pennsylvania Savings Association Insurance Corporation shows that although the largest association is $82.9 million , the remaining 67 associations have assets of between $125,000 and $13.5 million . to 117 years . These associations have been in business for a period of 28 The average net worth of these associations equals 13% of total savings on a GAAP accounting basis . This has been an historical pattern for a considerable portion of the Commonwealth's associations . Pennsylvania is the home of this country's first building and loan association . We further note that all savings and loan associations domiciled in Pennsylvania are managed in a conservative manner . Associations insured by the Pennsylvania Savings Association Insurance Corporation are normally examined by the examining staff of the bureau on an annual basis . Under the Savings Association Code of 1967 and the Department of Banking Code , the Department has the authority to examine or -2- 408 conduct investigations whenever it deems appropriate . Both Codes provide that the Department of Banking may , by written order , direct an association to discontinue any violation of law , or any unsafe or unsound business practice . Ancillary to these powers is the power to issue subpoenas , which includes contempt penalties for failure to appear or to testify before a Department proceeding . Any director , officer , attorney or employee of an association who after the Department orders to cease and desist from any violation of law , or any unsafe and unsound business practice , continues such violation or practice , may be removed from office . There are criminal penalties for directors , officers , employees and attorneys who engage in insider transactions , fail to keep proper records , repledge collateral , or submit required documents with false statements to the Department . Based upon our experience , we are confident the enforcement powers provided the Department by law are sufficient to monitor the safety and soundness of Pennsylvania's associations . The Savings Association Code of 1967 provides that whenever the general reserves of an association are not equal to at least 8% of the savings accounts , or whenever the net worth of the association is not equal to at least 10% of the savings accounts , it shall credit annually to its general reserves an amount equal to not less than 5% of its net income before payment of interest on savings accounts . The Savings Association Code requires adherence to various standards such as loan to value ratios , maximum loans to one borrower , maximum percentage of various types investments to assets and a maximum limitation on borrowing . These provisions are designed to ensure the safety and soundness of our savings associations and prevent the possibility of the insolvency of any association . -3- 409 The state capital requirements are significantly higher than those required by the Federal Savings and Loan Insurance Corporation ( hereinafter FSLIC) . Even with the recently adopted FSLIC capital requirements imposing higher capital requirements on the marginal deposits increase for rapidly growing FSLIC insured associations , the state requirements are still higher . Even though capital requirements play an important role in preventing insolvencies , the Department does not solely rely on them . Ultimately , conservative , profitable good management is the best insurance against insolvency . From a regulatory standpoint , the Department attempts through its examination procedures and the close relationship the Department has with its chartered institutions , to identify problem associations at the earliest possible moment . When such an association is identified , the Department generally requires one of the following approaches : pledging of deposits by certain savings members ; supervisory mergers ; or a supervisory conversion from a mutual to stock form . After the Commonwealth amended its law in 1979 to require that all state-chartered associations obtain account insurance , the Department had the task of reviewing the financial status of every association applying for insurance from the Pennsylvania Savings Association Insurance Corporation ( PSAIC ) . If the financial status of an association did not support a Department certification for PSAIC insurance , the Department would condition its certification upon the " pledging " of accounts by officers or directors These pledged accounts not only increased the association's net worth , but increased the pledgor officer's or director's motivation to insure good management . The Department continues to use this method to increase net worth and has found it to be successful ,. especially in the case of small or part-time associations . -4- 410 The second method is the traditional method of arranging for a supervisory merger . With the advent of statewide branching in 1982 , the Department may arrange the merger of any two associations located in the Commonwealth . Two reasons for the success of supervisory mergers are the Department's knowledge of the savings and loan industry in the state and its ability to foster mergers that are in the best interests of both associations . The third method is the relatively new procedure of recapitalizing an association by a supervisory conversion to the stock form . Using this method , the Department determines , after a public hearing , that no public purpose would be served by offering the stock to the current savings members and authorizes a sale of the entire stock issue to a single person or entity , or a control group . Stock conversions were first authorized in Pennsylvania in 1982. The statutory authorization for stock conversions in Pennsylvania gives the Department more flexibility than the Federal Home Loan Bank Board ( hereinafter FHLBB ) or the Federal Savings and Loan Insurance Corporation ( FSLIC ) . Since 1982 , the Department has completed two such transactions . The first resulted in a stock association that grew from $4,000,000 in deposits to over $ 80,000,000 in deposits . association is now well capitalized , is well managed , and has increased the net worth of PSAIC through its required deposit balances . Based upon our continuous monitoring of both federally- insured and nonfederally- insured thrifts , we report that at the present time we have no problem associations within the Pennsylvania state system . The statute establishing the Pennsylvania Savings Association Insurance Corporation ( PSAIC ) provides that the Department of Banking , through the Savings Association Bureau , shall monitor the operations of the -5- 411 PSAIC and require the corporation to furnish reports or records as deemed necessary or appropriate in the public interest . The PSAIC must annually submit a written report certified by an independent public accountant relative to the conduct of its business , including financial statements . The statute further provides that all applications for membership in the PSAIC shall be referred to the Department of Banking , that the Department examine the affairs of all such applicants , and that the Department provide certification of such applicants as to the quality and soundness of the applicant association's financial affairs , solvency , management and directorship . Since the PSAIC has been in operation , the Department , through the Savings Association Bureau , has provided the PSAIC with copies of reports of examinations , supervisory letters and related correspondence between the Bureau and the insured members . Accordingly , our supervisory letters require that the member associations provide copies of all their responses to the Savings Association Bureau for the PSAIC . In addition , as part of our monitoring program , the PSAIC provides the Savings Association Bureau with copies of its insured member associations ' monthly reports to the Insurance Corporation for review by the Savings Association Bureau . Since the inception of the PSAIC a representative from the Savings Association Bureau has attended all Board of Directors ' meetings and membership committee meetings , as well as annual meetings of the Insurance Corporation . This provides for continuous dialogue and a most effective joint supervisory program for all the state -chartered associations insured by PSAIC. The sole power to terminate insurance of accounts for those associations insured by PSAIC rests with the Insurance Corporation . It is appropriate , in our opinion , to emphasize that the safety of a -6- 50-923 0-85--14 412 savings association primarily comes from ( 1 ) sound management , ( 2 ) blue -chip home mortgage and investment portfolios , ( 3 ) strong supervisory- enforced reserve position , ( 4 ) adequate liquidity for meeting withdrawals , ( 5 ) the ability of the savings association to secure funds in time of need from the Federal Home Loan Bank's system , or the Federal Reserve Bank's discount window , or other reliable sources , and ( 6 ) in addition , the insurance of savings accounts . Effective dual regulation depends on the mutual respect and cooperation between the department and the Pennsylvania Savings Association Insurance Corporation . This , coupled with the appropriate remedial action , including the pledging of accounts , supervisory mergers and supervisory stock conversions , has contributed to the public confidence Pennsylvanians have in the Pennsylvania Savings Association Insurance Corporation's insurance . As the Department's line of communication between itself and the Pennsylvania Savings Association Insurance Corporation is operating effectively , the Department is not aware of any method that would materially improve that relationship . One important lesson to be learned from the Ohio situation is that the well - being of any financial institution depends ultimately on public confidence . All financial institutions perform the same economic function as a financial intermediary in the gathering of funds from the ultimate lenders and distributing them to the ultimate borrowers . The ultimate lenders exchange their cash for deposit accounts or debt instruments of the financial institution and the ultimate borrowers obtain cash from the institutions and give the financial institution a note or a security -7- 413 evidencing their obligation to repay their debts . All financial institutions ' asset - liability management plans assume that all the ultimate lenders will not ask the financial institution to honor withdrawal of deposits at one time . In fact , if this were not so , financial institutions could not perform their economic function of efficiently allocating credit in our ecomony . Therefore , public confidence is paramount . Furthermore , sound management and profitable operations with effective government monitoring is the key to maintaining public confidence . It seems premature to condemn a segment of the savings and loan industry for the actions of one large state -insured institution . None of the PSAIC-insured institutions have invested in the type of repos or reverse repos marketed by the ESM government securities firm . The privately insured institutions in Pennsylvania have been in business for a long time . They are strong , well -managed , and well -regulated . These are the key features to ensure that any type of financial institution remains fiscally sound . Again , Mr. Chairman , I appreciate the opportunity to appear before the subcommittee today , and I will be pleased to take any questions you may have . -8- 414 Official Advance Copy ofStatute Enacted at 1979 Session No. 1979-5 AN ACT HB 153 Establishing the Pennsylvania Savings Association Insurance Corporation and providing for its powers and duties. TABLE OF CONTENTS Section 1. Definitions. Section 2 . Section 3. Section 4. Pennsylvania Savings Association Insurance Corporation Purposes and powers. Board of directors. Section 5 . Section 6. Qualifications for membership in corporation . Exchange of information . Section 7 . Section 8. Faith or credit of Commonwealth not pledged. Bylaws, rules and regulations. Section 9. Corporation or member associations not subject to insurance laws. Section 10 . Section 11 . Liability of officer or director upon contracts. Perpetual life of corporation. Section 12. Section 13 . Section 14. Exemption from taxation . Application for membership . Functions of Secretary of Banking. Section 15 . Section 16. Section 17. Filing certificate of commencement of business. Termination of existence of corporation. Effective date. The General Assembly of the Commonwealth of Pennsylvania hereby enacts as follows: Section 1 . Definitions. The following words and phrases when used in this act shall have , unless the context clearly indicates otherwise, the meanings given to them in this section: "Association ." Any building, savings or savings and loan association organized under the laws of this Commonwealth and any Federal savings and loan association incorporated pursuant to the Federal act of June 13 , 1933 (48 Stat.128), known as the "Home Owners' Loan Act of 1933," which has its principal office in this Commonwealth and 75% of its total assets invested in this Commonwealth . "Corporation." The Pennsylvania Savings Association Insurance Corporation. "Directors" or "board of directors." The Board of Directors of the Pennsylvania . Savings Association Insurance Corporation . "Savings account." Any sum of money deposited with an association in exchange for a promise to pay interest or earnings to or for the account of the depositors. 415 2 Section 2. Pennsylvania Savings Association Insurance Corporation. A nonstock, nonprofit corporation is hereby created , which shall be known as the Pennsylvania Savings Association Insurance Corporation and the members of which shall be certain eligible associations of this Commonwealth as defined in section 1. Except as otherwise provided in this act, the corporation possesses all the powers , privileges and immunities which now are or hereafter may be conferred on corporations by the General Corporation Law applicable thereunder. Section 3. Purposes and powers . to corporations organized (a) Purposes. -The purposes of the corporation are to promote the elasticity and flexibility of the resources of member associations, to provide for the liquidity of such associations through a central reserve fund and to insure the savings accounts in such associations. (b) Powers. In furtherance of these purposes the corporation has the following powers : (1) To provide for the liquidity of member associations through the creation of a central reserve fund for the purpose of making loans to member associations. The central reserve fund shall not be subject to payment of insurance claims against the corporation by member associations or their account holders or otherwise. (2) To insure the savings accounts in member associations through the creation of a central insurance fund , which fund shall consist of capital contributions by each member in an amount equal to not less than 2% of the total savings on deposit with each member. (3) To borrow money and otherwise incur indebtedness for any ofits purposes; to issue its bond , debentures, notes or other evidences of indebtedness, whether secured or unsecured , therefor; and to secure the same by mortgage, pledge, deed of trust or other lien on its property, rights and privileges of every kind and nature or any part thereof. (4) To lend money to , and to guarantee, endorse or act as surety on the bonds, notes, contracts or other obligations of or otherwise assist financially, any member association; and to establish and regulate the terms and conditions with respect to any such loans or financial assistance and the charges for interest and service connected therewith . (5) To purchase, receive, hold , lease or otherwise acquire and to sell, convey, mortgage, lease, pledge or otherwise dispose of, upon such terms and conditions as its board of directors may deem advisable, real and personal property, together with such rights and privileges as may be incidental and appurtenant thereto and the use thereof, including, but not restricted to, any real or personal property acquired by the corporation from time to time in the satisfaction ofdebts or enforcement of obligations . (6) To invest any of its funds, upon proper authorization thereof by the board of directors, in any of the following: (i) Cash or deposits in checking or savings accounts, or under certificates of deposit in National or State banking institutions, to the 416 3 extent that such accounts are insured by the Federal Deposit Insurance Corporation. This condition regarding Federal insurance shall not apply to investments in certificates of deposit when such condition would result in a lower interest rate than would otherwise be available. (ii) Savings accounts in associations to the extent that such accounts are insured by the Federal Savings and Loan Insurance Corporation. (iii) Interest bearing bonds, notes, certificates of indebtedness, bills or other obligations of the United States, any state or the District of Columbia, or of any commission, instrumentality, agency, authority or political subdivision of the United States, any state or the District of Columbia , having legal authority to issue the same. (iv) Interest bearing bonds, notes or other interest bearing obligations of any corporation created or existing under the laws of the United States, any state or the District of Columbia. (v) Dividend paying stocks or shares having readily marketable values of any corporation created or existing under the laws of the United States or of any state. The board of directors may not invest more than 10% of its total assets in such stocks , nor more than 3% of its total assets in the stock of any one corporation . (vi) Loans secured by first mortgages or deeds of trust on otherwise unencumbered fee simple real estate or improved leasehold property in this Commonwealth . (vii) Ground rents in this Commonwealth. (viii) Collateral loans secured by pledge hereinabove named . of any security (ix) Direct loans to member associations under the terms and conditions established therefor by the board of directors. (7) To exercise all other corporate powers granted by general law to corporations in this Commonwealth which are not inconsistent herewith and which are necessary or appropriate to the purposes hereof. (c) Accumulated earnings .-The earnings shall be accumulated by the corporation and no part thereof shall be returned to member associations . The provisions of this subsection shall not prohibit the payment of interest by the corporation to member associations which have made deposits , loans or advances to the central reserve fund . Section 4. Board of directors. (a) Directors elected by member associations. -All of the corporate powers of the corporation shall be exercised by a board of directors, composed of 11 members who initially shall be appointed bythe Governor within 60 days of the effective date of this act with the advice of the Secretary of Banking, and who shall serve until the first annual meeting. After a minimum of 25 associations have become members of the corporation, the first annual meeting of the corporation shall be held , and the member associations of the corporation shall elect eight directors , each of whom shall be a registered voter of and shall reside in this 417 4 Commonwealth . Of the directors elected at the first annual meeting, three shall be elected for terms of two years each, three shall be elected for terms of three years each and two shall be elected for terms of four years each , and thereafter all terms shall be for four years each. (b) Directors appointed by Governor.- In addition to the eight directors elected by the member associations as provided in subsection (a) , the Governor shall, with the advice of the Secretary of Banking, appoint three directors of the corporation , one for a term of two years, one for a term of three years and one for a term of four years. The terms shall commence on the date of the first annual meeting of the corporation, and thereafter all terms shall be for four years. Any director so appointed shall be a registered voter of and shall reside in this Commonwealth . (c) Vacancies. - If any vacancy occurs in the membership of any director elected by the members of the corporation , through death, resignation or otherwise, the remaining directors shall within 60 days elect a person to fill the vacancy of the unexpired term. Any vacancy occurring in the term of director appointed by the Governor shall be filled by the Governor within 60 days, with the advice ofthe Secretary of Banking, for the unexpired term. Upon the expiration of the term of any director, the directorship shall remain vacant until his successor has been elected or appointed and has qualified . In no case shall a director whose term has expired continue to serve unless he is reelected or reappointed to a new term and has qualified. (d) Quorum. - Six members of the board of directors are a quorum at any meeting thereof. (e) Voting. ― In the election of directors and in voting on any other matter legally to come before a meeting of the corporation , each member association of the corporation has one vote, to be cast by a delegate authorized to act by that association . A delegate may not vote on behalf of more than one member association . A majority of the votes so cast shall elect directors or determine any question put to a vote. (f) Compensation.-The directors of the corporation may receive such reasonable compensation from the funds of the corporation as may be determined by the board of directors. (g) Surety bonds of officers and employees. -The directors of the corporation shall fix the amount of the surety bonds of the officers and employees of the corporation conditioned upon the faithful performance of their duties, as provided in the bylaws of the corporation . Section 5. Qualifications for membership in corporation. (a) General rule.( 1) The membership of the corporation consists of those associations: (i) the quality and soundness of whose financial affairs, solvency, management and directorship have been certified to the corporation in an expeditious manner, as approved for insurance of savings accounts, by the Secretary of Banking; and 418 5 (ii) which have thereupon filed a formal application for membership accepted by the board of directors, which acceptance shall not be denied except for good cause shown regarding the quality and soundness of their financial affairs, solvency, management or directorship. (2) The corporation may accept an applicant for membership subject to the imposition of certain conditions concerning the quality and soundness ofthe applicant's financial affairs, solvency, management and directorship . (3) Subject to the conditions set forth in paragraphs ( 1 ) and (2) , every association of this Commonwealth may become a member of the corporation and may invest in and pay such assessments, premiums and other charges as may be required for participation in the corporation . Membership in the corporation is for the life ofthe corporation , subject to the bylaws, rules and regulations of the corporation. (b) Withdrawal. -Any member may withdraw from the corporation upon written notice given one year in advance of the intended date of withdrawal and upon complying with the bylaws, rules and regulations of the corporation . Section 6. Exchange of information. The laws of this Commonwealth , including but not limited to the act of May 15, 1933 (P.L.565 , No.111 ) , known as the "Department of Banking Code," shall be construed and applied so as not to prevent an exchange of information relating to associations and their business, between the Secretary of Banking and representatives of the corporation. Any document or information supplied to the corporation by the Secretary of Banking shall be kept confidential unless the Secretary of Banking specifically specifies otherwise, and violation of such confidentiality shall subject the personnel of the corporation to the same sanctions to which the Secretary of Banking would be subject under the " Department ofBanking Code.' Section 7. Faith or credit of Commonwealth not pledged . Under no circumstances is the faith or credit of the Commonwealth of Pennsylvania pledged herein. Section 8. Bylaws, rules and regulations. (a) General rules and regulations. -Within 60 days of its appointment and before the acceptance of the membership of any associations, the board of directors shall promulgate, subject to the approval of the Secretary of Banking, such bylaws, rules and regulations as may be necessary and proper to carry out the provisions of this act and as are not inconsistent with this act . Thereafter, the bylaws, rules and regulations so adopted may be amended or revoked by the board of directors and will, upon approval of the Secretary of Banking become effective upon their adoption. The rules and regulations shall establish a limit on the amount of insurance which may be provided for each separate savings account of an association; and this limit shall be the amount of prevailing insurance 419 6 available from the Federal Savings and Loan Insurance Corporation or its successor instrumentality from time to time. : (b) Internal rules and regulations.-The board of directors shall have the power to adopt such bylaws, rules and regulations which may be necessary for the internal operations of the corporation. Section 9. Corporation or member associations not subject to insurance laws. Neither the corporation , the member associations, nor those persons owning savings accounts therein are subject to the provisions of any laws of this Commonwealth concerning insurance by reason of participation herein except that the provisions of section 641 , act of May 17 , 1921 (P.L.789, No.285) , known as "The Insurance Department Act of one thousand nine hundred and twenty-one," shall continue to apply. Section 10. Liability of officer or director upon contracts. No officer or director of the corporation , whether appointed or elected , is personally liable upon any of its contracts legally entered into on behalf of the corporation unless the same by its terms shall expressly obligate him or them . Section 11. Perpetual life of corporation. The life of the corporation is perpetual. Section 12. Exemption from taxation . The corporation is exempt from all special and ordinary taxes and from documentary stamp and transfer taxes imposed by this Commonwealth or any political subdivision thereof. Application for membership . (a) Applications before organization of board . All applications from associations for membership received by the corporation prior to appointment and organization of the board ofdirectors shall be referred to Section 13. the Secretary of Banking. The Secretary of Banking shall examine the affairs of all such applicants and as a result thereof if he finds the applicants to meet the qualifications for membership in the corporation set forth herein under section 5, he shall so certify them. The corporation shall not extend the benefits to be accorded to member associations to any applicant until: (1 ) it has received the report and recommendation as provided herein from the Secretary of Banking as to such applications so filed prior to appointment and organization of the board ofdirectors and has acted thereon in accordance with section 5 ; and (2) it has accepted for membership a minimum of 25 associations having savings accounts in the aggregate total of at least $25,000,000 . (b) Applications after organization of board .-All applications from associations for membership received by the corporation subsequent to appointment and organization of the board of directors shall be made to the corporation. The corporation shall then refer this preliminary application to the Secretary of Banking within 30 days of receipt thereoffor action in accordance with the requirements set forth herein under section 5 . 420 7 Section 14. Functions of Secretary of Banking. (a) Requiring corporation to discharge its obligation . - In the event of the refusal ofthe corporation to commit its funds or otherwise to act forthe protection ofdepositors of any member association ofthe corporation , the Secretary of Banking may apply to the Commonwealth Court for an order requiring the corporation to discharge its obligation under this act and for such other relief as the court may deem appropriate to carry out the purposes of this act. (b) Examinations and inspections; reports. -The Secretary of Banking may make such examinations and inspections of the corporation and require the corporation to furnish him with such reports and records or copies thereof as the Secretary of Banking may consider necessary or appropriate in the public interest or to effectuate the purposes of this act. As soon as practicable after the close of each fiscal year, the corporation shall submit to the Secretary of Banking a written report relative to the conduct of its business and the exercise of the other rights and powers granted by this act, during such fiscal year. Such report shall include `financial statements setting forth the financial position ofthe corporation at the end of such fiscal year and the results of its operations, including the source and application of its funds, for such fiscal year. The financial statements so included shall be examined by an independent public accountant, or firm of independent public accountants, selected by the corporation and satisfactory to the Secretary of Banking, and shall be accompanied by the report thereon of such accountant or firm. Section 15. Filing certificate of commencement of business . After the first meeting of the board of directors , a certificate shall be filed by the board of directors with the Department of State certifying that the corporation has commenced business as provided in this act. Such certificate shall be conclusive evidence that business was begun. Section 16. Termination of existence of corporation . If the corporation fails to insure savings accounts by January 1 , 1981 , its existence terminates at that time without further action by the General Assembly and the Governor, the provisions of this act then are null and void and shall expire on January 1 , 1981 . Section 17. Effective date. This act shall take effect in 60 days. APPROVED -The 6th day of April, A. D. 1979. DICK THORNBURGH 421 Official Advance Copy Act 1983-13 SESSION OF 1983 25 No. 1983-13 AN ACT HB 575 Amending the act of April 6, 1979 (P.L.17 , No.5) , entitled "An act establishing the Pennsylvania Savings Association Insurance Corporation and providing for its powers and duties, " further providing for the regulation of the amount of earnings paid on savings deposits by certain associations. The General Assembly of the Commonwealth of Pennsylvania hereby enacts as follows: Section 1. Section 3(b) of the act of April 6, 1979 (P.L.17 , No.5) , referred to as the Pennsylvania Savings Association Insurance Corporation Act, is amended by adding a paragraph to read: Section 3. Purposes and powers . (b) Powers . - In furtherance of these purposes the corporation has the following powers : (6.1) To approve any association insured by the corporation to pay any earnings on savings accounts except when the Pennsylvania Department ofBankingfinds that such payment of earnings would be excessive in light of the financial condition of the association or would constitute an unsafe or unsound business practice. *** Section 2. Section 804 of the act of December 14, 1967 (P.L.746, No.345) , known as the Savings Association Code of 1967 , is repealed insofar as it is inconsistent with this act . Section 3. This act shall take effect immediately. APPROVED- The 15th day of June , A. D. 1983 . DICK THORNBURGH 422 Mr. BARNARD. Mr. Bulman, I would like to ask you, as I did Mr. McEnteer. Under your jurisdiction, you have banks, savings and loans and credit unions? Mr. BULMAN. That's correct, Mr. Chairman. In the division of banking in the Commonwealth of Massachusetts, we have loan companies, we have credit unions, we have cooperative banks, we have savings banks and we have commercial banks . Mr. BARNARD. Thank you very much . STATEMENT OF PAUL E. BULMAN, COMMISSIONER OF BANKS , COMMONWEALTH OF MASSACHUSETTS Mr. BULMAN. Mr. Chairman and members of the Commerce, Consumer, and Monetary Affairs Subcommittee. My name is Paul Bulman and I presently serve as commissioner of banks of the Commonwealth of Massachusetts. Like most Americans, the citizens of Massachusetts have indicated concern about the recent events that have involved the privately-insured State S&L's in Ohio. This concern in Massachusetts did not escalate into anything resembling the Ohio situation however. The reaction can be more fully understood when one reviews a number of interesting records held by the Commonwealth of Massachusetts. First of all , our two private funds are the oldest continuously operated funds in the country. Founded in 1931 , they predate the start of the Federal Deposit Insurance Corporation which came into existence 2 years later. Today these two State funds hold $ 575 million in resources to insure nonfederally insured deposits of $ 15.3 billion in 245 savings and cooperative banks throughout the Commonwealth. This means that our insurance funds presently provide 32 cents coverage for every dollar on deposit. To the best of my knowledge, no other deposit insurance fund, whether it be Federal or State, can match that ratio. Our two funds have certainly provided a significant part of the public confidence in our thrift industry for the past 54 years . Whether they shall continue this role is not predictable at this time. Within the past week, because of the press coverage of Ohio, we have been advised that 41 privately insured savings banks have asked the Boston office of the FDIC for Federal insurance applications. Reportedly six of our privately insured cooperative banks have made similar requests for FSLIC insurance applications . Also, within the past week, the banking committee of the State legislature held a public hearing on a bill that, if enacted into law, would require our thrifts to obtain Federal insurance. Although my comments thus far have focused upon the status of the private insurance companies in Massachusetts, it should be noted that I, as a State regulator, do not look upon them as the primary source of public confidence in our thrift industries. Rather the thrift banks themselves have historically demonstrated what has been described as "good old Yankee conservatism." Many of these institutions were founded over 150 years ago; and the fact that they were able to survive through dozens of reces- 423 sions, depressions and other manifestations of economic upheaval says a lot for their inherent soundness . Today our 145 savings banks hold $27 billion of total resources and $2 billion of surplus funds, which means that the surplus-toasset ratio stands at 7.4 percent. Our 100 cooperative banks currently hold $5 billion dollars of total resources and $354 million in surplus, which works out to a surplus to asset ratio of 6.8 percent. In contrast, the March 1985 Federal Reserve Bulletin indicates that nationally the FSLIC-insured institutions hold a 3.9 percent ratio and savings banks hold a 5.2 ratio. When one looks at the current operating performance, the same disparity continues with the Massachusetts savings banks and cooperative banks showing returns on average assets of 0.44 percent and 0.72 percent, respectively, while nationwide savings banks and FSLIC- insured institutions were reflecting 0.07 percent and 0.24 percent respectively. While we obviously take some comfort from the traditionally higher financial performance of our thrift industry, we recognize the potential problem that could adversely impact the industry as it attempts to restructure its balance sheets to survive in a more competitive deregulated environment. Through annual examinations by a staff of experienced, well-trained field examiners, together with the close monitoring of quarterly call report data that has been computerized to yield individual bank performance ratios in comparison with peer group norms, we feel able to detect problems at a very early stage. To summarize, Massachusetts, during the past five decades has relied upon a three-stage plan to maintain public confidence in its banking system. First and foremost, the institutions themselves, through years of conservative practices have held higher capital positions and generally profitable operations. Our second line of defense has rested upon the State's continuous commitment to maintain a strong regulatory authority to monitor and supervise the industry. And, finally, we have the best funded insurance companies in the country, albeit private funds. In compliance with your specific requirements for detailed information, I am submitting a list of detailed responses. I would also like to thank the committee for your attention and affording Massachusetts the opportunity to testify here today. [The prepared statement of Mr. Bulman follows :] 424 MR. CHAIRMAN AND MEMBERS OF THE COMMERCE, CONSUMER AND MONETARY AFFAIRS SUBCOMMITTEE : MY NAME IS PAUL E. BULMAN, AND I PRESENTLY SERVE AS COMMISSIONER OF BANKS OF THE COMMONWEALTH OF MASSACHUSETTS . LIKE MOST AMERICANS , THE CITIZENS OF MASSACHUSETTS HAVE INDICATED SOME CONCERN ABOUT THE RECENT EVENTS THAT HAVE INVOLVED THE PRIVATELY-INSURED STATES & LS IN OHIO . THIS CONCERN IN MASSACHUSETTS DID NOT ESCALATE INTO ANYTHING RESEMBLING THE OHIO SITUATION. THE REACTION CAN BE MORE FULLY UNDERSTOOD WHEN ONE REVIEWS A NUMBER OF INTERESTING RECORDS HELD BY MASSACHUSETTS . FIRST OF ALL , OUR TWO PRIVATE FUNDS ARE THE OLDEST CONTINUOUSLY OPERATED ONES IN THE COUNTRY. FOUNDED IN 1931 , THEY PREDATE THE START OF THE FEDERAL DEPOSIT INSURANCE CORPORATION, WHICH CAME INTO EXISTENCE TWO YEARS LATER. TODAY, THESE TWO FUNDS HOLD $575 MILLION TO INSURE NON-FEDERALLY INSURED DEPOSITS OF $15.3 BILLION IN 245 SAVINGS AND CO-OPERATIVE BANKS . THIS MEANS THAT OUR INSURANCE FUNDS PRESENTLY PROVIDE 3 1/2 CENTS COVERAGE FOR EVERY DOLLAR ON DEPOSIT. TO THE BEST OF MY KNOWLEDGE NO OTHER DEPOSIT INSURANCE FUND , WHETHER IT BE FEDERAL, OR STATE, CAN MATCH THIS RATIO. OUR TWO FUNDS HAVE CERTAINLY PROVIDED A SIGNIFICANT PART OF THE PUBLIC CONFIDENCE IN OUR THRIFT INDUSTRY FOR FIFTY-FOUR YEARS. WHETHER THEY SHALL CONTINUE THIS ROLE IS NOT PREDICTABLE AT THIS TIME. WITHIN THE PAST WEEK WE HAVE BEEN ADVISED THAT FORTY-ONE PRIVATELY INSURED SAVINGS BANKS HAVE ASKED THE BOSTON OFFICE OF THE FDIC FOR FEDERAL INSURANCE APPLICATIONS. REPORTEDLY, SIX OF OUR PRIVATELY INSURED CO-OPERATIVE BANKS HAVE MADE SIMILAR REQUESTS FOR FSLIC INSURANCE APPLICATIONS. ALSO, WITHIN THE PAST WEEK, THE BANKING COMMITTEE OF THE STATE LEGISLATURE HELD A PUBLIC HEARING ON A BILL THAT, IF ENACTED INTO LAW, WOULD REQUIRE OUR THRIFTS TO OBTAIN FEDERAL INSURANCE . ALTHOUGH MY COMMENTS THUS FAR HAVE FOCUSED UPON THE STATUS OF THE PRIVATE INSURANCE COMPANIES IN MASSACHUSETTS , IT SHOULD BE NOTED THAT I, AS THE STATE REGULATOR, DO NOT LOOK UPON THEM AS THE PRIMARY SOURCE OF PUBLIC CONFIDENCE IN OUR THRIFT INDUSTRY. RATHER THE THRIFT BANKS THEMSELVES HAVE HISTORICALLY DEMONSTRATED WHAT HAS BEEN DESCRIBED AS "GOOD OLD YANKEE CONSERVATISM. " MANY OF THESE INSTITUTIONS WERE FOUNDED OVER ONE-HUNDRED AND FIFTY YEARS AGO, AND THE FACT THAT THEY WERE ABLE TO SURVIVE THROUGH DOZENS OF RECESSIONS, DEPRESSIONS AND OTHER MANIFESTATIONS OF ECONOMIC UPHEAVAL SAYS A LOT FOR THEIR INHERENT SOUNDNESS . TODAY, OUR ONE-HUNDRED AND FORTY FIVE SAVINGS BANKS HOLD $27 BILLION OF TOTAL RESOURCES AND $2 BILLION OF SURPLUS FUNDS, WHICH MEANS THAT THE SURPLUS TO ASSET RATIO STANDS AT 7.4% . OUR 100 CO-OPERATIVE BANKS CURRENTLY HOLD $5 BILLION OF TOTAL RESOURCES AND $354 MILLION IN SURPLUS, WHICH WORKS OUT TO A SURPLUS TO ASSET RATIO 6.8% . IN CONTRAST, THE MARCH 1985 FEDERAL RESERVE BULLETIN INDICATES THAT, NATIONALLY, THE FSLIC-INSURED INSTITUTIONS HOLD A 3.9% RATIO AND SAVINGS BANKS HOLD A 5.2% RATIO. WHEN ONE LOOKS AT CURRENT OPERATING PERFORMANCE, THE SAME DISPARITY CONTINUES WITH THE MASSACHUSETTS SAVINGS AND CO-OPERATIVE BANKS SHOWING RETURNS ON AVERAGE ASSETS OF .44% AND .72%, RESPECTIVELY, WHILE NATIONWIDE, SAVINGS BANKS AND FSLIC-INSURED INSTITUTIONS WERE REFLECTING .07% AND .24% , RESPECTIVELY. 425 NOW WHILE WE OBVIOUSLY TAKE SOME COMFORT FROM THE TRADITIONALLY HIGHER FINANCIAL PERFORMANCE OF OUR THRIFT INDUSTRY, WE RECOGNIZE THE PROBLEM POTENTIAL THAT COULD ADVERSELY IMPACT THE INDUSTRY AS IT RESTRUCTURES ITS BALANCE SHEET TO SURVIVE IN A MORE COMPETITIVE DEREGULATED ENVIRONMENT. THROUGH ANNUAL EXAMINATION BY A STAFF OF EXPERIENCED , WELL-TRAINED FIELD EXAMINERS, TOGETHER WITH THE CLOSE MONITORING OF QUARTERLY CALL REPORT DATA THAT HAS BEEN COMPUTERIZED TO YIELD INDIVIDUAL BANK PERFORMANCE RATIOS IN COMPARISON WITH PEER GROUP NORMS , WE FEEL ABLE TO DETECT PROBLEMS AT AN EARLY STAGE. TO SUMMARIZE, MASSACHUSETTS , DURING THE PAST FIVE DECADES, HAS RELIED UPON A THREE-STAGE PLAN TO MAINTAIN PUBLIC CONFIDENCE IN OUR THRIFT BANKS . FIRST AND FOREMOST, THE INSTITUTIONS, THEMSELVES, THROUGH YEARS OF CONSERVATIVE PRACTICES , HAVE HELD HIGHER CAPITAL POSITIONS AND GENERALLY PROFITABLE OPERATIONS . OUR SECOND LINE OF DEFENSE HAS RESTED UPON THE STATE'S CONTINUOUS COMMITMENT TO MAINTAIN A STRONG REGULATORY AUTHORITY TO MONITOR AND SUPERVISE THE INDUSTRY. AND FINALLY, WE HAVE THE BEST FUNDED INSURANCE COMPANIES IN THE NATION . IN COMPLIANCE WITH YOUR SPECIFIC REQUIREMENTS FOR DETAILED INFORMATION, I AM SUBMITTING A LIST OF DETAILED RESPONSES. THANK YOU FOR YOUR ATTENTION AND AFFORDING ME THE OPPORTUNITY TO TESTIFY THIS MORNING. 426 1. Please describe your agency's operations and enforcement powers , and the general condition of the thrifts in your state . In so doing, please answer or furnish the following : For each year, 1982 to date, the budget of the Massachusetts Office la. of Commissioner of Banks and the number of individuals employed in professional level examination/supervisory capacities . 1982 1983 1984 1985 Annual Budget $4,333,708 4,334,745 4,640,534 4,670,813 Examination/Supervisory Personnel 125 121 127 125 lb. The number and asset range of ( i ) state-chartered and insured and (ii ) state-chartered but federally insured, thrift institutions currently supervised by your office . (i ) State-chartered and insured (ii )State-chartered, but federally insured Number 196 49 Asset Range $2.3 to $743.1 million $38.5 million to 1.2 billion lc. Describe briefly the frequency with which Massachusetts institutions are examined and the civil and criminal powers available to your agency to supervise these institutions ( i.e. , cease and desist powers , suspensions or removal powers , civil fines , etc. ) Are you satisfied with the sufficiency of these powers? Massachusetts General Law presently requires a minimum of one examination every two years for each financial institution . However, we have historically examined almost all banks on an annual basis . My office is fully empowered to issue cease and desist orders , remove officers , and impose civil fines . I am satisfied with the sufficiency of these powers . ld. Do you impose on the institutions you supervise reserve , capital or other safety and soundness requirements designed to prevent the likelihood of insolvency? If so, what basic requirements do you impose? In recent years we have generally required a 5% surplus/asset ratio for our thrifts . If an institution falls below the 5% level, it is placed on a "watch list " and monitored monthly. If the level falls below 4% we begin to work actively with management to obtain corrective action . If the capital level falls to 3%, we either replace management , merge the institution into a stronger institution , or liquidate the assets . In this connection, we are cognizant of the federal agencies recent call for a 6% capital adequacy level. Because most of our thrifts hold a mutual-ownership charter which limits their ability to increase 427 capital to earnings retention , only, we are unconvinced that this higher level requirement could be realistically attained in a short time frame for the vast majority of the industry. As long as our thrifts maintain their traditional commitment to providing home financing and other consumer services, we will be satisfied with our 5% requirement . For those institutions that may be inclined to enter into activities formerly reserved for commercial banks , we would expect them to immediately raise their capital to the 6% level . This, of course, could only be obtained by converting to a stock corporation. le. How many of Massachusetts's ( i ) federally insured and ( ii ) nonfederally insured thrifts are presently on you "problem" list? As indicated in the response to question 1.d. , above, we have a "watch list" of those banks that have recently displayed one or more financial deficiencies or violations of law. Presently there are ten institutions that have minor deficiencies such as technical violations of community reinvestment or consumer protection laws , higher that average overhead expenses, deficient lending policies , or slightly less than 5% capital. We do not presently have any institutions that pose any high level of concern . 2a. Do you routinely and systematically make available to the insurance fund administrators ( i ) examination reports and related documents involving, and ( ii ) information about any supervisory actions taken against, the state/private insured thrifts? (i) Both private insurers are furnished with examination reports , audit reports and pertinent documents . (ii ) Bank Supervision's management staff meets three to four times annually with representatives of the insurance funds to discuss both industry wide and on a bank-by-bank basis , any negative trends , deterioration of financial components , alleged improprieties , anticipated management changes and other factors that may be material . 2b. Do you have authority to order the termination of an association's state/private deposit insurance? If so, under what set of conditions are you authorized to do so; and set forth the number of such insurance terminations from 1980 to date . If you do not have insurance termination authority, does that authority reside elsewhere? The Commissioner, personnally, does not have any authority to order the termination of an association's state/private deposit insurance . With regard to the Massachusetts Savings Banks insured by the Mutual Savings Central Fund, Inc. , and Cooperative Banks insured by the Cooperative Central Bank, termination of insurance coverage takes place only upon the happening of certain events as set forth in Chapters 168 and 170 of the Massachusetts General Laws and as set forth in the statutes governing their respective insurance funds . Termination of coverage by the applicable insurance fund occurs when there is a merger or consolidation between thrift institutions as to the institution whose corporate existence is dissolved . 428 Termination of coverage by the state/private insurer occurs when a state-chartered savings bank or cooperative bank is consolidated or merged into a federally chartered institution . Termination also occurs when a state-chartered savings bank or cooperative bank converts to a federal charter. Finally, when a state-chartered savings bank or cooperative bank acquires federal insurance under the FDIC or FSLIC, then state insurance terminates to the extent of the federal insurance coverage, but deposits in both savings banks and cooperative banks in excess of those covered by the federal insurance continue to be covered by their respective state/private insurance funds . Since 1980 , four savings banks have converted to federal charter, two cooperative banks converted to federal charter, resulting in termination of insurance by the Mutual Savings Central Fund, Inc. and the Cooperative Central Fund . Since 1980, three cooperative banks have merged into Massachusetts savings banks with termination of insurance by the Cooperative Central These banks are now insured by the Mutual Savings Central Fund. 3. Please set forth your views on how Cooperative Central Bank might operate more effectively to prevent or minimize losses to the fund; and how your agency's coordination and cooperation with the operators of the insurance fund could be improved. As the regulator of the two private deposit insurance companies I have no problem with their current operations. We have always maintained open lines of communication with the operators of both funds and have always received the full cooperation of the funds ' operators when dealing with institutions of supervisory concern . Please comment on the Ohio deposit insurance fund situation and the 4. adequacy of responses by state and Federal officials ( including the Federal Reserve, Home Loan Bank Board, and SEC officials ) . What specific lessons have been learned and what recommendations are you prepared to make to Congress regarding recent events in Ohio and their possible repetition elsewhere? I really can not comment on the problems in Ohio, because my only information has come from recent articles in the media . 6. Please feel free to provide any additional information or views . which you believe are relevant to the issues being studied by the subcommittee . I have no additional comments to make at this time. 429 Mr. BARNARD. I thank all of you very much. Is there any supervisory relationship at all between your office and the insurance funds? I mean, you don't examine-do you examine their funds or audit them in any way or examine them in anyway? Mr. BROWN. In Maryland, Mr. Chairman, we do not supervise the day-to-day operations of the insurance fund. However, under Maryland law, any changes that they make in their regulations or bylaws must be approved by the director of the division. Other than that we have nothing to do with the day-to-day operations. Mr. BARNARD. Mr. King? Mr. KING. Mr. Chairman, in North Carolina, the secretary of commerce who I serve at the pleasure of, has the statutory authority for that responsibility under State statute . Mr. BARNARD. Does he automatically serve on the board? Mr. KING. No, sir. Mr. BARNARD. He doesn't serve on the private insurance board? Mr. KING. No, sir. Now, about 2 years-2½ years ago, pretty soon after that statute was changed delegating that authority to the secretary of commerce or giving him that statutory responsibility, that responsibility was delegated to me as administrator of the savings and loan division. So , in my particular case, I do directly supervise the Financial Institution Assurance Corp. We examine them every year. We have designed a special examination program. Mr. BARNARD. Are they also independently audited? Mr. KING. Yes, sir, they have an independent audit by one of the big eight accounting firms. Mr. BARNARD. Mr. McEnteer? Mr. MCENTEER. We have the same thing in Pennsylvania, that PSAIC is required to have a certified public accountant audit it annually and we review those reports. We also have a representative of our savings association bureau at each meeting of the corporation and we look at their investments and what they are doing with their money and follow it very closely and consult with the manager of the association quite frequently. We keep close tabs on it. Mr. BARNARD. Mr. Bulman. Mr. BULMAN. Mr. Chairman, we examine all three funds in Massachusetts, produce examination reports much like those produced for all member banks and distribute those reports to the board of directors of those funds. Mr. BARNARD. Gentleman, the situation that happened at ESMdid any of you receive any notification from Federal agencies with reference to that company? Mr. BROWN. We did not in Maryland , Mr. Chairman. Mr. KING. No, sir, not at all in North Carolina. Mr. MCENTEER. No, sir, not to my knowledge. In Pennsylvania, we didn't receive anything . Mr. BULMAN. We did not in Massachusetts. But, in fairness, one of the comptroller officers testified earlier that there was a memorandum produced, I believe, in 1977 and from memory, I can recall seeing such a memorandum. I believe we obtained it from the Federal Deposit Insurance Corporation, which highlighted what they referred to as Memphis bond dealers. 430 Mr. BARNARD. In your regular examination procedure, would the situation that appeared in Home State- where they did not have a segregated account- where evidently there was no trust receipt or other evidence of ownership of these Government securities. Would that have been discovered by your examiners? Mr. BROWN. I think the examiners would pick that up and include it in their report. Mr. BARNARD. Would they have criticized it? Mr. BROWN. To the point of making a comment in the exam and then it would be up to me to take some action . Mr. BARNARD . Would the criticism have gone to the fact that they didn't have trust receipts? Would it have gone to the fact that they had, say, bought 35 to 40 percent more securities pledged than borrowed? Mr. BROWN. I think it would, Mr. Chairman, yes. I think the examiners would pick it up and would report it in detail to us. Mr. BARNARD. Mr. King? Mr. KING. Mr. Chairman, that would have been detected in our examination process . It is a normal part of the written examination program. In addition to that, we had, and I can't remember exactly the timeframe, 2 or 3 years ago now, three or four FSLICinsured institutions in the State, both State and federally chartered, that were burned in one of the earlier failures and as a result of that, we learned some lessons and put in a little more stringent procedures in our examination process and one of those, in fact, was to definitely ascertain, during the examination process, that collateral was delivered in these types of transactions. Mr. BARNARD. Mr. McEnteer, in addition to that question , do you have any knowledge of any Pennsylvania financial institutions that were involved with ESM? Mr. MCENTEER. We don't have any knowledge of any State-chartered financial institutions that were involved with ESM, especially the savings associations. I am not sure about any national banks that might have been involved . There are no State-chartered associations, to our knowledge, that were involved in any ESM transactions. As far as the savings and loans, we would have discovered it, I believe, because they are limited in their borrowing to 50 percent of their deposits and if something like Ohio happened, it would stick out like a sore thumb and also we confirm the securities, the presence of the securities or their deposit with a correspondent bank or something. When we go in on an examination, if they have a repo_situation, we want to know that they have the securities. Mr. BARNARD. Mr. Bulman? Mr. BULMAN. Yes, sir. I don't think there is any question that the total borrowings would have been recognized but more importantly I would hope that the examiners would have criticized the margin requirements required for Government securities . I believe the 25-percent margin requirement the committee heard this morning in testimony, is far and beyond what the normal margin requirement for Government securities is. My memory would suggest that it's somewhere between 5 and 10 percent in Massachusetts. Mr. BARNARD. Mr. Craig. 431 Mr. CRAIG. Thank you very much, Mr. Chairman and to all of the panel, I appreciate your testimony and your observations of this situation and your response and frank way to the chairman of the committee. Mr. Chairman, I have no specific questions of these gentlemen. Mr. BARNARD. Mr. Spratt. Mr. SPRATT. There was a suggestion made by Mr. Gray to the effect that once institutions insured by funds such as those with which you work in your own States, reached a certain level of size, then at that threshhold, these institutions should be required to obtain FSLIC coverage. Would you respond to that recommendation? Mr. BROWN. I feel that there is room for both systems in this country. We're not having any problems with our associations . We know what's going on, the insurer knows that's going on and I don't agree with Mr. Gray. Mr. SPRATT. Well his point was, taking his cue from the Ohio situation where one institution failed because of its size, wiped out the whole fund, that there came a point in risk when the FSLIC , with its much broader base and ultimately the Federal Government behind it, ought to be the insurer, but you don't think that's necessary in light of the situation in Ohio? Mr. BROWN. No, I do not, sir, no, sir. Mr. KING. Based on what I basically read in the newspaper and the little bit of additional knowledge that I picked up about the Ohio situation, I don't think who was insuring the accounts had anything to do with the problem. I think it was a combination of some bad and probably fraudulent management decisions made by the association in addition to the failure of the securities firm that led to the downfall and lack of proper oversight and supervision by the State regulator and the insurance fund and, you know, anytime you have a break down in the system, you're going to have those kinds of failures and the Federal system can have those same types of problems also. Mr. SPRATT. But the Federal system has the resources ultimately, to cover the loss . Mr. KING. No question about that . When you have received full faith and credit of the U.S. Treasury behind the insurance funds that prevents losing the public confidence, which was the basis for the failure in Ohio. It makes a big difference. Mr. SPRATT. Mr. McEnteer. Mr. MCENTEER. I don't believe the size of the association has anything to do with the failure or nonfailure. I think it is the management and the integrity of the management and the type of assets and we have no thought in Pennsylvania of making an association apply for Federal insurance when it reaches a certain size, although I will admit that most of ours are small. Our largest one, because of this Ohio situation, has made arrangements for lines of credit if anything_should happen there and the others, we have worked with the Federal Reserve, they came in and looked over our examination reports to determine that these associations are sound and have good assets on which to borrow, so I think we're in pretty good shape in Pennsylvania now for any emergency that might arise. T 1 432 Mr. BULMAN. I would just say that I think it is somewhat ironic that we are here today talking about solvent State funds, advising all their members to get FSLIC insurance. It seems to me in the last couple of weeks, we were reading about the failures of FSLIC. I don't know why we're all jumping into that system. There is an awful lot being made of the full faith and credit of the U.S. Government. I know of lines of credit established at the Treasury. I know of no law issued by this Congress that says the full faith and credit of the U.S. Government is involved. Mr. SPRATT. I agree. I understand that. But, implicitly, that back up is available and the resources are larger than any of your individual pools. Mr. BULMAN. I think the other issue that is important here, whether we talk about State funds Federal funds, is that they are all made up of industry premiums. The source of funds that we're using today are premiums paid for insurance by the industry itself. I don't know that we should get into the Treasury backing an industry. If an industry chooses to insure its own deposits, then that industry should be willing to pay for it. I don't know that the citizens of the United States that don't avail themselves of these services should be taxed for that process. The fundamentalist issue on States, as many of the State bankers in Massachusetts would tell you, is that they are going to maintain capital adequacy status in Massachusetts in their own banks and they are able to do that through reaching their State legislature, through reaching their State regulator and through their own central fund. They can maintain the safe and sound controls that they are interested in. Massachusetts bankers cannot maintain them in California and they are not willing to take their premium dollars and underwrite a Federal system that has much different standards. The opposite of that, of course, is the federal system pools those resources and protects all. Mr. SPRATT. Do the examiners who work for you or work in your State-regulated systems confer and consult with private auditors outside auditors for the S&L's whom they regulate? Mr. BULMAN. In Massachusetts , sir, on occasion, we will contact an auditor. We have authority, through statute, to appoint our own auditor. We can contract our own C.P.A. firm to examine an institution and the institution is billed for that examination . Mr. MCENTEER. In Pennsylvania, our examiners don't actually work with the auditors , but they confer with them on certain situations that arise . We have the availability to do that . They don't examine at the same time is what I am saying, but if something comes up, they confer with them. Mr. SPRATT. Well , we encountered the curiosity and the failure of the UAB in Knoxville where both the private audit firm , the outside auditors and the FDIC were in the bank at the same time and they apparently, from the facts we developed, weren't talking to each other. Each was doing his own thing and it just struck me as not a very wise allocation or use of resources in a period like that. Mr. MCENTEER. We don't have any of that in Pennsylvania. I hope we don't run into that. We get along very well with the private auditors. 433 Mr. KING. I might respond in our situation . We don't look at our process, that we go through in supervising our S&L's, as an audit function . We are examining the associations for compliance with State statutes, but mainly for safety and soundness reasons. We depend on the private auditors and all of our associations are required to have independent audits. That information is very important to us as a part of that process. It's not something that we ignore. We have a step in our examination process in which the audit report is reviewed as a part of the examination. If we have any questions then the contact is made directly with the independent auditor. Mr. BROWN. In Maryland, part of the preexam analysis by the examiner is going over the audit report that has been received, probably between examinations and that report is taken with him into the association for verification. There are times when they do talk to the auditor and might question something that is in the audit report, but we do look at it and study it very seriously. Mr. SPRATT. One more question, Mr. Chairman. Mr. Beason indicated that the State of North Carolina, your FIAC, in particular, has a fairly sophisticated monitoring system where monthly data comes to the attention of the FIAC which is watched carefully. Do your various agencies monitor broker deposit levels, outside investments and self-generated income among other items as indicia that trouble might be coming. Mr. KING. Well, as you indicated, the monthly reports that we get from the institutions is a very detailed report, in fact, almost to the point of being cumbersome. We have expanded it over the last 2 or 3 years and it is a joint report, one that was developed by us and FIAC together and all of those things would show up as separate items on that report. Mr. SPRATT. Broker deposits, self-generated income, outside investments? Mr. KING. Yes, sir, absolutely. Mr. SPRATT. Have you found a correlation between these accounts, growth in these areas and shakiness of these institutions? Mr. KING. I think the best way to respond to that is that we haven't had that type of tremendous growth in any of our institutions. Most of our operations are fairly conservative. Those that are more aggressive handle their growth in an orderly manner. We do watch associations very closely that are growing more than normal for that average size institution, but to date, we have experienced no problems. Mr. BROWN. We have some very tight regulations on loans to one person that cannot exceed more than 10 percent of the assets of an association. Any loans to an officer or a director must be approved by the division director and then there must be appraisal reports. It must be approved by two-thirds vote of the board of directors of the association. Mr. SPRATT. Who is the division director, is that a director? Mr. BROWN. No, the director of the association, two-thirds of the directors must approve a loan to another officer or director. At the same time, that loan must be approved by the division director and 434 I must have all the data, appraisal, et cetera, to go along with it. We do watch self-dealings and things of that nature very closely. Mr. SPRATT. I was talking about self-generated income. I'm talking about construction loans where points and fees are taken which are immediately booked as income before the project itself is completed and, in my opinion , the income is earned and realized . Mr. BROWN. Right, I agree with that. Mr. SPRATT. Rather than self-dealing. Mr. BROWN. We do watch that. Mr. KING. I would add for our associations in North Carolina, they are required to follow generally accepted accounting principles [ GAAP]. We do have the RAAP accounting and the loan lost deferrals and the appraised equity capital, but none of our privateinsured associations use it, so therefore they comply with generally accepted accounting principles and the GAAP accounting principles are pretty stiff on that type of situation, as far as taking in income before it is earned . Mr. BULMAN. In Massachusetts, we have specific point regulations that allow an institution to take one point to recover underwriting expenses. If there are other points in the contract, then they have to be tied into direct costs on the secondary market. If there are points on commercial loans, then they are deferred and they are accreted to income over the term of loan . We do that so that when we're using our performance measurement system in looking at the income statement, and measuring it to its previous month and industry norms, we're not looking at high and low periods based on point income. Mr. SPRATT. Mr. McEnteer. I'm sorry you didn't have a chance to answer. Thank you Mr. Chairman. Mr. BARNARD. Mr. Erdreich . Mr. ERDREICH. Thank you , Mr. Chairman . Just one question. I'm curious to what extent, if any, that your State agencies receive any communications from the various Federal financial regulatory agencies. I was shocked to see this letter of 1977 when the Comptroller of the Currency identified ESM as the "Memphis Bond Bandits," and said they apparently were notorious among some folks ' knowledge, but did you, or do your agencies have any regular communication with these Federal regulatory agencies? It seems to me but for a 22-cent stamp and the mailout of the banking circular that the Comptroller sent out in 1977, we may have avoided some of the chaos in Ohio. Mr. MCENTEER. In Pennsylvania, we work very closely with the FDIC and the Federal Reserve and the FSLIC. In 1977, I was an officer in a bank myself. It was a State-chartered bank and I didn't remember getting any of that information on ESM . I do know that there were some suede shoe guys from Memphis that used to come up to the Pennsylvania Bankers ' Association convention , annual convention and try to collar bankers at the doors of meetings and finally the officials of the Pennsylvania Bankers' Association barred them from coming to our convention and I guess they disappeared and took residence in Fort Lauderdale or some place. 435 But, I never saw any communication from any Federal or regulatory authority. Of course I wasn't in a position at that time and I have only been in this department since 1979. Mr. ERDREICH. Apparently, and this is just an example, but the Comptroller of the Currency's circular that it sent out, went out July 26, 1977, it went to presidents of all national banks and talked about various and proper security practices. It was triggered by the ESM investigation they did and the credit union folks came in very effectively and apparently dealt with their own credit union entitites and others. I'm just trying to get some sense. I take it then that your agencies are not on the mailing list for the Comptroller of the Currency. I understand that you're not under them in any way, but just to share information. If you got such a circular, would it be helpful? Mr. MCENTEER. I think we're on the mailing list more now since the Federal Financial Institution Examination Council has been in being and we have Conference of State Bank Supervisors as a representative on that and we get frequent bulletins from the Comptroller's Office. There's no question about it, the information that is exchanged today is much better than it has been over the years and it gets better all the time. I think we're all in business for the same purpose. I don't believe we're trying to keep secrets from anyone. We're trying to do a job for the banking industry and the people and it takes cooperation and that's what we're coming to right now. Mr. ERDREICH. Yes, Mr. Bulman. Mr. BULMAN. Sir, I think there are different levels of cooperation amongst Federal agencies and State agencies. For example, I think most of us share an awful lot of information with the FDIC because they represent the Federal presence in State banks. Now, we have very little dealings with the Comptroller of the Currency. We may have some dealings with him as well as the Fed through holding companies where you have a mixed group of State banks and national banks in a holding company environment. But, I think most of us work more closely with the FDIC because they represent the Federal presence in State banks. Mr. BROWN. In Maryland the savings and loan division is an independent agency. We get nothing from the Comptroller of the Currency. I can see where it might be advisable for me to be in contact with the State bank commissioner and, if she does get anything along those lines, she would let me have it. The only thing we get is data from the Federal Home Loan Banks and some of our State-chartered associations are federally insured, but as far as banks go, we get nothing. Mr. ERDREICH . Mr. King. Mr. KING. We are on the regular mailing list for the Federal Home Loan Bank Board and the Federal Home Loan Bank of Atlanta and in addition to that, the Federal Reserve Board . We get all their standard mailout information. To the best of my knowledge, we receive nothing at all from the Comptroller. Mr. ERDREICH . Thank you , Mr. Chairman . Mr. BARNARD . Mr. Kindness . 436 Mr. KINDNESS. Thank you, Mr. Chairman . Secretary McEnteer, your testimony indicated that your department has the authority, under law to , in effect, to take over control of an association and appoint a deputy receiver for that purpose in the event that the institution is an unsafe or unsound condition . Would you have similar authority with respect to the private insurance corporation for deposits? That is, under the Pennsylvania insurance setup, deposit insurance setup which is private, would you have the authority without going into a court to take over control? Mr. McENTEER. Yes. Under the banking code and the savings association code, the secretary of banking has that authority. Mr. KINDNESS . And if that insurance corporation had the assets or could readily obtain them by additional assessment of members or whatever mechanism might be employed from State to State, and others might want to respond to this, but if they had the assets or could readily obtain them by assessment, would you consider it prudent to take over direct control under your department? Mr. MCENTEER. You're talking about direct control of an association? Mr. KINDNESS . No. Of the insurance corporation . Mr. MCENTEER. Well , I don't know of any reason we would take direct control of the insurance association . Mr. KINDNESS . That is unless there is something highly unusual in the circumstances, you would allow the deposit insurance corporation to function and allow it to employ its assets to protect depositors, is that correct? Mr. MCENTEER. Yes, I believe that's part of the establishment of the insurance association. They can lend to a member association and they haven't, as yet, set up a general fund for lending purposes, but if we stepped in and found an association that wasn't operating properly, it would probably be the last resort to go to the insurance association . We would look around for a merger to start with and maybe a supervisory conversion to a stock company which we have done twice and have somebody come in with capital and take it over and that sort of thing. Mr. KINDNESS. Mr. King, in your case, you have direct supervisory authority with regard to the associations and the insurance function as well. Do you have sufficient sanctions available to you that in the event of need, for example, a growing run on savings and loans around the State, as occurred in Ohio, and lacking a proper response from the deposit insurance corporation, could you take over or appoint a receiver or conservator under existing law and operate the deposit insurance corporation? Mr. KING. Yes, sir, and I think probably the way we would approach that, in our situation, would be to replace management and directors, if necessary, in order to facilitate that situation rather than trying to place it in some type of receivership or conservator appointment, this type of thing. We do have the authority to remove management and directors for cause . 437 Mr. KINDNESS . But if you had some default in your supervison of the whole situation, would that be about the only reason that you would attempt to take over the deposit insurance function? Mr. KING. I think, like Mr. McEnteer, I can't imagine that situation happening. I suppose it could . It would have to-really the only situation I could really even envision would be, you know, some type of problem with the individual or individuals involved with the insurance corporation itself. Mr. KINDNESS . I just ask this because it appears that we're dealing with questions of principle and function here affecting a lot of States, when the trouble seems to be something that is highly irregular, highly unusual and shouldn't reflect on your States one iota, but it does reflect badly on my State of Ohio, but it seems to boil down to problems with the supervisory and regulatory function more than the insurance function , but we have a deposit insurance fund that's not functioning. It's controlled now by a conservator in the same hands, an employee of the division by the way, that conservator is . It's in the control of the same hands where the regulatory control has broken down. We got a tight little nest here that, as I say, just is not typical of any other State's functioning, it seems to me. In the State of Maryland, Mr Brown, is there any control directly under your function that could be asserted over the deposit insurance fund? Mr. BROWN. No. As I mentioned before, I have no jurisdiction over the insurance fund in their day-to-day operation, however, I don't know whether you were here when I made the comment before. Any rule, regulation , changes, changes in the by laws must be approved by the division director. Now, you're speaking of a default, probably, of the insurance corporation. There is nothing in the code that would give me the authority to take over the insurance corporation . I would say there would have to be a court- appointed conservator or receiver to do what you are referring to. Mr. KINDNESs . Or the Governor might go to the legislative branch and get a special law passed and then take over―― Mr. BROWN. Could be. Mr. KINDNESS [continuing]. The $81 million of assets or whatever it might be that was left at the time. Mr. BROWN. God forbid, let's hope that doesn't happen. Mr. KINDNESS . Yes, let's hope it doesn't happen. Mr. BROWN. But it is an interesting question . Mr. KINDNESS . I suggest that it is not the kind of contingency against which you would ordinarily expect to protect the functioning of your department or agency. Mr. Chairman , I yield back . Mr. BARNARD. Thank you very much. Gentlemen, we appreciate very much your being here today, the testimony that you have offered and thank you very much. Our next witnesses today are the Chairman of the Securities and Exchange Commission, the Honorable John S.R. Shad and also Mr. Thomas Tew, who is the trustee in bankruptcy for the ESM Government Securities. 438 We apologize that we have gone over somewhat, but you can understand the seriousness of the subject that we have before us today and how it is understandable. Because of that, I am going to ask Mr. Tew if he would permit us to hear your testimony, Chairman Shad, and ask questions of you so that you may depart and then we will work with Mr. Tew. I'm sure he doesn't have any problems with that. So , Mr. Chairman, at this time, we would like to have your testimony. I might say that your entire testimony, without objection, will be included in the record and you have the opportunity to summarize if you so see fit. STATEMENT OF JOHN S.R. SHAD, CHAIRMAN, SECURITIES AND COMMISSION, EXCHANGE ACCOMPANIED BY CHARLES HARPER, ASSOCIATE REGIONAL ADMINISTRATOR, MIAMI BRANCH OFFICE, AND DAN GOELZER, GENERAL COUNSEL Mr. SHAD. Thank you very much, Chairman Barnard and members of the committee, I appreciate this opportunity to testify concerning the Government securities market. It is requested that the written statement, as you have indicated, be included in the record. With me today is also Charles Harper, the associate regional administrator in charge of the SEC's Miami Office . The market in U.S. Government securities is by far the largest in the world. In 1984, just the 36 primary Government bond dealers, which report directly to the Federal Reserve Board, traded over $1.5 trillion per month, as compared with the total stock trading volume on all U.S. securities exchanges and over-the-counter markets of less than a $ 100 billion per month. In other words, the trading in the other stocks and bonds, over-the-counter and on the exchanges, amounts to less than 7 percent of the transactions handled by the 36 primary Government bond dealers, and there are many others away from them that trade, but I would say that those primary bond dealers do handle the bulk of the trading in Government securities, the original offering. The highly liquid, keenly competitive and efficient Government securities market is critical to the effective execution of the Nation's monetary and fiscal policies. The Securities Act of 1933 and the Securities Exchange Act of 1934 specifically exempt Government securities and broker-dealers from regulation by the SEC, but the general antifraud provisions apply to the offer, purchase and sale of all securities, including Government. The Commission also has jurisdiction over those broker-dealers registered with the SEC that deal in Government securities. The Federal Reserve Board obtains daily reports on market activity and positions, monthly financial statements and annual reports from the 36 primary Government securities dealers and encourages secondary dealers to report the same information on a monthly basis. Also, many entities-and I know you're well aware of this from the testimony you have just had from several-but let me repeat briefly that there are many other entities that are engaged in the Government securities market that are subject to the oversight of a 439 variety of Federal agencies. For example: The banks by the Federal Reserve Board, the Comptroller of the Currency, and the FDIC; the savings and loan associations and other thrift organizations by the Federal Home Loan Bank Board; registered securities firms and publicly owned corporations, other than banks and S&L's, by the SEC; credit unions by the National Credit Union Administration and pension funds by the Department of Labor, under ERISA. Various State agencies also regulate the activities of these entities as well as insurance companies. Now, I would like to briefly describe the Commission's response to the very serious problems of the Government securities market since 1977. The 1977 failure of Winters Government Securities Corp. resulted in $4 million of losses to three dealer firms before insurance and civil suit recoveries, if any. The Commission's injunctive and administrative actions alleged boiler-room sales tactics , excessive markups and misrepresentations concerning the safety of transactions in Government National Mortgage Association securities known as Ginnie Maes, as well as misrepresentations concerning the financial condition of Winters Government Securities. The defendants were enjoined from future securities law violations, barred from association with any broker-dealer, investment company or advisor as supervisors, and Winters and Co.'s brokerdealer registration was revoked . In 1982, Drysdale Government Securities, Inc., failed 3 months after it commenced operations causing approximately $300 million in losses to other dealers before insurance and civil suit recoveries, if any. Most of the losses were born by the Chase Manhattan Bank. The Commission alleged , among other things, that Drysdale borrrowed securities in increasing amounts and sold them in the cash market to obtain the accrued interest. The Drysdale officers were enjoined from future securities law violations and from aiding and abetting broker-dealer recordkeeping violations and were barred from association with any broker-dealer, investment company or advisor, or any municipal securities dealer. The Commission also assisted in criminal prosecutions. The Drysdale chairman was sentenced to 6-years imprisonment and ordered to pay $ 10 million to certain institutions he had defrauded before, actually before Drysdale Government Securities was set up before 1982. The Drysdale head trader was sentenced to 3-years imprisonment and the controller to 3 years probation. Last week the Commission's injunctive action against an Arthur Andersen & Co. partner, who had audited the Drysdale firm, was dismissed on the grounds that his alleged misconduct had not occurred in connection with-those are the key words -the purchase or sale of securities. The Commission will determine in the very near future whether to appeal this dismissal . Since the 1982 failure of Lombard-Wall , Inc., was apparently due to normal economic forces rather than fraud, and neither the SEC nor the Justice Department have brought actions against the firm or its principals. 440 Reported losses of $20 million was sustained by the New York State Dormitory Authority before insurance and civil suit recoveries , if any . Since the Commission's investigation of the Lion Capital Group is pending, I must limit my comments to publicly available information. Lion went into bankruptcy in 1984. About 60 institutions , including 24 State of New York school districts have alleged that they were induced to invest approximately $40 million in repurchase agreements with Lion by promises of yields higher than those available elsewhere, based on rate quotations provided by National Money Market Securities, Inc. , a California money broker. Lion's confirmations represented that the underlying securities were held with Bradford Trust Co. In response to creditors' demands for such securities, Bradford has claimed that these securities were collateral for loans by Bradford to Lion. A settlement proposal has been taken under advisement by the courts. Last week a New York State Grand Jury indicted certain Lion officers for alleged fraud and grand larceny. With reference to ESM Government Securities, in order not to prejudice suits filed and investigations in progress by the SEC, my comments must be limited to publicly available information. Charles Harper of the Commission's Miami Office first learned of apparent securities law violations by ESM at 8:30 a.m. on Monday, March 4, from Thomas Tew, who I would add has done an outstanding job in all aspects of this situation . At that time, Mr. Tew was retained by ESM; he had just been retained, in fact, the previous Friday, on March 1. The information that he provided indicated that ESM had incurred $250 to $300 million of unreported losses . That was Monday morning . By Monday afternoon, Mr. Harper had obtained Commission authority and a temporary restraining order from the U.S. District Court in Miami against future securities law violations , a freeze of the defendant's assets and the appointment of Mr. Tew as receiver. The Commission alleged that ESM's audited financial statements failed to properly reflect the firms' true financial condition. On Thursday, March 7, I called Paul Volcker, Chairman of the Federal Reserve Board; Gerald Corrigan, president of the New York Federal Reserve Bank; Edwin Gray, Chairman of the Federal Home Loan Bank Board; as well as senior SEC staff members to coordinate the effort of these organizations. The next day, on Friday, March 8, the Commission issued a formal order of investigation. Subpoenas were issued that afternoon, and the interrogation of witnesses began the next day, Saturday, March 9. Representatives of the SEC, the New York Federal Reserve Bank, and the Federal Home Loan Bank Board met in Miami on the next day, Sunday, March 10. That evening I was advised by Michael Wolensky, the senior member of the SEC's staff on the scene, of the conclusions of the investigation to date which I reported that evening, Sunday evening, to Paul Volcker. Since I was leaving to catch a plane-I was in New York at the time, and I was catching a plane back to Washington that night—I asked Mr. Wolensky to brief Governor Celeste of Ohio. Mr. Wolensky reached an aide of Governor Celeste and did brief him . 441 The staff's intensive investigation continued, and on Friday, March 15, the Commission authorized the staff to obtain a court order granting access to the bank records of Jose Gomez of Alexander Grant & Co. , the partner in charge of ESM's annual audit since at least 1980. The court immediately granted the application. On Monday, March 18, the Commission granted the staff authority to file an injunctive action against Jose Gomez, alleging that he lacked independence as the auditor of ESM because he had received at least $ 125,000 from ESM principals . On March 20, the court entered an order freezing Mr. Gomez' assets, restraining him from destroying or secreting relevant records and requiring him to provide an accounting, by March 26. He has asserted his fifth amendment privilege against self-incrimination. As mentioned, this investigation is proceeding. Preliminarily, it appears that approximately $200 million of the losses sustained by the Home State Savings Bank of Cincinnati and the American Savings & Loan Association of Miami were due to the extension of substantially more than normal margin to ESM and the concentration of their transactions with ESM . Home State and American were apparently controlled by, or under the control of Marvin L. Warner, at the time they engaged in those transactions. An additional $100 million of losses by municipalities and others appear to have resulted from the lack of adequate collateralization of their transactions with ESM . On March 21 , the Commission indicated , at House hearings , that it would review the regulatory structure of the Government securities market in consultation with the Federal Reserve Board and the Treasury and report its conclusions to Congress within 90 days. This effort is underway. Senior members of the Commission staff and I have met with Chairman Volcker of the Federal Reserve Board and Assistant Secretary Thomas Healy of the Treasury Department. The Commission also intends to publish a release shortly seeking comments on the nature and extent of unregulated Government securities dealer activities, alternative forms of regulation and oversight of Government securities dealers and markets and the extent to which those who deal with Government securities dealers are modifying their practices in response to the extensive publicity that has already occurred on ESM. Possible regulatory initiatives range from encouraging or requiring those who deal with Government securities dealers to properly collateralize such transactions. They range from that level to enacting rules and regulations under the supervision of a self-regulatory organization, or the direct aegis of one or more existing or new Federal agencies. Also because of the nature and frequency of transactions in Government securities, the vast majority are handled without incident through low-cost high-speed electronic book entry systems. Those who deal with Government bond dealers might be encouraged or required to use such facilities. It may also be necessary to adapt such facilities to the unique needs of the repurchase agreement market. 442 It would be premature to speculate on these and other possibilities before the Commission, in consultation with the Federal Reserve Board and the Treasury, has obtained and analyzed the best available facts. The Commission will attempt to weigh the costs and benefits of the various alternatives and promptly submit its conclusions to Congress. Thank you, Mr. Barnard. [The prepared statement of Mr. Shad follows: ] 443 STATEMENT OF JOHN S.R. SHAD , CHAIRMAN OF THE SECURITIES AND EXCHANGE COMMISSION , TO THE SUBCOMMITTEE ON COMMERCE , CONSUMER AND MONETARY AFFAIRS OF THE HOUSE COMMITTEE ON GOVERNMENT OPERATIONS Chairman Barnard and members of the Subcommittee : I welcome this opportunity to testify concerning the government securities market . It is requested that this statement be included in the record . This testimony briefly describes the size and nature of the government securities market ; the extent of the authority of the Commission and the Federal Reserve Board ( " FRB " ) over the government securities market ; problems involving government securities dealers ; the Commission's recent enforcement actions arising out of the failure of ESM Government Securities , Inc. ( " E.S.M. Government " ) ; and the Commission's review of the government securities market that is in progress . This testimony responds to many of the specific questions raised in Chairman Barnard's letter of March 20 , 1985. ΤΟ the extent not addressed herein , specific answers are set forth in the Appendix to this testimony . I. The Government Securities Markets The market in United States government securities is by far the largest in the world . In 1984 , just the 36 primary dealers , which report daily to the Federal Reserve Board , traded over $ 1.5 trillion per month , as compared with total 50-923 0-85--15 444 stock trading volume on all U.S exchanges and over- the- counter markets of less that $ 100 billion per month ( i.e. , 7 % of the government market ) . The highly liquid , keenly competitive and efficient government securities market is critical to the effective execution of the nation's monetary and fiscal policies . II . The Commission's and the FRB's Regulatory Authority The Commission's statutory authority over the government securities markets is based primarily on the anti - fraud provisions of the securities laws . Section 3 ( a ) ( 2 ) of the Securities Act of 1933 ( the " Securities Act " ) and 3 ( a ) ( 12 ) of the Securities Exchange Act of 1934 ( " Exchange Act " ) exempt government securities from registration . Section 15 ( a ) ( 1 ) of Exchange Act exempts from registration broker- dealers who effect transactions exclusively in government securities . As a result , while the Commission has regulatory authority over registered broker- dealers that engage in government securities business , it does not have statutory authority to regularly examine broker- dealers that restrict their business to government securities transactions . However , the general anti- fraud provisions of the federal securities laws ( Section 17 ( a ) of the Securities Act and Section 10 ( b ) of the Exchange Act and Rule 10b- 5 thereunder ) apply to the offer , purchase , or sale of securities by any person . Accordingly, the Commission may conduct investigations to 445 determine whether firms that deal exclusively in government securities have violated the anti - fraud provisions in connection with the offer , purchase , or sale of government securities . The FRB monitors the activity and financial soundness of the 36 primary dealers in government securities by obtaining daily reports of market activity and positions , monthly financial statements , and annual reports . The FRB supplements these reports with telephone calls and on- site visits . These oversight activities depend largely on voluntary compliance and moral suasion , as well as the ultimate threat of the FRB ending a firm's primary dealer status . The FRB has no statutory investigation or enforcement authority over any government securities dealers . The FRB has encouraged secondary dealers to report voluntarily the same information as is required of primarily dealers , on a monthly rather than a daily basis . As described below , the FRB also recently proposed voluntary capital adequacy guidelines for government securities dealers not subject to Federal regulation . Also , those entities that engage in government securities activities are subject to the direct regulatory oversight of several federal agencies : for the banks , the FRB , the Comptroller of the Currency and the Federal Deposit Insurance Corporation ; for the saving and loan associations and other thrift institutions , the Federal Home Loan Bank Board ; for the registered securities 446 firms , the SEC; for the credit unions , the National Credit Union Association ; and for the pension funds , the Department Various state agencies also regulate of Labor , under ERISA. the activities of the foregoing groups , as well as insurance companies . III . Government Securities Dealer Problems The following government securities dealer failures have occurred since 1977 : Winters Government Securities Corporation ( 1977 ) , Drysdale Government Securities ( 1982 ) , Lombard -Wall , Inc. ( 1982 ) , Lion Capital ( 1984 ) , and ESM Government ( 1985 ) . follows a review of each of these situations and the Commission's responses . Winters Government Securities Winters Government Securities Corporation ( " WGSC " ) , an unregistered government securities dealer , began business in 1973 and failed in 1977. It was involved in the sale of Government National Mortage Association ( " GNMA " ) mortgagebacked securities to banks , thrifts , and credit unions for delayed delivery . WGSC's activities were brought to the Commission's attention by the State of Alabama , which had received complaints from two savings and loan associations that WGSC had executed unauthorized trades for their accounts . unctive action In August 1977 , the Commission filed an injun against WGSC , Winters & Co. , a registered broker- dealer affiliate of WGSC , and seven individuals who were affiliated with WGSC as officers , directors , or salesmen . 447 In its action , the Commission alleged that the defendants had engaged in fraudulent sales practices in connection with the offer , purchase , and sale of GNMA securities for delayed or forward delivery and payment . The alleged fraudulent practices at WGSG included the use of " boiler- room" sales tactics , excessive mark- ups , and misrepresentations concerning the safety of the investments and the financial condition of WGSC. The failure of the firm occurred when the market price for these securities decreased and institutional customers of the firm who had been subject to the practices discussed above , disavowed trades that , if accepted , would have resulted in losses to them . As a result of WGSC's failure , three originating dealers sustained $ 4 million in losses , before insurance and civil suit recoveries , if any . As a result of the Commission's injunctive action , all of the defendants were enjoined from engaging in future violations of the antifraud provisions of the federal securities laws . The Commission also instituted administrative proceedings against the individual defendants , in which they were barred from associating with a registered broker- dealer , investment adviser , or investment company as supervisors . The Commission also revoked the broker- dealer registration of Winters & Co. 448 rysdale Government Securities , Inc. Drysdale Government Securities , Inc. ( " DGSI " ) was a government securities dealer , incorporated in 1981 , but dormant until it took over activities formerly conducted by its predecessor , Drysdale Securities Corp. ( " DSC " ) , _/ in February 1982. DGSI operated for approximately three months before its collapse in May 1982 , causing approximately $ 300 million in losses to other dealers , before insurance and civil suit recoveries , if any . Most of the losses were borne by the Chase Manhattan Bank . The transactions involved in the Drysdale failure were repurchase and reverse repurchase agreements concerning government securities . The DGSI failure was largely attribut- able to an alleged ongoing fraud . When DGSI began to function in February 1982 , it assumed short positions in government securities of over $ 2 billion , which included an unrealized loss exceeding $ 190 million . By commencing business , DGSI represented that it stood ready and able to fulfill its obligations under agreements to repurchase and to resell securities and pay the interest which had accrued on the underlying securities . The Commission alleged that DGSI's principals knew that the firm could meet those obligations J Drysdale Securities Corporation ( " DSC" ) was a registered broker- dealer . 449 only so long as it could continue to borrow securities in increasing amounts and sell them in the cash market to obtain the accrued interest . It was alleged that DGSI concealed this loss from other dealers and potential creditors . It was alleged that throughout its three and one-half months of business life , DGSI essentially engaged in a frantic and ultimately futile effort to meet the undisclosed deficit , mainly by expanding its positions and through speculative trading . Drysdale collapsed in May 1982. On July 27 , 1983 , the Commission filed a complaint for injunctive relief against DSC , officers of DSC and DGSI , and a partner of Arthur Andersen & Co. , DGSI's accounting firm . Without admitting or denying the allegations , the officers of DSC and DGSI consented to permanent injunctions from future violations of the antifraud provisions of the federal securities laws , from aiding and abetting violations of the Commission's brokerdealer recordkeeping requirements , and two of the officers were ordered , for a period of two years after the entry of their respective orders , to deliver a copy of the order to any broker- dealer with whom they sought to open a brokerage account . The action against DSC was subsequently dismissed , after DSC was dissolved . DGSI was not named in the Commission's action because it effectively had ceased to exist by July 27 , 1983 . 450 On March 29 , 1984 , the DGSI treasurer and head trader pleaded guilty to an information filed in federal court . The information charged him with securities fraud , willful failure to file tax returns and conspiracy to commit securities fraud , mail fraud , wire fraud and broker-dealer recordkeeping violations . A guilty plea was also entered in the matter by DGSI's former head cashier . On July 6 , 1984 , the DSC chairman and chief executive officer was sentenced by the United States District Court to eight years imprisonment ( subsequently reduced to six years ) , based upon his plea of guilty to securities fraud . The court also ordered him to pay $10 million in restitution for the benefit ( of certain institutional clients whom he had defrauded during a six-year period ending in 1982 , unrelated to the DGSI fraud . On the same day , he was sentenced by a New York State Court to a term of 2-1 /3 to 7 years ( to run concurrent with the federal sentence ) upon a guilty plea to grand larceny and securities fraud . That sentence was subsequently reduced to a maximum of six years . his DGSI activities . The state charges were based upon Without admitting or denying the charges , on December 28 , 1984 , he consented to a Commission Order which barred him from association with any broker- dealer , investment adviser , municipal securities dealer , or investment company . Without admitting or denying the charges , the former head cashier of DGSI also consented to a bar Order entered by the Commission . 451 On March 15 , 1985 , the DGSI head trader was sentenced by the United States District Court to three years imprisonment , to be followed by four years probation and , in each of those four years , 200 hours of community service . Based upon his consent , the Commission also barred the former controller of DGSI , who had been convicted in state proceedings of fraud and larceny and sentenced to three years probation . The Commission's injunctive action against the Arthur Andersen partner was dismissed on March 25 , 1985 , based upon a ruling by the United States District Court that the partner's alleged misconduct had not occurred " in connection with " the purchase or sale of securities . The District Court based its holding on the fact that alleged misrepresentations by the partner and Andersen related to the capitalization of DGSI , not to the value of the government securities underlying the repurchase agreement or the financial strength of the issuer of the securities . The Commission will , in the near future , determine whether to appeal this ruling . Lombard-Wall , Inc. Lombard-Wall was an unregistered government securities dealer that failed on August 12 , 1982 , apparently due to normal economic forces rather than financial fraud . Commission's inquiry was limited . Therefore , the Lombard-Wall was not affiliated with a broker-dealer registered with the Commission . 452 Losses were sustained primarily by one state governmental body, the New York State Dormitory Authority . actively investigated the firm . State agencies It immediately went into bank- ruptcy . These early assessments were not disproved , and the firm emerged from reorganization in November 1983. Total losses reported in the matter were $ 20 million to the New York State Dormitory Authority , before insurance and civil suit recoveries , if any. Under these circumstances , the SEC staff did not recommend a formal investigation nor the institution of enforcement proceedings to the Commission . Lion Capital Group , Inc. The Commission's investigation of this matter is pending . Accordingly , in order to avoid prejudice to the Commission's investigation and any litigation that may result therefrom, the discussion set forth below is based solely upon publicly available information . Lion Capital Group , Inc. ( " Lion " ) , a broker- dealer not registered with the Commission , filed for protection under Chapter 11 of the bankruptcy code on May 2 , 1984 , together with four associated entities . That filing raised issues concerning approximately $ 40 million invested by about 60 institutions , 24 of which were State of New York School Districts . Those districts had allegedly invested their 453 funds in repurchase agreements with Lion after receiving rate quotations through National Money Market Securities , Inc. , a California- based money broker . The school districts were allegedly induced to invest by a promise of yields higher than those otherwise available . Lion generally had no direct contact with the school districts other than to issue confirmations of transactions and to receive funds from the school districts and return the funds with the interest earned . The confirmations represented that securities underlying the repurchase agreements were held in trust at Bradford Trust Co. ( " Bradford " ) , Lion's clearing agent . However , shortly after the initiation of the bankruptcy proceedings , Bradford claimed that the government securities that it held as a result of transactions with Lion were not held in trust for the school districts but were collateral for a loan from Bradford to Lion . It appears that those customers that did not have possession of collateral are involved in litigation with Bradford , in which they alleged that Bradford's lien is invalid . A settlement offer is pending , and a hearing on the offer was held on March 11 and 12 , 1985. The Court has taken the settlement offer under advisement . On Monday , February 25 , 1985 , a New York State grand jury indicted the chief operating officer of Lion Capital , its operations officer , and its chief financial officer , 454 alleging , among other things , state law securities fraud and grand larceny . Initial reports of the amounts at risk as a result of the Lion bankruptcy were approximately $ 28 million . That amount later turned out to be $ 40 million , before insurance and civil suit recoveries , if any. IV . The E.S.M. Government Case . The Commission's investigation of ESM is pending and all discussion set forth below is based solely on publicly available information . E.S.M. Government is a broker- dealer , not registered with the Commission , that was engaged in the government securities business . It was able to do so , in part , based upon its allegedly fraudulent financial statements . The Commission first learned of apparent violations of the federal securities laws by E.S.M. Government at approximately 8:30 A.M. on Monday , March 4 , 1985 , when the Commission's staff received a telephone call from the Special Counsel to E.S.M. Government . The Special Counsel , who had been retained by E.S.M. Government on Friday , March 1 , advised the staff that a review of E.S.M. Government's records conducted over the weekend indicated that the firm had allegedly incurred approximately $ 250- $ 300 million of unreported losses . The Special Counsel reported that a substantial portion of those 455 alleged losses appeared to have been caused by large denomination government securities transactions and related interest expenses . Later on the morning of March 4th , the Special Counsel met with the staff to provide further elaboration . On the afternoon of March 4 , the SEC staff sought and obtained authority from the Commission to file a civil action in the U.S. District Court for the Southern District of Florida against E.S.M. Government and three affiliates , E.S.M. Securities , Inc. ( a broker- dealer registered with the Commission ) , E.S.M. Group , Inc. ( the holding company for E.S.M. Government and E.S.M. Securities ) , and E.S.M. Financial Group , Inc. The complaint , filed later in the afternoon of March 4 , requested a temporary restraining order against future violations of the antifraud provisions of the federal securities laws , a freeze of the defendants ' assets , and the appointment of a receiver . Without admitting or denying the charges , the defendants consented to the entry of a final judgment at the time the complaint was filed . As part of the judgment , the defendants ' assets were frozen and the Special Counsel was appointed receiver . In its complaint , the Commission alleged that ESM Government had purchased and sold securities for over five years when its audited financial statements failed to reflect 456 properly, as required by generally accepted accounting principles , the true financial condition of the firm. The losses which the firm had incurred had apparently been concealed by recording them on the financial statements of E.S.M. Government's parent company , E.S.M. Group , which in turn reflected a corresponding account receivable from E.S.M. Financial Group , a " shell " corporation which did not engage in any discernible business . Although it allegedly concealed the losses for several years , E.S.M. Government ultimately became unable to meet its obligations as they matured . E.S.M. Government's institutional customers have incurred losses which may exceed $300 million , before insurance and civil suit recoveries , if any . After filing the action against E.S.M. Government , Commission staff commenced an independent investigation of the matter . On Friday , March 15 , the Commission authorized the staff to file in the District Court an application for an order permitting access , without the delay that would otherwise be required by compliance with the Right to Financial Privacy Act of 1978 , to bank records of Jose Gomez , the managing partner of the South Florida offices of Alexander Grant & Company . Alexander Grant had examined and issued a report on E.S.M. Government's financial statements annually since at 457 least 1980 , and Gomez had been the partner in charge of those audits . The Court granted the Commission's application on the day it was filed . On Friday , March 15 , Chairman Shad contacted Chairman Paul Volcker of the FRB , Gerald Corrigan , President of the New York Federal Reserve Bank , Edward Gray , Chairman of the Federal Home Loan Bank Board , and senior staff members , to coordinate the efforts of these organizations . gation continued over the week- end . The investi- Representatives of these organizations met in Miami on Sunday , March 17th . On Monday, March 18 , after reviewing the bank records obtained pursuant to court order , the staff sought and obtained Commission authority to file an injunctive action against Gomez . In that action , which was filed on Wednesday , March 20 , the Commission alleged that Gomez had violated antifraud provisions of the Exchange Act , and sought a temporary and permanent injunction against future violations , as well as other equitable relief . The Commission alleged that Gomez lacked independence as the auditor for E.S.M. Government because he received at least $ 125,000 from principals of E.S.M. Government in the form of wire transfers into his personal bank account . On March 20 , the Court entered a temporary restraining order against future alleged violations by Gomez , freezing Gomez ' assets , restraining Gomez from destroying or secreting relevant records , and requiring Gomez to provide an accounting 458 by March 26 , 1985 , of all payments received from E.S.M. Government or related entities or principals . Gomez has subsequently asserted his Fifth Amendment privilege with respect to the accounting . The Court also scheduled a hearing. on the Commission's application for a preliminary injunction for March 28 , 1985 , which has been put over to April 9 , 1985 . The Commission's staff is continuing its investigation to ascertain whether other persons and entities have engaged in violations of the federal securities laws . In addition , the staff is continuing to assist the receiver in his efforts to locate and preserve E.S.M. Government's assets . The Commission's staff has also cooperated with other agencies in this matter , including banking agencies having jurisdiction over the financial institutions affected by the insolvency of E.S.M. Government . Preliminarily, it appears that three of the principal factors that contributed to the losses sustained by those who dealt with ESM have been the lack of adequate collateralization of their transactions ; the extension of more than normal margin to ESM by two savings and loan associations ; and the concentration by these two savings and loan associations of their transactions with ESM . These two savings and loans apparently were under common control at the time the transactions were made . It also should be noted that a number of the parties involved in ESM had relationships with other government securities firms who E. 459 had failed . Nicholas Wallace , an ESM principal , was previously associated with both WGSC and Hibbard O'Connor & Weeks . Ronnie Ewton and George Mead , also principals of ESM , were previously associated with Hibbard O'Connor & Weeks . In addition , Bradford Trust was the clearing agent for both Lion Capital and ESM . v. Government Securities Regulation Beginning in March of 1984 , representatives of the Federal Reserve Bank of New York consulted with the SEC staff on certain actions designed to improve the functioning of the government securities markets . In particular , the New York Federal Reserve Bank has taken steps to strengthen its market surveillance unit and curtailed certain repurchase agreements practices that had contributed to previously incurred losses . The Bank also proposed for comment standards for a voluntary capital adequacy program that would apply to government securities dealers not subject to Federal supervisory oversight . _ / The proposed capital guidelines include a liquid capital- torisk ratio applicable to otherwise unregulated government securities dealers that is broadly similar to the Commission net capital rule for registered broker- dealers , but is designed to address the specific risks of government bond dealers . These guidelines would measure both the credit and market risk associated with a government securities dealer's position and set a level designed Federal Reserve Bank of New York , Capital Adequacy Guidelines for U.S. Government Securities Dealers , Request for Comments (February 7 , 1985 ) . 460 to ensure that the dealer has sufficient liquid capital to absorb losses incurred on those risk positions . Primary government securities dealers are already required to submit reports used to test their capital adequacy in a manner broadly consisted with this proposal . The guidelines would also encourage certification by an independent auditing firm of compliance by unregulated dealers . Primary dealers in government securities and banks subject to Federal Reserve Board supervision would not be permitted to deal with a non-complying government securities dealer . Moreover , the Federal Reserve Bank would look for certification letters as an element of sound banking practices in examining member banks ' clearing and lending activities for government securities accounts , and would encourage other bank supervisiors to do so . On March 21 , 1985 , the Commission indicated at hearings held by the Telecommunications , Consumer Protection and Finance Subcommittee of the House Committee on Energy and Commerce that it would review the regulatory structure of the government securities markets , and would consult with the Federal Reserve Board and the Treasury. It also said that it would report to Congress its views regarding cost- effective modifications of the current regulatory scheme , taking into account the critical importance of this market to U.S. monetary and fiscal policies . This work has begun . Chairman Shad and senior members of the Commission staff have met with Paul Volcker of the Federal Reserve Board and Thomas Healy, Assistant Secretary of the Treasury , and members of their staff . 461 The Commission also intends to publish a release shortly , seeking comments , among other things , on the extent of unregulated government securities dealer activities , alternative forms of oversight of the government securities markets ; and the marketplace's reaction to the extensive ESM publicity and the extent to which those who deal with government bond dealers have modified their practices in response to such publicity . By this means , the Commission will obtain the benefit of the views of the securities industry , federal regulators , and others concerning the relative merits of the present and future form of regulation of the government securities markets . The Commission will incorporate the insights provided by these commentators in its report to Congress . There are many alternatives and possibilities that range from encouraging or requiring customers of government securities dealers to properly collateralize the transactions , limit their margin payments and concentration with any one dealer to compulsory rules and regulations under the supervision of self regulatory organizations or the direct aegis of an existing or new federal agency . Also , because of the speed and frequency of transactions in government securities , the vast majority are handled without incident by low cost , high speed electronic book-entry systems . Those who deal with government bond dealers might be encouraged or required to avail themselves of such facilities . It may also be necessary to adapt such facilities to the unique needs of the repurchase agreement market . 462 It would be premature to speculate on these and other complex possibilities before the Commission , in consultation with the Federal Reserve Board and the Treasury , has obtained and analyzed the best available facts . After the Commission receives the responses to its prospective release , the Commission will attempt to quantify the costs and benefits of the various alternatives , and will submit its conclusions to Congress . 463 APPENDIX Responses to Chairman Barnard's letter of March 20 , 1985 , in the order and as numbered in that letter 1. Discuss generally the SEC's statutory and regulatory role in regulating the government securities market and supervising broker- dealers who trade government securities . Answer : Government securities are specifically defined as exempted securities under the Securities Act of 1933 ( "Securities Act " ) and the Securities Exchange Act of 1934 ("Exchange Act " ) . Accordingly , these securities are not registered with the Commission and securities professionals who restrict their activities to trading in government securities only , are not required to register as brokerdealers with the Commission or to join a self- regulatory organization ( " SRO " ) . Nevertheless , the Commission may investigate government securities dealers for violations of the antifraud provisions of the federal securities laws . Section 17 ( a ) of the Securities Act and Section 10 ( b ) of the Exchange Act and Rule 10b- 5 thereunder , which prohibit misstatements or misleading information or omissions of material facts , and fraudulent or manipulative acts and practices , in connection with the purchase or sale of securities , apply with equal force to transactions in exempted government securities . Government securities dealers who also engage in brokerage or dealing in non- exempt stocks or bonds are subject to regulation with respect to their government 464 securities activities . In particular , those broker- dealers are required to register with the SEC and become a member of an SRO . The recordkeeping , financial respon- sibility requirements and certain other requirements imposed by the Exchange Act and SRO rules apply to their government securities activities . 2 ( a ) and ( b ) are answered on pages 12 through 16 of the accompanying testimony . 2 ( c) The Commission's Office of the General Counsel has prepared a report on the Commission's 1977 investigation of ESM , a copy of which is attached . 3 is answered on pages 4 through 12 of the accompanying testimony . 4 ( a) There continues to be a significant legal dispute over whether repurchase agreements ( " repos " ) and reverse repurchase agreements ( " reverse repos " ) are securities under the 1933 Act . Provide a brief analysis of this issue , including a discussion of the recent case law , and the SEC's official position on the issue . Answer : The Commission's staff is preparing a report on the status of repurchase agreements under the federal securities laws . That report will be forwarded to the Congress in the very near future . 465 4(b) Assuming that the SEC did take the position that such instruments are securities , would this mean that government securities dealers , such as ESM , Inc. , would be required to register as broker- dealers under the federal securities laws ? Answer: Generally , any person engaged in the business of buying and selling securities for his own account , as part of a regular business , must register with the Commission as a broker- dealer . ___/ Accordingly, if repurchase agreements were considered to be separate securities , government securities dealers trading these instruments would have to register as broker- dealers . 4 (c ) If ESM , Inc. , had been required to register as a broker- dealer with the SEC , would the SEC have been in significantly better position to detect and deal with the sort of fraud and misrepresentations that allegedly took place in this case? Answer : The federal securities laws subject broker- dealers to a comprehensive system of regulation . The broker- dealer regulatory system cannot be expected to prevent all frauds . That system , through the Commission's and self- regulatory organization's examination and enforcement authority can have a deterrent effect Section 3 ( a ) ( 5 ) of the Exchange Act defines a " dealer " as : " any person engaged in the business of buying and selling securities for his own account , through a broker or otherwise , but does not include a bank , or any other person insofar as he buys or sells securities for his own account , either individually or in some fiduciary capacity , but not as part of a regular business . " Section 15 ( a ) of the Securities Exchange Act of 1934 . 466 on fraudulent activity . While we cannot say whether the broker- dealer regulatory scheme would have prevented the failure of ESM , we believe that it could have detected the problems earlier . 5. Has the collapse of ESM , Inc. , seriously threatened any registered broker- dealer or other publicly- held corporations ? If so , please identify and discuss each one briefly . Answer : The Commission is not aware of any registered broker- dealers or publicly-held corporations which file with the Commission , other than Home State Savings Bank, which files reports with the Commission , and American Savings and Loan , which is publiclyowned but does not file reports with the Commission , which have suffered substantial losses due to the failure of ESM . Insuf- ficient records exist at ESM to establish conclusively at this point that no other registered broker- dealers or publicly- held corporations have suffered substantial losses as a result of their dealings with ESM . 6. Since the failure of Drysdale Government Securities , Inc. , in 1982 , what steps have any self-regulatory organizations , the securities market , or other private sector groups taken to prevent the recurrence of such failures and to improve the operations of the government securities market? How successful to you think these steps have been? Answer : Since the failure of Drysdale Government Securities , Inc. , in 1982 participants in the government securities markets have taken steps to improve the operations of those markets . Many participants 467 in these markets are requesting information on the financial condition of those institutions and brokers with whom they engage in repurchase transactions . In October , 1982 , the Public Securities Association prepared a pamphlet entitled " Business Practice Guidelines for Participants in the Repo Market . " This pamphlet discusses the valuation of accrued interest , margin requirements , and due diligence procedures , among other things . Currently , there is no self-regulatory organization for government securities dealers . 7 (a ) and ( b ) are answered on pages 17 through 19 of the accompanying testimony.. 7 (c) At this time , what legislative steps would the SEC propose or support to deal with such abuses and failures? Answer : On March 21 , 1985 , the Commission indicated at hearings held by the Telecommunications , Consumer Protection and Finance Subcommittee of the House Committee on Energy and Commerce that it would review the regulatory structure of the government securities markets and , after consultation with the Federal Reserve Board and the Treasury , provide any recommendations it may have with respect to regulation of the government securities market, including any prospective legislation . I 468 ATTACHMENT March 20, 1985 OFFICE OF THE GENERAL COUNSEL UNITED STATES SECURITIES AND EXCHANGE COMMISSION REPORT ON 1977 ESM GOVERNMENT SECURITIES, INC. INVESTIGATION In the early part of 1977, the Commission received information from the Office of the Comptroller of the Currency that indicated that ESM Government Securities, Inc. (" ESM" ) may have committed violations of the federal securities laws in connection with sale of GNMA securities to the National Bank of South Florida, which resulted in the bank reneging on a purchase from ESM of a $1 million GNMA security. On June 7, 1977, the Commission issued an order commencing a non-public investigation of ESM, and directing the staff to investigate whether ESM had violated antifraud provisions by, inter alia, purchasing securities for the account of customers without authorization and by misrepresenting the potential risk, safety and profitability of certain purchases . On November 10, 14, and 15, 1977 , the staff examined ESM's books and records at ESM's offices . That investigation revealed that in several tran- sactions, ESM had engaged in excessive mark-ups . */ On November 16, 1977, after ESM refused to cooperate further with the Commission's investigation , the staff issued a subpoena directing production of certain of ESM's books and records. After some initial compliance, ESM refused to provide further access to its records on the ground that the staff inquiries into ESM's mark-up policies exceeded the scope of the formal order. */ The preliminary inquiry indicated that in at least 16 transactions with six customers, ESM made a profit which greatly exceeded the profits made by its customers in those transactions . For example, a $2 million GNMA transaction on December 7, 1976, with Central Dupage Federal Savings and Loan Association of Wheaton, Illinois, resulted in a profit to ESM of $66,000, while the customer received $2,500 . And in a $4 million GNMA transaction with the same customer, ESM made a profit of $45,000 , while the customer made $10,000 . Instances of similar mark-up practices were discovered with other institutional customers. 469 To avoid further doubt concerning the scope of its investigation, the Commission, on January 10, 1978, issued an amended formal order to encompass ESM's mark-up policies as an area of inquiry. Pursuant to the amended order, ESM was served with a second subpoena. When ESM refused to comply with that subpoena, the staff sought authority to file a subpoena enforcement action, which the Commission granted. On January 27, 1978, the Commission filed an application with the United States District Court for the Southern District of Florida to enforce its subpoena. ESM sought to quash the subpoena on the ground that it was the product of prior illegal conduct by the staff. Essentially, it alleged that during the previous visits to ESM's offices, staff members (i ) had exceeded their authority by investigating matters outside the scope of the original order of investigation, and (ii ) had obtained ESM's consent to be searched through fraud, trickery or deceit by not advising ESM that it was the target of an investigation and by misrepresenting their purpose in being in its offices . ESM therefore urged that the January 1979 subpoena was the "fruit of a poisonous tree, " having been drafted on the basis of illegally obtained information. ESM also sued the Commission investigator engaged in the alleged misconduct to recover damages for violation of ESM's constitutional rights. Although the Commission denied the allegation of wrongdoing and was prepared to show that the staff did not misrepresent their reason for examining ESM's records, the district court enforced the subpoena without holding an evidentiary hearing on ESM's claims of misconduct. The court held that ESM's allegations did not provide a legal basis for denying enforcement of the Cammission's subpoena. On ESM's appeal , the Court of Appeals for the Fifth Circuit reversed and remanded the case to permit ESM to prove its allegations . 470 The court held that it would be an abuse of the district court's processes to enforce a subpoena that was the result of improper access to the firm's records . On June 9, 1981, the Commission determined to challenge the decision of the court of appeals by petitioning for rehearing en banc. The Commission determined, however, that if the petition was denied, it would not pursue the matter further in the district court. The Commission was informed by the staff that the underlying violations -the improper mark-up practices - had occurred almost five years earlier and that in light of the staleness of the charges, it would be very unlikely that the Commission could obtain an injunction in a district court against future violations . Before the Commission could even institute such an action, it would have to enforce its subpoena, a process that would have required going through a lengthy hearing in the district court on the charges of alleged staff misconduct which occurred almost four years earlier. The Commission attorneys representing the Commission investigator in ESM's damage action also informed the Commission of their concern that the district court might order discovery of of the investigator's personnel file, which could cause their client unnecessary personal embarrassment. Since the Commission determined not to pursue the subpoena should the petition for rehearing be denied, the Commission also authorized Commission attorneys representing the Commission investigator to seek to have the damage action dropped in return for the Commission's agreement not to pursue its investigation of ESM. The Commission's petition for rehearing was denied by the Fifth Circuit on June 25, 1981. The subpoena enforcement action was dismissed on November 20, 1981. ESM dropped its suit against the Commission investigator without prejudice to reinstitution of the suit if the Commission brought an action based on any conduct by ESM occurring before May, 1978 . 471 Mr. BARNARD. Thank you, Mr. Chairman. I am sure that we at this particular time in the country are in, maybe, an unusual state of concern about securities dealers and there may be an overreaction as to whether or not they all of them should be supervised. I interpret from your remarks today there is some question in your mind that we need to have a brand new system of regulations across the board, as far as the nonregistered dealers. I presume that is what you are saying today. Mr. SHAD. Well, I think we have to do a lot more more work to give you a well-informed response. It's notable that the 36 primary dealers are under a semi-voluntary type of regulation. Mr. BARNARD. Was Drysdale one of those 36? Mr. SHAD. No. Drysdale was unregistered, and while it was one of the 100 , it was not one of the 36. Mr. BARNARD. I am delighted that the Energy and Commerce Committee and other committees of Congress are looking into that. I think it very definitely needs to be looked into because we have some fallout in this particular situation with ESM, that not only affected savings and loans and banks, but likewise many innocent communities. I think it really requires that the Congress take a very deep look at that. So, inasmuch as that is under study and you have indicated that it is, I would like, at least for now, to turn my questions to the SEC's knowledge and investigation of ESM. As I understand it, the SEC launched an investigation of ESM soon after it opened for business in 1976 , but that the case was tied up in knots for 4 years due to the efforts of ESM's attorney, Mr. Steve Arky and his law firm. Is that true? Mr. SHAD. Yes, sir. Mr. BARNARD. This suit managed to completely halt the SEC's investigation of ESM for 4 years. The question is: Is it your normal practice to stop an investigation as soon as the target challenges one of your subpoenas? Mr. SHAD. By no means. Mr. BARNARD. Well, what was so special about this case, Mr. Chairman, that caused the Commission to stop its investigation? Mr. SHAD. I could give you a brief answer, but I think the best source of information about that would be the general counsel of the Commission. If I might ask Dan Goelzer to respond. He's here with us. Mr. GOELZER. Mr. Chairman, I wouldn't say that we stopped our investigation because their counsel challenged it. We issued subpoenas. They refused to comply with those, and we went into court to have those subpoenas enforced . The litigation that resulted, unfortunately, consumed 4 years until the Court of Appeals for the Fifth Circuit remanded the case back to the district court for yet further proceedings on those subpoenas. It took from early 1978 until the middle of 1981 to get even to that stage. At that point, the Commission was looking into sales practice violations. That is all that the Commission was aware of at ESM at the time, that they might have received excessive markups from certain of their customers. Those were about 4 years old. We had 472 no evidence to indicate that they had continued over that 4-year period. The Commission concluded, in light of that, that it would drop the investigation at that point. Mr. BARNARD. So, in other words, the case was only dropped after it was remanded. It was remanded in 1981 , right? Mr. GOELZER. That's correct . To make it very brief, the district court enforced our subpoena in 1978. ESM appealed to the court of appeals. The court of appeals determined that further fact finding was necessary in the district court, and in June 1981 remanded it to the district court. Mr. BARNARD. You didn't have any feeling at that time, then, that they were involved in any other questionable practices? Mr. GOELZER. No, sir. My understanding is that the matter was initiated because the Comptroller reported to us that they might have engaged in unauthorized trading on behalf of a certain national bank in Florida. When our people went in and began to look at their records, what they found was not unauthorized trading, but rather was excessive markups. When they began to inquire into these markups, that is the point at which the cooperation ceased. While that is certainly a problem in itself, it is not the problem that later brought them down. Mr. BARNARD. Did you make any inquiry of any of the Federal banking agencies as to their experience with ESM at that time? Mr. GOELZER. Not to my knowledge. It went the other way. The Comptroller brought the sales practice problems to our attention . I am not aware of any other communications with the bank regulators. Mr. BARNARD. What about the Home Loan Bank Board? Mr. GOELZER. Not to my knowledge, sir. Mr. BARNARD. I was thinking about the Unity situation in Chicago. Mr. GOELZER. I am not familiar with that. It's a matter that I am not familiar with, sir. Mr. BARNARD. Would it have been a matter of normal suspicion that with ESM's vigorous defense against your subpoena, that it would have made you, maybe, pursue the case even harder? Mr. GOELZER. Well, that's a difficult question to answer. Again, my understanding is that the only knowledge we had at that time was of the sales practice violations. That is, that they were earning more on their transactions with their customers than we might have considered proper. I agree it's unusual for someone to contest one of our investigations with that much fervor, but it is not unheard of either; it happens to us. Mr. BARNARD. What was the basis for your suit to begin with? Mr. GOELZER. Our suit was simply to enforce our subpoena. We subpoenaed certain records of theirs which we felt would illuminate these sales practice violations. Mr. BARNARD. You didn't have any real evidence of wrongdoing but you were subpoenaing records for that purpose? Mr. GOELZER. That's correct. We had some evidence, but not enough to bring an enforcement action. Mr. BARNARD. Well, in addition to this investigation, didn't the SEC initiate an entirely separate investigation during the time 473 period into Mr. Ewton and Mr. Seneca's purchase of America Bancshares , Inc.? Mr. GOELZER. Yes. I understand that there was an investigation at about the same period of time, I believe it was in 1978, of their disclosures with respect to their acquisition of shares of that company. Mr. BARNARD. You questioned their disclosures, is that it? Mr. GOELZER. Yes. To be precise, I would like to check and supply the information for the record, but my recollection is that the investigation involved whether they had accurately described their holdings and their relationships in a 13D filing with the Commission, which is required when someone owns more than 5 percent of a company's shares. Mr. BARNARD. What was the conclusion of that investigation? Mr. GOELZER. It's my understanding that it was closed without any action being taken. There was no enforcement action which resulted. Mr. BARNARD. Mr. Chairman, at the time that the SEC was investigating ESM and other similar Government securities firms, did the SEC have any reason to suspect that many unwitting financial institutions or municipalities were being sucked up into these scams? Mr. SHAD. In the course of the prior investigation or which investigation, Mr. Chairman? Mr. BARNARD. Well, of course, I guess the reasons for the subpoenasMr. SHAD. Back in 1977? Mr. BARNARD. Yes. Mr. SHAD. Not to my knowledge, but this is long before my association with the Commission and I would rather have somebody respond who is more current on it than I am. But I am not aware that it was thought to be a broad scale thing. It was an inquiry concerning one bank and their dealing with it and the question as to whether or not they were charging unreasonable markups. Mr. BARNARD. Let me just ask youMr. GOELZER. The information that was presented to the Commission when it started the investigation, in part, revolved around information that ESM, which was then dealing in GNMA forwards, wasn't adequately apprising its customers of the risks involved in dealing with GNMA forwards. Mr. BARNARD. And this was one of the reasons for your subpoena? Mr. GOELZER. Well, that's one of the things that triggered the investigation. I think, when our people went in and began to look at the records, the tangible thing that they found were these markup violations. If the investigation had ultimately gone ahead, I think we would have looked more broadly at these sales practice violations, but the tangible problem that caused the subpoena to be issued, as I understand it, was these excessive markups. Mr. BARNARD. Let me ask Mr. Harper a question, if I might. Mr. Harper, in your initial investigation of ESM, was the comptroller of the State of Florida notified of ESM's suspicious trading practices. 474 Mr. HARPER. I can't recall the answer to that. They certainly were aware of the law suit that we had against them. Let me just clarify something with the subpoena that we issued, and I think you'll understand. ESM was investigated shortly after Winters Government Securities went out of business . They were both located in the same building, and there was a big hullabaloo, just like now, when Winters went out of business. One of Winters' problems was markups. What we did in our investigation is that we subpoenaed the records from the customers t