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TREAS

.A13P4
v. 304

U. S. Department

of tge Treasury

PRES S RELEAS ES

)epartment of che Tree%erg

Washington,

O.C. ~ Telephone SII-a~

FOR IMMEDIATE

January

RELEASE

2, 1991

CONTACT:

Office of Financing
202/376-4350

TREASURY'S WEEKLY BILL OFFERING

The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling
approximately $20, 000 million, to be issued January 10, 1991.
This offering will provide about $1, 300 million of new cash for
the Treasury, as the maturing bills are outstanding in the amount
of S18, 696 million. Tenders will be received at Federal Reserve
Banks and Branches and at the Bureau of the Public Debt, Washington, D. C. 20239-1500, Monday, January 7, 1991, prior to 12:00
noon for noncompetitive
tenders and prior to 1:00 p. m. , Eastern
Standard time, for competitive tenders.
The two series offered
are as follows:
91-day bills (to maturity date) for approximately
$10, 000 million, representing an additional amount of bills
dated April 12, 1990, and to mature April 11, 1991 (CUSIP No.
912794 WD 2). currently outstanding in the amount of S19, 233
million, the additional and original bills to be freely

interchangeable.

182-day bills for approximately S10, 000 million, to be
dated January 10, 1991, and to mature July 11, 1991 (CUSIP No.
912794 WY 6).

tive

The bills will be issued on a discount basis under competibidding, and at maturity their par amount
and noncompetitive

Both series of bills will be
will be payable without interest.
issued entirely in book-entry form in a minimum amount of $10, 000
on the records either of the
and in any higher S5, 000 multiple,
Federal Reserve Banks and Branches, or of the Department of the
Treasury.
The bills will be issued for cash and in exchange for
Treasury bills maturing January 10, 1991. Tenders from Federal
Reserve Banks for their own account and as agents for foreign
monetary authorities will be accepted at
and international
the weighted average bank discount rates of accepted competitive tenders. Additional amounts of the bills may be issued to
Federal Reserve Banks, as agents for foreign and international
to the extent that the aggregate amount
monetary authorities,
of tenders for such accounts exceeds the aggregate amount of
Federal Reserve Banks currently
maturing bills held by them.
for
foreign and international
hold S518 million as agents
and S4, 478 million for their own account.
monetary authorities,
Tenders for bills to be maintained on the book-entry records
of the Department of the Treasury should be submitted on Form
PD 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week

series).

TE&ASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 2

Each tender must state the par amount of bills bid for,
which must be a minimum of $10, 000. Tenders over $10, 000 must
be in multiples of $5, 000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e. g. , 7. 154. Fractions may not be used. A single
bidder, as defined in Treasury s single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1, 000, 000.
Banking institutions and dealers who make primary
markets in Government securities and report daily to the Federal
Reserve Bank of New York their positions in and borrowings on
such securities may submit tenders for account of customers, if
the names of the customers and the amount for each customer are
furnished.
Others are only permitted to submit tenders for their
own account.
Each tender must state the amount of any net long
position in the bills being offered if such position is in excess
of $200 million. This information should reflect positions held
as of one-half hour prior to the closing time for receipt of
tenders on the day of the auction. Such positions would include
bills acquired through "when issued" trading, and futures and
forward transactions as well as holdings of outstanding bills
with the same maturity date as the new offering, e. g. , bills
with three months to maturity previously offered as six-month
bills. Dealers, who make primary markets in Government securities and report daily to the Federal Reserve Bank of New York
their positions in and borrowings on such securities, when submitting tenders for customers, must submit a separate tender for
each customer whose net long position in the bill being offered
exceeds $200 million.

bidder may not have entered into an
A noncompetitive
agreement, nor make an agreement to purchase or sell or otherwise dispose of any noncompetitive awards of this issue being
auctioned prior to the designated closing time for receipt of

tenders.

Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury.
will be made on all accepted tenders for the
A cash adjustment
difference between the par payment submitted and the actual

issue price as determined
No

and

companies

in investment
entry records
8/89

accompany tenders from incorporated banks
and from responsible and recognized dealers
securities for bills to be maintained on the bookof Federal Reserve Banks and Branches.

deposit need

trust

in the auction.

TREASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 3

for accepted tenders for bills to be maintained

on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on the issue date, in cash or other immediately-available
funds
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the
maturing bills accepted in exchange and the issue price of the
new

bills.

bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures.
Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
a

of the Treasury Circulars, Public Debt SeriesNos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of the circulars, guidelines, and tender forms may be obtained
from any Federal Reserve Bank or Branch, or from the Bureau of
Department

the Public Debt.
8/89

iepartmeni of the Treasvrg ~ Washlnyton,
Ail

FOR RELEASE AT

January

Il ~J

4:00 P. M.

CONTACT:

2, 1991

TREASURY TO AUCTION

D.C. ~ Telephone SS6-5

$8, 500

Office of Financing
202/376-4350

MILLION OF 7-YEAR NOTES

The Department of the Treasury will auction $8, 500 million
of 7-year notes to refund $5, 115 million of 7-year notes maturing
January 15, 1991, and to raise about $3, 375 million of new cash.
The public holds $5, 115 million of the maturing 7-year notes,
including $182 million currently held by Federal Reserve Banks
as agents for foreign and international monetary authorities.
The $8, 500 million is being offered to the public, and
any amounts tendered by Federal Reserve Banks as agents for
foreign and international monetary authorities will be added
to that amount. Tenders for such accounts will be accepted at
the average price of accepted competitive tenders.
In addition to the public holdings, Federal Reserve Banks
for their own accounts hold $397 million of the maturing securities that may be refunded by issuing additional amounts of the
new notes at the average price of accepted competitive
tenders.
Details about the new security are given in the attached
highlights of the offering and in the official offering circular.
oOo

Attachment

NB-]082

HIGHLIGHTS OF TREASURY
OFFERING TO THE PUBLIC
OF 7-YEAR NOTES
TO

BE ISSUED JANUARY

15, 1991
January

2, 1991

Offered:
To the public . . . . . . -. . . . . . . . . . . . $8, 500 million
Descri tion of Securit
Term and type of security
7-year notes
Series and CUSIP designation
E-1998

Amount

Maturity

date

Interest rate
yield
or discount
Interest payment dates
Minimum denomination
available
Investment

Premium

Terms
Method

of Sale:
of sale

Competitive

Yield auction
Must be expressed as an

tenders

yield, with two
decimals, e. g. , 7. 10%
Accepted in full at the average price up to $1, 000, 000
annual

tenders

Noncompetitive

Accrued interest
payable by investor

None

Pa ent Terms:
Payment by non-

institutional

investors

Deposit guarantee by
designated institutions

Full payment

.........

to be

with tender

submitted

Receipt of tenders
a) noncompetitive
b) competitive
Settlement (final payment
due from

(CUSIP No. 912827 ZT 2)
January 15, 1998
To be determined based on
the average of accepted bids
To be determined at auction
To be determined after auction
July 15 and January 15
$1, 000

Acceptable
January 9, 1991
prior to 12:00 noon, EST
prior to 1:00 p. m. , EST

Wednesday,

institutions):

a) funds immediately
available to the Treasury
readily-collectible
check
b)

Tuesday,

Friday,

January
January

15, 1991

11, 1991

OVERSIGHT BOARD
RESOLUTION

4:15 p. m.

FOR RELEASE AT

January
OB

91-1

CONTACT:

2, 1991

REFCORP ANNOUNCES

CORPORATION

FUNDING

AUCTIONS

$6. 9

Felisa Neuringer
Brian Harrington
(202) 786-9672

BILLION OF BONDS

The Resolution Funding Corporation will auction
945,
555, 000 of 30 year bonds and $2, 000, 000, 000 of 39-1/4 year
$4,
bonds on January 8, 1991 to provide funding to the Resolution
Trust Corporation.

The 30 year bonds will mature on January 15, 2021, while the
39-1/4 year bonds will be a reopening of the 8-7/8% REFCORP bonds
maturing on April 15, 2030. Both REFCORP bonds will be offered
to the public through yield auctions conducted by the Federal
Reserve Banks as fiscal agents to REFCORP. The bonds will be
available in book-entry form only and in minimum denominations of
$1, 000. Noncompetitive tenders must be submitted through a
primary dealer or a depository institution with a book-entry
account at a Federal Reserve Bank. Only commercial banks and
primary dealers may submit tenders for the accounts of customers.
Noncompetitive. tenders will be accepted at the average price of
accepted competitive tenders.

will have completed
its $30 billion borrowing program authorized by the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989.
Thus, no further new offerings of bonds are planned by REFCORP.
Including

this sale of bonds,

The bonds

may

interest

components

into whole bonds
Federal Reserve.

REFCORP

into their separate principal and
in book-entry form and may be reconstituted
the book-entry system maintained by the

be stripped

securities are contained in the
attached highlight's of the offering and in the Resolution Funding
Corporation offering circular dated October 13, 1989, and
offering circular supplement dated January 2, 1991.
The

details

the

new

HIGHLIGHTS

YEAR AND

Offered to the Public

Amount

Descri tion of Securit
Term and type of security
Series and CUSIP designation
date
Rate

Maturity

Interest
Investment

Terms
Method

Accrued
by

available.

tenders

Noncompetitive

$4 f 945, 555, 000

$2 g 000 ~ 000 J 000

30 year bonds
Series A-2021
(CUSIP No. 761157AG1)

39-1/4 year bonds (reopening)

15, 2021

tenders

interest payable

investor

(CUSIP No. 761157ACO)

April 15, 2030

based on the

i nvestors

To be determined
at auction
To be determined after auction
April 15 and October 15

Must be

Yield auction
expressed

as an annual
yield, with two decimals,

Must be

Accepted in full at the average
price up to $1, 000, 000

e. g. , 7. 10%

7. 10%

Accepted in

$1, 000

Full payment

with tender

Deposit guarantee by
designated institutions

$1 000

Yield auction
expressed

as an annual
yield, with two decimals, e. g. ,

full at the average
to $1, 000, 000
$22. 43132 per $1, 000 (from Octobe]
15, 1990, to January 15, 1991).

price

to be submit. t;ed

Tuesday,

January

Full payment
tender

Acceptable

funds

7/8%

To be determined at auction
To be determined after auction
July 15 and January 15

None

Pa ent Terms:
Payment by non-institutional

Receipt of tenders
(a) Noncompetitive
(b) Competztzve
Settlement:
Immediately available

Series B-2030

average of accepted bids

yield

of Sale:
of sale

Competitive

15, 1991
January 2, 1991

To be determined

denomination

Minimum

OF REFCORP OFFERINGS TO THE PUBLIC
YEAR BONDS TO BE ISSUED ON JANUARY

January

or discount
Interest payment dates

Premium

39-1/4

to be submitted

Acceptable

8, 1991

prior to 12:00 noon, EST
prior to 1:00 p. m. , EST
Tuesday, January 15, 1991

January 8, 1991,
prior to 12:00 noon, EST
prior to 1:00 p. m. , EST

Tuesday,
\

Tuesday,

January

15, 1991

with

apartment of the Treasury ~ Washlnltoh,

O.C. ~ Telephone S66-2

FOR IMMEDIATE

January

RELEASE

CONTACT:

3, 1991

Desiree Tucker-Sorini
(202) 566-8773

Announces Support for Tax Relief
for Desert Shield Participants

Treasury

Washington

The Treasury Department announced today
supports legislation sponsored by Senator
Robert Dole, Representative Bob Michel, Representative Dan
Rostenkowski and others which will provide additional tax relief
to military or civilian participants in the Desert Shield
operation in the Persian Gulf area.

that the Administration

The legislation will extend the time period for filing
federal income tax returns, paying federal income tax and taking
a variety of other actions, such as filing claims for refund of
federal income tax, until 60 days after the individual's
participation in the Desert Shield operation comes to an end.
The legislation provides that interest will not be charged on tax
payments made within the extended time period.
Federal income
tax refunds that are due to Desert Shield participants will,
however, continue to earn interest at the normal statutory rates.

x x x

NB-1083

~ pesrtmeni

of the Treasury

FOR RELEASE AT

January

12:00

4, 1991

Nashlneton,

NOON

TREASURY'S

El.

CONTACT:

c. ~

Telephone $$6-0

Office of Financing
202/376-4350

52-WEEK BILL OFFERING

of the Treasury, by this public notice,
invites tenders for approximately S11, 750 million of 364-day
Treasury bills to be dated January 17, 1991, and to mature
January 16, 1992 (CUSIP No. 912794 XV 1). This issue will provide about $2, 200 million of new cash for the Treasury, as the
maturing 52-week bill is outstanding
in the amount of $9, 554
million. Tenders will be received at Federal Reserve Banks and
Branches and at the Bureau of the Public Debt, Washington, D. C.
20239-1500, Thursday, January 10, 1991, prior to 12:00 noon for
noncompetitive tenders and prior to 1:00 p. m. , Eastern Standard
time, for competitive tenders.
The bills will be issued on a discount basis under competitive and noncompetitive bidding, and at maturity their par amount
This series of bills will be
will be payable without interest.
issued entirely in book-entry form in a minimum amount of S10, 000
on the records either of the
and in any higher S5, 000 multiple,
or of the Department of the
Reserve
Banks
and
Branches,
Federal
The Department

Treasury.

bills will be issued for cash and in exchange for
bills maturing January 17, 1991. In addition to the
maturing 52-week bills, there are S19, 341 million of maturing
bills which were originally issued as 13-week and 26-week bills.
The disposition of this latter amount will be announced next
The

Treasury

Federal Reserve Banks currently hold S914 million as
agents for foreign and international monetary authorities, and
$6, 761 million for their own account. These amounts represent
the combined holdings of such accounts for the three issues of
Tenders from Federal Reserve Banks for their
maturing bills.
own account and as agents for foreign and international
monetary
authorities will be accepted at the weighted average bank disAdditional amounts
count rate of accepted competitive tenders.
Federal
Reserve
issued
to
be
Banks, as agents
bills
of the
may
for foreign and international monetary authorities, to the extent
that the aggregate amount of tenders for such accounts exceeds
the aggregate amount of maturing bills held by them. For purposes of determining such additional amounts, foreign and international monetary authorities are considered to hold $190 million
of the original 52-week issue. Tenders for bills to be maintained on the book —entry records of the Department of the
Treasury should be submitted on Form PD 5176-3.
week.

NB-1 084

TREASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

page

bidder, as defined in Treasury s single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1, 000, 000.
Banking institutions and dealers who make primary
markets in Government securities and report daily to the Federal
Reserve Bank of New York their positions in and borrowings on
such securities may submit tenders for account of customers, if
the names of the customers and the amount for each customer are
furnished.
Others are only permitted to submit tenders for their
own account.
Each tender must state the amount of any net long
position in the bills being offered if such position is in excess
of $200 million. This information should reflect positions held
as of one-half hour prior to the closing time for receipt of
tenders on the day of the auction. Such positions would include
bills acquired through "when issued" trading, and futures and
forward transactions as well as holdings of outstanding bills
with the same maturity date as the new offering, e. g. , bills
with three months to maturity previously offered as six-month
bills. Dealers, who make primary markets in Government securities and report daily to the Federal Reserve Bank of New York
their positions in and borrowings on such securities, when submitting tenders for customers, must submit a separate tender for
each customer whose net long position in the bill being offered
exceeds $200 million.

noncompetitive bidder may not have entered into an
agreement, nor make an agreement to purchase or sell or otherwise dispose of any noncompetitive awards of this issue being
auctioned prior to the designated closing time for receipt of
A

tenders.

Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury.
A cash adjustment
will be made on all accepted tenders for the
difference between the par payment submitted and the actual

issue price as determined

in the auction.

deposit need accompany tenders from incorporated banks
companies and from responsible and recognized dealers
investment
in
securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches.
No

and

8/89

trust

TREASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 3

for accepted tenders for bills to be maintained

will be

made

for differences

between

the par value of the

bills accepted in exchange and the issue price of the
new bills.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures.
Accrual-basis taxpayers, banks, and other

maturing

8/89

PUBLI
Department

of'the Treasuri

FOR IMMEDIATE

Bureau of the Public Debt

RELEASE

~ ll'ashint,

CONTACT:

7, 1991

January

RESULTS OF TREASURY'S AUCTION

ton. DC 20'239

Office of Financing

202-376-4350

OF 13-WEEK

BILLS

Tenders for $10, 033 million of 13-week bills to be issued
on January 10, 1991 and mature on April 11, 1991 were
accepted today (CUSIP: 912794WD2).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

Investment
Rate

Price
98. 357
High
98. 349
Average
98. 352
Tenders at the high
were allotted 60%.
The investment rate is the equivalent coupon-issue yield.
TENDERS RECEIVED AND ACCEPTED (in thousands)

6. 50%
6. 53%
6. 52%

6. 70%
6. 73%
6. 72%
discount rate

Low

Location
Boston
New

York

Philadelphia
Cleveland
Richmond

Atlanta

39, 325

62, 340

9, 870

TOTALS

Type

Competitive
Noncompetitive

Public

Federal Reserve
Foreign Official

Institutions

An additional
issued to foreign

i&B-1085

9, 870

49, 065
27, 850
924, 040
918 120

Dallas
San Francisco
Treasury

TOTALS

555

7, 920, 090
54, 890
65, 285
109, 735
38, 525
303, 185
28, 340

1, 488, 185

Chicago
St. Louis
Minneapolis
Kansas City

Subtotal,

"—
I!—
53,

Received
53, 555
24, 414, 090
54, 890
65, 285
115, 735

49, 065
27, 850

$28, 222, 350

454, 040
918 120
$10, 032, 550

$24.-035, 110

$5, 845, 310

927 400

1 927 400

$25, 962, 510

$7, 772, 710

2, 177, 730

82 110

82 110
$10, 032, 550

$28/222

i 350

$122, 490 thousand

of bills will be
for new cash.

official institutions

ru~~I
Department

DE T
~

of the Treasury

FOR IMMEDIATE

Bureau of the Public Debt

RELEASE

lX'ashinyon,

CONTACT:

7, 1991

January

RESULTS OF TREASURY'S AUCTION

DC 20239

R
'~~4„

Office of Financing

202-376-4350

OF 26-WEEK

BILLS

for $10, 012 million of 26-week bills to be issued
10, 1991 and mature on July 11, 1991 were

Tenders

on January

accepted today (CUSIP: 912794WY6).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

6. 50%
6. 52%
6. 51%

Investment
Rate

Price

96. 714
6. 81%
96. 704
High
6. 84%
Average
6. 824
96. 709
Tenders at the high discount rate were allotted 53%.
The investment rate is the equivalent coupon-issue yield.
Low

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Philadelphia
Cleveland

Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Type

Competitive
Noncompetitive

Subtotal,

Public

Federal Reserve
Foreign Official

Institutions
TOTALS

Received
50, 560
25, 996, 340
19, 965
48, 555
49, 185
34, 735
1, 577, 320
40, 045
8, 090
52, 100
22, 270
563, 935
741 530
$29, 204, 630

(in thousands)
dl

50, 560
8, 630, 420
19, 965
48, 555
48, 245
33, 715
145, 070
22, 695
8, 090
52, 050
22, 260
188, 735

741 530
$10i 011 i 890

$25, 120, 585
1 475 155
$26, 595, 740

$5, 927, 845

2, 300, 000

308 890
$29, 204, 630

308 890
$10, 011, 890

1 475 155

$7, 403, 000

additional $446, 910 thousand of bills will be
issued to foreign official institutions for new cash.
An

NB-1086

~hSt
~~

Department

ot the Treasury

Bureau of the Public Debt

4'ashington,

DC 20239

Contact: Peter Hollenbach
(202) 376-4302

FOR RELE SE AT 3:OO PM
January 7, 1991

PUBLIC DEBT ANNOUNCES ACTIVITY FOR
SECURITIES IN THE STRIPS PROGRAM FOR DECEMBER 1990

Treasury's Bureau of the Public Debt announced activity figures for the month of December
of securities within the Separate Trading of Registered Interest and Principal of Securities
program. (STRIPS).
Dollar Amounts in Thousands

$473, 539,584

Principal Outstanding
(Eligible Securities)
Held in Unstripped

$359,953, 194

Form

$113,586, 390

Held in Stripped Form

Reconstituted

1990.

$5, 076, 440

December

The accompanying table gives a breakdown of STRIPS activity by individual loan description.
The balances in this table are subject to audit and subsequent revision. These monthly figures are
Statement o the u ic e t entitled "Holdings of Treasury
included in Table VI of the Month
"
Securities in Stripped Form. These can also be obtained through a recorded message on
(202) 447-9873.

oOo

TABLE

—HOLOINGS

OF TREASURY SECURITIES

STRIPPEO FORM, OECEllSER

31, 19M

(In thouwnds)
Malunty

Loan Doser tptron

1.5/brttt

t. »4tttt

Dale

$8.85$.5 54

$5.547.354

$1 ASt, tOO

6.933 861

6.442. 021

~ 71,040

I 1995

5/1 5/95

7. 127 086

5, 915.006

1,211,200

1905

8/1 5/95

7.95S.90 1

7.293,901

C-t094

1 1 I 1 5/04

Note

2/ t

'i'/2w Note

Strtppab Form

5/95

Not ~

tierrr NOte

Thea ibartth '

pa/tron ttatd ut
unatltppbd Farm

Total

1995

-0-

).«ttte

Note D-1995

310,550

6. 354.5SO

042, 000

jT/btttt

Note A. 1996

2/1 5/96

6 575, 199

8.343. 100

232, 000

C. 1996

5/15/96

20.00S.843

19,171.243

214,400

I 3/894 Note

Not ~ D. 1996

20, 250. 6'1 0

20.023.810

1/trrr Not ~ A. 1 g97

5/1 5/07

9,021.237

0.04$. 037

I 1997

8/t 5/07

9,342.436

0. 330.034

32.000

0. 702.$t0

2/15/98

9.N$. 320
9.150.064

0. 154. 1N

5/t 5/08

1, 106,307

0. 135.307

8/15/06

11,342.048

11.213.444

124, NO

9,$0$, 475

$.4N

T. t/ ~ rrr

1/1 5/95

) 5/btt/t Note
1 Trbrur NOt

~ C 1997

) 1/8& Note
)rrt Not ~

8. 1098
t

t/t 5/06

1/1 S/97

tggb

Note C

9 t/4/ttt

098

9 //barr

Not ~ A

191

2/1 5/00

9.002.0 75
9, 711,820

9 t/btrtt

Note B 1999

5/1 5/90

1Q.047, 103

0, 1 70.303

/toe Not

8/ 1 5/09

10.183.6«

10AS1.$44
10.7$$.0N

9.7/btttt Not ~ D 1998
1

C. 1990

1/1S/90

T/br/r

11/t 5/91

10, 773.0N

1/trur NOt ~ A. 2000

tl 1 5/00

0.673.033

T/btttt

8.2000

5/1 5/00

0, 40L230

1 Q,

C. 2000

$/ 1 5/00

1.0N, 646

Note

trot ~

9 Yett/t Note

1990

9 t/244 NO14 D 2000
1 1

2004

5/Stat Bond

1/1 5/00

1/1 5/04

510.886

4.000
2, NO

0.7'1 ~ .42$

6 301,008

~ .000

-0-

0.$73,033
4$$.030

t.tN

3.684.NO

-0-0~, 434~
2.7II, IN

1.0N. $44

-0-0-

$10,40$

-0-0-0-0-0-0-0-0-

-I-0-0-0-0-0-0-0-0-0-0-

5/1$/05

4 280 754

1, S30, NI

I/AS/05

9.200. 713

~,372. 113

N7. 4N

1 5/06

4, 7SS,916

4. 7$$.~ 1$

-0-

11 3/444 BOnd 2009-1 4

11/15/14

O. QOS, 504

1.Sl ~, 0$4

OAN. NO

~ t, tN

2015

2/1$I15

12.447. 790

2.052.430

10 5/btte Bond 2015

8/15/15

7, 140,~ 1 0

1,074, 070

6, 000.050

t. t 50, 040

124+ Bond
1

2005

0 Y4rttt Bond 2005
Bond 2008

9 Ybrttt

t/4rrr Bond

9 T/brrr Bond

2015

11/15/15

9 1 /4rttt Bond

0.~ L3N
'1

L47$~
~, 740.aa

-0-0-

N7 A%I

tILNQ

I, T7T~
4, 7II,IN

l~~

~ .4N. 044

7, 284, 054

2018

2/1S/18

T. t/44/tr

Bond 2016

$/15/18

1 ~,

$23, SS 1

1$~.35

t/trttt

Bond 2016

11/1$/18

1 ~,

$44.«4

li, lt t, NI

Bond 2017

5/15/17

~ . 104, 140

$.4$2.4$0

9-7/8& BOnd 2017

6/15/1 7

14,018,058

~ AS3, 84$

4, IOLNO

$/1 S/18

~ . 7tS.430

t.05$.$30

S 3/ ~ tur

t/694 Bond

2010

~I,NO

ttWtAN

III~

7Ã, IN

0.032.070

1,437+70

7.$$LIXO

10,0QQ

2019

2/15/11

10,250, 703

S.220.0$3

14,0N. gg

704 AXO

5-1/89e Bond 2010

8/1S/11

20.213.032

t, 104,032

~, OLNO

20, 1N

2/1 5/20

10.220.080

3.0$7.208
$24 t, N3

~t, NO

1.NS.NO

9W Bond

2018

9. 7/6% BOnd

1/1 Sl 1 0

1/2'

Bond 2020

6. Y4tttt

BOnd 2020

5/ 1 5/20

10. 154.003

8-Y4% Bond 2020

8/1 5/20

21.~ 1 ~.$58

~ 73.530.504

Tot ~ I

6tfectnre May

Not ~

1. 1047, ouruttee held

etnpped

lorttt were ~ torttte lor recoltatataton

Dn the ~ th woraday ol eaoh month ~ reap/tang ot T ~ ttte vt wta tte avartapte
The tte/anoee rn thta tao/a are cult/eat to audtt and euoeeouent adtuetmente

lo therr unatnpped

4, ~

17~

~ 1LNO

354, N3. 104

11LSN,SN

tp/m

aber 3.00 pm The taphohtsa

numpe

IIIII 447~73

43LTN

Nm
L07L 440

federal financing bank
WASHINGTON,

D. C.

20220

FOR

IMMEDIATE

0
J anuary

RELEASE

FEDERAL FINANCING

BANK

ACTIVITY

Charles D. Haworth, Secretary, Federal Financing Bank
(FFB), announced the following activity for the month of

November

1990.

FFB holdings of obligations issued, sold or guaranteed
other
Federal agencies totaled $177. 6 billion on
by
November 30, 1990, posting a decrease of $2. 9 billion from
the level on October 31, 1990. This net change was the
result of a decrease in holdings of agency-guaranteed loans
of $4, 549. 6 million and in holdings of agency assets of
$0. 2 million, while holdings of agency debt increased by
$1, 631.6 million. FFB made 28 disbursements during November.
Attached to this release are tables presenting FFB
November loan activity and FFB holdings as of November 30, 1990.

NB-1087

Page 2
FEDERAL FINANCING
NOVEMBER

1990

+Note
+Note
+Note
+Note

idi

BANK

AC1'IVZIY

AMOUNI'

FINAL

OF ADVANCE

MA'IURITY

ZNI~PST

INTEREST

RATE

(semi-

(other than
semi-annUal)

annual )

Central Li

Faci1 it

¹532
¹533
¹534
¹535

7, 570, 000. 00
21, 790, 000. 00
10, 000, 000. 00
10, 000, 000. 00

2/4/91
2/14/91
2/25/91
1/28/91

7. 434%
7. 443%
7. 381%
7. 392%

11/7
11/9
11/13
11/19
11/26
11/29

300, 000, 000. 00
300, 000, 000. 00
617, 000, 000. 00
170, 000, 000. 00
150, 000, 000. 00
600, 000, 000. 00

1/2/91
1/2/91
1/2/91
1/2/91
1/2/91
1/2/91

7. 434%
7. 443%
7. 395%
7. 428%
7. 376%
7. 413%

11/6
11/8
11/15
11/15
11/17
11/21
11/28
11/30

195, 000, 000. 00
13, 000, 000. 00
347, 000, 000. 00
21, 000, 000. 00
30, 000, 000. 00
308, 000, 000. 00
28, 000, 000. 00
119,000, 000. 00

11/15/90

7. 428%
7. 434%
7. 383%
7. 383%
7. 443%
7. 448%

11/25

1, 155, 000, 000. 00

11/25/05

11/6
11/16
11/27
11/28

Note No. 90-07
Achrance

Advance
Advance
Advance
Advance
Advance

¹1
¹2

¹3
¹4

¹5
¹6

TENNESSEE VALLEY AUTHORITY

Short-term
Short-term
Short-term
Short-term
Short-term
Short-term
Short-term
Short-term

Bond ¹61
Bond ¹62
Bond ¹63
Bond ¹64
Bond ¹65
Bond ¹66
Bond ¹67
Bond ¹68

ll/15/90
11/21/90
11/23/90
11/30/90
12/3/90
12/11/90
12/11/90

7. 374%
7. 413%

FARMER'S HCNE MNINISTRATION

RHIF — CBO

+rollover

¹57548

8 453%

8. 632%

ann.

Page 3
FEDERAL FINANCING
NOVEMBER

1990

ACTIVITY

OF ADVANCE

FINAL
MKIURI'IY

INTER'~

ZVrERE. m

RATE

(semi-

(other than
semi-annual)

annual)
—GUARANTEED

BAHK

AMOUNI'

GOVERNMENT

IDANS

ARIT fEN'I' OF DEFENSE

Fore i
Honduras

Mil

Sales

11/30/94

8. 003%

5, 209, 310.05
4, 314, 285. 68
1, 161, 139.08

5/15/91
5/15/91
5/15/91

7. 505
7. 547
7. 454

380, 000. 00

12/1/03

8. 361\

8. 536%

11/1
11/1
11/27

978, 000. 00
617, 000. 00
410, 000. 00

I/O/22

12/31/19
1/2/18

8. 857%
8. 844%
8. 460%

8. 7G1% qtr.
8. 748\ qtr.
8. 372% qtr.

11/30

2, 282, 541. 54

12/31/90

7. 413%

11/29

21, 999.98

GENERAL SERVICES MNZNISH%TION

.S.
Advance
Advance
Advance

York

Nl
g2

11/15
11/21

11/27

0
Cincinnati,

HCUS

I?K

& URBAN

11/30

Electric
Electric

Note A-91-01

Ene

ann.

AIMI N I SUCTION

tl230A

5332
Iowa Power 0295

Seven Sta

DEVEIDf~

(N
CA

Brazos
Brazos
Central

New

rat 'on

Page
FEDERAL FINANCING

(in millions)

ram

November

icy Debt:

irt-Import Bank
Fund
.-Central Liquidity
elution Trust Corporation
lessee Valley Authority
Postal Service

sub-total*
agency Assets:

'armers Home Administration
iHHS-Health Maintenance Org.
HHS-Medical Facilities
ural Electrification Admin. -CBO
mall Business Administration

1990

8
11, 339.
74.

0
50, 300. 0
14, 130.0
6, 697. 8

October 31
S

government-Guaranteed
Loans:
3D-Foreign Military Sales
d. -Student Loan Marketinq Assn.
UD-Community
Dev. Block Grant
UD-Public Housinq Notes +
+
neral Services Administration
I-Guam Power Authority
I-Virgin Islands
SA-Space Communications
Co. +
N-Shxp Lease Financinq
ral Electrification Administration
A-Small Business Investment Cos.
A-State/Local Development Cos.
A-Seven States Energy Corp.

T-Section 511
T-WMATA

sub-total*
S

1990

Net Chancre

11 1 90-11 30 90

11, 339. 8
87. 3
48, 163.0

82, 541. 6
52, 324. 0

52, 324. 0

4, 407. 2

8. 0
56, 891. 5

56, 891.7

5, 279. 8
4, 850. 0
239. 9
1, 903. 4
376. 8
29. 7
25. 3
2
1, 203.
4
1, 672.
18, 967. 8
340. 8
735. 2
2, 362. 7
23. 1
177. 0
38, 186. 9
177, 619.9

9, 747. 3
4, 880. 0
241. 0
1, 950. 8
367. 3
29. 7
25. 3
2
1, 203.
1, 672. 4
18, 965. 8
354. 6
738. 5
2, 360. 4
23. 3
177. 0
42, 736. 6
180, 538. 2

'91

Net Chancre

10 1 90-11 30 90

-0-13.4
137.0
2,-492.
-0-0

17.4
8, 818. 3
-252. 0
-0-

1, 631.6

8, 583. 7

-0-

-0-0-0-0-

69. 6
82. 7

275. 0

-0-0-0-

-0. 2
-0. 2

8. 2

BANK

14, 622. 0
6, 697. 8
80, 909. 9

69. 6
82. 7

sub-total*

grand total*
ue o roun zng
o a
may no
figures
not include capitalized interest
oes

-0. 4

274. 6

-4, 467. 5
-30. 0
-1.
-47. 41
9.
-0-5
-0-0-02. 0
-13.

-3. 84
2. 3
-0.
-0-3

-4, 549. 6
-2, 918.2

-4, 475. 8
-30. 0
-4.
-47. 40
9.
-0-5
-0107.
-0-3
-74. 5
-41.
-6. 84
6. 6
-0.
-0-3
-4, 556. 8
4, 301.5

department

of the Treasury

FOR RELEASE AT

4:00 P. M.

8, 1991

January

Washington,

O.C. ~ Telephone 566-2

CONTACT:

Office of Financing
202/376-4350

TREASURY'S WEEKLY BILL OFFERING

The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling approximately $20, 000 million, to be issued January 17, 1991. This
offering will provide about $650 million of new cash for the
Treasury, as the maturing bills are outstanding in the amount of
$19, 341 million. Tenders will be received at Federal Reserve
Banks and Branches and at the Bureau of the Public Debt, Washington, D. C. 20239-1500, Monday, January 14, 1991, prior to 12:00
noon for noncompetitive
tenders and prior to 1:00 p. m. , Eastern
Standard time, for competitive tenders.
The two series offered
are as follows:
91-day bills ( to maturity date) for approximately
$10, 000 million, representing an additional amount of bills dated
October 18, 1990, and to mature April 18, 1991 (CUSIP No. 912794
WE 0), currently
outstanding in the amount of $9, 982 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $10, 000 million, to be dated
January 17, 1991, and to mature July 18, 1991 (CUSIP No. 912794
WZ

3).

The bills will be
and noncompetitive

issued on a discount basis under competibidding, and at maturity their par amount
will be payable without interest.
Both series of bills will be
issued entirely in book-entry form in a minimum amount of $10, 000
and in any higher $5, 000 multiple,
on the records either of the
Federal Reserve Banks and Branches, or of the Department of the
Treasury.

tive

The

Treasury

bills will be issued for cash and in exchange for
bills maturing January 17, 1991. In addition to the
13-week and 26-week bills, there are $9, 554 million of
52-week bills.
The disposition of this latter amount

maturing
maturing
was announced

last week. Tenders from Federal Reserve Banks for
account and as agents for foreign and international
monetary authorities will be accepted at the weighted average
bank discount rates of accepted competitive tenders.
Additional
amounts of the bills may be issued to Federal Reserve Banks, as
agents for foreign and international monetary authorities, to
the extent that the aggregate amount of tenders for such accounts
exceeds the aggregate amount of maturing bills held by them.
For purposes of determining such additional amounts, foreign and
international monetary authorities are considered to hold $723
million of the original 13-week and 26-week issues. Federal
Reserve Banks currently hold $913 million as agents for foreign
and $6, 761 million for
monetary authorities,
and international
their own account. These amounts represent the combined holdings
of such accounts for the three issues of maturing bills. Tenders
for bills to be maintained on the book-entry records of the
Department of the Treasury should be submitted on Form PD 5176-1
(for 13-week series) or Form PD 5176-2 (for 26-week series).
their

own

TR1WSURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page

Each tender must state the par amount of bills bid for,
which must be a minimum of $10, 000. Tenders over $10, 000 must

of $5, 000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e. g. , 7. 154. Fractions may not be used. A single
bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1, 000, 000.
Banking institutions and dealers who make primary
markets in Government securities and report daily to the Federal
Reserve Bank of New York their positions in and borrowings on
such securities may submit tenders for account of customers, if
the names of the customers and the amount for each customer are
furnished.
Others are only permitted to submit tenders for their
own account.
Each tender must state the amount of any net long
position in the bills being offered if such position is in excess
of $200 million. This information should reflect positions held
as of one-half hour prior to the closing time for receipt of
tenders on the day of the auction. Such positions would include
bills acquired through "when issued" trading, and futures and
forward transactions as well as holdings of outstanding bills
with the same maturity date as the new offering, e. g. , bills
with three months to maturity previously offered as six-month
bills. Dealers, who make primary markets in Government securities and report daily to the Federal Reserve Bank of New York
their positions in and borrowings on such securities, when submitting tenders for customers, must submit a separate tender for
each customer whose net long position in the bill being offered
exceeds $200 million.

be in multiples

A noncompetitive
bidder may not have entered into an
agreement, nor make an agreement to purchase or sell or otherwise dispose of any noncompetitive awards of this issue being
auctioned prior to the designated closing time for receipt of

tenders.

Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury.
A cash adjustment
will be made on all accepted tenders for the
difference between the par payment submitted and the actual

issue price as determined

in the auction.

deposit need accompany tenders from incorporated banks
companies and from responsible and recog '. ized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches.
No

and

8/89

trust

TRF~URY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 3

Public announcement will be made by the Department of the
of the amount and yield range of accepted bids. Competitive bidders will be advised of the acceptance or rejection
of their tenders. The Secretary of the Treasury expressly
reserves the right to accept or reject any or all tenders, in
whole or in part, and the Secretary's action shall be final.
Subject to these reservations, noncompetitive tenders for each
issue for $1, 000, 000 or less without stated yield from any one
bidder will be accepted in full at the weighted average bank
discount rate (in two decimals) of accepted competitive bids
for the respective issues. The calculation of purchase prices
for accepted bids will be carried to three decimal places on the
basis of price per hundred, e. g. , 99.923, and the determinations
of the Secretary of the Treasury shall be final.
Treasury

Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on the issue date, in cash or other immediately-available
funds
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the
maturing bills accepted in exchange and the issue price of the
new

bills.

bill is

at issue,

held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures.
Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
a

purchased

and

Department of the Treasury Circulars, Public Debt SeriesNos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of the circulars, guidelines, and tender forms may be obtained
from any Federal Reserve Bank or Branch, or from the Bureau of

the Public Debt.
8/89

OVERSIGHT BOARD

D-, G--I, -TRESOLUTION
FOR

I MME D I ATE RE LEAS E
8, 1991
91-2)

CONTACT:

January
(OB

REFCORP ANNOUNCES

The Resolution

CORPORATION

FUNDING

RESULTS OF AUCTION

Funding

Felisa Neuringer

Brian Harrington
(202) 786-9672

OF 30-YEAR BONDS

Corporation

has accepted $4, 941 million

8. 59%
8. 61%
8. 60%

100 ' 375

$11, 019 million of tenders received from the public for the 30-year
bonds, Series A-2021, auctioned today. ' The bonds will be issued
January 15, 1991, and mature January 15, 2021.
The interest rate on the bonds bill be 8-5/8%. The range of
accepted competitive bids, and the corresponding prices at the 8-5/8%
interest rate are as follows:
Yield
Price
Low

High

Average

Tenders

at the high yield

100-160
100. 267

allotted

were

TENDERS RECEIVED AND ACCEPTED

Location
York

Philadelphia

4, 724, 641

13, 000
516, 140

13, 000
196, 140

4, 060

176 000

1 000

Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas

Totals

par amount

"rger

2, 000

11, 018, 641

of accepted tenders
tenders.

'The minimum

2, 000

San Francisco

noncompetitive

Acce ted

10, 307, 361

Cleveland

The $4, 941

(In Thousands)

Received

Boston
New

28%.

required

amounts

must

includes

4, 940, 921

$285 milli. on of

to strip the

be in multiples

REFCORP bonds

of that

~H E

OVERSIGHT BOARD

i RESOLUTION

RELEASE
(OB 91-3)

FOR IMMEDIATE

REFCORP ANNOUNCES

CORPORATION

CONTACT:

8, 1991

January

FUNDING

Felisa Neuringer

(202) 786-9672

Brian Harrington

RESULTS OF AUCTION

39-1/4

YEAR BONDS

Corporation has accepted $2, 000 million of
$6, 380 million of tenders received from' the public for the 39-1/4 year
The bonds will be issued on
bonds, Series B-2030, auctioned today.
January 15, 1991 and mature on April 15, 2030The Resolution

Funding

interest rate on the bonds will be 8-7/8%. The range of
accepted competitive bids, and the corresponding prices at the 8-7/8%
interest rate are as follows:
The

Low

High

Average

Tenders

at the high yield

Yield

Price

8. 48%
8. 52%
8. 50%

104. 433
103.963
104. 197

were

allotted

TENDERS RECEIVED AND ACCEPTED

(In Thousands)

Received

Location
Boston
New

84%.

York

Philadelphia
Cleveland

Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas

San Francisco

5, 999, 214

1, 863, 814

4, 000

299, 000
2, 000

129, 000
2, 000

76 000

1 000

6, 380, 214
The $2, 000 million of accepted tenders
noncompetitive tenders.

Totals

includes

$185 million

par amount required to strip the REFCORP bonds
Larger amounts must be in multiples of that amount.

'The minimum

$1, 600, 000.

1, 999, 814

the auction price, accrued interest

of $22. ~3132

LI DEBT E
Department

of the Treasury

FOR IMMEDIATE

Bureau of the Public Debt

RELEASE

CONTACT:

9, 1991

January

ll'ashington,

RESULTS OF TREASURY'S AUCTION

DC 20239

~~4

Office of Financing

202-376-4350

OF 7-YEAR NOTES

Tenders for $8, 544 million of 7-year notes, Series E-1998,
be issued on January 15, 1991 and mature on January 15, 1998
were accepted today (CUSIP: 912827ZT2).

interest rate

the notes will be 7 7/8%. The range
of accepted bids and corresponding prices are as follows:
The

Price

Yield

7. 94%
7. 95%
7. 95%

99. 656
99-603
99. 603
Average
$10, 000 was accepted at lower yields.
Tenders at the high yield were allotted
Low

High

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Philadelphia
Cleveland

Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Received

21, 482

21, 269, 807
6, 759
13, 873
29, 376

11, 936
1, 192, 786

12, 703
5, 649
17, 019
6, 683
409, 432
3 477

$23/000g982

45%.

(in thousands)

21, 469
7, 993, 351
6, 759
13, 864
20, 276

11, 808

371, 986
8, 703
5, 649
15, 019
6, 682
65, 382
3

477

$8, 544, 425

The $8, 544 million of accepted tenders includes $595
million of noncompetitive tenders and $7, 949 million of
competitive tenders from the public.

In addition, $165 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
An additional
$397 million
international monetary authorities.
of tenders was also accepted at the average price from Federal
Reserve Banks for their own account in exchange for maturing

securities.

NB-1089

r vu~
Department

I;Pq

of the Treasury

FOR IMMEDIATE

Bureau of the Public Debt

RELEASE

Washinyon,

CONTACT:

10, 1991

January

DC 20239

Office of Financing

202-376-4350

RESULTS OF TREASURY'S AUCTION OF 52-WEEK BILLS

Tenders for $11,767 million of 52-week bills to be issued
on January 17, 1991 and mature on January 16, 1992 were
accepted today (CUSIP: 912794XV1).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

6. 19%
6. 23%
6. 22%

Investment
Rate

Price

93.741
6. 59%
6. 63%
93. 701
High
6. 62%
93. 711
Average
Tenders at the high discount rate were allotted 72%.
The investment rate is the equivalent coupon-issue yield.
Low

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Philadelphia
Cleveland

Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Type

Competitive
Noncompetitive
Subtotal, Public

Federal Reserve
Foreign Official

Institutions
TOTALS

NB-1090

Received

49, 480
26, 925, 775
28, 570
45, 545
46, 140

(in thousands)
49, 480
10, 453, 135
28, 570

1, 808, 740

45, 545
46, 140
39, 970
427, 740

388 870
$30, 321, 260

168, 805
388 870
$11,766, 660

41, 650

36, 375
12, 495
53, 595
21, 620
862, 405

31, 255
12, 495
53, 035
21, 620

$26, 412, 195
1 179 065
$27, 591, 260

$7, 857, 595

2, 600, 000

130 000

$30, 321, 260

~~a~

1 179 065

$9, 036, 660
130 000

$11, 766, 660

of the Treasury

apartment

FOR IMMEDIATE

January

Washlnyton,

RELEASE

O. C. ~ Telephone i44-24
I

CONTACT:

11, 1991

UNITED

STATES
NEW

CHERYL

CRISPEN

(202) 566-5252

VENEZUELA TO DISCUSS A
INCOME TAX TREATY

AND

The Treasury Department today announced that representatives
of the United States and Venezuela will meet in Washington,
January 22-25, to discuss a possible bilateral income tax treaty
between their two countries.
Currently, no income tax treaty is

effect

between

the two countries.

negotiations

will take into account the model income tax
for Economic Cooperation
by the Organization
and Development,
the United Nations, and the U. S. Treasury
Department, as well as tax treaties recently concluded by the two
countries with other countries, and recent changes in their
respective income tax laws.
The

treaties published

tax treaties provide
in one of the countries

rules for the taxation of income
(the "source" country) by
residents of the other. They establish when the source country
rates of
may tax various classes of income and specify maximum
tax at source on certain items, such as dividends, interest and
royalties. They also provide for administrative cooperation
of the two countries and guarantee
between the tax authorities
non-discriminatory
taxation. Treaty benefits are limited to
residents of the two countries.
Income

derived

to offer comments or suggestions on the
are invited to write to Philip D. Morrison,

Persons wishing

negotiations
International
20220.

Tax Counsel,

Treasury

o 0 o

NB-1091

Department,

Washington,

8I I
Department

of the Treasury

FOR IMMEDIATE

DEBT
~

Bureau of the Public Debt

RELEASE

9'ashington,

CONTACT:

14, 1991

January

RESULTS OF TREASURY'S AUCTION

DC 20239

Office of Financing

202-376-4350

OF 13-WEEK

BILLS

Tenders for $10, 022 million of 13-week bills to be issued
on January 17, 1991 and mature on April 18, 1991 were
accepted today (CUSIP: 912794WEO).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

6. 084
6. 124
6. 12%

Low

High

Average

Investment
Rate

6. 26%
6. 304
6. 30%

Price
98. 463
98. 453
98. 453

$2, 450, 000 was accepted at lower yields.
Tenders at the high discount rate were allotted 95%.
The investment
rate is the equivalent coupon-issue yield.
TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

Received
76, 960
26, 747, 435
38, 110
75, 100

York

Philadelphia

Cleveland

71, 845

Richmond

Atlanta

54, 715

1, 481, 740

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Type

Competitive
Noncompetitive

Subtotal,

Public

Federal Reserve
Foreign Official

Institutions
TOTALS

An additional
issued to foreign

NB-" 092

(in thousands)
76, 960
8, 372, 980
38, 110
75, 100
71, 845
53, 555
173, 990
20, 430
12, 390
56, 205
30, 090
340, 055

62, 430
12, 390
56, 205
30, 090
1, 001, 055
699 815
$30, 407, 890

699 815
$10, 021, 525

$26, 293, 170

$5, 906, 805

056 075
$28, 349, 245

056 075
$7, 962, 880

1, 961, 120

97 525

$30, 407, 890
$2, 975 thousand

97 525

$10, 021, 525

of bills will be
for new cash.

official institutions

r +~~I
Department

D BT
~

of the Treasury

FOR IMMEDIATE

Bureau of the Public Debt

RELEASE

RESULTS OF TREASURY'S AUCTION

Tenders
on January

ll'ashington,

CONTACT:

14, 1991

January

DC "t)'2.f'9

Office of Financing

202-376-4350

OF 26-WEEK

for $10, 018 million of 26-week bills to be issued
17, 1991 and mature on July 18, 1991 were

accepted today (CUSIP: 912794WZ3).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

Investment
Rate
6. 474

Price

6. 18%
96. 876
6. 224
6. 51%
96. 855
High
6.
6.
Average
214
50%
96. 861
$300, 000 was accepted at lower yields.
Tenders at the high discount rate were allotted 7%.
The investment rate is the equivalent coupon-issue yield.
Low

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

Received
55, 775
24, 632, 430
26, 760

York

Philadelphia
Cleveland

Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco

Treasury

TOTALS

Type

Competitive
Noncompetitive

Subtotal,

Public

Federal Reserve
Foreign Official

Institutions
TOTALS

59, 475
66, 075
48, 950
2, 061, 330
41, 510
14, 150
56, 035
23, 150
730, 460

(in thousands)
lt

55, 775
8, 503, 280
26, 760
59, 475
66, 075
45, 810
388, 080

19, 650
14, 150
56, 035

23, 150
206, 280

553 000
$28, 369, 100

553 000
$10, 017, 520

$23, 952, 955

$5, 601, 375

$25, 453, 930

$7, 102, 350

2, 200, 000

715 170
$28, 369, 100

$10, 017, 520

1 500 975

715 170

additional $9, 430 thousand of bills will be
issued to foreign official institutions for new cash.
An

N8-1093

$Rt

apartment

of the treasury

FOR IMMEDIATE

January

14,

wasWnoion,

RELEASE
9

0.C.

CONTACT:

telephone $44-2c

CHERYL CRISPEN
202 5 -5 5

UNITED STATES INCOME TAX TREATY
WITH TUNISIA RATIFIED

Department announced today that instruments
were
exchanged with Tunisia on December 26, 1990,
of ratification
bringing into force the Convention between the Government of
the United States of America and the Government of the Tunisian
Republic for the Avoidance of Double Taxation and the Prevention
of Fiscal Evasion with respect to Taxes on Income. The
The Treasury

of the Convention will take effect, in the case of
withholding
taxes, for amounts paid or credited on or after
January 1, 1991, and in the case of other taxes on income, for
taxable years ending on or after December 31, 1990.
provisions

o 0 o

NB-1094

of the Treeao
aery

apartment

January

D.c. ~ Telephone

Naahlnyioa,

15, 1991

sil-20

Contact: Cheryl Crispen
(202) 566-5252

Robert Snow
(202) 535-5708
RAYMOND

GOVERNMENT

A. SHADDICK RECEIVES TOP
HONOR

FROM

PRESIDENT BUSH

A. Shaddick, Assistant Director for the U. S. Secret
received the
in the Department
of the Treasury,
Distinguished Rank Award from President Bush at a ceremony
January 9 in the White House.
This $20, 000 award is one of the
Presidential Rank Awards, and is the highest honor bestowed upon a
member of the Senior Executive Service.
Raymond

Service

In praising Mr. Shaddick and other award winners, President
"These talented
executives have performed
their
duties with the highest standards of excellence and
integrity. In so doing, they have upheld the public trust bestowed
the lives of countless American
upon them and have enriched
citizens. I applaud their many achievements, and I extend my

Bush said,
management

gratitude,

our country.

and

that of all Americans,

for their contributions

Echoing the high praise by the President, Treasury Secretary
Nicholas F. Brady stated, "The Treasury Department could not ask
for a more dedicated individual.
efforts and
Ray Shaddick's
diligence as the Special Agent in Charge of the Presidential
Protective Division are a model for all Treasury employees. "

Shaddick's award recognizes his flexible and creative
style in the U. S. Secret Service. His abilities have
been tested throughout his 21 years with the Secret Service.
He
was Special Agent in Charge of the Honolulu office, which due to
its location and high number of visiting foreign dignitaries
presented unique problems which Mr. Shaddick solved. In his role
as Special Agent in Charge of Presidential Protection he oversaw
security for the Presidential election and subsequent transition
starting in November 1988. Mr. Shaddick was recently promoted to
Assistant Director for Investigations.
Mr.
management

Mr.

Shaddick,

Centreville,

a native

Virginia.

of California,
oOo

presently

lives

artmeni of the TreaiusV
l

January

«/

Washington,

D.C. ~ Telephone $16-2o

g g

15, 1991

Contact: Cheryl Crispen

(202) 566-5252

&-'SURV

CHARLZS
GOVERNMENT

Roger Busby
(912) 230-2908

RINKEVI

HONOR

CH
FROM

RECEIVES TOP
PRESIDENT BUSH

Charles F. Rinkevich, Director of the Federal Law Enforcement
Training Center in the Department of the Treasury, received the
Distinguished Rank Award from President Bush at a ceremony
January 9 in the White House.
This $20, 000 award is one of the
Presidential Rank Awards, and is the highest honor bestowed upon a
member of the Senior Executive Service.

In praising Mr. Rinkevich and other award winners, President
"These talented
executives have performed
their
duties with the highest standards of excellence and
integrity. In so doing, they have upheld the public trust bestowed
the lives of countless American
upon them and have enriched
citizens. I applaud their many achievements, and I extend my

Bush said,
management

gratitude,

and

our country. "

that of all Americans,

for their contributions

Echoing the high praise by the President, Treasury Secretary
Nicholas F. Brady stated, "The Treasury Department could not ask
Charles Rinkevich's efforts and
for a more dedicated individual.
diligence in the operation of the Federal Law Enforcement Training
Center are a model for all Treasury employees. "

Rinkevich's's award recognizes his "aggressive leadership"
in directing the Federal Law Enforcement Training Center (FLZTC) in
Glynco, Georgia, where he is an integral player in the President'
strategy to combat crime. Since his appointment in 1983, FLZTC has
for our Nation's law enforcement
superior training
provided
personnel on a continuing basis at the lowest possible cost. It
serves over 60 federal agencies and graduates over 29, 000 students
Mr.

annually.

received a bachelor's
Rinkevich
Mr.
degree
in police
from Michigan State University,
administration
and a master' s
from Georgia State University.
degree in public administration
oOo

apartment

January

the Treasury

Nashlnoton,

15, 1991

O.C. ~ TelePhone S66-2t

Contact: Barbara Clay

(202) 566-5252

RICHARD

GOVERNMENT

NEWCOMB
HONOR FROM

RECEIVES TOP
PRESIDENT BUSH

R. Richard Newcomb, Director of the Office of Foreign Assets
Control
in the Department
received the
of the Treasury,
Distinguished Rank Award from President Bush at a ceremony
January 9 in the White House.
This $20, 000 award is one of the
Presidential Rank Awards, and is the highest honor bestowed upon a
member of the Senior Executive Service.

In praising Mr. Newcomb and other award winners, President
"These talented
their
executives have performed
duties with the highest standards of excellence and
integrity. In so doing, they have upheld the public trust bestowed
the lives of countless American
upon them and have enriched
citizens. I applaud their many achievements, and I extend my

Bush said,
management

gratitude,

our country.

" that of all

and

Americans,

for their contributions

Echoing the high praise by the President, Treasury Secretary
Nicholas F. Brady stated, "The Treasury Department could not ask
Rick Newcomb's efforts and
for a more dedicated individual.
diligence in the operation of the Office of Foreign Assets Control
are a model for all Treasury employees. "
Mr. Newcomb's award recognizes his "extraordinary leadership"
which has been vital in ensuring compliance with economic sanctions
and embargo programs
ordered by the President.
Recently, his
office quickly and effectively implemented the broad economic
Under his direction,
sanctions ordered against Iraq.
FAC has
become an extremely productive and efficient organization that has
achieved wide recognition for its many accomplishments.

native of Toledo, Ohio, Mr. Newcomb received a B.A from
Kenyon College, Gambier, Ohio, and a J. D. degree from Case-Western
Law School,
Cleveland,
Reserve University
Ohio.
He has been
admitted to the bar in both Ohio and the District of Columbia, and
is a member of the D. C. Bar Association.
A

oOo

NOTE

Due to a brief illness,
ceremony at which the awards
award at a later date.

TO THE

PRESS

Mr. Newcomb was unable to attend the
He will receive the
were presented.

Ipartment of the treasury
FOR RELEASE AT

January

4:00 P. M.

Nashlnyion,
CONTACT:

15. 1991

D.C. ~ Telephone S6$-20
Office of Financing
202/376-4350

TREASURY'S WEEKLY BILL OFFERING

of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling
approximately $20, 000 million, to be issued January 24, 1991.
This offering will provide about $2, 175 million of new cash for
The Department

bills are outstanding

in the amount
of $17, 821 million. Tenders will be received at Federal Reserve
Banks and Branches and at the Bureau of the Public Debt, Washington, D. C. 20239-1500, Tuesday, January 22, 1991, prior to 12:00
noon for noncompetitive
tenders and prior to 1:00 p. m. , Eastern
The two series offered
Standard time, for competitive tenders.
are as follows:
the Treasury,

as the maturing

91-day bills (to maturity date) for approximately
$10, 000 million, representing an additional amount of bills
dated October 25, 1990, and to mature April 25, 1991 (CUSIP No.
912794 WF 7), currently outstanding in the amount of $20, 666
million, the additional and original bills to be freely
interchangeable.
182-day bills for approximately $10, 000 million, to be
dated January 24, 1991, and to mature July 25, 1991 (CUSIP No.
912794 XA 7).
The bills will be
and noncompetitive

tive

The

bills will be issued for cash and in exchange for
bills maturing January 24, 1991. Tenders from Federal

Treasury
Reserve Banks for their

for foreign
will be accepted at the
of accepted competitive
weighted average
Additional
amounts
of
the
bills may be issued to
tenders.
Federal Reserve Banks, as agents for foreign and international
to the extent that the aggregate amount
monetary authorities,
of tenders for such accounts exceeds the aggregate amount of
Federal Reserve Banks currently
maturing bills held by them.
hold $591 million as agents for foreign and international
monetary authorities, and $4, 858 million for their own account.
Tenders for bills to be maintained on the book-entry records
of the Department of the Treasury should be submitted on Form
PD 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week
and

international

series).

Ve-3095

own

account and as agents

monetary authorities
bank discount rates

TE&ASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 2

bidder, as defined in Treasury's single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1, 000, 000.
and dealers who make primary
Banking institutions
markets in Government securities and report daily to the Federal
Reserve Bank of New York their positions in and borrowings on
such securities may submit tenders for account of customers, if
the names of the customers and the amount for each customer are
furnished.
Others are only permitted to submit tenders for their
own account.
Each tender must state the amount of any net long
position in the bills being offered if such position is in excess
of $200 million. This information should reflect positions held
as of one-half hour prior to the closing time for receipt of
tenders on the day of the auction. Such positions would include
bills acquired through "when issued" trading, and futures and
forward transactions as well as holdings of outstanding bills
with the same maturity date as the new offering, e. g. , bills
with three months to maturity previously offered as six-month
bills. Dealers, who make primary markets in Government securities and report daily to the Federal Reserve Bank of New York
their positions in and borrowings on such securities, when submitting tenders for customers, must submit a separate tender for
each customer whose net long position in the bill being offered
exceeds $200 million.
A noncompetitive
bidder may not have entered into an
agreement, nor make an agreement to purchase or sell or otherwise dispose of any noncompetitive awards of this issue being
auctioned prior to the designated closing time for receipt of

tenders.

Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury.
A cash adjustment
will be made on all accepted tenders for the
difference between the par payment submitted and the actual

issue price as determined

in the auction.

tenders from incorporated banks
and trust companies and from responsible and recogni~ed dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches.
No

8/89

deposit, need accompany

TREASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 3

Settlement

for accepted tenders for bills to be maintained

on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
funds
on the issue date, in cash or other immediately-available
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the
maturing bills accepted in exchange and the issue price of the
new

bills.
If a bill is

purchased

at issue,

and

is held to maturity,

the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures.
Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series
Nos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of the circulars, guidelines, and tender forms may be obtained
from any Federal Reserve Bank or Branch, or from the Bureau of

the Public Debt.
8/89

partment of the Triaury

Nashlnyton,

4:00 P. M.
16, 1991

FOR RELEASE AT

January

CONTACT:

D.C. ~ Telephone s66-lt
Office of Financing
202/376-4350

TREASURY TO AUCTION 2-YEAR AND 5-YEAR NOTES
TOTALING $21, 500 MILLION

will auction $12, 500 million of 2-year notes
and $9, 000 million of 5-year notes to refund $10, 262 million of
securities maturing January 31, 1991, and to raise about $11, 250
million new cash. The $10, 262 million of maturing securities are
those held by the public, including $725 million currently held
by Federal Reserve Banks as agents for foreign and international
The Treasury

monetary

authorities.

The $21, 500 million is being offered to the public, and any
amounts tendered by Federal Reserve Banks as agents for foreign
and international
monetary authorities will be added to that
amount.
Tenders for such accounts will be accepted at the aver-

age prices of accepted competitive

tenders.

In addition to the public holdings, Federal Reserve Banks,
for their own accounts, hold $929 million of the maturing securities that may be refunded by issuing additional amounts of the
new securities at the average prices of accepted competitive
tenders.
Details about each of the new securities are given in the
attached highlights of the offerings and in the official offering

circulars.

oOo

Attachment

NB-1096

HIGHLIGHTS OF TREASURY OFFERI
OF 2-YEAR AND 5-YEAR NOTES TO BE ISSUED JANUARY

LI J.

31, 1991
January

Offered to the Public

Amount

Descri tion of Securit
Term and type of security
Series and CUSIP designation

date
Interest Rate

Maturity

yield
or discount
Interest payment dates
Minimum denomination
available
Investment

Premium

Terms
Method

of Sale:
of sale

Noncompetitive
Accrued
by

interest payable

Pa ment Terms:
Payment by non-institutional
0 ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~

... . ... .

Receipt of tenders
a) noncompetitive
b) competxtxve

Settlement
a) funds

(final payment
institutions):
immediately

to the Treasury
re,~dily-collectible check

available

(CUSIP No. 912827

January 31, 1993
To be determined based on
the average of accepted bids
To be determined at auction
To be determined after auction
July 31 and January 31
$5, 000

Series K-1996

(CUSIP No. 912827

31, 1996
To be determined based on
the average of accepted bids
To be determined at auction
January

To be determined after
July 31 and January 31

auction

$1, 000

Yield auction

Must be expressed as
an annual yield, with two
decimals, e. g. , 7. 10%

None

Full payment

submitted

Deposit guarantee by
designated institutions

due from

W-1993

Accepted in full at the average price up to $1, 000, 000

tenders

Investor

investors

5-year notes

2-year notes

Yield auction

tenders

Competitive

$9, 000 million

$12, 500 million

Series

16, 1991

with tender

Accepted in full at the average price up to $1, 000, 000

to be
with tender

Full payment
submitted

Acceptable

January 23, 1991
prior to 12:00 noon, EST

Thursday,

Thursday, January 31, 1991
Tuesday, January 29, 1991

Wednesday,

prior to 1:00 p. m.

, EST

January

24, 1991

prior to 12:00 noon,
prior to 1:00 p. m. ,

EST
EST

OVERSIGHT BOMOS,

(

Resolution Trust Corporation

Contact:

FOR IMMEDIATE RZLEASE

January
OB

91-4

17, 1991

OVZRBZGHT

$02LRD ADVISES RESTRUCTURXKG

Art Siddon
Brian Harrington
(202) 786-9672
OF

1988 FSLIC

DEALS

Board for the Resolution Trust Corporation
established guidelines for exercising the government's
contractual options or for renegotiating the 1988 FSLIC
agreements to achieve maximum savings for the American taxpayer.
The Oversight

(RTC) has

The guidelines

grant the

prepay or restructure high
maintenance agreements, as
whenever the R2'C determines

RTC

interest

broad operating

flexibility to

FSLIC notes and yield
allowed. under the contracts,

case-by-case basis that such
restructuring will maximize savings to the taxpayer. The RTC is
also authorized to enter into negotiations to reshape the
agreements in order to save money for the taxpayers.
on a

Late in the last session, Congress appropriated $22 billion
for the 1988 Deals. The Oversight Board recently received from
the RTC its recommendations to save money as wall as a report on
the competitiveness of the 1988 Deal biddmg process.
"Given the billions of dollars to be saved, " said peter
Monroe, President of the Oversight Board, "the Board has acted
cpickly to give policy guidance and also has granted broad
operating flexibility so tha RTC negotiations to save money can
commence

immediately.

The RTC will be responsible for the actual restructuring
of
the deals. However, it will report monthly to the Oversight
Board regarding actions taken, amounts expended and cost savings
achieved or projected as a result thereof. The RTC Inspector
of the policy.
General also will review implerentation

Yith respect to the competitive bidding report, the Board
authorized the RTC to take appropriate actions where fraud or
other misconduct by private parties is discovered.
The Oversight Board formulates the policy, approves the
funding, and p"ovides general oversight over the RTC, the agency

for resolving the nation's failed thrifts.
Oversight Board includes Secre ary of the Treasury Nicholas Brady
as chairman, Federal Reserve Chairman Alan Greenspan, Secreta~
of Housing and Urban Develo-rent Jack Kemp, Phili Jackson and
responsible

Robert Larson.

January

STATEMENT

21, 1991

OF THE GROUP OF SEVEN

The Finance Ministers and Central Bank Governors of Canada,
France, Germany, Italy, Japan, the United Kingdom and the United
States met on January 20 and 21, 1991, in New York City for an
exchange of views on current international
economic and financial
issues. The Managing Director of the IMF participated in the
multilateral surveillance discussions.

Ministers and Governors reviewed their economic policies
prospects and reaffirmed their support for economic policy
coordination at this critical time. They noted that although
growth in all their economies had slowed, expansion of the world
economy continues, and the pace of activity could be expected to
pick up later this year. They noted that growth remains
particularly strong in Germany and Japan. Implementation of
sound fiscal policies, combined with stability oriented monetary
policies, should create conditions favorable to lower global
interest rates and a stronger world economy. They also stressed
the importance of a timely and successful conclusion of the
The

and

Uruguay

Round.

The Ministers and Governors also discussed the situation in
global financial markets in light of uncertainties arising from
the Gulf war and developments in the Soviet Union. They agreed
to strengthen cooperation and to monitor developments in exchange
The Ministers and Governors are prepared to respond as
markets.
appropriate to maintain stability in international financial
markets.

DEPARTMENT OF THE TREASURY
WASHINGTON

December

20, 19I90

ASSISTANT SECRETARY

„-„~3

)('g'J

The Honorable Lloyd Bentsen
Chairman
Committee on Finance

United States Senate
Washington, D. C. 20510
Dear Mr. Chairman:

After four decades as trust territories
under
the
stewardship
of the United States, the Federated States of
Micronesia ("the FSM") and the Marshall Islands concluded in 1985
an agreement with the United States giving both jurisdictions
the
status of freely associated states. This agreement, the Compact of
Free Association (the "Compact" ), was enacted as part of the
Compact of Free Association Act of 1985 (the "Act").'

Section 407 of the Act directs the Secretary of the
Treasury or his delegate to conduct a study of the effects of the
tax provisions of the Compact (as clarified by the provisions of
the Act) and to report the results of that study to the Committee
on Ways and Means of the House of Representatives
and the Committee
on Finance of the Senate.
The date for filing that report was
extended to January 1, 1991 by Section 11831 of the Revenue
Reconciliation Act of 1990.

directive.

This

report
am

sending

submitted
pursuant
to that statutory
similar letter to Senator Bob Packwood.

BACKGROUN

entered into force on October 21, 1986 with
respect to the Marshall Islands and on November 3, 1986 with
respect to the FSM. As modified by the Act, the tax provisions of
the Compact included the ollowing:
The Compact

recognition of the authority of the FSM and the
Islands to impose tax on the worldwide
income of their residents and confirmation that the
United States would allow relief from federal tax
in the form of the foreign tax credit and the
foreign earned income exclusion under Section 911
of the United States Internal Revenue Code (the

Marshall

"Code" )

'pub.

'Id.

L. No. 99-239 (1986).
, Compact

$254 (as clarified

by Act

$403) .

continuation
of eligibility of the FSM and the
Marshall Islands for convention benefits under Code
Section 274(h)(3)(A) and

extension

to the

the Marshall Islands tax
benefits under Code Section 936 as if they were
~ ST
possessions, so long as a tax information
exchange agreement with the U. S. is in effect. '
FSM and

first

constitutes
an
provisions
Islands have
that
FSM and
the Marshall
previously enacted their own income and business tax systems. The
tax systems which were in place prior to the enactment of the Act
are still in effect.
The
acknowledgment

of
the

these

The second provision
states that for purposes of Code
Section 274 (h) (3) (A), the term "North American area" shall include
both the FSM and the Marshall Islands'
Code Section 274(h)

deductions for expenses attributable
to attendance at
certain conventions held outside of North America. Inclusion of
these jurisdictions
in the "North American area" permits the
deduction of such expenses (so long as they are otherwise allowable
under Code Section 162) with respect to conventions held in the FSM
Prior to the Act, however, the FSM and
and the Marshall Islands.
the Marshall Islands were part of the Trust Territory of the
Pacific Islands, which has been included in the "North American
area" since the introduction of the restrictions under Code Section
274(h). Thus the Act merely clarified that this beneficial status
Islands
would continue to apply after the FSM and the Marshall

disallows

freely associated states.
The third provision is the extension of Code Section 936
benefits to the FSM and the Marshall Islands in the same manner as
This is potentially the
such benefits apply to U. S. possessions.
most significant
tax provision in the Act.
The tax credit
available under Code Section 936 would effectively eliminate
federal taxes on certain active business and investment income
U. S. businesses
earned
operating
in these
qualifying
by
benefits
these
do
not
However,
after
December
apply
jurisdictions'
unless
there
is
in
effect
an
exchange of information
31, 1986,
agreement with the United States of the kind described in Code
Section 274(h)(6)(C) (other than clause (ii) thereof).
As
neither
jurisdiction
has
discussed below,
yet finalized such an
became

agreement

'~dpi

with the United

States.

S 405 '

Compact

5 255

(as clarified

by Act, $

4Q4).

TAX INFORMATION

EXCHANGE

AGREEMENT

NEGOTIATIONS

In April of 1986, representatives
of the United States,
the Marshall Islands met to discuss the requirements of
a tax information exchange agreement.
In November of 1986, shortly
after the Compact entered into force, the Department of Treasury
wrote to the FSM and the Marshall Islands inviting both governments
to continue discussions regarding the steps necessary to put into
effect suitable agreements.
A negotiating
session was held in
December of 1986 to discuss specific tax information
exchange
provisions. Draft agreements were provided to both the FSM and the
Marshall Islands.

the

FSM and

For the next two years, there was no response from the FSM
with respect to our proposed agreement.
In January of 1989, the

expressed renewed interest in continuing negotiations
and
requested draft legislation
prepared
Revenue
by the Internal
Service to assist countries in adopting certain laws required by
tax information exchange agreements.
The requested material was
promptly sent to the FSM. We have not yet received a reply from
the FSM with respect to its further consideration of the proposed
agreement.
FSM

Significant progress has been achieved in the negotiations
with the Marshall Islands.
Several draft agreements have been
exchanged and draft legislation and other documentation have been
provided to the Marshall Islands. The negotiators have now agreed
on proposed
and we are currently
language
in the process of
a final agreement
preparing
for execution with the Marshall
Islands.

EFFECTS OF

PROV S ON

The Act directs the Department of Treasury to study the
effects of the above tax provisions and to report the results of
that study to the Committee on Ways and Means of the House of

Representatives and the Committee on Finance of the Senate. ' As
discussed below, during the period that the Compact has been in
force, there have been no measurable effects from these tax

provisions.

With respect to their internal tax laws, both the FSM and
the Marshall Islands had income tax and business tax laws in effect
prior to the Act. These laws remain in effect currently and were
not significantly amended as a result of the Act. In short, the
Act simply acknowledged the authority of the FSM and the Marshall
Islands to adopt their existing tax systems.

With respect to convention benefits, the Act continued the
"North American area" status which had previously been available to
both the FSM and the Marshall Islands. Moreover, because of their
distance from the United States mainland and the limited facilities
on the islands, there have been few, if any, business conventions
attended by United States taxpayers in either jurisdiction.

the only tax provision in the Act which would produce
measurable effects is the potential extension of Code Section 936
to these jurisdictions.
Since neither the FSM nor the Marshall
Islands has yet entered into a tax information exchange agreement,
for
Code Section 936 was only applicable
in these jurisdictions
that no
understand
two months
We
in 1986.
approximately
corporations claimed Code Section 936 benefits in 1986 with respect
to operations in the FSM and the Marshall Islands. However, the
benefits of Code Section 936 will be applicable for the Marshall
Islands in the near future when its tax information exchange
agreement is executed.
Thus

In conclusion, no effects are expected to arise from the
tax provisions of the Compact until a tax information exchange
agreement is executed with either the FSM or the Marshall Islands.

be pleased

you have any

answer

questions

concerning

them.

this matter, I

Sincerely,
enneth

Assistant

Gideon

Secretary
(Tax Policy)

would

DEPARTMENT OF THE TREASURY
WASHINGTON

Decembe

20, 1990

ASSISTANT SECRETARY

The Honorable Dan Rostenkowski
Chairman
Committee on Ways and Means
House of Representatives

Washington,

20515

DE CD

Dear Mr. Chairman:

After four decades as trust territories
under
the
stewardship
of the United States, the Federated States of
Micronesia ("the FSM") and the Marshall Islands concluded in 1985
an agreement with the United States giving both jurisdictions
the
status of freely associated states' This agreement, the Compact of
Free Association (the "Compact" ), was enacted as part of the
Compact of Free Association Act of 1985 (the "Act").'

Section 407 of the Act directs the Secretary of the
or his delegate to conduct a study of the effects of the
tax provisions of the Compact (as clarified by the provisions of
the Act) and to report the results of that study to the Committee
on Ways and Means of the House of Representatives
and the Committee
The date for filing that report was
on Finance of the Senate'
extended
to January 1, 1991 by Section 11831 of the Revenue
Archer's
Reconciliation Act of 1990 '

Treasury

directives

This

report

sending

submitted

a similar

pursuant

to that

statutory

letter to Representative

Bill

BACKGROUN

The Compact entered into force on October 21, 1986 with
respect to the Marshall Islands and on November 3, 1986 with
respect to the FSM As modified by the Act, the tax provisions of
~

the Compact included

the following:

Marshall

Code )

'Pub. L. No. 99-239 (1986) .

'Id.

, Compact

$ 254

(as clarified

by Act S

403).

continuation
of eligibility of the FSM and the
Islands for convention benefits under Code
Section 274(h)(3)(A) and

Marshall

the Marshall Islands tax
benefits under Code Section 936 as if they were
U. S.
possessions, so long as a tax information
exchange agreement with the U. S. is in effect. '
extension

first

to the

FSM

and

an
constitutes
provisions
that
Islands have
FSM
and
the Marshall
previously enacted their own income and business tax systems. The
tax systems which were in place prior to the enactment of the Act
are still in effect.

The
acknowledgment

of
the

these

provision states that for purposes of Code
Section 274(h)(3)(A), the term "North American area" shall include
both the FSM and the Marshall Islands.
Code Section 274(h)
disallows deductions for expenses attributable to attendance at
certain conventions held outside of North America. Inclusion of
these jurisdictions
in the "North American area" permits the
such
deduction of
expenses (so long as they are otherwise allowable
under Code Section 162) with respect to conventions held in the FSM
Prior to the Act, however, the FSM and
and the Marshall Islands.
Islands
were
the Marshall
part of the Trust Territory of the
Pacific Islands, which has been included in the "North American
area" since the introduction of the restrictions under Code Section
274(h). Thus the Act merely clarified that this beneficial status
would continue to apply after the FSM and the Marshall
Islands
The

second

freely associated states.
The third provision is the extension of Code Section 936
benefits to the FSM and the Marshall Islands in the same manner as
This is potentially the
such benefits apply to U. S. possessions.
most significant
tax provision in the Act.
The tax credit
available under Code Section 936 would effectively eliminate
federal taxes on certain active business and investment income
U. S. businesses
earned
operating
in these
qualifying
by
jurisdictions. However, these benefits do not apply after December
31, 1986, unless there is in effect an exchange of information
agreement with the United States of the kind described in Code
Section 274(h)(6)(C) (other than clause (ii) thereof).
As
discussed below, neither jurisdiction has yet finalized such an
became

agreement

Id. ,

with the United

States.

405.

Compact

5 255

(as clarified

by Act, g

404).

TAX INFORMATION

EXCHANGE

AGREEMENT

NEGOTIATIONS

In April of 1986, representatives
of the United States,
Islands met to discuss the requirements of
a tax information exchange agreement.
In November of 1986, shortly
after the Compact entered into force, the Department of Treasury
wrote to the FSM and the Marshall Islands inviting both governments
to continue discussions regarding the steps necessary to put into
effect suitable agreements.
session was held in
A negotiating
December of 1986 to discuss specific tax information
exchange
provisions. Draft agreements were provided to both the FSM and the
Marshall Islands.

the

FSM

and the Marshall

For the next two years, there was no response from the FSM
with respect to our proposed agreement.
In January of 1989, the
FSM expressed
renewed
interest in continuing negotiations and
Revenue
requested draft legislation
prepared by the Internal
Service to assist countries in adopting certain laws required by
tax information exchange agreements.
The requested material was
promptly sent to the FSM. We have not yet received a reply from
the FSM with respect to its further consideration of the proposed
agreement.

Significant progress has been achieved in the negotiations
with the Marshall Islands'
Several draft agreements have been
have been
exchanged and draft legislation and other documentation
provided to the Marshall Islands. The negotiators have now agreed
and we are currently
in the process of
on proposed
language
for execution with the Marshall
a final agreement
preparing
Islands.

EFF C S OF

SIONS

directs the Department of Treasury to study
above tax provisions and to report the results
that study to the Committee on Ways and Means of the House
Representatives and the Committee on Finance of the Senate. '
discussed below, during the period that the Compact has been
force, there have been no measurable effects from these
The Act

effects of the

provisions.

the
of
of
As

tax

With respect to their internal tax laws, both the FSM and
the Marshall Islands had income tax and business tax laws in effect
prior to the Act. These laws remain in effect currently and ~ere
not significantly amended as a result of the Act. In short, the
Act simply acknowledged the authority of the FSM and the Marshall
Islands to adopt their existing tax systems.

407.

I DEBT NEW
'

Di partment ot the Treasuri

FOR IMMEDIATE

Bureau of the Public Debt

M'ashinyon,

CONTACT:

RELEASE

22, 1991

January

RESULTS OF TREASURY'S AUCTION

DC '0239

Office of Financing

202-376-4350

OF 13-WEEK

BILLS

Tenders for $10, 041 million of 13-week bills to be issued
on January 24, 1991 and mature on April 25, 1991 were
accepted today (CUSIP: 912794WF7).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

Investment
Rate

Price
98. 450
98. 445
High
98. 448
Average
Tenders at the high discount rate were allotted 22%.
The investment rate is the equivalent coupon-issue yield.

6. 13%
6. 15%
6. 14%

Low

6. 31%
6. 34%
6. 32%

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

Received
39, 595
40, 168, 275
34, 245
52, 950

York

Philadelphia
Cleveland

(in thousands)
ll

39, 595
8, 768, 530
34, 245
52, 840
50, 260
36, 075
56, 700
16, 305
10, 735
41, 845

Chicago
St. Louis
Minneapolis
Kansas City

150, 260
40, 075
1, 538, 805
40, 305
10, 735
41, 845

TOTALS

$43, 665, 545

$10, 040, 585

$39, 299, 525

$5, 674, 565

Richmond

Atlanta

Dallas
San Francisco
Treasury
Type

Competitive
Noncompetitive

Subtotal,

Public

Federal Reserve
Foreign Official

Institutions
TOTALS

22, 525
689, 090

836 840

1 742 880

22, 525
74, 090

836 840

$41, 042, 405

1 742 880
$7, 417, 445

2, 558, 060

65 080
$43, 665, 545

65 080
$10 i 040 i 585

additional $37, 920 thousand of bills wil] be
issued to foreign official institutions for new cash.
An

NB-1097

$RI

DEBT NEW

rurs&I
Department

ot the Treasuri

FOR IMMEDIATE

Bureau ot the Public Debt

RELEASE

'4'ashington.

CONTACT:

22, 1991

January

RESULTS OF TREASURY'S AUCTION

DC 2023'9

Office of Financing

202-376-~350

OF 26-WEEK

BILLS

Tenders for $10, 031 million of 26-week bills to be issued
on January 24, 1991 and mature on July 25, 1991 were
accepted today (CUSIP: 912794XA7).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

6. 20%
6. 21%
6. 21%

Low

High

Average

Investment
Rate

6. 49%
6. 50%
6. 50%

Price
96. 866
96. 861
96. 861

$2, 000, 000 was accepted at lower yields.
Tenders at the high discount rate were allotted 95%.
The investment rate is the equivalent coupon-issue yield.
TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Cleveland
Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
Type

Competitive
Noncompetitive

Public

Federal Reserve
Foreign Official

Institutions

An additional
issued to foreign

NB-1098

$32, 526, 615

$10, 030, 865

$28, 339, 205

$5, 843, 455

$29, 700, 045

$7, 204, 295

702 920

TOTALS

37, 705
41, 920
33, 790
1, 481, 755
55, 450
5, 825
37, 760
17, 465
574, 885

46, 705
8, 810, 620
19, 565
37, 705
41, 920
31, 790
141, 755
15, 450
5, 825
37, 760
17, 465
121, 385

19, 565

Philadelphia

Subtotal,

—I!—

(in thousands)

Received
46, 705
29, 470, 870

702 920

1 360 840

2, 300, 000
526 570

526 570

$32, 526, 615
$305, 130 thousand

$10, 030, 865

of bills will be
for new cash.

official institutions

~partment

of the Treasury
FOR RELEASE AT

4:00 P. M.

22, 1991

January

Washington,
CONTACT:

O.C. ~ Telephone
Office of Financing
202/376-4350

TREASURY'S WEEKLY BILL OFFERING

of the Treasury, by this public notice,
two series of Treasury bills totaling
approximately $20, 000 million, to be issued January 31, 1991.
This offering will provide about $475 million of new cash for
the Treasury, as the maturing bills are outstanding in the amount
of $19, 534 million. Tenders will be received at Federal Reserve
Banks and Branches and at the Bureau of the Public Debt, Washington, D. C. 20239-1500, Monday, January 28, 1991, prior to 12:00
noon for noncompetitive
tenders and prior to 1:00 p. m. , Eastern
Standard time, for competitive tenders.
The two series offered
are as follows:
The Department

invites tenders for

bills (to

maturity date) for approximately
representing an additional amount of bills
dated November 1, 1990, and to mature May 2, 1991 (CUSIP No.
912794 WG 5), currently outstanding in the amount of $9. 969
million, the additional and original bills to be freely
interchangeable.

91-day

$10, 000 million,

182-day bills (to maturity date) for approximately
$10, 000 million, representing an additional amount of bills
dated August 2, 1990, and to mature August 1, 1991 (CUSIP No.
912794 WS 9), currently outstanding in the amount of $10, 691
million, the additional and original bills to be freely
interchangeable.
The bills will be
and noncompetitive

issued on a discount basis under competibidding, and at maturity their par amount
Both series of bills will be
will be payable without interest.
issued entirely in book-entry form in a minimum amount of $10, 000
and in any higher $5, 000 multiple,
on the records either of the
Federal Reserve Banks and Branches, or of the Department of the
Treasury.

tive

The bills will be issued for cash and in exchange for
Treasury bills maturing January 31, 1991. Tenders from Federal
Reserve Banks for their own account and as agents for foreign
monetary authorities will be accepted at the
and international
weighted average bank discount rates of accepted competitive
Additional amounts of the bills may be issued to Fedtenders'
eral Reserve Banks, as agents for foreign and international
to the extent that the aggregate amount
monetary authorities,
of tenders for such accounts exceeds the aggregate amount of
Federal Reserve Banks currently
maturing bills held by them.
hold $1, 393 million as agents for foreign and international
and $3, 955 million for their own account.
monetary authorities,
Tenders for bills to be maintained on the book-entry records
of the Department of the Treasury should be submitted on Form
PD 5176-1 (for 13-week series) or Form PD 5176-2 (for 26-week

series).

Ne-1099

$66-:

TREASURY'

26-~

AND

52-WEEK

BALLL

OppERZNGSg

page

Each tender must state the par amount of bi]].s bid for,
which must be a minimum of $10, 000. Tenders over $10, 000 must
be in multiples of $5, 000. Competitive tenders must, also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e. g. , 7. 15%. Fractions may not be used.
A single

bidder, as defined in Treasury s single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1, 000, 000.
and dealers who make primary
Banking institutions
markets in Government securities and report daily to the Federal
Reserve Bank of New York their positions in and borrowings on
such securities may submit tenders for account of customers, if
the names of the customers and the amount for each customer are
Others are only permitted to submit tenders for their
furnished.
Each tender must state the amount of any net long
own account.
position in the bills being offered if such position is in excess
of $200 million. This information should reflect positions held
as of one-half hour prior to the closing time for receipt of
tenders on the day of the auction. Such positions would include
bills acquired through "when issued" trading, and futures and
forward transactions as well as holdings of outstanding bills
with the same maturity date as the new offering, e. g. , bills
with three months to maturity previously offered as six-month
bills. Dealers, who make primary markets in Government securities and report daily to the Federal Reserve Bank of New York
their positions in and borrowings on such securities, when submitting tenders for customers, must submit a separate tender for
each customer whose net long position in the bill being offered
exceeds $200 million.

competitive

tenders.

Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury.
A cash adjustment
will be made on all accepted tenders for the
difference between the par payment submitted and the actual

issue price as determined

in the auction.

deposit need accompany tenders from incorporated banks
companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches.
No

and

1/91

trust

TE&ASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 3

for accepted tenders for bills to be maintained

will be

made

for differences

between the par value
in exchange and the issue

of the

bills accepted
price of the
new bills.
If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures.
Accrual-basis taxpayers, banks, and other

maturing

persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
Department of the Treasury Circulars, Public Debt Series
Nos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of the circulars, guidelines, and tender forms may be obtained
from any Federal Reserve Bank or Branch, or from the Bureau of

the Public Debt.
8/89

)epartment of the Treasur

Bureau of the Public Debt

FOR IMMEDIATE RELEASE

Y5'ashington,

CONTACI:

January 22, 1991

DC 20239

~ ~

~~IC ~~

Office of Financing

(202) 376-4350

TREASURY CLARIFIES RULE ON NONCOMPETITIVE

AWARDS

The Treasury today clarified its policy on noncompetitive awards. The word "competitive'
has been added to the language in its offering announcements
and circulars.
This change clarifies which designated closing time (either 12:00 noon for noncompetitive
or 1:00 p. m. , Eastern time, for competitive tenders) applies to the purchase or sale or
other disposition of noncompetitive awards acquired through a Treasury auction.
Offering announcements

and circulars will now read as follows:

A noncompetitive bidder may not have entered into an agreement, nor
make an agreement to purchase or sell or otherwise dispose of any
noncompetitive
awards of this issue being auctioned prior to the
I
d
d
f
g»
g
d
p

fbi"

oOo

PA-0'

OVERSIGHT BOMOS
ITT7

Resoluhon Trust Cozporahon
STREET, N. W. WhSHINGTON.

FOR IMMEDIATE RELEASE

January
OB

91-5

CONTACT:

22, 1991

20132
Art Siddon

D. C

Brian Earrington
(202) 786-9672

OVERSIGHT BOARD NAMES VICE PRESIDENT FOR FINANCE AND MANAGEMENT

The Oversight Board for the Resolution Trust Corporation (RTC)
announced
of Lloyd B. Chaisson as vice
today the appointment
president for finance and management, effective immediately.

Mr. Chaisson comes to the Oversight
Board from the U. S.
Department
of Housing and Urban Development (HUD) where, as a
member
of Secretary Jack Kemp's principal staff, he led the
implementation
of the Secretary's management reform agenda. His
initiatives eliminated many of the management weaknesses which
crippled the department during the 1980's and resulted in billions
of dollars of losses to the American taxpayer.
Mr. Chaisson will
As vice president of finance and management,
be responsible
for measuring RTC financial performance and
In this
compliance with the Oversight Board's strategic plan.
capacity he wil1 be the focal point for reviewing the RTC's
operating plans, assessing the loss and wor~g capital needs of
the corporation, and assessing performance against established

targets.

"Mr. chaisson's extensive experience in management reform
prove valuable to the Board as we continue to emphasize

vill

our

oversight and evaluation role, " said Peter H. Monroe, President of
the Oversight Board. "At BUD he was instrumental in leading the
effort to put in place a set of extremely successful management
asset to the members of the
He will be a valuable
reforms.

Oversight

Board.

to his service at

prior

HUD,

Mr.

Chaisson

with

the

degree from Dartmouth

and

was

management consulting firm.
McKinsey and Company, an international
top management
While at McKinsey, Mr. Chaisson counseled
on
organizat
onal
issues
at many of this
strategic, operational and
country's leading auto, aerospace, financial, and petrochemical

corporations.

Mr. Chaisscn holds an undergraduate
a graduate management degree from Yale.
The

Oversight

the policy, approves
formulates
oversight
of the RTC, the agency
es the general
'
a'L
L'
Board

OVERSIGHT BOA%3
I'717
FOR IMMEDIATE

January
OB

91-7

Resolution
STREET, N. W.

T~ Corporation
WASHINGTON,

BQ2QK) COKPLHTES

Art Siddon
Brian Harrington
(202) 786-9672

SEHZOR STXFF

Board for the Resolution

The Oversight

20232

Contact:

RELEASE

23, 199l

OVERSIGHT

D. C.

Trust Corporation

of its personnel reorganization
with the appointments
today of final senior staff members.
Today's staff appointments were Lloyd B. Chaisson Zr. , a
former management consultant with T"e McKinsey Company, as vice
president for finance and management, and Robert Vastine, former
staff director of the Senate Republican Conference, as vice
president for congressional affairs.
(RTC) announced

the completion

in place a highly capable and experienced
nanagenent tean which will bring to the Board the expertise
necessary to focus on our oversight and evaluation
"We now have

responsibilities,

Oversight

Board.

" said Peter

H. Monroe,

of the

president

;fonr e noted that the required critical staff skills have
shi ted in recent months toward management consulting,
account'ng, financial analysis, and legal expertise as the
Oversight Board has focused more on evaluating RTC performance
under the Financial Institutions Reform, Recovery and Enforcement

Act o f 1989 (FIRE%A)

This has resulted in the recent appointments
to Chaisson an= Vastine — of:
Richard H. Farina,

. . it". the Wash'. -.gton

counsel.

law

specialist in corporate

fi~

of Reed Smith

-nore-

Shaw,

in addition

law and

as general

partner

Arthur Z. SiMon, an experienced journalist and Treasury
Department public affairs director, as vice president for public

affairs/public

liaison.

Kurt Wierschem, a 15 year veteran of the savings and loan
industry who was formerly in charge of RTC conservatorships
and
resolutions in Florida and Puerto Rico, as vice president for
evaluation and oversight.
Monroe said the Oversight Board
with mid level management and support
accountants, financ'al analysts, and

will finalize
personnel

attorneys.

its staffing

primarily

The Oversight Board formulates the policy, approves the
funding, and provides the general oversight of the RTC, the
agency responsible for resolving the nation s failed thrifts.

OVERSIGHT BO&U3
I'r7'r

Resolution Trust Corporation
STREET, N. W. WASHlNGTON,

PQR ZEMEDI2LTE REZZ3kSE

CONTACT:

Janu~ 23, 1991
OB

91-

D. C

20232

Xrt SXCCon
Brian ERTxihgton
(202)786-0672

OVERSIGET BO2QG) NAMES VICE PRESIDENT FOR CONGRESSZONM

AFFA&tS

Board for the Resolution Trust Corporation
today the appointment of Robert Vastine as vice
for congressional affairs, effective immediately.

The Oversight

(RTC) announced

president

comes to the Oversight Board from the Senate
Conference where, as staff director, he led the Senate

Mr. Vastine

Republican

leadership

which

is responsible for establishing

a forum for policy discussions
for U. S. Senators.

maintaining

services

organization

and communications

and

As vice president for congressional
affairs, Mr. Vastine
will direct the Oversight Board's relations with Congress.

"The Oversight Board is fortunate to have obtained the
services of Mr. Vastine, a multi-talented professional who has
won the respect and admiration
of Congressional members on both
sides of the aisle, " said Peter H. Monroe, President of the

Oversight Board. "Mr. Vastme provides the Oversight Board with
the necessary experience and expertise to ensure that our
legislative goals and responsibilities are met. "

Prior to his erm with the Senate Republican Conference,
Vastine served as legislative director to Senator John Chafee.
From 1975 to 1977, he served the in the Ford Administration
as a
Deputy Assistant Secretary for Trade Policy at the Treasury
Department.
Mr. Vastine was the Republican Staff Director for
the Senate Committee on Government Affairs from 1971 to 1975, and
Znc. in Washington, as manager of
represented CPC International,
national government affairs from 1969 to 1971.
Fellow of the Institute of Politics, Kennedy School of
Governzen- at Harvard in 1977, Mr. Vas inc received his
dec ee from Haverford College and a mastez's degree
undergraduate
from John Hopkins University.
A

The Oversight Board foz=ulates the
funding, and provides general oversight
- ~=r~~~
ring the nation's

--'»

----'

policy, approves the
of the RTC, the ager. =;
="''ed

thrifts.

of the treason

~portment

Washlneton,

O.C. ~ l'eiephone

$56-2

UNTIL GIVEN
EXPECTED AT 10:00 A. MD
EMBARGOED

23' 1991

JANUARY

STATEMBfT OP EOSORABLE NICEOLAS

BRADY

Oversight Board of the
Resolution Trust Corporation
before the

Chairman,

Senate Committee

on Banking,

Housing

and Urban

23, 1991, 10:00 a.a.

January
538 Dirksen Senate Office Building

Affairs

Mr. Chairman, members of the Committee, ve are pleased to be
making our semiannual
appearance before your Committee today. We

look forvard to bringing you up to date on the progress heing
(RTC) and the Oversight
by the Resolution Trust Corporation
Board under the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 (FIRREA).

made

role as

of the Oversight Board
of the RTC. Accompanying me are the four other members of the
Board: Alan Greenspan, Chairman of the Federal Reserve Board,
Philip Jackson, Jr. , former member of the Federal Reserve Board
and currently adjunct professor at Birmingham 6outhern College,
Jack Rcmp, 6ecretary of the Department of Housing and Urban
Development, and Robert Larson, Vice Chairman of the Tauhman
Company and Chairman of the Taubman Realty Group. Also
accompanying us is Peter Monroe, vho is President of the
appear today in

Oversight

Chairman

Board.

We are here today to discuss RTC' ~ funding
needs as veil as
other issues that FIRREA requires for this semi-annual
appearance.

TC'S

FUNDING

NEEDS

Mr. Chairman, my most important objective today is to state
to the Committee as strongly as can the need for additional
funding for the RTC. If the RTC is to continue to carry out its
Congressionally assigned mission of resolving hundreds of failed
institutions and paying off their depositors vithout delay, then
If the RTC
must have additional funds as soon as possible.
fulfills its goals for January and February, and does not receive
vill have expended all available loss funds
additional funds,
vill he forced to stop closing and selling institutions hy
and
the end of February.

It is

that these funds are needed to protect
Without these funds, RTC vould have
of depositors.
alternative but to practice forbearance, that is, leave

the savings
no

vorth repeating

insolvent institutions open to cantinue to lase money for vhich
the taxpayers vill ultimately he liable. RTC has estimated that
forbearance for even one more quarter would cost the American
(These cost estimates are explained
taxpayers $750-$850 million.
in Appendix
This projected cost is in addition to the $250
million
to $300
already lost due to inaction last fall. This
vould bring the total cast of delay to aver $1 billion.

I).

Therefare,
dispatch.
Hov much

urge the Congress

vill

to act

on funding

with

he required?
Base4 an the RTC's draft
the nine-month period beginning January,
this fiscal year, an4 assuming funds are

1991,
plan for
through the end of
can complete
provide4 hy Congress, the RTC projects
approximately 225 additianal resolutions with $145 billion in
assets. To carry out the 4raft nine-month plan vould require
added loss funds of $30 billion through the end of fiscal year

operating

1991

of reasons, ve should consider whether
our actions should he limited just to this fiscal year' s
estimated needs. For one thing, the RTC may be able to exceed
expectations and resolve more than its goal of 225 institutions.
And together ve have already said to the public that the
government vill do what it needs to do to protect depositors.
Insolvent institutions already have incurred losses funded
primarily hy insured deposits.
Therefore, when these
institutions are sold or closed, cash is needed to pay the
difference between their deposit liabilities and the value of
assets assumed hy the institutions.
The fact is that this is not
a discretionary matter.
If ve do not act depositors will he left
Hovever,

for a

number

hanging.

the most sensible and appropriate way
for Congress to address the funding issue is to provi4e RTC with
the permanent funding necessary to get the vhole joh done. Such
funding would allow RTC to pursue its mandate aggressively and

Therefore,

ve believe

without costly interruption.
It should he noted that Congress
can responsibly provide such permanent funding vithout
diminishing its authority to oversee the clean-up process. The
RTC and the Oversight
Board appear before Congress regularly and
submit annual and semiannual reports.

afraid that if the Congress imposes on itself the
of repeated votes on funding, the result will he a start
and stop cleanup process that produces further delays,
substantial additional costs to taxpayers, and confusion and fear
in the minds of depositors.

burden

In June& 1990, at our semi-annual appearance, ve estimated
that the final cost of the SaL cleanup vould be in the range of
$90 to $130 billion in 19S9 present value terms. As ve explained
at the time, the actual cost is subject to a great deal of
uncertainty -- the number of cases, losses on assets, interest
rates, the condition of real estate markets, and the general
condition of the economy. Nov, the economy has entered a
dovnturn and the crisis in the persian Gulf has increased the
hesitance of potential buyers to make investment commitments.
All these factors are interrelated aad make predictions
hazardous.
Although the most likely cost scenario has probably moved to
the higher end of our original range, it nevertheless remains
within that range. In other vords, ve still believe that the
upper-end-of-the range estimate of $130 billion in 1989 present
value terms remains valid. However, as has been mentioned
numerous times, no one can guarantee any estimate based on such
volatile variables. We vill continue to monitor this situation

closely.

loss estimates are based on a cash flow model that
to vary a number of assumptions to take into account
their effect on the RTC's ultimate costs. This range is based
the resolution of from roughly 700 to just over 1000 thrifts.
more detailed explanation of our methodology can he found in
Appendix II to this testimony.
Our

permits

on
A

RTC WORX IN GETTING THE JOB DONE

size an4 complexity of the problem with which we
the Board believes that the RTC has made progress.

Given the

are dealing,

Bush announced his propose4 solution to the
When President
savings and loan crisis soon after taking office, he established
four principles vhich continue to guide us.

First, protect
men

the insured deposits of the millions
acted in trust hy putting their
insured savings and loans.
federally
in

and vomen vho

savings

Second, restore the safety and soundness of the savings
and loan industry so that a similar crisis can not

reoccur.

Third, clean up the SLL overhang so ve get the problem
behind us, and do it at the least cost to the taxpayer.

aggressively pursue and prosecute the crooks
an4 fraudulent operators vho helped create the problem.

Finally,

Mr. Chairman,

PIRREA gave RTC

day-to-day

operational

to resolve insolvent thrifts and sell assets. The
Oversight Board's responsibility is to set overall strategy,
policy and goals for the RTC, approve funding, and provide
aversight. Let me turn now ta matters that are required by law to
he addressed in our semi-annual report, and other matters of
interest to the Committee.
responsibility

required by PIRREA, our testimony vill cover the sixmonth period from April 1 thraugh 6eptember 30, 1990. In
addition, ve vill report on some af the key events accurring
since the end of that reporting period. My presentation is
supplemented
by a more detailed response, contained in Appendix
III, to several of the specific informatian requirements set
forth in FIRREA for this semiannual appearance.
As

Pro

ess in Resolutions

its

inception an August 9, 1989, through December 31,
1990, RTC seized 531 thrifts, and resolved 352 of them. That
left the RTC, as of January 1, 1991, in control of 179
conservatorships.
From

its resolution pace hy setting and
For
achieving goals.
example, for the three month period ending
June 30, the RTC's goal was the resolution af 141 institutions.
The RTC actually resolved 155. During the next quarter, the
RTC's goal was the resolution of 77 institutions
and it achieved
The RTC has achieved

resolutions.

For the 6-month period from October 1, 1990, to March 31,
1991, the RTC had expected to resolve 192 thrifts. As a result
of Congressional inaction on funding, RTC was forced to revise
its goal to resolve 97 thrifts. As of December 31@ 1990' RTC had
resolved 66 of its revised goal, and expects to meet its goal of
97 institutions
hy the end of February.
The New

Accelerated Resolution

Pro ram

ARP

Last summer the RTC began a pilot project, called the
Accelerated Resolution Program (ARP), to lower the cost of thrift
resolutions by pre-selling troubled institutions before they are
Such pre-sales should reduce the
put in conservatorship.
deterioration in franchise value and core deposits that can
result from placing an institution in conservatorship.
ARP is a
cooperative effort between the RTC and the Office of Thrift
Supervision (OTS) in which the OTS, in consultation with the RTC,
identifies which thrifts are ARP candidates. Then the OTS and RTC
establish a supervisory and regulatory framework within which the
institutions will operate while in ARP.

Nine institutions
were selected for the ARP pilot project.
They were chosen on the basis of: 1) bidder interest,
2) management-led
investor proposals, and/or 3) demonstrated
franchise value. The OT6 and RTC selected thrifts in different
geographic areas and of varying sizes ranging from $100 million
to more than $3 billion in assets.

In order to ensure open and competitive bidding, the
standard RTC bidding process has been followed.
As a result,
more than 1, 300 potential bidders from the RTC qualified bidders
list were notified by mail for each of the nine thrifts.

8ales have closed

of the nine institutions, and the
OTS and RTC have begun a review of this demonstration
program.
6ome valuable information
In all nine
already has been learned.
thrifts, there has been virtually no deposit runoff, management
has remained intact, and the institutions
have remained stable.
OT8

has begun

on seven

to review its

Group

Pro

thrifts to identify

candidates for the next phase of the program should the RTC
Oversight Board approve expansion beyond the pilot project. The
Board's decision will depend on the RTC's evaluation of the pilot

project.

8tatus of the

RTC

Conservatorshi

As of January 1, there were 179 thrifts in conservatorship.
In addition, the most likely candidates for new conservatorships
are in OTS's Group IV, which also contained 179 thrifts.
There
are another 356 thrifts in OTS's Group III for which the future

is uncertain.

of placing an institution in conservatorship
are that the RTC can stem losses, stabilize the institution, and
halt practices which may have contributed to insolvency.
Conservatorship
also helps the RTC prepare the institution for
resolution by reducing its assets by means such as securitization
and by reducing the institution's
high cost deposits.
The
is that conservatorship can
disadvantage of conservatorship
contribute to an erosion of franchise value. 8killed staff of ten
begin to leave in anticipation of a possible liquidation of the
institution, and depositors tend to accelerate their withdrawal
of funds. The Accelerated Resolution Program is intended to
avoid these disadvantages.
The advantages

Pro ress in Asset Dis osition

In addition to resolving insolvent institutions,
the RTC
must dispose of their assets, whether in conservatorship,
at

During the April through
or out of receivership.
semi-annual
our
report, receivership
September period covered hy
assets vere reduced hy 066. 8 billion in book
and conservatorship
value.

resolution,

its

inception through December 31, 1990, the
RTC has seize4 thrifts vith over $273 billion in initial assets.
asset sales and note
Through a combination of resolutions,
collections, it has reduced assets held hy over $127 billion, and
continues to hold assets of about $1i6 billion.
However,

from

has made progress, the Oversight Board and
RTC are concerned that RTC has not been able to sell more assets.
Therefore, the Oversight Board has over the past six months
seller financing
focused on developing policies - securitization,
that should enable the RTC to accelerate
and affordable housing
Even though

RTC

asset sales.

At our Board meeting

last

week, however,

Chairman

Seidman

tol4 us that there is a nev road block that will further delay
asset sales. The RTC Board has been advised that potential
personal liabilities may he imposed upon directors, officers, and
employees of the RTC and the Oversight Board in connection with
the RTC's securitization program as veil as in connection with
RTC's other asset disposition activities.
Chairman Seidman
indicated that a legislative solution to the problem is needed
and that his staff is currently drafting proposed legislation to
address the matter.
The Administration
is revieving this issue.
RTC Use

asset

of Private Sector to

FIRREA mandates
management
and

implement that,
and Disposition

the

Aid Asset

Sales

that the RTC make maximum delegation of
sales functions to the private sector.

has adopted a Standard
Agreement, or SAMDA program.
RTC

Asset Management

place4 over $10 billion

in real estate
contracts. Bids have
already been received to place another $10 billion under SAMDA.
Accordingly, most REO and delinquent mortgages in receivership
vill soon be un4er SAMDA contracts. The RTC is also proceeding
to place all such conservatorship assets under SAMDA contracts.
Private sector contractors vill be paid fees for managing
the properties as well as incentives to accelerate sales and
maximize the return to the RTC. While these contracts provide
fair returns for property management, the incentive fees will be
given for turning properties into cash rather than encouraging
managers to collect their management fees vhile they vait for the
real estate markets to improve.
The RTC has already
and delinquent
mortgages

under

SAMDA

There are incentives for selling at prices equal to or
greater than the RTC's estimates of recovery. There is a 20%
incentive payment for selling in the first year and 10% for
selling in the second year. Actual holding costs are deducted
from the sales price to encourage efficient management.
We believe the program
is promising, but we recognise the
difficulty of selling these assets in the current real estate

market.

ess toward Ninorit

Outreach

and Women Outreach Program seeks to
minority participation in the award of RTC contracts.
The RTC has conducted seminars throughout the country to inform
minority and women owned businesses of the many contractor
opportunities with the RTC and the registration and bidding
process. Advertisements are placed in minority print media to
publicize the program. As of November, 1990, RTC informs us that
over 3, 500 minority-owned
firms, over 4, 500 majority women-owned
firms, and approximately 900 minority women-owned firms were
registered as potential asset managers, brokers, lawyers and
other RTC contractors.
Over 900 contracts for such work, or
about 20% of total awards, have been awarded to minority and

The RTC Minority

encourage

women

owned

businesses.

also directs the RTC to give preference in purchasing
from investors with the same ethnic
identification as that of the failed thrift. As of November, the
FIRREA

thrifts to bids

resolved 14 minority
liquidated, 8 were acquired

RTC had

identification,

and

owned

institutions;

3 were

of the same ethnic
were sold to other buyers.
by buyers

The Oversight Board continues to monitor this effort by
to preserve minority-owned institutions and promote greater
awareness by minority and women-owned businesses of these
excellent business opportunities.
ENHANCBD

RTC

ENPORC

say a few additional words about some new enforcement
tools. As you know, in June 1990, President Bush announced a
initiatives designed to
package of legislative and administrative
intensify the fight against fraud in our nation's financial
Most of these legislative initiatives were
institutions.
embraced in a bi-partisan manner by the Congress and enacted as
the Comprehensive Thrift and Bank Fraud Prosecution and Taxpayer
Recovery Act of 1990.

Let

The new law provides

an array

of additional

powers

to the

Justice Department, hank regulators, the FDIC and the RTCp
particularly provisions which:
Provide authority to freeze or appoint a receiver for
the assets of fraudulent operators;
Enhance civil and criminal forfeiture authority;
Protect victims of fraud hy closing loopholes in the
bankruptcy laws that have in the past enabled some
executives to evade financial responsibility for their

misdeeds;

Allow the Justice Department to accept without
reimbursement
the services of federal attorneys,
enforcement personnel, and other employees;

law

Direct U. S. courts to give cases brought hy the FDIC
and the RTC priority consideration
and to establish
procedures for expedited appeals;

authorities a needed tool: the
ability to request the use of wiretaps for hank fraud
and related offenses.
In conjunction with the authorities provided in FIRREA, we
now have an effective arsenal of legal weapons available
to
combat fraud and to recover assets.
Using these authorities,
Give law enforcement

federal

law enforcement agencies are gaining ground against
fraudulent thrift officials. Of 566 defendants charged in
savings and loan cases from October 1988 through the end of 1990,
403 have been convicted and only 18 acquitte4.
Prison sentences
have been dealt totalling 768 years, and $231.8 million in
restitutions have been ordered. Of those convicted, substantial
numbers have been savings and loan chief executive officers,

chairmen,

presidents,

directors,

an4 other

RECENT OVERSIGHT

officers.

BOARD ACTIONS

Let me turn now to the key areas of Oversight Board activity
over the last six month period. First, I will discuss the
importance of asset sales and three Oversight Board actions in

this area:

securitization, seller financing and affordable
I will describe the Oversight Board's developing
oversight and evaluation role inclu4ing its management planning
housing.

procedures

Next,

and the relationship
Inspector General.

between

the Board an4 the

RTC

Finally, I will describe the Board's role in developing
policy for restructuring the 1988 Deals.

Revision of Asset Sales Strat

ies

said earlier, the increased number of resolutions
handled by the RTC makes it very important to accelerate its
asset sales. The Oversight Board is in the process of performing
an overall strategic review of RTC asset sales programs.
Our
goals are to increase both the sales pace and the return on asset
sales. Acquisition of this inventory is funded by working
capital borrowed by RTC from the Pederal Pinancing Bank (FFB).
These borrowings grew to $53 billion by December 31, 1990, and
are projected to reach $76 billion in Pebruary.
The RTC
estimates they may increase to over $100 billion by the end of
As

fiscal year 1991.

In developing asset sales policies, the Oversight Board
received valuable advice from the National Advisory Board and the
six regional boards established by FIRREA. Because the board
members know local economic conditions and are composed of
community leaders in the real estate, banking, housing, legal and
accounting professions, they have provided useful recommendations
for the Oversight Board.
The Need

for Securitisation

The Oversight Board recently directed the RTC to increase
use of securitization as a means to speed the sale of
performing financial assets. Securitization means the pooling of
financial assets with a positive cash flow and converting the
pool into one or more securities collateralized by the assets in
the pool.

its

The

policy applies to all securitizable

financial

assets

held by the RTC including mortgage loans, high-yield securities,
and any loans originated by the RTC under seller financing.
25% of all RTC assets are securitizable.
Approximately
The Board
believes that securitization should aid the RTC to sell these
assets more quickly, thus improving its cash flow position.
This, in turn, should materially lessen the pressures for working
capital borrowings through the FFB. Progress in the

securitization

area depends

I discussed earlier.

on the personal

liability protection

Seller Pinancin Poli
is one method to help the RTC sell its
While securitization
the RTC has informed the Board that
assets,
financial
performing
well
as real estate and delinquent
as
certain financial assets
mortgages are not securitizable and cannot be sold because
commercial financing is not available.
The

New

Accordingly, in December, the Oversight Board expanded its
seller financing policy to provide the RTC greater flexibility in

its asset sales

program.

hillion in seller financing
authority for assets that can't he sold at acceptable prices
As a result of such
because of inadequate commercial financing.
15% downpayment,
an
initial
sales, the RTC generally vill receive
over time. If buyers in
and receive the balance in installments
the RTC still comes
commitments,
their
such sales do not fulfill
This program provides

it has the 15% downpayment, it may have received a
of installment payments, it has shifted the asset's
operating costs to the private sector for a time, and it vill
It is important to remember
repossess the asset if necessary.
that the RTC has already paid for these assets so that the sale
Importantly, under this
can only reduce Treasury horrowings.
policy a minimum of $250 million is reserved solely for the
financing of affordable housing to qualifying low- and moderateout ahead:
number

income buyers.

This $7 billion program vill he measured, monitored and
evaluated for effectiveness hy the Oversight Board. The Board
has also directed the Inspector General to perform a front end
risk assessment of the program and conduct periodic audits of its
implementation.

Affordable

Housin

last

before this Committee, the Oversight
Board has adopted new policies regarding the Affordable Housing
Disposition Program. We believe the RTC is making progress in
responding to the FIRREA mandate in the area of affordable
housing for moderate-and lower-income persons.
Since

appeared

15, 1990, the Oversight Board approved a final
rule allowing for a number of marketing initiatives to expedite
the sale of properties.
The rule encourages the RTC to use hulk
sales and special marketing events such as home fairs, open
houses, and auctions to make qualified organizations and
individuals more aware of available properties.
Chairman Seidman has proposed a new program to sell to
eligible buyers during the clearinghouse period, the bulk of
RTC's single family affordable housing in a no reserve auction
and sealed hid process.
We have requested
Chairman Seidman to
provide more information on this initiative which the Oversight
Board clearly supports in principle.
The Oversight Board also approved a policy allowing the RTC
to accept offers from qualified buyers for single family
On

August

properties at prices as low as 80'4 of the market value. The
policy augmented an active RTC program to increase the
opportunities for low- and moderate- income buyers who are at or
below 80% of the local median income.

mentioned the minimum amount of $250 million
in seller financing which the Oversight Board made available to
the affordable housing program.
The RTC is establishing
guidelines for the implementation of seller financing.
The
Oversight Board previously authorized the RTC to pay up to $6
million to purchase forward mortgage revenue bond (MRB)
commitments to he exclusively reserved for the RTC affordable
One hundred eighty-nine
program.
million dollars has already
been reserved under this program which when combined with the
$250 million revolving affordable seller financing program
provides a minimum of $i39 million of financing for affordable
have already

housing.

Board has also encouraged the RTC to take
of the Federal National Mortgage Corporation's and the
Federal Home Loan Mortgage Corporation's demonstrated
capabilities in housing finance. Programs utilizing their
expertise in structuring and servicing seller financed mortgage
loans, including delegating the origination and servicing to
are now under
designated lenders with prudent underwriting,
consideration.
The Oversight

advantage

result of some of these new developments and the
growing experience of the program and staff, we can report that
Through December 31, 1990, the program
property sales increased.
had accepted approximately
$108 million of contracts on 2, 737
and
of
these,
properties,
1, 507 properties had closed. The
average sales price was $38, E42 for single family homes and
$936, 000 for the nine multi-family developments on which the RTC
had accepted offers.
RTC advises that the average income of
purchasers under the affordable program is less than 80% of
As a

national

median

income.

in conservatorship are hy statute not
subject to the 90-day marketing period, both the seller financing
and MRB programs are available for conservatorship
properties.
The RTC is encouraging non-profit organizations,
as well as
individuals, to make offers for conservatorship properties.
Although

properties

with the final rule in place, emphasis is switching to the
The RTC has had some
marketing of multi-family properties.
serious expression of interest in bulk packages of multi-family
affordable housing and its National Sales Center is currently
marketing its first bulk package of multi-family properties
consisting of three Florida developments with 590 units.
one key

to the progress in the affordable

housing

program

far has been the assistance of clearinghouses and technical
assistance advisors. The RTC has established 30 clearinghouse
agreements with state housing finance agencies including one with
the Federal Housing Finance Board with the participation of the

thus

district Federal

Home

Loan Banks.

he Board's Role in Oversi ht and Evalua

Under the Oversight Board's management planning procedures
believes are attainable.
the RTC is asked to set goals which
This is the best way to assure Chat RTC management is committed
to achieving these goals. The Board then evaluates the RTC's
performance against the goals.

For example, the Board has suggested improvements in RTC
planning and performance measurement through the operating plan
process. As mentioned earlier, the Board and RTC are working to
develop a final operating plan for fiscal 1991, rather than the 3
month plans submitted previouslyLonger planning periods more
accurately reflect the time horison needed by the RTC for proper
The nine month plan will be monitored monthly and
goal setting.
performance forecasts against goals will be provided quarterly
together with explanations of variances from plan. RTC will be
asked to submit a one year plan for fiscal year 1992.
The operating plan process provides a vehicle for setting
program goals and also funding needs.
Funding needs for both
loss funds and working capital are constantly updated for the
Board and compared to statutory constraints.

For example,

with each FFB funding

draw

the

RTC must

certify

to the Board that it is in compliance with all statutory funding
constraints after taking into consideration all contingent
liabilities -- notably "asset puts". Asset puts represent the
right of thrift buyers to "put" purchased assets back to the RTC.
The Board has required the RTC to provide a detailed monthly
analysis of such asset puts as to amount, term and

characteristics.

also must supply a weekly update of its rolling sixweek schedule of anticipated FFB borrowings.
In the area of accounting, the Oversight Board's CPA as well
as the Inspector General are reviewing the loss recognition
process used by the RTC. While the Board has received the RTC's
unaudited financial statements for the period ending December 31,
1989, the Board continues to press the RTC for audited financial
statements covering this period.
The RTC

to attempt to
a part of the Board's responsibility
eliminate potential fraud, waste, and abuse in RTC operations, it
has been working closely with the RTc Office of Inspector General
to set an aggressive audit and investigation agenda.
As

have been held with the IG on investigative
and audit activities.
The meetings focus on spotting areas of
vulnerability and correcting problems before they occur. The IG
has been directe4 hy the Oversight Board to undertake audits in
the highest risk areas. He has also been 4irected to audit a
As
sample group of completed resolutions and executed contracts.
mentioned earlier, the Oversight Board has 4irected the IG to
undertake a front end risk assessment of the seller financing
program and to periodically audit
and the 1988 Deal
Weekly meetings

restructurings.

The IG has opened 15 investigative
cases and closed 6 to
date. It has begun 15 audits and issued 6 reports. It has
identified 36 major areas on which it is planning to focus in
fiscal 1991. Currently at the level of 100, the IG plans a staff
of about 350 hy fiscal year 1992. The Oversight Board considers
it essential that an aggressive auditing program he pursued. In
a44ition, at the Board's direction, the IG has provided the Board
its detailed audit and investigation plan for the balance of this
fiscal year.

Pro ress in Rene

otiatin

1988 Deals

In September, the RTC reported to the Oversight Board on its
review of the assistance transactions entered
into by the Federal Savings and Loan Insurance Corporation
(FSLIC) prior to the passage of the Act. From its review, the
of some of the so-called "88
RTC conclude4 that a restructuring
Deals" could result in a savings of approximately $2 billion to
the taxpayers over the term of the loans but would require a
current appropriation of approximately $20 billion.
FIRREA mandated

$22 billion for the
(FRF) to pay obligations arising in FY 1991
as well as "permit the prepayment of certain higher interest rate
obligations and thus realise a savings of approximately $2
On

October 18, Congress appropriated

FSLIC Resolution

Fun4

billion".

Vnder FIRREA, the Oversight Boar4 has the responsibility
establish overall strategies, policies and goals for
restructuring the 1988 FSLIC assisted transactions.

Therefore,

statement

Agreements

the Oversight Board has adopted a policy
RTC in restructuring
the FSLIC Assistance
(see Appendix IV). The policy statement provides a

to guide the

series of guidelines for such restructurings and directs the RTc
to use Treasury borrowings efficiently so as to maximize overall
cost savings for the government with respect to the 1988 Deals as
a whole.

The important point here is that we must immediately begin
the restructuring process and use this fiscal year' s
appropriations to save taxpayer dollars. Accordingly, we have
ordered the RTC to start negotiations consistent with this policy
statement.
COSCLUSZOJC

In closing, let me reiterate what we said at the beginning
The job is getting done, but we still have a
of our statement.
long way to go. This is a task the government cannot escape if
we are to honor the promise to the American people to make good
on federal deposit insurance.

action to provide additional loss
funds is essential.
I repeat that without such action the RTC's
resolution process will halt and the taxpayers' costs will
increase. As discussed earlier, we believe the most sensible and
appropriate way for Congress to address the funding issue is to
provide RTC with the permanent funding necessary to get the whole
job done. Let me say again that without permanent funding the
result could be a start and stop cleanup process that produces
further delays, substantial additional costs to taxpayers, and
confusions and fear in the minds of depositors.
We will be glad to respond
to your questions.
Immediate

Congressional

iTanuary
RRK0RANDQN

f4u

%0)

10~ 1%90

Petar
Son~
President, RTC
iyht $4ILrd
Oavfd C. Cooke
Rxeoutive Directe
Cost af Dlaytsg Resolatfen+

that Qe +@date our Ieioran&ui of Novad~ 1i 1990
ast of delaying resalut fans. Msumafng that a&&ftional tucks
are sat available until late February or earLY ~4rchi the
rfll
h, ve fallen approximately
in
the
resal~im
&
~L
q
process. le estLaate the present value cost of this delay it ~ 5
gillian to g) 00 afllfon.
exolu&e three
These estimates
ham ~tiff@le factors~ asset deterioration or other lasses th t
Sht occur in undarstafM or undevaanage& institutions anitfng
resoLution, detezfaratfen of franchise value, and the affect that
can&ting vith insolvent institutions has on the cast of tun&s of
solvent instf tutions possibly causing a4&itiona1
aaron inally
have aske&

taf Lures.

tuzdfng far the RTC Ls delaye& beyon& the vary
befog
of Xarch, the cast of delay begins to ya op
hey
axponentially.
Thus, ve estijLato that an a&&itianal quarters delay
vould coat an additional 4750 aillion to OI50 Iillfon in present
value terms, ar an average 4250 Iillion ta almost $)00 million
aonth. (In actuality, sfnae the cost of deliy grove exponentially,
the cast of delay at the beginning of the secon4 quarter 4s
soeevhat less than 4250 Iillfon per Ionth virile the aost ot delay
at tha en4 of the aeaan& quarter is eoaevhet greater than %$00

Zf additional

Ii11ion. )

that the estiaate& aost of a second egarter~s delay fs
triple that ot ~ single quarter's delay js that the langer
the delay, the langer it takes to lake-up tor the time lost to
deLay. It takes tvfae as long to a&e-up for i tva quarter delay
as a one quarter delay. Far Example, if the number oj resolutfans
vere fncrease4 hy 40 peoent to sLake-up tor last tfie, ft vould
take 0 aonths to sake~ tor a one quarter delay an4 a year to
aak~ for a tvo quarter delay. Koreover& it Ls not realistic to
The reason

raughly

assuae a SO peroent fnorease& resolution rate can be sustained much
Zf there vas a hra quarter delay) a js
]anger than 4 aonths.
cent fnorease in the quarterly pace of resolutians fs probably
e most that is feasible heyan& the knitia1 0 ~anths push. Thus,
ft cauld take a year an& a half ta calpletely Ia)cewp tar a tvo

quarter delay.

previously aoto4, om eetiIIates 4o not take into account thrii
ss Iieet Ceterioretion or ether losses that ILiebt occur in
ta
exterstaf fed or endaraanaye4 hotf tutions Initin0 I'esolutiong
deterioration of tranohise value, m4 the &feet Chat ooapeti~
with insolvent Lnatitutions has on the oost of ~M Of Saryinally
solvent
institutions
failureI.
yoos @ly oaus Lay 044itional
Sevever, it
sot he unreasonable to assuie that these taotorI
aiSht Increase the oost of an @44iticeal Carter Celay hy It least
$0 paroent.
Ae

~14

RPPENDZI ZZ

r to
Cevel~d a cash
to v ry a

assmed

Hose

hake our estiMtes for our previous testimony, ve
flcnr Nodal for the RTC that gives Qs the ability
or
for thei, effect on the RTC. S
&e have 4iscussed before, our lov estimate

h~r ~ ass~tie
Ppulation
of about V00

~sts

a
already

resolved,

those

~titutions,

vhich jncluded
and all
oonservatorship

o"s classifie«s Croup XV thrifts by the OTS. Our +gh
te as ~ed a population of just over 1000 thrifts,
Mich included the 700 institutions in the lov estate, plus all
hotitutions classified as Croup III thrifta by the OTS.

It should

be noted that our cash flov aodel does not 4eal vith
individual
institutions.
Rather, total assets for Lndividual
thri f ts are divided into li 4i f f erent asset types and then
Croup IV
aggregated into tranches representing conservatorships,
RTc~s
resolution
selected
and Croup ZII thrifts.
is
of
The
pace
not by choosing individual thrifts each quarter, but by choosing
a volume of total assets in thrifts that are to be resolved each

quarter.

losses to be experienced by the RTC are ectiaated by
applying a loss estimate, or «haircut« to each of the li 4ifferent
asset types, and adding that to the negative tangible net vorth and
accumulated operating losses prior to receivership of the resolved
institutions.
In making estimates, ve used three different sets
The Nedium haircuts vere based upon the FDIC's
of haircuts.
Division of Research bank failure cost ao&el, vhile the other tvo
sets vere assumed to be higher and lover. The average aggregate
haircut for these three scenarios ranged from about ll to 15
percent.
Our cash flov aodel allevs us to choose vhat percentage of
resolved institutions are resolved in vhole bank, clean bank and
liquidation transactions, and to define each of these tresaction
types in terms of vhat percentage of each asset type gets passed
to an acquirer. Our aodel also a11ovs us to vary the pace of sale
of receivership assets by estiaating vhat percentage of each oi the
li asset types is sold each quarter until all are ahold.
The estimates in our previous testimony vere based upon yearend 1989 data, vith the OT6 Croup III and Group IV classifications
as of the end of April 1990. As OT6 has released nev 4ata and
thrift classifications, ve have incorporated this information into
Our latest estimates,
the cash f lov aodel ~
upon vhich the
President's budget numbers are based, use data ac of June 1990.
OTS has only recently released September 1990 data and nev Croup
The

and

Croup

III classifications;

analysis, it appears that this
change our current estimates.

based

nev 4ata

upon

vill

our

Preliminary

not substantially

A P1'F.N1)1X 111
Requirement~

Fslahlbhed In I IRRKA for
peri&~

Rcpnrt on lhc

prague

m»sic during Ibe 6-month

covered by Ihe semi-almu»l report in reelving e»scs involving
Inslilulinia insiued by the FSLIC print lo FIR REA, »ucl for
which corisclvator or receiver has been appointed (train I/89
to Ihc 3 year perio beginning 8/89), ihcsc inslilulions are
referenced below as those described in subsection (b)

during slich period.

of the

Dcl»lied ciisciission is included in Ihe testimony soetial tntltied Case
Rc~ilulinns". During Ihc six month perio, Ihc RTC delved 235
inslilutimr. ', ex&~ling ils gcxil of 2 lg institutieIa. During the same perio,
canscrvNnrship

and reecivcrship assets were teduoed by

$66.8 billion

book value.

(3) (A ).

short-tenn and long Icrm a~t to Ihc
United St»les Govclruncnt of obligations i~ucd nr incurred
Provide an estimate

Q~aiItmda

%'c interpret Ibis requitement to address R1Z shott4enn bortewings
frain Ihe Federal Financing Bank ("FFB ) and long-tenn bonowings
fram Ra~lotion Funding Corporation ( REFCORP").
During Use reporting ix»ind, Uic RTC had issued and outstanding
about 5$3.0 billion in nhligalinns in Ihe Form oF short-tetln wotking

capilal boilawings

fram thc

FFB. Approximately, $900 million

inlc~t exp&~ were incurred in conneclbp wilh Ihc: issuance ol'
Ihcse obligations during slich period. Ihcse botlowlngs are fully
cnllalcraiircd by assets having an esthnated fair Inatket value

cxc~ nf Ihc bonowed

~l.

Aeeonlingly, we
expect Ih»t ihc U.S. gnvcrnmart ullimalely will not incut any cmsl hr
collllccUon w lib thew shotl-Icllrl obli gallons'
subslantially

REFCORP issued $8.S billion of nhligatkrtui duthtg lhe reporting
period, wilh 533 billkm having a term of I'otty years, and Ihc balance
having a term of thirty years. Thc yield nn each issue was 8.88%. Tnlal
interest cxpcnsc is cxpu. ted ln bc a nomina'I $25.8 billion. Anmel fixed

inlet~i expense~ nf 575% million will bc inctrltod in coiutecticul
wilh these nblig»linm. Unshy FIRREA, interest on all REFCORP
is finulcd jrsinlly by Ilrc Feclcral Home Loan Banks (NLB»)
nnd Ihc Trc»smy, with ihc Fill. B enItriinuiraI limllcd ln ~ In»xNIIffll nf

nbligalinns

5300 million pcr yc»r.
As nf J»nu»ry 199I, REFCORP had outstanding Ihc lull $30 hillinn nf
obli@»uora oulhorircd by FIRREA, with average maturiIJm «f 33
yc»rs»nd »vcr»8C yiews of 8.76%. Tnlal inlerest on REFCORP
ohligsiions is cx pceicd In hc ~ tenmln»l 587.9 billinIL 7hc T~sury
slasIe of this inIcresl Is cspccsccl lo IIc ~ teominsl 57S billion.

cceqcclrerncnts

ill

Y~tabtkhed ln I'Ikkh:A fw'

.J cli~cssicat

of irrctjn&I

ions

cL~bcd

in sccbccclinn

(b) (3) (A) nnd

lilac

impact such saks nrc hevcng on lhe local markets In wl»vie scccb

ate located.

is hcdccdcd ln lhe laahnony section entitled Abet
D~itinn . lt is too early in thc process to assess lhe hnpacl of RlC leal
lhel RK
alntc snli~ on tice loc»l markets. To dele, there is no cvlckncc
ma&cts. Inc
sales have hed en ndvcrse impact on local teel estate
lhat lhe sale of RTC «sets hes
RTC's Nnlionel Advisory Board

DctniL.

Rcport on the pre~cess mnJc J»ring scccic pcrind in selling

and this
not adversely a(Tered local real eslele tnarkets lo date
clecrvatinn i» cole'istcwt with indcpcncknt reixctts. The RIG will,
markets tlaough
however, monitc» lice impacw of its sales activides in local
Advisory
Ihc inpul ccl' its Regional A Jvisory Boards. %c Regional
lhc Federal
I)ccards w ill receive analytical sccppolt from economists et
matlcet
Reserve In Irnck anJ ~scne Ihc impact oF WC sales on local
will be
cincclilhncn. In incrcieuinr, Ilcc ncw nathatwhic acccticm prccgtatn

Daecdbe Ihe a~mls Incccrled by Ihe Corporation in i. «iing
obligations, managing end miling assets aequirccl by Ihc
Corporation.

monilnce

carefully

We have inlc~mccl Ihis nxpiremcnt lo eddnm Ihe «eels of
rcceivcmbips nnd cncNervelorships whkh ere under Ihe managcmcnt
ol' Ihe

R1C.

Costs in Ilcc range nf 5250-5300 thoccsend were lncutted*ttlng Ihc period
Corpcctnticat.
in ccncnccainn with Ilcc Wccnnce of obligations by tice
conttaclors chaing Ihe April - Scplcmlcct
paid under
wns 599 millicm, cd whkh 518 million rcgaesents
rceclvctsllli1 nÃcct tonnage. 'Iclclll contracts

Tice

Ical

Aflirm

aelinw,

nun»nil

pni

J lo private

of NC as ccaaccrvatnr, assodatbn employe~
met management fcmclhms neer Ihc

ni~iinlcncsct
Icc pcrfccrtn

sccpcrvccice

of Ihc RTC Mnlceging Agcnl. %we staff arc elleacly

sccpplcmcnlccl by occlsidc
nv;lilcclicnc fee

cMlnctnts hired and paid fc» by Ihe

wvica~ fee which

tice instilulicac would typhelly

cllllM cd bcncincxc. Aacelingly, wc Iacvc
cxclicclrxl s»cb curls for Ilcc purposect ol this cakulnUon.

c'cnltrnct in IHncunl

I'.«I«blishcd In

acciulrcmcnls

I'Ik k I'.A

fcir

~ital;n~t

frcini »»sets
pmvldc an cslimatc of inccicnc ol'Ihc Corporaticin

acquired by Ihc Corporation.

InccNIc la lntelurt on
ln its cc«pciratc c«p«oily, thc RIG'a only
colucervatorships and
«dv»noes m»dc by Ilia Ccirpor«lion lo
of interest insane on
receiver«hips. Tlic R1C «ccrcicd $58$ million
recciverahipa in the six
adv«nccs «nd ki«ns lo collscf vatorships and
are not Inclucied in
mc«ilhs coded Scplcmbcr 30, 1990. Dividends
R1C'a claims against Uic
incoinc lice«we llicy are a rcciccction in
of Ilic receivership«, a retcchi of capiUI, and not Income.

asscU

period totallel
Howcvcr, dividends rcc.civcd by thc RTC dliring lhc
'~
$1 billion.

ol' «clcliii »ail
Pmvide an amcmmcnt of ariy polcnlial soccrcc
fccnds for the CorporaUon.

lhe Colporatbn are
only lcsnaining sciccrcc~ of additional flmds to
thc FFB and thc $S
Uic sccuiccl bohciwings for working capil«1 fmm
11icie
billion linc cif credit fmin tlic Treasury provided in FNREA.

llic

are cio other funcls cuhcntly wall«hie lo lhc

Vll Pmvide an estim«tc ol'Ihe lcm«ining exposure cif Ihc Unilccl
in coruiection with institccticins clcsLvil«AI in
(3) (A) which, in Ihc Oversight Reefs' »

Slates Government
scclaccclion (h)

ectimation,
sllcll pehod.

ill reciuirc assistance

or liclccid«lion

«A r Ih

ci I uf

R1C.

raoluUon cost tq he borne hy the RK in
in subsection (h) (3) (A)
nmncctinn with those institcctiona dcceri
(present v«lue).
i» pmjcclccl Ici Icc in Ihc r«ngc cif 590 lo $130 billion
Thc RTC h«s cxpcnclcd «ppmxilnatcly $37 billion fc» eslimalcd

Qc c~timalc of Ihc teil«I

Ic~s frcim

inccpUon through December

31, 1990.

APPENDIX

~DAUNT

tOLZCX

NO.

OretsfQht 544rd policy C4nce~LOQ
NaatractucfnQ of fSLTC Lasfatance kygee~ta

tat

etat~t

Ma polka

yggg~ea got the ETC fifth aspect to
natmctacfnQ oe the rjuC eg~~ta ( 1)ll meals") setenaS to fn
ia-tfon
on 2~ ) (11) ll) ot the federal
Loam aaak act, aa
jO1 or rraau. aue~t to the c ~~~a- or that 1e~, end fn eccom~
~th the Wdac~ pro fded
thfa polfcy aat~t, aK shall ~roice eny
eQ~~nta
~nd all loQal cfQhts to aa4Q, eeneQotfate, ec destruct~

aetablfahea

~~ 4

abate aarfnQs mould be gealf aod
TZNCL also Laataucta KC
ouch actions.
Co operate fn ~ QRhh4r that ggLkea ef g f cf ggt gee og gunda obtafch04 jtcR the
tundfnQ Cocporatfon ot tm the treaty.

stru

urfa

tol

to the 1)ll Deals:
Q) RTC shall aake efficient aae oj treasury funda appropriated Cna
time to tfaa tot the puzposo of loeerfnQ the Qorotn3ant'a orerall coot ot the
Nfth respect

1)ll

Deals.

shall Expend appropriated Sunda fn ~ RLzLDer deaf Qned to
aaxMao Qorornmnt coat aarfaQs fifth respect to the 19ll Deals aa a
~hole. ETC need not expend any partfcular acsount of appropriated funda
fn any apecf jfc traaaactfon.

(f)

RTC

(f f )

ETC need

not

oXplxLd

all appropriated

tunda

efllfnQ to do so as necessary to achforo cost aarfnQs.

(fff)

but should be

aqand appropriated junda to prepay aotoa, purchase
assota, or otherefso exercise tho Qorommt' ~ tfQhts
1'K aay roaeQotfate
and optfoas under tho aaLstfnQ toraa of 19II Deals.
tory of a transaction fnatead ot, or fn ccabfaatfon fifth, such uae oi

assets, aatk

L?C aay

appropriated

down

tuncLa.

(fr) tacept tor the aqandfture of appropriated tunda to aake
payments under the exfstfnQ teraa ot tho 19ll Deals, the
AersfQht Sosrd considers all axpeadftuzea oj appropriated funda to
~ chedulod

constitute

"rostructurfnQ"

ot the 1)ll Deals.

{r) In detorafafnQ hew and rhea to expend appropriated funda, ETC
take fate coasideratfon all colorant factors fncludfnQ, but not
lfiLf ted to:
~ hall

{a) asrfaQs aad pto)ected asrfaQs that aay be achferod
props@nants and aaetcfae of other QororncaEht gfQhta under
tho 1)ll peale:
Q) sari als and Paohocted sari aQa that zzy be achf orod
thtouQh teneQotfatfon 0 the teener of 19ll ygala
thtouQh

{c) pro jMAd

mranues:

iJLcroaoes

and

(d) projected costs

eaacciae ot iomamnt
projected SaTihgs
sogacd for the p

end

ggeggggaes

jn ~gQMnt

of thrift gailgggs gesulCQ+

eights endar 19II Deals.

tLK

projected oosts Ihall be consiW~ ~th
tg eath which they can be expected.

to seneyotiate the tata of 1%ii ~aalsi &t Ihall
~oek to fapxeve incentives for affective aaaay~t and disposition 4f assets
~set
Ln ~ a+mar consistent rith the ccncepts eaployed by KC 4+ its tendai
Ll
in
I
Ict
{C) %C ahab ~icy enffom criteria Cor its decisions
Ooncend~ the eo-caDed "stakL1Lsed" deals and the other 1&i& &als.
~y ~&otiate
cespect to any ot the et&Llkaed" or otlex 19II Oealsi
tezNLs so as to continue yield aaiatemece,
uset loss ccmrage, end ether
tocas of continukay assistance, obese delay so is consistent rith the goal of
candu~ the y~ernaaat's overall cost ef the 19ii Oeals. noteithstandfay the
Oversight hoard's general policy ~aicwt the use of such ceyoiay assistance
with respect to RC thrift resolutions apart free the 19II Seals.

%hexa SIC soaks

~ ~

aay seek to avoid ycmxnsant endertakbugs rhere fraud or other
bg persons contraction rith the gorernIIant presides a leal basis
Share fraud or other criILI'ml conduct appears, LVC shall refer the
RTC

misconduct

to do so.
aatter for prosecution.
Qocu~tn
Xn

sestructurini

19ll Deals:

Q) ETC say employ whatever resources it lamas reasonable and
RTC, hw~r.
appropriate, includiny FDIC personnel and outside contractors.
remains responsible for the overall plan of the effort, for the methods used
and results achieved, and for reportinN to Congress, the farsight aboard
the public.
(S) RTC shall thoroughly and coapletely documant its procedures.
decisions. and actions (and shall ncpafre the same by its agents and
contractors) in a manner so as to facilitate detailed auditiny and
investigation by RTC's Znspector Oeneral.
~ rformanee

and Nonitorin

shall report monthly to the Oversight Nard reyardiay actions taken
amounts azpended or to be expended, and cost savings schemed or projected as
a risult thereof. Reports shall be aade eith respect to the 19!l Deals
Ln4ividually and in the aygr~ate and shall include such detail, data
arplanations as the Chairman or the @resident of the Oversight aboard any
time to time request.
ETC

etat~t

~siiht

aboard' ~ sec~st tor
eapersodas the
the RTC as eet out ka the resoletioa adopted hf the
ia
Onraiyht Soard ce September g0, g)1g. ~or~ply, thea policy
&II&
the
sestnact~
Lma4iately eftectfve aad RTC say
innately to
Deals as prerhS@4 herein.

This policy

~~~tiers

tr~

statist

r U~I.i

of the Treasury

Department

FOR IMMEDIATE

DEBT NEW
~

Bureau of the Public Debt

RELEASE

RESULTS OF TREASURY'S AUCTION

Tenders

to be issued

were accepted
The

ll'ashinyon,

CONTACT:

23, 1991

January

DC 20239

~4„

Office of Financing

202-376-4350

OF 2-YEAR NOTES

for $12, 619 million of 2-year notes, Series W-1993,
31, 1991 and mature on January 31, 1993

on January

today

(CUSIP: 912827ZU9).

interest rate

of accepted bids

on the notes
and corresponding

Low

will be 7 %. The range
prices are as follows:

Yield
7-084

Price
99. 853

7. 094
99. 835
Average
7. 094
99. 835
$100, 000 was accepted at lower yields.
Tenders at the high yield were allotted 604.
High

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Philadelphia
Cleveland
Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury

TOTALS

Received
54, 670
36, 929, 735
27, 140

69, 720
188, 425
48, 880
1, 715, 270
83, 020
28, 360
93, 500

19, 980

500, 995
375 425
$40, 135, 120

(in thousands)
54, 670

11, 255, 235
27, 140
49. 720
143, 025
42, 880
353, 270
67, 020
28, 360

91, 500
19, 980
110, 995
375 425
$12, 619, 220

The $12, 619 million of accepted tenders includes
million of noncompetitive tenders and $11, 290 million
competitive tenders from the public.

$1, 329
of

In addition, $690 million of tenders was awarded at
average price to Federal Reserve Banks as agents for foreign
international monetary authorities.
An additional
$729 million
of tenders was also accepted at the average price from Federal
Reserve Banks for their own account in exchange for maturing

securities.

NB-1101

of the Treasury

department

Washington,

El.C. ~

Telephone 566-2os

PRE PARED REMARRS FOR
8ECRETARY NICHOLAS F ~ BRADY
DELIVERED BY DEPUTY SECRETARY JOHN ROBSON TO THE
UPS. 8AVINGS BONDS VOLUNTEER COMMITTEE
WEDNE8DAYi JANUARY 23'
WASHINGTON,
DE CD

1991

Thank you.
It is a great pleasure to welcome all of you to
the 29th Annual Meeting of the U. S. Savings Bonds Volunteer
Committee.
This is an important meeting to honor the people who
make Savings Bonds a success.
Today, we' re here to thank Allen
Jacobson and his entire leadership group for their outstanding
job last year. Allen will be passing the chairmanship to Ed
Hennessy this year, and I'm certain Ed's group will do a great
job for Savings Bonds in 1991.

Before turning to the subject of today's meeting, I'd just
like to take a moment to pay tribute to the brave men and women
in the Persian Gulf. They are constantly in our thoughts and
prayers, and I know you join me in supporting them.
Today, we are celebrating the 50th anniversary of U. S.
Savings Bonds. President Roosevelt issued the first Series E
Savings Bond in 1941. Since then, it's become the most widelyheld security of all time. This is an important program, and the
people behind Savings Bonds have proven their ability to make it
work for all Americans.

I'd like to express

appreciation for the Volunteer
efforts on behalf of our nation.
my

Committee's outstanding
always been able to depend on your commitment
we look forward to your continued
success.

We' ve

to excellence,

and

This year, our annual Volunteer Committee meeting is a
1991 is the first year we' ve included in our
the
leaders
of company payroll savings campaigns from
meeting
And that's appropriate,
throughout the country.
because you are
the volunteers who make the Savings Bonds Program the remarkable
success it is today, and I'm confident your hard work will carry

special one.

that tradition.

are coming off a great campaign year. In 1990,
Jacobson led the Committee to $8 billion in sales and 1.6 mill ion
That's a real victory for the Savings
new or increased savers.
Bonds Program, and it proves that our message of thrift and
fiscal responsibility still hits home with the American people.
We

NB-1102

Savings Bonds are strong investments that work for
They offer considerable benefits to payroll savers,
everybody.
companies offering the Payroll Savings Plan, and the United

States.

For savers, the Bonds offer a unique
benefits, including market-based interest
Savings Bonds also are
and local taxes.
and credit of the United States -- making
instrument available.

combination of
and freedom from state
backed by the full faith
them the safest savings

For the United States, bond sales save the nation millions
of dollars in debt costs each year.

Finally, and most importantly, Savings Bonds are an
important part of the nation's saving ethic. A saving economy is
a strong economy, and Savings Bonds can help Americans attain a
savings rate that will buttress our economic strength.
That's why your job is so important.
Through your
leadership and commitment, Savings Bonds have become an integral
part of the savings and investment fabric of our nation.
the Savings Bonds
Of course, as business professionals,
President
Campaign is only one of your many responsibilities.
Bush recognized this in a letter written to your Committee in

August,

when

he wrote:

"Throughout our country's history, the American character
has been marked by a willingness to volunteer one's service
for the public good. Your efforts to promote the sale of
Savings Bonds exemplify that spirit. "

is in tandem with the President s
service at all levels.
And to all of
Ed Hennessy as members of the 1991 Savings Bonds
Volunteer Committee, I look forward to working with you in your
upcoming mission.
Your personal leadership will come a long way
toward ensuring success.
Clearly,

commitment
you joining

this

Committee

community

those members of the 1990 Committee, you have my sincere
the thanks of all Americans for your work. You have
made a positive contribution
to your companies, your co-workers
and to the nation.
To

thanks

and

Thank you.

SECRETARY NICHOLAS F ~ BRADY
REMARKS FOR THE PRESENTATION OF AWARDS
U.
SAVINGS BONDS VOLUNTEER COMMITTEE

JANUARY 23 ~
WASHINGTON'

1991

D. C.

The strength of any nation resides in its people and in
their willingness to work for the common good. Clearly, the U. S.
Savings Bonds Volunteer Committee has made many great
contributions to our nation, and in your honor, I have a few
awards to present:
First, I would like to recognize all the members of the 1990
Committee for their distinguished
service to the Savings Bonds
Program.
Donald Heim [HIME] is with us on behalf of the 1990
Committee, and I am presenting the Treasury's Medal of Merit.

Please

Committee

Donald.

come on up,

greatly appreciate
members

the outstanding service all the 1990
to the Bond Program. Thank you.

have given

Ed Hennessy,
please join me
make your official appointment

at the

podium.

as 1991 National

It is

now

time

Chairman.

I am delighted to present you with this certificate
appointing you as National Chairman of the 1991 U. S. Savings
Bonds Volunteer Committee.
Good luck to you and your group this
year.

will

please join

at the

podium?
I
for you.
It is an honor to present to you this framed parchment
citation and this gold medal of merit in recognition of the great
value of your volunteer service to the Bond Program.
We want you
to know how much we appreciate you leadership of the 1990

Allen Jacobson,

have two awards

National

you

Bond Campaign.

Thank you, Allen, and congratulations
to all the members of
the 1990 and 1991 Committees.
Your contributions
are part of an
important effort to keep our nation strong, and I appreciate all
you are doing.
Once

again,

thanks

to all of you.

¹¹¹

rvrs~i
of the Treasury

Department

FOR IMMEDIATE

DEBT NEW
~

Bureau of the Public Debt

RELEASE

CONTACT:

24, 1991

January

ii'ashinyon,

RESULTS OF TREASURY'S AUCTION

DC 20239

Office of Financing

202-376-4350

OF 5-YEAR NOTES

Tenders for $9, 035 million of 5-year notes, Series K-1996,
on January 31, 1991 and mature on January 31, 1996
were accepted today (CUSIP: 912827ZV7).

to be issued

interest rate

the notes will be 7 1/2%. The range
of accepted bids and corresponding prices are as follows:
The

Price

Yield

7. 60%
99. 590
7. 63%
99.468
High
7. 62%
99. 509
Average
$10, 000 was accepted at lower yields.
Tenders at the high yield were allotted
Low

TENDERS RECEIVED AND ACCEPTED

Boston
New

York

Philadelphia
Cleveland

Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Received
16/571

23, 153, 394

9, 224

22, 499
235, 246

19, 393

1, 293, 241

20, 179
7, 150
26, 373
7, 717
612, 430
3

582

$2 5 / 426 / 999

23%.

(in thousands)

16, 571
904
381,
8,
9, 224
22, 499

76, 626
17, 853
308, 861
16, 179
7, 150
26, 373
7, 717
140, 330
3

582

$9, 034, 869

The $9, 035 million of accepted tenders includes $543
million of noncompetitive tenders and $8, 492 million of
competitive tenders from the public.

In addition, $180 million of tenders was awarded at the
average price to Federal Reserve Banks as agents for foreign and
international monetary authorities.
An additional
$200 million
of tenders was also accepted at the average price from Federal
Reserve Banks for their own account in exchange for maturing

securities.

NB-1103

SECRETARY OF THE TREASURY

NICHOLAS

G-7 PRESS

BRADY

CONFERENCE

1/2 1/9 1

Stanhope

Hotel,

New

York City

Good

afternoon,

ladies

and gentlemen.

for your patience.

Thank you very much

difficult logistics for each of

has been

know

you.

that this
We

sincerely appreciate your cooperation.
Secretary Brady will be glad to respond to your
questions.
Obviously, we' re on the record this afternoon.
We would ask that we embargo the contents
of the briefing
until 15 minutes after the close of the briefing. Thank
you very much.

Secretary Brady.

SECRETARY BRADY:

The communicaque

13
14

Roger.

Thank you,

this

from

G-7 meeting

greatly foreshortened, and since the two paragraphs that
are operative are very short, I just thought I would read
it. I will take a minute.

their
economic policies and prospects and reaffirmed their
support for economic policy coordination at this critical
time. They noted that although growth in all our

economies

continues

pick

15
16
17

ministers

The

had slowed,

and governors

reviewed

of the world

expansion

economy

of activity could be expected to
later this year.

and the pace

noted that growth

Japan.

particularly

remains

of sound fiscal

in Germany

policies combined with stability oriented monetary
policies should create conditions fa:orable to lower

and

Implementation

ALDERSON REPORTING
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strong

global interest

rates

also stress the importance
conclusion

of the

stronger world economy-

and a

a timely

reads.

cooperation
markets.

exchange

The

ministers

arising

ministers

The

They agreed

to monitor developments

and

from the Gulf

in the Soviet Union.

war and developments

strengthen

successful

in global financial

also discussed the situation
in light of uncertainties

markets

and

rounds.

Uruguay

The second paragraph

governors

They

stand ready

and governors

to respond as appropriate to maintain stability in
international and financial markets.
I would be glad to answer any questions you

might

have.

pay

for the

Mr.

Secretary,

war

effort

I did have with ministers

go on

Well, those discussions
and Germany

us what

which

did not

discussions.

But I did have

tell

Can you

countries?

the various

from Japan

into G-7 meetings.

do you agree on any formula

among

SECRETARY BRADY:

conclusion

you reached

with them?

SECRETARY BRADY:

all that

global developments

that

we had

would

extensive

* Communique

come about

language

tell

I can

discussion

you

as a result

reads

'. . .

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overnors

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not going to

are prepared
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sharing

of those developments.

because I

WASHINGTON,

first of

with Japan about

in the Gulf and the burden

I could only say

Yes.

to. . . "

global interest

rates

stronger world economy.

and a

also stress the importance of a timely
conclusion of the Uruguay rounds.
reads.

The second paragraph

in light of uncertainties

markets

cooperation
markets.

exchange

successful

The

ministers

The

They agreed

to monitor developments

and

from the Gulf

arising

in the Soviet Union.

war and developments

strengthen

and

in global financial

also discussed the situation

governors

They

are prepared

and governors

to respond as appropriate to maintain stability in
international and financial markets.
I would be glad to answer any questions you

might

have.

pay

for the

Mr.

Secretary,

war

effort

I did have with ministers

go on

into

-7 meetings.

Can you

countries?

the various

Well, those discussions
from Japan

us what

did not

and Germany

discussions.

But I did have

tell

which

conclusion

you reached

with them?

SECRETARY BRADY:

all that

global developments

that

do you agree on any formula

among

SECRETARY BRADY:

we had

would

Yes.

extensive

I can

discussion

tell

you

with Japan about

in the Gulf and the burden

come about

as a result

I could only say

ALDERSON REPORTING
1111 FOURTEENTH

sharing

of those developments.

because I

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first of

not going to

-- it

get into numbers

constructive.

was very

The

said that they would do their share,

Japanese

they would be making

that

and

sooner rather

an announcement

than

later.
about the Germans'

What

with as well.

had a

discussion

discussions

in previous

talks

on burden

Secretary Gentcher and
although I talked in broad outlines

sharing
10

The

The Germans

SECRETARY BRADY:

have gone on between

Secretary Baker, and
about the situation as

the Gulf, again further
12

discussion

Gentcher

talk.

will

come

information

Gentcher

and

Secretary

have a chance

Secretary, in view of the reference to
paragraphs that you read, how do you attend
Mr.

the last two

to strengthen

been doing?

cooperation

beyond

SECRETARY BRADY:

what you

Well, I think

it quite fully,
characterize it by saying the

question.

you could

remain

developments

going on in the Gulf.

developments

going on in the Soviet Union.

that particular

after Secretary Baker

foreign minister

by developments

was expanded

open.

discussed

In other words,

already

that's

and

a good

I think that

telephones

will

historic
We have historic

we have

far the reaction in the financial

ALDERSON REPORTING
1111 FOURTEENTH

have

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markets,

particularly
And

to act in

exist.
that
and

that

any way

for

But should

a need

create problems

some

reason unforeseen

discuss appropriate

re not going
where

none

at this time

to get together on the telephone
actions, we' re ready to do that.
meeting.

have got a two-day

all

know what

to get ahold of each
other, and we would be prepared to discuss any changes in
the basic pattern of stability that might arise.

each other thinks.

We know

how

But were there any
12

we'

would

for ministers

stability continues,

as long as that

of stability.

has been one

currency markets

specific changes

you

agreed on at this meeting?

SECRETARY BRADY:

Not

really.

Secretary, with reference to the Gulf
there's also longer term considerations,

Mr.

concerns

aren't there?

monetary

concerned

though,

Isn't that

policies.

we have

on a

something

and

also that

are

you

about?
SECRETARY BRADY:

of economic

a divergence

You have

seen so far

Well, I think the pattern

one of

relative stability.

that

Changes

daily basis but not changes of great magnitude.
I
think while you could say that while there were reasons

for the dollar to weaken,

to strengthens

Certainly

there were also reasons

any resurgence

in our

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own

for

economy

latter part of this year could

the

during

Obviously,

when

there are concerns in other parts of the

the dollar is strengthened

world,

concerns.

jumps

and

it if that's

want

as a result of those

anybody

smart enough

to predict exactly

be able

just

unusual

I don't think

exactly
going to go.

know

be one.

make

that

turns,

if it

sure that
we'

which way

it is

does take

re ready to do something

called for.
Mr. Secretary, what can you tell us about
the discussions in terms of the Soviet Union, as far as
the Soviet Union is concerned?
SECRETARY BRADY:
Well, the situation in the
Soviet Union was discussed, and as you know, in this
country, President Bush is studying the situation
carefully. That things are on hold until he gets a better
idea and his advisors get a better idea of what might be

forthcoming.

about
10

13
14

15
16

And

withholding

minus,

what's

until that time, I think everybody

judgment.

And

I would say, either plus or

is the result of other ministers
Mr.

Secretary,

expect economic activity to pick

should

expect the economy

SECRETARY BRADY:

ALDERSON REPORTING
1111 FOURTEENTH

as well.

a two-part

mean

Well,

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you

later this year, does
to pick up?

I think

SUITE 400
D. C. 20005
WASHINGTON,

question.

that Chairman

Greenspan

has said that he expects that in the middle

this year, economic activity could resume a positive
growth pattern.
of the so-called blue chip
My reading
economists in this country would indicate that most feel
that particular way. Some don' t, but most do.
I think we have had an unusual circumstance
before us in this country.
I can't imagine it should be a
mystery to anybody why consumers are hesitant to make
purchases.
We have had a possibility
of a war and now a
war takes place.
The first time in many, many years.
It's no surprise to me that people wanted to
curb their purchases, either in looking at buying a car or
taking a trip so that the automobile industry in December
did badly.
I can understand that. Credit card companies
tell me that charges to credit cards are down. I can
understand that.
I think any family would want to take a wait and
see posture.
So I believe as something that is very
complex, very hard to understand for the average American.
As it begins to unfold, we are getting an explanation
of
it hour by hour on television, everybody will understand

it. It

now,

energy

13
14

15
16
17

19
20

looks as though

and

things

are going according

I expect that to release

significant

to plan

amount

into our economy.
Mr. Brady,

ALDERSON REPORTING
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sounds

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comments

the Germans
2

Japanese

in their version.

That's not really the case

SECRETARY BRADY:
4

The
up

discussions

Jim went

I split

were Jim Baker and

as you remember

the world in terms of raising

sharing.

as the

not have been as forthcoming

may

concerning

money

I went to the Far East
to the Gulf and Germany

the

and France and England.
and some

of the

countries.

it's

)ust a question of it following
channels.
I couldn't characterize it the way you have at
all. I think it's way too early for that.
Sir, was that issue discussed and what was

the result?

of debt.

What

19
20

21
22

part of the world are
Okay.

SECRETARY BRADY:

did have a discussion

talking

you

about?

discussion

I' ve

got

it.

did

particular
reference to Poland and Egypt where in the case of Egypt,
as I'm sure you are well aware, the United States has
forgiven $7 billion with the foreign military sales. We
talked about that. We talked about the United States'
initiative to forgive debt to Poland.
have our usual

Brazil, Poland

Well,

SECRETARY BRADY:

And

countries.

on debt with

discussed

All countries

that
want

ALDERSON REPORTING
1111 FOURTEENTH

among

all of the

do something

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G-7

for Poland.

It's
how

a question

how do you

wide of a program

of debt reduction

forgive debt for one country,
another

it.

contain

In other words,

do you go?

you

do you say about

what

one?

I think that you have to make your
distinction for these two countries. President Bush has
talked about a new world order, and certainly, that is
And

that

something

they made an unusual

negotiations
12

all

contemplate.

now

stones of the coalition

foundation
10

of the

in the Gulf with Egypt,

there.

contribution

with regard

One

And

so the debt

to that country follow

on from

that.
they' ve been a leader in

In the case of Poland,

13
14

the

were the

movement

from Eastern

Europe

to free markets.

They

early country to do that and they have also been
the one that has had the most ambitious program.
So it

makes

distinctive

sense in our view to take these two countries

19
20

cases

their particular

problems.

Secretary, you talked about the debt.
package that all -- (inaudible).
Mr.

Did you

SECRETARY BRADY:

detail

still

and

going together

the Administration

talk to

them

of not letting

ALDERSON REPORTING
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llll

you

are well aware is

in Washington.

Did you
by

Well, not in any particular

that program as I'm sure

and work on

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about the apparent

the capital

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gains

tax?
Strange as

SECRETARY BRADY:

5
6

13
14

19
20

21
22

23
24

may

seem, they

interest in capital gains.
I know you can't talk about the amounts
that Germany may contribute.
Can you talk about the form
their help would take? Straight cash or other forms?
SECRETARY BRADY: Again, I don't want to
characterize the particulars of either one of the
discussions.
With regard to the Japanese discussions
which fall into my purview, I will say to you that they

had no

understand
12

statement

the problem completely.

They made the

they want to do their share.

They' re going to get about

You
quickly.
on materials which

can't run an army, a military campaign
aren't needed. So the discussion did contain the idea
that most of this would be in direct cash assistance.
How much is the fair share for Japan?
SECRETARY BRADY:
As I said at the beginning,
I'm not going to get into figures.
I think it's only
appropriate that after having had the chance to discuss
the matter with us, that the Japanese make their own
announcement
on this particular amount.
But, sir, do you expect so far are
operations of the war running according to projections, or
above or below projections so far?
ALDERSON REPORTING
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Well, you know, projections

SECRETARY BRADY:

what?

You know,

necessary.
an

you

are in a war, you do what is

estimates

So we can have preliminary

operation

like Desert

those estimates

different
carried out.

various

cost,

Storm would

are estimates

going to be private.

which

scenarios as to

what

do.

and we

for the

But obviously,

moment

And

are

they vary between

that

how

war would

like is going on now, it's one
thing. If it's one that's combined with land operations,
it's another. So there isn't any way of being totally
precise about it at this time. It changes on a daily
basis.
Mr. Secretary, as regards a sound fiscal
policy, what does that mean in regards to the U. S. budget
deficit? Your reference to leading the way. Are you
anticipating that the U. S. will take the lead in that

process?

If it's

13
14

15
16

Well, this

SECRETARY BRADY:

there has been

which

the budget

discussion,

last fall.

a war

agreement

our budget

was

argument,

Now,

much

subject over
but I consider that
a

arrived at with a great deal of

and some hard,

obviously,

deficit

discussion,

hard negotiations

because the economy has slowed,

has gone down,

ALDERSON REPORTING
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but I consider

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that that

is tough.

will restrain

budget

think in years to come people will see that

whereby

5
6

agreement

communiques

Secretary,

with Germany

what

announcements

are

I said to you a minute
13
14

15
16
17

and

Japan.

now

(inaudible)

Well, I think
from those two

ago, the Japanese

to see
countries. As

we have

said that they

that burden sharing be part of our operations
on their part that
the Gulf and a full understanding
was important
that they do it as well.
country

is the total
States is seeking to raise?

Mr.

that the United

21
22

made

identified

you have

their full share. The Germans the same.
I certainly feel that with regard to both
discussions, there was no drawing back. A full
understanding
of how important it is to the people of this

would

19
20

a system

can begin to

SECRETARY BRADY:

it is

start to control spending in this
country, and for that reason, it is extraordinarily
significant and does work towards providing fiscal
restraint.
we

Mr.

spending.

Secretary,

it
amount

I said, I'm not going to
with any specific figures today.
SECRETARY BRADY:

come up

how much

Mr.

express concern to

extending

Secretary, did
you about

any

of the other nations

the possible cost of

the war?

ALDERSON REPORTING COMPANY,
INC.
FOURTEENTH STREET, N. W.

llll

SUITE 400
D. C. 20005

WASHINGTON,

(202)289-2260
(800) FOR DEPO

I can

No.

SECRETARY BRADY:

tell

you

that

there

every single one of the six other ministers,

from

was an

of the job that the Allies have done in the
Gulf, the leadership of president Bush and the forces that
have exhibited out there.
appreciation

of what had been done.

There was no questioning

Just a strong
feeling as I have mentioned to you that they want to do
their share, and every single one of them at one time or
another expressed their full support.
Can I have your follow-up on what I asked
suggestions

before though.

kind of contributions

that

you have given

mean

have been given

SECRETARY BRADY:

And

out numbers

out.

on what

Can you

give

I can'

No,

period of time are

what

talking

about?

What

SECRETARY BRADY:

that unfortunately

patient.

periods at this time.

understand

and they

share.

be done.

amount?

what might

you

are just going to have to be

not going to add any numbers

Both the Germans

the dimensions
have

I have said to you is

of what's

or any time
and the Japanese

going on in the Gulf,

said that they expect to do their full

Let's

all the

ALDERSON REPORTING
1111 FOURTEENTH

way

back.

INC.
STREET, N. W.
COMPANY,

SUITE 400
D. C. 20005

WASHINGTON,

(202)289-2260
(800) FOR DEPO

Is the Soviet situation in the Balkans
institutions on hold? (inaudible)

international

Well, I would take

SECRETARY BRADY:

that matter from the President
those matters

who

cues on

has said that

I believe

gets a better
in the Baltic States with

are on hold until everybody

idea of exactly what is going on

put

respect to their relationship with the Soviet Union.
So I think this is a question of making an
appraisal and one that you shouldn't make after one or
days' events.

two

(inaudible)
12

Mr.

intervention

began?

so far?

there been any intervention

But not at

there

somewheres,

of or nothing

have been minor

may

but nothing

that

Not

know

of.

that I

know

of. I

which

mean

of accounts

the United States was part

to our attention.

you approach

the Soviet

(inaudible).
SECRETARY BRADY:

ALDERSON REPORTING
FOURTEENTH

llll

war

to calm the market

that I

balancing

was brought

Would

since the

all?

SECRETARY BRADY:

Not

SECRETARY BRADY:

has there been any

Secretary,

in the foreign exchange markets

Has

there wasn'

No,

SECRETARY BRADY:

Well,

I think

COMPANY,
INC.
STREET, N. W.

SUITE 400
WASHINGTON,
D. C. 20005

(202)289-2260
(800) FOR DEPO

that

what

to
are fast

ought

what

moving.

I stated to

They

matter of consultation

President

proposed

before.

you

daily,

are changing
with our

Allies.

These events
and

it's

As you know,

the

earlier in the year special status for
of technical

the Soviets so that they could take advantage

their economy.
There is a meeting to be held by the President,
and Secretary Gorbachev in the not too distant future, and
I think you' ll just have to wait as events unfold to see
where we are.
I don't think it's going to be complicated,
but I think it's a question of looking at what' s
happening, not reacting just the first time you see
something.
Coming to a considered judgment and making a

determination.

assistance to help

them with

Did everybody

15
16

SECRETARY BRADY:

rushing

agree to keep

on hold?

say that there was

I would

a statement

from the

situation

nobody

the Soviet Union for any number

particularly those from Europe who are closest to the
situation felt that the thing was so fast moving and
changing daily that it didn't make any sense to put
forward changes at this particular time.
Just take two more questions.

21
22

You mentioned

make

statement.

of reasons,

fiscal policy

In your discussions,

ALDERSON REPORTING
1111 FOURTEENTH

what

COMPANY,

STREET, N. W.
SUITE 400
WASHINGTON,
D. C. 20005

(202)289-2260
(800) FOR DEPO

but primarily,

in your

Germany's

INC.

mix would

be of taxation

and so on,

involved

down

the interest

Can you say something

about that7

in this process of bringing

structure.

to Minister Vigel

fiscal response
12

and Krowlato

Pearl.

They

said that

delicate balance between monetary
policy and fiscal actions which would have to carry the
German program.
They felt that they were up to that task,
and that they could continue on the path that they were on
now which was interest rate levels as we see them, and
they

felt there

rate

Yes, I can, but I would refer

SECRETARY BRADY:

you

in other words, to help

was a

in the next months

necessary

was

ahead.

Last question.

Mr.

to take action if

the market.

Secretary,
there were

No.

it is is

pretty

much

picture of

it is

open telephones.

In other words,

discussion

last

mental

you had a good thorough

Everybody

during

understands

in the

the other minister

what

you a

few days.

has said

that period of time.

If
market

What

is -- the best I can give

or turns in

jumps

which

as I described

weeks

any unusual

said that you were ready

(inaudible)
SECRETARY BRADY:

you

developments

or several months,
and movements

take place in the next several

there is unusual

in one direction

ALDERSON REPORTING
1111 FOURTEENTH

SUITE 400
D. C. 20005

WASHINGTON,

(202)289-2260
(800) FOR DEPO

in the

or the other which

INC.
STREET, N. W.
COMPANY,

turns

of the

are out of character with the basic strengths

currencies,

talk about

then the ministers

do something

and perhaps

Let

about

discuss again I think

to focus on.

everybody

will get on the phone

it.

it's

important

have had an unusual

stability.

Here we have a war in the Gulf

proportions

and

yet currencies

and

for

pattern of

of historic

are fluctuating

less than

they do on some days for rumors

basis.
10

of the most unfounded
So I think that that's what we are striving for.

I'm very pleased

got stability
12

could continue

markets,

time.

that

that over the past several months we have
felt that if we
and all of the ministers
that kind of a relationship

was what

Thank

the world needed at this particular

you.

16
17

19
20

21
22

23
24

ALDERSON REPORTING COMPANY,
INC.
FOURTEENTH STREET, N. W.

llll

between

SUITE 400
D. C. 20005

WASHINGTON,

(202)289-2260
(800) FOR DEPO

OVZasK;EI' Bourn, ,
1117' F
FOR IMMEDIATE

Resolution Trust Corporation
STREET, N. W. WASHINGTON. 0-C ~0-"32

Contact.

RELEASE

Janua. ry 24, 1991
OB

91-8

RTC REGION

Brian P. Harrington
(202) '786-9675

ADVISORY B02LRD TO HOLD OPEN MEETING

will
29,

of the New York-based Region 1 advisory board
their quarterly open meeting in Boston, Mass. on January
1991, from 10:30 a. m. to 3:30 p. m.
The meeti. ng, open to all member
of the public and press,
be in the auditorium at the Federal Reserve Bank of Boston,
The members

hold

Atlantic

Avenue

will

600

in Boston.

The Financial Institutions
Reform, Recovery and Enforcement
Act of 1989 (FIRRZk) required that the oversight Board establish
six regional advisory boards to provide advice to the Resolution
Trust Corporation
(RTC) on the policies and programs
for the

disposition

of real estate of the nation's

failed thrifts.
of Annapolis, Md.

board includes Henry Berliner
Pa. ; Mirian
Charles Kopp of Philadelphia,
Cambridge, Ohio; and Walter Terry of Baltimore, Md.
The

chairman;

Saez

Discussions at the meeting will center on the activities of
Region 1 as related to the RTC's affordable housing disposition,
pricing policies, private sector contracting and administration of
delinquent real estate mortgages.
In addition, there will be
market
report by a Federal Reserve Bank
regional real estate
economist.
Time also will be reserved for members of the public
to address the board with their comments concerning the RTC's

disposition

of real estate.

Board
represents
Region 1 Advisor
the states of
Connecticut, Delaware, Kentucky, Maine, Maryland, Massachusetts
New
New
Jersey, New York, North Carolina
Hampshire,
Rhode Island, Vermont, Virginia, West, Virginia, and
Pennsylvania,
the District of Columbia.

The

OVZRSrcm' HOmn
277

FOR IMMEDIATE

January
OB

91-9

Resoluhon Trust Corporation
STREET. N. W. WhSHINCTo. i

RZLZASE

25, 1991

Contac

D. C

Brian P. Harrington
(202) 786-9672

RTC REGION 2 ADVISORY BORED TO HOLD OPEN MEETING

of the Atlanta-based Region " Advisory Board
will hold their quarterly open meeting in Miam~ on Friday,
February 1, 1991, from 10 a. m. to 3. 30 p. m.
The meeting, open to all members of the public and. press,
vill be at Miami-Dade Community Col'ege, Wol-son Campus, Room
1101, Building l, in Miami.
The members

Institutions Reform, Recovery and Enforcement
that the oversight Board establish
to provide advice to the Resolution
Trust Corporation (RTC) on the policies and programs for the
disposition of real estate of the nation's ailed thrifts.
The Financial

Act of 1989 (FIRMA) required
six Regional Advisory Boards

board 'ncludes Philip Searle of Naples,
Fla. , as acting chairman; G. Z, indsay Crump of Savannah, Qa. ;
Alpha Johnson of Mobile, Ala. ; Stanley Tate of North Miami, Fla. ;
and Ralph Thayer of New Orleans, La.
The five-member

Discussions at De meet'ng wi'1 center on the activities of
ousing disposition
Region 2 as related to the RTC's affordable
sector
private
contracting
and
policies,
program, pricing
estate
mor-gages.
real
addition
delinquent
Zn
administration of
esta"-.
-arket report by a Federal
there will be a regional real
will
be reserved for members
also
Time
economist.
Reserve Bank
"it?
Board
=.e comments concerning
of the public to address the
the RTC's disposition of real estate.
Region 2 represents the -ta-es of .~aha. -a, Florida, Georgia
Louisiana, Miss'ssipp , Sou=' Carol'". ~d e. .nessee.
'

r uuwi
Department

KBT

of the Treasury

FOR IMMEDIATE

Bureau of the Public Debt

RELEASE

Kashinyon, DC '0" 39

CONTACT:

28, 1991

January

RESULTS OF TREASURY'S AUCTION

Office of Financing

202-376-4350

OF 13-WEEK

BILLS

Tenders for $10, 006 million of 13-week bills to be issued
on January 31, 1991 and mature on May 2, 1991 were
accepted today (CUSIP: 912794WG5).
RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

6. 20%
6. 22%
6. 22%

Low

High

Average

$1, 000, 000

was

Investment
Rate

6. 39%
6. 41%
6. 41%

Price
98. 433
98. 428
98. 428

accepted at lower yields.

Tenders at the high discount rate were allotted 96%.
The investment rate is the equivalent coupon-issue yield.
TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Philadelphia
Cleveland

Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Type

Competitive
Noncompetitive
Subtotal, Public

Federal Reserve
Foreign Official

Institutions
TOTALS

NB-1104

Received
52, 945
26, 076, 210
33, 155
68, 840
191,990
36, 750
1, 705, 130
64, 525
8, 890
45, 590
26, 920

718, 290

(in thousands)
52, 945
8, 693, 630
33, 155
68, 840
114, 590
36, 750
295, 330
34, 125
8, 890
45, 590
26, 920
213, 290

382 370
$29, 411, 605

382 370
$10, 006, 425

$26, 101, 080

$6, 695, 900

$27, 445, 805

$8, 040, 625

1, 855, 200

1 344 725

110 600

$29, 411, 605

1 344 725

110 600

$10, 006, 425

LI DEBT E
Department

of' the

FOR IMMEDIATE

Treasury

Bureau of' the Public Debt

RELEASE

ll'ashington,

CONTACT:

28, 1991

January

RESULTS OF TREASURY'S AUCTION

H&.

DC '20239

Office of Financing

202-376-4350

OF 26-WEEK

BILLS

for $10, 030 million of 26-week bills to be issued
31, 1991 and mature on August 1, 1991 were

Tenders

on January

accepted today (CUSIP: 912794WS9).

RANGE

OF ACCEPTED

COMPETITIVE

BIDS:

Discount
Rate

Investment
Rate

Price
96. 835
96. 825
High
96. 825
Average
$2, 000, 000 was accepted at lower yields.
Tenders at the high discount rate were allotted 35%.
The investment rate is the equivalent coupon-issue yield.
Low

6. 26%
6. 28%
6. 28%

6. 55%
6. 58%
6. 58%

TENDERS RECEIVED AND ACCEPTED

Location
Boston
New

York

Received
44, 215
26, 950, 395

Chicago
St. Louis
Minneapolis
Kansas City

17, 425
49, 100
57, 615
42, 640
1, 454, 140
45, 810
6, 355
53, 470

TOTALS

604 760
$29, 924, 825

Philadelphia
Cleveland

Richmond

Atlanta

Dallas
San Francisco
Treasury
Type

Competitive
Noncompetitive
Subtotal, Public

Federal Reserve
Foreign Official

Institutions
TOTALS

17, 505
581, 395

~4„

(in thousands)
44, 215
775
767,
8,
17, 425
49, 100
57, 615
42, 640
209, 140
32, 560
6, 355
52, 170
17, 505
128, 395
604 760

$10, 029, 655

$25 i 614 i 785
1 346 640
$26, 961, 425

$5, 719, 615

2, 100, 000

863 400
$29, 924, 825

863 400
$10, 029, 655

1 346 640

$7, 066, 255

of the Treasury e Nashlneton,

~ pariment

4:00 P. M.
29. 1991

FOR RELEASE AT

January

CONTACT:

O.C. ~ Telephone $66-2041
Office of Financing
202/376-4350

TREASURY'S WEEKLY BILL OFFERING

The Department of the Treasury, by this public notice,
invites tenders for two series of Treasury bills totaling
approximately $20, 000 million, to be issued February 7, 1991.
This offering will provide about $775 million of new cash for the
Treasury, as the maturing bills are outstanding in the amount of
Tenders will be received at Federal Reserve
S19, 228 million.
Banks and Branches and at the Bureau of the Public Debt, Washington, D. C. 20239-1500, Monday, February 4, 1991, prior to 12:00
noon for noncompetitive
tenders and prior to 1:00 p. m. , Eastern
Standard time, for competitive tenders.
The two series offered
are as follows:
91-day bills (to maturity date) for approximately
$10, 000 million, representing an additional amount of bills
dated May 10, 1990, and to mature May 9, 1991 (CUSIP No. 912794
WH 3), currently
outstanding in the amount of S20, 171 million,
the additional and original bills to be freely interchangeable.
182-day bills for approximately $10, 000 million, to be
dated February 7, 1991, and to mature August 8, 1991 (CUSIP No.

912794

5).

The bills will be
and noncompetitive

issued on a discount basis under competitive
bidding, and at maturity their par amount
Both series of bills will be
will be payable without interest.
issued entirely in book-entry form in a minimum amount of $10, 000
on the records either of the
and in any higher $5, 0GO multiple,
Federal Reserve Banks and Branches, or of the Department of the
Treasury
The bills will be issued for cash and in exchange for
Treasury bills maturing February 7, 1991. Tenders from Federal
Reserve Banks for their own account and as agents for foreign
monetary authorities will be accepted at
and international
the weighted average bank discount rates of accepted competitive tenders. Additional amounts of the bills may be issued to
Federal Reserve Banks, as agents for foreign and international
to the extent that the aggregate amount
monetary authorities,
exceeds the aggregate amount of
accounts
such
for
of tenders
Federal Reserve Banks currently
maturing bills held by them.
hold S1, 053 million as agents for foreign and international
and S4, 758 million for their own account.
monetary authorities,
Tenders for bills to be maintained on the book-entry records
of the Department of the Treasury should be submitted on Form
PD 5176-1 ( for 13-week series) or Form PD 5176-2 ( for 26-week

series).

NB-1106

TREASURY'S

13- 26-

AND

S2-%EEK BILL OFFERINGS

Page

bidder, as defined in Treasury s single bidder guidelines, shall
not submit noncompetitive tenders totaling more than $1, 000, 000.

and dealers who make primary
Banking institutions
markets in Government securities and report daily to the Federal
Reserve Bank of New York their positions in and borrowings on
such securities may submit tenders for account of customers, if
the names of the customers and the amount for each customer are
furnished.
Others are only permitted to submit tenders for their
Each tender must state the amount of any net long
own account.
such position is in excess
position in the bills being offered
of $200 million. This information should reflect positions held
as of one-half hour prior to the closing time for receipt of
tenders on the day of the auction. Such positions would include
bills acquired through "when issued" trading, and futures and
forward transactions as well as holdings of outstanding bills
with the same maturity date as the new offering, e. g. , bills
with three months to maturity previously offered as six-month
bills. Dealers, who make primary markets in Government securities and report daily to the Federal Reserve Bank of New York
their positions in and borrowings on such securities, when submitting tenders for customers, must submit a separate tender for
each customer whose net long position in the bill being offered
exceeds $200 million.

Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury.
A cash adjustment
will be made on all accepted tenders for the
difference between the par payment submitted and the actual

issue price as determined

in the auction.

and

1/91

trust

'H&ASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 3

for accepted tenders for bills to be maintained

bills.

If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures.
Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
of the Treasury Circulars, Public Debt SeriesNos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of the circulars, guidelines, and tender forms may be obtained
from any Federal Reserve Bank or Branch, or from the Bureau of
Department

the Public Debt.
8/89

ipaFtmellt 4~ the TFI4sIIrV ~ Washlneion,
FOR RELEASE WHEN

January

30, 1991

AUTHORIZED

PRESS CONFERENCE
CONTACT:

TREASURY

O.C. ~ Telephone See-204

FEBRUARY QUARTERLY

Office of Financing
202/376-4350

FINANCING

will raise about $17, 175 million of new cash
and refund $17, 335 million of securities maturing February 15,
1991, by issuing $12, 500 million of 3-year notes, $11, 000 million
of 10-year notes, and $11, 000 million of 30-year bonds. The
$17, 335 million of maturing securities are those held by the
public, including $1, 431 million held, as of today, by Federal
Reserve Banks as agents for foreign and international
monetary
The Treasury

authorities.
The three issues totaling $34, 500 million are being offered
to the public, and any amounts tendered by Federal Reserve Banks
as agents for foreign and international
monetary authorities
will be added to that amount.
Tenders for such accounts will be
accepted at the average prices of accepted competitive tenders.
In addition to the public holdings, Federal Reserve Banks
hold $1, 944 million of the maturing securities for their own
accounts, which may be refunded by issuing additional amounts of
the new securities at the average prices of accepted competitive
tenders.

10-year note and 30-year bond being offered today will
eligible for the STRIPS program.
The

Details about each of the new securities are given in the
attached highlights of the offering and in the official offering

circulars.

oOo

Attachment

NB-ll07

HIGHLIGHTS

OF TREASURY OFFERINGS TO THE PUBLIC
1991 QUARTERLY FINANCING

FEBRUARY

January
Amount

Offered to the Public

....

Descri tion of Securit
Term and type of security
Series and CUSIP designation

for STRIPS

CUSIP Nos.

Components

Issue date
Maturity date

Interest rate
Investment

yield

or discount
Interest payment dates
available
Minimus denomination
Amount required for STRIPS
Premium

of Sale:
of sale
Competitive tenders

Terms
Method

$12, 500 million
3-year notes
Series R-1994
(CUSIP No. 912827
Not applicable

February 15, 1991
February 15, 1994
To be determined based on
the average of accepted bids
To be determined at auction
To be determined after auction
August 15 and February 15
$5, 000
Not

applicable

Yield auction
expressed as

Must be

yield with two
e. g. , 7. 10X
Accepted in full at the average
price up to $1, 000, 000
an annual

decimals,
Noncompetitive

tenders

Accrued interest
payable by investor

Payment

investors

$11,000 million

10-year notes

30-year bonds
Bonds of February 2021
(CUSIP No. 912810 EH 7)
Listed in Attachment A

Series A-2001
ZW

30, 1991

(CUSIP No. 912827 ZX 3)
Listed in Attachment A
of offering circular
February 15, 1991
February 15, 2001

based on
the average of accepted bids
To be determined at auction
To be determined after auction
August 15 and February 15
$1, 000
To be determined after auction
To be determined

Yield auction
expressed as
an annual yield with two
decimals, e. g. , 7. 10X
Accepted in full at the average
price up to $1,000, 000
Must be

of offering circular
February 15, 1991
February 15, 2021

based on
the average of accepted bids
To be determined at auction
To be determined after auction
August 15 and February 15
$1, 000
To be determined after auction
To be determined

Yield auction
expressed as

Must be

yield with two
e. g. , 7. 10X
Accepted in full at the average
price up to $1,000, 000
an annual

decimals,

None

non-institutional

Deposit guarantee by
designated institutions

K~eDetee:
Receipt of tenders
a) noncompetitive
b) competitive

Settlement (final payment
due from institutions):
a) funds irrmediately

available to the Treasury
b) readily-collectible check

Full payment to be
submitted with tender

Acceptable

Tuesday, February 5, 1991
prior to 12:00 noon, EST
prior to 1:00 p. mee EST

Wednesday,

Friday,

February 15, 1991
February 13, 1991

Wednesday,

February

prior to 12:00 noon,
prior to 1:00 p. m. ,

Friday,

6, 1991
EST
EST

February 15, 1991
February 13, 1991

Wednesday,

Thursday, February 7, 1991
prior to 12:00 noon, EST
prior to 1:00 p. m. , EST

Friday,

February 15, 1991
February 13, 1991

Wednesday,

epariment of CNe Treasury

-'e 1'eleyhone

washjnlton'I;c.

556.20-

UNTIL GIVEN
EXPECTED AT 10:00 A. M.

EMBARGOED

JANUARY

31' 1991

STATEMENT

OF HOSORABLB NICHOLAS

BRADY

Oversight Board of the
Resolution Trust Corporation
before the
House Committee on Banking, Finance an4 Urban Affairs
January 31' 1991' 10'00 a m
2128 Rayhurn House Office Building
Chairman,

Mr. Chairman, members of the Committee, ve are pleased to he
making our semiannual appearance before your Committee today.
We
look forvard to bringing you up to 4ate on the progress being

the Resolution Trust Corporation {RTC) and the Oversight
Board under the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 (FIRREA).

made

appear today in my role as Chairman of the Oversight Board
RTC. Accompanying me are the four other members of the
Board: Alan Greenspan, Chairman of the Federal Reserve Board,

of the

Philip Jackson, Jr. , former member of the Federal Reserve Board
and currently adjunct professor at Birmingham Southern College,
Jack Kemp, Secretary of the Department of Housing and Urban
Development, and Robert Larson, Vice Chairman of the Tauhman
Company and Chairman of the Taubman Realty Group. Also
accompanying us is Peter Monroe, who is President of the
Oversight Board.

needs as well as
We are here today to discuss RTC's funding
other issues that FIRREA requires for this semi-annual
appearance.
RTCiS

Mr. Chairman, my most important objective today is to state
to the Committee as strongly as I can the need for a4ditional
fun4ing for the RTC. If the RTC is to continue to carry out its
Congressionally assigned mission of resolving hundre4s of failed
institutions and paying off their depositors vithout delay, then
If the RTC
must have additional funds as soon as possible.
and
does
and
not receive
February,
January
for
fulfills its goals
all
available
loss funds
vill have expended
a4ditional funds,
vill he forced to stop closing and selling institutions by
and
the end of February.

NB-1108

It is

that these funds are needed to protect
Without these fun4s, RTC would have
the savings of depositors'
but to practice forbearance, that is, leave
no alternative
insolvent institutions open to continue to lose money for which
the taxPaYers will ultimately he liable. RTC has estimated that
forbearance for even one more quarter would cost the American
(These cost estimates are explained
taxpayers $750-$850 million.
cost is in a4dition to the $250
projected
This
in Appendix I).
to $300 million already lost due to inaction last fall. This
woul4 bring the total cost of delay to over $1 billion.
worth repeating

Therefore,
dispatch.

urge the Congress

to act

on funding

with

In my letter to the Chairman
will he required?
dated October 10 last year, I projected that "forty billion
dollars . . . beyond currently authorized spending should be
sufficient to fund the losses in RTC case resolutions through the
end of fiscal year 1991."
How much

Based on the RTC's draft operating plan, additional loss
funds of $30 billion will he required through the end of fiscal
year 1991. This number is $10 billion less than my October
projection. The RTC needs $10 billion less of loss funds
because, due to the funding delay,
will he unable to resolve
all the institutions it had planned to resolve.

The $30 billion of additional
$17.7 billion of already available

funds,

when

combined

with

loss funds, will cover RTC's
estimated total FY 1991 operating losses of $i7. 7 billion.
For working capital, the RTC estimates in its draft
operating plan that its working capital horrowings for the ninemonth period en4ing September 30 will he $i7 billion.
This would
bring total working capital horrowings for fiscal year 1991 to

$5i. 2 billion.

Provided that $30 billion in added
or before March 1, the RTC projects
plan that it can complete approximately
resolutions with $1i5 billion in assets
1991
on

loss funds are provided
in its draft operating
225 additional
hy the end of fiscal year

While the RTC's draft operating plan calls for new loss
funds of $30 billion, we shoul4 consider whether our actions
should he limited just to this fiscal year's estimated needs.

Full funding sufficient to resolve all failed thrifts, would
RTC to pursue its man4ate aggressively
and without costly
interruption. It would even permit the RTC to exceed expectations
and resolve more than its goal of 225 institutions
for the fiscal
year. It should he noted that Congress can responsibly provide
allow

full funding vithout diminishing its authority to oversee the
RTC's operations.
The RTC and the Oversight Board are required
to appear before Congress at least tvice a year and they must
submit annual an4 semiannual reports.
From October 4, 1989, to
the present, officers of the Board, RTC and Treasury have
testified to Congressional committees 48 times.
vorry that if the Congress imposes on itself the burden of
votes on funding, the result vill be a start and stop
process
that produces further delays, substantial
cleanup
additional costs to taxpayers, and fear in the minds of
depositors that the government vill not meet its stated

repeated

commitments.

The fact is that funding is not a discretionary
matter. The
losses we are talking about today have already taken place. When
institutions are sol4 or closed, cash is needed to pay the
difference between their deposit liabilities and the value of
their assets. If we do not act depositors vill he left hanging.
Together ve have already said to the public that the government
will do vhat it needs to 4o, to protect them.
Ultimately, I believe that the government will fulfill its
commitment to depositors and cover RTC losses in full.
Thus, the
question becomes vhether to provide full or short-term funding.
We believe full funding
is clearly least costly to the taxpayer,
and the least disruptive method of funding.

In June, 1990, at our semi-annual appearance, we estimated
that the final cost of the SCL cleanup vould be in the range of
Borne have asked
$90 to $130 billion in 1989 present value terms.
There
are
a
number of
is
so
vide.
estimates
the
of
range
why
reasons: uncertainties about the number of cases, losses on
assets, interest rates, the condition of real estate markets, and
the general condition of the economy. Nov, the economy has
entered a downturn and the uncertainty caused hy the crisis in
the Persian Gulf has increased the hesitance of potential buyers
All these
to make real estate investment commitments.
and
make
predictions
uncertainty
create
interrelate4 factors

imprecise.

the range of losses the government vill
have to face is directly related to movements in the real estate
market.
In turn, this affects both the number of institutions
that vill fail and the loss taken on assets acquired in
To

oversimplify,

resolution.

markets

vill

one can

he in

six

predict with exactitude where real estate

months.

likely cost scenario has probably moved to
original range, it nevertheless remains
In other words, ve still believe that the
within that range.
upper-end-of-the range estimate of $130 billion in 1989 present
Although the most
the higher en4 of our

valid. However,
no one can guarantee

value terms remains
numerous

times,

volatile variables.
closely.

as has been mentioned
any estimate hase4 on such

will continue to monitor this situation

In April of 1990, the Oversight Board completed the
development of a cash flow model which projects RTC's sources and
uses of funds on a quarterly basis through 1996. This cash flow
model gives the Oversight Board the ability to vary a number of
assumptions to estimate the effect on the Resolution Trust
Corporation's tRTC's) need for loss fun4s and working capital.
more detailed explanation of our methodology can he found in
Appendix II to this testimony.
RTC NORE

GETTISG THE JOB DOSE

of the problem with which we
are dealing, the Board believes that the RTC has made progress.
Shen President Bush announced his proposed solution to the
Given the

size

and complexity

savings and loan crisis soon after taking office, he established
four principles which continue to guide us.
o

First, protect the

insured deposits of the millions
acted in trust by putting their
savings in federally insured savings and loans.

men

and women who

Second, restore the safety and soundness of the savings
so that a similar crisis can not

and loan industry

reoccur.

Third, clean up the S&L overhang so we get the problem
behind us, and do it at the least cost to the taxpayer.

Finally, aggressively pursue and prosecute the crooks
and fraudulent
operators who helped create the problem.
Mr. Chairman,

FIRREA gave RTC

day-to-day

operational

to resolve insolvent thrifts and sell assets. The
Oversight Board's responsibility
is to set overall strategy,
policy an4 goals for the RTC, approve fun4ing, and provide
oversight. Let me turn now to matters that are required hy law to
be addresse4 in our semi-annual report, and other matters of
interest to the Committee.
As recpxired by FIRREA, our testimony will cover the sixmonth period from April 1 through September 30, 1990. In
addition, we will report on some of the key events occurring
since the end of that reporting perio4. My presentation is
responsibility

supplemente4

hy a more

detailed response,

contained

in Appendix

to several of the specific information requirements
forth in FIRREA for this semiannual appearance.
Pro

set

ess in Resolutions

its

inception on August 9, 1989, through December 31,
seised S31 thrifts, and resolved 352 of them. That
left the RTC, as of January 1, 1991, in control of 179
conservatorships.

1990,

Prom

RTC

its resolution pace by setting and
goals. For example, for the three month period ending
June 30, the RTC's goal vas the resolution of ill institutions.
The RTC actually resolved 1SS. During the next quarter, the
RTC's goal vas the resolution of 77 institutions
and it achieved
80 resolutions.
The RTC has achieved

achieving

For the 6-month period from October 1, 1990, to March 31,
1991, the RTC had expected to resolve 192 thrifts. As a result
of Congressional inaction on funding, RTC vas forced to revise
its goal to resolve 97 thrifts. As of December 31, 1990, RTC had
resolved 66 of its revised goal, and expects to meet its goal of
97 institutions
hy the end of February.
The Nev

Accelerated Resolution

Pro

ARP

Last summer the RTC began a pilot project, called the
Accelerated Resolution Program (ARP), to lover the cost of thrift
resolutions hy pre-selling troubled institutions before they are
Such pre-sales should reduce the
put in conservatorship.
deterioration in franchise value and core deposits that can
ARP is a
result from placing an institution in conservatorship.
cooperative effort hetveen th» RTC and the Office of Thrift
Supervision (OTS) in which the OTB, in consultation vith the RTC,
identifies vhich thrifts are ARP candidates. Then the OTS and RTC
establish a supervisory and regulatory framework vithin which the
institutions vill operate vhile in ARP.
vere selected for the ARP pilot project.
Nine institutions
They were chosen on the basis of: 1) bidder interest,
investor proposals, and/or 3) demonstrated
2) management-led
franchise value. The OTS and RTC selected thrifts in different
geographic areas and of varying sixes ranging from S100 million
to more than $3 billion in assets.

In order to ensure open and competitive bidding, the
As a result,
standard RTC bidding process has been folloved.
the
RTC
from
qualified
bidders
bidders
potential
more than 1, 300
nine
the
thrifts.
each
of
list vere notified hy mail for

Bales have closed on seven of toe nine institutions, and the
ITS and RTC have begun a reviev of this demonstration program.
already has been learned.
In all nine
Some valuable information
virtually
no
been
has
4eposit runoff, management
thrifts, there
have remained stable.
has remained intact, and the institutions

to review its Group IV thrifts to identify
candidates for the next phase of the program should the RTC
oversight Board approve expansion heyon4 the pilot project. The
Board's decision vill depen4 on the RTC's evaluation of the pilot
project.
OTS

has begun

Status of the

Conservatorshi

RTC

of January 1, there vere 179 thrifts in conservatorship.
In addition, the most likely candidates for new conservatorships
are in OTS's Group IV, which also contained 179 thrifts. There
are another 3S6 thrifts in OTS's Group III for which the future
is uncertain.
As

of placing an institution in conservatorship
losses, stabilize the institution, and
halt practices which may have contributed to insolvency.
Conservatorship also helps the RTC prepare the institution for
resolution hy reducing its assets hy means such as securitization
The
and by re4ucing the institution's
high cost deposits.
disadvantage of conservatorship
is that conservatorship can
contribute to an erosion of franchise value. Skilled staff often
begin to leave in anticipation of a possible liquidation of the
institution, and depositors tend to accelerate their vithdrawal
of funds. The Accelerated Resolution Program is intended to
The advantages

are that the

RTC

can stem

avoid these disadvantages.

Pro ress in Asset Dis osition

to resolving insolvent institutions, the RTC
of their assets, whether in conservatorship, at
resolution, or out of receivership.
During the April through
September period covered hy our semi-annual report, receivership
and conservatorship
assets vere re4uced hy $66. 8 billion in hook
In addition

must dispose

value.

Hovever, from its inception through December 31, 1990, the
RTC has seized thrifts vith over $273 billion in initial assets.
Through a combination of resolutions,
asset sales and note
collections,
has reduced assets held by over $127 billion, and
continues to hol4 assets of about $1i6 billion.

has made progress, the Oversight Board and
RTC are concerned that RTC has not been able to sell more assets.
Therefore, the Oversight Board has over the past six months
Even though

RTC

focused on developing

an4

affordable

asset sales.

housing

policies - securitisation,

- that

should

enable the

seller financing

RTC

to accelerate

At our Board meeting on January 16, however, Chairman
Seidman advised us of a new roa4 block that will further delay
asset sales. The RTC Board has been advise4 that potential
personal liabilities may he imposed upon directors, officers, and
employees of the RTC and the Oversight Board in connection with
the RTC's securitimation program as well as in connection with
RTC's other asset disposition activities.
Chairman Seidman
indicated that a legislative solution to the problem is needed
and that the RTC is developing proposed legislation for

consideration

Congress.

of Private Sector to Aid Asset Sales
FIRREA mandates that the RTC make maximum delegation of
asset management an4 sales functions to the private sector. To
implement that, the RTC has adopted a Standard Asset Management
and Disposition Agreement,
or SAMDA program.
Tho RTC has already placed over $10 billion in real estate
Bids have
and delinquent
mortgages under SAMDA contracts.
billion
under SAMDA.
already been received to place another $10
Accordingly, most REO and delinquent mortgages in receivership
will soon he under SAMDA contracts. The RTC is also proceeding
to place all such conservatorship assets under SAMDA contracts.
Private sector contractors will he paid fees for managing
the properties as well as incentives to accelerate sales and
maximize the return to the RTC. awhile these contracts provi4e
fair returns for property management, the incentive fees will be
given for turning properties into cash rather than encouraging
managers to collect their management fees while they wait for the
real estate markets to improve.
Thoro aro incentives for selling at prices equal to or
greater than tho RTC's estimates of recovery. There is a 20%
incentive payment for selling in the first year and 10% for
selling in the second year. Actual holding costs are deducted
from tho sales price to encourage efficient management.
RTC Use

believe the program is promising, hut wo recognise the
difficulty of selling these assets in the current real estate
%e

market.

Pro

ess toward Minorit

Outreach

The RTC Minority

and %omen Outreach Pzogzam seeks to
minority ParticiPation in the avard of RTC contracts.
The RTC has conducted seminars throughout
the countrY to inform
minority and vomen owned businesses of the many contractoz'
opportunities vith the RTC and the registration and bidding
process. Advertisements are placed in minority print media to
publicize the program. As of November, 1990, RTC informs us that
over 3, 500 minority-owned
firms, over i, 500 majority vomen-owned
firms, and approximately 900 minority vomen-owned firms were
registered as potential asset managers, brokers, lawyers and
Over 900 contracts for such vork, or
other RTC contractors.
about 20% of total awards, have been avarded to minority and

encourage

owned

women

businesses.

also directs the RTC to give preference in purchasing
from investors vith the same ethnic
identification as that of the failed thrift. As of November, the
FIRREA

thrifts to bids

resolved li minority owned institutions; 3 vere
liquidated, 8 were acquired hy buyers of the same ethnic
identification, and 3 vere sold to other buyers.

RTC had

Board continues to monitor this
minority-owned
institutions and promote

The Oversight

to preserve

awareness

by minority

and women-owned

excellent business opportunities.
ENHANCED

Let

businesses

effort

hy RTC

greater
of these

LA% ENFORCEMENT

say a few additional words about some new enforcement
in June 1990, President Bush announced a
package of legislative and administrative
initiatives designed to
intensify the fight against fraud in our nation's financial
institutions.
Most of these legislative initiatives were
embraced in a hi-partisan manner hy the Congress and enacted as
the Comprehensive Thrift and Bank Fraud prosecution and Taxpayer
Recovery Act of 1990.

tools.

As you know,

The nev law Provides an array of additional powers to the
Justice Department, hank regulators, the FDIC and the RTC,
particularly provisions which:
Provide authority to freeze or appoint a receiver for
the assets of fraudulent operators;
Enhance civil and criminal forfeiture authority;

Protect victims of fraud hy closing loopholes in the
bankruptcy laws that have in the past enabled some
executives to evade financial responsibility for their
aisdeeds;

Allov the Justice Department to accept vithout
reimbursement
the services of federal attorneys,
enforcement personnel, and other employees;

Direct

U. S.

courts to give cases brought

law

the FDIC

priority consideration and to establish
procedures for expe4ited appeals;
o
Give law enforcement authorities a needed tool: the
ability to request the use of viretaps for hank fraud
and relate4 offenses.
In conjunction vith the authorities provided in FIRREA, we
now have an effective arsenal of legal veapons available
to
combat fraud and to recover assets.
Using these authorities,
federal law enforcement agencies are gaining ground against
an4 the RTC

fraudulent thrift officials. Of 566 defen4ants charged in
savings and loan cases from October 1988 through the end of 1990,
i03 have been convicted and only 18 acquitted.
Prison sentences
have been dealt totalling 768 years, and $231.8 million in
restitutions have been ordered. Of those convicted, substantial
numbers have been savings and loan chief executive officers,
chairmen, presi4ents, directors, and other officers.
RECENT OVERSIGHT

BOARD ACTIONS

Let me turn nov to the key areas of Oversight Board activity
over the last six month period. First, I vill discuss the
importance of asset sales and three Oversight Board actions in
this area: securitization, seller financing and affordable
Next, I will describe the Oversight Board's developing
housing.
oversight and evaluation role including its management planning
procedures and the relationship hetveen the Boar4 and the RTC
Inspector General.
Finally, I vill 4escrihe the Board's role in developing
policy for restructuring the 1988 Deals.
Revision

Asset Sales

trat

ies

I said earlier, the increased number of resolutions
handled hy the RTC makes it very important to accelerate its
asset sales. The Oversight Board is in the process of performing
As

overall strategic reviev of RTC asset sales programs.
goals are to increase hath the sales pace and the return
an

Our

asset

sales.

Acquisition

of this inventorY

funded

hy working
Bank (FFB).
hil»on hy December 31, 1990, and
are projected to reach $76 billion in February
The RTC
to
over
$100
billion hy the end of
estimates they may increase

capital

borrowed
These horrowings

hy RTC from
grew to $&3

the Federal Financing

fiscal year 1991.

In developing asset sales policies, the Oversight Board
received valuable advice from the National Advisory Board an4 the
six regional hoards established hy FIRREA. Because the hoard

members know local economic conditions and are composed
community leaders in the real estate, banking, housing,

accounting professions, they have provi4ed
for the Oversight Board.

The Need

of
legal

and

useful recommendations

for Securitisation

its

The policy applies to all securitizahle
financial assets
held hy the RTC including mortgage loans, high-yield securities,
and any loans originated hy the RTC under seller financing.
Approximately 25% of all RTC assets are securitizable.
The Board

believes that securitization should aid the RTC to sell these
assets more quickly, thus improving its cash flow position.
This, in turn, should materially lessen the pressures for working
capital horrowings through the FFB. Progress in the
securitization area depends on the personal liability protection
I discussed earlier.

Seller Pinancin Poli
While securitization
is one method to help the RTC sell its
performing financial assets, the RTC has informed the Board that
certain financial assets as well as real estate and delinquent
mortgages are not securitizahle an4 cannot he sold because
commercial financing is not available.

The New

Accordingly,

in December,

the Oversight

seller financing policy to provide the
its asset sales program.

RTC

Board expanded

its

greater flexibility

hil'ion in seller financing
authority for assets that can't he sold at acceptable prices
because of inadequate commercial financing.
As a result of such
sales, the RTC generally will receive an initial 15% downpayment,
and receive the balance in installments
over time. If buyers in
such sales do not fulfill their commitments,
the RTC still comes
out ahead: it has the 15% downpayment,
it may have received a
number of installment
payments, it has shifted the asset's
operating costs to the private sector for a time, and it will
repossess the asset if necessary.
It is important to remember
that the RTC has already paid for these assets so that the sale
can only reduce Treasury horrowings.
Importantly, under this
policy a minimum of $250 million is reserved solely for the
This program

provides

financing of affordable
income buyers.

housing

to qualifying

low- and moderate-

This $'7 billion program will he measured, monitored and
evaluated for effectiveness hy the Oversight Board. The Board
has also directed the Inspector General to perform a front end
risk assessment of the program and conduct periodic audits of its
implementation.

Affordable

Eousin

Since we last appeared before this Committee, the Oversight
Board has adopted new policies regarding the Affordable Housing
Disposition Program. We believe the RTC is making progress in
responding to the PIRREA mandate in the area of affordable
housing for moderate-and lower-income persons.

15, 1990, the Oversight Board approved a final
rule allowing for a number of marketing initiatives to expedite
The rule encourages the RTC to use hulk
the sale of properties.
sales and special marketing events such as home fairs, open
houses, and auctions to make qualified organizations and
individuals more aware of available properties.
Chairman Seidman has proposed a new program to sell to
eligible buyers during the clearinghouse period, the hulk of
RTC's single family affordable housing in a no reserve auction
The Oversight Board clearly supports
and sealed bid process.
this initiative.
The Oversight Board also approved a policy allowing the RTC
to accept offers from qualified buyers for single family
properties at prices as low as 80% of the market value. The
policy augmented an active RTC program to increase the
opportunities for low- and moderate- income buyers who are at or
below 80% of the local median income.
On

August

mentioned the minimum amount of $250 million
in seller financing which the Oversight Board made available to
The RTC is establishing
the affordable housing program.
The
guidelines for the implementation of seller financing.
authorized
the
RTC
to
Oversight Board previously
pay up to $6
million to purchase forward mortgage revenue bond
commitments to be exclusively reserved for the RTC affordable
one hundred eighty-aine million 4ollars has already
program.
under this program which when combined with the
reserved
been
$250 million revolving affordable seller financing program
provi4es a minimum of $439 million of financing for affordable
have already

housing.

Board has also encourage4 the RTC to take
advantage of the Federal National Mortgage Corporation's and the
Federal Home Loan Mortgage Corporation's demonstrated
capabilities in housing finance. Programs utilizing their
expertise in structuring and servicing seller financed mortgage
The Oversight

loans, including delegating the origination and servicing to
are now under
designated lenders with prudent un4erwriting,
consideration.

result of some of these new developments and the
experience of the program and staff, we can report that
property sales increased.
Through December 31, 1990, the program
had accepted approximately
$108 million of contracts on 2, 737
As a

growing

properties, and of these, 1, 507 properties had closed. The
average sales price was $38, 4i2 for single family homes and
$936, 000 for the nine multi-family developments on which the
ha4 accepted offers. RTC advises that the average income of
purchasers under the affordable program is less than 80% of
national

median

RTC

income.

Although properties in conservatorship
are by statute not
sub)ect to the 90-day marketing period, both the seller financing
and MRB programs are available for conservatorship
properties.
The RTC is encouraging non-profit organizations,
as well as
individuals, to make offers for conservatorship properties.

final rule in place, emphasis is switching to the
of multi-family properties.
The RTC has had some
serious expression of interest in bulk packages of multi-family
affordable housing and its National sales Center is currently
marketing for April sale its first bulk package of multi-family
properties consisting of three Florida developments with 590
units.
With the

marketing

to the progress in the affordable housing program
far has been the assistance of clearinghouses and technical
assistance advisors. The RTC has established 30 clearinghouse
agreements with state housing finance agencies including one with
thus

One key

the Federal Housing Finance Board vith the participation
12 district Federal Home Loan Banks.
Environmental

would

environmental

of the

MOO

also like to address briefly the issue of the RTC's

responsibilities.

requires

the RTC to identify properties vith natural,
cultural, recreational or scientific significance. However, the
FIRREA conference report made clear that this reporting provision
was not intended to impose any duty with respect to such
properties or create any liabilities for the RTC in connection
FIRREA

with such

properties.

The Oversight Board felt that it vas inappropriate
to
delegate these responsibilities to individual special purpose
public or private agencies. Rather, it was the Board s judgment
that the RTC should address this issue through a strengthened
internal identification capacity, combined vith the procurement,
as necessary, of the best available services from both the public
and private sectors.
Appropriate agencies vould include the Fish
and Wildlife Service, the EPA, and many other private and public
sector agencies.

I assure you that the Oversight Board intends that the RTC
fully comply vith this important identification function,
including the proper notification to interested parties,
consistent vith realizing the hest sales proceeds for properties'
The

Board's Role in Oversi ht

and Evaluation

Board's management planning procedures
the RTC is asked to set goals vhich it believes are attainable.
This is the hest way to assure that RTC management is committed
to achieving these goals. The Board then evaluates the RTC's
performance against the goals.
Under

the Oversight

improvements
in RTC
the
through
operating plan
planning and performance
process. As mentioned earlier, the Board and RTC are vorking to
develop a final operating plan for fiscal 1991, rather than the
Longer planning
three and six month plans submitted previously.
periods more accurately reflect the time horizon needed hy the
The nine month plan vill he
RTC for proper goal setting.
forecasts against goals vill he
performance
monitored monthly and
provided quarterly together vith explanations of variances from
plan. RTC vill he asked to submit a one year plan for fiscal

For example,

the Board has suggested
measurement

year 1992.

The operating plan process
program goals and also funding
loss fun4s and working capital
Board and compared to statutory

Provi4es a vehicle for setting
needs. Pun4ing needs for both
are constantly updated for the

constraints.

For example, with each PPB funding draw the RTC must certifY
to the Board that it is in compliance with all statutorY funding
constraints after taking into consideration all contingent
liabilities -- notably "asset puts". Asset puts represent the
right of thrift buyers to "put" purchase4 assets hack to the RTC.
The Board has required the RTC to provi4e a detailed monthly
analysis of such asset puts as to amount, term and

characteristics.

also must supply a weekly update of its rolling sixweek schedule of anticipated FFB horrowings.
In the area of accounting, the Oversight Board's CpA as well
as the Inspector General are reviewing the loss recognition
process used hy the RTC. While the Boar4 has received the RTC's
unaudited financial statements for the period en4ing December 31,
1989, the Board continues to press the RTC for au4ited financial
statements covering this period.
As a part of the Board's responsibility
to attempt to
eliminate potential fraud, waste, and abuse in RTC operations, it
has been working closely with the RTC Office of Inspector General
to set an aggressive audit and investigation agenda.
Weekly meetings have been held with the IG on investigative
and audit activities.
The meetings focus on spotting areas of
vulnerability and correcting problems before they occur. The IG
has been directed hy the Oversight Board to undertake audits in
the highest risk areas. He has also been directed to audit a
As
sample group of completed resolutions and executed contracts.
mentioned earlier, the Oversight Board has directe4 the IG to
undertake a front end risk assessment of the seller financing
program an4 to periodically audit it and the 1988 Deal
restructurings.
The RTC

The IG has opened 15 investigative
cases and closed 6 to
date. It has begun 15 audits and issued 6 reports. It has
identified 36 major areas on which it is planning to focus in
fiscal 1991. Currently at the level of 100, the IG plans a staff
of about 350 hy fiscal year 1992. The Oversight Board considers
it essential that an aggressive auditing program be pursued. In
addition, at the Board's direction, the IG has provided the Board
its detaile4 audit an4 investigation plan for the balance of this
fiscal year.

pro

ess in

Ren

otiatin

1988 Deals

In September, the RTC reported to the Oversight Board on its
FIRREA mandated reviev of the assistance transactions
entered
into hy the Pederal Savings and Loan Insurance Corporation
(PSLIC) prior to the passage of tho Act. Prom
review, the
RTC concluded that a restructuring
of some of the so-called "88
Deals" could result in a savings of approximately $2 billion to

its

the taxpayers over the term of the loans hut vould require
current appropriation of approximately $20 billion.

October 18, Congress appropriated

$22 billion for the
(FRF) to pay obligations arising in FY 1991
as well as "permit the prepayment of certain higher interest rate
obligations and thus realize a savings of approximately $2
On

FSLIC Resolution

Fund

billion".

Under FIRREA, the Oversight Board has the responsibility
to
establish overall strategies, policies and goals for
restructuring the 1988 PSLIC assisted transactions.
Therefore, the Oversight Board has adopted a policy
statement to guide the RTC in restructuring the PSLIC Assistance
Agreements
(see Appendix IV). Tho policy statement provides a
series of guidelines for such restructurings and directs the RTC
to use Treasury borrowings efficiently so as to maximize overall
cost savings for the government vith respect to the 1988 Deals as

a whole.

point here is that ve must immediately begin
the restructuring process and use this fiscal year' s
appropriations to save taxpayer dollars. Accordingly, we have
ordered the RTC to start negotiations consistent vith this policy
statement.
The important

COSCLUSIOS

In closing,
of our statement.

let

reiterate vhat we said at tho beginning
is getting done, hut vo still have a

Tho foh

to go. This is a task the government cannot escape if
are to honor tho promise to the American people to make good
on federal deposit insurance.
Immediate Congressional action to provide additional loss
I repeat that vithout such action the RTC's
funds is essential.
resolution process vill halt and the taxpayers' costs vill
increase. As discussed earlier, wo believe tho most sensible and
appropriate way for Congress to address tho funding issue is to
provide RTC with the full funding necessary to get the whole )ob
done. Let me say again that vithout full funding the result
long way

start

stop cleanup process th
produces further
delays, substantial additional costs to ta
and fear in the minds of depositors that the gover~
t 'll
meet its stated commitments.

could be a

vill

and

be glad to respond

to your questions

january 10, 1%90
RRXORAJG)QX TOg

~er
I, gyggog
Orasiaent,

OEvtd

Rxeoutim

iyht ~Lrd

y4gte

Cost of Oelaytag Reaolaticns
haw asked that ze update our Iegerandus of Noveaher 1& 1010 on
oost o! delaying resolutions. assuaLny that additional tunds
Ere not available until gate fe~ggy or Iarly March, the RTc rill
have tallen approximately
pz qQQz4er behind Ln the resolution
process. 1e estLILate the present value oost of this delay it 0250
million fo $) 00 aillion.
~ese estimates exclude three
aoeguantitiahle factors~ asset deterioration or other losses that
~baht occur in understaffed or underaanayed institutions anitiny
resolution, deterioration of franchise value@ and t?Le effect that
coipet~ with insolvent institutions has on the oost of funds of
aar finally solvent hetitutions
caus~ a4Citional
yossihly
Zou
tbsp

taiXures.

for the KC is Oelayed beyond the very
cost of delay begins to eo ep
esttaate that an additional tparters delay
n
weld ooet an additional 4750 Iillion to QI50 aillion in present
value teras, or in i
$g~aglion to almost 0$00 aileron W
aonth. (In actuality, sinoe the cost of delay grove exponentially,
the cost of delay it the hoiinniny of the second charter is
solevhat less than f250 Iillion per aonth awhile the east of delay
it the end of the seoond quarter is eomevhat greater than 4)00
Billion. )
The reason that the estiaated east of i second quarter' ~ delay is
toulhh triple that of a single charter's Ce]ay Xo that the longer
the 4eiar, the 1onler kt takes to lake uy tot the the lost to
for i tvo quarter delay
delay. Rt takes tvIoe is loW to aDce
it
e number of resolutions
tor
exaayle,
Is a one charter 4elay.
aa3ceW
to
for
lost togae, it would
rere Cnoreaeed hy 10 yeroent
i gear to
ties 0 aonths to I&e~ tor I on» charter Celay NCgealistio
to
loreover,
Celay.
not
s
quarter
tvo
for
~
j,
aak~)
tuch
resolution
rate
sustained
increased
can
he
issuae
$0 peroant
Xf Chare vas I tvo quarter delay, i SI
lonler than 4 sonths.
cent fnorease in the Cuarter1y yacc of resolutions Ls probably
~ aost that is feasible beyond the initial 0 sonths push. Thus,
it cauld take i year and lait to ooaplete)y Iakenp for a tvo
quarter delay.

Zf additional Cunning
innine
cf Xarch,
exponentially.
Thus,

%he

evieusly setule, em eetiaates 4o not
~go aggo~g
SI basset 4eterioration M other 1oeeeg fh4t QiQhQ

enderstatfe4 er en4eraanaSe4 hutitutfens ayait~ ~elution,
4eterioratfen oC tranohise mlue, a@4 Che afgeW at oo~gi3'
eith @solvent institutions has on the ooit 4f ~'Q5$4f mari+z$]y
~ol~t 4astituttons
possibly oausiny 44itiona1
gensvar, it eeu14 net ho unreasonable to as+ac that these gagrCzI
aiSht Lacrwse gabe oost o! an @44itional Cuartex 4elay
aC leait
So yazoent.

Appendix
HETHODOLOGY

FOR BSTIMATING

RTC LOSSES

of Fa' ed nst'
The Oversight Board's current low estimate assumes a
population of about 700 failed institutions, which includes those
already resolved, those in conservatorship,
and all institutions
classified as Group IV thrifts by the Office of Thrift
Supervision (OTS). The high estimate assumes a population of
just over 1000 thrifts, which includes the 700 institutions in
the low estimate, plus all institutions classified as Group III
thrifts by the OTS.
s

tions

umber

ace of Resp ution

The cash flow model

does not deal with individual

total assets for individual thrifts are
divided into 14 different asset types and then aggregated into
tranches representing conservatorships,
Group IV and Group III
thrifts. The RTC's pace of resolution is selected not by
choosing individual thrifts each quarter, but by choosing a
volume of total assets in thrifts that are to be resolved each
For the $90 to $130 billion range, it was assumed that
quarter.
the RTC would resolve $40 billion of assets per quarter.
sses on Assets
ssum t'ons Beh nd
The 14 asset types are: cash; government and agency
securities; mortgage-backed securities; high yield bonds; other
investment securities; mortgage derivatives; performing permanent
mortgages on 1-4 family residences; other performing mortgage
loans; consumer loans; all other loans; other owned real estate
(ORE); other delinquent assets; service subsidiaries; and other
assets.
The losses to be experienced by the RTC are estimated by
applying a loss estimate, or "haircut" to each of the 14
different asset types, and adding that to the negative tangible
net worth and accumulated operating losses (prior to
In making estimates,
receivership) of the resolved institutions.
three different sets of haircuts were used. The medium haircuts
were based upon the FDIC Division of Research's bank failure cost
model, and, thus, were based on the actual loss experience of the
FDIC. The other two sets of haircuts were assumed to be higher
institutions.

Rather,

the estimated effect of changes in
interest rates, the condition of real estate markets and the
The weighted average haircuts
general condition of the economy.
for these three scenarios ranged from about 13 to 25 percent,
follows:

and lower,

depending

Three Haircut

Scenarios:
FDIC

~o
Weighted

Avg.

13-14%

16-18%

22-25%

Weighted average haircuts are given as ranges because they
vary depending upon the asset mix of the particular

population estimated to fail. These ranges are for the
Oversight Board's low and high population estimates.
The
Oversight Board has preferred not to disclose the haircuts
on individual
asset types out of concern that they could be
used by buyers against the RTC during negotiations.

Present Value Estimates
In the May/June testimony, the Oversight Board estimated
that the cost of resolving all institutions that will come to the
RTC would be in the range of $90 billion to just over $130
billion, in present value terms.
Our current estimates suggest that the RTC's ultimate costs
are still in this range. These estimates use a discount rate of
7. 38%, which was the rate the RTC paid for working capital funds
from the Federal Financing Bank during late-1990 (when these
estimates were originally made).
Data Used
The estimates

in the May/June testimony were based upon
1989 data, with the OTS Group III and Group IV
classifications as of the end of April 1990. As OTS has released
new data and thrift classifications,
this information has been
incorporated into the cash flow model. The latest estimates,
upon which the President's budget numbers are based, use June
1990 data. OTS has only recently released September 1990 data
and new Group IV and Group III classifications;
based upon
preliminary analysis, it appears that this new data will not

year-end

substantially

change current

estimates.

sse s

ions

assed to

allows the Oversight Board to change the
of institutions that are resolved in whole bank, clean
bank and liquidation
transactions, and to define each of these
transaction types in terms of the percentage of each asset type
that is passed to an acquirer. The Oversight Board's current
estimates assume that the RTC will pass an average of about 32%
of all assets to acquirers.
The cash flow model

percentage

ace

ons

sse

Sa es

The model also allows the Oversight Board to vary the pace
of sale of receivership assets by estimating the percentage of
each of the 14 asset types that is sold each quarter until all
are sold.

1st

Half
Yr. 1

2nd
Hal

Yr. 1

Yr.

Yr. 6+

100%

Cash

Govt/agency

90%

10%

MBS

60%

30%

10%

Perf Perm 1-4s

25%

15%

20%

14%

20%

15%

4O%

3O%

14%

2O%

2oi

20%

15%

Othr

Perf Mtgs

~Consum

Lns

15%

10%

All Othr Lns
Junk Bonds

Othr

Invest Sec

15%

10%

30%

25%

20%

3S%

20%

DRZ

14%

2O%

20%

2O%

22%

0th Delinq Asst

14%

2O%

20%

2O%

22%

Service Subs

10%

25%

4O%

20%

3erivatives

25%

20%

35\

2O%

)ther Assets

10\

10%

2S%

30%

2O\

11.0%

18.3%

19.5\

16.0%

4eighted

Avg.

19.4%

8. 6%

7. 2%

ffect of Interest Rates
No specific interest rate
extremely difficult to estimate

assumptions were used. It is
with any precision what effect
change in interest rates maY have on the value of any given
tYPe. For example, if everYthing else were held equal,
in interest rates would increase the value of some assets held by
the RTC, such as securities, mortgage loans, etc. However
interest rates have declined, other economic factors which
If real estate
influence RTC asset values have also changed.
interest
as
rates
same
time
the
fell, the effect
values fell at
on the value of RTC assets could go either way.

Because the effect of these factors is virtually impossible
to accurately predict, the Oversight Board estimates are for
ranges of both the number of institutions and the losses on those
institutions' assets. Ultimately, the RTC's actual experience
The RTC's recent
must act as a guide for any estimates.
experience suggests that the downturn in the economy may increase
the RTC's costs. It appears at this time, however, that the
RTC's costs still appear to be within our original present value
estimates (though perhaps somewhat higher within this range).
o'ections
TC
The Oversight Board staff developed a cash flow model in
order to perform sensitivity analyses, to make cost estimates,
and, perhaps most importantly,
to render an independent judgement
regarding RTC projections of funding needs. In other words, the
Oversight Board does not simply accept RTC requests for funds
without questioning the assumptions implied in these requests.
Likewise, of course, the RTC does not depend upon the Oversight
Board for its projections of funding needs.
Rather, the RTC
makes its own independent
estimates based upon market conditions
and the institutions
likely to be resolved during a particular
period of time.
The projections contained in this testimony and in the
President's budget reflect what the Oversight Board, the
Administration
and the RTC, in consultation,
believe are
reasonable estimates, given that the RTC receives additional
funds to cover losses in a timely manner.

A PPF.NDTX I I I
NecNrlresnente

Sr&ahiished hs YIRRFA

fot

Rcporl cm Ihc progress made during Ihc 6-month peri rl
arveted by Ihe aml-annual report in resolving esse~ iccvolving
FSLIC prie lo FlkkEA, eccl I'ur
hurtllWkse htatated by

Dialled clccnrsslan Is indccdcd In Ihc leNhnony aoctlan entklod

latciver has boen appainlod (I'rcrn I/I9
lo the 3 year perhtd beelltsdng 8/89) Tllcsc nL%I ilcllicrls af c
lefclelteed bcjow aa Ihaac described in subsection (b) (3) (A ).

cxrcccxvalotship and receivership assets «ere

which cxnmevatte

Plcrvlde an

cw'

col~le af Ihe short-term

Utdted SINea Ooverlmlcllt
during auch Iceriod.

and lang Inlet nxu lu tice

of obligations

l%%lccl

M innNrcd

. Derring

R~~dcctkrc.

lice six month period, Ih

iceailcclicrac, cxnxxling ils goal

RK Ieccalvcxl

of 2 IS Inatlluticaa.

Case

23$

During Ihc same pcricjd,

Iedctcxxl by

$66.g billion

book value.

%'c interpret Ibis recpcltemcnl la addtem R7C abort-tcrln bartewhlgs
from thc Fcdcral Financing Bank ( FFK) and bng-term banewlngs

fmn Rc~lcNion Funding Corporation pREKURP").
Dccring the
~hotel

~ng pcxiod, Ihc R1C

553.0 billion

had kcaucd and outstanding

in obligations in Ihe farm

of shalt-Icrln

working

capital bonuwings fmm thc FFB. Apprettlmately, $900 million In
interest cxpcscscs were inncrexl In cotutactlatt with Ihe issuance ul'
IIKM obligations dclring sclch period.

%cue bcNIowlnga ace fully

eollatcralir& by assets having an aalmaled fair market value
scclxctanlially in cxoaec cd Ihc bonewed aSncntnl. Aaealcllngly, wc
cxpcxt lhsl lhc U.S. Snvcrnmncl ulllmaldy will nat Incur any axed
cmuccc4cat with Ihncc slcart-ictm obligatlana

Icc

AS ldllion of nhligalinntt

darhtg lhe lepalling
wnh 533 lulllocc having ~ term of forty yeats, and Ihc balan ~
having a lnm c4 thirty yeats. lire yidd on each Isauc was S.S8%. Total
inl«~t cxpcnsc Is cxpoc~ io lr. ~ nominal $2$.g billion. Anmcal Axed

REFCORP ac~cod

.
p rind,

lot~i

cxpensc~ ccf 57$$ million will hc Inntmxl in cotucocticrc
erich Ihcsc obligaticrcc. Unshy FIRREA, interest on all REFCORP
»hligaticrvc
ncccl

fcmcl«AI jccintly

hy the Fodcral Home Loan Bani

lhc Trc mccry, with tie«Fill. B carctrihuticat

$300 million

s (FIII.Ai)
uf

limilod tu a marin»r»

year.

of january l99I, REFCORP had auhNanding Ihc full $30 hiilinn
oldjgstlcrcs accthorirod hy FIRRF~, with average matccritlaa c4 13
years and average yickls of S.76%. Taial interest on REFCORP
obligations is cxpcx~ lu be ~ ncrninal 587.9 billion. Inc T~scccy
As

&it

~aeeyuiremcnts

ill

VMahlhdscd

ln VlRkKA fur

Rcport tm Ihe ptogtem made duriag sech period in selling
aecas of iasAWkms described in sulnoction (b) (3) (A) and thc
Impact such sales are havtng tm Ihc local markets in which such
~ acts ate ktcatod.

Dctaihxl Jiscteeion is included ln Ihe tcsthnony sectiaa entitled

Asset

lexee

lo annus Ihe hnpact of RlC Ical
+tate sala un Ua loal marlavs. To date, there is no evlcknae that RK
sales have had an adverse impact cat local Ical estate markets. lac
RTC's National Advisory Board tcports Ihat the saic of RTC asiets has
not adversely affined local Ical estate markets to date and this
Dispositinn

it is Ioo arly in Ihc

observation is cclwistcnt with ituIepettdcnt reiwtts. The

R1C will,

however, monit(» Iltc impact of its saks activltks in local markets tluough
the inintt A' its Rcgiutatl Advisuty Boards. 1hc Regional A Jvtsory

Beards will nx~ive analytical support fram ooanmtists at thc Federal
Ractvc In Irack anJ mawne Ihc hnpact of R1C sales on local matket
L'%IndilkNL4. In pnltindar, Uu: ncw natksnwklc auction pnrgram will bc

IV Dcsctla tu:

carefully nun Jtorc

We have inta~1axl Ihis tutpsltcntcnl

lacurtcd hy Ihc GNporadon in h~uing
obiigathms, ntanaging and mlllng amets acquired by tbc

rccclvctsllips and cÃllNetvatorshlps

Gwptnuthe.

of the RTC.

lo acklnm thc assets nf
Ihc managclIlcnt

lakh atc under

Costs in Ihc range of 5250-5300 Ihotamtd wcte lncurtod*sting Ihc pctinJ
with Um hmwncc of obligatlnmby Ihe Cnrycsrntkat.
in

~sinn

con~~

1lsc nNal anwuatt paiJ Io private
turing Ihe April - Scplcmlar
peiod was 599 millins, c4 which 5 I S million n1scxrenls fca pai J unckr
ruxivcrship a%let mansgclllcnt ccallracts.

Afte Ihc ~t~sinnl~ta of R'K as onrectvalnt, assodalkm cmployocs
neiinuc Io pcrfaen asset mana@Mal fimdions unde Ihc
siq~rvbical

&sf

Ihc RTC Managing Agent.

wqg~~tc J by

onside

cmrac~

himcl

1hac staff arc alrealy
anJ pakl fry by Ihc

iuititutke fee wsvkw~ fry which Ihc institulke wnikl lypk:ally
oaunac In ts eual awew i4 iw ice~. Aa~elingly, wc have
of this calculation.
cxcluckal wseh c~s for Ibc

bi~

tcsprlreencsstv

Vstablishcd ln Vl It It I'.A f(sl

Provide an estimate

of isasnne of Ihc Corporats(as

I'nsm

as~Is

ln its corp(sratc capacity, Ihc

R1C's only

advanc(~ made by Ihc C(ssporation to cot~rvatorships and
reecivcrship((. Thc R1C a~mscd 5$gg million of intescst in(asmc on
~dvaslccs (slid Ioasas I(l c(ssL%xvatofshlps arid tcceivcrships in Ihe aix
months cssckd Scptcmbx 30, l990. Dividends are not indudcd in

acqeited by the Ccsrpsnation.

hs(wham

hccasaa: tlscy are ~ rc(tuctian

RR(CIS Of Ilse le(&iv(FYASipa

provide an ammnscnt

r~roru

of any

C~~i~

potential source

of a(L lit i alai

its

R1C's claims against the

~ return Of Capital

However, dividends ~wived by Ihc

ls Interost (ns

lncsnnc

and Slot illCOISIC.

RM doing

thc pcrhal totaled

billioss.

llsc (snly r(sssaining a(ssssc(~

of addltknal

funds to Ihe C(srls(srallnn

are

Ihc accssnxl b(srrsswinga for working capital from Ihc FFB and Ihe 55
hillion lin(: (sf cnalit fsosn Ihe Trcnnsry provided in FNREA. 'Tbete

are n(s other fssnds cssncntly avallaMe Io the RTC.

Yll hovtde an csllnmte of Ihe tutnalnhsg cxpoaurc (sf Ihc United
States Oovcrsusscsst in osnusccllaa «ith instilssliosa( (k~+Iscd in
Ndascctissn (h) (3) (A) «he%, hs Ihc OverAghs 8(s:(l(ls'i
e(thnatian, will rcspshc mskstasscc ce Sqaidati(sn allu sisc csal (jf
audi pcrhld.

1lsc estimate (sf lhc t(stal resolution cast Io bc bottle hy Ihe R'K in
cosnsccli(as with Ih(x(c iss(stitutlana descrihal in subsection (h) (3) (A)
ls prie. 'l(. (l l(s I(c in Illa range of 590 Io 5 I 30 Mllion (pl(a(est vnlssc).
'Tlsc RTC h(cs cxpcn(kJ approx isnatcly 537 Mllksn f(sr estimatal
%ac((~ I'nan issccpUnn Ihlossgh December

3 I, l 990.

POLICY

Oversight
Nestzuctuziag

Board Policy Coaceraing RTC
of tSLIC Assistance kgremante

ee and Statuto

SmTma~ No. 16

Bac

round

statist establishes guidelines tor the RTC with zeepect
tbe restructuring of the FSLIC agree~ts ("1988 Deals" ) referred to in
Section 21k(b) (11) (B) of tbe tederal Scorn Loan Baak let, as asaaSed by Section
501 ot FIRRXA. . Pursuant to tbe aequi~ate of that law, and in accordance
with the guidaace provided by this policy stagnant, RTC "shall exercise any
aad all legal rights to modify, renegotiate, or restructure such agreesants
where savings would be realised by such actions. " pIRREL also instructs RTC
to operate in a maaaez that "makes ef ficieat uee of fuads obtained fran the
Pundiag Corporation or fraa tho Treaeuxy. "
This policy

2. Restructurin
With

(I)

Policiee

respect to tbe 1988 Deals:
RTC

time to time
1988 Deals.

shall

tor tbe

make

efficieat

puzpoeo

use ot Troasuzy funds appropriated from
of lowering tbe goveamnt' ~ overall coat of the

(i) RTC shall ezpead appropriated fuads ia a sinner designed to
mzhiize govoznsant cost savings with respect to the 1988 Deals ae a
whole.
RTC need aot ezpend any particular
funds
amount ot appropriated
ia aay specific transactioa.

(ii)

«illiag to

need aot ezpend
do so as necessary
RTC

(iii)

RTC may

appropriated

Eundo.

all appropriated

tunds but should be

to achieve coot eaviags.

ezpead appropriated funds to prepay aotos, purchase
aseote, or otherwise ezerciee tho government'e rights
and optioas under the ezistiag teaas ot 1988 Deals. RTC may renegotiate
terms of a transaction iaetoad ot, or ia combination with, such uso of

assete,

mark down

(iv) Acept for tbe ezpaWture of appropriated funds to make
paymente uader tho ezietiag terms of the 1988 Deals, tbe
Board considers all ezpendituree ot appropriated funds to
constitute "restructuring" of tbe 1988 Deals.

scheduled
Oversight

(v) Za determining

how and when

ezpend appropriated

shall take iato coaeideratioa all relevant factors including,

lisLited

to:

fuade, RTC
but aot

(a) savings and pzo5ected savings that may be achieved
through pzepayments and ezercise of other govoaamnt rights under
the 1944 Deals;
through

aad pro jected eaviags that may be
reaegotiatioa of the terms of 1988 Deals;

(b) savings

revenues;

and

of thrift failures resulting
rights under 198 8 Deals .

(d) projected costa

government

frcxa

projected savings and projected costs shall be considered «ith
~ard for the probability with «hich they can be expected.
where RTC seeks
improve incentives

due

to renegotiate the terms of 1988 Deals, it shall
for effective management and disposition of assets

seek to
in a manor consistent with the concepts employed by
Managesent and Disposition kgrw~nts.

RTC

in ita Standard

~set

shall eaploy unifozm criteria for ita decisions and actions
ao-called "stabilized" deals and the other 1988 Deals. eith
the
concendLag
of
the "atabilised" or other 1988 Deals, RTC may renegotiate
respect to any
terms ao as to continue yield maintenance, asset loss coverage, and other
forms of continuing assistance, where doing ao ia consistent «ith the goal of
reducing the governaent'a overall cost of the 1988 Nile, notwithstanding
the
Oversight Board'a general policy egret the uae of such ongoing assistance
with zeapect to RTC thrift resolutions apart from the 1988 Deals.
(C)

RTC

to avoid goveznaeat undertakings «here fraud or other
contracting «ith the goveznsent provides a legal basis
Ihere fraud or other crisLinal conduct appears, RTC shall refer the
matter for prosecution.
(D)

misconduct
to do ao.

RTC may

seek

by persons

Ezecution

In restructuring

1988 Deals:

(4) RTC may employ «hatever resources it deems reasonable and
appropriate, including FDIC personnel and outside contractors.
RTC, however,
remains responsible for the overall plan of the effort, for the methods used
and results achieved, and foz reporting to Congress, the Oversight Board, and
the public.
(B) RTC shall thoroughly and completely document ita procedurea,
decisions, and actions (and shall require the same by ita agents and
contractors) in a manner ao aa to facilitate detailed auditing and
investigation by RTC'a Inspector Geaoral.

Pezfozmance

and Monitorin

shall report monthly to the Oversight Board regarding actions taken'
oz to be ezpended, and coat savings achieved or projected as
a result thezeof. Reports shall be made with respect to the 1988 Deals
individually and in the aggregate and shall include such detail, data, and
erplanationa aa the Chairman or the President of the Oversight Board may fzcmL
RTC

amounts

time

ezpended

to time zequeat.

Zmmdiatel

Effective

This policy statmant supersedes the Oversight Board's request for
reccmaendations
the RTC as set out in the resolution adopted by the
Oversight Soard on September 20, 1990. Lccordingly, this policy stateaant is
ismdiately effective and RTC aay begin lmdiately to restructure the 1988
Dea1s as provided herein

fri

OVERSIGHT BOAIU3
T

~ 7

Resolution Trust Corporation
STREET. hLW. WASHINGTON.

D. C 2

02 3z

Contact: Brian P- Harrington
(202) 786-9675

FOR IMMEDIATE RELEASE

January 31, 1991
OB 91-10

RTC REGION 3 M)VTSORT BOARD TO HOLD OPEN KEETZNQ

The members of the Kansas City-based Region 3 Advisory Board
will hold their quarterly open meeting in Little Rock, Ark. on
February 6, 1991, from 12:30 to 4:00 p. m.
The meeting,

be in the Fulton
Statehouse Plaza,

open

to all

members

of the public

at the Statehouse
in Little Rock.

Room

Convention

and.

press, will

Center,

Three

Institutions Reform, Recovery and Enforcement
that the Oversight Board establish
to provide advice to the Resolution
for the
Trust Corporation
(RTC) on the policies and programs
nation's
failed
thrifts.
estate
the
of
of
real
disposition
Ill. , as
Donald Jacobs of Evanston,
The Board includes
Minn.
of
Minneapolis,
;
Emery Fager of
chairman; Evelyn Carroll
Topeka, Kansas; Ritch LeGrand of Sioux City, Iowa; and Layne
Morrill of Kimberling City, Mo.
Discussions at the meeting will center on the activities of
Region 3 as related to the RTC's affordable housing disposition
program, pricing policies, private sector contracting procedures
of delinquent real estate mortgages.
In
and administration
real
estate
market
report by a
addition, there will be a regional
Time also will be reserved for
Federal Reserve Bank economistmembers of the public to address the board with their comments
concerning the RTC's disposition of real estate.
The Region 3 Advisory Board represents the states of Arkansas,
The

Financial

Act of 1989 (FZRI'EA) required
six Regional Advisory Boards

Illinois,

Nebraska,

Indiana, Iowa, Kansas, Michigan, Minnesota,
North Dakota, South Dakota, and Wisconsin.

Missouri,

federal.

f';iunci~=

WASH

=-;,~

IMMEDIATE

a
(n

IN GTON, D. C. 20220

February

RELEASE

FEDERAL FINANCING

BANK

ACTIVITY

Charles D. Haworth, Secretary, Federal Financing Bank
(FFB), announced the following activity for the month of

December

1990.

FFB holdings of obligations issued, sold or guaranteed
Federal agencies totaled $179-1 billion on
other
by
December 31, 1990, posting an increase of $1. 5 billion from
the level on November 30, 1990. This net change was the
loans
result of a decrease in holdings of agency-guaranteed
assets
of
of
agency
of $1, 199.7 million and in holdings
$0. 2 million, while holdings of agency debt increased
during
FFB made 38 disbursements
by $2, 662. 9 million.

December.

Attached to this release are tables presenting FFB
December loan activity and FFB holdings as of December 31, 1990.

NB-1109

rEB

FOR

Page 2
FEDERAL FINANCING
DECEMBER

1990

ACTIVZIY

IN722KSI'

INIKR EST

RATE

(settu. —
annual)

12/3
12/3
12/3

NATIONAL

$ 166, 000, 000. 00
16, 000, 000. 00
578, 000, 000. 00

12/1/98
12/1/06
6/3/91

8. 039%
8. 405%
7.487%

15, 000, 000. 00
2, 500, 000. 00
5, 000, 000. 00

1/2/91
1/4/91
1/28/91

7. 365%
7. 350%
6. 857%

1/2/91
1/2/91
1/2/91

7. 395%
7. 229%
7. 187%

12/17/90
12/11/90
12/24/90
12/31/90
1/8/91
1/15/91

7. 380%
7. 350%
7. 229%
7. 170%
6.877%
6.793%

3/31/94
5/31/95

7.791%
7.914%

CREDIT UNION ADMINISTRATION

idi

Central Li

Facili

+Nate ¹536
Nate ¹537
Note ¹538
RESOZVZION

12/3
12/6
12/26
TRUE

CORPORATION

Nate No. 90-07
Advance
Advance
Advarxa

¹7
¹8

12/4

12/10
12/17

¹9

200, 000, 000. 00
400, 000, 000. 00
2, 100, 000, 000. 00

TENNESSEE VALIDLY AVI80RITY

Short-term
Short-term
Short-term
Short-term
Short-term
Short-term

Bond
Bond
Band
Bond
Bond
Bond

¹69
¹70

¹71
¹72
¹73
¹74

12/3
12/7

12/11
12/17
12/24

12/31

256, 000, 000. 00
30~ 000~ 000 00
177, 000, 000. 00
221, 000, 000. 00
141,000, 000. 00
239, 000, 000. 00

DEPARIMEP1' OF

Farci

Mili

Morocco 9
Morocco 13

+rollaver

Sales
12/7
12/7

BANK

ANXNT
OF AOVAN

Nate ¹92
Nate ¹93
Nate ¹94

58, 625. 79
20, 169.00

(other than
semi-annual)

7. 960% qtr.
8. 582% ann.

Page 3
FEDERAL
DECEHHER

FINANCE

Advance

New

1990 ACTIVE%

¹4

12/28

Electric ¹267
S. Mississippi Electric ¹330

United Power Asscm. ¹159A
+Associated Electric ¹328
*Cajun Electric ¹197A
*Colorado~ Electric ¹96A
*Colorado-Ute Electric ¹96A
~loraCk~e Electric ¹203A
*Colorado-Ute Electric ¹203A
*Colorado-Ute Electric ¹203A
*Cooperative Power Assoc. ¹156A
*N. C. Central Electric ¹278
Wld Dominion Electric ¹267
K)glethorpe Power ¹320
K)glethorpe Power ¹320
Kkglethorpe Power ¹335

*S. Mississippi Electric ¹330
United

Power Assoc. ¹67A

Assoc. ¹159A

Note A-91-02

~turity

extensicn

FINAL
MAIURITY

(semi-

(other t'. m

annual)

semi-annual)

York

Old Daninion

~ted

BANK

AMXÃl'
OF ADVANCE

1, 204, 246. 99

5/15/91

6. 963%

12/10
12/17
12/31
12/31
12/31
12/3 1
12/31
12/3 1
12/31
12/31
12/31
12/31
12/31
12/3 1
12/31
12/31
12/31
12/31

534, 873. 00
296, 000. 00
340, 000. 00
3, 730, 321.80
38, 153, 846. 11
1, 076, 972. 57
1, 293, 697. 82
1, 922, 345. 76
6, 882, 930.83
1, 037, 819.17
7, 464, 070. 81
99, 357. 12
3, 197, 137.76
15, 150, 942. 15
9, 348, 066. 10
4, 792, 000. 00
510, 789.92
5, 734, 059. 43
1, 575, 000. 00

12/3 1/92
12/3 1/19

12/31/19
12/31/13
12/3 1/19

7. 612%
8. 185%
8. 204%
7. 370%
8. 316%
7. 370%
7. 370%
7. 370%
7. 370%
7. 370%
7. 366%
7. 366%
7. 369%
7. 367%
7. 367%
7. 375%
8. 304%
8. 259%
8. 304%

12/31

577, 524, 522. 09

3/29/91

6. 797%

12/7

12/31/19
12/3 1/92
1/2/18
12/31/92
12/31/92
12/31/92
12/31/92
12/31/92
12/31/92
12/31/92
12/3 1/92
12/3 1/92
12/31/92
12/3 1/92

7. 541% qtr.
8. 103% qtr.
8. 122% qtr.
7. 303%
8. 231%
7. 303%
7. 303%
7. 303%
7. 303%
7. 303%
7. 299%
7. 299%
7. 302%
7. 300%
7. 300%
7. 308%
8. 220%
8. 175%
8.220%

qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.
qtr.

page
FEDERAL FINANCING

(in millions)

December

Procrram

Agency Debt:
Export-Import
NCUA-Central

Qank

Liquidity Fund
Resolution Trust Corporation
Tennessee Valley Authority
U. S. Postal Service

sub-total*
Agency Assets:
Farmers

Home

Administration

DOT-WMATA

sub-total*

total*

may no

5
53, 000. 0
14, 055. 0
6, 697. 8

o a

capitalized

o roun

ance

interest

BANK

1990

12 1 90 12 31 90
$

50, 300. 0
14, 130.0

85, 204. 5
52, 324. 0

52, 324. 0

4, 407. 2

82. 7
4, 407. 2

5, 244. 1
4, 850. 0
233. 0
1, 903. 4
477. 4
29. 7
25. 3
32. 7
672. 4
1, 889.
6
18,
325. 1
729. 8
2, 375. 0
22. 9
177. 0
36, 987. 2
179, 083. 0

Net. Change

8
11, 339.
74. 0

6, 697. 8
82, 541. 6

56, 891.3

Government-Guaranteed
Loans:
DOD-Foreign Military Sales
DEd. -Student Loan Marketing Assn.
DHUD-Community
Dqv. Block Grant
DHUD-Public Housing Notes +
General Services Administration
+
DOI-Guam Power Authority
DOI-Virgin Islands
NASA-Space Communications
Co. +
DON-Shxp Lease Financing
Rural Electrification Administration
SBA-Small Business Investment Cos.
SBA-State/Local Development Cos.
TVA-Seven States Energy Corp.
DOT-Section 511

figures
+does
not include

2
11,370.
81.

7. 8

Administration

sub-total*

grand

November

69. 6
82. 7

DHHS-Heafth Maintenance Org.
DHHS-Medical Facial|ties
Rural Eleqtrificatj.
on Admin. -CBO

Small Bustiness

1990

30. 4
7. 5
0
2, 700.
-75

'0
-0-

2, 662. 9

'91

Net Changi

10 1 90-12 31 90

30.
518.
11,-327.
-0
11,246.
24.

8. 0
56, 891.5

-0-0-0-0-

-0. 2
-0. 2

275.
-0
-0
-0
-0
274.

5, 279. 8
4, 850. 0
239. 9
4
1, 903.
376. 8

-35.
-0-7
-7.
-0-0
100.
5
-0-0-1, 170.
-0-5
-78. 2
-15.
-5. 7

-4, -30.
511.
-11.
-47.
110.
-0

69. 6

29. 7
25. 3
2
1, 203.
672. 4
1, 967.
8
18,
340. 8
735. 2
2, 362. 7
23. 1
177.0
38, 186 ' 9
$ 177, 619.9

12. 4
-0.

-0

-1, 063.
-0
-152.
-57.

-11.

-0-1

-1, 199.7

-5, 7P

1, 463. 0

5, 7(

of the Treasury

Department

FOR RELEASE AT

February

12:00

Iashlnaton,

NOON

1, 1991

-; &,

TREASURY'S

i-'~,

CON&pCTa

Cl.

c. ~

Telephone S6I-204

Off'ce of Fina.",='n=
202/376-4350

n»

52-WEEK BILL OFFERING

The Department of the Treasury, by this public notice,
invites tenders for approximately $11, 750 million of 364-day
Treasury bills to be dated February 14, 1991, and to mature
February 13. 1992 (CUSIP No. 912794 XZ 2). This issue will
provide about S 2, 150 million of new cash for the Treasury,
as the maturing 52-week bill is outstanding in the amount of
$9 594 million. Tenders will be received at Federal Reserve
Banks and Branches and at the Bureau of the Public Debt, Washington, D. C. 20239-1500, Tuesday, February 12, 1991,
prior to
12:00 noon for noncompetitive tenders and prior to 1:00 p. m. ,
Eastern
Standard
time, for competitive tenders.
The bills will be issued on a discount basis under competitive and noncompetitive bidding, and at maturity their par amount
will be payable without interest.
This series of bills will be
issued entirely in book-entry form in a minimum amount of S10, 000
and in any higher $5, 000 multiple,
on the records either of the
Federal Reserve Banks and Branches, or of the Department of the

Treasury.

bills will be issued for cash and in exchange for
In addition to the
Treasury bills maturing February 14, 1991.
maturing 52-week bills, there are S19, 601 million of maturing
bills which were originally issued as 13-week and 26-week bills.
The disposition of this latter amount will be announced next
The

Federal Reserve Banks currently hold S1, 131 million as
agents for foreign and international monetary authorities, and
$7, 477 million for their own account. These amounts represent
the combined holdings of such accounts for the three issues of
Tenders from Federal Reserve Banks for their
maturing bills.
moneown account and as agents for foreign and international
tary authorities will be accepted at the weighted average bank
Additional
discount rate of accepted competitive tenders.
Federal
Reserve Banks,
amounts of the bills may be issued to
monetary authorities,
as agents for foreign and international
to the extent that the aggregate amount of tenders for such
accounts exceeds the aggregate amount of maturing bills held
For purposes of determining such additional amounts,
by them.
foreign and international monetary authorities are considered to
million of the original 52-week issue. Tenders for
hold S 170
bills to be maintained on the book-entry records of the Department of the Treasury should be submitted on Form PD 5176-3.
week.

NB-11] 0

TREASURY'8

13-i 26-i

AND

52-NEER pZLL pppERZNGS

page

Each tender must state the par amount of bills bid for
which must be a minimum of $10, 000. Tenders over $10, 000 must
be in multiples of $5, 000. Competitive tenders must also show
the yield desired, expressed on a bank discount rate basis with
two decimals, e. g. , 7. 15%. Fractions may not be used.
A single

rities and report daily to the Federal Reserve Bank of New York
their positions in and borrowings on such securities, when submitting tenders for customers, must submit a separate tender for
each customer whose net long position in the bill being offered
exceeds $200 million.

A noncompetitive
bidder may not have entered into an
agreement, nor make an agreement to purchase or sell or otherwise dispose of any noncompetitive
awards of this issue being
auctioned prior to the designated closing time for receipt of

competitive

tenders.

Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the Treasury.
A cash adjustment
will be made on all accepted tenders for the
difference between the par payment submitted and the actual

issue price as determined

in the auction.

deposit need accompany

tenders from incorporated banks
companies and from responsible and recognized dealers
in investment securities for bills to be maintained on the bookentry records of Federal Reserve Banks and Branches.
No

and

1/91

trust

TEKASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 3

Public announcement will be made by the Department of the
of the amount and yield range of accepted bids. Combidders
petitive
will be advised of the acceptance or rejection
of their tenders. The Secretary of the Treasury expressly
reserves the right to accept or reject any or all tenders, in
whole or in part, and the Secretary's action shall be final.
Subject to these reservations, noncompetitive tenders for each
issue for $1, 000, 000 or less without stated yield from any one
bidder will be accepted in full at the weighted average bank
discount rate (in two decimals) of accepted competitive bids
for the respective issues. The calculation of purchase prices
for accepted bids will be carried to three decimal places on the
basis of price per hundred, e. g. , 99.923, and the determinations
of the Secretary of the Treasury shall be final.
Treasury

Settlement

for accepted tenders for bills to be maintained

bills.

If a bill is purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures.
Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.
of the Treasury Circulars, Public Debt Series
Nos. 26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of the circulars, guidelines, and tender forms may be obtained
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.
Department

8/89

epartment of the Treasury

Wasp)niton, D.C.
CD-

EMBARGOED

Telephone 556-2a

l lf

UNTIL GIVEN

EXPECTED AT 10:OO A. M.
FEBRUARY

4, 1991

to the Press by
Secretary of the Treasury
Nicholas F. Brady
Fiscal Year 1992 Budget
Remarks

ladies and gentlemen.
This morning, the
President transmitted to the Congress his budget for fiscal year
1992. The President's proposal builds on last year's budget
agreement and continues to restrain spending and encourage
Good morning,

economic growth.

will comment
will discuss the budget
answer your questions.
Mike Boskin

Darman

the economic forecast and Dick
Then we' ll be glad to

itself.

will discuss, the economy is in a recession, but we
will be of short duration.
Obviously, we wan. the
Gro.
th is the key to
economy to get back on the growth path.
increased jobs and rising living standards for all Americans.
As Mike

expect that

From a

concerning

policy standpoint,

this budget.

First,

there are
reducing

a number

the budget

of points

deficit

controlling spending must remain our number one priority.
Dick will indicate, this budget does just that.

by
As

agreement we reached with Congress last fall
meets the fundamental
test of providing real, enforceable budget
deficit reduction, and the President's 1992 budget is an
that agreement.
Over the next
important step in implementing
borrow
in
the
credit
will
markets a
five years, our government
half trillion dollars less than it would have borrowed in the
absence of the budget agreement.
The budget

As the President has said, the budget agreement will
transform spending debates in Washington into a battle of ideas,
not a bidding war. And the President's 1992 budget holds the
growth of spending to less than the ra e of inflation in order
continue progress in reducing the budget deficit ith no new

taxes.

NB-1111

budget again supports economic growth in
various ways, including Family Savings Accounts, a capital gains
reduction, a permanent extension of the research and
tax credit, early IRA withdrawals for first-time
experimentation
Zones.
Enterprise
homebuyers and
The

president's

our prospects for long-term economic growth will be
improved if we modernize our financial system to make banks safer
The rules governing our financial system
and more competitive.
is
must deal with the reality that new technology and innovation
Tomorrow, we will
sweeping the financial services industry.
propose reforms that will protect depositors and taxpayers, while
competitiveness of our entire
improving the international

Finally,

economy.
Now,

Darman

I'd like to turn first to

for their comments.

Mike Boskin and then

to Dick

of the 7teasury

~partment

Washlneton,

D.C. ~ Teleyhona $84-204&

MODERNIZING THE FINANCIAL SYSTEM:
RECOMMENDATIONS
FOR SAFER NORE COMPETITIVE

BANKS

1991

EBRUARY 5

ACT SHEET

The Need

safer

and

Re orm

ore

com

d'
et't've:
'

The Bankin

NB-1112

~ws that date back to the 1930s.
to protect depositors and
Banks must be ~&~u
taxpayers.
'
o et 'v banking system is
te t'ona
A strong,
essential to a strong, growing economy.
8 stem

o o

Under

as
d

-date
0

''f

d
'

Stress
i
vo ' ut'

the
d

financial

way

when the economy slows,
jobs.
costing
hurting businesses and
'
corn etitors:
eh nd 'nte nat'o
Our banks are
world
in
the
is
banks
30
largest
the
Only one of
including
the
top
American, compared to nine Of 30,
three, just 20 years ago.

Weak banks

end'

The

Benefits of Reform
A

safe

modern,

industrY

will

benefit workers

and

rotect
and

internationally

ositors

businesses,

Protect de ositors

and

Depositor confidence

result from:
A

and
and

ers:

and taxpayer

system;
bank
and a

failures;

protection will

well-ca italized banking

safe, competitive,

limitations

competitive b k'
a ers, serve consumers,
stren then our nation

er e osure to losses

strong, well-ca italized

insurance

from

fund.

Serve consumers:
An

efficient, integrated

mean:

financial

services system will

will have access to a wider ran e of
services at the least possible cost.

Consumers

also will enjoy the convenience
nationwide access to services.
Benefit workers and businesses:
Consumers

healthy

banking

will ensure:

system with strong,

competitive

banks

Jobs are reserved because loans are not called at
the first sign of economic downturn.
Small businesses that lack access to securities
markets
an count on banks in bad times as well as
good

Stren then the nation:
A

world-class

financial services system provides a
for a world-class economy:
International economic leadership in the 21st
century will require an internationall
f
1
Y

foundation

The

Princi les Governin

First,

Reform

will

reserve de osit insurance for small savers
while
rotectin ta a ers b reducin the overextended de osit
insurance s stem. Deposit insurance, originally intended to
protect small depositors who could not protect themselves, has
been expanded so that large, sophisticated investors receive
unneeded protection.
This reform will restore market discipline
over risky activities that have increased the possibility of
taxpayer exposure to losses in the banking system.
we

Second, we will make banks stron er and safer b
stren thenin the role of ca ital -- not by raising capital
standards, but with a plan to attract capital to the banking
industry.
This will include rewarding well-capitalized banks
with new activities that will attract still further capital,
taking prompt corrective action to address under-capitalized

~d.

and

banks.

Third,

we w'

l
h

make banks
g' 1

com

et't've

mode

niz'n

financial markets have put banks at a competitive disadvantage
at home and abroad -- that has weakened the system and hurt the
economy.
Changes will allow banks to engage in a broader range
of financial services and to operate nationwide.
Fourth, we will
e ulato
structu e

regulatory

st
mo

s stem b
t.
Currently, overlapping
to confusion and uneven results.

en then the bankin

e e

responsibilities

f'c'e

lead

makin

the

RE COMMENDAT IONB

PART ONE:

DEPOSIT INSUEULHCE

AND

BANKINQ

REPOM

deposit insurance recommendations go
The Administration's
of deposit insurance and encompass
narrow
issue
the
well beyond
the entire range of safety, soundness and competitiveness issues
facing the banking system. They form a balanced, integrated
No single
package that must be considered as a whole.
will be effective by itself, and indeed, could be
recommendation
counterproductive

adopted

in isolation.

ital

Stren then the Role of Ca

single most powerful tool to make banks safer is
capital. Capital standards need not be raised, but the role of
capital can be strengthened.
This will discourage excessive
risk-taking, reduce the possibility of bank failure, and provide
a cushion to absorb losses ahead of the insurance fund and,
ultimately, the taxpayer.
The

better able to keep lending,
loans to build capital ratios, during
economic declines.
And they are better able to meet competitive
challenges and to take advantage of new opportunities.
Nell-capitalized
rather than shrinking
S

ecific

Recommendations:

'd'1-bddd'''(hdhd
Ca

banks are

ital-based

ervision,

ca ital-based

osit

insurance

further in other sections of the report) will provide incentives
for banks to build and maintain strong capital bases and make
bank franchises more attractive.
In addition, 'nterest rate risk
will be added to credit risk as a criterion for risk-based
capital standards.

II.

Reduce the Overextended

osit Insurance
intended to protect

Sco e of De

Deposit insurance, originally
small
depositors who could not protect themselves, has been expanded so
that large, sophisticated investors receive unneeded protection.
This has increased the exposure of taxpayers to possible losses
and decreased market discipline on risky banks.
By

returning

deposit insurance

to its original purpose,

can reduce the

cover depositor

possibility that taxpayer funds will be needed to
losses, while simultaneously reintroducing market

discipline that will help curb excessive risk.
S

ecif'c

Recommendations:

deposits:

Insured

"Pass-throu h" covera e of man t es w' l e eliminated,
reducing government protection for large, sophisticated
institutional investors.
okered insured

osits will

be elimina

ed, ending a

practice that has given banks access to large pools of belowmarket-rate funds that are deposited without concern on the part
of the depositor about the safety of the investment.
ndividual insurance covera e w'll be imited to 100 000
er ' st' ut'on after a two-year phase-in period, plus another
$100, 000 per institution for a retirement account. This change
will reduce taxpayer exposure to losses from coverage for
wealthier individuals with multiple accounts, including
individual, joint and revocable trusts, in a single failed
institution.
*h

'll

"h~f

the costs and benefits of movin toward a s stemwide
100 000 er
'mitat'o . This would more effectively limit
erson 'nsurance
taxpayer exposure to losses resulting from coverage of multiple
accounts, but should not be implemented until it can be shown
that the benefits would outweigh the potentially large
administrative costs.
Uninsured

deposits:

The government must preserve its ability to protect
banking system and the economy in genuine systemic risk

the

circumstances.
But protection of uninsured deposits as a matter
exposure and encourages
excessive
of course both expands taxpayer
'
'm'

ve a e
su e
u
e os'tors,
risk-taking by banks. To
uninsured
to
cover
deposits
only if
the FDIC will be permitted
that would be the least costly approach. To protect the system
in rare instances of systemic risk, the Treasury and Federal
Reserve could step in and order that uninsured deposits be
covered. This policy would be implemented after three years to

allow for an appropriate

Non-deposit

creditors:

While protecting

exception,

gLlmtai

transition.

vera

uninsured deposits should be the rare
ed' o s s o d
on-de os'

III.

Risk-Based

osit Insurance

Flat-rate premiums subsidize high-risk, poor]y
institutions at the expense of well-run institutions and the
There is a perverse incentive to take risks because
taxpayer.
there is no cost to offset the upside potential.
S

ecific Recommendations:
First, in the short-term,

emiums based on ca ital levels
will reward institutions that build capital to act as a buffer
ahead of the insurance fund.
In the longer term, a demonstration
project may lead to remiums set b rivate 'nsurance.

IV-

roved Su ervision

limits, the insurance fund and
the taxpayer remain exposed to possible bank losses. Effective
bank supervision can help.
Capital standards need not be
increased. But because well-capitalized institutions are the
safest, regulation should be reoriented towards a system of
capital-based supervision that provides rewards and penalties
that encourage banks to hold adequate capital.
The rewards of capital-based supervision would be much
greater regulatory freedom for well-capitalized banks to expand
and engage in new financial activities.
The sanctions of
capital-based supervision would involve "prompt corrective
action" to address problems as capital levels decline, well in
advance of insolvency.
Even with

ecific

deposit insurance

Recommendations:

ital-based su ervis'on would establish five zones for
their capital levels. Those with capital in
excess of minimum requirements will be eligible to engage in a
broad range of new financial services.
Those with less than
minimum capital would be subject to increasingly
stringent
corrective action -- including dividend cuts or even forced sale
of the bank
aimed at preventing failure.
Ca

banks based on

—

Restrictions on Risk Activities
State-chartered banks with federal deposit insurance may be
authorized by charter to engage in risky activities that are
precluded for national banks.
It is important to protect federal
taxpayers from such excessive risks while maintaining state
regulatory responsibilities under the dual banking system.

ecific

direct
not

VI.

ldp''q 1'f''1d

ecommendat'ons:

activities

'nvestment

ermitted

or national

at onvide Bankin

banks.

state

banks and

'm't activities

and Branchin

lead to safer, more
and more competitive banks, decreasing taxpayer
exposure to losses. The U. S. is the only major industrialized
country without a truly national banking system.
After 1992,
members of the European Community will permit international
banking throughout the EC. Not only do we put our banks at an
international competitive disadvantage, but we also forego
Nationwide

efficient

banking

and branching

would

significant

safety, efficiency and consumer benefits.
Already, 33 states permit nationwide banking and another 13
permit regional banking.
Only four prohibit all interstate
banking.
So the trend is clearly toward interstate banking.
Yet
there is almost no authority for interstate branching.
Given the
cost savings and efficiency arguments for interstate branching,
the advantages to consumers and taxpayers of interstate branching
are clear.

ecific

ecommendat'ons:
w'

ed for bank holding
three-year delay
e s te b n 'n
for national banks in any state in which the
bank's holding company could acquire a bank. Thus, after the
three-year delay, full nationwide branching will be permitted.

Full nationwide

companies following
w
e utho ' ed

VII.

oderniaed

bank'

be autho

Pinancial

ces

Banks are no longer the protected and steadily profitable
businesses they once were. Technological advances and
innovations by competing financial services providers have ended
their monopoly on transaction accounts and certain types of
business credit. They no longer enjoy protected access to lowcost funds from interest rate controls. And old laws that once
protected them from competition have become barriers that impede

The result
banks from responding to changing market conditions.
has been declining profitability and increasing bank failures.
The losers are not just banks, but also depositors, taxpayers and
the overall strength of the economy.

Out-of-date laws must be adapted to permit well-capitalized
they have lost to
banks to reclaim the competitive opportunities
Banks with expertise in other financial
changing markets.

services should be allowed to provide them for consumers, an
other financial ser ices companies with natural synergles with
This will provide
banking should be allowed to invest in banks.
new sources of capital for the banking system and help promote
safe, strong, well-capitalized banks.
The proposed

exposure

prevent

changes will be accompanied

of the federal deposit

activities.
ecific Recommendations:

by safeguards
insurance fund to these

new

In order to strengthen the banking system, new rules will
ermit financial affiliates for we 1-ca ita 'zed banks. A new
financial services holding company structure will permit a single
securities, mutual
company to own affiliates engaging in banking,
funds and insurance.
The new rules will allow commercial firms
to own financial services holdin com anies.
To protect the deposit insurance fund and the taxpayer, ~onl
well-ca italized banks will be permitted to engage in new
financial activities. Onl the bank will have access to de osit
insurance, strict re lation will be focused on the bank, and the
new financial activities will be in se aratel
ca italized

affiliates.

VIII. Credit

Union Reforms

The law required

credit union industry
structure
S

ecific

governing

the credit union industry-

capital in the
of the regulatory

Recommendations:

adequate capitalization of the credit union
fund, the double countin
of fund assets w'1 be

To ensure

insurance

~1''

a study of adequacy of
and insurance fund and

P'dd''

accountability for credit union regulation, the ederal bankin
re lator will serve on the National Credit Union Administration
Board

PART TNO

REGULATORY

RESTRUCTURING

The current regulatory structure is complicated, overlapping
confusing.
Individual institutions often are supervised by
several regulators, and bank holding, companies rarely have the
same regulator as their subsidiary hanks.

and

redesigned

structure

should

reduce duplication

and

and efficiency.
improve consistency, accountability
also separate the insurer from the regulator.
S

ecif'c

Recommendations:

present four-regulator model (the
Office of the Comptroller of the Currency,
Insurance Corporation and Office of Thrift
simplified to two, with the same regulator
holding company and its subsidiary bank.
The

Federal Reserve,
Federal Deposit
Supervision) will be
responsible for a bank

ederal Reserve will su ervise all state-chartered banks
o din com anies.
new Federa
a 'n
e c under
w'
su ervise all national banks and their
o 'n

the
reasu

and

wil

PART THREE

OTS

'd'
res onsibi

will go
1
the date it

. ghhd
it'es
on

RTC.

ocussed on insurance

'ons.

thr'fts to the

letes ass' nin
he

over the entire organization

will take over

enc

a' ed 'nst'

jurisdiction

banks,
h

an 'n

1d' g

national
com

should

resolution

and

RECAPITALI ZATION OP THE BANK INBURANCE

FUND

The Bank Insurance Fund (BIF) has experienced losses in each
of the last three years due to increasing numbers of bank
failures. FDIC projects additional losses over the next two
years that, under the most pessimistic assumptions, could exhaust
the fund's net worth. The FDIC must exercise the authority given
to it in the FDIC Assessment Rate Act of 1990 to recapitalize the
BIF fund in the near term. Because the FDIC has the authority
is essential, a plan to
and because industry participation
recapitalize the fund ought to be worked out with the industry by
the FDIC within the following parameters:

'tal'

oa s

ov'de su

u d

2.
a

3.
4.

t
t
t

shou d take

'nto account an

act

the health of

s s e
u

shou d use

ene a

dust

unds.

acce ted acco

rinci

es.

rue~i
Department

T
~

of thc Treasury

FOR IMMEDIATE

Bureau of the Public Debt

RELEASE

E
~ M'ashington,

CONTACT:

4, 1991

February

RESULTS OF TREASURY'S AUCTION

R
e&~Rp

DC 20239

Office of Financ'ng

202-376-~350

OF 26-WEEK

BILLS

Tenders for $10, 058 million of 26-week bills to be issued
on February 7, 1991 and mature on August 8, 1991 were
accepted today (CUSIP: 912794XB5).
RANGE

OF ACCEPTED

COMPETITIVE BIDS'

Discount
Rate

5. 91'
5. 94%

Low

High

Average

21'
discount rate

5 94+o
~

Tenders at the high
rate
The investment

Investment
Rate
6. 184
6 21o

Location

New

Received
39, 430
30, 123, 930
25, 260
40, 160
47, 745

York

Philadelphia

Cleveland
Richmond

31, 230
1, 789, 930

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Type

Competitive
Noncompetitive

Subtotal,

Public

Federal Reserve
Foreign Official

Institutions
TOTALS

were

is the equivalent

TENDERS RECEIVED AND ACCEPTED

Boston

Price
97. 012
96. 997
96. 997

38, 250
6, 900
51, 825
17, 995
560, 185

allotted 614.
coupon-issue yield.

(in thousands)
dl

39, 430
8, 785, 225
25, 260
40, 160
42, 745
29, 060
60, 180
19, 300
6, 900

51, 825
17, 995
197, 335

742 430

742 430
$33, 515, 270

$10' 057 ' 845

$28, 740, 075

$5, 282, 650

$30, 146, 505

$6, 689, 08Q

2, 450, 000

2, 450, 0QQ

918 765

918 765
$10, 057, 845

1 406 430

$33, 515, 270

1 406 430

additional $455, 035 thousand of bills will be
issued to foreign official institutions for new cash.
An

NB-]1] 3

'd~e,

of the Treasury

~partment
FQ~

I'MED:ATE

Washington,

RELEASE

".
. ont''y

Release of U. S. Reserve Assets

-elease"

The Treasury

for the

month

O.C. ~ Telephone 585-20'
February ~, 19"'

Department today
of December 19+0.

U. S.

at.

reserve assets

~s indicated ir this table, U. S. reserve assets ar ounte&. to
340
million at the end of Dece. ber, p fr=r. $83, 059 million in
S83,
".o ~err ber.
-'.

U. S. Reserve

(in millions

End

of
"anth

Total

Reserve

Assets
of dollars)

Special

Gold

Drawing

Reserve

Position

Fore ign

Assets

Stock 1/

Rights

November

83, 059

11,059

52, 070

8, 871

December

83, 340

11,059
11,058

10, 989

52, 217

9, 076

2/3/

Currencies

IMF

1990

at $42. 2222 per fine troy ounce.
2/ Beginning July 1974, the IMF adopted a technique for valuing the SDR
based on a weighted average of exchange rates for the currencies of
The U. S. SDR holdings
selected member countries.
and reserve
position in the IMF also are valued on this basis beginning July
1974.
1/ Valued

3/ Includes
4/ Valued

NB-1114

allocations

SDRs by

the

IMF

at current market exchange rates.

plus transactions

in SDRs.

General Explanations
of the

President's Budget Proposals
Affecting Receipts

Department of the Treasury
February 1991

CONTENTS
Page
Capital Gains Tax Rate Reduction for Individuals

Family Savings Accounts

IRA Withdrawals

Penalty-Free
Permanent

for First-Time Home Buyers

Research and Experimentation

Tax Credit

Expense Allocation Rules

Enterprise Zone Tax Incentives

Solar and Geothermal

Energy Credits

Targeted Jobs Tax Credit

Deduction for Special Needs Adoptions

Low-Income Housing Tax Credit

Health Insurance

Deduction for the Self-Employed

Extend Tax Deadlines for Desert Shield/Storm

Participants

33
35

Medicare Hospital Insurance (HI) for State and Local Employees

Motor Fuels Excise Tax

Increase in IRS FY 1992 Enforcement
Miscellaneous

Funding

Proposals Affecting Receipts

CAPITAL GAINS TAX RATE REDUCTION FOR INDIVIDUALS
The Budget again includes a reduction of the capital gains tax rate for individuals on
The Budget provides for a 10, 20, or 30 percent exclusion for longlong-term investments.
term capital gains on assets held by individual
taxpayers for one, two or three years,
respectively. The three-year holding period requirement will be phased in over three years.
In his State

of the Union Address on January 29, 1991 the President asked Congressional

in a study led by Federal Reserve Chairman
leaders to cooperate with the Administration
Alan Greenspan to sort out technical differences over the distributional
and economic impacts
of a capital gains reduction.
A reduction in capital gains taxes should benefit all Americans by providing
for saving and investment that would result in higher national output and more jobs.

incentives

Current Law

Under current law, the full amount of capital gains income is generally taxable but the
rate on such gains is capped at 28 percent.
Capital gains are generally subject to 15
When capital gains taxes interact with other
percent or 28 percent statutory tax rates.
provisions in the income tax code, however, the actual tax cost of an asset sale can be
include
the requirement
that
itemized
significantly
higher.
Interacting
provisions
deductions for medical and miscellaneous
expenses exceed a percentage of adjusted gross
income, the phase-outs with increasing income of I RA deductions,
passive activity loss
limitations, and the phase-out of personal exemptions and the three percent floor on itemized
deductions enacted in 1990.
While the Tax Reform Act of 1986 eliminated the capital gains exclusion of prior law, it
did not eliminate the legal distinction between capital gains and ordinary income, or between
short-term and long-ter'm capital gains.
These distinctions currently serve to identify those
rate and subject to the limitations on
transactions eligible for the 28 percent maximum
include
all property
effectively
assets
deduction
except
of capital losses.
Capital
inventories or other items held for sale in the ordinary course of business and certain other
listed assets.
Examples of capital assets include corporate stock, a home, a farm or
Gains or losses from the sale or exchange of capital
business, real estate, and antiques.
assets held for one year or longer are classified as long-term capital gains or losses.
Individuals with capital losses exceeding capital gains may generally deduct up to $3, 000
A net capital loss in excess of the deducii&in
of such losses against ordinal income.
Special rules alloii individuals to treat losses of up io
limitation may be carried forward.
$50, 000 ($100,000 on a joint return) with respect to stock in certain small business
corporations as ordinar losses.

Depreciation recapture rules recharacterize a portion of capital gains on depreciable
These rules vary for different types of depreciable property.
property as ordinary income.
For personal property, all previously allowed depreciation not in excess of the realized
income.
as ordinary
recaptured
For real property using
capital gain is generally
no
depreciation
recapture
if
the asset is held at least
straight-line
depreciation, there is
before
1987, generally only the excess of
one year.
For real property acquired
straight-line
depreciation
is recaptured
of
claimed in excess
depreciation
as ordinary
to
the
rules
disposition
applicable
of depletable property
income. There are also recapture
and to certain other assets.
Capital gains and losses are generally taken into account when "realized"- upon the sale,
Certain dispositions of capital assets, such as
exchange, or other disposition of the asset.
transfers by gift, are not generally realization events for income tax purposes.
In general,
in the case of gifts the donor does not realize gain or loss, and the donor's basis in the
In certain cases, such as the gift of a bond with
property carries over to the donee.
accrued market discount or of property that is subject to indebtedness
in excess of the
donor's basis, the donor may recognize ordinary income upon making a gift. The capital gain
in a charitable contribution
of appreciated property (other than tangible personal property
donated in 1991) is included as a preference item in calculating the alternative minimum tax.
Gain or loss is not realized on a transfer at death, and the beneficiary's
basis in the
inherited asset is generally the fair market value of the asset at (or near) the date of
death.
Reasons for Chan e

Restoring a capital gains tax rate differential is important to restore economic growth
and competitive strength by promoting savings, entrepreneurial
activity, and risky investment
in new products, processes, and industries.
At the same time, investors should be encouraged
to extend their horizons and search for investments with longer-term growth potential.
The
future competitiveness
of this country requires a sustained flow of capital to innovative,
technologically advanced activities that may generate minimal short-term earnings but promise
strong future profitability.
A preferential tax rate limited to longer-term
commitments of
capital will encourage business investment
and long-term
patterns that favor innovation
growth over short-term profitability.
The resulting increase in national output will benefit
all Americans by providing jobs and raising living standards.
In addition to the improvements in productivity and economic growth, a lower rate on long-term capital gains will also
improve the fairness of the individual income tax by providing a rough adjustment for the
taxation of inflationary gains that do not represent any increase in real income.
Incentives for Lon er-Ran e Investment.
A capital gains preference has long been
recognized as an important incentive for capital investment.
The first tax rate differential
for capital gains in this country was introduced by the Revenue Act of 1921. For the next 65
years there was always some tax rate differential
for long-term capital gains.
The
preferential treatment for capital gains has taken various forms, including an exclusion of a
fixed portion of the nominal gains, an exclusion that depended on the length of time
a

-3But at no time
taxpayer held an asset, and a special maximum tax rate for capital gains.
between 1921 and 1987 were long-term capital gains ever taxed at the same rates as ordinary
income. In 1990, Congress set the maximum marginal tax rate on capital gains at 28 percent,
or three percentage points below the maximum marginal rate on ordinary income. Nevertheless,
as shown in Figure l, the average effective tax rate on realized capital gains is currently
substantially higher than it has been in the past.

By eliminating the capital gains exclusion and lowering tax rates on ordin~ income, the
1986 Act increased the incentives for short-term trading of capital assets.
This occurred
because the tax rate on long-term
capital gains was increased while the tax rate on
short-term
capital gains was reduced.
By providing for a sliding scale exclusion that
held at least three years after a phase-in
provides full benefits only for investments
period, the Budget proposal would increase the incentive for longer term investing.

The Cost of Ca ital and International
The capital gains tax is an
Com etitiveness.
important component of the cost of capital, which measures the pre-tax rate of return
required to induce businesses to undertake new investment.
Evidence suggests that the cost
of capital in the United States is higher than in many other industrial nations.
While not
for the higher cost of capital, high capital gains tax rates hurt the
solely responsible
ability of U. S. firms to obtain the capital needed to remain competitive.
By reducing the
cost of capital, a reduction in the capital gains tax rate would stimulate
productii e
investment and create new jobs and growth.
Our major trading partners already recognize the economic importance of low tax rates on
capital gains.
Virtually all other major industrial nations provide much lower tax rates on
capital gains or do not tax capital gains at all.
Canada, France, Germany, Japan, the
Netherlands, and the United Kingdom, among others, all treat capital gains preferentially.

The Lock-In Effect.
Under a tax system in which capital gains are not taxed until
realized by the taxpayer, a substantial
tax on capital gains tends to lock taxpayers into
their existing investments.
Many taxpayers who would otherwise prefer to sell their assets
to acquire new and better investments may instead continue to hold onto the assets rather
than pay the current high capital gains tax on their accrued gains.

First, it
This lock-in effect of capital gains taxation has three adverse effects.
talent because it
produces a misallocation of the nation's capital stock and entrepreneurial
distorts the investment decisions that would be made in the absence of the capital gains tax.
to withdrav. from an
For example, the lock-in effect reduces the ability of entrepreneurs
Productivity
in the economy suffers
enterprise and use the funds to start new ventures.
to
where
it
can
move
capital
be
most productive, and
because entrepreneurs are less likely to
to
because capital may be used in a less productive fashion than if it were transferred
effects
can
These
be
especially
critical
for
smaller
enterprises.
efficient,
other, more
firms which ma~ not have good access to capital markets and where ownership and operatiori
Second, the lock-in effect produces distortions in the investment
frequently
go together.
For example, some individual investors mai be induced to
portfolios of individual taxpayers.

FIGURE 1.
AVERAGE EFFECTIVE TAX RATE ON CAPITAL GAINS

1964-1988
Percent

24
22

16
14
12

10
64

76
Year

Department of the Treasury
Office of Tax Analysis
January 1991

-5assume more risk or hold a different mix of assets than they desire because they are
reluctant to sell appreciated investments
Third, the lock-in
to diversify their portfolios.
effect reduces government receipts.
To the extent that taxpayers defer sales of existing
investments, or hold onto investments until death, taxes that might otherwise have been paid
are deferred or avoided altogether.
Therefore, individual investors, the government,
and
other taxpayers lose from the lock-in effect. The investor is discouraged from pursuing more
attractive investments and the government loses revenue.

Substantial evidence from more than a dozen studies demonstrates that high capital gains
tax rates in previous years produced significant lock-in effects.
The importance of the
lock-in effect may also be demonstrated
by the fact that realized capital gains were I6
percent lower under the high tax rates in 1987 than under the lower rates in 1985, even
though stock prices had risen by approximately
50 percent over this period. The high tax
rates on capital gains under current law imply that the lock-in effect is greater than at any
prior time.
Penalt
on Hi h-Risk Investments.
Full taxation of capital gains, in combination with
limited deductibility
of capital losses, discourages risk taking.
It therefore impedes
investment in emerging high-technology
and other high-risk firms. While many investors are
willing to take risks in anticipation of an adequate return, fewer are willing to contribute
"venture capital" if a significant fraction of the increased reward will be used merely to
satisfy higher tax liabilities.
A tax system that imposes a high tax rate on gains from the
investment reduces the attractiveness of risky investments, and may result in mani worthwhile
projects not being undertaken.
In particular, it is inherentli
more risky to start net~ firms and invest in new products
and processes than to make incremental
investments
in existing firms and products.
It is
therefore the most dynamic and innovative
firms and entrepreneurs
that are the most
disadvantaged
Such firms have
by high capital gain tax rates that penalize risk taking.
traditionally
been contributors
and have
to America's edge in international
competition
provided an important source of new jobs.

Under the U. S. income tax system, income
Double Tax on Co orate Stock Investment.
earned on investments in corporate stock is generally subjected to two layers of tax. Income
on corporate investments
is taxed first at the corporate level at a rate of 34 percent.
Corporate income is taxed a second time at the individual level in the form of taxes on
The combination of
capital gains and dividends at rates ranging from I5 to 3l percent.
income taxes thus can produce effective tax rates that at. &
corporate and individual
To the extent the return io
substantially
greater than individual income tax rates alone.
in
value
the
of the stock (rather than through
the investor is obtained through appreciation
tax
rates
in
provides
a form of relief from this
capital
gains
dividend income), a reduction
While a lower capital gains tax rate reduces the cost
double taxation of corporate income.
of capital for both corporate and noncorporate business, the greater liquiditi' of shaies
publicly-traded
companies suggests that the oi erall effect would be to reduce the bias
towards noncorporate business that results from our dual-level tax system.

Descri tion of Pro osal
General Rule. The capital gains tax rate would be reduced by means of a sliding-scale
exclusion. Individuals would be allowed to exclude a percentage of the capital gain realized
upon the disposition of qualified capital assets, and would apply their current marginal rate
on capital gains (either 15 or 28 percent) to the reduced amount of taxable gain
of the exclusion would depend on the holding period of the assets. Assets held three years
Assets held at least two years but
or more would qualify for an exclusion of 30 percent.
Assets held at least one
less than three years would qualify for a 20 percent exclusion.
For example,
year but less than two years would qualify for a 10 percent exclusion.
individuals
subject to a 28 percent tax on capital gain (i.e. , taxpayers in the 28 and 3l
percent tax brackets for ordinary income) would pay rates of 25. 2, 22. 4, and 19.6 percent for
The corresponding
assets held one, two, or three years, respectively.
figures for
rate
would
13.
12.
and
15
be
10.
5
individuals subject to a
percent.
percent
5,
0,
Qualified assets would generally be defined as any assets qualifying as capital assets
under current law and satisfying the holding period requirements,
except for collectibles.
Collectibles are assets such as works of art, antiques, precious metals, gems, alcoholic
beverages, and stamps and coins.
Assets eligible for the exclusion would include, for
example, corporate stock, manufacturing and farm equipment, a home, an apartment building, a
stand of timber, or a family farm.
Phase-in Rules and Effective Dates.
The proposal would be effective generally for
dispositions of qualified assets after the date of enactment.
For the balance of 1991, the
full 30 percent exclusion would apply to assets held at least one year.
For dispositions of
assets in 1992, assets would be required to have been held for two years or more to be
eligible for the 30 percent exclusion, and at least one year but less than two years to be
eligible for the 20 percent exclusion.
For dispositions of assets in 1993 and thereafter,
assets would be required to have been held at least three years to be eligible for the 30
percent exclusion, at least two years but less than three years for the 20 percent exclusion
and at least one year but less than two years for the 10 percent exclusion.
Additional Provisions. In order to prevent taxpayers from benefitting from the exclusion
provision for depreciation deductions that have already been claimed in prior years, the
depreciation
recapture
rules would
be expanded
to recapture all prior depreciation
deductions.
All taxpayers would be able to benefit from the proposed exclusion to the extent
that a depreciable asset has increased in value above its unadjusted basis.
The excluded
portion of capital gains would be added back when calculating income under the alternative
minimum
tax, however, the special rule relating to contributions
of tangible personal
property in 1991 would not be modified.
Installment
sale payments received after the
effective date will be eligible for the exclusion without regard to the date the sale
actually took place.
For purposes of the investment interest limitation, only the net
capital gain after subtracting the excluded amount would be included in investment income.
The 28 percent limitation on capital gains not eligible for the exclusions would be retained.

Exam les of the Effects

~EI
investments

of Pro osal

TETAI

lgglhppphdf

lgl*ldl'dd

capital gain of $500 in late

have a reported long-term

1991.

Under current law, her tax on the $500 capital gain would be 15 percent
gain, or

of the

$500

full

$75.

Under the proposal, her tax would be reduced to $52. 50, which is 15 percent of $350 ($500
less the 30 percent exclusion).

~EI

B. E
pl
of $40, 000.

In 1993, they sell corporate stock realizing a
capital gains
on stock held 15 months and a $2, 500 capital gain on stock held 5 years.

$1,500 capital

gain

Under current law both gains would be subject to taxation at a tax rate of 28 percent.
Tax on the $1,500 gain would be $420, and tax on the $2, 500 gain would be $700, for a
combined tax of $1, 120.
Under the proposal,
a 10 percent exclusion
The
percent exclusion.
stock held 5 years would
than their liability under

~EI

the gain from the sale of stock held 15 months would be eligible for
and the gain on the stock held 5 years would be eligible for a 30
tax on the stock held 15 months would be $378 and the tax on the
be $490, for a combined tax of $868, which would be 22 percent lower
current law.

py*CI

0
f tl
Id
y
p
in order to start a new company

like to sell the company
making a new product.
Taxpayer C has a salary of $380, 000 and $20, 000 in dividend and interest income. Taxpayer C
sells the stock in the computer software company for $2 million, resulting in a capital gain
of $1.8 million after deduction of his $200, 000 cost basis.
would

Under current law, Taxpayer C would pay a capital gains tax of about $523, 840 (depending
on the level and composition of his itemized deductions), leaving him with net proceeds of
$1,476, 160 from the sale of the company.

Under the proposal, the capital gains tax, including the alternative minimum tax, would
be about $427, 915 (again, depending on the level and composition of his itemized deductions).
The net proceeds from selling the company would now be about $1,572, 085. Thus, Taxpayer C
would have about $95, 925 of additional funds that could be invested in the nev, business.

Revenue Estimates

Capital gains realizations are highly responsive to changes in stock prices and gener
economic conditions as well as to capital gains fax rates. Furthermore, taxpayers may adjust
their purchases and sales of capital assets and their other income sources and deductions
Since 1978, Treasury revenue estimates of capital gains have
response to new tax rules.
taken into account expected changes in taxpayer behavior.

These behavioral effects are the subject of continued empirical research.
Office of Tax Analysis (OTA) incorporates all effects believed to be important and presents
The proposal is expected to increase Treasury
its best estimate of the expected effects.
receipts as compared to current law receipts due to increased realizations.
The revenue
estimates noted below assume a February 15, 1991 effective date. The increase in revenues is
expected to be greatest in fiscal year 1992, due to the unlocking of existing capital gains,
and smaller thereafter.
The expected changes in revenues are modest in comparison to the
magnitude of the expected total amount of revenues from the 'capital gains tax (in excess of
$40 billion per year).
Details of Revenue Estimates

The details of the revenue estimates are shown in Table 1. Line I of Table 1 shows the
revenue loss that results from a flat 30 percent exclusion on the amount of capital gains
that would be realized at current law tax rates; i.e. , "baseline" realizations
that would
have occurred without a change in tax rates.
This loss is what a "static" revenue estimate
for a 30 percent exclusion would show. This "static" revenue loss is estimated to be $11.3
billion in fiscal year 1992, gradually increasing to about $18 billion by 1996.
Line II of Table 1 shows the estimated revenue from additional realizations that would be
induced by a flat 30 percent exclusion.
These induced gains arise from several sources.
They represent realization s accelerated from future years, realizations
due to portfolio
shifting, or realizations that would otherwise have been tax-exempt because they would have
been held until death, donated to charity, or not reported.
As indicated by a comparison of
line I and II, revenues from induced realizations are estimated to be sufficient to offset
the static revenue loss on current gains for several years, but not in the long run.
This
conclusion is based on Treasury's analysis of the findings of numerous statistical studies of
the responsiveness
of capital gains to lower tax rates, and is consistent with the revenue
experience of previous capital gains tax rate changes.

Line III shows the revenue effects of limiting the exclusion to 20 percent for assets
held two years and 10 percent for assets held one year, and the phase-in of these holding
period limitations.
The estimates reflect a reduction in static revenue losses, the effects
of induced realizations,
and the effects of deferring
realizations
of assets not yet
qualifying for the full 30 percent exclusion.
These provisions, which are aimed at promoting
a longer-term investment horizon, produce revenue gains in the long run, although a small net
revenue loss over the budget period.

TABLE

REVENUE EFFECTS OF THE PRESIDENT'S CAPITAL GAINS PROPOSAL
Fiscal Year ($ Billions)
Item

1991

1992

1993

1994

1995

1996

1991-96

-1.7

-11.3

-13.0

-14.6

-16.2

-18.0

-74.7

2.3

14.9

15.1

14.7

15.1

16.3

78.3

Static effect of 30% exclusion

II.

Effect of taxpayer behavior

III.

Effect of the 3-year holding period

0.0

-0.1

-0.8

0.3

IV.

Effect of

depreciation recapture

0.0

-0.2

0.4

1.0

1.5

1.7

4.2

Effect of treating excluded gains
as a preference item for AMT
purposes

-0.1

-0.5

0.1

0.8

1.2

1.4

2.7

VI.

Effective date of proposal

0.0

0.3

0.0

0.3

VII.

Total revenue effect of proposal

0.4

3.0

1.7

0.9

1.7

9.5

full

Department of the Treasury
Office of Tax Analysis

January, 1991

Note: Details may not add to total due to rounding.
attributablc to taxpayer decisions to realize more capital gains,
This line reflect an estimate of thc nct effect of an increase in budget receipts
1/
into
capital
gains and dcfcrral of shortccrm gains as a result of lower tax rates.
income
ordinary
of
conversion
from
resulting
and a decrease in receipts
an adjustment to thcsc lines to reAcct an assumed cffectivc date of February 15, 1991.
Lines 1-V rcQect January 1, 1991 etfectivc date. Line VI represents

-10Lines IV and V show the revenue effects of expanded depreciation recapture and treating
exc1uded capital gains as a preference item for purposes of the alternative minimum
tax.
the
critical
to
turning
are
provisions
proposal
from
two
These
one that would otherwise
one
that
is
run
to
the
in
revenue-raising
revenue
lose
long
probably
even beyond the budget
two
these
provisions
raise
the
Over
9
budget
period,
$6.
billion in revenue.
period.
The
that
if
means
a
depreciable
recapture
proposal
asset is sold, the exclusion
full depreciation
will apply only to the amount by which the current selling price is higher than the original
cost. Treating excluded gains as a preference item for purposes of the alternative minimum
tax primarily affects high-income individuals and raises $2. 7 billion over the budget period.
Line Vl shows the revenue effect of making the effective date of the proposal February 15,

1991.
The total revenue effect of the proposal is shown in line VII. The proposal is expected
to raise revenue in every year and $9.5 billion over the budget period. Treasury's estimates
indicate that the Administration
proposal would produce increased revenues not only throughout the budget period, but for the foreseeable future. ~
These estimates

do not include

the effects of potential

increases

growth expected from a lower capital gains tax rate. This conforms
and revenue estimating practice of assuming that the macroeconomic
spending proposals are already included in the economic forecast.

in long-run economic
to the standard budget
effects of revenue and

Because the methodological differences between OTA, Congressional estimators, and
experts have not yet been resolved,
the Budget reflects the deficit impact
Administration's
Pay-As-You-Go proposals with the Administration's
estimates and
zero (neutral) entry for capital gains rate reduction (see Table II-8, Part One,
of the Budget of the U. S. Government, Fiscal Year 1992).

outside
of the
with a

p. 18,

FAMILY

SAW

INGS ACCOUNTS

Current Law

Taxation of Investment Income and Savin . Investment income earned by an individual
taxpayer is generally subject to tax. The funds saved out of each year's income, which are
used to make additional
deposits to savings or other investment
accounts, additional
of
stocks
or
purchases
bonds, or to acquire other investments, are generally not deductible
taxable income.
in calculating
The major exception is the tax treatment of retirement
savings under certain tax-favored retirement savings arrangements,
contributions to which are
generally deductible and investment earnings of which are generally excludable from gross
income. These investments are generally taxed when the amounts contributed and earned are
later distributed.
Individual Retirement Accounts. The current law for Individual Retirement Accounts (IRAs)
generally grants married taxpayers who do not participate in a qualified retirement plan or
who have adjusted gross incomes (AGI) below $50, 000 the right to make deductible contributions to an IRA. There is a lower income threshold of $35, 000 if the taxpayer is unmarried.
The deductibility of contributions for taxpayers participating in a qualified retirement plan
is phased out as their AGI increases from $10,000 below the income threshold up to the
threshold.
Taxpayers who do participate in a qualified retirement plan and who have adjusted
gross incomes above these thresholds may make only nondeductible contributions to an IRA.
Both deductible and nondeductible
IRA contributions are limited to the lesser of $2, 000 or
individual's
the
compensation for the year.

Married individuals who both work and otherwise qualify may each contribute to an IRA, so
if each spouse has compensation of $2, 000 or more, each may contribute $2, 000. If only one
to contribute an
also have the opportunity
married individuals
spouse works, qualifying
The
limit
on
deductible
contributions
additional $250 to an IRA for the nonworking spouse.
reduced for adjusted gross incomes in
to the IRA of a nonworking spouse is proportionately
the applicable phase-out ranges.
Withdrawals
from an IRA prior to age 59-1/2 are generally subject to a 10 percent
of amounts which were not deductible when
additional
tax.
Except for distributions
income tax, and withdrawals must begin by
to
regular
contributed, IRA withdrawals are subject
age 70-1/2.

terms, deductible IRAs effectively exempt investment income from taxation.
(The income tax imposed on withdrawals merely recaptures the tax saved from deducting the
income itself is effectiveli
contribution,
plus interest on that tax saplings; the investment
exempt from tax. ) This favorable tax treatment provides an incentive to save; IRAs are
The tax exemption of
designed to provide this incentive specifically for retirement savings.
retirement
investment
income is also a feature of section 401(k) and other tax-qualified
Nondeductible IRAs alloi~ only a deferral of taxes on investment income, not an
arrangements.
exemption.
In economic

-1 1-

-12Reasons For Chan e

There is general concern that the rate of national saving and;n
relative to that needed to sustain future growth and to maintain our relative economic
position in comparison with the performance of other industrial nations.
Addressing this
problem requires that both public dissaving (the budget deficit) be reduced and that pr. vate
Incentives provided by the proposed Family Savings Accounts will
saving be increased.
provide an important incentive to encourage private saving.

The availability of savings accounts in the form of IRAs was sharply curtailed by the Tax
Reform Act of 1986, which resulted in a large decline in IRA participation.
Prior to the
Act, any individual under the age of 70-1/2 could make deductible contributions, up to the
current limits, to an IRA.
One of the goals of the current proposal is to expand the
availability and attractiveness of tax-exempt saving to a large segment of the population.
goal of the current
is saved for other than retirement
saving. The proposal recognizes that
homes, for educational expenses, for
income in the future.
An additional

proposal is to expand savings incentives to income that
purposes, while not eroding incentives for retirement
individuals save for many reasons: for down-payments on
large medical expenses, and as a hedge against uncertain

Descri tion of Pro osal

The Family Savings Account (FSA) differs from a deductible current-law IRA in two
respects: the contributions are not deductible, but if the account is maintained for at least
seven years, neither the contributions nor the investment earnings are taxed when withdrawn.
As in the case of IRAs, the economic effect of an FSA is to exempt investment income from
taxation. The proposal would allow individuals (other than dependents) to make nondeductible
contributions to an FSA up to the lesser of $2, 500 or the individual's compensation for the
year. Contributions would be allowed for single filers with adjusted gross income (AGI) no
more than $60, 000, for heads of households with AGI no more than $100,000, and for married
taxpayers filing joint returns with AGI no more than $120,000. Contributions to FSAs would
be allowed in addition to contributions to current-law qualified pension plans, IRAs, 401(k)
plans, and other tax-favored forms of saving.
Earnings on contributions retained in the FSA for at least seven years would be eligible
for full tax exemption upon withdrawal.
However, withdrawals of earnings allocable to contributions retained in the FSA for less than three years would be subject to both
percent additional
tax and regular income tax.
Withdrawals
of earnings allocable to
contributions retained in the FSA for three to seven years would be subject only to regular
income tax. The proposal would be effective for years beginning on or after January 1, 199 l.

-13~Elf

~
P

The proposal would increase the total amount of individual saving that can earn tax-free
investment income. Generally, individuals would be able to contribute to FSAs, IRAs, 401(k)
plans, and similar tax-favored plans, and would receive tax exemption on the investment
income from each source.

The ability to contribute to an FSA would significantly
raise the total amount of
allowable contributions
to tax-favored savings accounts.
The contribution limit is $5, 000
for joint return filers as compared to the $4, 000 IRA limit for a working couple.
These
contribution
total
limits
higher
for FSAs will provide additional marginal incentive es for
The higher eligibility limits on FSAs also expand the incentives to more
personal saving.
taxpayers.
Despite the difference in structure, the value of the tax benefits in present value of an
FSA per dollar of contribution is equivalent in terms of its tax treatment to the value of
current-law deductible IRAs, assuming that tax rates are constant over time. Both FSAs and
deductible IRAs effectively exempt all investment income from tax. The contributions to FSAs
are not deductible, but the income tax imposed on withdrawals from an IRA effectively offsets
the tax savings from the deduction of the contribution
(plus interest on the tax savings).
Individuals who expect higher tax rates when the funds are withdrawn would generally prefer
the tax treatment offered in an FSA to that in an IRA. Conversely, individuals who expect
lower future tax rates would generally prefer an IRA as a vehicle for retirement savings.
However, the FSA offers more flexibilitv, because full tax benefits are available seven years
after contribution and the account need not be held until retirement.
This gives individuals
an added degree of liquidity.
Revenue Estimate

Fiscal Years

1991

1992

1993

1994

1995

1996

1991-96

-2. 3

-6.5

(Billions of Dollars)

-1.3

Family savings accounts:

-* Revenue loss of less

than

$50 million.

-1.8

PENALTY-FREE IRA WITHDRAWALS FOR FIRST-TIME HOME BUYERS

Current Law

Married taxpayers who do not participate in a qualified retirement plan or who haie
adjusted gross incomes below $50, 000 generally may make deductible contributions
to an
Individual Retirement Account (IRA). There is a lower threshold of $35, 000 for unmarried
The deductibility
taxpayers.
of contributions for taxpayers participating in a qualified
retirement plan is phased out over the last $10,000 below the income threshold for each
income tax filing status.
Taxpayers who do participate in a qualified retirement plan and
who have adjusted gross incomes above these thresholds
may make only nondeductible
contributions to an IRA. Both deductible and nondeductible IRA contributions are limited to
the lesser of $2, 000 or the individual's
compensation
for the year.
Married individuals
generally may contribute an additional $250 to an IRA for a nonworking spouse.
Withdrawals from IRAs must begin by age 70-1/2. IRA withdrawals,
except those from
nondeductible contributions, are subject to income tax. In general, withdrawals from an IRA
prior to age 59-1/2 are subject to a 10 percent additional tax.

Reasons For Chan e

The intent of this proposal is to expand savings incentives to income that is saved for
first-time home purchases.
Increased flexibility of I RAs would help to alleviate the
difficulties that many individuals have in purchasing a new home.
The attractiveness and eligibility of IRAs for mani taxpayers was sharpli curtailed by
the Tax Reform Act of 1986. This resulted in a large decline in IRA participation.
Prior to
70-1/2
the 1986 Act, any individual under the age of
could make deductible contributions, up
to the current limits, to an IRA.
The current proposal is designed to enhance the
attractiveness of deductible IRAs by making them more flexible.
This increased flexibility
would provide an incentive for more taxpayers to save for the purchase of their first home.
Descri tion of Pro osal

The proposal would allow individuals to withdraw amounts of up to $10,000 from their IRAs
The 10 percent additional tax on earli withdrawals would
for a "first-time" home purchase.
for penalti -free withdrawals
Eligibility
be waived for eligible individuals.
would
be
limited to individuals who did not own a home in the last three years and are purchasing or
constructing a principal residence that costs no more than 110 percent of the median home
price in the area where the residence is located. The proposal would be effective for years
beginning on or after January 1, 1991.

-15-

-16~Eff

fP
This proposal will help encourage individuals

to save for the purchase of a first home.

Revenue Estimate

Fiscal Years

1991

1992

1993

1994

1995

(Billions of Dollars)
Penalty-free I RA withdrawals
for first time home buyers:

-~ Revenue loss of less than $50 million.

1996

1991-96

PERMANENT RESEARCH AND EXPERII~NTATION

TAX CREDIT

Current Law

Present law allows a 20 percent tax credit for a certain portion of a taxpai er's
"qualified research expenses. " The portion of qualified research expenses that is eligible
for the credit is the increase in the current year's qualified research expenses over its
base amount for that year. The base amount for the current year is computed by multiplying
the taxpayer's "fixed-base percentage" by the average amount of the taxpayer's gross receipts
A taxpayer's fixed-base percentage generally is the ratio of
for the four preceding years.
its total qualified research expenses for the 1984-88 period to its total gross receipts for
this period.
Special rules for start-up companies provide a fixed-base percentage of 3
In no event will a taxpayer's
A
fixed-base percentage exceed 16 percent.
percent.
taxpayer's base amount may not be less than 50 percent of its qualified research expenditures
for the current year.
In general, qualified expenditures consist of (1) "in-house" expenditures for wages and
supplies used in research; (2) 65 percent of amounts paid by the taxpayer for contract
research conducted on the taxpayer's behalf; and (3) certain time-sharing costs for computers
used in research.
Restrictions further limit the credit to expenditures for research that is
in
nature
and that will be useful in developing a new or improved business
technological
In addition, certain research is specificall& excluded from the credit, including
component.
research performed outside the United States, research relating to style, taste, cosmetic, or
seasonal design factors, research conducted after the beginning of commercial production,
research in the social sciences, arts, or humanities,
and research funded bi persons other
than the taxpayer.

The credit is available only for
trade or business of the taxpayer.
requirement with respect to in-house
expenses are incurred, the principal
to use the results of the research in
taxpayer or certain related taxpayers.

research expenditures paid or incurred in carrying on a
A taxpayer is treated as meeting the trade or business
research expenses if, at the time such in-house research
purpose of the taxpayer in making such expenditures is
the active conduct of a future trade or business of the

basic
Present law also provides a separate 20 percent tax credit ("the university
research credit") for corporate funding of basic research through grants to universities and
The university
basic research
basic research.
other qualified organizations
performing
certain
This
from
basic research
prior years.
credit is measured by the increase in spending
(including
credit applies to the excess of (1) 100 percent of corporate cash expenditures
basic research over (2) the sum of a fiixed
grants or contributions)
paid for university
research floor plus an amount reflecting any decrease in nonresearch giiing to universities
by the corporation as compared to such giving during a fixed base period (adjusted for
if
A grant is tested first to see if it constitutes a basic research payment;
inflation).
not, it may be tested as a qualified research expenditure under the general RAE credit.

-17-

-18The R&E credit is aggregated with certain other business credits and made subject to a
The sum of these credits may reduce the first $25, 000 of
limitation based on tax liability.
regular tax liability without limitation, but may offset only 75 percent of any additional
tax liability.
Taxpayers may carry credits not usable in the current year back three years
and forward 15 years.
The amount of any deduction
credit taken for that year.

for research expenses is reduced by the amount

of the tax

The R&E credit in the form described above is in effect for taxable years beginning
December 31, 1989. However, the credit will not apply to amounts paid or incurred
December 31, 1991.

after
after

Reasons for Chan e

The current law tax credit for research provides an incentive for technological
innovation.
the
Although the benefit to the country from such innovation is unquestioned,
not
market rewards to those who take the risk of research and experimentation
be
may
The credit
sufficient to support the level of research activity that is socially desirable.
is intended to reward those engaged in research and experimentation
of unproven technologies.
The credit cannot induce additional R&E expenditures unless its future availability is
known at the time firms are planning R&E projects and projecting costs. R&E activity, by its
nature, is long-term, and taxpayers should be able to plan their research activity knowing
that the credit will be available when the research is actually undertaken.
Thus, if the R&E
credit is to have the intended incentive effect, it should be made permanent.
Descri tion of Pro osal

The R&E credit would be made permanent.
~E%

Stable tax laws that encourage research allow taxpayers to undertake research with
greater assurance of the future tax consequences.
A permanent R&E credit (including the
university
basic research credit) permits taxpayers
to establish and expand research
activities without fear that the tax incentive would not be available when the research is
carried out.
Revenue Estimate

Fiscal Years

1991

1992

1993

1994

1995

1996

1991-96

-1.8

-6.2

(Billions of Dollars)
Permanent

R&E tax credit:

-0.5

-1.0

-1.3

-1.6

RESEARCH AND EXPERIMENTATION

EXPENSE ALLOCATION RULES

Current Law

The tax credit allowed for payments of foreign tax is limited to the amount of U. S. tax
otherwise payable on the taxpayer's income from foreign sources.
The purpose of this
limitation is to prevent the foreign tax credit from offsetting U. S. tax imposed on income
from U. S. sources.
Accordingly, a taxpayer claiming a foreign tax credit is required to
determine whether income arises from U. S. or foreign sources and to allocate expenses between
such U. S. and foreign source income.
Under
determined

the above limitation rules, an increase in the portion of a taxpayer's income
to be from foreign sources will increase the allowable foreign tax credit.
Therefore, taxpayers generally receive greater foreign tax credit benefits to the extent that
their expenses are applied against U. S. source income rather than foreign source income.

Treasury regulations issued in 1977 described methods for allocating expenses between
U. S. and foreign source income.
Those regulations
contained specific rules for the
allocation of research and experimentation
(R&E) expenditures, which generally required a
certain portion of R&E expense to be allocated to foreign source income. Absent such rules,
a full allocation of R&E expense to U. S. source income would overstate foreign source income,
thus allowing the foreign tax credit to apply against U. S. tax imposed on U. S. source income
and thwarting the limitation on the foreign tax credit.

Since

1981 these

R&E allocation

subject to seven different
suspensions and temporary modifications by Congress.
The Technical and Miscellaneous
Revenue Act of 1988 (TAMRA) adopted allocation rules which were in effect for only four
months.
For 20 months following the period when the TAMRA rules were in effect, R&E
allocation was controlled by the 1977 Treasury regulations.
The Budget Reconciliation Act of
1989 subsequently reintroduced the TAMRA rules, once again on a temporary basis. These rules
were extended to taxable years beginning on or before August 1, 1991 by the Omnibus Budget
Reconciliation Act of 1990.
regulations

have

been

Under the R&E allocation rules enacted by TAMRA (and temporarily recodified in 1989
and 1990), a taxpayer must allocate 64 percent of R&E expenses for research conducted in the
United States to U. S. source income and 64 percent of foreign-performed
R&E to foreign
source income. The remaining portion can be allocated on the basis of the taxpayer s gross
sales or gross income. However, the amount allocated to foreign source income on the basis
of gross income must be at least 30 percent of the amount allocated to foreign source income
on the basis of gross sales.

19-

-20-

~RR

believes in
As evidenced by its continued support for a R&E credit, the Administration
of U. S.-based research
the provision
of tax incentives to increase the performance
activities.
The allocation rules in this proposal provide such an incentive. Although the
corporations that are subject to the foreign tax credit
proposal benefits only multinational
with respect to such entities.
an effective incentive
limitation,
it will provide
By
enhancing the return on R&E expenditures, the proposal promotes the growth of overall R&E
activity as well as encouraging the location of such research within the United States.

Descri tion of Pro osal

The proposal would extend for one year the R&E allocation rules that were first enacted
by TAMRA and were re-enacted on a temporary basis in 1989 and 1990. The proposal would
be effective for all taxable years beginning after August 1, 1991 and ending on or before
August 1, l992.

~ffff*

Under the
source income
than the rules
the benefits of

proposal, the automatic allocation of 64 percent of U. S.-performed R&E to U. S.
generally permits a greater amount of income to be classified as foreign source
applicable under the 1977 regulations.
As discussed above, this will increase
the foreign tax credit for many taxpayers.

of these rules is best illustrated through an example.
Assume that an
unaffiliated U. S. taxpayer has $100 of expense from research performed in the United States,
that 50 percent of relevant gross sales produce foreign source income, and that 30 percent of
The operation

the taxpayer's gross income is from foreign sources.
Subject to certain limitations not
applicable to these facts, the 1977 regulations would have required the taxpayer to allocate
at least $30 of R&E expense to foreign source income ($100 x 30% gross income from foreign

sources).
Under the proposal $64 is automatically allocated to U. S. source income based on the
place of performance ($100 x 64%). The remaining $36 may be allocated either on the basis of
gross sales or on the basis of gross income (subject to the limitation described below).
A
gross sales apportionment of the remainder would result in $18 ($36 x 50%) being allocated to
foreign source income, while a gross income apportionment would result in $10.80 ($36 x 30%)
being allocated to foreign source income.

The amount allocated to foreign
least 30 percent of the amount so
will not affect the result here since
the gross income method is greater
limitation).

source income using the gross income method must be at
allocated using the gross sales method.
That limitation
the $10.80 apportioned to foreign source income under
than $5.40 ($18 apportioned
under gross sales x 30%

-21As a result
allocate at least
the $30 required

of the allocation rules in the proposal, the taxpayer in this example must
$10.80 of U. S.-performed RRE expense to foreign source income, compared to
to be so allocated under the 1977 regulations.

Revenue Estimate

Fiscal 5'ears

1991

1992

1993

1994

1995

(Billions of Dollars)
One year extension of
R&E expense allocations:

-. 3

1996

1991-96

ENTERPRISE ZONE TAX INCENTIVES
Current Law

Existing Federal tax incentives generally are not targeted to benefit specific geographic
areas. Although the Federal tax law contains incentives that ma~ encourage economic development in targeted economically distressed areas, the provisions generally are not limited to
use with respect to such areas.
Among the existing general Federal tax incentives that aid economically distressed areas
This credit provides an incentive for employers to hire
is the targeted jobs tax credit.
workers and often is available to firms located in economically
economically disadvantaged
in low-income
A Federal tax credit also is allowed for certain investment
distressed areas.
of certain structures that ma~ be located in economically
housing or the rehabilitation
Another Federal tax incentive permits the deferral of capital gains
distressed areas.
In addition, tax-exempt state and
taxation upon certain transfers of low-income housing.
local government bonds may be used to finance certain activities conducted in economically
distressed areas.

Reasons for Chan e

distressed areas share in the benefits of economic growth, the
Administration
proposes to designate Federal enterprise zones which will benefit from
relief
relief.
The tax incentives and regulatory
targeted tax incentives and regulatory
of the
and private sector revitalization
provided by this proposal will stimulate government
areas.

To help economically

Descri tion of Pro osal

proposed enterprise zone initiative would include selected Federal income tax
These incentives will be offered in conjunction with
employment and investment incentives.
relief.
Federal, state, and local regulatory
Up to 50 zones will be selected over a
four-year period.

The

The incentives are: (i) a 5 percent refundable tax credit for qualified employees with
respect to their first $l0, 500 of wages earned in an enterprise zone (up to $525 per worker,
with the credit phasing out when the worker earns between $20, 000 and $25, 000 of total annual
wages); (ii) elimination of capital gains taxes for tangible property used in an enterprise
zone business and located within an enterprise zone for at least two years: and (iii)
of contributions to the capital of corporations engaged in the
expensing by individuals
conduct of enterprise zone businesses (provided the corporation has less than $5 million of
to acquire tangible assets located within an
total assets and uses the contributions
enterprise zone, and limiting the expensing to $50, 000 annually per investor with a $250, 000
lifetime limit per investor).

-23-

-24The willingness of states and localities to "match" Federal incentives will be considered
in selecting the special enterprise zones to receive these additional Federal incentives.
~ffff

fff

investment
and job creation in
Enterprise zones would encourage private industry
economically distressed areas by removing regulatory and other barriers inhibiting growth.
They would also promote growth through selected tax incentives to reduce the risks and costs
of operating or expanding businesses in severely depressed areas.
A new era of
cities and rural areas help
is needed to help distressed
public/private
partnerships
themselves.
Revenue Estimate

Fiscal Years

1991

1992

1993

1994

1995

1996

1991-96

-0. 8

-1.8

(Billions of Dollars)
Enterprise zone incentives:

-0. 1

-0.2

-0.3

-0.5

SOLAR AND GEOTHERMAL ENERGY CREDITS
Current law
is allowed for investment
The
in solar or geothermal
energ) property.
amount of the credit is 10 percent of the investment.
Solar property is equipment that uses
solar energy to generate electricity or steam or to provide heating, cooling, or hot water in
Geothermal property consists of equipment, such as a turbine or generator, that
a structure.
converts the internal heat of the earth into electrical energy or another form of useful
energy. The credits for solar and geothermal property have been scheduled for expiration a
number of times in recent years, but have been extended each time. The credits are currently
scheduled to expire on December 31, 1991. A number of other energy credits, such as the
credits for ocean thermal and wind energy property, have expired in recent years.
A tax credit

Reasons for Chan e

The geothermal and solar credits are intended to encourage investment in renewable energy
Increased use of solar and geothermal energy would reduce our nation's
technologies.
reliance on imported oil and other fossil fuels and would improve our long-term energy
security. Use of geothermal and solar energy resources also reduces air pollution.
Descri tion of Pro osal

The solar and geothermal

credits would be extended through

December 31, 1992.

Revenue Estimate

Fiscal Years

1991

1992

1993

1994

1995

(Billions of Dollars)
One year extension of
solar and geothermal
energy credits:

Revenue gain of less than $50 million.
-* Revenue loss of less than $50 million.

1996

1991-96

TARGETED JOBS TAX CREDIT

Current Law

The

targeted jobs tax credit (TJTC) is available on an elective basis for hiring
individuals
from nine targeted
are:
The targeted
groups.
groups
( I ) vocational
rehabilitation
referrals; (2) economically disadvantaged
22; (3)
youths aged 18 through
Vietnam-era veterans; (4) Supplemental
economically disadvantaged
Security Income (SSI)
cooperative
recipients; (5) general assistance recipients; (6) economically
disadvantaged
education students aged 16 through 19; (7) economically disadvantaged
former convicts; (8)
eligible work incentive employees; and (9) economically disadvantaged summer youth employees
aged 16 or 17. Certification of targeted group membership is required as a condition of
claiming the credit.

The credit generally is equal to 40 percent of the first $6, 000 of qualified first-year
wages paid to a member of a targeted group. Thus, the maximum credit generally is $2, 400 per
individual.
With respect to economically disadvantaged summer youth employees, however, the
credit is equal to 40 percent of up to $3, 000 of wages, for a maximum credit of $1,200.
The credit is not available for wages paid to a targeted group member unless the
individual either (1) is employed by the employer for at least 90 days (14 days in the case
of economically disadvantaged summer youth employees), or (2) has completed at least 120
hours of work performed for the employer (20 hours in the case of economically disadvantaged
summer youth employees).
Also, the employer's deduction for wages must be reduced by the
amount of the credit claimed.
The credit is available with respect to targeted-group
employer before January 1, 1992.

individuals

who begin work for the

Reasons for Chan e

The TJTC is intended to encourage employers willing to hire workers who otherwise may be
unable to find employment.
Job creation incentives are required in the current economic
climate.
Descri tion of Pro osal

The TJTC would be extended for one year. The credit would be available with respect to
targeted-group individuals who begin work for the employer before Janua~ 1, 1992.

-27-

-28Revenue Estimate

Fiscal Years

1991

1992

1993

1994

1995

(Billions of Dollars)

One year extension
of targeted jobs
tax credit:

-~ Revenue loss of less than $50 million.

1996

1991-96

DEDUCTION FOR SPECIAL NEEDS ADOPTIONS
Current

Law

Expenses associated with the adoption of children are not deductible under current law.
However, expenses associated with the adoption of special needs children are reimbursable
under the Federal-State Adoption Assistance Program (Title IV-E of the Social Security Act).
Special needs children are those who by virtue of special conditions such as age, phisical or
mental handicap, or combination of circumstances, are difficult to place for adoption.
The
Adoption Assistance Program includes several components.
these
requires
One of
components
States to reimburse families for costs associated with the process of adopting special needs
children. The Federal Government shares 50 percent of these costs up to a maximum Federal
share of $1,000 per child.
Reimbursable expenses include those associated directly with the
adoption process such as legal costs, social service review, , and transportation
costs. Some
children are also eligible for continuing
Federal-State assistance under Title IV-E of the
Social Security Act. This assistance includes Medicaid.
Other children mai be eligible for
continuing assistance under State-only programs.
Reasons for Chan e

The Tax Reform Act of 1986 (the 1986 Act) repealed the deduction for adoption expenses
associated with special needs children.
Under prior law, a deduction of up to $1,500 of
expenses associated with the adoption of special needs children was allowed.
The 1986 Act
provided for a new outlay program under the existing Adoption Assistance Program to reimburse
The group of children
expenses associated with the adoption process of these children.
covered under the outlay program is somewhat broader than the group covered by the prior
The prior law deduction was available only for special needs children assisted
deduction.
under Federal welfare programs, Aid to Families with Dependent Children, Title IV-E Foster
The current adoption assistance outlay program
Care, or Supplemental
Security Income.
expenses for these special needs children, as well as
provides assistance for adoption
special needs children in private and State-only programs.
Repeal of the special needs adoption deduction may have appeared
of the Federal concern for the adoption of special needs children.

to some as a lessening

purpose of the Adoption Assistance Program is to enable families in modest
In a number of cases the children are in
circumstances to adopt special needs children.
The prospective parents would like to
parents.
foster care with the prospective adoptive
formally adopt the child but find that to do so would impose a financial hardship on the
entire family.
An important

under the
While the majority of eligible expenses are expected to be reimbursed
is concerned that in some cases the
Administration
continuing expenditure
program, the
areas or in special circumstances.
limits may be set below actual cost in high-cost
for
deduction
special needs children mai alert
Moreover, inclusion in the tax code of a
families who are hoping to adopt a child to the mani forms of assistance provided to families
adopting a child with special needs.

-30Descri tion of Pro osal

The ProPosal would Permit the deduction from income of expenses incuned that are
associated with the adoption of special needs children, up to a maximum of $3, 000 per child
Eligible expenses would be limited to those directly associated with the adoption process
under the Adoption Assistance program.
These include
that are eligible for reimbursement
and
transportation
costs. Only expenses
court costs, legal expenses, social service review,
the
rules
of
the
under
Adoption Assistance program
for adopting children defined as eligible
but
reimbursed
would
were
deducted
which
be included in income in
would be allowed. Expenses
occurred. The proposal would be effective January I,
the year in which the reimbursement

1992.
~Eff

The proposal when combined with the current outlay program would assure that reasonable
expenses associated with the process of adopting a special needs child do not cause financial
The proposed deduction would supplement the current
hardship for the adoptive parents.
Federal outlay program.
In addition, the proposal highlights the Administration's
concern
that adoption of these children be specially encouraged and may call to the attention of
families interested in adoption the various programs that help families adopting children
with special needs.
There is currently uncertainty regarding whether Federal and State reimbursements
are
income to the adopting families. The proposal would clarify the treatment of reimbursements
by making them includable in income but also deductible, up to $3, 000 of eligible expenses
per child. Additionally, qualified expenses up to this limit would be deductible even though
not reimbursed.
While the costs of adoption of a special needs child are only a small part of the total
costs associated with adoption of these children, the Administration
believes that it is
important to remove this small one-time cost barrier that might leave any of these children
without a permanent family.
Revenue Estimate

Fiscal Years

1991

1992

1993

1994

1995

(Billions of Dollars)
Deduction for special
needs adoption:

Revenue loss of less than $50 million.

1996

1991-96

LOW-INCOME HOUSING TAX CREDIT
Current Law

is allowed for certain expenditures with respect to low-income residential
The low-income housing credit generally may be claimed bi owners o
ual'fied low-income buildings in equal annual installments over a 10-year credit period as
long as the buildings continue to provide low-income housing over a I5-year compliance

A tax credit
rental housing.

period.
the discounted present viue of the installments may be as much as 70 percent
costs of new
of eligible expenditures.
Eligible expenditures
include the depreciable
and substantial
construction
rehabilitations.
They also include the cost of acquiring
rehabilitated so long as they have not been
existing buildings which have been substantiall~
placed in service within the previous 10 years and are not already subject to a 15-year
The basis of property is not reduced by the amount of the credit for
compliance period.
purposes of depreciation and capital gain.
In genera

The annual credit available for a building cannot exceed the amount allocated to the
As originally enacted, the total
building by the designated State or local housing agency.
allocations by the housing agency in a given year could not exceed the product of $1.25 and
however, for certain
the State's population.
A State credit allocation is not required,
projects financed with tax-exempt bonds subject to the State's private activity bond volume
limitation.

States could not originally allocate the low-income housing credit after 1989. The
Omnibus Budget Reconciliation Act of 1989 extended each State's allocation authority through
The Omnibus Budget
1990, but at a reduced annual level of $0. 9375 per state resident.
Reconciliation Act of 1990, however, increased the allocation authority for 1990 to $1.25 per
State resident and extended allocation authority through 1991 at the same annual level.
Reasons for Chan e

The low-income housing credit encourages the private sector to construct and rehabilitate
the nation's rental housing stock and to make it available to the working poor and other lowhousing vouchers and certificates, the credit
income families.
In addition to tenant-based
is an important mechanism for providing Federal assistance to rental households.
Descri tion

of Pro osal

extend the authority
an annual level of $1.25 per State resident.

The proposal

would

of States to allocate the credit through

-31-

1992 at

-32Revenue Estimate

Fiscal Years

1991

1992

1993

1994

(BI11Ions

One year extension of
low-income housing
tax credit:

-0. 1

-0.2

]995

1996

1991 96

-0.3

-1.3

of Dollars)

-0.3

HEALTH INSURANCE DEDUCTION FOR THE SELF-EMPLOYED
Current

Law

Current law generally allows a self-emploved individual to deduct as a business expense
up to 25 percent of the amount paid during a taxable year for health insurance coverage for
himself, his spouse, and his dependents.
The deduction is not allowed if the self-employed
or his or her spouse is eligible for employer-paid
individual
health benefits.
Originally,
this deduction was only available if the insurance was provided under a plan that satisfied
the non-discrimination
requirements
of section 89 of the Code. Section 89 has since been
repealed retroactively, however, and no non-discrimination
currently appli to
requirements
The value of any coverage provided for such individuals and their families
such insurance.
for self-employment
The deduction is
tax purposes.
by the business is not deductible
scheduled to expire after December 31, 1991.

Reasons for Chan e

The 25 percent deduction for health insurance costs of self-employed individuals was
added by the Tax Reform Act of 1986 because of a disparity between the tax treatment of
owners
of incorporated
and
unincorporated
businesses
(~e, partnerships and sole
Under prior law, incorporated businesses could generally deduct, as an
proprietorships).
employee compensation expense, the full cost of any health insurance coverage provided for
their employees (including owners serving as employees) and their employees' spouses and
individuals
dependents.
operating through an unincorporated
By contrast, self-employed
business could only deduct the cost of health insurance coverage for themselves and their
spouses and dependents to the extent that it, together with other allowable medical expenses,
exceeded 5 percent of their adjusted gross income. (Coverage provided to employees of the
self-employed, however, was and remains a deductible business expense for the self-employed. )
The special 25 percent deduction was designed to mitigate this disparity in treatment.
Further, the Tax Reform Act of 1986 raised the floor for deductible medical expenses
(including health insurance) to 7.5 percent of adjusted gross income.
Descri tion

of Pro osal

The proposal would extend the 25 percent deduction
~EE

through

December

31, 1992.

The proposal will continue to reduce the disparity in tax treatment between
individuals and owners of incorporated businesses, compared to prior law.

-33-

self-empl()vcd

-34Revenue Estimate

Fiscal Year

1991

1992

1993

1994

1995

(Billions of Dollars)
One year extension of
health insurance
deduction for the
self-employed:

1996

1991 96

EXTEND TAX DEADLINES FOR DESERT SHIELD/STORM PARTICIPANTS
Current Law

Section 7508 of the Internal Revenue Code generally suspends the time for performing
various acts under the internal revenue laws, such as filing tax returns, paying taxes or
filing claims for refund of tax, for any individual serving in the Armed Forces of the United
States or in support of the Armed Forces in an area designated as a combat zone.
The
designation of a combat zone must be made by the President of the United States by Executive
Order.
The suspension of time provided by section 7508 (prior to its recent amendment, discussed
below) covers the period of service in the combat zone, including any period during which the
individual
is a prisoner of war or missing in action, any period of continuous hospitalization outside the United States as a result of injuries suffered in such service, and the
next 180 days thereafter.
The spouse of a qualifying individual is generally entitled to the
same suspension
of time, regardless of whether a joint return is filed.
No interest is
charged during the suspension period on underpayments
of tax, and (prior to the recent
discussed below) no interest is credited during the suspension
amendment,
period on
overpayments of tax. Special rules apply if the collection of tax is in jeopardy.
On January 21, 1991, the President signed Executive Order 12744, designating as a combat
zone the Persian Gulf, the Red Sea, the Gulf of Oman, a portion of the Arabian Sea, the Gulf
of Aden, and the total land areas of Iraq, Kuwait, Saudi Arabia, Oman, Bahrain, Qatar and the
United Arab Emirates.
This designation is retroactive to January 17, 1991 (January 16 in the
United States), the date specified as the commencement of combatant activities.
As a result
of this action, qualifying individuals serving in the combat zone will have the benefit of
section 7508 beginning on January 17, 1991. Under regulations, members of the Armed Forces
serving outside the combat zone in direct support of military operations in the combat zone,
under conditions qualifying for compensation under 37 U. S.C. g 310 (relating to duty subject
to hostile fire or imminent danger), are also entitled to the benefit of section 7508.
On January 30, 1991, the President signed into law legislation (P. L. 102-2) which amends
section 7508 in several respects, effective August 2, 1990. First, it extends the coverage
of section 7508 to include individuals serving in the Armed Forces or in support of the Armed
Forces in the "Persian Gulf Desert Shield area" (to be designated by Executive Order) at any
time during the period beginning August 2, 1990 and ending on the date on which any part of
the area is designated by the President as a combat zone. As under current law, relief also
Second, the Desert Shield legislation reverses
extends to spouses of qualifying individuals.
of tax, so that interest i~
the prior rule in section 7508 regarding interest on overpayments
period.
Finally, the Desert Shield legislation
generally credited during the suspension
extends the suspension period to include periods of continuous hospitalization
in (as well as
five
than
of
more
Not
years
hospitalization
in the United
outside of) the United States.
States can be taken into account for this purpose, however, and hospitalization in the United
States is not taken into account in determining the suspension period for the individual's

spouse.

-35-

-36Reasons for Chan e

the Persian Gulf area was not a combat zone and
There was accordingly a need to extend
the Desert Shield legislation had not been enacted.
in the Desert Shield operation,
participating
the coverage of section 7508 to individuals
many of whom were sent to the Middle East on short notice with little time to make provision
for the filing of tax returns and payment of taxes.
At the time the proposal was developed,

Descri tion of Com leted Action

of Executive Order 12744

Enactment of the Desert Shield legislation and the promulgation
have implemented the proposal discussed in the Budget.
Revenue Estimate

Fiscal Years

1991

1992

1993

1994

1995

1996

1991-96

(Billions of Dollars)

Extend tax deadlines for
Desert Shield/Storm
participants

Revenue gain of less than $50 million.
-* Revenue loss of less than $50 million.

Note:

This revenue estimate was prepared prior to the designation of the Persian Gulf area
as a combat zone and the enactment of the Desert Shield legislation.
Because this
proposal is now a feature of current law, the revenue loss is zero, but the baseline
receipts forecast must be adjusted by a corresponding amount.

MEDICARE HOSPITAL INSURANCE (HI) FOR STATE AND LOCAL EMPLOYEES
Current Law

State and local government employees hired on or after April 1, 1986, are covered bi
Medicare Hospital Insurance and their wages are subject to the Medicare tax (1.45 percent on
both employers and employees). Unless a State or local government had a voluntary agreement
with Social Security, employees hired prior to April I, 1986. are not covered bi Medicare
Hospital Insurance nor are they subject to the tax.
Reasons for Chan e

State and local government employees are the only major group of employees not assured
Medicare coverage. One out of six State and local government employees are not covered by
voluntary agreements or by law. However, an estimated 85 percent of these employees receive
full Medicare benefits through their spouse or because of prior work in covered employment.
Over their working lives, they contribute on average only half as much tax as is paid by
workers in the private sector. Extending coverage would assure that the remaining 15 percent
have access to Medicare and would eliminate the inequity and the drain on the Medicare trust
fund caused by those who receive Medicare without contributing fully.
Descri tion of Pro osal
As of January 1. 1992. all State and local government
Medicare Hospital Insurance.

employees

would

be covered hy

~Eff

additional two million State and local government
employees would contribute to
Medicare.
Of these, roughly 300, 000 employees would become newly eligible to receive
Medicare benefits subject to satisfying the minimum 40 quarters of covered employment.
An

Revenue Estimate~

Fiscal Years

1991

1992

1993

1994

1995

1996

1991-96

(Billions of Dollars)
Extend Medicare hospital
insurance coverage to
State and local employees:

* Net of income

tax offset.

1.5

7. 3

MOTOR FUELS EXCISE TAX
Current Law

The Omnibus Budget Reconciliation Act of 1990 raised the motor fuels excise tax b) 5. 1
cents from 9 to 14. 1 cents a gallon on motor gasoline and from 15 to 20. 1 cents a gallon on
One-tenth of a cent is deposited into the Leaking Underground
diesel fuel.
Storage Tank
Trust Fund, and half of the remaining 5 cent increase is deposited into the General Fund.
The remaining 2. 5 cents are deposited into the Highway Trust Fund. The General Fund and
Highway Trust Fund portions of the tax are scheduled to expire at the end of fiscal year

1995.
Current services forecasts incorporate extension of the trust fund portions of the tax at
their current rates through the end of the budget period, but provide that the General Fund
portion of the tax expires as scheduled at the end of the fiscal year 1995. Thus, the
the
portion of the motor fuels excise tax rates in fiscal year 1996 underlying
highway
current services forecasts are 11.5 cents per gallon on gasoline and 17.5 cents per gallon on
diesel fuel.

Reasons for Chan e

The current motor fuels excise taxes expire at the end of fiscal 1995. While the current
services forecasts incorporate extension of the highway portion of the motor fuels tax at
their current
rates of 11.5 cents for gasoline and 17 5 cents for diesel fuel, the
Administration
Budget proposal incorporates extension in 1996 at the prior rates of 9 cents
for gasoline and 15 cents for diesel fuel.
The lower rates in 1996 will be sufficient to
finance the Administration's
proposed increase in highway and transit programs.
Descri tion of Pro osal

to the current services forecasts, under the Administration s proposal the
portion of the motor fuels excise taxes which is dedicated to the Highway Trust Fund will be
extended for fiscal year 1996 at the level of 9 cents per gallon on gasoline and 15 cents per
gallon on diesel fuel.
In contrast

Revenue Estimate

Fiscal Years

1991

1992

1993

1994

1995

1996

1991-96

-2. 7

(Billions of Dollars)
Limited extension of motor
0
fuels excise taxes:

-39-

INCREASE IN IRS FY 1992 ENFORCEMENT FUNDING
Current Law

The IRS currently allocates substantial resources to direct enforcement of the tax laws.
Direct enforcement encompasses activities designed to encourage accurate reporting of taxable
income and to assess or collect taxes, penalties. and interest which are owed but not paid.
In allocating resources to these activities. the IRS does not simply seek to collect the
maximum amount of taxes through direct enforcement activities; the additional objective is to
increase tax revenues indirectly by encouraging and enhancing voluntary compliance.
Reasons for Chan es

The IRS has identified a number of enforcement areas in which specific problems exist
that could be resolved by the application of additional resources.
In addition, the gap
between taxes owed and taxes voluntarily
to the Federal deficit and
paid contributes
undermines the system of voluntary compliance.
Descri tion

of Pro osal

The proposal calls for additional IRS funding for tax law enforcement,
collection of delinquent taxes, penalties, and interest.
The specific programs,
authority, and estimated FY 1992 receipts are as follows:

and for the
new budget

Field Audit Initiative —
An additional
94 staff years are to be
o Examination
Total budget authority for the initiative for FY
applied to income tax audits.
1992 is $6.0 million.
This initiative will apply an additional 671
o Collection of Accounts Receivable —
staff years with total FY 1992 budget authority of $34.0 million, to the accounts

receivable inventory.
~Eff

the
Consequently.
activities are in the area of direct enforcement.
proposal should enhance the level of revenue collection. encourage taxpayers to correctly
report their income for tax purposes. and expedite the collection of past due taxes.
All

affected

-42Revenue Estimate

Fiscal Years

1991

1992

1993

1994

1995

(Billions of Dollars)

Increase in IRS FY 1992
enforcement funding:

". Revenue gain

of less than $50 million.

0. 1

0.2

0.7

MISCELLANEOUS PROPOSALS AFFECTING RECEIPTS
Descri tion of Pro osals

Extend abandoned mine reclamation fees. The abandoned mine reclamation fees, which are
scheduled to expire on September 30, 1995, would be extended. Collections from the existing
fees of 35 cents per ton for surface mined coal and 15 cents per ton for under ground mined
coal are allocated to States for reclamation grants.
Extensive abandoned land problems are
exist
in
certain
expected to
States after all the money from the collection of existing fees
is expended.
Im rove retail com liance with the s ecial occu ation taxes.
To increase compliance
and
rates
revenues, wholesalers would be required to ensure that their retail customers pa&
the special taxes in connection with liquor occupations that are levied on retailers.
The
would
effective
be
proposal
beginning October 1, 1991.

Increase HUD interstate land sales fee. The Interstate Land Sales Full Disclosure Act
gives HUD the responsibility
of registering certain subdivisions that are sold or leased
across state lines. A fee is charged when a developer files a statement of record about the
subdivision with HUD. The fee charged cannot exceed $1,000 for any one developer. The fees
collected cover only a portion of administrative costs. The proposal would remove the $1,000
fee limitation to help fully offset the direct administrative costs of the program.
Amend railroad unem lo ment insurance (UI) status.
Under present law, all railroads,
including Amtrak and other public commuter railroads, make experience-rated Ul contributions
that are based partly on industry-wide
costs and partly on their own line' s
unemployment
unemployment
costs. To prevent public subsidies from being diverted to pay for the high
cost of the private sector railroads, public commuter railroads were exempt from
unemployment
the full railroad unemployment
tax rate in 1990. Instead, they reimbursed the Ul trust funds
for the actual unemployment
and sickness insurance costs of their employees.
Under the
proposal, Amtrak and other public commuter railroads would reimburse the trust funds for the
actual unemployment
costs of their employees after January 1, 1991.

-44Revenue Estimate

Fiscal Year

]991

1992

1993

1994

1995

(Billions of Dollars)

Extend abandoned mine
reclamation fees:
Improve retail compliance with
liquor occupation taxes:

Increase HUD interstate
land sales fee:
Amend railroad UI status:

Revenue gain of less than $50 million.
Revenue loss of less than $50 million.

1996

1991-1996

Department

of the Treasury

Washington,

D.C. 20220

Official Business
Penalty for Private Use, $300

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Citation Information
Document Type: Transcript

Number of Pages Removed: 17

Author(s):
Title:

Date:

Treasury Secretary Nicholas Brady News Conference (Topic: Deposit Insurance Study and
Recommendations for Financial Services Reform)

1991-02-05

Journal:

Volume:
Page(s):
URL:

Federal Reserve Bank of St. Louis

https://fraser.stlouisfed.org

of the Treaeug

leportment

paehlnygon,

D.c. ~ Telephone See-20

TESTIMONY OF SIDNEY L. JONES
I.'~ PT. uBEFORE TR3'. (
SUBCOMMITTEE ON DOMESTIC MONETARY POLICY
OF THE HOUSE BANKING COMMITTEE
U.
HOUSE OF REPRESENTATIVES
FEBRUARY 5, 1991

Mr. Chairman and Members of the Committee, I am pleased to
meet with you to discuss the general economic outlook.
My
comments will concentrate on reviewing current economic
conditions and the Administration's
economic forecasts published

in the President's

1992 budget.

CURRENT

ECONOMIC

CONDITIONS

During the 1980s, rapid changes occurred throughout the
world economy leading to structural reforms in Western and
Eastern Europe and the continued emergence of new economic forces
in the Pacific Basin and Latin America.
In the United States,
the cyclical expansion that began in November 1982 created almost
eight years of sustained economic growth, relatively stable
inflation, and the addition of more than 20 million jobs. The
U. S. economy grew at an average rate of 3. 6 percent from the
fourth quarter of 1982 through the third quarter of 1990, a
This sustained growth is even more
record peacetime expansion.
impressive when compared with the stagflation that preceded it
a combination of sluggish economic activity, double-digit
inflation rates, chronic unemployment problems, and unusually
high interest rates.

early-1989 through the third quarter of 1990, however,
the pace of economic activity in the United States slowed to an
During the
average annual real GNP growth rate of 1.2 percent.
last three months of 1990 the real output of goods and services
declined at a 2. 1 percent annual rate according to the
The negative fourth quarter estimate
preliminary GNP figures.
reduced the 1990 annual growth rate to only 0. 3 percent from the
1.8 percent pace reported during 1989- The GNP price deflator
rose 4. 0 percent in 1990, slightly more than the 3. 7 percent
increase in 1989, and the unemployment rate moved up from the 5. 3
percent level reported during the first half of the year to 6. 1
percent by December 1990.
From

NB-1115

GROWTH OF REAL GNP
PERCENT CHANGE
QUARTERLY
ANNUAL RATE

FOURTH QUARTER TO FOURTH QUARTER

6. 5

6.3
1948-89
AVG.

3.8

5. 1

=3.3A

5.0
3.6

3.5
1.9

0. 6

1.7

1.8

0.6

0. 3

0. 4

0.3

-0. 1

-1.9
75

-2. 1
83

1990

II III

The disruptive effects of the oil price shock beginning last
August eroded consumer and business confidence at a time when
economic activity already had slowed.
Consumer spending, which
accounts for two-thirds of the GNP, had been soft for many
months, particularly
the purchases of automobiles and other
durable goods. Residential building had been in decline since
the mid-1980s and new housing starts had fallen to the low level

last reported

Business investment
during the 1981-82 recession.
in new plant and equipment had contracted and surveys of future
plans had become more pessimistic.
Government spending had
responded to fiscal pressures, particularly the restraint of
defense spending.
The creation of new jobs had decelerated in
manufacturing,
construction, and some service industries.
The combination

distorting

caused by

of marketplace

forces, particularly

the

effects of inflation and the collapse of confidence
oil and war shocks, disrupted the U. S. economy. During

the last quarter

of 1990, widespread declines occurred in
spending, particularly for durable goods, business fixed
investment, residential construction, and inventory investment.

consumer

Partially offsetting these declines were strong improvement
in the net export balance, increasing State and local government
spending, and a large rise in Federal defense outlays.
Real
final sales for the fourth quarter remained flat and the overall
decline in the quarterly GNP reflects the rundown of inventories.
Businesses reduced their inventories by more than $16 billion in
real terms during the fourth quarter following an increase of
about $5 billion in the third quarter, a swing of $21 billion
dollars of inventories.

Despite the negative fourth quarter result, most analysts
believe that the current downturn will be relatively brief and
mild. The major arguments supporting this consensus outlook
include:
0

Stocks of inventories

remain low relative to current
sales and have been declining for several months rather
than rising as typically occurs during the early stages
of an economic downturn.
The aggregate inventory-sales
ratio actually declined in the fourth quarter. But the
liquidation of inventories does not appear to be
gathering downward momentum.
This suggests that
production activity to replenish inventory stocks may
respond quickly when consumer and business spending
resumes.
For example, auto inventories are at
relatively low levels because of cutbacks in production
during the fourth quarter of 1990. Orders placed with
durable goods manufacturers also have held up well.
Exporting industries continue to register strong sales.
Merchandise exports grew in real terms at a strong 15
percent annual rate during the final quarter of last
year. For all of 1990, merchandise exports were up 71/2 percent while real nonpetroleum merchandise imports
increased only 2-1/4 percent during the year. Further
declines in the U. S. dollar since mid-1990 have
improved the competitive position of American farmers
and companies in foreign markets.
Export sales should
remain strong despite the slowdown of economic activity
in some countries, the disruptive oil and war shocks,
and the disappointing
delay in completing the important
trade negotiations.
Uruguay Round of multilateral
The surge of inflation linked to the runup of oil
The implicit GNP
prices appears to be moderating.
is
affected
which
price deflator,
by shifts in the
composition of output, increased by only 2. 8 percent in
the fourth quarter, down from a low 3. 7 percent pace
Continued easing of price
during the third quarter.
restore
purchasing power and
pressures will help
confidence needed to stimulate personal consumption and

business

spending.

Business investment in new plant and equipment is
expected to remain flat during 1991 according to recent
There does not appear to be any widespread
surveys.

erosion of spending
0

plans.

growth of Federal government spending in Fp
defense and non-defense programs, will
both
for
1991,
economic activity.
sustaining
State and
to
contribute

The rapid

government spending also has continued
the growing size of their budget deficits.

local

despite

activity should be stimulated by the large
reduction in interest rates that has occurred. Since
their late summer highs, Treasury 3-month bill interest
rates have declined approximately 150 basis points to
the 6 percent zone and Treasury 30-year bond interest
rates have dropped 65 basis points to the 8-1/4 percent

Economic

zone.

policy by:
Reducing the target for the Federal funds rate
from 8 percent in August to 7 percent by the end
of the year and to 6-3/4 percent in early January.

Eliminating reserve requirements
time and Euro-dollar liabilities

Cutting

The Fed has eased

the discount

on December
was cut to 6

18.

percent.

rate

from 7

February

on nonpersonal
on December 4.

to 6-1/2 percent
rate

1 the discount

share Chairman Greenspan's concern about the
sluggish growth of the money supply in recent months
and support his increased emphasis on monitoring the
growth of money and credit in the formulation of

monetary

policy

has tried to serve as a
"catalyst" by encouraging banks to grant loans to
Officials have met frequently with
worthy borrowers.
bank regulators to encourage them to be more sensitive

The Treasury

Department

to tight credit conditions.
In summary, the decline in real output during the fourth
quarter of 1990 does not appear to be turning into a cumulative
downturn.
The decline in payroll jobs in January demonstrated
that the pattern of recovery will not be a simple upward trend
line, but the fundamental factors needed for resuming economic
growth are in place.
ECONOMIC

ASSUMPTIONS USED IN PREPARING
THE FY 1992 BUDGET

events -- particularly the oil and war shocks and
about resolving structural weaknesses in domestic
financial institutions -- make economic forecasting unusually
difficult. Nevertheless, there is widespread agreement with the
Administration's
recent forecast published in the FY 1992 budget
that the current downturn is likely to be relatively mild and
brief. For Calendar 1991, the Congressional Budget Office (CBO),
Current

uncertainty

Blue Chip Consensus (an average of approximately
fifty private
economic forecasters), and several private econometric models
agree that moderate growth will be registered for the entire
year. There is further agreement that the upturn will continue
in 1992.

Outlook for Real GNP Growth

(Percent, 4th qtr. to 4th qtr. )
Administration

(Troika)

1991

1992

0.9

3.6
3.4

Data Resources (1/91)

1.3
0.9
1.0

Meyer & Assoc. (1/91)

0.5

3.7
3.3

Wharton (1/91)

2.2

2.6

CBO (1/91)
Blue Chip (1/91)

2.8

The CBO and Blue Chip Consensus estimates also agree with
the Administration's
view that positive economic growth will
the
second
begin during
quarter of this year. Of the private
forecasters participating in the Blue Chip panel, 70 percent the
downturn to end by June.

Quarterly

Pattern of Forecasts of Real Growth

(Percent Change, Annual rate)
Decline
Peak to
~Troo

Administration

(Troika)

2.0

2.8

-1.2

CBO (1/91)

-1.7

0.8

2.3

3.9

-1.0

Blue Chip (1/91)

-1.4

0.3

2.0

2.7

-1.0

Data Resources (1/91)

-2.1

3.0

3.6

-1.4

Meyer & Assoc. (1/91)

-2.1

2.4

2.9

-1.6

4.1

3.3

-0.8

Wharton (1/91)

'Including

dedine in 1990-IV. Total decline

at annual rate.

to the possible depth of the current downturn, the
estimates a decline of la2 percent from the
Administration
cyclical peak in the third quarter of 1990 to the trough in the
first quarter of 1991. The Blue Chip Consensus and CBp both
project a similar decline of 1.0 percent. The average decline
during the previous eight post-war recessions has been 2. 6
percent. Therefore, the current cyclical downturn is expected to
be relatively mild.
intermediate-range
Turning to the Administration's
economic
projections, we anticipate a return to more normal growth rates
A moderate
following the current downturn.
snapback of activity
is expected in 1991 leading to a sustained period of expansion,
rates and lower short- and
improving inflation and unemployment
long-term interest rates. The annual figures prepared by the
Administration
for the five-year budget estimates are summarized
As

below.

Summary

Actual

1989

of Administration

~pretuuiu

1990

Economic Assumptions

Short-term
Forecast

1991

Lon er- erm

1993

1992

Percent chan e 4th

tr. to 4th

ro'ections

1994

1995

1996

tr.

5.6

4.3

5.3

7.5

7.1

6.8

6.5

Real GNP

1.8

0.9

3.6

3.4

3.2

3.0

GNP deflator

3.7

4.0

4.3

3.8

3.6

3.5

3.4

3.3

Consumer price index

4.6

3.9

3.6

3.5

3.4

3.3

Nominal

GNP

P rcent avera
Total unemployment

3-mo. Treas. bill rate
10-yr. Treas. notes

rate

f r

calendar

ear

5.2

5.4

6.7

6.6

6.2

5.8

5.4

5.1

8.1

7.5

6.4

6.0

5.8

5.6

5.4

5.3

8.5

7.5

7.2

6.8

6.6

6.4

of the TF4siirY

department

~ Washlnyton,

TEXT AS PREPARED FOR DELIVERY
FOR IMMEDIATE RELEASE

Contact: Cheryl Crispen
202-566-2041

SECRETARY NICHOLAS
REMARKS

FINANCIAL
TUESDAY~

O.C. ~ Telephone %66-264t

BRADY

PRESS
SERVICES REFORM
TO THE

FEBRUARY 5~

1991

of the key goals of the Treasury is to ensure that we
have a strong economy in order to maintain and improve the
standard of living for all Americans, and also so we can compete
effectively in an increasingly global economy. So the issue
today is not banking reform per se, but rather a significant step
in achieving this more fundamental objective.
One

Today, our banking system is under stress.
Technology is
the
changing
do business, but our
way financial institutions
banks are hampered by out-of-date laws. The laws that govern
financial services should deal with the real world in which banks

institutions must operate.
American families look to banks, thrifts and credit unions
to finance homes and cars and to save for their children' s
education and their own retirement.
American businesses look to
these same institutions for funds to expand and create jobs. And
a strong, internationally
competitive U. S. financial system is
essential to a strong, growing economy.
This chart shows that the major laws governing banking in
this country date back to the thirties and forties. Yet the
seventies and eighties have produced stunning technological
changes and other innovations that have changed the face of the
financial system.
Bank credit cards, ATM cards and the 800 number allow people
to access banking services across state lines and around the
world, but banks themselves are constrained by outmoded rules.
such as money market.
Bank competitors can offer innovations,
funds and commercial paper, that put banks at a competitive
disadvantage at home and abroad.
Today, as this chart shows, only one of the 30 largest
Just 20 years ago, the three largest
in the world is American.
were American.
banks
30
and nine of the top
and

other financial

NB-1116

our banking laws to deal with the reality
not
just for the banks, but for the country.
of the marketplace,
system hurts the economy, particularly during
A weak banking
difficult economic times. Weak banks are forced to pull back
just when their good customers need them most. When loans stop
at the first sign of an economic downturn, jobs are lost.
Businesses must be able to count on banks in bad times as well as
good.
We

must modernize

reform is needed.
There can be no doubt that fundamental
The banking system is safe, but it is not as efficient and
competitive as it ought to be. If we expect to exert world
economic leadership in the 21st century, we must have a modern,
world-class financial services system in the U. S.

First, the Administration

s plan will preserve basic deposit
protection for every small saver in America. There
will always be a safe place for Americans to invest for the
future. But the plan will limit taxpayer exposure to possible
losses by reducing the overexpansion of deposit insurance.
insurance

Originally intended to protect small depositors who could
not protect themselves, deposit insurance ha expanded to cover

large, sophisticated investors who are able to evaluate
investments and protect themselves.
This chart shows the growth of insured deposits and
therefore increasing exposure of the insurance fund to possible
losses. One bank recently advertised that a family of three
could receive $1.2 million of insured deposits in one institution
by using their system of multiple accounts.

this, the Administration's plan will prevent
accounts in a single institution.
It will end passthrough coverage for institutional
investors.
It will eliminate
brokered deposits which are used by weak banks to avoid a
marketplace test in raising funds from depositors.
And it will
To address

multiple

limit protection of uninsured
systemic

risk.

depositors

to genuine cases of

Second, the plan will make banks stronger and safer by
strengthening the role of capital -- not by raising capital
standards, but with a plan to attract capital to the banking
industry.
This will discourage excessive risk-taking, reduce the
possibility of bank failure, and provide a cushion to absorb
losses ahead of the insurance fund.

Improved and more frequent supervision will be based on
capital levels, with rewards for well-capitalized banks and
prompt corrective acticn when capital falls below minimum levels.
And risk-based
deposit insurance premiums will be phased in a a
further incentive to build capital.
Well-capitalized banks are better able to keep lending
during economic declines, and they are better able to meet
competitive challenges and take advantage of new opportunities.

Third, the Administration's
plan will make banks more
competitive by modernizing outdated laws like the one that
restricts interstate banking and branching. A California bank
can open a branch in Birmingham, England, but not in Birmingham,
Alabama.
And after 1992, English and German banks will be able
to move freely back and forth within the European Community.
But
American

banks

can't

even branch

across state lines.

that 33 states now permit interstate
a bank holding company from out-of-state can
a subsidiary in these states. Another 13
states permit regional banking. Only four states totally
prohibit interstate banking.
This

map

shows

banking -- meaning
own a bank through

So the trend in the states is clearly to permit interstate
It has become a question not of whether, but of how.
banking.
The plan will permit interstate banking and branching because

there are substantial cost savings and efficiencies that will
benefit taxpayers, consumers and depositors.

Similarly, laws must be changed to permit banks to reclaim
The
the profit opportunities they have lost to changing markets.
plan will allow banks to affiliate, on a two-way street basis,
with a broad range of financial firms through the formation of
financial services holding companies.

protect the deposit insurance fund and the taxpayer, only
banks will be permitted to
companies that own well-capitalized
In addition, only the bank
engage in new financial activities.
will have access to deposit insurance, strict regulation will be
focused on the bank, and the new financial activities will be in
separately capitalized affiliates with no access to the federal
safety net.
To

Fourth, the plan will strengthen the banking system by
The current
making the regulatory structure more efficient.
regulatory structure is complicated, overlapping and confusing.
Individual institutions often are supervised by several
And
regulators, and are governed by conflicting regulations.
ho]ding companies rarely have the same regulator as their
subsidiary banks.

four-regulator structure will be simplified to
responsible for a bank holding
bank.
The Federal Reserve wil]
company and its subsidiary
supervise all state-chartered banks and their holding companies.
The Comptroller of the Currency and the Office of Thrift
Supervision will be combined under Treasury and will supervise
all national banks and all thrifts and their holding companies.
The

current

two, with the same regulator

the Treasury report includes principles which
govern the FDIC's efforts to recapitalize the Bank
Insurance Fund. The FDIC is working with the industry on a plan
under the authority given to FDIC in the FDIC Assessment Rate Act

Finally,

should

of 1990.

all, these changes and reforms
They will address the reality of
marketplace and create a U. S. banking and

are essential to the
the modern financial
financial system that
is internationally competitive, that will protect depositors and
taxpayers, serve consumers, and strengthen the economy.
All in

future.

Now,

I' ll

be glad

to take

your questions.

¹¹¹

„T

L
Department

of the Treasury

RELEASE

FQR IMMEDIATE

Bureau of the Public Debt
fpg

5, 1991

February

Washington,

I.„'gr,
c ~ ~ 3 OCQNTACT:
'

DC 20239

~f.IC ~~

Office cf Financing

202-376-4350

RESULTS OF TREASURY~ S 'MCIXON

Tenders

to be issued

OF 3-YEAR NOTES

for $12, 648 million of 3-year notes, Series R-1994,

on February

were accepted today

15, 1991

and mature

on February

(CUSIP: 912827ZW5).

15, 1994

interest rate

will be 6 7/8%. The range
prices are as follows:
Yield
Price
99. 747
Low
6. 97&o
98~o
99. 720
6.
High
99. 720
6. 98'o
Average
Tenders at the high yield were allotted 61%.
TENDERS RECEIVED AND ACCEPTED (in thousands)

The

of accepted bids

on the notes
and corresponding

Location

Boston
New

York

Philadelphia
Cleveland

Richmond

Atlanta

Chicago
St. Louis
Minneapolis
Kansas City

Dallas
San Francisco
Treasury
TOTALS

Received
32, 440

39, 145, 230
26, 475
44, 210
61, 040
31, 985
775
365,
1,

47, 015

19, 225

48, 730
14, 935
566, 175

79 845
$4 1 I 483 f 080

32, 420
150
040,
12,
26, 475
44, 210

38, 040

26, 580

183, 020
34, 235
19, 195
46, 730
14, 935
61, 675
79 845

$12, 647, 510

$769
$12, 648 million of accepted tenders includes
million
of
879
million of noncompetitive tenders and $11,
competitive tenders from the public.
at the
In addition, $1, 212 million of tenders was awarded
average price to Federal Reserve Banks as agents for foreign
An additional
$1, 644 million
international monetary authorities.
of tenders was also accepted at the average price from Federaj
The

Reserve Banks for their

securities.

NB-1117

own

account in exchange

for maturing

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Document Type: Transcript

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Author(s):
Title:

Date:

News Conference By Treasury Undersecretary David Mulford Following the Meeting of the
Gulf
Crisis Financial Cooperation Group (Topic: Economic Aid to the Front-Line States)

1991-02-05

Journal:

Volume:
Page(s):
URL:

Federal Reserve Bank of St. Louis

https://fraser.stlouisfed.org

)v,
i
~

Department

of the Treaea&
FOR RELEASE AT

.-eb=uary

Waehln~n,

-,j

4:00 IEBI|s:
P.~d. ' 4~ Q

991

D.C. ~ Telephone See-2I

CONTACT:

Office of

F nan

202/376-4350

'~~T pF
TREASURY'S

ldEE'k'L'j'jBILL

OFFERING

The Department of the Treasury,
by this public notice,
invites tenders for two series of Treasury bills totaling approximately S19, 200 million, to be issued FebruarY 14, 1991. This
offering will result in a paydown for the Treasury of about S400
million, as the maturing bills are outstanding in the amount o
S19, 601 million.
Tenders will be received at Federal Reserve
Banks and Branches and at the Bureau of the Public Debt, Washington, D. C. 20239-1500, Monday, February 11, 1991,
prior to
12:00 noon for noncompetitive tenders and prior to 1:00 p. m. ,
Eastern
Standard
time, for competitive tenders.
The two
series offered are as follows:

91-day

bills (to

maturity date) for approximately
representing an additional amount of bills
dated November 15, 1990, and to mature May 16, 1991
(CUSIP No. 912794 WJ 9), currently outstanding
in the amount
of $10, 550 million, the additional and original bills to be
freely interchangeable.

$9, 600

million,

182-day bills for approximately $9, 600 million, to be
dated February 14, 1991, and to mature August 15, 1991
(CUSIP
No. 912794 XC 3).
The bills will be issued on a discount
and noncompetitive
bidding, and at maturity

basis under competitive
their par amount will
be payable without interest.
Both series. of bills will be issued
entirely in book-entry form in a minimum amount of $10, 000 and in
on the records either of the Federal
any higher $5, 000 multiple,
Reserve Banks and Branches, or of the Department of the Treasury.
The bills will be issued for cash and in exchange for
Treasury bills maturing February 14, 1991. In addition to the
maturing 13-week and 26-week bills, there are $9, 594 million of
maturing 52-week bills. The disposition of this latter amount was
Tenders from Federal Reserve Banks for their
announced last week.
own account and as agents for foreign and international
monetary
authorities will be accepted at the weighted average bank discount
rates of accepted competitive tenders. Additional amounts of the
bills may be issued to Federal Reserve Banks, as agents for foreign
to the extent that the
and international
monetary authorities,
aggregate amount of tenders for such accounts exceeds the aggregate amount of maturing bills held by them. For purposes of determining such additional amounts, foreign and international
monetary
million of the original
authorities are considered to hold $811
13-week and 26-week issues.
Federal Reserve Banks currently hold
million as agents for foreign and international monetary
$981
authorities, and S 7, 477 million for their own account. These
amounts represent the ccmbined holdings of such accounts for the
three issues of maturing bills. Tenders for bills to be maintained
on the book-entry records of the Department of the Treasury should
be submitted on Form PD 5176-1 (for 13-week series) or Form
PD 5176-2 (for 26-week series).
NB-1118

TREASURY'8

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page

bidder, as defined in Treasury's single bidder guidelines, shall
tenders totaling more than $1, 000, 000.
not submit noncompetitive

the names of the customers and the amount for each customer are
furnished.
Others are only permitted to submit tenders for their
own account.
Each tender must state the amount of any net long
position in the bills being offered if such position is in excess
of $200 million.
This information should reflect positions held
as of one-half hour prior to the closing time for receipt of
tenders on the day of the auction.
Such positions would include
bills acquired through "when issued" trading, and futures and
forward transactions as well as holdings of outstanding bills
with the same maturity date as the new offering, e. g. , bills
with three months to maturity previously offered as six-month
bills. Dealers, who make primary markets in Government securities and report daily to the Federal Reserve Bank of New York
their positions in and borrowings on such securities, when submitting tenders for customers, must submit a separate tender for
each customer whose net long position in the bill being offered
exceeds $200 million.
A noncompetitive
bidder may not have entered into an
agreement, nor make an agreement to purchase or sell or otherwise dispose of any noncompetitive
awards of this issue being
auctioned prior to the designated closi. ng time for receipt of

competitive

tenders.

Payment for the full par amount of the bills applied for
must accompany all tenders submitted for bills to be maintained
on the book-entry records of the Department of the TreasuryA cash adjustment
will be made on all accepted tenders for the
difference between the par payment submitted and the actual

issue price as determined

in the auction.

and

trust

TREASURY'S

13-, 26-,

AND

52-WEEK BILL OFFERINGS,

Page 3

Public announcement will be made by the Department of the
Treasury of the amount and yield range of accepted bids. Competitive bidders will be advised of the acceptance or rejection
of their tenders. The Secretary of the Treasury expressly
reserves the right to accept or reject any or all tenders, in
whole or in part, and the Secretary's action shall be final.
Subject to these reservations, noncompetitive tenders for each
issue for $1, 000, 000 or less without stated yield from any one
bidder will be accepted in full at the weighted average bank
discount rate (in two decimals) of accepted competitive bids
for the respective issues. The calculation of purchase prices
for accepted bids will be carried to three decimal places on the
basis of price per hundred, e. g. , 99.923, and the determinations
of the Secretary of the Treasury shall be final.
Settlement for accepted tenders for bills to be maintained
on the book-entry records of Federal Reserve Banks and Branches
must be made or completed at the Federal Reserve Bank or Branch
on the issue date, in cash or other immediately-available
funds
or in Treasury bills maturing on that date. Cash adjustments
will be made for differences between the par value of the
maturing bills accepted in exchange and the issue price of the
new

bills.

bill is

purchased at issue, and is held to maturity,
the amount of discount is reportable as ordinary income on the
Federal income tax return of the owner for the year in which
the bill matures.
Accrual-basis taxpayers, banks, and other
persons designated in section 1281 of the Internal Revenue Code
must include in income the portion of the discount for the period
during the taxable year such holder held the bill. If the bill
is sold or otherwise disposed of before maturity, any gain in
excess of the basis is treated as ordinary income.

of the Treasury Circulars, Public Debt Series26-76, 27-76, and 2-86, as applicable, Treasury's single
bidder guidelines, and this notice prescribe the terms of these
Treasury bills and govern the conditions of their issue. Copies
of the circulars, guidelines, and tender forms may be obtained
from any Federal Reserve Bank or Branch, or from the Bureau of
the Public Debt.
Nos.

8/89

Department

2"'

J~
4

m=6

l7s9

~ ~

MODERNIZING
THE FINANCIAL SYSTEM
RECOMMENDATIONS

for
SAFER, MORE COMPETITIVE BANKS

a
Y

February 1991

THE SECRETARY OF THE TREASURY
WASHINGTON

February

J. Danforth

The Honorable

president of the Senate
United States Senate
Washington,
Dear Mr.

5, 1991

Quayle

20510

President:

pleased to transmit our final Report on the
the
federal deposit insurance system, entitled Modernizin
Financial S stem: Recommendatio s for Safer More Com etitive
Banks. Section 1001 of the Financial Institutions Reform,
Recovery, and Enforcement Act of 1989 (FIRREA) (Pub. L. No. 10173) directed the Treasury Department to produce this Report in
consultation with the depository institution regulatory agencies
and others, including the public.
am

For more than a year, the study group reviewed
Our
from its member agencies and the public.
reform
and
goal has been to develop practical proposals to
strengthen the federal deposit insurance system; modernize our
financial system to make banks safer and more competitive, both
and streamline the bank
domestically and internationally;
regulatory structure.
recommendations

benefit from legislative
I therefore urge
enactment of the Report's recommendations.
Congress to give high priority to the passage of the
Administration's
legislative proposal implementing the Report's
recommendations,
which we will submit shortly.
I am also transmitting the Report to the Speaker of the
House of Representatives.
Sincerely,
The public would

significantly

Nicholas

Brady

THE SECRETAR Y OF THE TR EASUR Y
WASHINGTON

February

The Honorable

Thomas

Speaker of the House

House

5, 1991

Foley

of Representatives

Washington,

20515

Dear Mr. Speaker:

I am pleased to transmit our final Report on the
federal deposit insurance system, entitled Modernizin
the
Fin ncia S stem: Recommendations
for Safer More Com etitive
Banks. Section 1001 of the Financial Institutions Reform,
Recovery, and Enforcement Act of 1989 (FIRREA) (Pub. L. No. 10173) directed the Treasury Department to produce this Report in
consultation with the depository institution regulatory agencies
and others, including the public.
For more than a year, the study group reviewed
Our
from its member agencies and the public.
to develop practical proposals to reform and
strengthen the federal deposit insurance system; modernize our
financial system to make banks safer and more competitive, both
and streamline the bank
domestically and internationally;
regulatory structure.
recommendations
goal has been

public would significantly benefit from legislative
I therefore urge
of the Report's recommendations.
to give high priority to the passage of the
Administration's
legislative proposal implementing the Report's
recommendations,
which we will submit shortly.
The

enactment
Congress

the Senate.

also transmitting

the Report to the President

Sincerely,

Nicholas

Brady

TABLE OF CONTENTS

..... . . .

EXECUTIVE SUMMARY

SUMMARY OF RECOMMENDATIONS

STUDY PARTICIPANTS.

Reduction

Role of Capital.

Improved Supervision.

Vll.

vm.

~. . . . . . . . . . . . . . . . .

xiii

.............

....................

.............

...........
.

T~w

~PQ Th~r

.......

...................

Banking and Branching.

Modernized

Financial Services Regulation

Credit Union Reforms

—Reca

Restructurin

italization

...........................

Nationwide

ulato

Restrictions on Risky Activities

—Re

. . . . . . . . . . . ~. . .
~

49
54
62

............

........... .. ...........

Other Deposit Insurance Recommendations

~P5

xviii

of Overextended Scope of Deposit Insurance.

Risk-Based Deposit Insurance

mRfrm

B kin

sit Insurance

Strengthened

..................................

CONCLUSIONS AND RECOMMENDATIONS.

~p~n~ —De

of the Bank In

DISCUSSION CHAPTERS

History

of Deposit Insurance

Capital Adequacy

III.

Scope of Deposit Insurance

IV.

Brokered Insured Deposits

V.
VI.
VII.
VIII.

IX.

Insurance

Pass-Through

Insurance Treatment
Alternatives

of Foreign Deposits

to Federal Deposit Insurance

Risk-Related Premiums
Risk-Management

Techniques

Prompt Corrective Action

XI.

Market Value Accounting

XII.

Role of Auditors

xm.

Credit Unions

XIV.

Collateralized

XV.
XVI.

Borrowing

Federal Home Loan Bank System Subsidies
Optimal Size

of Insurance Fund

XVII.

Interstate Banking and Branching

XVIII.

Financial Services Modernization

XIX.

XX.
XXI.

Reform of the Regulatory
Bankruptcy

Structure

Exemptions

Foreign Deposit Insurance Systems

EXECUTIVE SUMMARY

A sound, internationally competitive banking system is critical to the Nation's economic
vitality and the financial well-being of our citizens. Banks provide a safe place for savers to
keep their funds. Bank lending has been an important engine for economic growth. Federal
deposit insurance and other parts of the "federal safety net" are designed to facilitate these crucial
roles for banks.

But this federal safety net has been overextended, and taxpayers are now exposed to
substantial losses through federal deposit insurance. We can and should place prudent limits on
taxpayer exposure by returning the scope of deposit insurance to its historical purpose—
protecting small, unsophisticated savers. But this alone will not be enough.
In the end, the most effective way to minimize taxpayer exposure is through a strong,
competitive, well-capitalized banking system. Deposit insurance reform must therefore bolster
the safety and soundness of the U. S. banking system
enhance the competitiveness of the
—
both aspects of reform are crucial.
industry

F r-Pa Problem. Reforms
b hgtughttii
(Il R

must address
~ I
d ft
P
restrictions that have prevented banking organizations
financial markets and technology; (2) the v r x n
excessive exposure for taxpayers and weakened market
th
h
phd pg tl
I
~
remedial action; and (4) an n r
i iz
itin

bt:

gglltt

~tits

hgld

four interrelated parts of the current
Id I gth,
M by d Mt gd
from responding to the evolution of
i n f
i in r
resulting in
discipline for banks; (3) a ~fra mented

dh
u

fun

I'IR
.

f'I

~
fth b
b
d
tby
which
has
our
evolution
of
financial
markets,
vigorous new
laws
the
brought
adapt
banking
to
competition to markets traditionally served by banks. Advances in technology and information
processing, for example, have spurred innovative competitors to develop products that are
sometimes superior substitutes for traditional bank products. Consumers have clearly benefitted.
But archaic restrictions on both geographic location and financial activities have constrained
banks' ability to follow evolving markets, serve customers, and compete effectively.

t, th

Having lost traditional customers to new competitors, banks have increased their
concentration on remaining customer segments. Weaker banks with virtually unlimited access
to federally guaranteed funds have chased too few good lending opportunities, which has created
problems for healthier banks:
underpriced loans, narrowed spreads, eroded underwriting
standards, and incentives to reach for riskier loans within the range of traditional bank activities.
The result is diminished profitability, which has undercut the safety and soundness of the banking
sy3tem.

At the same time, our hamstrung banking organizations have become much less
Twenty years ago, we had eight banks among the top 25 in tlie
competitive internationally.
world. Now we have none. As our foreign competitors are expanding all over the world, U. S.
banks are steadily retreating from the international marketplace.

Second, deposit insurance coverage has AX)~d@ well beyond its original purpose pf
It now guarantees the deposits of wealthier
depositors.
protecting small unsophisticated
investors.
This overextension of deposit
individuals, corporations, and large institutional
insurance has dramatically increased taxpayer exposure.
Overextended deposit insurance has also removed ~mr~kf ~i~i~lin that should have
constrained the increased riskiness of weak banks. Depositors should have shifted funds away
and risky banks, forcing them to shrink or decrease risk.
from unprofitable, undercapitalized,
federal
insurance
and
no risk of loss, depositors have been more than willing
But with expanded
to supply funds to weaker banks engaged in activities that produce inadequate returns and
excessive risk. With so little to lose, these weak, undercapitalized banks have had a perverse
incentive to take excessive risk —the "moral hazard" problem —exposing the taxpayer to even
greater losses.

Third, b k re ulation and su rvi ion helps provide a substitute for the market discipline
removed by deposit insurance. But in the face of the problems discussed above, our fragmented
and archaic regulatory system has not been successful in stemming the weakening of the banking
industry. In recent years, banks have experienced record loan losses and failures that are rapidly
depleting the deposit insurance fund.
There has not always been a satisfactory regulatory
mechanism for promptly correcting banking problems. Moreover, with as many as four banking
regulators involved in the affairs of a single banking organization, no single regulator has had
either the full information or the clear authority and responsibility for the decisive, timely action
necessary to deal with weak institutions.

F Bh,

B~hh

BIIF)t tll

II hit B

insured deposits. It is projected to decline still further over the next two years. Without aii
infusion of funds, the Federal Deposit Insurance Corporation (FDIC) could face the problems
that plagued the Federal Savings and Loan Insurance Corporation —too little cash, too many
incentives for forbearance, and possible exposure for the taxpayer.

F ur ndament 1R f
. The Administration recommends four fundamental reform&
to ensure a safer, more competitive banking system that will continue its role as an engine for
productive investment and economic growth.
First, to increase bank competitiveness, tlie
proposal would authorize nationwide banking, new financial activities, and commercial ownership
of banking organizations —provided these new owners are willing to maintain well-capitalized
banks that protect the taxpayer. Second, to reduce taxpayer exposure and address the loss Of
market discipline, the proposal would rein in the overexpanded scope of deposit insurance;
improve supervision by strengthening the role of capital; and assess risk-based premiums. Third~

our fragmented
recapitalize the

system

regulatory

would

be streamlined.

Finally,

industry

funds

would

BIF.

i i n
. Nationwide banking and branching will make banks safer
through diversification and more efficient through substantially reduced operating costs. But
hanidng organizations must also he allowed to use their expertise to participate in the ~full ran e
—but to do so outside the bank and outside the federal safety net. While
rvi
i
appropriate safety and soundness limitations will be needed, the taxpayer can no longer afford
the artificial restrictions that constrain a bank's ability to make maximum use of its resources and
At the same time, financial and commercial firms must be
expertise in serving customers.
allowed to affiliate with banks to create a strong, diversified financial services system that can
compete head-to-head with diversified financial firms around the world.

Overextended insurance coverage must
be reined in without reducing the basic protection for small depositors and without losing the
benefits of economic stability. Narrowing coverage would reduce the exposure of the taxpayer
and reintroduce an important level of market discipline by sophisticated depositors. This limited
additional amount of direct market discipline would help deter banks from pursuing risky
activities and would direct funds toward sound and profitable banks.
v

by itself cannot resolve the problem, however, because
should protect —a substantial part of each bank's
funding base. It is therefore critical to strengthen the role of capital and improve supervision as
strong supplements for market discipline. Qggiil is the single most important protection for the
taxpayer. It reduces the incentive of a bank to take excessive risk and absorbs losses ahead of
the deposit insurance fund. The proposal would improve supervision by creating a system of
rewards and incentives for banks that build and maintain capital —with prompt corrective action
for those that do not. Moreover, permitting financial and commercial companies to own banks
will both increase the value of the bank franchise and tap a vast new reservoir of capital for
investment in banks.
Additional
deposit insurance

market discipline
will still protect

—and

Finally, assessing risk-based premiums would be another important supplement to direct
market discipline.
Premiums would vary according to levels of capital, because capital is a
crucial measure of risk and because firms should be rewarded with lower premiums for
maintaining higher capital. In addition, an FDIC demonstration project would test the feasibility
Of using private reinsurers to provide market pricing for risk-based premiums.

A streamlined, efficient regulatory system would
further supplement market discipline and apply prompt, decisive corrective action to weak and
unsound institutions.
In addition, for a given banking organization, one federal regulator should
have basic regulatory authority, responsibility,
and accountability for fundamental banking
activities. A simplified and effective regulatory structure is necessary to reduce the taxpayers'
exposure through deposit insurance.

line

The Bank Insurance Fund must be recapitalized. The FDIC is
meeting with industry groups to develop a plan for recapitalization.
This Report sets fprtli
The
Fund
must
satisfy.
must
have
sufficient resources so that the
objectives that such a plan
failed
institutions.
The
of
resolving
Fund
FDIC can do its job
should be recapitalized with
recapitalization
should
the
avoid
But
plan
industry funding.
imposing unnecessary stresses Oii
term.
the banking system in the near

All four components of reform are needed to revitalize the nation's banking syste&
Reining in the overextended scope of deposit insurance, improving regulation, and recapitalizing
BIF are insufficient. In the long run, the competitiveness of banking and financial organizations
both at home and abroad depends on allowing them to compete efficiently nationwide and iq
related financial activities. A banking system that is both sound and competitive is crucial to the
health of this nation's economy.

SUAIMARY OF RECOMMUVDATIONS

The Recommendations
explanations are included.

of this Report are

—DEPOSIT

PART ONE

summarized

below. Where appropriate,

INSURANCE AND BANKING REFORMS
n

Rl f

Capital is a crucial tool for making banks safer. The role
system would be strengthened through four separate reforms:

Premiums:
level of risk-based capital.

Insurance

Premiums

would

be assessed based on an

Well-capitalized institutions would be allowed to
financial activities through separately capitalized affiliates.

Capital-Based Expanded Activities:
engage in newly permitted

in the supervisory

Well-capitalized institutions would undergo less intrusive
while undercapitalized institutions would be subject to increasingly stringent

Capital-Based
institution's

of capital

Capital-Based Supervision:
regulation,
restrictions.

brief

Capital A@usted for Interest Rate Risk: Interest rate risk would be included in riskbased capital standards.

in f

Deposit insurance has been extended well beyond its original purpose of protecting small
savers. The following reforms are needed to restore coverage to reasonable limits.

Reduce Coverage of Multiple Insured Accounts: In the short term, depositors would
be limited to $100,000 per institution for individual accounts and $100,000 per institution
in retirement accounts. The long term goal is limited coverage per depositor across all
depository institutions.
Pass-through coverage would be
Certain "Pass-Through" Coverage:
eliminated for deposits by professionally managed pension plans and for Bank Investment

Elhnh~te

Contracts.

Eliminate Coverage of Brokered Deposits

Eliminate Coverage of Non-Deposit Creditors

Limit Coverage of Uninsured

Depositors

Require Least Costly Resolution Method: The FDIC will not protect uninsured
depositors unless it is cheaper to do so.

Systemic Risk Exception: The Treasury and the Federal Reserve Board will
retain the flexibility, in cases where they jointly find systemic risk, to fully protect
uninsured depositors.

Improved

Methods to Reduce Systemic Risk: Technical proposals to reduce systemic risk
will be included in the Administration's
legislative package.

Three-Year Transition: To enable the system to adjust gradually,
policies will be phased in after a three-year delayed effective date.

To improve liquidity when banks fail,
Liquidity Mechanism:
uninsured depositors will receive a "final settlement payment" immediately after
a failed bank is resolved, rather than waiting for receivership distributions.

No Assessments

on Foreign Deposits

IH. Risk-Base
A.

Premiums

these new

De o it

Based on Capital Levels

Premiums Set by Private Reinsurers (Demonstration Project): The FDIC will conduct
a demonstration project to determine the feasibility of using the private insurance sector
to help set risk-based premiums.

IV. Im rov
A.

rvisi n

Capital-Based Supervision

Rewards for Well-Capitalized

Prompt Corrective Action for Undercapitalized Banks: Progressively stronger
supervisory actions triggered by declines in capital.

Banks

xiv

Early Resolution for FaiTing Banks: Banks resolved before capital is completely
exhausted.

Improved capital measurement

Annual on-site examinations

Accurate reserving for loan losses

Increased market value reporting: More market value disclosure would
be required, but market value accounting is inappropriate at this time.

Improved Reporting from Independent

V. R
A.

ri i

Auditors

ivii

Restrictions on Risky Activities of Federally Insured State-Chartered

Banks

Direct equity investment in real
estate and other commercial ventures, which is already prohibited for national
banks, would be prohibited for state banks as well.

Limit Activities Not Permitted

Prohibition

of Direct Investment Activities:

for National Banks: Federally insured state

chartered banks would generally be prohibited from engaging in activities not
permitted for national banks, unless the state bank is fully capitalized and the
FDIC finds that the activities do not create a substantial risk of loss to the
insurance fund.

No Limits on Riskless Agency Activities

VI.
Full Nationwide

i nwi

B nkin

Banking Authorized

Interstate Branching Authorized

n hin

for Holding Companies in 3 Years

for Banks

National Bank Interstate Branching: Permitted immediately wherever interstate
banking is permitted, but no preemption of ~in ~si~t branching restrictions.

State Bank Interstate Branching:

Authorized

but not required for all states.

VH. M
Permit Well-Capitalized

rniz

Fin n i

rvi

i n

Banks to Have Financial Affiliates

Includes Securities, Mutual Funds, and Insurance

Allow Financial Companies

to Own Well-Capitalized

Banks

of New Financial Holding Companies

Commercial Ownership

Safeguards: To protect the insured depository from risks from new activities
prevent it from subsidizing those activities.

Only for Well-Capitalized

Safety Net Confined to Bank

Strict Regulation Focused on Bank

Financial Aff iiiates Separately Capitalized

Functional Regulation of Affiliates

Funding and Disclosure Firewalls

Umbrella Oversight

VIII.
A.

Banks

redit

ni n

R f rms

Changed Accounting Treatment of Insurance Fund

Eliminate as Asset on Credit Union Balance Sheets

Gradually

Expensed Over Twelve Years

Reorganized Board of National Credit Union Administration

Representative

Included from New Federal Banking Agency

xvi

and tp

IX.

on Collateralized

No Assessments

Uniform Bankruptcy

mmn

Borrowing

Exemptions

PART TWO

—REGULATORY

RESTRUCTURING

for Each Banking Organization

A Single Federal Regulator

Federal Reserve to Regulate All State Banking Organizations

New Federal Banking Agency Under Treasury

Organizations

to Regulate All National Banking

and All Thrifts

FDIC to Function Solely As Insurer

PART THRI& E —RECAPITALIZATION

OF THE BANK INSURANCE FUND

The Bank Insurance Fund is under stress and must be recapitalized.
should meet these four tests:

The recapitalization

It should provide sufficient resources.

It should take into account any impact on the health of the banking system.

It should rely on industry funds.

It should use generally accepted accounting principles.

XV11

STUDY PARTICIPANTS

Title X of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989
(FIRREA) directed the Treasury Department to conduct this study of federal deposit insurance
and related issues in consultation with the Comptroller of the Currency, the Federal Reserve
Board, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, the National
and the Office of Management and Budget. The Council of
Credit Union Administration,
Economic Advisors and the Office of Policy Development within the Executive Office of the
President participated as well.

FIRREA also directed the Treasury to obtain the participation of the public. To this end,
the Treasury issued a Federal ~Re ist r notice on December 6, 1989, in which it solicited public
comments until March 9, 1990. During this period, more than one thousand public comments
were received from individuals, depository institutions, trade associations, government agencies,
These comments as well as those of the participating
consultants, academics, and others.
agencies have been reflected both in the Discussion Chapters that analyze individual issues, and
Conclusions and Recommendations based on these Chapters.
in the Administration's

The following individuals

Treasur
John

made important

De artment

C. Dugan (Study Director)

Jerome H. Powell
Robert R. Glauber
John R. Hauge
Gordon Eastburn
Mark G. Bender
Joan Affleck-Smith
Gerard B. Hughes
Brian S. Tishuk
Christine M. Freidel
Stephen L. Ledbetter
Patrick G. Garabedian

xvlli

contributions

to produce this Report:

ffi

mtrllr f

J. Michael

Shepherd
Don Coonley

Fred Finke
James Kamihachi
David Nebhut
Mark Winer
Irene Fang

ral R erv Boar

Edward C. Ettin
Myron L. Kwast
David S. Jones
Allen N. Berger
James M. O' Brien
Frederick M. Struble
Richard Spillenkothen
Roger T. Cole
Rhoger Pugh
James V. Houpt
Gerald A. Edwards, Jr.
J. Virgil Mattingly, Jr.
Ricki R. Tigert
Scott G. Alvarez
Gregory A. Baer

Office of Thrift Su ervision
Jonathan L. Fiechter
John L. Robinson
Carol A. Wambeke
Robert J. Fishman
Michael G. Bradley
Eric Hirschhorn

Federal De osit Insurance Co
Wm. Roger Watson
Arthur Murton

George French
Lynn Nejezchleb
Robert Miailovich

oration

Robert Walsh
Christine Blair
Michelle Borzillo
Fred Cams
Ben Christopher
Vivian Comer
Seth Epstein
Gary Fissel
Jay Goiter
Joseph Guzinski
David Holland
Roger Hood
Kathy James
Pete Konstas
Alane Moysich
Claude Rollin
Detta Voesar

Cr di

i nal

ni n Admin'

D. Michael Riley
Dr. Charles H. Bradford
Sue Nelowet
Lindsay Lucke Neunlist

f Mana

ffi
Alan

emen

B d e

B. Rhinesmith

F. Stevens
neil

Redburn

of Economic Adviso

Charles Jacklin
Elizabeth Powers
Jeremy Stein

ffice of Polic

Develo ment

Lawrence B. Lindsey
Michael Klausner

ti n

CONCLUSIONS AND RECOMMENDATIONS

Inr

The taxpayer has become too exposed to losses through the federal deposit insurance
system. This Report provides recommendations to reduce this exposure while strengthening the
banking system's ability to play its crucial role in our economy.
In the long run, the only real protection for taxpayers is a banking system that is usaf,
d IRDRDNND;
Ih t
d RIDDNI'
RDRW. \BANN,
IRRDI,
g I t D y' t
d; d *
I'
I
f
ith
d byf
Th th
db
DD ftN
'
R mm n
n 1 i n
n Section address each of these issues.

dthtt ~ll

sets forth deposit insurance recommendations for a fer m r om etitiv
banking system —including a reduction in the overexpanded scope of deposit insurance
coverage; a stronger role for capital; improved supervision; nationwide banking and
branching; and new financial activities for companies that own well-capitalized banks.

Pgr~l~n

DINT~

Idb

our fragmented

~hh

regulatory
t

fdb

system

tt*t

—which

~ tdt ~ g
I .) ~
Ih M
apply to all federally insured depositories.

N~fR

will strengthen
I~ h

Before describing specific recommendations,
f
f . Th ftl tgdt
I
d
Dt
I
Ch P
lmmIKR. D! f

Pth

d~lid

ghdbhli

bank supervision.
R

it is important to set forth in detail the need
Dt
I,
Chp
I

d&
th

N~ID

gh
b

Cdhdltij

t thi
k I g

*dly

Higgry. Deposit insurance was a direct response to the banking crisis of the 1930s.
More than 5, 000 banks had failed from 1930 to 1932, resulting in losses to depositors of almost
$800 million —or more than $6 billion in 1990 dollars. Another 4, 000 banks failed in 1933.
The banking system was on the verge

of collapse.

The Federal Reserve's actions during this
banks through the discount window —its "lender
money supply contracted, with ensuing deflation
from bank failures also created a chain reaction
runs were widespread.

period to ease the liquidity problems of troubled
of last resort" function —were ineffective. The
and a worsening depression. Depositor losses
of losses in other parts of the economy. Bank

There was, in short, a crisis of confidence in the banking system when Franklin Roosevelt
took office in March 1933. The nation's banks were already closed because of the declaration
of bank holidays in all 48 states. President Roosevelt's emergency declaration of a nationwide
bank holiday was merely a stopgap measure by the federal government to continue the status
quo.
The times required dramatic action to restore confidence in the system, and one result was
This became the third leg of the so-called "federal safety net"
federal deposit insurance.
protections for banks, along with the Federal Reserve's discount window lending and its
guarantee of the large-dollar payments system.
Proponents of deposit insurance argued that it would stop depositor runs, protect small
depositors from losses, and help restore the stability and confidence necessary to carry out basic
banking functions. It was also intended to help prevent systemwide bank failures.

Critics —including President Roosevelt —argued that the cost of deposit insurance would
be exorbitant and would require the use of tax revenues. Another criticism was that deposit
insurance would remove market discipline and penalties for bad management, thus subsidizing
poorly-run banks.
In the end, both sides proved correct. For many years the benefits of deposit insurance
far outweighed the costs. But the scope of deposit insurance expanded greatly during the same
period, weakening market discipline at the same time that banks began to lose some of their best
customers to new markets and new nonbank competition.

The combination of these two factors has been a recipe for substantial losses. Constrained
by outdated laws from competing in new markets, banks have reached for riskier traditional
lending opportunities without appropriate discipline from the marketplace.
At the same time,
our fragmented regulatory system has not always been able to check increased risk with early and
decisive action.
Changes must be made. But understanding these changes requires an understanding of
the important role that deposit insurance continues to serve —protecting small depositors and
helping to prevent bank runs and systemic risk.

i r R ns. Banks provide
involve the use of liquid bank deposits.
unsophisticated depositors to store liquid
payments system for checking and other
the economy.

a number of important functions for the economy that
One basic function is to provide a safe place for small,
assets. Another important function is to provide a safe
transaction accounts, which is of incalculable value to

A third important function of banks is the "intermediation" of the liquid deposits of small
savers into speciaNzed, ilhquid loans, particularly for borrowers who do not have access to the
securities markets. The relative volume of this type of intermediation has decreased over time

level of direct access by borrowers to
there is no longer a need for bank
As Figure 1 shows, the percentage of financial assets held by depository
intermediation.
institutions has declined significantly in recent years. Nevertheless, bank intermediation remains
crucial to the economy, deploying resources in productive investments that might not otherwise
be made.
with increasing nonbank competition and the increasing
For certain types of credit,
the securities markets.

Each of these important banking functions involves the use of ~li i f bank deposits, or
extremely short-term liabilities that are often withdrawable on demand. At the same time, bank
assets are concentrated in highly iLlig~i loans, which cannot be sold quickly without a loss in
value. The combination of these two factors makes banks inherently susceptible to depositor
runs, or panic withdrawals of deposits.
Runs are a destructive form of "market failure" in which unfettered market forces are
unable to achieve the most efficient use of resources. A sustained withdrawal of funds itself
creates losses because a bank must sell illiquid assets at fire-sale prices to meet the demands for
cash. Sooner or later, a run will itself cause a bank to fail, regardless of the bank's actual
condition at the time the run began. As a result, a depositor has an incentive to run if he
believes that others will run, regardless of the bank's actual condition —those at the beginning
of the withdrawal line lose nothing, while those at the end risk losing everything. This is the
psychology that can create panic withdrawals, absent deposit insurance.

Compounding this problem is the difficulty of determining the riskiness of a bank,
precisely because it invests in illiquid assets requiring individualized
credit judgments.
Professional analysts are often wrong about the condition of a troubled bank, which means it is
that much more difficult for the average depositor to assess. This perpetual uncertainty about
a bank's actual condition also helps create incentives for runs at the first sign of trouble.

mi
k.
depositor losses in bank
spread to other banks or
discussed are contagious

In addition to individual bank runs, the larger problem associated with
failures is systemic risk, or the likelihood that trouble in one bank will
other parts of the economy. The three types of systemic risk most often
runs, correspondent banking problems, and payments system problems.

Contagious runs occur when a run on one bank generates a run on another, unrelated
institution.
For example, a depositor could well assume that a problem in one bank is due to
regional economic conditions that are likely to affect all neighboring banks (as in Texas during
the 1980s). Given the uncertainty described above in evaluating bank risk, the fear that others
will panic, and the low cost of withdrawing funds, systemwide panic withdrawals could ensue
in the absence of deposit insurance.
This in turn can feed on itself to create further runs.

Significant depositor losses can also create direct losses to other banks if, for example,
to

the depositor who loses funds in one bank can no longer make good on mortgage payments
another bank. Resulting loan losses can cause additional bank failures.

Figure

Financial Assets Held by Depository Institutions
As a Percentage of Total Financial Sector

1974 - 1989

Percent
65

)))))))))%))1
55

l)l)
))))l

)))I ~ ))~ ) ~ ))~ ) ~ )~ ) ~ )~
)%)))
)))))
~))

)ll)))

)ll

~ ~ ~ ~ ~ ~ ~ ~

))~ ) ~ ))))y

)I'~)l')I

)g$ ~

&li)

35
1974

1975

1976

1977

1978

1979

1980

1981

1983

1982

1984

1985

1986

1987

Year
Depository Institutions

All

Other:

~ ~ ~ ~ ~ ~ ~ ~ ~

Source: FRB Annual Statistical Digest.

)~ ~ ~

Pension and Retirement Funds
Insurance Companies
Agencies and Mortgage Pools
Market Funds
Mutual/Money
Monetary Authority

1988

1989

The failure of a large bank with a correspondent banking system can also create systemic
fajlures. Tile resolution of Continental Illinois in 1984 is a good example. Nearly 1000 banks
had deposits at Continental at the time it failed. Sixty-six of these banks had uninsured deposits
exceeding 100 percent of capital, and another 113 had deposits equalling 50-100 percent of
capital. If uninsured depositors in Continental had not been protected, its failure would have
significantly weakened a number of these other banks.
Finally, in the absence of a federal safety net, depositor losses could spread quickly to
other banks through the payments system, especially the large-dollar payments system. Default
jn large payments to one party can in turn create defaults on other obligations, with the process
spreading quickly through a chain reaction.
In the end, while relying on some market discipline from depositors is important, relying
too heavily on such discipline can be extremely costly. Small, unsophisticated depositors can
lose their funds. The runs that result can bankrupt healthy banks and increase losses at insolvent
ones. Systemwide losses become a real possibility.
Moreover, substantial depositor losses
undermine the important functions of banks described above, all of which depend critically on
depositor confidence.

nfi

fDe

. Deposit

insurance was designed to stop runs, maintain
confidence in the banking system, and prevent small depositor losses. It has been remarkably
successful in achieving these goals even in the worst of times. For example, during the worst
period of bank and thrift failures in Texas, there were few instances of actual losses to depositors
and few bank runs. This is the type of stability and depositor confidence that prevents disruption
of important banking functions, such as the payments system and the intermediation process.

Indeed, for nearly 50 years, deposit insurance seemed to provide nothing but benefits to
the economy. It did remove an important degree of market discipline that would otherwise check
excessive risk-taking by bank managers. But some market discipline from large, sophisticated
market
investors remained intact.
In addition, the government system for supplementing
—
—
discipline
appeared to be adequate.
primarily supervision and examination
Perhaps most important, banks had a very stable and profitable franchise. Traditional
bank lending was the primary source of commercial credit in the economy. Funding costs were
low and stable, because banks had a legal monopoly on demand deposits that could not pay
interest by law, and other deposits were subject to interest rate controls. While banks were
prevented from competing in other financial businesses like securities and insurance, they were
also shielded from meaningful competition in their basic businesses of transaction accounts and
corporate lending. Because of these advantages, bank stocks, like public utilities, were once
thought to be among the safest, most conservative investments —federally regulated companies
with high dividend payments.

In this environment, both small and large banks prospered and grew. Banks and bank
branches prolj ferated domestically, and money center banks expanded aggressively all over the

world. The industry
system.

was stable and profitable,

and there was widespread

confidence in the

perhaps the key statistic was the decline in the number of bank failures. These decrea~
from 4, 000 in 1933 to 370 during the period 1934 through 1941 and declined still further from
1942 through 1980, when the total number was 198, and the greatest number of failures in any
Figure 2.
one year was 20.

. This situation

changed dramatically in the late 1970s
and the 1980s. The failure of hundreds of SEcLs caused the insolvency and reorganization of the
Federal Savings and Loan Insurance Corporation, and many more of these S&Ls have yet tp be
resolved. Nine of the ten largest bank holding companies in Texas were reorganized with FMC
or other outside assistance. From 1987 through the end of 1990, the FDIC fund declined frpni
over $18 billion to approximately $9 billion.
1

A substantial minority of the $&L
Looking ahead, the situation remains troubled.
At the same time, commercial
industry does not meet the new and higher capital standards.
banks' loan charge-off ratios and nonperforming loan ratios (including repossessed real estate)
are at their highest levels since banks began using the reserve method of accounting in 1948.
Figure 3.

Events have thus demonstrated that the criticisms leveled in the 1930s against the idea of
federal deposit insurance had considerable merit.
While there has been stability, deposit
insurance and the other two components of the federal safety net have permitted weak, poorlymanaged institutions to stay in business too long —aggravating losses and misallocating resources
to unproductive investments. The resulting costs have been borne by well-run institutions and
taxpayers.

There are three fundamental and interrelated reasons why these costs have escalated.
First, the traditional bank franchise has eroded through competition and outdated restrictions on
the ability of banks to serve customers in new financial markets; profits have decreased, losses
have increased, and capital levels have declined. Second, the scope of deposit insurance has
dramatically expanded, increasing taxpayer exposure and further removing market discipline at
a time when weaker banks have reached for more risk. Third, government attempts to
supplement market discipline —capital requirements and supervision, for example —have not
been adequate to check new problems in the industry. Each of these fundamental problems is
discussed below.

ti iv B

documented both in Congressional
rvi
M
rni ti n. Banks are
they once were. Old laws designed
that impede banks from adapting to
fragility and losses.

The erosion of the traditional bank franchise is welltestimony and by Discussion Chapter XVIII, Financial
no longer the protected and steadily profitable businesses
to "protect" banks from competition have become barriers
changed market conditions. The result has been financial

Figure 2

Number of Failed Banks by Year

1934 - 1989
Number

250

200

150

100

0
1934

1940

1945

1950

1955

1960

Source: FDIC Annual Reports and Statistics on Banking.

1965

1970

1975

1980

1985

Figure 3

Net Charge-Offs to Total Loans
Insured Commercial Banks

1960 - 1989

Percent

1.2

1.0

0.8
jj!jI4i

iiIIi

0.6

0.4

'I)irij

jII

jj j

0.2

0
61

Source: FDIC Annual Reports and Statistics on Banking.

For example, because of marketplace innovations, banks no longer have protected sources
pf low cost funds. Uninsured money market funds developed to allow consumers to capture
inarket rates of return. This eventually resulted in the elimination of interest rate controls and
banks' monopoly on transaction accounts —both for the benefit of consumers.

Likewise, banks have lost their near monopoly on certain types of business and consumer
credit because of the development of the commercial paper market, securitization, and trade
credit, as well as vigorous nonbank competition from securities, insurance, and finance
companies. (Figure 4 demonstrates the dramatic expansion of the commercial paper market in
comparison with commercial and industrial loans. ) Similarly, thrifts have lost their leading role
in the home mortgage business, due in part to the development of mortgage securitization, which
facilitates mortgage origination by other types of financial institutions.
/gal Figure 5.
In short, banks and thrifts have often been unable to provide new forms of credit to their
best, most creditworthy customers. Not surprisingly, these customers have frequently turned
elsewhere to meet their credit needs.

Banks have responded in several ways. On the positive side, they have been innovative
in developing certain new businesses, such as credit cards, automatic teller machines, mortgage
banking, and financial advisory work.
They have been less successful in expanding into
securities, insurance, and other financial activities because of the outdated legal restrictions of
the Glass-Steagall Act and the Bank Holding Company Act of 1956 —even though banks have
natural expertise in these areas and even though natural synergies exist. Even in such activities
as discount brokerage and commercial paper, where banking organizations have made some
headway, the regulatory approval process and litigation costs have made these activities less
efficient and less profitable.

Moreover, as traditional lending opportunities have decreased, the supply of bank deposits
Weaker banks with
has grown in part through the expansion of federal deposit insurance.
virtually unlimited access to federally guaranteed funds have bid up deposit rates and chased too
few good lending opportunities, which have created problems for healthier banks: underpriced
loans, narrowed spreads, eroded underwriting standards, and incentives to reach for riskier loans
within the range of traditional bank activities. Commercial real estate loans are only the most
recent example of a series that includes regionally concentrated energy and agricultural loans,
The result has been
loans to developing countries, and loans in highly leveraged transactions.
poor earnings and a resulting decline in industry capital.
Meanwhile, diversified financial and commercial companies have recognized the synergies
involved in providing banking and other financial services to consumers. They provide a ready
source of capital for investment in banks. But despite aggressive efforts to expand into banking
they have been only partly successful.
Outside capital has proved to be a crucial source of strength for
This is unfortunate.
other financial industries, including both the securities and insurance industries. Even the thrift

Figure 4

The Growth of the Commercial Paper Market
Ratio of Bank C&l Loans to Commercial Paper Outstanding

1960 - 1989

Ratio

60 65

70 75

1977

1979

1981

1983

1985

1987

1989

Figure 5

The Growth of Mortgage Pools

1970 - 1987
Mortgages in Pools as a Percent of Total Mortgages

1970

1972

1974

1976

1978

1980

1982

1984

Source: U. S. Department of Commerce and Statistical Abstract of the United States.

1986

industry has benefitted, where, despite numerous restrictions, non-thrift companies have
Indeed, thrifts affiliated with diversified
purchased and supported their thrift subsidiaries.
companies have simply failed less often than thrifts unaffiliated with such companies, and, jn the
few instances of failure, the diversified parents provided additional funds to their failed
subsidiaries to lessen the cost to the federal government.

Similarly, banks have operated under extremely inefficient and costly restrictions pn
geographic diversification. Interstate banking was prohibited until recently; interstate branching
remains virtually prohibited; and even in-state branching continues to be restricted in a nuniber
of states. Critics argue that the inability to expand efficiently within the United States helped
create incentives for banks to stretch for riskier profit opportunities and more volatile funding
sources.

At the same time, banks confined to local markets have been particularly susceptible to
deeper and more frequent regional recessions. Texas is a classic example, where banks were
In the late 1970s, Texas banks were
battered by the sharp downturn in the energy industry.
confined by state laws to Texas, but were considered among the best-capitalized, most profitable
banks in America. Ten years later, nine of the top ten Texas bank holding companies had been
reorganized with FDIC or other outside assistance. Of the nine, the only ones that avoided
FDIC assistance were those that were purchased by out-of-state bank holding companies through
a special exception to state restrictions on interstate banking
the acquisition of Texas
Commerce by Chemical Bank).

Through state action, interstate banking has finally become a reality. Thirty-three states- two-thirds of the country —have voted to permit nationwide interstate banking, while another
13 states permit regional interstate banking. Only four states continue to prohibit interstate
banking altogether.

Intrastate branching

restrictions have eroded as well.

Yet the system continues to impose costly and needless burdens on banks that choose to
expand, because interstate +r~~hin is generally prohibited. Branching is often a more efficient
form of interstate expansion that creates immediate cost savings, such as consolidated
management and more efficient data processing systems. These savings go right to the bottom
line to build both profits and capital, thereby enhancing safety and soundness. Yet despite tliese
benefits, interstate branching

is virtually

prohibited.

In short, unable to adapt and follow their best customers into related lines of businesses,
banks have become steadily less competitive in their traditional activity of lending. Likewise,
there have been costly barriers to efficient geographical diversification through interstate
branching.
Losses have increased and capital has decreased. Taxpayers have become more
exposed.

The eroding competitiveness of commercial banks in the domestic market has been
mirrored in the international marketplace.
As recently as 1983, three U. S. commercial banks
were among the world's top twenty in asset size; by year-end 1988, no U. S. bank was rank~

In addition,
ainong the world's top twenty.
two
were
U. S. banks.
capitalization ln 1988, only

the world's

top fifty banks

in market

Moreover, while U. S. banks are rapidly withdrawing from foreign markets, foreign banks
are strengthening their position in the U. S. For example, both the number and assets of the
overseas branches of U. S. banks peaked in the mid-1980s, but have trended downward since
then.

U. S. banking organizations

can be expected to encounter even greater international
in
coming years. Most industrialized countries outside the United States
competitive pressures
banks
to
engage in a wide range of activities, including combinations of banking,
permit their
securities, and insurance. In this respect, the most important recent international development
for U. S. banking organizations is the European Community's 1992 program, which is expected
to allow for "universal banking" Community-wide.

i n f
1 I
n
At the sametimethatanumberofbanks
were
—
becoming weaker, the scope of deposit insurance was expanding
increasing taxpayer exposure
and further eroding market discipline.
In the late 1930s, deposit insurance began to expand to
cover uninsured depositors in bank failures.
This occurred in so-called "purchase and
assumption" transactions, or P&As, in which acquiring institutions purchase all of the assets and
assume all of the liabilities —including uninsured deposits —of failed institutions.
This practice

directly shifted losses from uninsured depositors to the FDIC. While this may have been less
disruptive to the community and to the banking system, the practice further reduced market
discipline in the system and increased taxpayer exposure.

In response to Congressional concern, the FDIC temporarily shifted away from this
practice in the late 1950s and early 1960s. But the practice resumed and expanded in the 1970s
and 1980s, when it was argued that P&As were less expensive than paying off individual
depositors. By the mid-1980s, however, it became clear that P&As were not necessarily cheaper
than other resolution
methods in which uninsured depositors would have suffered losses.
Nevertheless, from 1985 through 1990 —the period of the highest number of bank failures since
the 1930s —over 99 percent of uninsured deposits have been fully protected in bank failures.

Similarly, until recently, bank creditors have typically been fully protected, and this same
total protection has sometimes extended even to the holding company creditors of failed banks.
Such blanket protection has further eroded market discipline and increased taxpayer exposure.
At the same time, the scope of ~in ~r
deposit coverage dramatically expanded. The
ainount insured per depositor increased from $2, 500 initially to $100,000, a four-fold rise after
adjusting for inflation (gg Figure 6); the number of separate depositor "capacities" that could
be insured up to $100,000 in each bank increased substantially through regulatory interpretations;
and new insurance-expanding
techniques developed, such as brokered deposits and "passthrough" coverage.

Figure 6

Growth of Deposit Insurance Coverage
(In Thousands of Dollars)

Thousands
100

90
80
70

60
50
40

30
20
10

0
Jan 34

Jun 34

1950

Source: Federal Deposit Insurance Corporation.

1966

1969

1974

1980

~ks

and thrifts took advantage of this
government's guarantee to attract deposits, rather
balance sheets to raise funds. This is demonstrated
increase over time of the ratio of insured deposits to
taxpayer exposure and decreased market discipline,

coverage to grow by using the
than to rely on the strength of their own
by Figure 7, which shows the substantial
total deposits. The result has been increased
enabling weak banks and thrifts to grow and
expanded

proliferate.

v rnm n
1 m n
t M rk D i Iin Facedwithaneroded
insurance
overexpanded
and
coverage, the government system for supplementing
bank franchise
become
has
increasingly
discipline
inadequate.
market
First, capital requirements have been
effectively weakened as banks have reached for off-balance sheet activities and higher leverage
to increase profitability. Recently adopted risk-based capital standards are an improvement, yet
they fail to take interest rate risk into account. Moreover, capital adjustment methods, such as
reserving for anticipated loan losses, have not always resulted in reported capital levels that
reflect economic reality.

Second, the flat-rate system of deposit insurance pricing has compounded the problem by
failing to penalize institutions that assumed more risk. This is a luxury we can no longer afford.
Third, states sometimes authorized federally insured, state-chartered thrifts and banks to
engage directly in high-risk activities far beyond those permitted for national banks and federallychartered thrifts. The results in the thrift industry, particularly with direct commercial real estate
While the Financial Institutions Reform, Recovery, and
investment, have been disastrous.
Enforcement Act of 1989 (FIRREA) stopped much of this for thrifts, a number of states continue
to permit these direct investment activities for banks.
Finally, supervisory and regulatory policies need to be modified and strengthened.
losses.
Insolvent thrifts were often allowed to stay open far too long, thereby compounding
While some institutions were forced to cut or eliminate dividends, regulators sometimes waited
too long to require cuts, thereby reducing the capital cushion available to protect the insurance
funds. Critics have also argued that the absence of firm, uniform regulatory rules has created
near-total regulatory discretion, which has made regulatory action more difficult as a practical
matter.

The difficult job of regulation has not been made easier by our regulatory system. We
have been unsuccessful in restraining the deterioration of the bank and thrift industries despite
tlie presence of more bank examiners than any country in the world. The system is fragmented
and needlessly complex. With as many as four federal regulators involved in the affairs of a
single banking organization,
in many cases no one regulator has the full information,
responsibility, and accountability for dealing decisively with troubled firms. Moreover, the
system has been too susceptible to occasional bouts of bureaucratic infighting and inconsistent
standards.

Figure 7

Growth of FDIC-Insured Deposits
(As Percent of Total Bank Deposits)

Percent

80
75

60
55

1934

1940

1945

1950

1955

1960

Source: Federal Deposit Insurance Corporation.

1965

1970

1975

1980

1985

1989

. In sum,

the combination of an overexpanded insurance
coverage, Ole erosion of bank profitability, and inadequate government substitutes for market
discipline has produced a predictable result: the taxpayer is exposed to unacceptable losses
There is no better evidence for this than the increasing
through federal deposit insurance.
nuinber and cost of failures, which have skyrocketed in the 1980s.

part

of the explanation for these statistics is no doubt the natural shakeout and
of an industry that has finally become subject to competition after a long period

consolidation
But losses are too high. The
of protection and indirect subsidy by the federal government.
taxpayer is too greatly exposed, and the frequency of costly failures has even had some negative
jinpact on depositor confidence —which is the very thing that deposit insurance was intended to
enhance.

It is time to adopt a series of reforms to make banks safer and more competitive.

PART ONE: DEPOSIT INSURANCE AND BANKING REFORMS

The Administration's recommendations for deposit insurance and banking reforms fall into
nine categories, all designed to strengthen the safety, soundness, and competitiveness of the
banking system:
Strengthened

Reduction

Role of Capital

of Overextended Scope of Deposit Insurance

Risk-Based Deposit Insurance

IV.

Improved Supervision

Restrictions on Risky Activities

VI.

Nationwide

Banking and Branching

VII.

Modernized

Financial Services Regulation

VIII.

IX.

Credit Union Reforms
Other Deposit Insurance Recommendations

Each of these categories represents a different approach to strengthening the banking
system. Some focus on stronger market discipline; others on improved supplements to market
discipline; and still others on a healthier, more competitive banking system. Taken together,
they form a balanced, integrated package that must be considered as a whole.
No single
recommendation will be fully effective by itself, and indeed, some could be counterproductive
if adopted in isolation. For example, piling on restrictions in the name of safety and soundness
without addressing bank competitiveness is an invitation to greater taxpayer exposure.
In addition, there must be appropriate transition periods for many of the recommended
changes. A number represent fundamental reforms that will require considerable time for the
"
banking system to adjust. They are not short-term, "quick fixes, but long-term proposals for
enhancing the strength of the industry. Specific transition proposals are therefore included where
appropriate.

ren

hndRl
fR

mmn

i I

Capital-Based Supervision

Capital-Based Insurance Premiums

Capital-Based Expanded Activities

Capital Adjusted for Interest Rate Risk

Reasons for Recommen

tio

The single most powerful tool to make banks safer is capital. It is an "up-front" cushion
to absorb losses ahead of the taxpayer, and banks are less likely to take excessive risk when they
have substantial amounts of their own money at stake. Yet the safety net has permitted banks
to have lower capital ratios than other financial companies. The bank regulatory system is not
adequately focused on the crucial importance of capital. Capital standards should not be raised,
but the role of capital must be strengthened —regulation should be redesigned to provide more
incentives for banks to maintain strong levels of capital.
The discussion below draws on
~
Ch p
II, ~Citd Ad

'»'

The Low Ca ital Ratios of Ban
The safety net appears to have allowed banks to run
their capital ratios down to extremely low levels. As Figure 8 shows, over the last 150 years
the ratio of aggregate capital to total assets of the banking system has generally declined from
a high of over 50 percent in the 1840s to its current levels of well under 10 percent.
Contemporary levels are one-sixth the level of the mid-1800s, and less than one-half the level

of 50 years ago.
this decline no doubt reflects the increasing efficiency of the U. S. financial
system. But there were particularly sharp declines in capital ratios after the creation of the
Federal Reserve in 1913 and the FDIC in 1933, the two safety net institutions.
Moreover, it is
difficult to believe that the market would allow banks to operate in recent years with such a small
capital buffer were it not for a perception of federal government protection.

Much

This point is highlighted by Figure 9, which shows dramatically that large financial
institutions covered explicitly or implicitly by a government safety net —banks and government~ponsored enterprises (GSEs) —have much lower capital ratios than unprotected financial
institutions.
indeed, bank capital ratios might even be at the lower GSE level were it not for
the minimum capital requirements established by bank regulators. ) In short, banks are among

Figure 8

Equity as a Percent of Assets
For All Insured Commercial Banks*

1840 - 1989
Percent

Creation of
Federal Reserve

Creation of FDIC

1933

1914

1840 1850 1960 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1989
Year

*Ratio of aggregate dollar value of bank book equity to
aggregate dollar value of bank book assets.

Source: Statistical abstract through 1970.
Report of condition thereafter.

P% aaWL

«s

~~~

~«

~ ~

Figure 9

Financial Institution Capital Levels
Median Equity Capital-To-Total Assets Ratios
(As of December 31, 1989)

Percent
35

Property/Casualty
Insurance
Companies

Securities

22.29

Business Credit
Companies

19.69

20
Life
Insurance

Companies

90 Large

Personal
Credit
ComPanies

13.30

13.76

National Bank
Holding Comp.

10
Fannie
Mae

50 Largest
Banks

5.00

I';". '. .?:.
?

6.27
~

2.40

Sources: Bank Call Reports and
Standard and Poor's Compusat Service, Inc.

the most highly-leveraged

non-government

companies in the country.

The particular benefits of capital are described below.

of Bank Failure.

Almost by definition, adequate capital decreases
the likelihood of failure and therefore makes banks safer. The more capital a bank has, the more
it can withstand unexpected losses without becoming insolvent. The capital "cushion" buys time
for a bank and its regulator to work through problems.

Lower probabilit

Less Incentive to Take Exces iv R' k. The combination of low capital and federal]y
Owners with little at stake have an
insured deposits creates the "moral hazard" problem.
incentive to take excessive risk with a virtually unlimited supply of funds. This gambling witli
other people's funds creates the classic "heads I win, tails you lose" situation, with gains kept
by owners and losses put to the FDIC or the taxpayer. Higher capital requires owners to put
more of their own money at stake, which creates a powerful incentive to control excessive risktaking —making banks safer.

Buffer in Front of the Tax a er. When banks do fail, every dollar in losses absorbed
by capital is one less dollar absorbed by the FDIC or the taxpayer. From the perspective of the
insurer, capital serves as a "deductible" for bank owners to absorb losses first, just as a car
owner absorbs losses on his deductible before the insurance company pays.

Less Misallocation of Credit. With low levels of capital, the incentive for bank
management to take excessive risk can result in a misallocation of resources to risky investments.
If the number of weak institutions is large, interest rates will be too low for loans to finance
these risky investments, and too high for loans to finance less risky investments.
With a
sufficient amount of competition from poorly capitalized banks, even well capitalized banks must
accept these skewed rates of interest. Critics argue that this is exactly what has occurred in
certain commercial real estate markets, with overbuilding
downturns —which in turn has resulted in bank failures.

eventually

causing severe economic

Hel s Avoid "Credit Crunches. " In an economic downturn, a poorly-capitalized bank
that suffers losses is likely to be forced to restrict credit in an effort to shrink assets and build
capital ratios. A well-capitalized bank can afford more losses and yet continue to lend in the
same circumstances.
Adequate capital thus helps keep credit available even in hard times.

Increases Lon -Term Cpm etitivenes
As discussed above, adequate capital helps
ensure the long-run viability of a bank, which helps it to develop and maintain long-term
customer relationships.
Adequate capital also helps provide the time (by absorbing losses) aiid
the financial resources to respond to both positive and negative changes in its environment.
For
example, a well-capitalized bank has much more flexibility to expand to take advantage of ne+
opportunities than a poorly-capitalized bank.

Over the long run, a strong capital position is likely to make banks stronger and more
Indeed, often the most nationally and internationally competitive U. S. banking
profitable.
organizations are also the best capitalized. There is also evidence that the best-capitalized banks
the argument that increasing capital
tend to earn the highest returns on equity, notwithstanding
for a given firm should theoretically reduce its return on equity.
In sum, it is crucial to strengthen the role of capital in the bank regulatory system. The
regulatory focus should be reoriented without losing the key protections of the current system.
There should be rewards for firms that build and maintain strong levels of capital, and prompt
corrective action for firms that fail to do so. There should be new opportunities for banks to
build and attract capital, and improved measurement of capital in relation to risk. Over time this
should result in a strong, well-capitalized banking system —the best protection for the taxpayer.

ecifi R

mm n

ital-Based Su ervisi n

This system would gear supervision to levels of capital. As capital declines below
minimum levels, the system would provide for prompt and increasingly strong corrective action.
Conversely, as capital increases above minimums, a banking organization would have additional
authority to engage in new financial activities and to receive less intrusive regulation.
Again,
these new supervisory actions based on capital levels would not ~rl gc the current regulatory
Capital-based supervision
system; instead, they would supplement and strengthen supervision.
is described in more detail in Section IV, Im rov
rvi i n.

a it l-Based Insuranc

Premiu

Deposit insurance premiums should be assessed on the basis of risk, and a bank's riskbased capital should be the measure used for risk. The more risk-based capital a bank has, the
lower the premiums it should pay (just as a car insurer permits lower premiums with higher
deductibles). This will create yet another incentive to build and maintain strong capital. The
Premium .
m n f Ri k-Bas
specific proposal is discussed in more detail in Section III, A

I-B sed Ex anded Activiti

Section VII sets forth recommendations for a new financial services holding company
FSHC), which would permit banking organizations to engage in new financial activities in
banks could take
affiliates ggtsi~d of the federal safety net. FSHCs with well-capitalized
advantage of these new activities, providing another incentive to build and maintain capital in

the bank. At the same time, commercial
new source of capital for banks.

companies could own pSHCs,
tapping an

im~~t

This system will not only help firms that already own well~pitalized banks ln addit, pg
firms with undercapitalized banks will be able to attract the necessary new capital to engage iq
new finance act vit es, either from the flnancid markets or from diversified fnanci~ md
commercial companies. A more attractive franchise will attract more capital

ital Ad'usted for Interest Rate Risk

The current risk-based capital standards are based primarily on credit risk, not interest
rate risk. As a result, there is some incentive for banks to shift into assets that are more
sensitive to interest rate risk. Until recently, there has been no systemwide method for b~k
regulators to monitor interest rate risk and no established method for adjusting capital to reflect
that risk. The Office of Thrift Supervision has recently proposed an interest rate risk capital
rule, and that is an innovative step forward.
The bank regulators should do likewise, and a system should be established to reflect
interest rate risk in risk-based capital. International participants in the Bank of International
Settlements, including the United States, are currently developing such a proposal. This process
should be encouraged, but the issue is too important to wait for a new international agreement.
U. S. bank regulators should develop a reporting system here within one year, which would form
the basis for a system to adjust capital for interest rate risk.

H. Reduc ion f Ov rext n

f De

L't fR
A.

Limit Individual

Coverage to $100,000 Per Institution

Two-year transition period

Separate $100,000 Coverage of Retirement Savings

Set Goal of $100,000 Per Capacity Systemwide

Eighteen-month

FDIC feasibility study

Eliminate Certain "Pass-Through"

Coverage

Eliminate Coverage for Certain Pension Plans

Reduce Coverage of Multiple Insured Accounts

mmn

i Insu

Exception for self-directed plans

Eliminate Coverage for Bank Investment

Contracts

Eliminate Coverage of Brokered Deposits

Two- Year Phase-In

Exception for Resolution Trust Corporation

Eliminate Coverage of Non-Deposit Creditors

Limit Coverage of Uninsured

Depositors

Require Least Costly Resolution Method

Systemic Risk Exception

Improved Liquidity Mechanism

Methods to Reduce Systemic Risk

Three- Year Transition

No Assessments

on Foreign Deposits

Reaso

for R

mm n

Deposit insurance was intended to protect small, unsophisticated depositors who could not
be expected to protect themselves. It was not intended to offer full protection to wealthier ~d
sophisticated investors, and it certainly was not intended to extend to every uninsured depositor
and to bank creditors. Yet this is precisely the expansion of coverage that has occurred in r~ent
years —directly increasing taxpayer exposure and directly decreasing market discipline on ask„
banks. (There has recently been some reduction in the coverage of nondeposit creditors )

The time has come to reverse this trend. The Administration recognizes that deposit
insurance has helped provide crucial confidence in the banking system and that exclusive reliance
on depositor discipline cannot work. The federal government must stand behind this country' s
banking system. But taxpayers are becoming alarmed that they might be called on to cover the
losses of sophisticated depositors and creditors when there is no genuine threat to the system.
Moreover, the expansion of deposit insurance coverage has taken place at the same time
This is almost certainly not mere
that failures and losses have increased geometrically.
coincidence.
The removal of market discipline as a check on excessive risk is a likely
contributor to the problem.
Indeed, it appears that as coverage increased in recent years, no judgment was made about
either the increase of the taxpayer's exposure or the ability of the government to control
increased risk caused by the reduction in market discipline. The dramatic rise in costly failures
suggests that risk did increase and that the government response was indeed inadequate.
Accordingly, the recommendations
to reduce the scope of coverage are two-fold: to
reduce the taxpayer's liability for losses sustained by large and sophisticated depositors; and to
return the system to a level of coverage that preserves stability, while obtaining an importaiit
level of market discipline from these same sophisticated investors. For the reasons discussed
below, overextended coverage should be reduced for both insured and uninsured depositors aiid
creditors —but only with appropriate ~tran i ion periods to prevent abrupt changes to the system.
The conceptual framework for these recommendations is included in Discussion Chapter III,
of D sit Insuranc .
Ins r D
sit C vera e. Over the years, the explicit coverage of deposit insurance has
dramatically expanded through the use of loopholes, legislative changes, and regulatory policy
The amount covered in each insured account has jumped from $2, 500 in 1934 to $100,000
tory
—a four-fold rise after adjusting for inflation —with
the largest single increase occurring ii'
1980
ust over 10 years ago. See Figure 6. Regulatory
80, just
policy permits numerous separately

accounts within a single institution through separate insured
capacities" (~e. , joint
individual
retirement accounts, etc. ). And wealthier depositors can
accounts, trust accounts,
amount
of
unlimited
deposit insurance by opening up separately insured accounts in
acquire an
institutions
The brokerage of insured deposits has expedited this process.
different depository
Meanwhile, "pass through" insurance has allowed institutional investors to take advantage of
increasingly larger amounts of deposit insurance.
insured

~ile

the taxpayer's exposure has thus increased, troubled banks have been able to turn
to these new sources of insured deposits for funding when markets would otherwise impose
higher funding costs —appropriately —to reflect greater bank risk. Indeed, there has been a
pronounced shift in bank funding from uninsured deposits to insured deposits, as discussed
above.

Critics argue that reversing this trend will have little effect in an era when government
policy has resulted in the protection of virtually all uninsured deposits, as well as insured
deposits. This is wrong for two reasons. First, as recommended below, the government policy
for routinely protecting all uninsured deposits should end.

Second, even if there was no reduction in the current Q ~f
protection of uninsured
depositors, it would still make sense to reduce explicit insurance coverage.
Even today,
uninsured depositors exercise a greater degree of market discipline than insured depositors
because of the uncertainty about whether the government will change its voluntary policy of
usually providing full protection. This "constructive ambiguity" has often resulted in uninsured
depositors either demanding higher risk premiums or withdrawing
funds from a risky bank;
insured depositors in the same circumstances have been largely indifferent to the bank's risk.

vera e. It would seem obvious —indeed, very nearly a
tautology —that deposit insurance coverage should not extend to uninsured deposits and other
liabilities.
Those with deposits over $100,000 should be able to protect themselves without
ninsured

De osit

r C

guarantees; they make their large deposits with full knowledge that the funds have
insurance; there is no reason why the taxpayer should be exposed to their losses; and such
depositors are likely to be in a better position to monitor excessive risk-taking by bank managers.
government

Yet, the preferred FDIC practice in recent years has been to fully protect uninsured
depositors. This is not merely true of so-called "too big to fail" situations, which are discussed
more fully below. FDIC policy has resulted in the protection of over ninety-nine percent of
~~insured deposits during the record period of bank failures occurring since 1985.
Indeed, the current coverage policy seems exactly contrary to logic. One would expect
a policy that protects only instr 4 depositors, with an occasional extension of coverage in rare
+«uinstances to uninsured depositors.
Instead, the policy has been to protect uninsured
depositors whenever possible, with exceptions occurring only in those few instances when the
FDIC cannot find an acquirer for the failed institution.

ere are a number of reasons why the FDIC has adopted this policy of blanket
sometimes the least expensive resolution methpd;
protection, including the following: (1) it is
the systemic risk problems associated with large baiik
(2) it can maintain stability and avoid
it appears more equitable to smaller
failures (3) it avoids disruptions to the community; (4)
be protected under the "too big tp fa, i
banks, because they believe that larger banks will always
pressures are likely to favor protecting all
doctrine; and (5) the immediate institutional
depositors, rather than inflicting widespread losses.
believes that some of these
As discussed below, the Administration
legitimate, but that the pendulum has swung too far. The current system makes it far tpp ~sy
to protect too many uninsured depositors and creditors; the taxpayer is effectively underwnt, „g
too many depositors that do not need protection; too much market discipline has been fempyQ
and the result has been too much bank risk with too many costly failures.

S ecifi Recommendati

Redu

vera e

f Multi

red A

recommends reining in the overexpansion of deposit insurance
The Administration
coverage to multiple insured accounts. This type of proposal has obvious merits. Today' s
While the popular
coverage of multiple accounts seems excessive by almost any definition.
perception is that deposit insurance is already limited to $100,000 per person, the reality is much
different —depositors can have multiple accounts insured up to $100,000 each within a single
Both
institution, and an unlimited number of insured accounts across different institutions.
practices should either be eliminated or sharply reduced.

For example, current FDIC rules permit an individual depositor at a single institution to
have separate $100,000 coverage for his or her individual account, joint account, revocable trust
account for family members, individual retirement account, Keogh account, "pass-through"
pension fund accounts, unincorporated business account, and others. (These separately insured
types of accounts are otherwise known as separately insured "capacities. ") Banks and thrifts take
advantage of this overextension of the federal guarantee to expand their non-market funding base.
For example, a recent advertisement proudly proclaimed that a family of three could acquire as
much as $~12 milli n in insurance coverage from a single depository institution through the usc
of these types of accounts. Qg Figure 10.
An individual can receive this same coverage of multiple accounts at any other federally
insured institution, making the total potential coverage infinite.
Deposit insurance was Mt
intended to provided such unlimited coverage. Accordingly, the Administration
recommeiids
significant reductions in this overexpansion of the federal safety net.

Figure 10

The Expanded Scope of Deposit Insurance Coverage

Here's how a family of three - husband, wife, and one child - can increase their coverage
to $1.200, 000 in a single depository institution (this example assumes that each individual
holds no other account with the institution):

Accounts:

Individual

$100,000
$100,000
$100,000

Husband
Wife
Child

Joint Accounts:

$100,000
$100,000
$100,000

Husband and Wife
Husband and Child
Wife and Child
IRA/Keogh

Accounts:

$100,000
$100,000

Husband
Wife

Revocable Accounts:
Husband as Trustee
Husband as Trustee
Wife as Trustee for
Wife as Trustee for

for Wife
for Child
Husband
Child

Total Insurance Coverage:

Source: Recent depository institution

advertisement.

$100,000
$100,000
$100,000
$100,000
$1,200, 000

Limi In ivi

The FDIC should generally roll back coverage at each institution tp $100
There is no clear reason why a depositor should receive an addit, png $100
individual.
—half of the joint account should be aggrega~ with g
coverage for a joint account
individual account for the purposes of the $100,000 coverage. Likewise
w;th deppsited
revocable trust accounts for family members should be eliminated
aggregated with the depositor's individual account.

~~&

Separate insurance for other insured capacities, such as escrow accounts and ~le
proprietorship accounts, may present closer questions. Nevertheless, with the exception note
believes that separate capacities shpuld be
below for retirement savings, the Administration
insurance is appropriate
eliminated unless the FDIC makes a new determination that sep

ate

Two- ear transition

rio

The Administration recommends that the proposed elimination should take effect within
two years from the date of enactment of legislation to give institutions time to adjust. However,
the FDIC may determine within one year, after reviewing each capacity individually,
that
separate insurance coverage is consistent with both the fundamental purpose of deposit insurance
to protect small depositors and the need to limit the expansion of deposit insurance coverage.

e grate

100 000 Covera e of Retiremen

Savin s

Notwithstanding
the proposal to limit the number of separately insured capacities, the
Administration believes that a single, separate $100,000 capacity per institution is appropriate
for retirement savings to encourage long-term savings and investment.
This would require
aggregating the separate insured capacities for Keogh accounts, individual retirement accounts,
and those pension fund accounts that continue to "pass through" to individual depositors under
the recommendations set forth below. As with the basic $100,000 coverage for individuals, the
consolidation of retirement savings into one capacity should not occur until two years from the
date of enactment of legislation.

t Goal of 100 000 Per Ca acit

mwid

In addition to limiting the number of separately insured capacities within depositor
institutions, the Administration believes that limiting deposit insurance coverage to $100,0OO Per
capacity systemwide is an appropriate long-term goal. For example, deposits in an individual' &
own capacity in all insured accounts in all banks,
thrifts, and credit unions would receive
more than $100,000 of coverage.
c
Such a limitation would have no effect on the overwhe»ing
majority of de pp sitors
tors in America.
A
According to preliminary estimates from the 1989 Su~ey

Finances, less than six percent of households have more than $100,N6 in total
deposits in insured depositories, while over 87 percent have less than $50, 000 in total deposits.
data reveal the pattern of h~~h~l
deposits, not ~in
deposits, which is the
zltiNate concern. )
Of Consumer

use

i~i@

Although this goal will be difficult to achieve because of administrative complexities, the
Adainistration believes it may be attainable over a five-year period. It will not be necessary to
constantly monitor the account balances in every account in America. Nor will it be necessary
to put in place ail elaborate system to avoid delaying the resolution of a failing bank until the
Nsured status of every depositor is determined.

For example,

it may be possible to put the rule in place and selectively audit for
coapliance off r the resolution of a failed bank. Most depositors would pay attention to the rule
simply because it has been enacted into law —few people will be indifferent to the potential
effect on their bank deposits, even if they believe the rule is difficult to enforce.
Moreover, as the Administration recommends in Section VII, banks would be able to
offer depositors the alternative of safe, ~nin ~r
money market accounts that might invest only
in full faith and credit government securities. This would provide conservative depositors with
a convenient, protected method of leaving funds in excess of $100,000 with a depository
institution.

Nevertheless, the FDIC has recently informed
any such systemwide limitation, even if phased-in
FDIC's fundamental objections is the administrative
system, citing preliminary
estimates of more than
circumstances.

Ei h

n-month FDI

the Treasury that it is strongly opposed to
over a long period of time. One of the
cost that might be associated with such a
$1 billion over five years under certain

i ili

Such estimated costs are indeed substantial, but so is the exposure to the taxpayer of
liailing out large depositors who have more than $100,000 in federally insured accounts.
A
systemwide limitation demands a detailed, technical analysis of the costs and benefits associated
~th the least expensive, yet feasible, way to implement such a system. This would include an
examination of the data systems that would be required; the reporting burden on individual
lianks; the interface with existing data processing systems maintained by banks; and data on the
systemwide pattern of individual deposits.

The FDIC should carry out this detailed cost-benefit analysis within eighteen months,
"sag appropriate outside consultants and technical experts. The Administration believes that,
i~ tlie end, the ultimate costs may prove to be far less than the benefits. Nevertheless, Congress
»«id determine this only after it receives the feasibility report. If the report is positive,

appropriate legislation could then be enacted to educe taxpayer exposure by limiting
coverage per capacity on a systemwide basis.

Elimin

ertain

"P -Throu h"

insu~+

So-called "pass-through" deposit insurance enables banks to raise large amounts f f„„d
f'om insbtuuond investors on a fully-insured basis (Data are provided in Discussion Chapter
V, P -Thr u h Insurance. ) This practice removes market discipline from some of the ye
participants who would be the best able and most likely to provide it.
Pass-through insurance occurs when a fiduciary deposits funds for a large number pf
beneficiaries, with $100,000 of deposit insurance "passing through" to each of the beneficiaries.
In cases where the funds are not used for investment purposes or where the trustee is not g
sophisticated investor, it may be appropriate for deposit insurance to pass through to tlirt
unprotected beneficiaries. For example, escrow accounts established by either lawyers for clients
or landlords for tenants would appear to be a prudent use of pass-through insurance. The same
would be true of escrow accounts maintained to facilitate mortgage servicing for homeowners
and check processing for consumers.

But there is no reason to expand the taxpayer's exposure through pass-through insurance
for brokered deposits and certain institutional pension fund deposits. Because the general topic
of brokered deposits is addressed separately below, this subsection focuses on the use of passthrough insurance by pension plans.

Eliminate Covera e for

rt in P

i n Pl

Pass-through insurance applies to certain depositors that are also institutional investors,
such as pension funds, the managers of which earn substantial fees to invest participants' and
'C
eneficiaries funds prudently. The behavior of pension fund fiduciaries is governed b a strict
y
o criteria under trust and federal pension law designed to protect the best interests of their
beneficiaries.

Indeed, for purposes of deposit insurance, there is very little difference between a
professional
investor wh
who manages money for a pension fund and one who manages money for
p
either a money market mutual fund or an employee health and welfare
plan. Each is paid to
invest other peop le's
esm
money; each is required to invest prudently; and each invests substan~
sums in bank de posits.
sits. The difference is that the pension fund's deposits are generally cov«~
by deposit insurance, while the deposits of the money market fund and emplo ee heait"
y
ot. The sophisticated pension fund manager may therefore exercise lc»
p
market discipline over bank
ank in
investments than the sophisticated managers of money market funds
and employee health andd welfare
welf
plans. This differential treatment makes little sense.

9 fine

Ben fi Pl

. Moreover,

there are even greater levels of beneficiary protection
The sponsor of a defined benefit plan has a
available to defined benefit pension plans.
commitment to pay benefits to plan participants based on established formulas involving such
factors as years employed, age, and salary earned. The sponsor bears all of the investment risk
Participants in
from plan funds and typically employs a professional investment manager.
defined benefit plans are protected from risky banks not only by prudent professional
management, but also by a separate "safety net" —in the event of bank failure, the plan's
sponsor (and control group) and the Pension Benefit Guaranty Corporation (PBGC) are liable to
These protections make passpay for any losses that would otherwise accrue to beneficiaries.
insurance
unnecessary
and
inappropriate for defined benefit plan deposits in
through deposit
banks.

9 fin

n rib i n Pla
The other major category of pension plans that receives
pass-through deposit insurance coverage is defined contribution plans. Many defined contribution
plans stipulate a percentage of each participant's earnings to be contributed to the plan by the
employer. Others provide for an election by each participant to defer a percentage of pre-tax
In either case, investment risk
earnings, which is often matched by employer contributions.
Participants in these plans do not receive the same "safety net"
remains with the participant.
protections as participants in defined benefit plans, that is, loss protection from plan sponsors and
PBGC. Nevertheless, the plans do have similar investment rules and many are professionally
managed. With the exception noted below, these plans should not receive pass-through deposit
insurance treatment.

Exce ion for

If- ir

Pass-through insurance should continue to apply to self-directed defined contribution
plans. Unlike plans where an institutional investor makes investment decisions on behalf of
beneficiaries, self-directed plans give beneficiaries the discretion to choose such investments as
bank deposits. When these beneficiaries make such a choice, they should be eligible for the
same deposit insurance treatment as individual savers who do not participate in such plans.

At the same time, consistent with FDIC action to roll back the number of separately
insured capacities, pension fund deposits receiving pass-through coverage should be aggregated
~ith the beneficiary's other retirement savings for purposes of applicable $100,000 limitations.
this proposal may require some changes to various rules and practices under the Employee
Retirement Income Security Act of 1974, it would not create substantial new administrative
as a condition to
burdens because the FDIC already requires the necessary recordkeeping
receiving pass-through coverage.

m n

Eliminate Covera e for Bank Inv

lnsura„~ comp~, .
Finally, pass-through insurance can create competitive inequities
"GICs, " to retirement fund jnvestors
have offered so-called Guaranteed Investment Contracts, or
since the beginning of the 1980s. GICs permit these investors to deposit funds with th&
insurance company over time with a guaranteed interest rate for the term of the contract QICs
are obviously not covered by federal deposit insurance.
In recent years, banks have begun to offer a product similar to GICs called Bank
"
Investment Contracts, or "BICs, which explicitly take advantage of pass-through deposit
insurance as a marketing tool. While BICs may have a greater degree of interest rate risk than
bank deposits, it appears that this risk can be effectively managed through contract limitations
and hedging strategies.
Thjs
The problem remains, however, that BICs are fully insured by the government.
provides banks with a new opportunity to attract large deposits by expanding the use of the
government's guarantee. Meanwhile, insurance companies offering GICs totally outside of the
Banking organizations should be permitted
safety net do not have this competitive advantage.
to offer BICs to pension fund managers, but not with federal deposit insurance.

Eliminate

overa e for Brokered De

The brokerage of insured deposits has expanded the scope of deposit insurance coverage
for wealthier depositors. According to the preliminary results of the 1989 Survey of Consumer
Finances, households with more than $100,000 in depository institutions hold almost threequarters of the insured brokered deposits held by all households. There is no clear public policy
reason why the taxpayer should routinely protect these wealthier depositors from losses. Such
depositors do not need deposit insurance to find safe ways to invest their funds.
The use of brokered insured deposits also increases the ability of depository institutjoiis
to avoid a marketplace test in raising funds from depositors. FIRREA corrected the worst abuses
of brokered deposits by curtailing their use by weak banks and thrifts. But the fact remains that
brokered deposits allow even healthy institutions to expand their sources of governmentguaranteed funding.
De sit,
As set forth in Discussion Chapter IV, Br k r
In r
expanding the ability of firms to use the government's credit, rather than their own financial
condition, to raise funds is an invitation for increased risk and an increased misallocation of
resources.
Critics will argue that deposit brokerage helps provide a more even distribution of «nds
inthes ystem,
stem with
withddeposits flowing more easily to institutions with greater lending opportunities
The problem is that today these deposits are ~in @~re, rather than ~nin
which means that
there is no market discipline involved in sending these funds to distant parts of the country to
ks and thrifts. Other mechanisms have long existed to even out credit flows with

~r,

funds, such as the federal funds market, correspondent banking networks, and the
The brokerage of ~nin ~r deposits could be a useful
Federal Home Loan Bank System
credit is not an
addition to these mechanisms, but the expansion of government-guaranteed
appropriate way to accomplish this objective.
uninsured

Ph se-In

Accordingly, the brokerage of insured deposits should be eliminated over a two-year
period, although obviously all brokered deposits previously sold would remain subject to current
insurance rules until maturity.

Ex e tionf

oluti n

i n

on the use of brokered insured deposits should not apply to institutions
in conservatorship with the Resolution Trust Corporation (RTC) or the FDIC. As governmental
entities, the RTC and the FDIC should have the ability to temporarily use government-guaranteed
credit for liquidity purposes if the practice would lower resolution costs for the taxpayer. The
problems associated with issuing brokered insured deposits —decreased market discipline, for
example —are not an issue when the government is operating and closely supervising a failed

The prohibition

institution.

Eliminat

Covera e

f Non-De o

There are sometimes good reasons for the FDIC to protect uninsured depositors in bank
failures, but there are very seldom good reasons for protecting other kinds of bank creditors.
General, subordinated, and holding company creditors do not have the same characteristics as
the most liquid forms of bank deposits.
Failing to protect these non-deposit creditors in bank
The
failures does not pose the same degree of systemic risk as failing to protect depositors.
taxpayer should not be exposed to the cost of bailing out these creditors.

Moreover, as discussed below, uninsured depositors will receive government protection
from losses in circumstances involving systemic risk. It is therefore that much more critical for
other creditors and shareholders to monitor and discipline the risky behavior of bank managers.
Government protection undermines this discipline.
Accordingly, the Administration strongly endorses the current FDIC policy of allowing
&on-deposit creditors to suffer losses in bank failures. Indeed, in FIRREA the Administration
P«posed and Congress enacted a provision that facilitated the ability of the FDIC to implement
this policy. The so-called "pro rata" provision allows the FDIC to expose creditors to their
normal pro rata bankruptcy losses even if uninsured depositors are made whole. The FDIC has
&ready taken advantage of this authority in several instances.

holding company creditors unprotected h
the current FDIC policy of leaving
discipline. These creditors were fully protected in the failure pf
provided important market
has been rare for the FDIC to provide such full protectipn
Continental Illinois, but since then it
were not protected in the recent resolution of the Ba„k
For example, holding company creditors
companies have at times had funding problems ~
of New England. While some bank holding
of a free market.
a result, those are the necessary consequences

I.ikewise,

Limi

ra e

to protect the banking system and
The government must always maintain the flexibility
risk. At times, this policy has led tp the
the economy in circumstances of genuine systemic
other countries around the world.
protection of uninsured depositors, just as it has in
m ) The resolution of the Bank pf
i In
Discussion Chapter XXI, F r i n De
New England is the most recent example.

be protected, which is
But this does not mean that uninsured depositors should always
coverage creates enormous
essentially the current policy. This overexpansion of insurance
banks from important market
exposure for the taxpayer, while at the same time shielding
rather than seeking tp
discipline. The priority of FDIC policy should therefore be changed:
to limit its protection
extend protection to uninsured depositors whenever possible, it should seek
are designed
to insured depositors whenever possible. The Administration's recommendations
change of this
to achieve this change in policy and priority, fully recognizing the need to make a
systemic
nature only after a substantial transition period and to retain flexibility to protect against
risk.

R uireLea

Cpstl

inM

The first recommendation is that the FDIC should be required to use the least expensive
resolution method unless the Treasury and the Federal Reserve Board determine that systemic
risk requires otherwise. Contrary to widespread perception, current law does not require the
FDIC to choose the least costly resolution method. As a result, sometimes the blanket protection
of uninsured depositors is a by-product of the least costly resolution method; many other times
it may not be. Either way, the misperception that such blanket protection is always the result
of the least expensive resolution method makes it much easier to provide insurance coverage «
uninsured depositors.

It is true that sometimes the least costly method of resolving a failed bank will reqUi«
For example, a bidder may pay a substantial premium «
protecting uninsured depositors.
acquire the total franchise of a failed bank, purchasing gl of its assets and assuming &1 pf its

This "purchase and assumption" resolution method can have the additional benefit «
costs associated both with sorting out insured from uninsured
saving FDIC administrative
It is possible that the
depositors and taking on additional assets for resale and liquidation.

liabilities.

savings could offset the additional
and administrative
depositors from suffering losses.

premium

cost of preventing

uninsured

On the other hand, a purchase and assumption transaction will often be more costly than
an alternative resolution method known as an "insured deposit transfer, " where an acquirer
assumes only insured deposits and purchases only some of the failed bank's assets. The premium
paid by an acquirer in an insured deposit transfer is likely to be similar to the premium paid in
This is true because much of the franchise value of a
a purchase aild assumption transaction.
attaches
to
its
small, core deposits, which are insured, rather than to the large
failed bank
are
uninsured.
that
Yet, the insured deposit transfer method does not require the FDIC
deposits
to assume the cost of protecting uninsured depositors, as is the case with the purchase and
assumption

method.

How does the law permit the FDIC to choose the more costly resolution method? The
answer is that the chosen resolution method only needs to be less expensive than liquidating the
bank and paying off its insured depositors —it does not need to be the ~l
costly resolution
method. The current legal standard is therefore inconsistent with the Administration's
goal of
the cost to the insurance fund of resolving failed banks. The perfectly legitimate
~minimizin
claim that a purchase and assumption transaction is "cheaper than a liquidation" helps perpetuate
the misperception that it is in fact the "cheapest" resolution method. This misperception makes
it easier to justify protecting uninsured depositors in a particular case.

The legal standard should be changed to specifically require the least costly resolution
method. This change is likely to result in more losses for uninsured depositors and less exposure
for the taxpayer.
However, if the least costly method would result in full protection for
uninsured depositors in a given case, then it should be permitted.

Risk Exce tion

case, the presence of systemic risk could require a decision to protect
uninsured depositors, even if it is not the least costly resolution method. The FDIC usually has
iiot make this decision alone, and indeed, its practice is to consult the Federal Reserve and the
Treasury.
A finding demands a broader government consensus that systemic risk exists and
requires extraordinary government action.
In a given

Because the Federal Reserve is responsible for financial market stability, and because
action could require Federal Reserve discount window loans, the Federal Reserve
should be formally
Likewise, since the
involved in the systemic risk determination.
Adininistration
is more directly accountable to the taxpayer than the Federal Reserve, the
Treasury Department should also be involved.
government

to protect
recommends that (I) any determination
Accordingly, the Administration
uninsured depositors on the basis of systemic risk should be made jointly by the Federal Reserve

and the Treasury Department; (2) the extra cost incurred from protecting uninsured depositor
ould be advanced to the FDIC by the Federal Reserve; and (3) the FDIC should repay tht
advance with industry funds.

in this manner, government flexibgjt„would
the decision-making
maintained, but would be difficult to exercise without an appropriate level of acc unt bQiy
intended result is that the extraordinary step of covering uninsured deposits wouM not be
except in situations where systemic risk is truly present.

By broadening

~„

At the same time, the recommendation provides more flexibility for the Federal Res ~e
to provide bridge liquidity to protect the system The industry would remain liable, as it should
to repay this bridge liquidity.

ved Li ui it Meehan'

Uninsured depositors that are unprotected in bank failures do not lose all their funds;
instead, they typically receive a partial recovery based on their claim on bank assets. This partial
recovery can be substantial, sometimes amounting to over 90 percent of the value of the
uninsured deposits.

The problem is that partial recovery can take long periods of time during which the full
value of the deposits can be tied up in a failed bank receivership.
This temporary loss of
liquidity magnifies all of the problems associated with depositor losses, including systemic risk
problems through the payments system and correspondent banking networks. If FDIC policy
changes to produce more losses to uninsured depositors, then mechanisms for dealing with this
liquidity problem must be developed and refined.
The most promising approach is the "final settlement payment" proposed by the American
Bankers Association (ABA). In resolutions where uninsured depositors were not fully protected,
the FDIC would make an immediate payment equal to the weighted average recovery of the
FDIC standing in the shoes of depositors in past bank receiverships.
(In recent years, Ole
weighted average recovery rate has been over 80 percent. ) The recovery rate would be posted
in advance so that uninsured depositors would be on notice concerning the exact extent of their
potential loss.
In any particular bank failure, the FDIC might have to pay either more or less to
uninsured depositors than they would be entitled to receive under current law. But over time,
the over-payments and under-payments
should cancel each other out so that the FDIC shoUld
break even. The advantage of this approach is that it makes liquidity immediately available
without exposing the FDIC to significant losses over time.

There are technical problems that need to be resolved with the final settlement pay+e~t
approach, particularly for larger banks. (These are set forth in
Discussion Chapter III, ~Sea

In,

Tllere is also a legal question involved in paying individual depositors
leN in a particular case than their ~r age share of actual recoveries from the bank receivership.
these problems must be addressed, the FDIC should be given the authority to use this
approach if the problems are resolved. At the very least, a "modified payout" approach should
be adopted to provide immediate liquidity based on individual cost estimates in particular

)

~le

resolutions.

One final point should be made to avoid confusion. The Administration only endorses
tbe liquidity aspect of the ABA's final settlement payment approach. There is no endorsement
of an "automatic haircut" of all uninsured depositors in all bank failures. For the reasons
discussed above, uninsured depositors may sometimes be protected if (1) it is genuinely the least
costly way to resolve the institution; (2) it is necessary to protect against systemic risk; or (3)
to do so is essential to provide depository services to the community.

4. M

t Reduc

stemi

R' k

The general thrust of the Administration's recommendations is to reduce the number of
occasions that require full protection of uninsured deposits, recognizing the exception for
instances involving genuine systemic risk. At the same time, more must be done directly to
reduce the systemic risk involved in bank failures.
This in turn will reduce the number of
occasions that uninsured depositors must be protected.
Much significant progress has already been made. For example, the Clearing House for
Interbank Payments System (CHIPS) has recently adopted an interbank netting system that has
substantially reduced the systemic risk that would be caused by a large bank failure.
The
clearing organizations
for securities and derivative instruments have also made significant
improvements since the market break in October of 1987 (as recommended by the Presidential
Task Force on Market Mechanisms in 1988).

Nevertheless, additional improvements can and should be made. The "Group of 30, a
iioii-partisan consulting group on international economic policy, has made recommendations
to
significantly reduce clearing and settling times, which could indirectly reduce the systemic risk
caused by a large bank failure. There are a number of other, technical proposals designed to
reduce systemic risk that ought to be considered as part of any legislative proposal.

5. Thr

Y ar T nsition

if adopted, could result in substantial changes to the
Finally, the recommendations,
system. These changes should not be made abruptly. As with other recommendations,
significant changes to the Q ~fc policy of protecting uninsured deposits should be phased in.
&e Administration recommends a three-year delayed effective date.
banking

Ass

n Forei n D

Beginning with the Banking Act of 1933, Congress has consistently excluded d
foreign offices of U. S. banks from both insurance coverage and insurance assessmen~
legislative history is set forth in more detail in Discussion Chapter
i .) For the reasons set forth below, this long standing pohcy
r i n D

I.ike

I„

other uninsured deposits, foreign deposits have been protec~ by Qe FDIC,
resolving failed banks —particularly larger banks, where foreign deposits are concent
Th
Protection has prompted smaller banks to argue that foreign deposits should be treated just ]jJ e
domestic deposits, with insurance up to $100,000 and assessments for the full amount. It is
unfair, they argue, that smaller banks have to pay premiums on their entire domestic funding
base, while the very largest banks can escape premiums on a substantial part of their funding
base by taking deposits overseas.

Despite this appearance of unfairness, foreign deposits should not be assessed for three
fundamental reasons. First, it would signal a broad expansion of the federal safety net and the
government's liabilities at a time when exposure should clearly be reduced. The FDIC's decision
to protect uninsured foreign deposits has been voluntary; it has not been required by law. As
discussed above, the Administration believes that the FDIC should reduce its blanket coverage
of gl uninsured depositors, whether foreign or domestic. This reduced coverage is important
both to increase market discipline and to reduce the government's liability.

The proposal to assess foreign deposits directly undermines
the thrust of the
Administration's
recommendation.
With assessments, the FDIC is much more likely to fully
protect foreign deposits in all cases. It is a signal to expand insurance coverage when we should
be taking steps to reduce it. We should not expand our deposit insurance liabilities.
Second, as Congress has repeatedly recognized, assessing foreign deposits would directly
impair the international competitiveness of U. S. banks. This is particularly true in the highly
competitive interbank and wholesale loan market, where spreads have been extremely narrow.
For example, it is estimated that foreign branches of U. S. banks raise between two-thirds and
three-quarters of their funds in the interbank deposit market, where spreads have averaged
approximately 12 basis points over the last two years. Adding the current 19.5 basis poiiit
assessment would obviously make this unprofitable.

The third reason is fairness. It is true that the assessment base for the largest baiik
a much smaller percentage of their total deposits than the assessment base for smaller baiiks
This seems to imply that large banks are paying much less than their fair share for deposit
insurance. In fact, historical data show that just the opposite is true: during the period of record
bank failures in 1985-89, large banks more than
paid for their own failure costs, and in fact
subsidized the failure costs of smaller banks.
/gal Table 1. (The inclusion of resolution costs
of Continental Illinois in 1984 and Bank of New England in 1991 do not change this result. )

Finally, the revenue effect is uncertain because assessing foreign deposits is likely to
sits. Awarding to seve& publ shed est mat, the effect of
reduce the amount of such depo
increased costs from increased assessments is likely to reduce the amount of foreign deposits
rcent to more than 50 p rcent I addlton, 1t 1s uncl~ how many banl
my here from 37 p
~ill merely restructure their branches as foreign subsidiaries in order to avoid assessments,
decreasing potential revenue to the FDIC.

~er

Table

of Resolution Costs by Bank Size Failures
of FDIC-Insured Banks and Savings Banks, 1985-89

Distribution

Percent of
total costs

Asset size of bank

Less than $30 million .....
$30-$100 million .............
$100-$500 million ...........
$500 million-$1 billion ....
Greater than $1 billion. ...

11.8
16.5
16.0
3.8
51.5

Percent of
total

assessments

2.6
8.8
13.3
4.6
70.7

Note: There were 750 failures of banks with less than $1 billion in total
assets, and nine failures of banks with more than $1 billion in total assets
during this period. The total cost of these failures was about $16 billion.
Source: Federal Reserve Board.

IH. Risk-B

Pr miums Based n

a ital

mmn

Risk-Based Capital Used as Standard

FDIC Discretion to Adjust

Two- Year Phase-In

Premiums

Set b Private Reinsure

Demonstration

Project

Re onsf

mm n

The current flat-rate system of deposit insurance pricing actually rewards firms for taking
more risk because there is no additional premium expense. The results are likely to be more
numerous and more costly bank failures than if premiums varied with risk. Moreover, flat-rate
premiums subsidize high-risk, poorly-run institutions at the expense of well-run institutions and
the taxpayer (although this effect is somewhat mitigated by risk-based capital).
This pricing system is perverse.
A private insurance company would always charge
higher premiums to riskier firms, with insurance firms competing to set the appropriate price.
The ideal result would be firms "paying their own way" for their own levels of risk; a
continually solvent insurance fund; and a better allocation of economic resources to productive
firms and productive investments.
As a practical matter, it is unlikely that a risk-based premium system could achieve this
ideal result by itself. For example, it could be difficult to price individual bank risk correctly
problems occur, and because bank failures are so unevenly distributed over time, it is
difficult to set long-run revenues to cover long-run costs.

~fr

There is also an important constraint on the level of premiums that can be charged to
undercapitalized banks. It cannot be so large as to threaten the viability of an otherwise sound
+stitution.
For example, large increases in premiums during an economic downturn could
further aggravate banking problems even though a bank's weakened capital position might not

decisions.
detail in Discussion Chapter VIII, Ri k-R 1

be the result of poor management

These and other problems are discussed in morc

Pr mi m

In short, risk-based premiums should be viewed as a complement to, rather th~
substitute for, other methods of checking excessive risk-taking, including risk-based c pi@
requirements; direct market discipline; strong supervision; and direct restraints on risky activities
Accordingly, the Administration recommends two risk-based premium proposals. The first, for
the short-term, would authorize the FDIC to establish risk-based premiums as a private insurer
would, with capital levels used as the fundamental measurement of bank riskiness. The second
for the longer-term, would establish a demonstration project to introduce the private insurance
Both proposals are general]y
market into the process for pricing bank insurance premiums.
consistent with the FDIC's separate recommendations to Congress in its risk-based preniiuni
study required

by FIRREA.

ecifi R

Prmi

Base

a it

mm n

Capital should be used as the primary measure for risk in adjusting premium levels. As
discussed in Section I above, capital is the single most important protection against excessive
bank risk. While both capital and the insurance fund absorb losses ahead of the taxpayer, capital
has one distinct advantage —it makes banks less likely to fail. In addition, capital is a
straightforward,
visible way to measure risk, and indeed, empirical evidence shows that low
capital levels are a good advance indicator of banks' likely failure.
Using capital makes good insurance sense from another perspective, which is the role it
" Every dollar in bank losses absorbed
plays as a "deductible.
by capital is one less dollar
absorbed by the insurer, just as every dollar in loss paid for by a car owner on his or her
deductible is one less dollar for the car insurer to pay.

Finally, tying premiums to capital gives bank owners an added incentive to maintain
strong levels of capital. As discussed above, this type of incentive is part of the Administration's
overall proposal to strengthen the role of capital.

R' k-Based

a ital Us d

The Administration believes that the specific capital measure most appropriate for ris"based premiums would be the combination of Tier 1 and Tier 2 capital currently used for ris"based capital. This measure accounts for off-balance sheet risk which is
appropriate.
7
dition, Tier 2 capital includes subordinate debt, and for a
variety of reasons set forth i"
Discussion Chapter II, institutions should be encouraged to hold
more subordinated debt.

Hpwever, unlike the FDIC, the Administration recommends that the correct capital ratio
i h
assets, not total assets. This would
is the prpportlon of Tier 1 and Tier 2 capital to ri kfor
risk-based
concept
which
capital,
U. S. supervisors have adopted within the
reinforce the
the
Basle
Committee
established
on
Bank
by
Supervision.
guidelines
By contrast, using the
capital-tp-total-assets ratio (or "leverage ratio") would appear to blunt the primary importance
now attached to risk-based capital standards.

Mpreover, the FDIC's current proposal would use a new definition of capital for premium
While the intent is apparently to
purposes based on adjustments to bank loan loss reserves.
in
the
reserving
inaccuracies
the
system,
proposal would create yet another capital
remedy
This
banks
to
seems
for
satisfy.
unnecessarily complicated.
Problems with the
standard
should
be
corrected
for
all
measures
of
system
not
capital,
reserving
merely the one related to
risk-based
premiums.
setting

FDIC Discretion to Ad'u

It is important that the FDIC maintain the discretion necessary to adjust and refine the
Over time, the standard may include factors other than capital,
risk-based premium standard.
although it is strongly recommended that capital remain the dominant factor for the near term.

Two-Year Phas

The capital-based premium proposal should be approached carefully and only after public
A two-year phase-in would be appropriate to
comment, as the FDIC has already suggested.
allow institutions to adjust.

Pr miums Set b Priva e Reinsur

The second method for assessing risk-based premiums is to involve the private market in
a more direct way, on the theory that markets should be better able to assess and price bank risk
than a government agency. The most feasible approach appears to be an integration of primarily
government insurance and just enough private reinsurance to serve as an overall price-indicator
&or Ole FDIC. The details of one such approach are set forth below, which would have to be
«rther refined in an FDIC demonstration project before it could be considered for enactment into
law on a systemwide basis.

Lia ilit
An integrated approach would require private reinsurers to face the
same risks as the FDIC, but on a smaller scale. For example, the FDIC could reinsure ~i
—the
P«crease coverage for) a small ~r rata fraction of its risk that a covered bank would fail
Private reinsurers would cover perhaps five percent of potential depositor losses at a given bank,
ith the FDIC covering the remainder.
The proportion insured should be large enough to

warrant careful monitoring by the insurer, but small enough to attract a wide pool of potential
insurers. (This type of approach was included in legislation introduced in the Senate in 1989
the "Deposit Insurance Reform Act of 1990" (S. 3040).)

But the FDIC would not negotiate the price of the risk ~~
mi
the reinsurer. Instead, the reinsurer would negotiate directly with the covered bank to det
the premium that the reinsurer would charge. The FDIC would take the reinsurer's premium
into account in setting its premium.

R i

~„

. Such a system

could very well entail eligibility requirement
Insurance conipames
for private reinsurers, which would likely include capital requirements.
could be permitted to estaMish
would obviously be eligible, and banking organizations
affiliates, so long as these affiliates did not reinsure affiliated banks. Reinsurers
.reinsurance
could act individually or in a consortium, the latter being the most likely means of insuring the
deposits of large banks.

Eli ibilit

R ui m n

~ttT

. I

ldd

i
unilaterally

to cancel the policy and avoid
duration, and they could not allow the reinsurer
There
liability for preexisting losses. Periodic premium adjustments would be permissible.
would be flexibility for the bank to terminate a reinsurer's coverage provided that another
reinsurer was found.

P tential Pr ble
The private reinsurance
earlier detection of problems than the current system.

system could produce better pricing and
At the same time, there are numerous
practical difficulties. There may be problems involved in governmental monitoring of a large
group of private insurers, although to the extent that private reinsurers are part of banking
organizations, there would be some cost economies in monitoring. There may also be instances
where the objectives of the public insurer may conflict with those of the private insurer,
particularly in the areas of closure and failure resolution policies. In addition, the cost-benefit
implications of the extensive regulatory framework that might be required to administer this
system would have to be carefully weighed.

The extent to which private insurers would be willing to provide such insurance under
terms consistent with public policy objectives is unclear. It may be necessary, for instance, for
a private insurer to have the right either to compel closure of a bank that is no longer insurable
in the private market or, if public policy considerations require the bank to remain open, to
transfer the entire insurance burden to the public insurer (while retaining liability for latent losses
up to the time of transfer). There are also systemic risk issues, with the potential for proble»
of the banking industry spreading to the insurance industry, and vice versa. Finally, another
concern is that publicized premium changes could trigger adverse market reactions and rUii~
among uninsured depositors and creditors.

D m n

i n Pr

For al] of these reasons, the Administration recommends that the FDIC adopt a
demonstration project to determine the feasibility of using the private sector to help price riskWhile no market for this product exists today, there have been numerous
based premiums.
indications of interest in recent months by both private firms and private industry groups. This
interest must be tested and explored before such a substantial change is considered for adoption
on a systemwide

basis.

The demonstration pro]ect should consist of the FDIC enlisting a sampling of private
reinsurers and banks to simulate a reinsurance arrangement.
The participating insurers would
be asked to simulate the actions they would take under actual reinsurance. These would include
producing the contracts that would exist between the insurer and both the banks and the FDIC;
setting the pricing structure; and obtaining the information necessary for the insurers to evaluate
aii4 monitor the risks in the subject banks. The simulation should be "real" enough so that it
The program would also involve actual
reflects how the system would actually work.
reinsurance transactions, if possible.
The demonstration project could be conducted within one year, with the results reported
back to Congress by the study participants including, but not limited to, the FDIC. The purpose
would be to establish whether reinsurance is feasible; whether private participants are sufficiently
interested and have the capacity to make the system work; whether public policy goals can be
satisfied by a system that relies heavily on private sector participation; and what additional
changes in the regulatory structure would facilitate the development of a private reinsurance
system.

IV.

Imrv

mmn

Rewards for Well-Capitalized

Banks

Prompt Corrective Action for Undercapitalized

Early Resolution for Failing Banks

Three- Year Transition Period

Improved Capital Measurement

Capital-Based Supervision

Annual on-site examinations

Accurate reserving for loan losses

Increased market value reporting

Improved Reporting from Independent

Reasons

frR

Banks

Auditors

mmen

i ns

Bank supervision is critical to reducing taxpayer exposure to losses from bank failures.
Part Two of this study sets forth recommendations
for streamlining our fragmented and complex
«guiatory structure. This section provides recommendations for improvements to specific types
of supervision, with a particular focus on capital. The current approach to such supervision is
forth in Discussion Chapter IX, Ri k Mana
and the particular supervisory
m n T
~ssues related to troubled institutions are set forth in Discussion Chapter X, Pr m t
orr tiv
~A~in.

hni;

As discussed in Section I above, minimum capital standards should not be raised across
the board.
But because of the crucial protections provided by capital, regulation should be
reoriented toward a system of capital-based supervision. This system would provide well-defined
«gulatory rewards to firms that maintain high levels of capital, and well-defined sanctions to

ose that do not. The intended result is that banks will have strong incentives to hold
amounts of capital at all times.

adeqU,

The rewards of capital-based supervision would be greater regulatory freedom for +,
capitalized banks to expand and engage in new financial activities. Not only wouM this proyi
an incentive for banking organizations to maintain capital, but it would also provide the ~@
to help build capital.
The sanctions of capital-based supervision would be designed to help correct superviM
problems early, before they grow into much larger problems. Such "prompt corrective aetio
criticism of the regulatory response to the savings and lo,
would address a fundamental
problem. This criticism is that regulators waited too long to act, and much longer than t
market would have tolerated in the absence of deposit insurance and the federal safety Jet
This failure to take prompt corrective action may have allowed some institutions to f;
that could have been saved. Other firms with low capital took excessive risks in an effort
recover —the moral hazard problem —and created much larger losses than were necessary. Tl
proposal for prompt corrective action would address these problems by creating a system
specific corrective actions as the level of a firm's capital declines to particular trigger points
This new system of capital-based supervision depends critically on accurate, up-to-da
measurements of capital. Recommended improvements, as discussed below, include annual oi
site examinations; more accurate reserving for loan losses; and increased market value reportinI
Finally, improved reporting from independent auditors would also help strengthen supervisioj

It is important to emphasize one additional point. The proposal does not make capital tI
~nl supervisory tool available to bank regulators; it merely recognizes the crucial role th;
capital plays. Other supervisory tools unrelated to capital would still be in place if the propos
were adopted. Capital-based supervision would simply provide regulators with more ability t
act promptly and decisively to correct supervisory problems —and make such actions more likel

to occur.

ecifi R

a ital-Based Su ervision

Capita-b~~ sup rvislon
of capital. Those with the

would est blish zones" for bank
on their P~CU13
levels
highest levels of capital would be in Zone 1, while those ~it~
the lowest levels would be in Zone 5. Rewards and
supervisory remedies would depend oui th
particular zone into which each bank falls.

RwrdsfrWII-

a i liz

Banks in Zone 1 would realize the most regulatory freedom. To achieve Zone 1 status,
a bank would have to maintain risk-based capital significantly above its minimum capital
While the exact amount would be left to the banhng regulators to defiine
requirements.
by
regulation, it is important that banks have incentives to maintain additional levels of both equity
Npitai and subordinated debt.

The most important reward for a Zone 1 bank would be the ability to engage in a broad
iange of new financial activities du'ough a new FSHC. The Administration's
proposal for
establishing these new financial services holding companies is set forth in Section VII below.
rewards include expedited procedures —elimination of the cumbersome
Other regulatory
"applications" process —for all of the following: opening new branches; acquiring new banking
and nonbanking affiliates; and engaging in the newly authorized activities.
Zone 2 banks would be ones that satisfy their minimum capital requirements, but do not
have the additional equity capital to qualify for Zone 1. In most ways, these banks would be
treated much as they are under current law. Generally, they would not reap all the benefits
accruing to Zone 1 banks, although they could take advantage of new financial activities if they
could demonstrate both (1) substantial progress towards meeting Zone 1 requirements;
and (2)
the financial and managerial resources necessary to conduct the new activities. But they would
generally not be subject to any of the corrective actions that would apply to banks in Zones 3,
4, and

5.
In sum, capital-based

expanded activities will make the bank franchise considerably more
for firms that own ntther well-capitalized banks or nndercapitalized
banks.
By
expanding their ability to affiliate, firms with undercapitalized
banks will be able to attract the
accessary new capital to engage in new financial activities, either from the financial markets or
from diversified financial and commercial companies.
attractive

Pr m

rr tiv Aci

nf r

i liz

3, 4,

and 5 would be ones that fail to meet their minimum capital
requirements by progressively larger amounts; these banks would be subject to the new system
«p«nipt corrective action. Banks in Zones 3 and 4 would be subject to dividend restrictions,
growth constraints, and other supervisory actions. Banks in Zone 5, having virtually no prospect
«recovery, would be promptly placed into conservatorship for subsequent sale or liquidation.
Banks in Zones

The key factor to the success of prompt corrective action is that both stockholders and
anagenient believe that the preannounced steps will in fact occur if capital declines. Only with
+&h expectations will stockholders and management behave prudently.
But a supervisory policy
"4it is inflexible,
and mechanistic can raise costs by forcing actions in
ruleoriented,
iiinstances that call for patience.

P ompt corrective action therefore blends rules and flexibility by creating a grrgi~mg

that certain corrective actions will occur, with enhanced discretion for other corrective action
The strength of the presumptive supervisory actions increases as the degree of undercapitalizati
int nsifies. The primary supervisory agency may grant relief from presumptive actions only
it believes and specifically finds that an exception is in the public interest.

While more specific details will be provided in the Administration's legislative propos,
a general description of the series of prompt corrective actions that would be taken is set foi
below.

Zgnn3 banks would be ones with capital below any of the minimum capital requirement
but not so far deficient as to require drastic supervisory actions. Presumptive sanctions woU
include the filing of an acceptable capital plan that would promptly restore the bank to Zoiic
or Zone 2; and a prohibition on expansion by acquisition unless it was part of a plan to imprp
capital. In addition, the FSHC that owns the bank would become subject to consolidated spit
requirements unless it divested or recapitalized the bank, and the umbrella supervisor would hai
the authority to examine unregulated affiliates of the bank. (The issue of consolidated capit
i n f Fin
rni
ial
rvi
requirements is described in more detail in Section VII, M
~Rgglat~in.

)

Discretionary tools for Zone 3 banks would include restrictions on dividends and ass
growth; restrictions on risky activities of the bank or affiliates that threaten the bank; the ability
to remove management; and other supervisory actions. Of course, all restrictive supervisoj
remedies would end if the bank were recapitalized into Zone 2.

~n~4

banks would be ones with capital
1 below any minimum
capit;
standard, as defined by the regulator, and would be one step from mandatory conservatorshil
Presumptive sanctions would include a prohibition on dividends; the filing of an acceptabj
capital plan that would either feasibly restore the bank to Zone 2 or result in the sale of the banl
growth restrictions; and other supervisory sanctions.
Optional tools would include all tho&
authorized for Zone 3 banks, plus the ability to order the sale of the bank or to place it I
conservatorship.
Again, all sanctions would be avoided or would end if the bank wei
recapitalized into Zone 2.

Earl Resolution for Failin

Finally, ~zone
banks would be ones with capital below a "critical leveL" Ttt
presumptive sanction would be early resolution through conservatorship or receivership, with &
subsequent sale or liquidation of the bank unless it was recapitalized into a higher zone

Supervisory relief for Zone 5 banks would require the concurrence of the FDIC aiid t"
appropriate federal banking regulator.
If no exception is granted, early resolution m'g&
nevertheless require extended conservatorship, during which the bank would be scaled ~~c '

atiticipation
Nses would

of either sale to the private sector or longer-term liquidation.

The objective in such
be, as it is with ail of the proposed steps, to impose costs on management an
stpckhplders for excessive risk-taking while protecting against systemic risk and strictly limiting
tbe potential for taxpayer loss. Early resolution may or may not ultimately lead to cessation pf
gyrations, but it would concentrate the risk of failure on equity holders, lead to the replacement
and limit losses. No entity would be too large to be subject to such
pf senior management,
steps,

al Au h ri

Finally, the success of prompt corrective action and early
the
on
to
authority
act swiftly. In general, regulators currently have ample
respiutipn depends
to take corrective action as their condition declines
authprity to require institutions
dividend restrictions, growth restrictions, management changes, etc. ). But they are not always
. A number of regulatory steps depend upon a showing
aMe tp exercise such authority grrm~tl
pf "unsafe or unsound conditions" or a violation of law, and the time needed for implementation
pf a supervisory remedial action, such as issuance of a cease and desist order, can be greatly
protracted when the bank contests the regulator's determination.

This process should be expedited consistent with due process protections for bank owners
The prompt corrective action proposal would preserve the right to challenge an
and managers.
examiner's determination
of an institution's particular capital zone. But once the zone is
appropriately determined, there would be only very limited ability to challenge any corrective
action taken by the regulator and authorized for that zone. This expedited process would produce
greater consistency in supervisory actions; place investors and managers on notice regarding the
presumed supervisory response to falling capital levels; and reduce the likelihood of protracted
administrative challenges to the regulator's actions.

There is a related issue that will also require new regulatory authority. This is the ability
to place a Zone 5 institution into conservatorship while it still has some low
level of positive book capital. Although this last resort in the prompt corrective action system
could sometimes occur quickly, in general it would occur only after a bank had failed to meet
capital plans; gone through Zones 3 and 4 with unsuccessful remedial actions; and finally reached
&e stage where the probability of its continued success had declined to an unacceptably low
pf the bank regulator

level.

Such early resolution would clearly save substantial resolution costs that would otherwise
be bprne by the FDIC. Nevertheless,
it has been argued that it might be an unconstitutional
taking to close an institution that still had positive book capital. For the reasons set forth in
Discussipn Chapter X, Pr m t Cprrectiv
A i n, legal issues associated with early resolution
i be addressed.
Accordingly, it is appropriate to provide early resolution authority in order
to avpid losses to the Bank Insurance Fund and the taxpayer.

ar ransition

Thr

Prompt corrective action includes fundamental changes to the supervisory syst m
b king syst m should have three y~s to adjust to the new mles, with one except on: FSH
with well capitalized bank subsidiaries in Zones 1 and 2 that take advantage of new fm~&
activities would become subject immediately to the prompt corrective action system

a ital Mea

rem n

Finally, capital-based supervision obviously depends directly on the accurate measurem~
of capital. If poor quality assets are carried at book value, capital is erroneously measured @
corrective actions are delayed. The Administration therefore recommends several methods f
These include annual on-site examinations; appropriate loan lq
improved measurement.
reserving; and increased market value reporting.

Annual on-site examin ti

In general, annual on-site examinations are critical to appropriate capital measuremec
On-site examinations provide data that are valuable in identifying current and potential proble
institutions.
This is supported by the experience of the federal regulatory agencies and t
statistical research, which indicates that data regarding troubled loans are among the most useful
indicators of a bank's future performance. When examiner classifications and other troubled loi
data result in appropriate loan charge-offs and in adequate levels of loan losses, capital levels z
conservatively measured and institutions needing regulatory resolution are more easily identified

However, examination information relating to asset quality can quickly become stal~
Accordingly,
the Administration
recommends
each yea
thorough on-site examinations
Exceptions might be appropriate for smaller institutions —those having less than $1 billion I
assets —provided they are well-capitalized.
This recommendation may require the dedicatia
of significant additional resources to examination.

Accurate reservln

frI

n lo

Prompt and accurate reserving for loan losses is also designed to assure a more accuraI
measure of capital. Most bank loans are nontraded assets without ready market values, bi
examiners have considerable experience in anticipating probabilities of repayment of individU'
loans and of classifying loans on the basis of that probability. It may be possible to suppl««
such judgment with statistical procedures that would also provide more uniformity of treat+«~
Efforts to develop such guides are in process.

Accordingly,

it is essential that banks take charges against earnings sufficient

t«&"&

reserves at least equal to estimates of future loan loss based on annual examiner
equations. This would assure a "truer" measure of equity capital, which again, is critical to
prompt corrective action.
their loan loss

mark

Under Generally Accepted Accounting

(Q~)

ciples
hi to cal costs, with subsequent ch
'M
unless
items
are
sold
or settled. Critics have sh~l„
g
and economic measures of in o
ments of the true condition of d
Market Value Accounting (MVA) has bc n pro~~
A detailed analysis of the issues involved in
fggncial information about depository institubons.
A
n 'n .
MVA is set forth in Discussion Chapter XI, M k

"~~~g

Under comprehensive MVA, assets and liabilities would be carried on the balance sheet
Advocates of MVA contend that this would provide
at their estimated fair market values.
economically more meaningful measures of capital, enabling regulators to better identify problem
banks and thrifts. In addition, by making the actual performance and condition of firms more
transparent to private investors, proponents suggest that MVA would enhance the accountability
"
of managers. A particular aim of MVA is to discourage transactions, such as "gains trading,
that are motivated by accounting, rather than by economic, considerations.

Despite its theoretical appeal, comprehensive MVA has a number of problems that argue
against its adoption at this time. Because active trading markets do not exist for the bulk of the
assets and liabilities of depository institutions, many note that, under MVA, fair market values
would have to be estimated using some form of discounted cash flow analysis. The subjectivity
inherent in such procedures would reduce the comparability of faU' market value estimates across
Such
institUtions and render it difficult to verify valuations through audits and examinations.
inability problems would make financial statements more prone to manipulation, thus increasing
whose viability is heavily
Nicertainty about the true conditions of depository institutions,
indent on public confidence. Although it is possible that reasonably specific standards could
be developed to provide the basis for appropriate accounting and auditing practices in this area,
such a process is likely to require considerable time.

a comprehensive MVA
A second concern is the cost of developing and implementing
on smaller
system. Such costs could be substantial, and would likely fall disproportionately
bRllks and thrifts.
Care must be taken to recognize these costs in setting accounting standards.
incremental costs of comprehensive
Piecluding a formal cost-benefit analysis at this time.
However,

hard estimates

of the

it would be premature to impose comprehensive MVA on
and thrifts. An often-mentioned alternative would be to adopt MVA only for those assets
Given the above drawbacks,

banks

MVA are not available,

market values, such as marketable securities and certain residen
mortgages. However, recording some balance sheet items at market and others at historical &
would fail to reflect certain hedging positions undertaken to minimize interest rate sensitivj
As a consequence, the partial MVA approach could result in volatility and distortion in repor
mcome and capital that are misleading indicators of a firm's true financial condition. Adopt
of the partial MVA approach would appear premature at this time, as well.

that have clear secondary

An alternative change in accounting standards would be to require for the present tj
insured depository institutions provide estimates of the fair market values of their assets s
liabilities through supplemental disclosures in financial statements and regulatory reports, sq
as footnotes and memoranda items. Such an approach would not affect the earnings and capj
of institutions reported in the main bodies of their financial statements.

relative to adpptipii
The disclosure approach has a number of advantages
comprehensive MVA. First, market value disclosures would be substantially less costly
implement than comprehensive MVA. In addition, the disclosure approach would provi
flexibility and time for accounting bodies, preparers, and users of financial reports, includi,
regulators, to assess the reliability and cost of market value information.
Thus, the disclos&
approach could lead to the development and eventual adoption of comprehensive MVA,
deemed appropriate.
More detailed disclosures should initially be required only of larg
institutions, which could be given latitude to develop their own cost-effective methodologies f
estimating market values. If these methodologies prove to be useful, they could then form tl
basis for accounting standards applicable to all depository institutions.

Im roved Re ortin

from Inde enden

The final recommendation

i rs

for improving

supervision concerns the relationship betwet
auditors, which is described in detail in Discussion Chapb
XR,
I
. I I
d&R dlb
d
b
bj
since virtually all of the larger banks that pose the greatest risk to the system are already audih
(all but two banks with over $1 billion in consolidated assets), and the costs appear to exc~ &
benefits for the smaller banks that are not currently audited.

banking regulators and independent

R~IIA

Nevertheless,
the Administration
does recommend two changes that could provi~
significant benefits at very little cost.
As described in Discussion Chapter XII, the'
recommendations expand on reporting requirements that the regulatory agencies, including &
Securities and Exchange Commission, already require of certain financial institutions.

First, auditors

or banks should be required to provide a copy of audit «P~
management letters, and other reports or correspondence directly to regulators soon aft« tht'
are provided to client banks. When audits take place between
regulatory examinations, pro»«
audit reports directly to regulators could provide
them with important new information.

Second, banks should provide prompt notification to appropriate regulators of changes
~it rs and qualifications of audit reports. This would improve the quality of information
in auditors and qualifications in audit reports can indicate
le to regulators, because changes
, the practice of banks
~ienis at institutions. It could also reduce "opinion shopping"
It
opinions and
g guidance)
~ch ng for audit ng fiirms to give them favo~le audit
and th ft that are subject to the
require banl
agencies
kould b noh' that the
requirements of the Securities and Exchange Act of 1934 to report changes in auditors
to the institution's appropriate federal regulator.

(ii.

~unt

dr~y

~~g
tiy

other proposals specifically
Finally, existing statutes and practices already address
affect the communication between auditors and the banking
iiientioned in FIRREA that would
Similarly, as set forth in detail in Discussion Chapter XII, many of the auditing
regiilators.
Act, which are also mentioned in FIRREA,
ppyisions of the United Kingdom's 1987 Banking
regulators' existing supervisory authority.
ge generally duplicative of U. S. banking

ri i

mmn

iii

Restrictions on Risky Activities of State-Chartered

Prohibition

Banks

of Direct Investment Activities

Limit Activities Not Permitted for National Banks

No Limits on Riskless Agency Activities

frR

mm n

A fifth approach to reducing taxpayer exposure to bank losses is to limit directly the
riskiness of bank activities. This is a traditional approach that has been used for many years by
" Banks
both the states and the federal government to confine banks to "the business of banking.
are generally not allowed to invest insured deposits directly in commercial enterprises, and other
well-known laws restrict bank activities even in closely related financial lines of business like
Mcurities and insurance.
Banks therefore confine most of their direct activities to traditional
business and consumer lending.

Yet such restrictions on bank activities have not avoided substantial bank losses (indeed,
the lack of diversification has contributed to losses). Recent problems in the
banking industry are not the result of exotic new activities; instead, they are the product of
traditional bank lending to traditional customers.
some argue that

Advocates of activities restrictions argue that even such traditional bank activities are
&herently risky, requiring new limitations.
The extreme position is that insured deposits should
only be invested in virtually riskless investments,
such as short-term government securities or
highly-rated commercial paper —the so-called "narrow bank" or collateralized deposit approach.
o
The less extreme view is that the government
should begin prohibiting particular typess of
traditional bank loans as too risky, such as commercial real estate loans or loans in highly
leveraged

transactions.

Neither approach
forth in

tob
ass
VII,

apractm pluton to
D
Alternativ
t F

Discussion Chapter
propo~ raises questions about whether nonbanking

t~y

sbmh g p o

firms would prom

the narrow bank
pp op

nancial intermediation to the economy, and whether they could operate without the threa
economical]y damaging runs. In any event, formidable transition problems alone cast subs~
doubt on the feasibility of this approach.

l~s

Prohibiting particular types of bank loans is also problematic. Categories of
@„
with
overreactions
problem,
to
yesterday's
usually
practices
are
that
out for prohibition
real
estate
is
lending
a
Commercial
good
example.
corrected.
market has already
and the regulators have already stopped banks from making the most speculative typ s
commercial real estate loans that have created so many losses —to the point now where z
are concerned that there is too little commercial real estate lending. Statutory prohibitions ~0
only exacerbate this problem.
A second problem with singling out categories of loans is the potential for deliber
policies of government credit allocation. In the name of safety and soundness, some types
Over time, such picking q
credit would be prohibited, while others would be permitted.
choosing by the government could result in credit allocation based on social policy rather g
market forces. Such a policy could create serious long-term economic problems.

Excessive State Powers. There is, however, one area of bank activities that does reqU
limitations.
This is the ability of federally insured state-chartered banks to engage in cert;
kinds of activities not permitted for national banks, particularly equity or direct real est,
investment.
States should not have unlimited authority to provide risky powers to state bm
that are federally insured. The federal government has too much exposure to loss with too lit
ability to control risk. This was one painful lesson of the thrift crisis, in which federally insur
state-chartered thrifts racked up huge losses through a wide range of non-traditional din
investments, including shopping centers, windmill farms, fast food franchises, and stud farm,
At the same time, the dual banking system has produced a number of impo4
innovations and benefits for banking consumers, including Negotiable Order of Withdraw
accounts (NOW accounts) and adjustable rate mortgages. The so-called "laboratory of the state
should be permitted to continue as a source of innovation, but federal limits must be imposed
prevent the kind of "nuclear meltdown" that occurred with federally insured state-charter
thrifts.
In FIRREA, the Administration and Congress struck an appropriate balance between tli&
competing interests for federally insured state-chartered thrifts. The legislation did not elimiM
the differences between state and federal thrifts, but it did impose limitations on the states' abili
to authorize risky thrift activities. The Administration recommends that similar limits apPb'
federally insured state-chartered banks.
In providing these recommendations, it is important to recognize that state-chartered &~
have not yet caused the same kind of losses as state-chartered thrifts.
Indeed, inany s&~
chartered banks have exercised their broader authorities both
and Pro~i~
prudently

because of the enormous exposure of the federal insurance funds and the federal
a certain level of federal involvement is clearly appropriate,

Nevertheless,
taxpayer

ifi R

k A ivi i

fDi

mm n

Inv

B
n A ivi i

National banks are not permitted

to make direct equity investments with insured deposits
ill commercial real estate and other commercial enterprises,
although some states permit stateWhile states banks have been more limited and
qhartered banks to conduct such activities.
prudent about this authority than state thrifts, direct equity investment remains a greater risk to
the federal deposit insurance fund than traditional bank loans that have a more senior claim on
,

assets.

Just as FIRREA prohibited

such investments for federally insured thrifts, so should they
be prohibited for federally insured banks, subject to an appropriate transition rule (perhaps as
long as five years). Moreover, certain types of new financial activities should be reserved for
'nonbanking
subsidiaries of FSHCs described in Section VII; they should not be conducted
'
directly by the bank or a subsidiary of the bank.
'

LimitAcivii

P rmi

i n

1B n

There are other instances in which state-chartered banks are permitted to engage directly
activities not permitted for national banks. In general, these activities do not pose unusual risk
to Ole deposit insurance fund. Nevertheless,
there may be instances where unusual or significant
' additional risk is present that creates federal exposure. To guard against this risk, state banks
lliiist satisfy two conditions to engage in activities not permitted for national banks:
they must
»sfy their capital requirements, and they must receive a determination from the FDIC that the
'Ltivities do not create a significant risk of loss to the insurance fund.
' in

Limi

n Ri kl

ivi i

Finally, as in FIRREA, the new federal restrictions on activities would not apply to
'Qeiicy activities authorized by the states for state banks. As Congress recognized in FIRREA,
'%elicy activities present virtually no risk to the insurance fund. The federal government should
~e'efore not intrude on the ability of states to authorize their state banks to engage in any agency
~

Sctivity.

B nkin

VI. Nationwi

List

Full Nationwide

mm n

n hin

for Holding Companies

Banking Authorized

Three-Year Delayed Effective Date

Interstate Branching Authorized

for Banks

National Bank Interstate Branching

Permitted wherever interstate banking is permitted

No preemption

of intr~fgg branching limitations

State Bank Interstate Branching

States determine whether to authorize

Barriers to out-of-state banks removed

Branches of out-of-state banks may not engage in
activities prohibited for in-state banks

National treatment

Immediate effective date

for foreign banks

Reasons for R

mm n

Nationwide banking and branching would lead to safer, more efficient, and mi
competitive banks, directly decreasing taxpayer exposure to losses. Yet the United States is
only major industrialized country in the world that does not have a truly national banking sy»
While much progress has been made toward national banking in recent years, we still hav~
cumbersome system for geographic expansion and diversification that imposes needless costs
banks throughout the system.

There are two potential methods for banking organizations to expand across state lines.
First, bank holding companies could purchase or charter separate banks in separate states with
separate capital structures, and separate regulation.
separate management,
Second, a bank
branch
could
across
state
simply
state
one
lines
into another state.
located in
Through state action, nationwide

banking through the bank
yefy nearly a reality. Thirty-three states have passed laws to permit
13 states permit regional banking; and
bank holding companies;
banking.
The trend toward
prohibit all forms of interstate

holding company method is
nationwide banking through
only four states continue to
full nationwide banking is

unmistakable.

~in

is a different

story
branch across state 1
provide to banks' bottom lines, not to
g o
seNices that would become available to the consumer, restrictions on interstate branching

make

no sense.

The continuing usefulness of branching restrictions is particularly questionable, given the
alrea4y broad expansion of banking organizations through the cumbersome, less efficient holding
The issue is no longer ~wh P~r there should be nationwide geographic
company method.
The Administration believes that banks should make this decision for
expansion, but how.
rather
than
have the government make their decision for them through artificial and
themselves,

constraints.
Interstate branching would promote
immediate cost savings; and increase consumer benefits.
inefficient

safety and soundness;

provide

fet and Soundness. As set forth in Discussion Chapter XVII, Int r tate Bankin and
5GI~hin, branch banks have historically had a better safety record than unit banks, which have
no branches. This is not surprising,
since geographic diversification protects banks from failure
cause4 by localized problems.
For example, during the 1970s, Texas banks were confined by
state laws to a single full-service location, but were considered among the best-capitalized,
most
profitable banks in America. Ten years later, after severe problems with the energy economy,
nine of the top ten had been reorganized
with FDIC or other outside assistance. Appropriate
regional diversification might have prevented some of these failures.

interstate expansion through branching is likely to be much more efficient
than acquiring or chartering
separate banks in each different state. Such branching would save
Under the current
increase profits, and help build and attract capital into the industry.
lf
»st m of expansion through separately acquired banks, there are numerous parallel and
necessary costs that must be incurred in each state. These include separate boards of directors
,
In4 management; separate regulatory reports; separate examinations; separately audited financial
'statements; separate support and control functions; and separate computer systems.
~Efficienc

»,

each bank must satisfy capital requirements separately, which creates complex
"easUry exercises of balancing capital among subsidiaries.
There are also cost allocation
In addition,

proMems, and transfers of funds between subsidiaries is more cumbersome and costly
between branches. In sum, the current system amounts to nothing more than a set of arbi~
roadblocks to efficient, consolidated management.

. Finally,

interstate branching will create important convenience,
consumers, particularly those who frequently cross state lines for work or other reasons
a customer with a bank account in one state typically cannot get full-service
from an affiliated bank in another state without opening a separate account; there wou]d b,
such problem with interstate branching. An interstate branching network will also make ~l,
banking services more available to travelers.

mer Ben fi

In sum, it is time to adopt an efficient nationwide

Full Nationwide

Bankin

S ecifi R

mmn

Authoriz

frH

banking system.

Three-Year Dela ed Eff tiv D

Now that thirty-three states have adopted nationwide banking, it is time to move the er,
country to the same system. The Douglas Amendment to the Bank Holding Company Act sh(
be repealed. However, because this would be a substantial change for state banking systems
do not permit interstate banking, there should be a three-year delayed effective date.

Interstate Branchin

Authorized

frB

The rules would initially be different for
generally provides affirmative authority only to
incentive to shift to national charters to avoid
branching authority of state and national banks is

national and state banks, because Cong
However, given
the banks it charters.
state branching restrictions, over tiiiic
likely to converge.

National Bank Interstate Bran hin

Permitted wherev

nkin

Congress should authorize a national bank to branch into any state in which t"& @
holding company could acquire a bank, which would effectively end the branching res~",
of the McFadden Act. This could be accomplished by converting an existing affiliated bs""
'

an existing bank and converting

it into a branch; or branching ~d ~nv . At
the repeal of the Douglas Amendment becomes effective, the result
In the interim, interstate branching by
sou]d be nationwide branching for national banks.
~onal banks would be governed by the same geographic limits as apply to interstate expansion
tiirpugh holding companies.

a brsnch; acquiring
e end of three years, when

reem tion

f in

n hin

limi

The proposal would not preempt state laws that limit branching ~wi in a particular state
The McFadden Act would continue to apply to intrastate branching by national banks
intrastate branching are inefficient and anticompetitive,
they are still
&tate laws restricting
Thus, a national bank could branch into a state
properly within the purview of state legislatures.
with county-wide branching, and continue to branch within one county. But to go beyond county
or acquisition of a separate institution through a holding
lines would require the establishment
not be permitted.
would
Further branching
(Only 10 states still have intrastate
company.
brmching restrictions. ) In addition, courts have upheld the authorization by the Office of the
Comptroller of the Currency for national banks to branch to the extent state law permits thrifts
to branch in several of these states.

~j]e

tat Bank Interstate Bran hin

above, the branching rules would be different for state banks because
Congress typically provides affirmative new authority only to the banks whose charter it defines
Q„national banks). It typically does not provide direct new authority to state banks, which
are the province of state legislatures.
As mentioned

h riz

State determine whe her

Each state would have to determine for itself whether to authorize interstate branching
lower for its own state banks. Given the grant of such authority to national banks, there would
obviously be strong competitive pressure to do so.

Barriers to out-of-state

m v

be able to limit the ability of an out-of-state bank to branch inside its
(except during the three-year period when states could still restrict certain out-«-»«
outcompanies from acquiring in-state banks) This removal of barriers would apply to
branches of both state and national banks.

A state would not
borders
holding
Of

state

B nh
ivii

-f-

rhi

Activities of a national bank would continue to be defined by federal law, A diffc
problem arises with state banks. When a state bank that is permitted to engage in one ~
activities in its "home state" branches into a "host state" that permits a different set of act, yit
recommends that the host state'~ 1,
which law applies to the branch? The Administration
incentive
to charter a bank in the state ~jQ
should apply. There should be no regulatory
most liberal activities rules and then branch into fifty other states. Each state should g
appropriate authority to govern the activities of state banks operating within its borders.

in 1

nfr

Consistent with the policy of affording foreign banks national treatment, foreign bank
organizations should have the same opportunity to engage in interstate branching and bankin~
U. S. banks.

Imm diat

effectiv

Because interstate branching could only occur in states that have already autborii
interstate banking, and because of the potential for immediate and significant cost savings,
new interstate branching rules should become effective immediately
upon enactment
legislation.
Interstate branching in states that do not now permit interstate banking woi
become effective with the lapse of the Douglas Amendment after three years.

VII. Modernized Financi I

List of Recomm n

H v F'

p rmi Well-Ca i alized Banks

ion

i ns

'
I Aff'

Includes Securities, Mutual Funds, and Insurance
Allow Financial Companies

ommercial Ownershi
C,

rvi

to Own Well-Capitalized

of Financial

rvi

H I in

Banlu

m anies

5gffegiards

Only for Well-Capitalized

Safety Net Confined to Bank

Strict Regulation Focused on Bank

Financial Affiliates Separately Capitalized

Functional Regulation of Aff iliates

Funding and Disclosure Firewalls

Banks

mrna

State law standard for insurance sales

Consumer disclosure firewalls

Umbrella Oversight

Reaso

f rR

the taxpayer.
The nation's banks must be economically viable and competitive to protect
&e erosion of the traditional bank franchise is well documented, both ' in Congressional
n. Banks are no
rni
M
rvi
i
testimony and by Discussion Chapter XVIII, Fin
laws designed to
lotiger the protected and steadily profitable businesses they once were. Old

"protect" banks from competition have become barriers that impede banks from adaptinI
changed market conditions. The result has been financial fragility and losses, as set fprtlI
for Ref rm discussion above.
detail in the N
The time has come for change. Laws must be adapted to permit banks to
profit opportunities they have lost to changing markets. Where banking organizat, pns
natu& exp ~se in other lines of business, they should b glowed to provide it for the ben
of the consumer. Likewise, where other financial companies have natural synergic»
banking, they should be allowed to invest in banks. New sources of capital must be t pp+

Put another way, protecting the taxpayer demands a we11-capitalized banking systein ]
a banking organization must be competitive to build, attract, and maintain capital in its b~
Simply piling on restrictions in Qe name of safety and soundness will not achieve this ej
Adapting to market innovation is critical.
Accordingly, as set forth below, the Administration proposes to allow banks to affili
with a broad range of financial firms through the formation of financial services holgi
companies (FSHCs). Commercial companies would in turn be permitted to own these ni
FSHCs (~ee Figure 11). This proposed structure would create a level playing field that perm
banking, financial, and commercial companies to affiliate with each other on fair terms.
taking this long overdue step; three points are paramount.

First, the proposed changes will not be a panacea for banking problems, particularly
the short-term.
But in the long run, without increasing their costs materially, banki
organizations will be able to earn incremental profits by applying their expertise and resour&
in related financial activities. This blending of banking, finance and commerce will creat(
stronger, more diversified financial system that will provide important benefits to the consun'
protections for the taxpayer.

and important

Second, the proposal will benefit firms that own undercapitalized banks, as well as fin
that own well-capitalized banks. Firms with undercapitalized banks will be able to attract n&
capital to engage in new financial activities either from the financial markets or from diversi'
financial and commercial companies. A more attractive franchise will attract more capital.
Third, the proposal includes crucial safeguards to prevent an expansion of
insurance and the federal safety net to cover new activities. In combination with other
insurance reforms, this will allow banking organizations to increase profitability and
capital without exposing the taxpayer to greater risk.

S ecific Recommen

depo
depo
attr

ti ns

The Administration's recommendation to establish FSHCs is outlined below. Addi"o'
details will be provided in the Administration's
legislative proposal.

Figure 11

Proposed Financial Structure

Financial Services
Holding Company

Commercial
Company

Oversight

by Primary

Bank

Regulator

Insured

Regulated

Bank

by Primary

Securities Affiliate
Bank

Regulated by SEC

Regulator

Insurance Underwriting
Affiliate
Regulated by

State Insurance Commission

Funding

Firewalls

rmi W ll-Ca i aliz d

Includes S

riti

FSHCs with well-capitalized banks would be allowed to earn incremental revenue
financial activities related to banking. The current bank holding company structure o„l,
replaced with the new financial services holding company. Wep~pitalized
that f
in
a
broad
new
the
to
ability
range of financial act, yj
engage
FSHCs would be rewarded with
These
new
financial
affiliates.
affiliates
could engage iq
through separate holding company
financial activity, including full-service securities, insurance, and mutual fund activities (bUt
(Because of their special ownership characteristics, mutually-p~
real estate activities).
insurance companies affiliated with banks would be permitted to engage in insurance activ,
directly from the holding company, rather than through affiliates. )

Allow Financial

wn W 11-

om ani

i liz

By the same token, securities, insurance, and mutual fund companies could gener,
affiliate with well-capitalized banks. This "two-way" street is expressly intended to provide:
competition among firms engaged in the financial services business.
Moreover, as set forth below, FSHCs could be owned by commercial companies, v
strong fiirewalls between the bank and its commercial affiliates. However, FSHCs would
themselves be permitted to engage in commercial activities. There would be exceptions
financial firms that engage in a limited amount of such activities at the time that legislation ~
enacted.
Similarly, a limited amount of nonfinancial activities would be permissible
securities and insurance affiliates that engage in commercial activities in the ordinary course
business (ee, , merchant banking activities by securities firms, and passive investment&
insurance companies).

ommercial Ownershi

of Finan i

rvi

Commercial firms should be permitted to own FSHCs, although stronger firewalls i'
be established between a bank and its commercial affiliates than between a bank and its finan&
affiliates. Allowing only indirect commercial ownership of a bank through an FSHC, rather &
direct ownership, facilitates the enforcement of stronger firewalls.

The time is right to permit broader combinations of banking and commerce. Coni+«'
companies have been an important source of capital, strength, management expertisc ~
strategic direction for a broad range of non-banking financial companies as well as thl
institutions.

More important, banks need capital, and commercial companies constitute almost 8Q
~cent of the capital of U. S. businesses. A number of commercial companies have been and
,vill continue to be interested in owning banks. Indeed, many of the large financial companies
in bank ownership already have broad commercial affiliations,
that might be most interested
gcluding nine of the 15 largest securities companies.

Critics argue that it would be more difficult to regulate banks if they were owned by
(commercial companies, and that there might be biased allocations of credit and inappropriate
While these concerns are legitimate, there are ways to
(g@centrations of economic power.
"egress such problems without the total prohibition on affiliation.
Indeed, none of the
banking and commerce has been evident among the
;hypothetical problems of combining
;commercial companies that currently own depository institutions (thrifts, nonbank banks, and
&industrial banks).
Finally, while it is true that few other countries permit exactly this form of affiliation,
of banking and commerce in our most formidable trading
there are significant combinations
partners, Germany and Japan. Moreover, if the safety net is confined to the bank in the new
fiiiaiicial services holding company structure so as not to spread to financial affiliates, it should
bc feasible to keep it from spreading to commercial affiliates. Indeed, one model to accomplish
I|this could be based on the oversight approach adopted in last year's "Market Reform Act of
1990" for securities firms owned by commercial companies.
1

The case for allowing combinations of banking and commerce is particularly compelling
: in the context of permitting commercial firms to acquire failed banks. In some circumstances,
&substantial losses to the government
from a failed bank might be avoided only by allowing a
&commercial firm to purchase the failed bank. In particular, the pool of available buyers for a
&large failed bank may be very small if it is limited only to financial services companies.

~ks

5~fe uan@
Authorizing new financial affiliations for banks will enhance the competitiveness of both
and the banking system —and a strong banking system is the most important protection

«r the taxpayer. But there must be appropriate safeguards to ensure that the federal safety net
„dac»ot cover these new activities and expose the taxpayer to undue risk. These safeguards
;miist also ensure that funding advantages of insured depositories are not used to subsidize new
'fmaiicial activities to compete unfairly
Accordingly, the
with nonbank financial firms.
Administration proposes the following safeguards for engaging in new activities.

Onl

for Well-Ca italized Ban

Only well-capitalized
~tivities through FSHCs.

banks would be rewarded with the ability to engage in new financial
This makes sense for several reasons. First, financial companies

wouM have a strong incentive to build and maintain bank capital at high levels, providiiil
ost important single protection for the taxpayer Second, the ability to engage in new activ
meed be a new source of earnings that would help build and attract new capital that coul
located to the bank. Finally, additional capital at the bank would be an added protection
any additional risks associated with any new activities

While the level of additional bank capital should be set by the banking regulator, it
be significant, and banks should be encouraged to hold higher levels of both subordjna~,
and equity. In addition, banks meeting their minimum capital requirements and deinpnst
an upward trend toward satisfying the additional amount would be eligible for new fm~
affiliations on a more closely supervised basis.

af t Ne

B nk

nfined

Only the bank would have access to deposit insurance, the Federal Reserve's discc
window, or the federal payments system. Financial affiliates and the FSHC itself woUM h
no such access. This principle is critical. The federal safety net cannot be extended to tlI
entities without eroding market discipline, exposing the taxpayer to additional losses, and Un fa
subsidizing the activities of financial affiliates. The corollary, of course, is that creditors of
FSHC or financial affiliates should receive no federal protection in the event of FS.
insolvency. While the federal safety net should not be extended beyond the bank, this sho
not suggest that regulators should be unconcerned about the stability of our financial system m
generally.

ritRe

inF

nBnk

Regulation would be focused on protecting the bank, which has access to the fel(
safety net, rather than on protecting its holding company, which has no such access. The sy$t
of capital-based supervision, described above, would provide direct safeguards for the exer(
of new activities. For example, an FSHC with a bank falling into Zone 2 —one that only m&
minimum capital requirements —would have a choice: infuse capital to restore the bank to Z&
1 within one year, or divest the new financial affiliates. This is a powerful incentive to maint
adequate bank capital. It also helps prevent new activities from creating problems for anythI
but a well-capitalized bank.

Financial Affiliate

Se arat

i liz

As mentioned above, new activities would be carried out in separately capitahz
As a result, the affiliates could fail without affect ng the capita of the bz
(Restrictions on loans from a bank to its affiliates, described below, maintain this indePeii~ "
Activities would be carried out in affiliates rather than subsidiaries because of the PerceP" "

of the

b~.

pager distance from the bank

—and

therefore greater distance from the likelihood of safety net

protection.

n ion

fAff '

Financial activities would generally be regulated by function, rather than by institution
blikiiig activities by the banking regulator; securities activities by the SEC; insurance activities
insurance commission; and so on (gg Figure 11). For example, the SEC would
by fhe state
Banks' pooled investment activities
generally regulate banks' issuance of their own securities.
And banks with new
gould be regulated in a manner more similar to investment companies.
Securities affiliates would transfer much of their current securities activities out of the bank.
Functional regulation is likely to be more efficient and more effective than having mu]tiple
each regulating essentially the same activity.
agencies

Fundin

and D'

r Fi

w 1

Funding firewalls would be required to contain the safety net within the insured bank.
The transfer of funds between a bank and its affiliates or holding company presents two potential
The safety net could be exposed to losses from affiliates; and the bank's funding
~problems.

the safety net could "leak" into affiliated financial activities.
Administration's proposed restrictions on these transactions —so-called "funding firewalls"
signed to address both concerns.

advantages

from

The

—are

First, Section 23A of the Federal Reserve Act would apply, as it does today, to require
that bank loans to affiliates would be fully collateralized and to limit strictly the amount of such
loans to any one affiliate and in aggregate to all affiliates. This provision would be strengthened
to other types of affiliate transactions, including tax-sharing arrangements, fees, and
, ~to apply
. management contracts.

Second, Section 23B of the Federal Reserve Act would continue to require
basis.
t raiisactions between a bank and its affiliates be conducted on an arms-length
Third, the FSHC would be required to provide prior notice to the bank regulator
usually large transfers of funds between the bank and any affiliate.

that

forth
Fourth, stringent dividend restrictions would apply to undercapitalized banks, as set
FSHCs from
the discussion of prompt corrective action. This would help prevent
miihng" the assets of their subsidiary banks.

transactions
Fifth, the regulator would have the authority to prohibit or restrict certain
These
+ee& the bank and its securities affiliate or certain customers of the securities affiliate.
so-called
@+'etionary funding firewalls would be similar to several of the Federal Reserve's
)I

"Section 2p" firewalls for bank holding companies engaged in certain securities activities
firewalls are intended to prevent undue exposure of the bank's credit in securities transact,
It is critical to maintain regulatory discretion in setting these firewalls because of their evoh
nature, rather than codifying inflexible restrictions in statutory language.

Finally, firewalls should not restrict or impede operational, managerial, or niarkei
synergies between a bank and its financial affiliates. Such restrictions defeat the very pUg
of permitting affiliations between banks and financial companies —to capture synergies
Thus, there would be no limitation pn sh,
efficiencies for the benefit of the consumer.
management, employees, officers, or directors. There would also be no general lirnitatipg
the ability of a bank and its affiliates to market each other's products (except for strict disclp~
requirements, as discussed below).

a. State

law standard

for insu

firewalls, an excepfjpq
Although there should generally be no cross-marketing
appropriate for the cross-marketing of bank and insurance products. It is true that there
obvious synergies between banking and insurance, as consumer groups and the Gen
Accounting Office have both recognized. Seventeen states permit their banks to sell insuran
and the sale of life insurance in savings banks in New England has generally been recogni
as a boon for consumers. It is also true that insurance agency sales pose no risk to the delx
insurance funds, as Congress recognized in FIRREA. Such sales could provide a virtu&
riskless stream of income to banks throughout the country.
Nevertheless, the manner in which insurance is sold by banks has generally been regular
at the state level, which is consistent with the McCarran-Ferguson Act's restrictions on the ri
of the federal government in regulating insurance activities. While there is much discussion ni
of increasing the federal government's regulation of the insurance industry, that has not occurr~
Accordingly, unless greater federal regulation of insurance is sought, the federal governs
should generally defer to the states on the manner in which banks are permitted to sell insure
products of either affiliated or unaffiliated companies.

At the same time, however, the Administration
recommends that national banks
permitted to sell insurance products of affiliated or unaffiliated companies in states that pe«
such activities for their own banks. This is consistent with the concept of generally leaving
issue of bank insurance marketing to state law.

Consumer disclosure firewalls

Consumers will clearly benefit from the convenience and availability of mo« ~&"~
products in banks, such as money market accounts.
But there must be rigorous d's
requirements to prevent customer confusion between federally insured deposits and other fi~~~

Recent celebrated cases of abuse in failed banks and theft
that are not insured.
legislative proposal will include such requirements.
igiderscore this need. The Administration's

products

™,

Umbrella

versi h

As discussed above, bank regulation should be focused on prot t g the bank
access to Se fQerd safe y net, not on Protecting its holding company or finance affiliates.

At
"umbrella
oversight"
certain
of
the
FSHC
the same
by the bank regulator is nec
from
affiliate
risk.
insured
dePository
Umbrella
the
oversight is designed to id ~Qf„
protect
problems in the holding company or affiliates that are likely to cause diff cult,
f g,
The sole, guiding principle of umbrella oversight is to
bank, md to apply remedial action.
protect the insured bank. This oversight would include:

The ability to examine the FSHC and bank, and also to examine any nonbank
affiliate which poses a risk to the bank. (The regulator, if any, of the nonbank
affiliate would have reciprocal examination rights. )
The ability to require sale of a nonbank affiliate if such affiliate poses a clear
threat to the bank.

For banks that fall below minimum

capital standards, the ability to require that
the parent company either: (1) bring bank capital back to minimum standards; (2)
sell or otherwise divest the bank; or (3) become subject to bank capital standards
and other holding company regulations to be applied to the entire organization on
a consolidated basis.
These and other similar protections for the bank will be included in the Administration's
proposal. Unlike current law, however, there would be no cumbersome, bank-like regulation
of the FSHC for the following reasons. First, such holding company regulation risks implicit
'government backing of the FSHC by the government,
increasing the taxpayer's exposure—
where there is federal regulation, there is likely to be federal protection.

Second, full holding company regulation deters investment in banks. While non-banking
'companies are interested in owning banks, they will not be if the price is government regulation
hy bank supervisors
of all non-banking activities.
Finally, it is practically infeasible for a bank supervisor to effectively regulate a complex
«diverse range of businesses. Bank regulation should be concentrated on the bank, which
& effectively regulated, and not on protecting a diversified FSHC that should be subject to
~ormal market discipline.

hne Aco nin T

nin

mmn

Eliminated as Asset on Credit Union Balance Sheets

Gradually

r anizedB

Kxpensed Over Twelve Years

fNaion

Includes Representative

Reas

' '

i n

From New Federal Banking Agency

f rR

mmn

FIRREA requires an evaluation of "the adequacy of capital of insured credit unions and
the National Credit Union Share Insurance Fund, including whether the supervision of such fund
"
40ul4 be separated from the other functions of the National Credit Union Administration.
Di
XIII, gdklL4IB.
1I i
t hah i ~ d
1
i
Ch p

i 1A
uac
In general, both the credit union industry and the National Credit
The ratio of equity
Union Share Insurance Fund (NCUSIF) appear to have adequate capital.
capital to total assets of the credit union industry was higher than the same ratio for the banking
~4ustrjj as of year-end 1989 (although the ratio was lower for credit unions below $100 million
~ +sets). Using the banks' risk-based standard, aggregate union capital was even higher —core
spital of 11 percent to risk-weighted assets.

Likewise, the capital of the NCUSIF is substantial. The approximately $2 billion in the
"~~4 creates a reserve-to-insured deposit ratio of 1.28 percent, which is substantially higher than
&&
ratio for either banks or thrifts.

The problem, however, is the double counting of assets in both the insurance fund and
» «e4it union balance sheets. The credit unions' contribution of one percent of assets to
~P~talize the deposit insurance fund in 1985 is still counted as an asset by both credit unions
+4 &e deposit insurance fund. This practice increases the exposure of the taxpayer for two

~ns.

First, unlike bank deposit insurance, credit union deposit insurance provides only 0qe
layer pf protection between the taxpayer and credit union losses. This is credit union cap
since most of the assets of the credit union insurance fund also count as industry capital
bank deposit insurance, the taxpayer has two layers of protection: bank capital and the p
Insurance Fund, which have no overlapping

accounting treatment.

Second, the current system creates systemic risk problems. Whenever the credit z
insurance fund dips below one percent, credit unions must begin expensing the losses 0g $
As a result, any systemwide downturn could cause a reduct, 0j
own books simultaneously.
credit union capital at the very time it was most needed, creating even more failures aiid z
deductions to credit union capital. This cycle could feed on itself.
I
r. Credit union regulation and credit union dy
insurance are essentially combined in the National Credit Union Administration (NCUA), iii
as thrift regulation and deposit insurance were formerly combined in the Federal Hpiiiq L
Bank Board. Because of perceived conflicts of interest between these two functions, FIRR
separated thrift insurance from thrift regulation. The insurance function was then consoling
with bank insurance under the FDIC, and the regulation function was moved under the Treas
Delertment, alongside the Office of the Comptroller of the Currency —in part to err
consistent rules for banks and thrifts.

tati n f I

r r fr

In theory, the same criticisms that applied to the combination of thrift insurance;
regulation apply to credit union insurance and regulation. Similar potential conflicts exist wl
the charterer, regulator, and insurer are housed in one agency, and the lack of "construct
friction" between an independent insurer and an independent regulator could lead over tim(
more complacent supervision.
In practice, however, there is no evidence that credit union regulation and insurance
been susceptible to the same kind of regulatory lapses as thrift regulation and insurance.
date, the problems of the two industries have not been comparable.

But there does remain one serious area of concern for the taxpayer. The full faith i
credit of the United States government stands behind federally insured deposits in 41 federal
insured institutions —banks, thrifts, and credit unions.
Despite our fragmented regulate
system, there is some uniformity and consistency of rules for banks and thrifts through a sin
deposit insurer. More important, the Executive branch of government has direct accountabij
to the taxpayer for bank and thrift regulatory policy through the Secretary of the Treasury;
Office of the Comptroller of the Currency; and the Office of Thrift Supervision. No such dii
accountability exists for credit union regulation and insurance.

ifi R

T atmen

h n ed Aecountin

Eliminated

mm n

Tlie double counting of insurance fund assets as credit union assets should be eliminated.
~is would create an additional layer of protection for the taxpayer in the event of substantial
union losses, with its use creating no immediate impact on industry capital. While such
losses seem remote now, the thrift industry experience shows how quickly taxpayer losses can
~iiie a reality through federal deposit insurance. Taxpayer exposure must be reduced.

~it

raduall

Ex e

vrTwlv

To prevent abrupt losses to the industry, a twelve-year transition period for expensing the
assets appears appropriate.
double-counted
The annual expense rate would be roughly
comparable to the current growth adjustment rate that credit unions pay annually.
This phase-in
because it will give credit unions time to build capital at the same time as they
i& reasonable
expense the one percent deposit.

aniz

fNai

dBoar

nal

Because credit union regulation and insurance shows none of the same signs of problems
regulation in the 1980s, it is not necessary to separate the two functions at this time.
However, it is important to ensure that there is some nexus for consistent treatment (but not
umform treatment) of all federally insured depository institutions.
It is also important that the
Executive branch have a certain level of accountability
and responsibility for credit union
regulation because of taxpayer exposure through deposit insurance.

e thrift

In ludes Re

enta iv fr m

nkin

Accordingly, the Administration recommends that the Board of Directors of NCUA be
organized. One of the two positions not occupied by the Chairman should be fiHed with a
&oleral regulator
that has responsibility
for a broad range of federally insured depository
~»totions. While this could be a member of the board of FDIC, the Administration prefers that
the position be filled with the Treasury Department's
top banking regulator. Under the proposal
@ forth in Part Two of this Report, this regulator would be the director of the new Federal
SIiiking Agency. This reorganization provides an important nexus between the Administration
+~ tbe regulation of all federally insured institutions.
It would also help ensure consistent

I&a«ry policy among banks, thrifts, and credit unions.

IX.

A. No Assessments on Collateralized

her De o i Insu

Uniform Bankruptcy

mmn

mm n

Borrowing

Exemptions

Reaso

f rR

mm n

on two other deposit insurance issues: (1)
feasibility of adding collateralized borrowing to the deposit insurance base; and (2) possi
changes to bankruptcy exemptions. The recommendations below are based on the issues set fo
Borr win, and Discussion Chapter XX, B~~p
in Discussion Chapter XIV, ollateraliz

FIRREA requires recommendations

S ecific Recomm nda i

A. No Assessments on Collateralized

B rrowin

Collateralized borrowing, which is a source of funds for depository institutions, inclu(
repurchase agreements, loans from the Federal Reserve discount window, Federal Home Lc
Bank advances, and other secured borrowing arrangements. While collateralized borrowings '
not insured, the standard practice of overcollateralization
generally provides full recovery
most secured creditors.
~

Collateralized borrowing can be costly to the insurance fund in two ways. First, to
extent it replaces uninsured deposits which would have suffered losses, the resolution cost of
institution is increased. Second, when a depository institution shifts its funding from depo~
to collateralized borrowing, its insurance fund loses a source of premium income. Howev~
because collateralized borrowing does not represent a substantial proportion of overall fundi
for depository institutions, the actual costs to the FDIC are limited.

Despite potential costs to the FDIC, collateralized borrowing should not be included
the deposit insurance assessment base for the following reasons: (I) it would increase the 0
of secured borrowing for banks and thrifts; (2) it would put banks that are government securi&
dealers at a competitive disadvantage with non-bank government securities dealers; and (3)
could discourage the use of longer-term Federal Home Loan Bank advances, which are

tool for managing interest rate risk. (Discussion Chapter XV, F
H m
an
i ie, examines the use of Federal Home Loan Bank advances for managing
interest rate risk. )

important

niform Bankru

tc Ex m ti

The magnitude of losses incurred in failed banks and thrifts has increased the importance
However, bankruptcy
of the FDIC's ability to maximize recoveries on acquired assets.
debtor's
property available to satisfy debts owing to the FDIC
exemptions limit the amount of a
N4 other creditors. Although the FDIC has not been able to measure the amount of its losses
exemptions, the amount is believed to be significant based on
resulting from bankruptcy
combined FDIC and RTC experience in certain states with broad bankruptcy exemptions.

FIRREA requires this Report to consider the impact on the deposit insurance funds of
varying state and federal bankruptcy exemptions and the feasibility of (a) uniform exemptions;
when necessary to repay obligations owed to federally insured
(b) limits on exemptions
and
depository institutions;
(c) requiring borrowers from federally insured depository institutions
to post a personal or corporate bond when obtaining a mortgage on real property.
Based on the considerations set forth in Discussion Chapter XX, the Administration
continues to support uniform bankruptcy exemptions (as it did in the Federal Debt Collection
Procedures Act of 1990). Uniform federal exemptions would minimize the loss to the deposit
insurance funds resulting from borrowers of insured depository institutions declaring bankruptcy
hand exempting
assets. The current widely divergent state bankruptcy exemption statutes result
in adverse collection actions and unfairly disparate treatment of debtors based solely upon their
domicile.

However, this option was considered by Congress in 1990 for debts owed to the United
5~tes and rejected. The next most effective way to protect the deposit insurance funds would
be to set limitations
on bankruptcy exemptions based on the conduct of the debtor. Such
limitations could be used to permit certain exempt property to be liable for debts arising from
Se misuse of loan proceeds or from the misuse of bankruptcy planning devices.

PART TWO: REGULATORY RESTRUCTURING

of strengthened

regulation and supervision of insured depositories is the
of the current regulatory system for banks and thrifts. (Regulation is the
restructuring
establishment of rules, and supervision is the enforcement of those rules through examination of
operations. ) The present complicated structure for bank and bank holding
a depository's
company (BHC) regulation and supervision is divided among the Federal Reserve, the OCC, the
gpss and state banking agencies. The OTS focuses on thrifts. Qz Figure 12.)
A major element

lato

rin

The consequence is
The result is too many regulators with overlapping responsibilities.
of
with
consumers
well
as
duplication
effort,
the additional cost.
as
bearing
less accountability,
por example, a BHC with a state-chartered non-member bank subsidiary would be supervised
Furthermore, BHCs rarely have the
lay the Federal Reserve, the FDIC, and its state regulator.
one regulator as their subsidiary bank(s). The result is a regulatory framework that has been
across banking organizations, nor to address as
able neither to foster consistent regulation
the
many supervisory needs of the banks. (For a more
promptly and efficiently as necessary
see
reform and historical recommendations,
detailed discussion of the need for regulatory
r )
f Th R 1
Discussion Chapter XIX, R form
~

a regulatory

system today from
structure.
It effectively began with the establishment of
Lincoln, other component parts were added in the early
completed with the Bank Holding Company Act in 1956.
information flows,
overhauled, even though technology,
iMovation, and consumer sophistication have completely
M'rvices from the time of the Great Depression.
No one creating

scratch would design the current
the OCC in 1863 under President
20th century, and it was largely
It has never been comprehensively
global competition, private sector
transformed the world of financial

It is clearly desirable to move to a simplified, streamlined regulatory structure, such as
«one discussed below. However, this restructuring should be implemented only after other
elements of the Administration's
comprehensive proposal are in place. It should also be
implemented gradually over time to avoid disruption of the financial system.

regulatory structure should achieve the following objectives compared to
«current system: greater accountability, efficiency, and consistency of regulation and
+P vi»M, through a reduction in the number of regulators; improved consumer benefits from
«reduced duplication and overlap; and the separation of the regulator from the insurer. In
atta»ng these goals, significant roles for the Treasury, the Federal Reserve, and the FDIC
should be retained.

~ redesigned

Figure 12

Current Federal Regulation and Supervision of Banks and Thrifts
and their Holding Companies

FRB

TREASURY

OTS

State and
Federal
Thrifts

FDIC

OCC

Holding
Company

National
Bank

Holding

Company

State
Member
Bank

Holding
Company

State
Non-Member

Bank

Holding
Company

F de

Iator A

roa h

B nkin

A enc

strongly reflecting the proposals of the 1984 ~Re
Two specific recommendations,
'
1
i
n
f
in
i
R
n
r
(gg Discussion Chapter XIX), would help
the
four
First,
present
federal
these
goals.
regulator bank' g fnodel (i
achieve
Fed
and
would
be
FDIC,
OTS)
simplified
to
OCC,
and
two,
the
Reserve,
s e fede&
1 o
The Fede~ R
would be responsible for a BHC and its subsidiary bank(s).

Q~f

ibl

5 dl~lh

dth'

BHC

performed bY the FDIC with regard to statewhartered
In addition, a new federal
to the Federal Reserve.

g„)g~g, „„.„

non-member banks would be t sfemR
regulator, the Federal Banking Agency
under
created
and
be
would
would
Treasury,
be
responsiMe for all ~n&i~n bank and
(FBA),
functions
of
the
and
The
OCC
those
BHCs.
regulatory
their
responsibilities presently
out
Reserve
for
the
BHCs
of
national
Federal
banks
the
would
therefore
be
transferred
to the
by
pBA. The FBA would also take responsibility for the affairs of OTS at the date it completed
assigning thrifts to the RTC. (Sing Figure 13.) When a BHC contains both state-chartered and
aational banks, jurisdiction over the entire organization would go to the charterer of the largest
subsidiary bank. The Federal Reserve and the FBA would mutually agree on BHC regulatory
policies and practices.

c~R

Such consolidated regulation would clearly promote the goals of regulatory accountability,
efficiency, consistency and consumer benefits enumerated above.
Accountability would be
enhanced, as responsibility for bank regulatory matters would be focused in only two entities,
the Federal Reserve and the FBA. Efficiency would be improved by having the same federal
regulator/supervisor
for each BHC and subsidiary bank. Consistency would be achieved by
having questions concerning bank regulation and BHC/bank supervision decided by the Federal
Reserve and the FBA together. Consumers would expect to benefit from the harmonized bank
regulation and supervision through reduced BHC/bank paperwork time and cost. Finally, the
federal regulator (Federal Reserve or FBA) would be different from the insurer (FDIC).

Joint decision-making
by the Federal Reserve and the FBA would ensure that their
(The states
+sights on policy were obtained and their respective interests were considered.
w«14 offer a counterpoint to the two federal regulators by continuing to charter, regulate, and
supervise state banks. ) The Federal Reserve's ability to carry out monetary policy and discount
wiiido+ activities would be preserved, as would its capacity, in concert with the Treasury, to
intake the important
systemic risk ("too big to fail" ) judgments.

The sharing of BHC supervisory responsibilities with the Treasury through the FBA
This is wholly
w«ld ensure that there was regulatory accountability in the Administration.
ppr0priate in that the Administration
bears responsibility for the successful functioning of the
economic and financial system. This is also in keeping with the prominent role finance
st es play abroad, in count es such as Japan and Germany, in bm regulatory matters.

Figure 13

Proposed Federal Regulation and Supervision of Banks
and Thrifts and Their Holding Companies

Federal Reserve
Board

TREASURY

Federal Banking
Agency

State and
Federal
Thrifts

Holding
Company

National
Bank

Holding
Company

State
Bank

Holding
Company

I F

used On Insurance

i n

The second change would be to consolidate all insurance and resolution programs for
blnks and thrifts in the FDIC. It would no longer supervise banks, but it would administer the
insurance system, protect the safety and soundness of its insurance funds, and manage
resolutions (as it does thrift resolutions through the current RTC). The FDIC
Niy resulting bank
w0uid receive copies of all bank call reports to be able to monitor banks'. performance and could
&xamine troubled bailks with the approval of the Federal Reserve or the FBA. It could also take
ciif0rceinent actions it deemed necessary against unsafe and unsound banks if either federal
rcgiihtor, upon its request, failed to act.

~sit

Focusing the FDIC's duties solely on insurance and problem bank/thrift resolution offers
appropriate complement to the consolidated regulatory structure and a recognition of the
iiiip0rtance of these activities. The FDIC would also need to continue its surveillance of state~hartered bank activities to decide whether those that exceed activities permitted for national
baiiks should properly benefit from federal deposit insurance. (Otherwise, the state-chartered
established and capitalized
bank would have to engage in such an activity in a separately
intention to narrow the scope of the safety net, the proper
affiliate. ) Given the Administration's
—
inside or outside the insured depository —is of great significance.
location of such activities

In addition,

a significant number of banks may fail in the coming years, although the

system of prompt corrective action should help to reduce that number
over time. Timely resolution of these problem banks is necessary to avoid assets overhanging
the market and weakening the earning potential of the remaining banks. The FDIC's recent and
ongoing experience in its work with the RTC will provide important benefits in dealing promptly
with the assets of problem banks that purchasers of those banks do not want.
proposed early intervention

PART THM~:E: RECAPITALIZATION

OF THE BANK INSURANCE FUND

The Bank Insurance Fund (BIF) is the FDIC fund that insures deposits in commercial
banks and some savings banks. The Fund has declined substantially
since 1987, and needs to
with
funds
industry
in
the
near term. In October 1990, the Congress passed an
be recapitalized
Administration sponsored bill, the FDIC Assessment Rate Act of 1990, which gave the FDIC
the additional authority it needed to implement a recapitalization
plan for BIF.

frR

itali

ion

The predecessor to the BIF was created in 1933 by the Federal Deposit Insurance Act.
The Fund was initially capitalized by a contribution of $150 million from the Treasury and $139
million from the Federal Reserve System; these amounts were fully repaid in the 1940s. At the
Fund's iiiception, deposits were insured up to $2, 500, which represents about $25, 000 in
1990
dollars.

From its beginning in 1934 until 1988, the Fund experienced a decline in its net worth
only once —in 1947, when the Fund returned to the Treasury the funds contributed in 1933 to
capitalize it. As Table 2 shows, the Fund always held equity of substantially more than $1.00
for every $100 in insured deposits.
As recently as year-end 1987, the Fund's net worth was
$18.3 billion, or $1.10 for every $100 in insured deposits.

more
level

Since 1987, however, the Fund has incurred sizable losses, reducing its net worth by
than 50 percent. Each of the last three years has produced a new record low in the Fund's
relative to the amount of insured deposits.

h Pro'ecti ns. According to current estimates by FDIC Chairman

L. William

Seidman, the Fund sustained a net loss of approximately $4. 7 billion in 1990, subject to an audit
by the General Accounting Office. Over 80 percent of this loss represents reserves for failures
expected in 1991. These losses have reduced the Fund's net worth to approximately $8.5 billion,

«only $0.44 per $100 in insured deposits.
The FDIC's most recent baseline projection is that, assuming

that the current recession

a moderate one of about six months duration, BIF's net worth will decline to approximately
&39 bilhon by the end of 1991. For 1992, the FDIC's baseline projection is for a further
me to $2.4 billion. Under more pessimistic assumptions, the FDIC projects that the Fund
Is

would

decline to

$0 by year-end 1991, and fall further to negative $5.8 billion

1992.

V~ous other private and public sector studies have also projected that the Fund will
"perience another substantial decline in the next two years, particularly if economic conditions
are unfavorable.

Table 2
Insured Deposits and the Deposit Insurance Fund,

Deposits
Year (December 31)

100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
40,000
40,000 s
40,000 5
40, 000
40,000
40,000
20,000
20,000
20, 000
20, 000
20,000
15,000
15,000
15,000
10,000
10,000
10,000
10,000
10,000
10,000
10,000
10,000
10,000
10,000
10,000
10,000
10,000
10,000
10,000
10,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000
5,000 4

1989..
1988..
1987..
1986..
1985..
1984..
1983..
1982
1981..
1980..
1979..
1978..
1977
1976..
1975..
1974..
1973..
1972
1971..
1970..
1969..
1968..
1967
1966..
1 965.......
1964..
1963..
1962
1961..

1959..
1958..
1957
1956..
1955..
1954..
1953..
1952

1951..
1950..
1949..
1948..

1947
1946..
1945..
1944..
1943..
1942
1941
1940..

1939..
1938..
1937
1936..
1935..
1934..

' Deposits

in insured

banks

'
Percentage of

Insurance

coverage

Total

Insured

2,465, 922
2, 330,768
2,201,549
2, 167,596
1,974,512
1,806,520
1,690,576
1,544, 697
1,409,322
1,324,463
1,226, 943
1,145,835
1,050,435

941,923
875,985
833,277
766,509
697,480
610,685
545, 198
495,858
491,513
448, 709
401,096
377,400
348,981
313,304 s
297,548 s
281,304
260,495
247, 589
242, 445
225, 507
219,393
212,226
203, 195
193,466
188,142
178,540
167,818
156,786
153,454
154,096
148,458
157,174
134,662
111,650
89,869
71,209
65,288
57,485
50,791
48,228

1934-1989

of dollars)

(In millions

1,873,837
1,750,259
1,658,802
1,634,302
1,503,393
1,389,874
1,268, 332
1,134,221
988,898
946,717
808,555
760,706
692, 533
628, 263
569, 101
520,309
465, 600
419,756
374, 568
349,581
313,085
296, 701
261,149
234, 150
209,690
191,787
177,381
170,210
160,309
149,684
142, 131
137,698
127,055
121,008
116,380
110,973
105,610
101,841
96,713
91,359
76, 589
75,320
76,254
73,759
67,021
56,398
48,440
32,837
28, 249
26,638
24, 650

50,281
45, 125
40,060

23, 121
22, 557
22, 330
20, 158

18,075

insured

Deposit
insurance

deposits

fund

76.0
75.1
76.9
75.4
76.1
76.9
75.0
73.4
70.2
71.6
65.9
66.4
65.9
66.7
65.0
62.5
60.7
60.2
61.3
64. 1
63.1
60.2
58.2
58.4
55.6
55.0
56.6
57.2
57.0
57.5
57.4
56.8
56.3
55.2
54.8
54.6
54.6
54.1
54.2
54.4
48.8
49.1
49.5
49.7
42.4
41.9
43.4
36.5
39.7
40.8
42.9
45.5
46.8
44.4
44.7
45.1

.91
.92
.91
.89

.87
.83

.80
.77
.78

.77

.77
.73

.73
.74
.78
.80
.82

.76
.78
.81
.80
.82
.85
.85
.84

2, 222.2
2,089.8
1,965.4
1,850.5
1,742. 1
1,639.6
1,542.7
1,450.7
1,363.5
1,282.2
1,243.9
1,203.9
1,065.9
1,006.1
1,058.5
929.2
804.3

.81

.82

.79
.77

.76
.75
.72
.72
.74

.77

.89
.65

.71

.59

703.1
616.9
553.5
496.0

.69
.78

452. 7
420.5

.79
.83
.79

.76

383.1
343.4
306.0
291.7

.73

in foreign

'age

Sg.wp from January 1 to June Sp, tg84.
'. g
of
for ind~kfu~
sr u Rsarsmsnt a~unt in-state governmental
and KKgh amunt
Source: FDIC Annual Reports

$] QQ QQQ

Total deposits

13,209.5
14,061.1
18,301.8
18,253.3
17,956.9
16,529.4
15,429.1
13,770.9
12,246. 1
11,019.5
9,792.7
8,796.0
7,992.8
7,268.8
6,716.0
6, 124.2
5,615.3
5, 158.7
4, 739.9
4, 379.6
4,051.1
3,749.2
3,485.5
3,252.0
3,036.3
2,844.7
2,667.9
2, 502.0
2,353.8

branches are omitted from totalss
because they are not insured. Insured deposits are estimated
regular Call dates the percentages
ges as determin
termined from the June Call Report
submitted by insured banks.

, ~&~

Ratio of dspoei
hllld to

units provided

prowdaj

in 1 974.

1978

by applying

The FDIC uses its borrowing authority to finance its work;ng
onstrain
the ~sets that are ret ned in renlving failed inst t t ons. The Fund faces const
nts
Npbd
in
authority
the
borrowing
near
term.
this
pf
0& the use

g rr

win

have outstanding liabilities at any time no greater than nine times
has a $5 billion line of credit from the Treasury that is not subject
is currently well within this limitation on borrowing. Hpwever
Fund could run out of borrowing authority, and thus be unaMe tp
resolve institutions, before it could exhaust its net worth. The liquidity constraints faced by BIF
rciiifprce the need to address the condition of the Fund as soon as practicable.

By law, the Fund may
its ilet worth. (The Fund also
to this limitation. ) The Fund
because pf this limitation, the

d. The

depletion of BIF's resources is a direct result of the
b@ytened pace of bank failures that began in the late 1980s. In some measure, these failures
Nc the result of the failure to adapt our outdated banking laws and regulatory practices to the
In prior eras, this regulatory system served us well. Now it
gliNiging financial marketplace.
prevents efficient geographic diversification, limits the range of permitted activities, and renders
pur banks unable to compete effectively on the world financial scene.

Fund is De let

failed to produce timely intervention by regulators
In some cases, earlier intervention could have reduced or minimized

In addition, our system has sometimes
in

deteriorating

institutions.

losses to the Fund.

Finally, the Fund is under stress because the federal deposit insurance safety net has been
It now protects almost all depositors —insured as
extended well beyond its original purposes.
—and permits individuals and corporations to have essentially unlimited
well as uninsured
insurance

coverage.

Recapitalization of the Fund —while necessary —will not by itself contain the long-term
exposure of the taxpayer to bank losses.
In the end, only a safe, profitable, competitive,
modernized banking system can do that. Our outdated banking laws prevent the achievement of
structural
&is goal. This Report proposes reforms that are designed to eliminate underlying
Aaws in pur banking
In addition, the Report includes proposals
and supervisory system.
dcsigiied tp rein in the overextended
scope of federal deposit insurance, and to return federal
It is critical that these
deposit insurance to its original purpose of protecting small savers.
reforms be enacted to ensure the success of any plan to recapitalize the Bank Insurance Fund.

lizati n

A plan to recapitalize

1.
2.

3.
4.

It
It
It
It

should
should
should
should

BIF should be designed to meet these objectives.

provide sufficient resources.
take into account any impact on the health of the banking system
rely on industry funds.
use generally accepted accounting principles.

These criteria are discussed below.

uffi i nc

The plan must provide sufficient resources for BIF to meet its needs. There are a num
of perspectives from which to evaluate these needs.

The Ideal Level

f the

Fund. The Fund must have resources that are adequate

to ir

its needs. Beyond that truism, there is no known scientific means of deriving an "optic
level" for the Fund. Ultimately, a judgment must be made as to the contingencies the F~
should be expected to handle.

Based on prior law and a review of historical Fund levels, FIRREA affirms
"designated reserve ratio" for BIF of 1.25 percent of insured deposits. With insured depo,
today of roughly $2 trillion, a Fund of $25 billion would be necessary to meet that goal. 3
FDIC Assessment Rate Act of 1990 gave the FDIC the authority to vary the designated rese.
ratio to take into account expectations as to the Fund's anticipated needs, and to raise or lo~
premiums accordingly.
Over time, it might be desirable to return the Fund to the 1.25 percent target, aiid
maintain it at that level or higher. Immediate achievement of that goal, however, would requ
a special assessment of roughly $20 billion on the banks in 1991, in addition to regu
assessments of over $5 billion. This would be detrimental to the health of the banking indUs
and could increase losses to the FDIC.

FDI pro'ectio

The FDIC believes that it can foresee losses over a one-to-two Y'
period with some degree of accuracy, but does not attempt to project losses beyond two Ye
because it has little confidence in the results. As noted above, the FDIC's baseline p«jec"t
for the next two years indicate that, if there is a moderate recession of about six months dUrati&
the Fund's net worth will decline to $2.4 billion by the end of 1992. Based on assumption.
considers pessimistic, including a recession more than a year in duration, the FDIC projects &
the Fund would decline to $0 in 1991 and to negative $5.8 billion in 1992.

pi' '

The 1992 Budget is required to project BIF outlays over
a
a
moderate
Assuming
recession
and
period.
no
change
in
current law, the current
five-year
~line projections are that the net worth of the Fund will be negative $2.2 billion by the en
pf Fiscal Year 1992, and will decline to negative $22.2 billion by the end of Fiscal Year 1996.

B pi 0'

The Congressional Budget Office's (CBO's) most recent baseline
ProJections show the Fund declining to negative $2. 8 billion at yearend
1992, remaining
and
1994,
through
increasing
negative
to
positive
$4.2 billion in 1996. These
y
~ectipns assume that the recession ends by mid-1991. CBO also projects better results for a
lder recession, and worse results for a longer, more severe one.

g~n;]gr»~n. The projections set forth above include varying assumptions about premium
However, they point to a common conclusion —it is quite possible that
~tes Mid failures.
further losses will eliminate the remainder of the Fund's equity over the next two years. Beyond
the iiext year or so, however, the size of the Fund's losses is highly uncertain.
The future state of the economy will be the single most important factor in determining
In addition, the Administration's banking
lwses, and that is obviously not knowable today.
should
if
make
banks
adopted,
stronger
and less likely to fail. This should
reform proposals,
positive effect on the Fund over time. However, this effect is difficult to
have a substantial
quantify

with precision.
In light

the near-term

clearly meets
future

needs

of this uncertainty, it would be wise to adopt a flexible recapitalization
needs

plan that
the Fund, and that can expand (or contract) to meet the

of the Fund as they become clearer.

2. Im

n h

Bnkin

$200 billion in equity and average annual after-tax earnings of roughly $18
biilioii during 1985-89, the banking system appears to have the capacity to finance a substantial,
multi-year recapitalization of BIF However, a recapitalization could produce incremental strains
It is desirable
ou the system at a time when failures and losses are already at an all-time high.
to recapitalize the Fund in a manner that satisfies BIF's needs, without materially increasing bank
With over

&ures or reducing the availability

of credit to

the economy.

There are two important ways in which a recapitalization could be counterproductive.
First, if funds are withdrawn from the banking system too suddenly, with no opportunity for the
could cause substantial
to plan or to spread the costs over time, the recapitalization
N«mental failures and losses to the Fund. Second, a recapitalization could negatively affect
" It should be possible to
''edit availability, given the increased evidence of a "credit crunch.
umize the negative impact of the plan on credit availability, however, by stretching out its
mplementation over time and by placing clear limits on the banks' obligations.

f Indu

Fun

yanking leaders have expressed confidence that the industry can provide a private M
solution to the recapitalization of the Fund. In addition, the FDIC has recently stated th
believes that the Fund's resources are sufficient to handle the losses it now foresees, alth&
it may require additional funds for liquidity.

Since the Fund was initially capitalized in 1933, the banking industry has fui]y born&
burden of paying for bank losses. Industry leaders express confidence that this record
continued. However, others have questioned whether the industry can fully fund ]os~s ~
more pessimistic scenarios.

nerall

Acc

ed A

n in

Prin i I

Confidence in the recapitalization plan and in the banking system will be strengthens,
Reliance on non-standard account
the plan is straightforward
and easily understood.
techniques will undermine support for any plan.

nluin
The Administration will submit proposals as part of its comprehensive deposit insum
and banking reform legislation, to the extent any changes in law are required to implement
terms of the plan.

DISCUSSION CHAPTERS

DISCUSSION CHAPTERS
TABLE OF CONTENTS

Histo

osit

Insurance

Introduction

Origins of the Current

Benefits

2.
3.
4.
5.

Concerns Raised by the Existence of Deposit

Insurance

Moral Hazard
Concerns about Insurance

How

.. .
.. .
of

. . .

Background

The Period
The Period
The Period
The Period
Changes in

1934
1942
1972
1980

to
to
to
to

1942
1972
1980

the Present
the Financial Marketplace

Affecting Banks

Summary

Deposit Insurance
An

Coverage and

. . . . . . . . .
Przcxng . .
Concerns about Bank Supervision .
Concerns about the Competitiveness
.. . . .
the Banking Industry

Historical

and Supervisory

Systems

Overview

the FDIC

I-4
I-4
I-4
I-6
I-9

I-11

Summary

2.
3.
4.
5.
6.

Large Banks

Protection of Small Depositors
Prevention of Banks Runs t
The Cost of Runs on Banks
Systemic Effects of Runs on Individual
0

2.
3.
4.
E.

I-2

of Federal Deposit

and Purpose

Insurance

Deposit Insurance

System

Has Handled

Historical Background
1

Bank

Failures

. . . . . . . . .

I-11
I-12
I-13
I-13
I-16
I-17
I-17
I-18
I-18
I-19
I-25
I-27
I-27

I-30
I-30

2.
3.
4
5.
6.
7.

payoffs
Bridge Bank Authority
Open-bank Assistance
Forbearance and Government Ownership
Treatment of Parties in a Bank Failure
Asset Disposition in Bank Failures

H.
Ca

ital

Purposes

4.
5.
6.

and

II-

Benefits of Capital

Adequate Capital Lowers the Probability
of Bank Failure
Reduces Incentives to Take Risks
Acts as a Buffer Ahead of the Insurance
Funds and the Taxpayer
. . . . II
Reduces Misallocation of Credit Caused
. . . . II
by the Safety Net
. . . II
Helps to Avoid "Credit Crunches"

. . .
. . . .. .

Increases

Long Term Competitiveness

Bank

Capital Ratios in Perspective

Historical Trends

Capital Holdings by Institutions
Under the Safety Net
Bank Capital by Asset Size Class

. . II
. . . II

Not

II.
II.

Risk-Based Capital

2.
3
4.
5.
~

IIII-

Ade

Introduction

Summary

of Risk-Based Capital
Components of Risk-Based Capital
Minimum Capital Requirements
Interest Rate Risk
Potential Effectiveness of Risk-Based
Purposes

Capital

Responding

Capital

Arguments

Against

Increased

. . . . . . . . . .. . ..

Raising Additional Capital
Difficult and Costly
Higher Capital Requirements
U. S. Banks'

International

Competitiveness

Would be
Would Hurt

II-

II.
II.
II-

Higher Capital

May

II-14
Asset Growth
II-15
Capital Requirements Wou]d
Higher
5.
Result in Consolidation
II-16
6. How'Rm0High Should Minimum Capital Ratios
Be
II-17
Increased Reliance on Subordinated Debt . . II-19
1. Arguments in Favor of Subordinated Debt II-19
2. Required Minimum Subordinated Debt
Holdings
II-19
3. Potential Problems with Subordinated
D ebt
II-20
Current Usage of SND
4
II-23
5. Feasibility of Substantial SND
4~

Requirements

Increase Risk Taking.
Higher Capital Requirements

Would

Slow

II-24

Issuances

of Risk-Based Capital

Comparison

and

Based Deposit Insurance

Sco e

Risk-

osit Insurance

Introduction

The

. . . . . . . . . . . . . . . . III-1

Trade-Off Between Stability
Depositor Discipline

and

III-2

Perspectives in the Trade0ff
Reconciling Stability with Depositor
Dzscxplxne
Competing

2.
C.

2.
3.
4.
D.

Proposals

for

Reform

Legal Rights and Capacities
Increasing Market Discipline

Increasing
Increasing

Stability

Depositor Discipline

"Too Big To Fail"
Insured Deposit Payoff Risks

Market

Policy Objectives in Resolving Bank Failures

Rules

II-25

Discipline

from Depositors

vs. Discretion

III-3
III-7
III-11
III-11
III-13
III-18
III-20
III-27
III-29

III-31
III-35
III-36

Public

Appendix:

Comments

. . . III

Legal Rights and Capacities

The Legal Underpinnings

Proposal for Eliminating
Rights and Capacities

Brokered Insured

Different,

III
III

osits

Introduction

IV-:

Background

IV-:

2.
C.

Empirical

Arguments

Deposits

3.
D.

Historical Trends

IV-:

For and Against Use of Brokered
IV-(

Increased Taxpayer Exposure Through
Expansion of Scope of Deposit
Insurance Coverage
Increased Costs Associated with
Brokered Deposits

Potential Benefits of Brokered

IV-'

Depos

Policy Options
1

Unit Insurance

Weak

Institutions

4.
5.
6.

Introduction

Eligibility

Protection

IV-1
IV-1

V-1

Requirements

Accounts Receiving

for Pass-Through

Pass-Through

Institutions
Defined Contribution Plans
Defined Benefit Plans

V-2

Coverage

Pension Plan Deposits in Depository

IV-8
IV-9
IV-9

Insurance

Other Requirements
Eliminate Brokered Deposits

Pass-Throu

IV-tI

IV-8

on Brokered

Coverage

Deposits
Interest Rate Limits
Growth Limitations

its

IV-'
IV-8

Restrict for

IV-;

Studies

V-3
V-4
V-6

4.
5.
D.

Multi-Employer

State

and Local Government

Public Policy Issues Concerning Pass-Through
Insurance
. .. . . .. ... . . . . .
1

Protecting Small Depositors and
Promote Bank Stability
Risk to the Insurance Fund
Efficient Allocation of Capital

.........
Plans .

Plans

Insurance

of Forei

Treatment

V-8

V-9

V-11

V-13

History

Regulatory

Appendix:

V-8
V-8

V-15

osits

n De

Introduction

VI-1

Background

VI-1

Arguments

in Favor of Assessing
Foreign Deposits

1.
2.
3.
4~

Improved

Banks 0 ~
Other Arguments

Deposits

VI-2
VI-3
VI-4

Fund

for Assessing Foreign
and Insuring

Against Assessing
Foreign Deposits

Expanding

Funding Markets
Adverse Impact on Trade

the Safety Net

Effects
Effect on Bank Profitability
The Fairness Issue
Effects on Foreign Countries
Effect on International Interbank
Competitive

to Federal

Introduction

VI-5
VI-5
VI-6
VI-6
VI-6
VI-7
VI-7
VI-8
VI-8
VI-9

VI-9

Other Options

Alternatives
A-

VI-2

for Smaller

Competitiveness

Arguments

2.
3.
4.
5.
6.
E.

Increased Revenue to Insurance
De Facto Insurance
The Fairness Issue
~

and Insuring

osit Insurance

. . . . . .

. . . .. . . ..

VII-1

Analysxs

Capitalized

Privately

ork

Private Insurance
Insurance

. .

Analyszs

Private Supplement
— Summary

Reinsurance

to Federal Insurance

VII

Insurance

Approaches

Implications

of Mispriced Deposit Insurance
as a Subsidy or Tax . . . .

Premiums

Moral Hazard

Counterbalances
Under Current

VII
VII

Regulatory

Problems

Ex Ante

vs.

VII
VII

VII

to Increased Risk-Taking
System

Market Discipline

General

VII

Premiums

. . . . . . . . .. . . . . ..

VII

VII
VII

Introduction

VI]

System

VI'

to Federal

. . . .. .
1. Narrow Banks . . . . . . . . . . . . .
2. No Deposit Insurance . . . . . . . . .

Non-Deposit

VI]
VI]
VI]

— Summary

as a Supplement

a Public-Private
Might Work

Risk-Related

. .. . . . . . . . .. . .. .

How

Deposit Insurance

Private Deposit Insurance

Analyszs

Private Deposit Insurance Might

How

State Deposit Insurance Systems—
Summary

. . . .
. .. ... .
. . .. ..
..

Bias Against Effective Policies

2. Government Inefficiency .
State Deposit Insurance Systems
2.

to Federal Deposit

General Objections
Insurance

Discipline
in Pricing Bank Risk
Ex Post Risk
V1

VII.
VII

Adverse Selection
Monitoring the Insured

Proposals

1.
2~

IX.

VIII-6
Using Market Information to Assess Risk VIII-6
Using Nonmarket Information to Assess
Risk
VIII-9

Arguments For and Against
Premiums

2.
G.

for Risk-Related

Comments

Introduction

The Nature

The

2.
E.

IX-1
IX-2
IX-2
IX-2
IX-3
IX-3

Interest Rate Risk

Operational Risk
Fiduciary Risk
Foreign Exchange Risk

in Insured Depository

IX-3
IX-3
IX-4
IX-5
IX-6

Credit Risk

Interest Rate Risk
Operational and Fiduciary Risk
Foreign Exchange Risk
Supervisor's

Insured

by Insured

Credit Risk

Institutions

2.
3.
4.

Role in Risk-Management
Depository Institutions

of Supervision

and Areas

for

Improvement

Potential Shortcomings

Supervisory Process
Options for Supervisory

IX-7
IX-7
IX-8

Process
Tools for Controlling Risk
The Supervisory

Shortcomings

VIII-20

Premiums

IX-1

Risk-Management

VIII-14
VIII-14
VIII-16

of Risk-Taking
Depository Institutions

2.
3.
4.
5.

Risk-Related

on Risk-Related

ement Techni

Premiums

of Market Information
of Nonmarket Information

The Use
The Use

Public

Risk-Mana

VIII-4
VIII-6

in the
Improvements

IX-14
IX-14
IX-16

Summary

Prom

Introduct1on

Prerequisites

IX-2

X-1

Corrective Action

for Prompt Corrective Action
Identification of Undercapitalized

X-2
X-6

Banks

Supervisory Authority
Willingness to Use Supervisory
Authority
Evaluation and Conclusions

4C.

X-7
X-8

Proposals to Encourage Prompt Corrective
A

ctlon

Supervision to Control Moral Hazard
. . . . . .
Early Reorganization

Corrective Action and Costless
Failures . . . . . . . . . . . . .

Prompt

Public

X-10

. .
..

X-10
X-13

Bank

. . . .
. . . . . . . . . .. ...

X-21

................
Accounting Standards . . . . . . . .

Comments

X-22

Market Value Accountin
A.

Introduction

XI-1

Current

XI-1

3.
C.

Historical Cost Principle Under
Increased Need for Accurate Financial

The

G AAP

Information

XI-3
XI-4

Market Value Accounting

XI-6

XI-1

Background

The Case
The FASB

for Market Value Accounting

Financial

Instruments

Project
Relevance of Market Value Information
Intent and Ability to Hold to
Maturity

viii

XI-8

2.
E.

Transaction

Prices vs. Going Concern

Values

Reliability of

Issues Involving
Issues Involving

Assets

Measurement

4.
5.

F-

. . .

Market Value Accounting

Measurement

Assets

XI-11

Tangible

XI-13

Intangible

XI-16

Issues Involving
Liabilities
Measurement Issues Involving

XI-18
XI-19
XI-20

Contzngencxes

Verification and Accounting Standards
Costs of Market Value Accounting . . . . .
1. Direct Implementation Costs
2. Factors Offsetting Direct
Implementation
Costs of MVA
Possible Economic Effects of Market Value

XI-24

XI-25

Safety and Soundness
Credit Availability
Financial Stability

XI-26
XI-28
XI-29
XI-30

Competitiveness

Alternatives

Accounting

to
e

Market Value

Comprehensive
~

for Marketable
Assets
Supplemental Disclosures of Market
Value Information
Greater Disclosures of Raw Data

XI-31

Market Value Accounting

XI-22

XI-23

Account1ng

2.
3.
4.

XI-12

XI-32
XI-34

Role of Auditors

Audit Functions

XII-1
XII-1
XII-1

Institutions

XII-3

Introduct1on

Audit and Regulatory

Examination

Regulatory Functions
Audit Coverage of Depository

Functions

XII-2

Analysis of Communication
and Regulators . . . .

3.
D.

Between Auditors

. . .

XII

XZZ

Auditor Access to Regulatory Reports
Submission of Audit Reports to
. . . . .
Regulators
Auditor Participation in Conferences
. . . .
- . . .
and Meetings

.
..

XII

. .

of the Bank of England System
for Using Auditors for Supervisory
. . . .
Purposes . . . . . - - 1. Overview of Bank of England System .
2. Analysis of Specific Provisions of the

XII

Consideration

.
.

XZZ.

. .. . . . . . . . . . . .

XII

1987 Act

for Strengthening

Options

Regulators

2.
3.
4.

the Ties Between

. . . . .

External Auditors

and

XII

Require Audit Reports to be Sent
Promptly to Regulators
Require Prompt Notification of Changes
in Auditors
~
Require Auditors to be More Accountable
to Regulators
~
~
Adopt an Enhanced Mandatory Audit
~

XZZ.

XII-

Requirement

XII-

Credit Unions

. . . . . . . . . . ...
Structure of the Credit Union System .
History of the NCUSIF . . . . . . . .
Credit Union Capital . . . . . . . . .

Accounting

B.
C.

XIII

. .

XIII

..
..

XIII
XIII

. . . . . . . . . . . .

XIII

Introduction

Insurance

Treatment

Deposit

Arguments
Arguments

Adequacy

Separating

of the
NCUA

One

.
.
.
.

Percent

Supporting Current Treatment
Against Current Treatment .

.
NCUSZF . . . . . . . . . . .
from NCUSIF. . . . . . . . .

XIII
XIII'
XIII

XIII.

XIV.

Collateralized
A.

Introduction

Use

Management

Cost of Collateralized

2.
E.

Borrowing

Resolution Costs
Reduction in Premium

with Assessing Insurance
on Collateralized
Borrowing

Impact on Government
Market
Impact on Depository

Asset-Liability

Home

XIV-3
XIV-3
XIV-4
XIV-4
XIV-5

XIV-5

Premiums

Securities
Institutions'

Management

XIV-6
XIV-6
XIV-7
XIV-7
XIV-8

Loan Bank S stem Subsidies

. . . . . . . . . . . . . . . .

Introduction

The Structure
System

FHLBank System Advances

2.
3.
4.
5.
6.

XIV-1

XIV-5
XIV-5

. . .. .. . ... . .. . .

FDIC

Increased Funding Costs

Policy Options

Federal

to the

Income

Problems

Securities

Trading in the Government
Market
Treatment of Creditors

4.
D.

XIV-1

of Collateralized Borrowing by
Depository Institutions
Incentives to Use Collateralized Borrowing
1. Potential Cost Savings
2. Liquidity and Asset--Liability

XV.

Borrowin

of the Federal

Home

Program

Loan Bank

. . . . . .

Source of Funds for FHLBank Advances

Use of FHLBank Advances
Terms of Lending for FHLBank Advances
Cost of FHLBank Advances
FHLBank Advances and Interest-Rate Risk
Effect of FHLBank Advances on FDIC Risk

Exposure

XV-1

XV-2
XV-2
XV-4
XV-4
XV-5
XV-6

Subsidy Associated
Operat], ons
~

1.
2.
E.

Community

Affordable

Investment
Housing

The Bank Insurance

and
XV-

Program
Program

XVXV-

XV-

Fund

. . . . . . . .. .

Fund

Status

Income and Expenses

Liquidity

Effects of

Legislation

FIRREA and More

The Savings

1.
Interstate

Base

and Borrowing

Association

Authority

Insurance

Bankin

Introduction

The Current

and Branchin

Regulatory

The Regulation

XVI
XVI
XVI
XVI

Fund

Sources of Funding
Current Status of SAIF

XVI

of BIF
Recapitalizing BIF
Liquidity

XVI
XVI
XVI
XVI

Adequacy

Assessment

XVI

Recent

Policy Issues

2.
3.
4.

XV-

XVI

Current
The

XV.

XVXV-

Beneficiaries of Housing Subsidies
Efficiency of the Housing Subsidies

Introduction

Subsidies

Government Backing
Federally Imposed Obligations

0 timal Size of Insurance

2.
3.
4.

of Implicit

Market Perception

Housing

System's Community Investment
Affordable Housing Programs

FHLBank

with the FHLBank System's

Environment

of Geographic Expansion

XVI'
XVI

of Current

The Origins

The McFadden Act
The Douglas Amendment

of Interstate

XVI I-4
XVI I-6
XVI I-7

Branch Banking

XVII-8

National

Home-State

2.
F.

VIII.

XVII-10
XVII-12
XVII-12

XVII-13

Regulation

XVII-13
XVII-14
XVII-15

Structure

XVII-16

Bank Branching

Host-State Regulation

Effects

1.
2.
3.
G.

XVI I-8
XVI I-9

Safety and Soundness
2. Consumer Benefits
3. Efficiency
4. Payment Processing
5. Competition and Credit Avail ability
Models of Interstate Banking
~

on Bank

Bank Holding
Small Banks

Analogies

Concluding

XVI I-2
XVI I-4

Law

Early Bank Branching
Regulatory Policy
The Current Status of Geographic
Expansion

Advantages

XVII-1

Companies

with Canada and California

XVII-16
XVII-16
XVII-17
XVII-18

Comments

Financial Services Modernization
A.

Introduction

The

2.
3.
4.
C.

The

2.
D.

Traditional

Banking Franchise

Prior to the Civil
Early Federal Intervention
The Glass-Steagall Act
Banking

The Bank Holding

Company

Erosion of the Traditional

War

Act

Franchise

Balance Sheet Considerations
Other Evidence of Franchise Erosion

The Current

XVIII-1

New

Market Environment

Activities for

xiii

Banks

XVIII-1
XVIII-1
XVIII-2
XVIII-5
XVIII-7
XVIII-9

XVIII-9
XVIII-11
XVIII-12

XVIII-12

Product Expansion

Firms

by Nonbank

of Finance

The Convergence

and Commerce

Global Competition

XVI

Erosion of International Stature
2. The Implications of EC '92
The Need for Financial
Conclusions:
Modernzzatzon

2.
XIX.

Introduction

Existing Regulatory

XVIII

XIX-1

System

XIX-1

Banks and Bank Holding Companies
and Thrift Holding Companies
Credit Unions

XIX-2
XIX-3

Thrifts

Arguments
Arguments

For Restructuring
Against Restructuring

Previous Restructuring

Responsibility
Supervision
Svitzerland

Bankru

Proposals

XIX-1

Exem

XIX-3
XIX-4
XIX-5

XIX-6

Proposals Other Than the Bush Task
Group Report
Proposals of the Bush Task Group on
Regulation of Financial Services

2.
E.

XVI

Structure

For and Against Regulatory
Restructuring

XVIII
XVIII

Arguments

XX.

ulator

XVIII

Alternative Reform Proposals
Major Public Policy Considerations

of the

Reform

XVIII
XVIII

for Bank Regulation and
in G-7 Countries and

XIX-6
XIX-7

XIX-10

tions

. . . . . . . . . . . .. . . .
Behind Exemption Provisions . . . .

Introduction

XX-1

Policies

XX-1

The Bankruptcy

Code's Exemption

x1v

Provisions

Analysis

E.
gXZ.

Exemptions
Limitations on Exemptions
Bonds to Secure Commercial

Uniform

n De

Institutions

Insured

Summary

Forei

osit Insurance

International

Structure and Organization

2.
3
4.
5.
6.
~

Loans from
XX-7

.........

of Deposit Insurance

Use

Membership and Administration
Methods of Funding

XX-8

XXI-1
XXI-1
XXI-2

Coverage Limits
Types of Deposits Covered

XXI-3
XXI-3
XXI-4
XXI-5

Distressed Banks

XXI-6

Handling

XX-4
XX-5

................

Introduction

XX-4

S stems

........

Reform Proposals

Canada

France
Germany

Ital&

United Kingdom
Japan 0

Conclusion

XXI-6
XXI-8
XXI-8
XXI-10
XXI-12
XXI-15

XXI-16

Chapter

HISTORY OP DEPOSIT INSURANCE

A. Introduction

Federal deposit insurance

was

established

in 1933 in

response to the worst economic crisis in U. S. history, the Great
stood at record levels, bank failures
Unemployment
Qepression.
panic withdrawals of deposits were commonplace
were widespread,

public confidence in the banking system was nonexistent.
losses. The dismal
/any small savers suffered substantial
nation's
our
financial system called for decisive
condition of
action.
and

federal guarantee of the safety of small deposits was
implemented with the creation of the Federal Deposit Insurance
Corporation (FDIC) in 1933 and the Federal Savings and Loan
Insurance Corporation (FSLIC) in 1934. That guarantee has
remained in effect to this day.
Federal deposit insurance has
been highly effective in achieving its fundamental
goal, that of
eliminating almost all panic deposit withdrawals.
A

For many years deposit insurance appeared to be an
unmitigated success.
Prior to 1980, bank and thrift failures
vere relatively rare and deposit insurance costs were small.
The
deposit insurance funds grew steadily as investment income and
insurance premiums received from banks and thrifts consistently
exceeded insurance expenses.
No taxpayer funding was required.
This was in part due to the relatively predictable financial
environment
Insured
in which banks and thrifts operated.

depositories served fairly well-defined market niches free of the
degree of competition from foreign and nonbank financial firms
which exists today.
By the standards of the 1980s, interest
rates were stable, enabling most institutions to avoid wide
Swings in economic net worth due to interest rate movements.
During the decade of the 1980s, commercial bank deposit
insurance became much more expensive and risk exposure increased;

thrift deposit insurance suffered a financial calamity requiring
of billions of dollars of taxpayer money. As discussed
chapter, reasons for this dramatic increase in insurance
«sts include economic downturns in oil, agriculture and real
estate, increased interest-rate volatility, fundamental changes
in the financial marketplace which have led to increased
«mpetition from foreign and nonbank financial intermediaries,
institutions.
»d inadequate supervision of undercapitalized
hundreds
in &his

It is

possible that recent insurance losses are simply the
result of an exceptionally unfavorable confluence of events,
zather than the result of some inherent weakness in the deposit
insurance system. The magnitude and scope of insurance losses
pver the last ten years, however, have led many observers to
claim that the risk exposure of the deposit insurance funds is
According to this view there are serious flaws
put pf contrpl.
system which create incentives fpz
insurance
in the deposit
If this view is
excessive risk-taking by insured institutions.
correct, bank regulators, Congress, and insurers should say witg
Shakespeare's Cassius, "The fault, dear Brutus, is not in ouz

stars, but in ourselves

This chapter is organized as follows: Section B briefly
reviews how the deposit insurance system came into being jn the
1930s. Section C discusses the purpose and benefits of federal
This is followed in Section D with a summary
deposit insurance.
of the concerns and criticisms that have been leveled against tQq
deposit insurance system. The evolution of the financial
performance of federally insured institutions,
and the risk
exposure of the deposit insurance funds, is discussed in Section
E. Section F provides information on the operation of the U. S.
deposit insurance system, and Section G provides a detailed
discussion of how the FDIC has handled bank failures.

B. Origins of the Current Deposit Insurance

System

Franklin D. Roosevelt was sworn in as the 32nd
President of the United States in March of 1933, the nation's
banking industry was at its nadir.
The nation s banks were
closed, banking holidays having been declared by authorities in
all 48 states. One of the new president's first official acts
was to have the federal government take charge of the situation:
he proclaimed a nationwide bank holiday to commence on March 6
and to last for four days.
Administration
officials quickly
drafted legislation to legalize the holiday and to begin the
resolution of the banking crisis.
When

That crisis had been developing for some time. During the
comparatively prosperous years of the 1920s, banks failed at the
rate of more than 600 per year. Most of these banks were smalli
poorly capitalized Midwestern institutions serving agricultural
markets, and their demises had little direct impact on the

national

however,

A look at these pre-Depression
serves to emphasize two points.

economy.

First,

failures,

banks are dependent on the confidence of deposit«8
of the banking business is to fund relatively long
term illiquid assets with relatively short-term liabilities.
a number of depositors lose confidence in a bank and seek to
withdraw their deposits, the bank might not be able to liquidate
The nature

assets quickly enough to satisfy all withdrawal requests in a
If there is no deposit insurance system,
timely manner.
bank
about which rumors of troubles are heard are
depositors in a
line. One result
motivated to be at the head of the withdrawal
"run"
as
depositors
inundate
the
bank
a
with demands for
can be
Unable
to
satisfy
the demands, the bank, absent
their money.

is forced to close.

outside aid,

second point that the bank failures of the 1920s serve to
ezphasi2, 'e js the unusual structure of the U. S. banking system, a
structure that still exists to a considerable extent today. Many
banks in the United States were small and undiversified.
They
from expanding geographically
wez& prevented
by restrictive state
Consequently,
they had little way of avoiding or
branching laws.
of
local
the
economic difficulties on their
impact
mitigating
financial conditions.
A

With the onset of the
of bank failures increased

Depression,

the rate and significance

substantially.
More than 5, 000 banks
failed during the three-year period from 1930 through 1932,
resulting in losses to depositors of almost $800 million (or more
Another 4, 000 banks failed in
than $6 billion in 1990 dollars).
4
1933.
Some economic historians
believe that actions by the Federal
Reserve System to ease the liquidity problems of banks during
these early years of the Depression were ineffectual.
The
central bank failed to adopt an aggressive stance with respect to
either open market purchases of securities or discount window

Several reasons have been cited for this lack of
them being a general belief that bank failures
were an outgrowth
of bad management, that many troubled banks
were not members of the Federal Reserve System, and a
monetary
preoccupation at certain times with international
operations.
response,

among

difficulties.
Thus

the possible collapse of the nation's banking system
most pressing problems facing Franklin Roosevelt

w~s among the
when he took

~nationwide
emergency

office on March 4, 1933.
bank holiday and the quick
banking legislation restored

&o~ger-term

potentially

solution

one such

His declaration of a
enactment by Congress of
a degree of order, but a
Deposit insurance was

was needed.

solution.

Between 1886
The concept of deposit insurance was not new.
»d the establishment of the Federal Deposit Insurance
«rporation in 1933, 150 deposit insurance or guaranty proposals
were introduced
Moreover, fourteen states had
in Congress.
tried insurance or guaranty programs for their banks, beginning
"&th New York in 1829. None of these programs was in existence
in 1933, however.

I-3

Six pre-Civil War programs had for the most part been
successful but had lost participants as a result of (1) the "fry
banking" movement that began in the 1830s and (2) the
establishment of the national bank system in 1863. And the eight
in farming states —
durin~
programs that had been adopted--mainly
the first two decades of the 20th Century had failed to survive
the economic troubles of the agricultural industry in the 192p8

The demise of these earlier state programs was used jn 1933
as one argument against a federal deposit insurance program.
Opponents also feared that the cost of deposit insurance wou]d h
exorbitant and would require the use of tax revenues. Another
argument was that deposit insurance would remove penalties for
thus subsidizing poorly run banks.
bad management,

of factors combined to overcome these arguments,
Chief among them was the nation's grave economic
however.
condition. Section 8 of the Banking Act of 1933, which was
signed by President Roosevelt on June 16, 1933, established the
Federal Deposit Insurance Corporation and provided for a
temporary insurance plan to be initiated on January 1, 1934. A
permanent plan did not come into being until the Banking Act of
That law became effective on August 23, 1935.
1935 was adopted.
Deposit insurance for savings and loan associations was provided
for in the National Housing Act of 1934 with the creation of the
A

number

Federal Savings and Loan Insurance

Corporation.

C. Benefits and Purpose of Federal Deposit Insurance

social benefits associated with insuring
bank deposits are the provision of a safe haven for small
depositors and the prevention of widespread deposit runs and the
The most important

damage

they cause.

Protection of Small Depositors
Government action Often is triggered by the desire to help
particular group that is perceived to be disadvantaged in some
In the case of deposit insurance, the argument is that
way.
there are people who are relatively unsophisticated financiallY
who should have easy access to a safe means for both making
payments and for storing wealth.
If this were the sole reason
for government intervention, it would seem that the current
system provides far more insurance coverage than necessary, aM
that either lower deposit insurance coverage or a more limited
alternative form of protection would be appropriate.

2. Prevention of
The primary

financial

Bank Runs

purpose

stability

of deposit insurance is to promote
destructive bank deposit ru»

by preventing

runs are caused by a combination of two factors.
First
loans, the primary bank asset, are illiquid in that they can not
Second, most depositors
ye sold quickly without a loss in value.
to
withdraw
their
ability
deposits either on demand or
gave the
These two factors virtually guarantee that a
Qn short notice.
yank will be unable at any time to fulfill its potential
pg]igation to convert all or most of its liabilities to cash. Of
c0urse under normal circumstances a bank will not be called upon
fu]fill all of its obligations on short notice; this is what
ql]ows a bank to invest in illiquid assets.
Dank

If there is no deposit insurance and a depositor believes
tgat heavy withdrawal demand may soon make a bank unable to meet
its deposit obligations, that depositor will have the incentive
Once a bank has depleted its
to withdraw his or her funds.
inventory of liquid assets, it must begin to sell illiquid assets
each such
to meet further withdrawal demands.
By definition,
sale means a bank is realizing a liquidation loss on the asset.
At some point a bank will have suffered enough losses to render
it unable to fulfill its obligation to the remaining depositors.
Note, it is the "first come, first served" nature of the process
that gives depositors the incentive to run. Those depositors at
line lose nothing, while those at
the beginning of the withdrawal
A depositor who merely suspects that
the end lose everything.
other depositors are going to run will get in line whether he or
at that time or not. This leads to "panic"
she desires liquidity
runs.
Since the failure of one bank may affect how depositors
view other banks, bank runs may be contagious.
It is this
contagion effect of bank runs that deposit insurance was designed
to alleviate.
of the functions of the system of Federal Reserve Banks
is to serve as a "lender of the last resort;" that is, to extend
credit to economically solvent banks which are experiencing
In theory, a lender of the last resort
liquidity difficulties.
could prevent runs on solvent banks as well as deposit insurance
could. The most important difference between the two in terms of
run prevention
is that deposit insurance works automatically
while the lender of the last resort has discretion over whether
to extend credit. The other important difference is that the
&&~der of the last resort does not attempt to prevent depositors
in insolvent banks from suffering losses.
One

lender of the last resort may not be as effective in
Preventing runs on healthy banks as is deposit insurance.
In order
~~Ppose a run develops on an economically solvent bank.
"
&0 function
as a true "lender of the last resort, the Federal
~~serve would have to make a quick judgment, perhaps that very
~~y, regarding whether or not the bank is indeed solvent or has
"fficient collateral. In practice, the Fed's loans must all be
c»»teralized, making it less important from the Fed's
However, it would be
PersPective whether the bank is solvent.
A

I-5

difficult for anyone to predict whether the Federal Reserve would
decide to extend credit in any particular case. Given this
uncertainty, depositors may still have incentive to run. Zn
addition, banks may have incentive to hold excessive liq idity tl
avoid the threat of runs.

The Cost

Runs on Banks

can impose substantial "external" costs,
case of contagious bank runs such costs jnclude disruption of th~
money supply process, the payments system and financial
Indzvzdual bank runs also can cause systemic
intermedxatxon.
problems by disrupting the payments system, thus imposing thizdparty costs. Where bank runs force the fire-sale liquidation Of
assets, costs must be incurred by buyers in evaluating the
quality of banks' non-marketable assets; from the standpoint of
economic efficiency these costs are simply wasted resources.
In
addition, the threat of bank runs may induce bankers to adopt
unduly conservative lending practices which reduce the funds
Bank runs

for productive investment.
Contractionary Effect on the Money Supply
This argument for deposit insurance focuses on the banking
industry's role in the money supply process. The system of
fractional reserve banking enables banks to lever the stock of
high-powered money (cash and reserves at the Federal Reserve)
into a stock of money several times larger. This enables the
banking industry to be the major conduit through which the
Federal Reserve can control the money supply.
Bank runs,
especially if they are widespread, have the potential to sharply
curtail the money supply. If depositors who withdraw their funds
do not redeposit their funds in other banks, then, barring anY
offsetting government action, bank reserves will be reduced and
the banking system s ability to create money will be diminished.
The resulting reduction in the money supply may lead to deflation
and recession.
available

In the absence of a mechanism to prevent or stop bank runsi
crises in the form of systemic or contagious bank ruN
can cause economic disruptions.
However, in terms of protecting
the money supply, isolated runs or runs that involve a flight 0&
funds from some banks to other banks in the system should not be
a concern, since little or no money would be withdrawn from tbe
system.

financial

Disruption

of the

Payments

System

While nonsystemic bank runs do not threaten the money
supply, they do pose a threat to the payments system.
Deposit
insurance may be justified to prevent individual bank runs in
order to provide a safe payments system. The existence of a

functioning payments system is of incalculable value.
value is simply in minimizing the real resources
this
of
part
As an economy develops, the
payments.
making
to
devoted
essential medium in making payments evolves from commodity to
Banks have been an integral part of this
paper to electronics.
evidenced
as
by their role in checking services,
gevelopment,
and
electronic
transfers of funds.
credit cards,
smoothly

to economizing on resources, a well functioning
has
many of the characteristics
of a "public
payments system
de f ense or environmental
good&& such as national
cleanup.
That
of
a
benefits
payments
the
system
in
which
market
is,
participants can make transactions quickly, easily and with
confidence accrue to all members of society. Government often
plays a role in ensuring adequate provision of public goods, and
in the case of the payments system that role has typically
involved providing resources to facilitate the mechanism
(~e.
clearinghouse services) and eliminating risk to participants.
In addition

pose a risk
facing a run may be unable
participants in the system.
Bank runs

to the payments system because a bank
to meets its obligations to the other
Such disruptions will interfere with
of the system. To the extent that this

the smooth workings
threat can be removed by deposit insurance, the fluidity of
of the economy can be
payments system and the functioning
A more detailed
discussion of the adverse effects
improved.
an individual
large bank failure is contained in the next

the

section.

Interference

with Financial

Intermediation

to posing a threat to the money supply and the
social costs by interfering
credit-allocation role of banks. Bank runs are costly,
it is argued, in part because runs can disrupt or destroy an
This
important conduit of investment
funds in the economy.
~r9ument for deposit insurance therefore focuses on the role of
In addition
system,

payments
with the

banks

bank runs can impose

as intermediaries

in the economy.

is necessary for

to grow, and savings
~re necessary to provide the resources for that investment.
Because the people who want to save are not necessarily the
People who have investment projects, the need for borrowing and
&e~ding arises.
to lend under certain terms,
A saver is willing
~~& in fact prefers certain lending
arrangements to others.
Likewise, investors prefer some borrowing contracts to others.
Direct financing occurs to the extent that borrowers and lenders
&"o prefer the same arrangements
can find one another without
»«rring significant search costs. Zf they cannot find one
that
~~other, or if there are lenders who prefer arrangements
horrowers are unwilling
to accept (or vice versa), then there is
a role for financial
These institutions provide
intermediaries.
Investment

an economy

real service to the economy: investment and output will be
greater, and this should translate into enhanced social welfare.
Financial intermediaries improve the allocation of credit g
reducing the search and information costs of bringing borrowers
In addition to this brokerage function,
and lenders together.
financial intermediaries perform a portfolio transformation
func'tion by modifying the attributes of the financial securitie3
that pass between the borrowers and lenders. Two important
attributes that are altered by this process are the risk and
maturity of the instruments.
Savers would like to hold portfolios which include a broad
To achieve
range of investments to avoid wide swings in wealth.
this directly, savers would need to find many borrowers and leng
small amounts to each. An intermediary can pool the savings Of
large number of lenders and provide the funds to many borrowers.
This allows lenders to achieve a more certain return than they
could otherwise obtain through direct financing.
a

direct financing, the maturity of the instrument is the
for the borrower and the lender. Because people face
uncertainty as to when they will desire funds with which to
conduct transactions, they may be unwilling to commit funds over
long periods, and, as a result, less investment will be funded.
Intermediaries can issue debt that is short-term or that is
easily callable in order to provide lenders with some protection
against this uncertainty.
Intermediation thus reduces the need
for maturity matching and allows long-term investment to be
With

same

funded

with short-term

lending.

assets have tended to be
in loans to borrowers for whom "public information on
the economic condition and prospects . . . is so limited and
expensive that the alternative of issuing marketable securities
is either nonexistent or unattractive. "' Because these
borrowers cannot easily convey information about their own
creditworthiness to lenders (or conversely, because lenders
cannot easily ascertain the creditworthiness),
there are
information costs associated with the borrowing and lending
arrangements available to them.
Banks alleviate these costs 4Y
specializing in evaluating and monitoring this class of
borrowers.
This allows banks to find profitable investment
opportunities in essentially nonmarketable assets.
Part of the social cost of bank runs is that they force t&&
liquidation of these nonmarketable assets. Buyers of these
assets must incur substantial evaluation costs, since the ban~
experiencing the run possesses specialized information about t&~
quality of its assets that cannot be quickly or easily
transferred.
In addition, creditworthy borrowers may lose
financing (often for extended periods, given the information
I-8
Banks are intermediaries

specialized

whose

costs noted), production
plans

may

frustrated.

may

be interrupted,

~b'1't
fb
indirect social costs.

substantial

and consumption

previously

noted,

in the

absence of deposit insurance, the belief that a panic run will
In the face of the threat of runs,
occur is self-fulfilling.
depositors would require banks to hold more liquid assets in
This would
order to protect them against losses in a panic run.
reduce the amount of funds available for long-term investment.
as will be discussed in the next section,
pp the other hand,
have the effect of channeling excessive
insurance
may
deposit
industry.
funds to the banking

important to emphasize that bank runs are a type of
"Market failure" is a term used by economists to
market
denote situations in which unfettered market forces are unable to
achieve the most efficient use of resources.
In our context, the
"market" may participate in a panic-induced
run which imposes
substantial real resource costs on the economy. A banking system
which is subject to runs does provide a check on risk-taking
by
banks, but this is not without cost: if the run is on a solvent
and costly.
If the bank is
bank, the run is unnecessary
insolvent, the insolvency could have been handled in a more
orderly manner with a much lower net cost to society

It,

failure.

4. Systemic

Effects of

Individual

Runs on

Large Banks

section, contagious bank runs
significant costs upon the economy as a whole. It can
however, that the collapse of a large bank may, in and
of itself, have a serious impact on the entire system even if the
problem does not spread.
There are two major components to this
argument.
First, there may be a disruption of the payments
system, and second there may be "ripple effects" felt by other
banks which maintain deposits at the failed institution.
As

discussed

in the previous

can impose
be argued,

Disruption

of the

Payments

System

There are two important elements of the payments system at
electronic funds
from a large bank failure: (1) large-dollar
transfer systems, and (2) check clearance.

»»

of the dollar value of all electronic funds transfers
concentrated in two electronic systems used principally to
transfer large-dollar payments between banks, Fedwire and
Clearing House Inter-bank Payments System (CHIPS). CHIPS, which
» used mostly for the settling of transactions involving foreign
«»nge, international investment, and trade activity, has in
p ace a variety
These include bilateral credit
of safeguards.
»i«, as well as aggregate net debit caps which limit any one
participant's total exposure. Also, if a bank does fail, and is
boost

I-9

unable

fund

participants
its obligations, the other
a

must take
amount of

proportional
that obligation, with each assuming
debt.
the defaulting participant's
However, it is possible that banks could be unable to meet
if this were the case more
these new, unexpected obligations; ensue.
failures among these banks could partially Furthermore,
collateralized;
additional obligations would be
meet part of the obligation
this collateral has been sold tountil
new collateral could be
CHIPS system would be hampered
on

secured.

The check-clearing networks are
payments system potentially at risk.

adversely

affect check collection in

on the
accepted
have
funds before
now left the
absorbing the
drawn

the other part of the
A large bank failure
two ways.

First,

cpulg

checks

failed bank may be dishonored, and if other banks
these, they may have provided their customers the
If the money has by
being notified of the failure.
bank
that
may end up
bank accepting the check,

loss.

The second consequence

lies in the

check clearing services

large banks provide for smaller ones. The failure of a
large institution could impose serious hardships on these
correspondent banks as is discussed below.

many

Loss to Correspondent
Large banks tend

These moneys originate

Banks

from smaller banks.
from correspondent banking activity, such
services described above. Depending upon

to be net borrowers

as the check clearing
the method of resolution of the large bank, many smaller banks
could suffer direct losses. In the extreme case, these losses
could threaten the capital position of the smaller institutions.
However, even in less severe instances, this could damage the
liquidity of the correspondent banks, and impair their ability t(
Finally,
provide payments to, or on behalf of their customers.
other local banks would suffer financial loss as it would take
longer for them to convert check deposits into good funds.
The situation at Continental
Illinois Bank in April of 1984
an example of how correspondent banks could be put at risk if
a large bank fails. Approximately 2, 299 banks had funds invests~
in Continental.
Of these, 976 had funds in excess of $100, 000
invested.
In all, 66 banks had more than 100 percent of their
capital in funds at Continental and another 113 had between 5o
percent and 100 percent.

large bank failure can have additional ramifications as
well; for example, many large banks provide custodial services «
smaller institutions, holding securities for them or their
customers.
The collapse of the large bank can impose costs on
A

particularly if the failure occurs at the time
While these problems are not as
are
being settled.
transactions
to
the
disruptions
payment system, or losses in
important as
To the extent
wholesale banking activity, they are not trivial.
insurance
can
prevent
the
disorderly
deposit
from
that
it can contribute exiting
significantly
the system of large institutions,
to the improved functioning of the economy.
these holders,

Summary

Deposit insurance provides important economic benefits which
the market could not achieve on its own: the protection of small
depositors and the prevention of widespread bank runs.
Bank runs
qre costly because they interfere with the money supply process,
role of
the payments system, and with banks' intermediary
to
productive but illiquid investment projects.
Bupplying credit
peposit insurance achieves these benefits by protecting all
deposits below a certain size and thus removing the incentive for
these deposits to participate in a bank run.
Concerns

Raised hy the Existence of Deposit Insurance

became increasingly apparent that
potential to impose enormous costs on
society. The failure of hundreds of S&Ls caused the insolvency
and reorganization
of the FSLIC. Nine of the ten largest bank
holding companies in Texas were reorganized with FDIC or other
outside assistance.
From 1987 through the end of 1990, the FDIC
fund will have declined from over $18 billion to about $9
During

the 1980s

deposit insurance

had the

billion.

Currently, a substantial segment of the S&L industry does
standards recently imposed by the Office of
. oot meet the capital
Thrift Supervision; and commercial banks' loan charge-of f ratios
and nonperforming
loan ratios are at their highest levels since
. »nks began using the reserve method of accounting in 1948. Data
~on the growth of FDIC and FSLIC insurance
outlays are presented
in Tables 1 and 2.
,

Events have thus demonstrated that some of the criticisms
leveled in the 1930s against the idea of federal deposit
merit. The system has subsidized
, i~8urance had considerable
These institutions
i9»y risky, poorly managed institutions.
h»e exploited the federal safety net by funding speculative
„P~o]acts with insured deposits.
The resulting costs have been
'»me by well-run institutions and by the taxpayers.
i

„,

risk-exposure of the deposit insurance fund naturally is
uenced heavily by national and regional economic performance.
pities argue, however, that the escalating cost of deposit
'i»urance can be blamed in large part on serious flaws in the way
)
,
,

The

Table

—

Loss By The Federal Deposit Insurance Corporation For Protection of Depositors, 1934 1989
(In millions of dollars)
All

Number of

Banks

Deposit Assumptions'

Deposit payoffs

cases
Losses'

Number of

Banks

Number of

Losses'

Banks

Assistance transactk
Number of

Losses'

Banks

Year'
1 934-1 939 .. ..
1 940-1 949 .... .

..
.

312
99

1950-1959......
1960-1969......
1970-1979......
1 980 .................
1 981 .................
1 982 .................
1 983 .................

28
43
76
10
10
42
48
80
120
145
203

1 984
1 985 . .
. .
1 986 . . . .
1 987 .
.
1 988
1 989 ...............

... ..... .. ...
. ... .. .. .....
....... ........
..

Total

.....

18
6
3
5.3
107

207

31
588
1,297
1,522
1,906
877
1,815
2, 147
6,022
6,090

1,644

22, 434

221

207
38
12
27
23
3
2
7
9
16
29
40
51

36
32
532

105

0.6

16
16
53

2.4
0.4
103.6

7
5
26

817

36
62
87
98
133
123
129

29
2
25
1,443
447
537
1,229
1,222
2, 076
1,269

62
46

2, 823

957

8,396

155

5
3.4
2
1

70
26

110
116
429
758
470

0
0
0

0
0
0
3
9
3
2

4
7

' Includes estimated losses in active cases. Not adjusted for interest or allowable return, which was collected in some cases in which the dishy
was fully recovered.
No cases in 1962 required disbursements.
'Deposit assumption cases include $347.6 million of disbursements for advances to protect assets and liquidation expenses which had been ex
in prior years.
'Assistance transactions include: a) Banks merged with financial assistance from FDIC to prevent failure through 1988; b) $2.3 billion of rec
liabilities at book value payable over future years.
'Includes CINB Assistance Agreement which had been previously excluded.
'Assistance losses in 1988 and 1989 include estimated costs payable in futures years.
Source: Federal Deposit Insurance Corporation.

Table 2
Attrition Among FSLIC-Insured Institutions,

1934-1988

Number of failed institutions

No FSLIC
assistance involved

FSLIC assistance involved
Mergers and other types of assisted
resolutions

Liquidations

Year
Total
Number

millions of

dollars)

1983.

1984 .
1985 .
1986 .
1987 .
1988

10
17
26
91

10,967.9

1980 .
1981 .
1982

Total. .

13
0
1
1

9
9

' These figures represent the estimated present value cost of resolution.
* Stabilizations with a total cost of about $7 billion.
Source: Berth and Bradley (1989).

cost '

assets (in
millions of

348.8
0.0
88.5
36.1
262.6
1,497.7
2, 141.3
583.8
3,043.8
2, 965.2

1934-1979.

Total
(in

15.7
0.0
30.4
2.9
60.6
583.3
630.1
253.7

Number

Total

Total
cos't (In

millions of

dollars)

130
11
27
62
31

13
22

2,277.5
2, 831.7

36
30
179

6,685.9

541

4, 109.5
1,457.6
13,819.7
17,626.0
4, 368.5
3,582.5
4,227.0

11,871.3
7,61 6.6
97,694.7
166,373.4

290.4
166.6
728.3
800.4
214.1
159.3

391.5

2,811.3

1,426. 1
28, 347.8

35,335.8

Nonfailed
attrition

AII

of
institu-

Total

tions

Man-

agement
consIgnment

cases

Supervisory
mergers

Total
number

Voluntary

assets

(in
billions of

dollars)

mergers

0
0
0
0
0
0
23
29
25

N/A

18s

54
184
34
14
10
5
5
6

333

N/A

143
95
297
462
153
67
111
125

N/A

621

1,070
1,164
1,251
1,334
N/A

31
47
45
74
25

151
254

3,998
3,757
3,295
3, 146
3, 136
3,246
3,220
3, 147
3,001

798

1858

N/A

63
215
215
83

659
700

819
978

Concerns have been raised
banks are supervised and insured.
abput the scope of deposit insurance coverage, the rules
gpverning insurance premiums and about many aspects of bank
supervision as well. These include closure policy, capital and
accpunting standards, the powers and activities available to
banks, and rules governing banks' affiliations and transactions
The most important criticisms are
with other entities.
summarized

in this section.

Moral Hazard

deposit insurance reform
as
the moral hazard problem.
known
become
has
focuses on what
The

current debate regarding

scenario is as follows. To the extent that bank creditors
are protected by the deposit insurance system, there is no
incentive for them to be concerned with the condition of the
In fact, their incentive is to seek the
financial institution.
highest return without having to be concerned with the risk/Further, without
return trade-off typical of other investments.
any market penalties for assuming more risk, the incentive for
bank management
is to assume a higher risk profile than would he
safe-and-sound
Because the FDIC has
consistent with
operations.
handled most bank failures, and all failures of large
institutions, in a way that protects virtually all depositors an~
other general creditors of the bank, '~ it is alleged that the
operation of market forces which would otherwise constrain bank
risk-taking is inadequate.
The

Market discipline is provided by equity holders, who stand
to lose their investment in a bank failure, and also by holding
company creditors, subordinated
bank creditors and other general
creditors who may not be certain of full recovery (see footnote
12). These other sources of market discipline notwithstanding,
the moral hazard argument is simply that the bank's depositors
(at least) do not penalize bank risk-taking, so that risk will b&
greater than if depositors did penalize bank risk-taking.
To put the matter

another way, a system in which banks paY
insurance and in which some or all bank
depositors perceive themselves to be fully protected can be
alleged to allow banks to increase risk without fully
"internalizing" the cost of this risk. It follows that banks
will take too much risk, and the result will be the financing of
economically inefficient projects and high deposit insurance

flat rates for deposit

costs.

Another formulation of the moral hazard problem is often
used to describe the incentives facing undercapitalized
banks
As a bank approaches insolvency,
has less and less to lose
from pursuing speculative projects.
If the gamble succeeds, the
bank may be restored to profitability.
If the gamble fails, 4&e
bank loses little since
may have been headed for failure

the bank wins, tails the FDIC loses, I' has become
cliche to describe the moral hazard problem in this case.
concerns about Insurance Coverage anl Pricing

any ay

IIHeads

the extent depositors are fully protected by the FDIC,
higher deposit rates from riskier banks. To
timey will not demand
depositors believe themselves to have de
age extent uninsured
facto coverage, they will not demand deposit rates which fully
Given that depositors will not sufficiently
compensate for risk.
discipline banks against risk-taking, it is argued that banks
fail]. take undue risks--the moral hazard problem described above.
To

If this story accurately portrays
logical conclusion is that increasing

the real world, the
the risk of loss to large
the scope of insurance

or otherwise reducing
reduce risks in the system.
will
Thus, it is argued by
coverage,
those concerned with the scope of insurance coverage that
depositors should have greater incentive to monitor the condition
of banks in which they place funds and to exert discipline on
more-risky banks by either withdrawing
funds or demanding a
higher return to compensate for increased risk.
Apart from the
it is also argued that reducing
supposed effect on bank behavior,
the scope of coverage would translate directly into lower FDIC
depositors,

costs in handling

bank

failures.

Another frequently expressed concern is that a bank's
insurance premium does not depend on its condition or its risk
exposure.
Instead, banks are assessed a flat percentage of
deposits, with possible rebates based on the insurer's aggregate
loss experience.
By tending to insulate a bank's deposit costs
from its condition,
this contributes to banks incentives to
undertake high-risk activities.
Critics recommend making
premiums depend either on some a priori measure of each hank's
risk exposure, or on some measure of each bank's current

condition.

observers have a more fundamental concern with the
pricing of deposit insurance, namely that a deposit insurance
Some

based on bureaucratically
determined premiums must
invariably misprice risk, with substantial adverse ramifications
for credit allocation.
In this view, the deposit insurance
system could be improved by utilizing
the private sector in
'insuring bank deposits.
proposals along these
several
are
There
lines which vary considerably in the manner in which the private
sector would be utilized.
system

"3 ~

Concerns
The

"insurance
~'exposure

about Bank Supervision

FDIC's risk exposure can depend on the extent of deposit
The FDIC's risk
coverage and the method of pricing
can also be influenced through supervision of insured

it.

For purposes of this chapter, "supervision" will be tak~
to encompass the establishment of rules and regulations, the
process of enforcing those rules and, more generally, the
evaluation of bank safety and soundness.
banks.

facing the S&L industry have brought
to concerns about the perceived ill
effects of supervisory forbearance. "Supervisory forbearance' i
a decision by supervisors to refrain from formal enforcement
actions, generally because the supervisor has confidence in
intention and ability to correct problems without
management's
Supervisors tend to see such discretion as normq
formal action.
In less savory usage, "forbearancen
and desirable flexibility.
connotes ignoring or bending rules, or weakening rules to make j
easier for banks to comply with them. It is generally accepted
that a great deal of forbearance of both types was granted to thi
S&L industry
in the 1980s. The free reign given to insolvent an~
institutions to "grow out of their problems"
undercapitalized
contributed importantly to the cost of the S&L problem.
Similarly, as discussed below, there are those who are concerned
that supervisors are not sufficiently aggressive towards
undercapitalized
commercial banks.
The problems

considerable

prominence

Generally speaking, the most strenuous critics of
forbearance argue that supervisors have too much discretion and
should instead be bound by rules requiring them to take specifiec
actions against undercapitalized
institutions.
Supervisors are
alleged to be too heavily influenced by the regulated industry or
by elected officials who are in turn influenced by the industry.
Because of these forces, it is argued, the exercise of
supervisory discretion tends to lead to too much forbearance.
primary focus of bank supervision is to ensure that banks
an adequate level of capital, and some prominent
observers of the banking industry contend that many banks do not
have adequate capital levels. "~ Capital acts as a buffer to
absorb losses that the FDIC would otherwise have incurred.
By
giving bank owners something to lose, capital mitigates the moral
hazard problem described above. The continued operation and
speculative investment strategies of hundreds of insolvent S&Ls
during the past decade dramatically illustrates the importance «
capital adequacy in controlling deposit insurance costs.
A

maintain

A related concern is that bank capital
is not measured
correctly. Some critics of the current rules have repeatedly
called for a requirement that banks use some form of market-vol«
accounting. 14 There are a variety of proposals along these
lines, which vary according to what, would be marked-to-market,
how, and how often, but all of them are motivated by a desir~ «
improve the criteria by which regulators may intervene in the
affairs of a troubled bank. It is sometimes suggested, for
example, that some institutions have exploited current rules

regarding the accounting
nzecognize all gains and

for marketable

securities to, in effect,

defer all losses. "
as the statutory capital requirements are the
As important
are enforced. Some critics of the
which
they
+armer in
are
sppervisory system have concerns about how institutions
sppervised as they approach and reach the point of insolvency.
solvent but
pne set, of concerns relates to whether
institutions are being adequately supervised;
undercapitalized
'the other relates to whether economically insolvent institutions
' are being closed or reorganized
in a timely manner.
i

There are several

reform proposals which would attempt to
costs
insurance
by eliminating
supervisory forbearance and
reduce
non-viable banks in a timely manner.
r closing
Some of these
'
to close or reorganize a bank
pz'Oposals would require supervisors
:;ghee its capital ratio falls below some positive number.
Other
establish
would
mechanisms
under which a bank would
proposals
automatically be closed when some market-determined
event
example, if a bank could not roll over subordinated
;, occurred--for
debt. One can also regard depositor discipline proposals as
types of "timely closure" proposals, since, absent support from
the lender of last resort, runs by uninsured depositors could
force regulators to close a bank.
i

, ".

banks are
in which solvent but undercapitalized
also can have substantial effects on deposit insurance
&costs. One purpose of supervision is to counteract the
i~incentives
undercapitalized
banks have to increase risk-taking,
and to prevent
inappropriate fund transfers from the bank to its
institutions
Those concerned about how undercapitalized
&owners.
are supervised advocate remedies ranging from outright seizure of
institutions which fall below some positive capital-to-asset
ratio, to restrictions on growth and activities, and limits on
&dividend payments and other transfers out of the bank.
A concern sometimes
expressed by bank supervisors is that
„they have insufficient
authority to require exceptionally risky
', banks to hold more capital. '
They contend that the litigious
~~&Ore of U. S. business
coupled with the standards of evidence
x'e5lired
in
law proceedings make it almost
administrative
,
'iWossible to impose any penalties on banks whose activities are
'h«& legal and profitable.
That is, the mere potential to suffer
&osses through,
for example, excessive concentration in
'"&~ommercial real estate may not be sufficient
grounds to sustain a
„s"Pervisory order to increase capital.
Only actual losses are
9'ounds to sustain such an order, and by that time it may be too
'&~« to avoid insurance losses. Some supervisors go so far as to
which has caused insurance costs to
Y t~at this is the problem
90 Out of control
The manner

~;supervised

~.,
, ~:

yll

there is an important set of proposals which are
motivated by the desire to limit the activities which can be
Supporters of these proposals
funded with insured deposits.
insurance
safety net is spread too wide
contend that the deposit
There are many proposals along these lines which vary according
to what activities can be funded with insured deposits,
activities are permissible to bank holding companies, and what
restrictions should exist on transactions between banks and tgz
affiliates or subsidiaries.

Finally,

Concerns

about the Competitiveness

of the Saaki. ng Zndust~

concern which has gained increasing prominence in recent
years is that the U. S. has forced its insured depositories in&0
Layer upon lay~
an increasingly untenable competitive position.
to
the
1927
McFadden
back
regulation
dating
of piecemeal
Act,
coupled with recent changes in financial markets, are alleged tq
have created a situation in which bank and thrift franchise
With less and less to lose, th
values are inexorably declining.
argument goes, banks have increasing incentives to take risks an
mounting insurance costs are inevitable.
A

Profit margins available to banks have been narrowed hy a
variety of forces including increased competition from foreign
and nonbank providers of financial intermediary
services, the
growth of securitization,
and a growing ability of former prime
bank customers to access capital markets directly.
It is argue
that the U. S. regulatory structure has prevented banks from
adapting effectively to these changes.
Banks in the U. S. are

restricted by both the Glass-Steagall
Company Act from affiliating with
"6
nonfinancial firms,
and the activities allowed to bank holding
companies (BHCs) and their affiliates are limited to those
"closely related to banking. " The determination of what

Act and the Bank Holding

constitutes

acceptable BHC activities, intra-BHC transactions,
consolidated BHC capitalization rests with the Federal
Reserve Board (FRB), which is the federal regulator of BHCs.
Intrastate and interstate bank expansion, both through brancbi~~
and acquisitions by holding companies, are severely restricted b'.
a labyrinth of state and federal statutes.
Thrift institution&
are required to hold 70 percent of their assets in mortgages a~&
mortgage-related assets.
and

It is

alleged that, these restrictions

make

difficult

&o&

banking organizations and thrift institutions
to attra«
capital, respond to market forces, and diversify appropriatelj
These concerns are heightened by the coming deregulation
European banking in 1992, "7 which may further weaken the
competitive position of U. S. banks in the world financial mar~e"

banks,

There are numerous proposals for improving the health of the
Most such proposals advocate a complete
banking industry.
Others advocate
elimination of branching restrictions.
Thrift
the
Qualifying
Lender
Test, which would
eliminating
largely eliminate the distinction between thrifts and commercial
Many proposals would more or less completely
banks.
eliminate
restrictions on the types of entities with which banks could
affiliate and the activities permissible to BHCs. These
proposals vary considerably in terms of the types of activities
which could be funded with insured deposits and how the new
powers would be supervised.

E. Historical Background
The preceding sections discussed on a conceptual level the
purposes, goals and concerns with federal deposit insurance.
We
now turn to a brief review of the performance
of commercial banks
and the recent changes in the financial marketplace
and thrifts,
operate.
in which these institutions
1. The Period 1934 to 1942
The early years of the FDIC's existence were a period of
relatively conservative bank behavior. '8 Bankers who survived
'the Depression were extremely cautious.
Legislation enacted in
the 1930s limited bank behavior, essentially to insulate banks
'from competing with one another too aggressivelyEntry was
limited by cautious behavior on the part of regulators and by a
still-depressed

economy.

the exception of the recession years of 1937-1938, the
throughout the 1930s from the low point reached
in 1933. Nevertheless,
the FDIC handled 370 bank failures from
1934 to 1942. Most of these were small banks, with the FDIC
«alizing an aggregate book loss of only about $23 million as a
Iresult of these failures.
With

ieconomy

expanded

The introduction
of federal deposit insurance may have
„i~~r~ased the ability of small and undiversified
banks to attract
[&eP«its. Thus, deposit insurance may have tended to perpetuate
structure characterized by the existence of many very
&4 banking
»all firms, and may have indirectly encouraged retention of
restrictive state branching laws.
had been recognized for
pome time that a branch banking
system potentially was more
I~table than unit banking because
allowed banks to diversify
)He09raphically.
As the failure rate began to increase during

many

~t~t~~

moved

to liberalize branching restricti

1929 to the enactment of the Banking Act of 1935, 13 states
~r+a«« laws providing broader branching powers for banks. '
~fter 1935,
was almost 30 years before any state again
Liberalized branching.
rom

The Period 1942

to 1972

II,

financial policies and
private-sector restrictions produced an expanding
Bank failures declined significantly;
only 28 insured
system.
banks failed in the period 1942-1945. Banks emerged from World
Loan losses were practical]y
War II in very liquid condition.
In fact, many banks experienced sizable recoverie
nonexistent.
on previously charged off loans.
During World War

government

During the three decades from 1942 to 1972 banking behaviz
In general, economic
continued to be very conservative.
performance was favorable, with recessions reasonably mild
short in duration, and the number of business failures and the
This was a period of
volume of loan losses at low levels.
general prosperity, with a secularly increasing GNP, generally
low levels of unemployment
and, beginning in the early 1950s,
level.
Until about 1960, banks continue
relatively stable price
to operate in an insulated, safe environment.
Gradually, banks
began to change the way they operated, and some of the
restrictions began to be dismantled.
The Depression experience
ceased to be a dominant force influencing bank management.
Still, during these 30 years, there were only 109 failures of
FDIC-insured banks.

It would be an oversimplification to think of this period a
being uniform.
Banking changed substantially
in this 30-year
period. Beginning in the early 1960s, some states started to
liberalize branching laws. Additionally, the bank holding
company vehicle was used increasingly
to enter new product
markets and circumvent branching restrictions, and the appearanc
of negotiable certificates of deposit represented a dramatic
shift in bank-funding strategies.
3.

The Period 1972

to 1980

Banking behavior began to change
From a performance standpoint,

in many respects during
earnings became more
volatile. Loan losses rose dramatically, and even in some verY
good years (1977-1978) they never returned to the low 1960s
levels. More and more bank funding involved purchased moneyi
even for moderate-sized banks, and demand balances became
relatively less important.
Banks entered new product marketsi

1970s.

tbsp

expansion possibilities broadened, and traditio»&
services began to be offered by some financial
conglomerates.
Some of these developments
occurred suddenlY
while others reflected a changing regulatory and competitive

geographic

banking

environment.

The performance of the economy during this period was no&
very strong.
Real growth was sluggish and the economy
experienced a severe recession. The economy also
was subgec&e&

various shocks that affected banking

and business in general.
increase
the
rapid
in
of
oil
prices beginning in
effects
L973, and the ensuing deflation in oil prices, caused loan
~rob]. ems for banks heavily exposed to certain energy-related
:redits.
The economy experienced a serious shock in October 1979 when
Reserve embarked on a program designed to reduce
Federal
the
|nflation. One component of the Federal Reserve's inflationfighting strategy was the decision to allow interest rates to
[luctuate more freely. High and volatile interest rates soon
resulted, to the particular detriment of thrift institutions.
The Period 1980 to the Present
-o

8AIF-Xnsured

Savings Associations

industry experienced considerable financial
fifficulties throughout the 1980s, and its problems have received
The industry's
current plight can be traced, in
much attention.
the
extraordinarily
interest rates of the early
to
high
part,
nature
of
the
S&L
business
makes the industry's
1980s. The
earnings very sensitive to changes in interest rates, and this
eas especially true before the widespread use of adjustable-rate
S&Ls' balance sheets traditionally
consisted
nortgages.
fixed-rate mortgages funded by savings
primarily of long-term,
and time deposits.
Interest rates paid on these deposits were
constrained by Regulation Q. Whenever market interest rates rose
above regulated
rates, S&Ls faced deposit outflows.
The S&L

In part to help S&Ls cope during these periods of
Sisintermediation,
which became especially troublesome during the
inflationary environment of the 1970s and early 1980s, the
regulators and Congress took steps to deregulate deposit interest
~ates. In 1978, S&Ls were authorized to offer a six-month moneynarket certificate of deposit which paid a market-related
interest rate, and within a year this instrument accounted for 20
percent of S&LSI deposits. 21 The Depository Institutions
&eregulation and Monetary Control Act of 1980 established a
-omittee to phase out all deposit interest-rate ceilings by
&a~eh 1986, and allowed S&Ls (and banks)
nationwide to of fer
&nterest-paying consumer transactions accounts, Negotiable Order
if Withdrawal (NOW) accounts.
In a further attempt to help them
keeP up" with rising interest rates, in 1981 the Federal Home
&an Bank Board (FHLBB) authorized
federally chartered S&Ls to
offer adjustable-rate
mortgages.

but did not
reduced disintermediation
on the S&L
rates
litigate the overall impact of rising interest
S&Ls' average cost of funds rose from about seven
'industry.
' rcent in 1978 to over 11 percent in 1982, and exceeded the
This led to
+&rage return on mortgages during 1981 and 1982.
These developments

large operating losses, illiquidity and extensive insolvencies
It has been estimated that by 1982
throughout the industrywould have been insolvent by
industry
S&L
virtually the entire
marked-to-market.
As a result of these
about. $100 billion if
1980
from
failed
through
S&Ls
470
1983, as compar&
developments,
with 226

failures

from 1934 through

1979.

The regulatory response to these problems was based in lar&
part on a lack of adequate resources to deal with the situatioz
and a belief that conditions would improve when interest rates
declined to normal levels. This response included shoring up
industry earnings and net worth with a variety of accounting

changes which,

the industrY,

while not improving the real economic position
avoided (at least technically) insolvencies and

interest rates to decline. 4
In addition to a more lenient definition of capital, less
"regulatory" capital was required of S&Ls. Minimum regulatory
capital requirements were reduced from five percent of
liabilities to four percent in 1980, and to three percent in
1982. S&Ls were permitted to expand rapidly, and many did just,
that. For example, S&L assets in Texas grew from $38 billion to
$85 billion between year-end 1982 and year-end 1985. Moreover,
took advantage of liberal new asset powers
many institutions
(particularly in Texas and California) to expand into
nontraditional,
higher-risk lines of business in which they had
little or no experience. These new powers had been granted by
Congress and certain states in an attempt to give S&Ls
alternative earnings sources. Capital requirements which had
been inadequate to cushion traditional S&L risks were certainly
inadequate to cushion these new higher risks.
The combination of undercapitalized
growth into high-risk
activities, particularly speculative real estate lending and
direct investment, an extremely severe regional economic
depression in the Southwest, and instances of insider abuse and
fraud has resulted in financial difficulties for a substantial
segment of the S&L industry.
As of September 30, 1990, there
were 206 S&Ls with $98. 8 billion in assets under RTC
conservatorship
. The remainder of the industry consisted of
2, 389 S&Ls with $1.0 trillion in assets. Four hundred nineteen
of these private sector (nonconservatorship)
S&Ls, with $246
billion in assets, do not meet the capital requirements
established under FIRREA effective December 7, 1989. Eight
hundred thirty private sector S&Ls with $586 billion in asset~
would

bought

time for

fail the fully
in effect.

currently

phased-in

requirements

they were

of the S&Ls not meeting their capital requirements ~~
others will survive.
The savings and loan system is
entering a transitional period which will determine the fate «
the undercapitalized
segment of the industry.
Table 3 provides

fail;

Some

Table
Distribution

of FSLIC/SAIF-Insured

Thrift Institutions
(In millions

Tangible capital-to-assets
than 0%
Number of thrift
institubons

1990' ..-------.

1989--------1988---------.

----.
1988....-------

1987---',

1985--------~

cf June

SQ,

395
530
508
672
672
705

by Tangible Capital-to-Assets

Total

assets

Tangible capital-to-assets

3-6%

Number of thrift
institutions

$213,524
288, 586
283,002
335,795
324,399
335,017

324
362
441
471
581
726

Ratio,

1985-1990

of dollars)

less

1996. All other years are as of December 31.

Source: Office of Thrift SupeNision.

Total

assets

$283,077
275,006
425, 106
339,201
335,335
347,512

Number of thrift
institutions

823

815
864
891
995
1009

Total

assets

$468, 909
468,494
418,220
355,566

315,938
258,647

Tangible capital-ttHtssets
greater than 6%
Number of thrift
institutions

1155
1171
1136

1113
972
806

Total

assets

$199,767
202, 568
195,865
188,429
156,261
95,775

description of the S&L industry's capital-to-asset ratio
distribution from 1985 through June of 1990. The number of
institutions with negative capital was significantly reduced in
1990 due to resolutions of insolvent institutions by the
Resolution Trust Corporation (RTC). Figure 1 illustrates the
dramatic decline of aggregate net income in the industry from
The ability of the S&L industry to
1984 through June of 1990.
on the behavior of interest
contingent
be
will
capital
attract
real-estate
markets and the econom
local
rates, the condition of
generally, and other factors influencing the value of an S&L
charter.
BIP-Insured Savings Banks
At year-end

1989 there were 489 BIF-insured

savings banks

billion in assets." These institutions generally are
That is, they invest predominantly
"qualified thrift lenders.
Of these 489
products.
in mortgages and mortgage-related
institutions, 469 with $241 billion in assets are state-chartere~
and supervised by the FDIC, and 20 with $39 billion in assets ar~
federally chartered and supervised by the Office of Thrift

with $280

Supervision.
When

interest rates rose dramatically

in 1979-1980

and agair

in 1981-1982, most FDIC-insured savings banks found themselves
locked into long-term, low-yield assets (primarily mortgages)
while their deposit costs rose substantially.
Between 1978 and
1983, interest and fees on savings banks' real-estate loans

fluctuated between $7. 94 and $8. 97 per hundred dollars of such
loans. Meanwhile, interest and dividends on savings and time
deposits rose from $6. 22 to $9. 66 per hundred dollars of such
deposits. As a result, savings banks' return on average assets
fell from 0. 59 percent to a negative 0. 93 percent, and the
industry-wide equity-to asset ratio fell from 6. 8 percent to 4. 8
percent.
14 FDIC-insured savings banks with $17, 421 million
in assets received some form of FDIC assistance during this time
(excluding the use of net worth certificates).

to late 1980s were generally more favorable for
savings banks.
Interest rates fell from their high
levels of the early part of the decade. Savings banks generally
avoided rapid asset growth into new high-risk activities, so that:
credit quality problems were for the most part not serious. In
addition, most FDIC-insured savings banks were located in Ne&
England, which did not suffer any substantial real-estate
downturns for most of the decade of the 1980s. Between 1984 and
1988 only four savings banks received assistance from the FD1C
(not including those with ongoing assistance agreements entered
into before 1984).
More recently, many savings banks insured by the Bank
Insurance Fund (BIF) have experienced considerable difficulty
The mid-

FDIC-insured

Figure

Net Income of FSLIC/SAIF-Insured

Institutions

1984 1990
-

Millions

of Dollars

131.42

5000
2500

3,728.29

-7,779.13

1,021.82

-17,561.40

-6, 473.10

1989

1990*

0
-2500

-5000

-7500

-10000
-1 2500

-15000
-1 7500

1984

1985

1986

1987

1988

Net Operating

Through June 30.
Source: Office of Thrift Supervision.

Income

Net Non-Operating

Income

resulting from problems in real-estate loan portfolios and,
Most of thes~
some instances, losses on securities activities.
the
Northeastern
in
U.
located
s.
are
Only 16
banks
savings
assets--less
in
billion
1
than
five percei
institutions with $12.
assets--are
located
in
other
regions.
industry's
the
of
Information on the equity-to-assets ratios of BIF-insured
savings banks is presented in Table 4. The data in Table 4
indicate that as of mid-1990, 16 savings banks with assets of ~~
billion reported equity ratios less than three percent, and 44
savings banks with assets of $64 billion reported equity zatios
of three percent to six percent. These data, however, probably
understate the severity of the problems facing the savings bank
industry, as can be seen from further inspection of othez
financial data.
As indicated in Figure 2, the net income of all BIF-insured
savings banks has declined four consecutive years beginning in
1986. For the first six months of 1990, 29 percent of all
savings banks were unprofitable and the industry lost a combined
These losse
$443 million (a return on assets of -0. 33 percent).
are caused primarily by weaknesses in real estate loan
portfolios, which make up a substantial fraction of savings bank
assets (Figure 3). Noncurrent real estate loans at statechartered BIF-insured savings banks have grown more than 500
percent since 1986 (Figure 4). As a percentage of total assets,
noncurrent real estate loans grew from one percent to 4. 2 percen
from 1986 to mid-1990.
Capital adequacy must be evaluated in light of savings
real estate loan exposure. At mid-year 1990, ten state
chartered savings banks, with $5. 6 billion in assets, had levels
o f noncurrent
loans plus f oreclosed real estate more than double
their total capital and reserves (Table 5). Another 32 statechartered savings banks, with assets of $34. 9 billion, had
noncurrent loans plus f oreclosed real estate that exceeded their
capital and reserves. The growth of problem assets relative to
the capital cushion has been dramatic.
A year ago, only two
savings banks with assets of $594 million had noncurrent loans
plus foreclosed real estate more than twice the amount of their

banks'

capital

and

reserves.

Commercial

Banks

The high interest rates of the late 1970s and early 1980s
which adversely affected thrift institutions
were a product of ~i
inflationary economy; the inflation rate as measured by the
annualized growth rate of the Consumer price Index had been
high as 16.8 percent in the 1st quarter of 1980. By 1986'
however, the inflation rate had fallen to
This
1 percentmoderation of price increases lowered interest rates and created
a more favorable environment for thrifts, but deflationary

Table 4
Distribution

of FDIC/BIF-Insured

Savings Banks By Equity-to-Assets

Ratio,

1985-1990

(In millions of dollars)

Equity-to-assets less than
percent

Total

Number of

assets

savings banks

990'-""
989......988...""

16
13
5

987...--

988...-985....--

As of June

$19,008
22, 153
20,268
1,516
13,961
39,255

Equity-to-assets

3 to 6 percent

Number of

Total

savings banks

assets

43
38

39
58

$63,666
73, 131
62, 124
80,722
70,366
70,397

30; all other years are as of December 31, unless otherwise noted.

Source: Federal Deposit Insurance

Corporation.

Equity-to-assets greater than 6
percent
Number of
savings banks

418
432
447
442
405
290

Failed 1965 through Sept. 14,

1990

Total

Number of

Total

assets

savings banks

assets

$183,547
184, 191
206, 618
179,896
151,743
94,849

7
1

0
2
1

$4, 258
855

0
1,766
32
5,691

Figure 2

Net Income of FDIC-Insured

Savings Banks

1984 1990
-

Millions of Dollars

3,000

2, 368

2, 500

2, 085
2, 000

1,444

1,500

1,235

1,000

500

118
-772

-443

1989

1990*

0
(500)

(1,000)

1984

1985

1986

*As of June 30.
Source: Federal Deposit insurance Corporation.

1987

1988

Securities and Other Gains
Net Operating income

Figure 3

Real Estate Loans as a Percent of Total Assets
State Chartered FDIC-Insured Savings Banks

1985 - 1990

Percent of Total Assets

1988

1989

1990*

30
20

10
0
1985

1986

1987

* Through June 30.
Source: Federal Deposit Insurance Corporation.

Total Real Estate Loans

Fixed-Rate Real Estate Loans

Figure 4

Noncurrent Real Estate Loans*
State Chartered FDIC-Insured Savings Banks

1986 - 1990

Millions of Dollars
7000

5, 881

6000

5, 474
5000

4, 570
4000

3000
2, 343

2000

1,205

971

1000

0
1988

1988

1987

1989

March

31, 1990

June 30, 1990

* Includes

Real Estate Loans 90 Days Past-Due
and in Nonaccrual Status.

Real Estate Loans as a
Percent of Total Real Estate Loans
Noncurrent

Year-end

1986

1987

1988

1989

1.02%

1.01%

67%

3.16%

Source: Federal Deposit Insurance Corporation.

31,
1990

March

3.81%

June 30,

1990
4 16%

Table 5

Assets Relative to Capital and Reserves
BIF-Insured
State-Chartered
Savings
Banks,
June 1989-June 1990

Troubled

(In millions of dollars)

June 1990
loans plus
repossessed real estate
Noncurrent

More than 200% of Capital and Reserves ... ........ .
Between 100% and 200%
of Capital and Reserves. ..
Between 50% and 100%
of Capital and Reserves. ..
Less than 50% of Capital
and Reserves ....................

Number

of
banks

June 1999

Assets

of
banks

$5,579

$595

34,946

15,007

48, 165

11,995

354 143,688

Source: Federal Deposit Insurance Corporation.

437 210,110

pressures in some sectors of the economy put pressure on
borrowers, resulting in credit-quality problems for many
commercial banks.

sector was particu]ar]y hard
the 1970s farm exports had grown at record levels, rising f
billion in 1970 to $41 billion in 1980. It was generally
believed that American agriculture was in a unique positio
benefit from an inability of foreign food production to keep
Government officials and agricultural
with population.
researchers expounded on the need to expand production and mo
extensively capitalize the production process. Farm debt
though farm income was
lock step with real-estate values even +
debt.
often insufficient to support the
shifted unfavorably for
Demand and supply conditions
American agriculture in the late 1970s and early 1980s. High
domestic production, unfavorable exchange rates, debt problems
The

agricultural

countries that had previously imported substantial amounts pf
American farm products, and increases in foreign food production
combined to lower the prices received by American farmers.
As a
real
farm
income
result,
declined, highly leveraged producers
experienced severe cash flow problems, and farm real estate
values declined.
In the major grain producing areas of the
Midwest and Northern Plains States, farm real estate values fell
by as much as 50 percent between 1981 and 1986.

result of these developments, 204 "agricultural banks"
(those with at least 25 percent of their loans to agricultural
borrowers) failed between 1984 and 1987. This represented 37
percent of all bank failures that occurred during this period.
These were generally small banks with assets less than $50
As a

million.

severe was the sectoral deflation experienced in
the energy-producing
states. The price of oil had risen
dramatically during the 1970s as a result of the behavior of the
Organization of Petroleum Exporting Countries (OPEC) cartel.
From its peak of $40 per barrel in 1981, the price of West Texas
Intermediate crude oil declined steadily to about $31 in
November,
1985 before falling to less than $12 in July, 1986.
Service industries that had supported the oil industry in these
states suffered severe downturns.
In Texas, reduced demand fo r
office space at the time large quantities of commercial real
estate were being completed resulted in difficulties for
Even more

construction and related service industries.
Real-estate value~
fell sharply; office vacancy rates in Dallas, Houston and Austin
exceeded 30 percent in 1987. In the fourth quarter of 1987 the
annualized rate of residential mortgage foreclosures in Texas ~»
15 percent of mortgages outstanding. ~

in the energy belt has resulted in a large
Defaulted energy loans played an
number of bank failures.
Illinois
important role in the collapse in 1984 of Continental
bank
the
largest
to
receive
FDIC assistance.
National Bank,
Between 1985 and 1989, there were 486 bank failures in Texas,
and Oklahoma, or 54 percent of all bank failures
Louisiana
time. Nine of the ten largest Texas bank holding
that
during
with FDIC or other outside assistance.
&ompanies were reorganized
of MCorp, First RepublicBank
This includes banking subsidiaries
Corporation, First City Bancorporation and BancTEXAS. The cost
to the FDIC of resolving the difficulties of these four banking
organizations is estimated at about $6. 7 billion.
The

depression

large portfolios of loans to lessdeveloped countries (LDCs) also have been a source of concern to
and the FDIC since the mid-1980s.
bank regulators
While losses
loans
have
not
been
a
LDC
factor
on
primary
in any bank failures,
such losses have reduced the capital available to cushion the
FDIC against loss and have increased the fragility
of the banking
Money-center

banks'

system.

Not all
macroeconomic

the blame for bank failures can be attributed to
events. A substantial role is played by
mismanagement
An OCC study examined
and, in some cases, fraud.
the causes of 171 bank failures that occurred during the period

1979 through 1987. The study found that "self-dealing,
undue
dependence on the banks for income or services by a board member
or shareholder,
inappropriate transactions with affiliates, or
unauthorized
transaction by management officials was a

factor leading to failure in 35 percent of the failed
insider
fraud. "
Material fraud, in fact, played a significant role in 11 percent
of the failures.
During their decline, 24 percent of the
rehabilitated banks experienced significant insider abuse, but
none were seriously
affected by material fraud. '
There were 12, 706 FDIC-insured commercial banks in operation
at the end of 1989, with assets of $3. 3 trillion.
These
institutions had an aggregate equity capital to asset ratio of
6 2 percent,
and an aggregate return on assets of 0. 52 percent.
There are aspects of current bank performance that are of
oonce» to bank supervisors and the FDIC. Two-hundred six banks
failed or received assistance during 1989, fifteen less than the
~«ord of 221 set in 1988. Although the number of banks on the
FDIC's "problem" list declined during 1989 by 300 to 1, 093 at
Y&ar-end, net charge-off rates for the banking industry for 1989
~er+ the highest since banks began reporting the data in 1948.
F&ve of the ten largest U. S. banks reported
losses in 1989, as
did one-fourth of all U. S. banks with assets over $10 billion.
These losses generally reflected problems in real-estate loan
significant

About a quarter of the banks with significant
abuse also had significant problems involving material

banks.

portfolios and, in the largest banks, the effect of reserving
against losses on loans to LDCs.

Changes

in the Financial Marketplace

Affecting

and other depository institutions
do, who they
and the nature of the environment within which

What banks

compete with,

operate, all change over the years. These changes can affect
profitability of banking and consequently the health of
banking industry.

series of tables and graphs, three
significant interrelated trends concerning banking are isolated
banking has become a riskier, more volatile business; banks are
encountering greater degrees of competition; and the banking
In an accompanying

itself is changing.
Banking Is Riskier

business

Perhaps the most persuasive piece of evidence that banking
a riskier business is the number of failed banks (Figure 5).
Between 1943 and 1981, the greatest, number of banks that failed
in any one year was 17, in 1976. Annual failures increased
dramatically in the 1980s, however, reaching a peak of 221 in
1988. Net loan chargeoffs also rose significantly in the 1980s,
reaching a peak of 1.15 percent of total loans in 1989 (Figure
6). A decade by decade comparison of the banking industry's
return on assets reveal a fall in that measure of profitability
during the most recent decade (Table 6). The slide is more
evident when a trend line is fitted to industry return on assets

for the period 1960-1989 (Figure 7).
One cause of bank difficulties
has been a general rise in
both the level and volatility of interest rates (Figure 8).
Double-digit interest rates became common in the 1980s. The
marketplace has reacted to the banking industry's difficulties
being wary of bank stocks. As a percent of the Standard and
Poor's 500 Stock Index, the Salomon Brothers 35 Bank Index has
generally fallen since 1975 (Figure 9). The Bank Index was 55
percent of the S&P 500 in 1975, but only 38 percent in 1989.
Banks Are Encountering

More Competition

The financial marketplace has become more crowded.
A
greater variety of players are offering a wider variety of
products and services. One result is that the banking industry ~
share of financial sector assets fell from 34 percent in 1960 «
27 percent in 1989 (Table 7). The decline was most pronounced in
the 1980s: banks still had 33 percent of the total in 1980. The
decline in the proportion of financial sector assets held by t"e
banking industry was due to increasing proportions held by

Figure 5

Number of Failed Banks by Year

1934 - 1989

Number

250

200

150

100

0
1934

1940

1945

1950

1955

1960

Source: FDIC Annual Reports and Statistics on Banking.

1965

1970

1975

1980

1985

Figure 6

Net Charge-Offs to Total Loans
Insured Commercial Banks

1960 - 1989

Percent

1.2

1.0

0.8

0.6

0.4

0.2

0
61

Source: FDIC Annual Reports and Statistics on Banking.

Table 6

Selected Balance Sheet Ratios for Insured Commercial Banks, 1934-1989
(In percent)

1934-39

11.88
29.43
2.48

EqlNtll/assets-

Loans/assets ..
Loans/eqUQ.
Reserves/loans
Loans/tepost'ts.
Return on
Retum on

33.92
0.46
3.84

assetseqUQ

Net interest

margin.

Net loan chargEH)ffs/loans
Net loan char~ffs/net

1.85

and leases
income ..

Source: Federal Deposit Insurance

Corporation.

1940's

1950's

1980's

1970's

6.89

7.38
38.35
5.20
1.65
42. 19
0.61
8.22
2.32
0.07
4.39

7.62
51.49
6.75
1.98

6.39
53.73
8.41
1.33
65.00
0.77
12.09
3.00
0.39
26.86

22.04
3.20

23.79
0.56
8.19
1.46

58.92
0.73

9.61

2.76
0.17
11.88

1980's

6.11
57.75
9.45
1.78
74.15

0.61
9.94
3.32
0.82
78.39

1980-84

5.96
54.71
9.18
1.14
69.67
0.69
11.65
3.20
0.57
45.04

1985-89

6.22
59.94
9.64
2.20
77.42
0.55
8.77

3.41

0.99
108.96

Figure 7

Return On Assets
Insured Commercial Banks

1960 - 1989

Percent

1.0
0

0
0

0.8
0

0.6

0.4

0.2

Return on Assets
Trend Line

Source: FDIC

Annual Reports and Statistics on Banking.

Figure 8

Average Interest Rates
Rate

1961 - 1988

16
14
12

1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988

—
~
~

Mortgage Rates '
Commercial Paper &
Gov't. Securities '
Trend Line, Gov't. Securities

—

' Existing Home Purchases - U.S.
Average
2

Sources: U.S. Department of Commerce, Business Statistics.

Average Yield on 6-Month Maturity Paper
on new issue %May T-bills

3 Yield

Figure 9

Bank Stocks as a Percent of S8 P 500
Bank Index as a Percent of A&P 500

1975 - 1989

70
New York City Crisis

Fed Tightens Monetary Policy
Prime Rate reaches

21%
Penn Square collapses

ContiItental

illinois

Rescued
FIRREA enacted

1975

1977

Source: Salomon Brothers.

1979

1981

1983

1985

1987

1989

Table 7
Financial Assets Held by Financial Sector,

1960-1989

(In percent)

Commercial
banks

989...-"987.....-"

985.....--

983.....-982.......981 .........
979.........
978.........
977.........
976.........
975.........
974.........
973.........
972.........
971 .........
970.........
969.........
,

967.........
965.........

26.56
26.73
27.24
28.51
29.49
30.25
30.32
31.14
32.32
32.83
32.80
33.53
33.49
34.25
35.30
37.19
36.96
34.91
34.89
35.12
34.81
34.40
33.94
33.66
33.53
34.22

Source: Federal Reserve Board Annual

Other
depository
institutions

Agencies and

14.11
16.61
16.98
17.28
18.09
18.98
18.37
17.67
18.22
19.11
20.71
21.64
21.98
21.56
20.99
20.26
19.77
19.51
17.90
17.29
17.37
17.52
17.96
18.40
11.65
16.97
Statistical Digest.

pools

10.80
10.48
10.40
9.67
8.80
8.54
8.21
7.94
7.28
6.85
6.68
5.96
5.41
5.24
5.14
5.08
3.87
3.04

3.02
3.19
2.65
2.11
2.03
2.25
1.85

1.71

Monetary
authority

2.59
2.75
2.84

3.04
3.08
3.17
3.33
3.56
3.66
3.85
4.29
4.57
4.78
5.09
5.27
5.27
5.19
5.17
5.68
5.76
5.89
5.93
6.17
6.35
6.27
7.90

Insurance
companies

14.47
14.13
13.78
13.37
13.66
13.56
14.03
14.11
13.95
14.15
14.81
14.98
15.13
15.32
15.10
15.01
15.37
16.04
16.44
17.02
17.44
18.07
18.72
19.05
19.26
21.82

Pension and
retirement
funds

15.55
14.90
14.85
14.69
15.06
14.75
15.70
14.86
14.13
14.74
12.57
12.03
11.94
11.06
10.65
9.46
10.52
12.21
11.85

11.46
11.33
11.29
10.97
10.47
10.50
8.75

Mutual and

money
market funds

8.08
7.39
7.64
7.91
6.21
5.41
4.79
5.43
4.95
3.06
2.50
1.66
1.65
1.90
1.98
1.75
2.30
3.20
3.39
3.25
3.53
4. 12
3.83
3.28
3.50
2.57

Other

7.84
7.01
6.27
5.52
5.61
5.34
5.26
5.29
5.48
5.41
5.65
5.62
5.63
5.59
5.57
5.98
6.02
5.92
4.41
4.54
4.64
3.90

3.81
4.12
4.07
3.65

mortgage agencies, pension
government-sponsored
money market funds.
and
funds, and mutual

and retirement

Figures 10 and 11 present more vivid evidence of
increased competition being encountered by U. S.
commercial paper market has attracted a number of high-quality
organizational customers that once relied on bank loans for
short-term funds. The ratio of bank commercial and industrial
loans to commercial paper outstanding has accordingly decreaseg
(Figure 10). C&I loans fell from almost 10 times the amount of
commercial paper outstanding in 1960 to only 1.2 times j.n ]989
In Figure 11, the growth in competition afforded by foreign
is depicted. In 1972, foreign banking
banking organizations
organizations controlled 3. 6 percent of U. S. domestic banking
assets. In 1989, the proportion was 21.4 percent.
A major change in the financial
industry has been the growt
of what might be termed nontraditional financial instruments.
One example is provided by the packaging of mortgages for resale
-also known as "securitization. " The proportion of mortgages in
mortgage pools grew from one percent in 1970 to 23 percent in
1987 (Figure 12). By increasing the efficiency and liquidity of
the mortgage market, securitization has contributed to a
narrowing of spreads available to bank and thrift mortgage
lenders.

another example of the growth of nontraditional
financia
instruments,
the volume of financial futures contracts traded
each year increased from 0. 6 million in 1977 to 117 million in
1988, for an annual growth rate of 61 percent (Figure 13).
As

The Banking

Business

Changing

of the most important functions of banks is to provide
credit. The making of loans is probably the form that most often'
comes to mind when the credit-providing
function of banks is
mentioned. Loans, however, have not constituted a stable
percentage of the banking industry's assets. During the 1930s,
loans were only 30 percent of industry assets. The percentage
actually fell during the 1940s. The decline was due to the lar9~
quantities of government securities that banks acquired durin9
world War II and to the constraints on non-war related economic
activity during those years.
One

Since the 1940s, the proportion of loans in bank portfolio
increased, reaching a peak of almost 60 percent f
the period 1985-1989. While the loans to assets ratio of t~e
banking industry was increasing, however, the equity to assets
ratio remained static (Table 6). This has most likely resul«
in a steadily increasing level of risk in the banking system
because loans are for the most part more risky than the oth«
major category of bank assets--investment
securities.

has steadily

Figure 10

The Growth of the Commercial Paper Market
Ratio of Bank C&l Loans to Commercial Paper Outstanding

1960 - 1989
10

60 65 70 75

1977

1979

1981

1983

Note: Horizontal axis is not continuous for years 1960-1957.
Source: U. S. Department of Commerce, Business Statistics.

1985

1987

1989

Figure 11

Foreign Controlled Banking Assets
as a Percentage of Total Domestic Banking Assets

1972 - 1989

Percent

ill!i!ill

I!!

15
l'i!

I!j
ilii'jl

!!!
li!

.Ill!I!i

'l!!i!!!
I

I„!IfI!I,fl

'!I

1973

1975

1977

1979

1981

1983

1985

1987

1989

Figure 12

The Growth of Mortgage Pools

1970 - 1987
Mortgages in Pools as a Percent of Total Mortgages

1970

1972

1974

1976

1978

1980

1982

1984

Source: U. S. Department of Commerce and Statistical Abstract of the United States.

1986

Figure 13

Futures Market
Financial
Growth of the
Contracts Traded
Futures
Volume of Financial
- 1988

1977

Millions of Traded

Contracts

140

120

100

1978

1980

1982

1984

1986

1988

As the percentage of the banking industry's
assets devoted
the
composition
risen,
of
has
the
loan
loans
portfolio has
to
Two major changes are that the proportion
of real
changed.
+state loans has increased and the proportion of commercial and
industrial loans has decreased (Figure 14). This shift in
portfolio composition has exacerbated the effects of downturns in
The reduction in CEI lending,
regional real estate markets.
move. The rise of the
however, by banks has not been a unilateral
market
has
forced
banks
to seek other lending
qommercial paper

opportunities.

In the last several years banks have developed a market in
(HLTs) to augment their corporate
highly leveraged transactions
Some observers have expressed concern that
finance business.
these transactions expose banks to more risk than conventional
Thus far, however, no bank failures have
commercial lending.
been

attributed

HLTs.

in the banking business

bear noting. For
noninterest income has become more important,
constituting 16 percent of total income in 1989 (Figure 15) . And
off-balance sheet activities have increased substantially.
The
major categories of such activities grew in dollar terms from 58
percent of bank assets in 1982 to 116 percent of bank assets in
Other changes

example,

1989 (Figure

16).

Summary

the financial marketplace in
general, have been undergoing significant changes.
Risk has
risen. Competition from both inside and outside the industry
The banking

industry,

and

Maintaining profitability is more difficult than it
once was, and in that sense the health of the banking industry
increased.

has been on

1".

the decline.

Deposit Insurance

and supervisory

The supervisory
system
'United States is exceedingly
level is divided among five
&h&

'&he

has

systems

overview

for depository institutions in the
complex. Authority at the federal
principal agencies: the Office of

Comptroller of the Currency (OCC), the Federal Reserve Board,
Federal Deposit Insurance Corporation (FDIC), the National

Administration
(NCUA), and the Office of Thrift
"Pervision (OTS). The discussion in this chapter will cover all
! f these agencies except the NCUA, which is covered in a separate
'&zedit Union

credit unions.
In addition to the five principal agencies, a number of
&&her federal entities,
such as the Securities and Exchange
" ~i»ion and the Department of Justice, have responsibilities
' g»ding depository institutions. Moreover, depository
chaPter on

Figure 14

Real Estate and CB I Loans as a Percent of Total Loans
Insured Commercial Banks

1939 - 1989

Percent

„

„„0

00 0 00

00 0

00 0 0

000

0
1940

1945

1950

1955

1960

1965

1970

1975

1980

1985
C&l Loans

Source: FDIC Annual Reports and Statistics on Bankina

Real Estate Loans
Trend Lines

Figure 15

Non-Interest

Income as a Percent of Interest Income
Insured Commercial Banks

1982 - 1989

Percent

lki

lil

I!!Ii

Ikii!:,:;
I
li

ill,

ii!

ill

Ij
II

I!!Ii

"ll

Ii!

4
II

I!
I

ii
II

I!ijfi
h

f
hl

t
li
If

ji
h

I!
I!'

1982

Sourec: FDIC

1983

1984

1985

1986

Annual Reports and Statistics on Banking.

1987

1988

1989

Figure 16

Selected Bank Off-Balance Sheet Activities
as a Percent of On-Balance Sheet Activities
I984 - i989

Percent

140
120
ft

!!i!

100

lli

ii
iii

fli

I
ti";

ijl

I!
lfi

tl!t

I!I

III

fll

liil

!
I

ll :II

ii
ii ii
I

iii
if

jii

!Il

ff!

jif'

ijj
i!I I
I!i

fij,

jlI
fi

ii
ii

Ilj

I!I

jiji

iji

ifi

'ii

lji

1985

Llli

iij

fjl

1984

ilj

jij

!I!

II
fl

lji

If,

li ::I'

jlj

ljt

IIII

j!
fi

lij

III
If

I!I

ll!!

ji!jl I

I!
if

I!Iir

Ill

Ijl

I'I

!!!if

If!1

II!

1986

ji!'

il)

1987

1988

1989

Note: Of-balance sheet activities include loan committments, standby and commercial letters of credit, futures and
forwards contracts, and commitments to purchase foreign exchange.

Source: FDIC Annual Reports and Statistics on Banking.

be chartered either by a state or the federal
State-chartered
depository institutions are, in most
government.
both
a state and a federal supervisor.
instances, supervised by
regulatory system has undergone
The depository institutions
the
over
years.
The most recent changes were
a number of changes
Reform, Recovery, and
mandated by the Financial Institutions
Enforcement Act of 1989 (FIRREA). The Act abolished the
independent Federal Home Loan Bank Board (FHLBB), which had been
the federal supervisor of savings and loan associations and some
An office of the Department
of the Treasury, the
savings banks.
assume
of
created
to
the
duties
many
of the FHLBB. The
was
0TS,
of the FHLBB, however, which
deposit insurance responsibilities
entity, the Federal Savings
gag been carried out by a subsidiary
Insurance
Corporation
were transferred to the
Loan
(FSLIC),
and

institutions

:
:.

may

FDIC.

FDIC provided deposit insurance to
469
state-chartered
savings banks, 20
12, 706 commercial banks,
federally chartered savings banks and, as a result of FIRREA, to
savings associations that had
2, 878 federally and state-chartered
formerly been insured by FSLIC. The FDIC is the primary federal
' supervisor,
however, only for those state-chartered
banks that
:are not members of the Federal Reserve System. There were 7, 491
of these nonmember banks at year-end.
The FDIC also supervised
469 state-chartered
year-end
1989. The FDIC has
savings banks at
:;limited authority to close a bank. That authority mostly resides
.:with the OCC for national
banks, with the state banking agencies
:-:in the case of state-chartered
banks, and with the Office of
'„ Thrift Supervision
for savings and loans. In addition, the FDIC
:can terminate insurance under certain circumstances.
As

of year-end 1989, the

The OCC is the chartering
authority and primary federal
supervisor for national banks, which numbered 4, 180 at year-end.
;", The
remaining 1, 035 FDIC-insured commercial banks on December 31,
;

:1989, were state-chartered members of the Federal Reserve System.
:;This category of institution
is supervised at the federal level
." by the Federal Reserve, which also is the primary federal
):supervisor for bank holding companies.
At year-end 1989, 8, 846
of
the nation's banks were subsidiaries of bank holding
i
",

of which there were 6, 444.
C.
Chartering authority for federal savings associations now
'resides, as a result of FIRREA, with the OTS. That agency
".
. supervises not only the federal savings associations it charters
"t a»«hose state-chartered savings associations with federal
::~ep«it insurance and savings and loan holding companies. At
':" arend 1989, there was a total of 2, 878 federal savings
.~as«ciations and state-chartered savings associations with
i' ««ral deposit insurance.
::companies,
Pa

ii.

a great deal of formal

and informal

cooperation
the federal supervisory agencies. This includes
coordination of examinations, exchange of examination reports
discussion and coordination of enforcement actions. There is
also considerable cooperation between the FDIC and the various
state banking commissions with regard to examinations,
enforcement actions and, in most cases, the decision to close
There

among

bank.

Prior to the enactment of FIRREA, deposit insurance in bang
of two separate agencies.
and thrifts was the responsibility
FDIC provided deposit insurance for banks, and the FSLIC provide
deposit insurance for thrifts. The FDIC now administers the
deposit insurance program for both types of institutions,
although through two different funds.
The Bank Insurance Fund (BIF) is the successor to the
Permanent Insurance Fund that had been in existence for banks
since 1935. The Savings Association Insurance Fund (SAIF) is thi
successor to the thrift fund that had been administered by the

FSLIC.

Funds for the federal deposit insurance programs are
At the time of
provided by assessments on insured institutions.
the passage of FIRREA in 1989, the assessment rate for banks was
1/12 of one percent (0. 083 percent), and the assessment rate for
FSLIC-insured institutions was 0. 208 percent.
FIRREA increased
the BIF rates to 0. 12 percent for 1990 and to 0. 15 percent for
1991 and thereafter.
The SAIF rates were increased to 0. 23
percent for 1991 and are scheduled to fall to 0. 18 percent in
1994 and to 0. 15 percent in 1998. More recently, the FDIC Board
voted to increase the BIF insurance premium to 0. 195 percent for

1991 and thereafter.

In October 1990, Congress enacted the "FDIC Assessment Rate
Act of 1990, " which rendered obsolete a number of the FIRREA
provisions regarding assessment rates. The Act grants broad
discretion to the FDIC Board to set premiums for both BIF and
SAIF members in order to maintain designated reserve ratios.
Ceilings on assessment rates and assessment rate increases were
eliminated.
Also eliminated was the recgxirement that investmen~
earnings on reserves in excess of 1.25 percent of insured
deposits will be distributed to fund members, as well as the caP
of 1.50 percent on the funds' reserve ratios.
At year-end

1989, the Bank Insurance

Fund

contained

the

BIF's predecessor, the Permanent Insurance Fund, which had
reached a peak level of $18. 3 billion in 1987. Losses of $4
billion in 1988 and 0. 8 billion in 1989 reduced the fund to $13.2
billion by year-end 1989. Further losses of perhaps $4 bil»~"
are expected in 1990.
&

deposit insurance fund administered by the FOLIC had
reserves of $6. 4 billion at the end of 1980. Due to difficulties
in the thrift industry, however, the fund began incurring losses
in 1984 and had a deficit of $75 billion by the end of 1988.
to expected future losses. FIRREA
The deficit was attributable
S.
the
U.
taxpayers
responsible for much of these
made
in effect
losses.
The

How

the FDIC Has Handled Bank Pailures+

In principle, how the FDIC handles bank failures can have an
important impact on bank risk-taking and the cost of the deposit
It often is argued that to the extent the FDIC
insurance system.
handles failures in a manner which protects uninsured depositors
these creditors have no incentive to
and other general creditors,
a bank s condition, and all discipline against riskThis section reviews the
taking is removed from the system.
used
in
bank failures.
Table 8
FDIC
has
handling
the
methods
(than is available in Table 1)
presents more detailed information
for the 1980-89 period on the types of transactions the FDIC has
Information on the FDIC's loss
used in handling bank failures.
for
recent years, is presented in
transaction
experience by
type,
monitor

the "Early

Closure" chapter.

1. Historical Background
The Banking Act of 1933 provided the FDIC with the authority
to pay off insured depositors of failed institutions through

created Deposit Insurance National Banks (DINB) . No other
The 1935 Banking Act gave the
resolution process was authorized.
FDIC the additional
authority to pay off depositors directly or
to
bank.
It also gave the FDIC authority
through an existing
facilitate
to
make loans, purchase
assets and provide guarantees
a merger or acquisition.
newly

1935 and 1945 the FDIC resolved approximately 390
bank failures,
using either the payoff method or a merger with a
healthy bank.
In payoff resolutions, the insured depositors were
The receivership held
Paid off and a receivership was created.
&he assets of the failed bank against which the uninsured
The FDIC also
«Positors became general creditor claimants.
maintained a claim against the receivership as a general creditor
Uninsured
for the amount advanced to insured depositors.
«P»itors frequently did not receive the full amount of their
«Posits, and even when they did, long delays typically created
«me loss through foregone interest.
Between

first,

the majority of failures were resolved with
Payoffs. However, the mix shifted so that at the end of the ten
Year period, more failures were resolved through merger (or
assumption). Eventually, payoffs were generally limited to
At

Table 8
Failure Resolutions by Transaction Type,
Purchase and assumptions
Year

1980 .....
1981 ....

"Whole bank" '

"Traditional"

7
$218,331

8
4, 808, 042

1982 .....

1983 .....
1984 .....

1985 .....
1986 ....
1987 .....
1988 .....

1989 .....
Total. .....

' The

0
$0
0
0
0

0
0

1,905,924

0
0
0
0
0
19
584, 092

Insured deposit
payoffs

transfers

0
0
0

531
$39,936,130

Insured deposit

"Small loan"

35
11,046, 997
36
7,026, 923
62
87
2,235, 182
98
6,375,900
114
3,833,870
54
1,523,979
30
960,982

(P&A's)

0
0
0
0
0
0
0

0
0
0
0

Open-bank

assistance

0
$0
0
0

3
$17,832

$7,953,OOO

51,018

0
0

4, 599,000

8
8,543, 000
3
2, 890,000
2
34, 147,919
4
5,895,930

0
0
12
499,517
7
325,841

87
23,099,693

0
0
58
3,013,685

759,400
40
2, 190,700
30
1,153,000
22
1,630,243

216
$61,035,758

58
$3,013,685

$6,558,701

110
37,351,973

' 1980-1989

130

585,418
9
164,037
4
356,051
22
284, 315
21
575, 100
11
348,300

$6,

g, i

20, i
7,(

36,(
6, 7

7
718,800

6,4

19
2, 551,115

9,5

123,700

13,539,018

548, 024

5,699

6,0

94
$3,053,795

69
$80, 843,481

$1 68, 8

53,6

second row in each year contains total assets in thousands of dollars.
The "whole-bank" P&As include some large bank failure transactions in which the acquirer has a contractual relationship with the Federal
Insurance Corporation (FDIC) to service problem assets. This involves an ongoing loss exposure for the FDIC. The term "whole-bank" P&A normalI
to a transaction in which the FDIC has no ongoing exposure.
Source: Federal Deposit Insurance Corporation.
a

in which no buyers came forward--often in states that
thereby complicating any potential
Qjd not permit branching
In merger transactions, a healthy bank assumed all
acquisition.
deposits and general creditor claims. The acquiring bank then
Obtained all good assets from the failed bank and an offsetting
cash payment from the FDIC. The FDIC would hold and liquidate
These transactions became favored because they
the bad assets.
imposed fewer
pere less disruptive to the local community,
resource demands on the FDIC and avoided some liquidation costs.
Unlike the more recent "purchase and assumption transactions"
«scribed later in this section, in the old assumption
transactions the failing institution was not actually closed and
was established.
no receivership

situations

During the period from 1945 through 1955 there were only 25
failures of FDIC insured banks. Each of these was resolved
Thus, no depositor or
through the merger and assumption method.
This
other general creditor suffered a loss during the period.
resulted in extensive questioning of FDIC policies during Senate
hearings of FDIC Directors during
Banking Committee confirmation
the Fall of 1951. Senator Fulbright argued that providing 100
percent insurance coverage de facto was an extension of coverage
intended by Congress.
In response,
beyond the scope originally
to
make
a
cost
between
comparison
a payoff and
the FDIC agreed
liquidation on the one hand, and an assumption transaction on the
other, and pursue the cheaper alternative.
(The informal cost
test subsequently became an explicit requirement of the Garn-St
Germain Depository Institutions
Act of 1982).
Between 1955 and 1958 there were nine payoffs and only three
assumption transactions.
From 1959 through 1964 there were 18
In the original assumption
payoffs and no assumptions.

transactions, troubled banks were not closed. This meant that
the FDIC required approval of the shareholders
and creditors of
the failed bank before consummating
the resolution transaction.
In the mid-1960's, the FDIC recognized that if the Comptroller
of
'the Currency or the state banking authority closed a bank and
created a receivership, the assumption transaction could be
arranged without the consent of the former stockholders
(and thus
reduce

its cost)

the late 1960s, the FDIC realized that acquiring
might be willing to pay a premium for the assumed
«posits and good assets. By 1968 an explicit bidding process
»4 been established for handling closed bank purchase and
assumption transactions.
For the next fifteen years most failed
banks, including virtually
all large ones, were handled in this
In these transactions, the potential acquirers bid on
&he failed bank's deposits,
certain other liabilities, and
specific good assets (including enough cash to balance the
During

institutions

package)

2. payoffs
Over the past 20 years, only about 25 percent of bank
failures have been resolved through payoffs. These have been
banks in which no acquirer offered a premium sufficient to pass
the cost test, or the presence of fraud or significant continge~
difficult to estimate losses in order to apply tl
claims made
cost test. The largest payoff transaction was the Penn Square
Bank in July of 1982. Penn Square had deposits of $470 million
The FDIC expected a
of which $250 million were insured.
substantial number of lawsuits to be filed by banks which had
in poorly performing loans from penn
purchased participations
and assumption transaction,
purchase
the FDIC
Square. Under a
would have had to protect the acquiring bank against these
contingent claims as they were resolved in court. On the other
hand, a payout resolution exposed the FDIC to, at most, the

insured

deposits

collections).

(less the FDIC's share of receivership

major benefit of payout resolutions is that, by exposin
in failed banks to losses, they promote
depositors
large
depositor discipline.
However, the actual resolutions could be
very disruptive to the local economy as uninsured funds are
frozen while FDIC liquidators recover the receivership assets.
In 1984, an attempt was made to develop a payout procedure which
reduced the disruption.
The result was termed a modified
out
It involved an initial payment of a conservative estimate ~a
of the
receivership recoveries being paid immediately to uninsured
depositors with additional, future payments being made if
collections exceeded expectations.
The insured deposits and
selected assets were transferred to an acquiring bank through a
bidding process similar to a purchase and assumption transaction
One

The modified payout
Continental Bank required

process

was

still

being refined

when

assistance in 1984. The banking
agencies did not consider a payoff of Continental to be a
feasible option, due to the risk of disrupting financial markets
and the payments system.
Once a decision was made to protect
uninsured depositors and creditors in a large failed bank, it ~~'
thought to be unfair to apply a more stringent routine in the
failure of smaller banks.
One lasting benefit of the modified payout experiment wa~
the development of procedures for an insured ~de osit transfer
This transaction is now routinely used whenever a healthy bank i'
willing to pay a premium to acquire insured deposits and,
perhaps, certain assets of a failed bank for which a payoff wo~&~
otherwise be warranted.

I-32

Bridge Bank Authority

].984, Continental Bank experienced a run of uninsured
dsposltors and other unprotected funding sources. The sale of
liquid assets and collateralized borrowing from the Federal
Bank
Rzserve produced the cash to accommodate the outflow.
regu]. ators recognized that the bank would require additional
However, any assistance package would have required
qssistance.
As time passed, uninsured
construct.
to
deposits were
time
insured
deposits
and
secured
loans. Therefore, the
zpplaced by
cost to the FDIC of undertaking an insured deposit transfer
Although the situation at Continental was
pntinued to increase.
than
magnitude
normal, the FDIC typically faces
pf a greater
increasing resolution costs as uninsured depositors and general
creditors become aware of a bank's deteriorating condition and
funds or collateralizing
protect their positions by withdrawing
loans.
In 1987, the FDIC was given statutory authority to create
»bridge banks. " A bridge bank is a limited-life
institution into
bank is merged through a Purchase and
which an insolvent
The bridge bank then can
Assumption
(P & A) transaction.
continue operations
processing customer payments) until a
The FDIC has
deal is negotiated with the ultimate purchaser.
discretion as to which liabilities to merge into the bridge bank.
All insured deposits will be transferred.
is
Beyond that,
conceivable that only a percentage of the uninsured liabilities
thus imposing a "haircut" on other
might be transferred,

(~e,

creditors

(including

uninsured

depositors).

To the
of bridge banks has several advantages.
possible or desirable to inflict losses on
creditors or uninsured depositors, this can be done at
the outset without having to rush into a final transaction.
By
continuing its operations, the failing bank may be able to retain
more of its value to acquirers,
and there is likely to be less
disruption to the local communityThe moral hazard problems
that arise as a result of prolonging the operations of a failing
'bank are eliminated,
because the failing bank is closed,
management
is replaced and holding company creditors and
'shareholders lose their investment.
The use

extent it
nondeposit

deemed

1989, the FDIC had used its bridge bank
five occasions. Most prominent among these were the
created to deal with the failures of the banks of
'&wo large Texas
bank holding companies (BHCs). On July 29, 1988,
I4«f the banks of First RepublicBank Corporation with $32. 9
~illion in assets were closed and placed in a bridge bank, and
s~b«fluently acquired by NCNB, a North Carolina bank holding
0%»y. On March 28th and 29th, 1989, 20 of the banks of MCorp
"&&h $15.8 billion
in assets were closed and placed in a bridge

Through
„~«hority on
;bridge banks

bank,

and

year-end

subsequently

acquired by BancOne, an Ohio

BHC.

Open-Bank

Assistance

In 1950, the FDIC was given legislative authozity
assistance to open banks. Section 13(c) of the Federal Deposit
whlen in the opi
Act was modified to permit such assistanc'e
of the Board of Directors the continued operation of such b „&,
essential to provide adequate banking service in the community
Act of 1982
The Garn-St Germain Depository Institutions
assistance
provide
to pzevent
FDIC
may
The
that authority.
of
"essentiality
failure of any insured bank. A finding
a
bank
assisting
exceeds the cost
of
cost
the
if
required only
closing and liquidating

it.

The FDIC first used its authority under Section 13(c)
1971. During the period 1971 through 1989, there have been 1, ]4g
transactions in which the FDIC made expenditures in connection
Of those, 84]
with troubled commercial banks or savings banks.
and
were
64
open-bang
transactions were P&As, 244 were payoffs
The 64 open-bank assistance
assistance transactions.
transactions included some large banks including First
Pennsylvania Bank, N. A. (1980) with assets of almost $8 billion
Continental Illinois National Bank (1984) with assets of $36
billion, The Bowery Savings Bank (1985) with assets of $5
billion, BancOklahoma (1986) with assets of $2 billion, BancTEXA
Group (1987) with assets of about $1.5 billion, and First City

Bancorporation

(1988) with assets of $11 billion.

The financial importance
greater than their relatively

of open-bank transactions is
small number would indicate.

to the FDIC's 1989 Annual Re ort estimated losses to
the Corporation since 1933 total $8. 4 billion for deposit
assumption transactions,
$2. 8 billion for payoffs, and $11.2
billion for open-bank assistance transactions.
The remainder of
this section provides information on some of the major open-bank
assistance transactions of the 1980s.

According

FDIC-Insured

Savings Banks

unanticipated steep rise in market interest rates in th'
and early 1980s caused severe stress on certain
segments of the financial services industry.
Institutions that
financed long term investments with short term borrowings were
especially hard hit. Among this category were FDIC-insured
savings banks. These banks were heavily invested in residenti»
mortgages and mortgage backed-securities.
Although the credit
quality of the assets had not deteriorated, the market value of
assets fell below the value of liabilities at many institutio~8
In some cases the market value of assets fell to 75 percent or
less of the outstanding liabilities.
Closing and liquidating
these institutions would have placed an enormous burden on the
FDIC fund.
Arranging P&A transactions in which the FDIC provi«
The

late 1970s

tge buyer with cash to compensate
qould have been equally expensive.

for the negative net

worth

created "Income Maintenance Agreements" for
zssisted mergers to avoid recognizing the losses at once, with
drop towards
age expectation that interest rates would eventually
Under
these
levels.
agreements,
the
FDIC
would
gistoric
pay the
acquiring bank the difference between the asset yield and the
Thus the FDIC
qverage cost of funds for a number of years.
rate
risk
interest
in
the
the
transaction.
retained
This type of
agreement was used in nine of the twelve assisted mergers of
failing savings banks that occurred between 1981 and early 1983.
Because market interest rates later declined, the FDIC reaped
significant savings from these arrangements.
The FDIC

The FDIC did not close the failing savings banks.
assisted mergers were undertaken in ways that minimized
retained by the managers and investors of the failed

Instead,
the value

Senior management and trustees of the failed banks
from serving with the surviving institution.
debt
holders were required to accept losses in the
Subordinated
or extended terms. Although
form of lower interest payments
their losses would have been greater in a liquidation,
these
were
offset
lawsuits
avoiding
which
have
savings
might
delayed
by
the transactions,
the greater cooperation obtained from state
supervisors and the greater flexibility for the acquirers in
continuing leases and other contractual arrangements.
In
addition, an important consideration was that these savings banks
were mutual institutions.
Therefore, there were no stockholders
benefiting from the transactions.

institutions.

were

prevented

The Bowery Savings Bank, with assets of $5 billion, was the
largest savings bank to receive FDIC assistance.
A large number
Of FDIC-insured
institutions, as well as other interested
parties, were invited to submit bids f or The Bowery. The
proposal which was accepted included a $100 million equity
contribution by the new investors and installation of a new
management
team.

Illinois National Bank
difficulties of Continental Illinois National

Continental
The

Bank

public in 1982 when it experienced large losses resulting
„&rom the purchase
of hundreds of millions of dollars of energy
„&owns from the failed Penn Square
Bank in Oklahoma City.
By
arly 1984, in excess of eight percent of the bankls total loans
~re not performing as agreed, more than twice the average
&er«ntage of nonperforming
loans at, the nation's banks. In
&+r&y May, Continental
experienced a massive deposit run
~i9gered by rumors of the bank's impending collapse and the
,

~+came

~i&hdrawal

of several billion dollars of foreign deposits.

FDIC, the OCC and the Federal Reserve beg,
solutions
to Continental's problem.
to consider possible
The regulators did not consider feasible a payoff of insu~,
depositors. More than $30 billion in uninsured deposits
other private claims would have been tied up in receivership
with uncertain ramifications for economic stability.
Effecting
During

this time, the

modified payoff could well have required a cash advance greater
Runs on other banks could have
than the size of the FDIC fund.

creating substantial additional costs for the FDIC as
well as disruption of credit.
Continental's size and its large volume of troubled loans
lawsuits made it difficult to attract a merger
and outstanding
partner at a reasonable cost. It became increasingly clear tlag
open bank assistance would have to be the final solution.
The
final assistance package included top management changes; the
sale of problem loans to the FDIC in return for the FDIC's
assumption of the bank's $3. 5 billion borrowing from the Federal
Reserve Bank of Chicago; and a $1 billion capital infusion from
the FDIC including a preferred issue convertible into an 80

resulted,

percent ownership interest in Continental Illinois Corporation.
As of this writing the FDIC retains an ownership
interest in
Continental.
BancTEXAS Group

In July, 1987, the FDIC made a one-time cash contribution
$150 million to assist 11 of the subsidiary banks of BancTEXAS
Group, a BHC in Dallas, Texas. These banks had about $1.3
billion in assets. Control of the organization was assumed by
group of outside investors, who contributed $50 million in new

capital.

transaction was determined by the FDIC to be less
expensive than either a p&A or a payoff. problem assets were
retained and managed by the new owners with no ongoing financial
commitments by the FDIC, which would not have been the case in a
payoff. The investor group which approached the FDIC sought
control of the entire franchise.
There were tax and accounting
reasons for this, but in addition the investors believed that th&
value of the entire franchise was much greater than the value «
a few banks within the franchise.
The FDIC believes it was correct in evaluating the
transaction as being very cheap. In light of the subsequent
performance of the Texas economy, the investor group had not
asked for enough assistance to make BancTEXAS a viable
organization.
The lead bank in Dallas
in March, 1990i ~"~
the investor group lost its $50 million failed
investment.
The

pirst City Bancorporation
April 20, 1988, the FDIC consummated a plan to
recapitalize the subsidiary banks of First City Bancorporation of
Texas, an $11 billion organization with 59 banking subsidiaries.
Control of First City was assumed by a private investor group
that raised $500 million in new capital through a stock offering,
FDIC provided $970 million in assistance.
pn

porbearance

and Government

Ownership

of the FDIC's failure-resolution methods would
not be complete without some discussion of the instances in which
procedures or failure-resolution
qormal supervisory
methods have
for
selected
troubled
superceded
financial
been
institutions.
These instances fall into two categories--forbearance
from
enforcing capital or other supervisory standards for operating
institutions which are financially troubled but are judged to be
«viable, " and instances in which the FDIC takes an ownership
position in the institution resulting from an assistance
A

discussion

transaction.

Forbearance

Programs

as just defined is not a failure-resolution
method since the institutions
receiving it are supposedly
financially viable. Nevertheless, the concept of forbearance has
received considerable criticism as a contributing factor in
increasing the ultimate cost of depository institution failures.
This is particularly
true of the forbearance received by many
insolvent S&Ls during the 1980s, described above in the section
on the performance
of S&Ls during the 1980s.
Forbearance

The Garn-St
and other

Germain

Act included

provisions

whereby

savings

qualifying institutions could apply for net worth
certificates if they met certain conditions with respect to
losses and low surplus ratios. The net worth certificate program
w~s a form of capital
forbearance in which notes were exchanged
between the insurer and a savings bank, resulting
in the creation
of "regulatory capital" which the institution could use to
satisfy supervisory requirements.
Altogether, 29 FDIC-insured
«»ngs banks participated in the program; 16 have retired their
certificates, 10 have failed or merged, and as of year-end 1988
three still have certificates on their books.
In March of
banks

pressure from Congress, the FDIC, the OCC and the FRB
Joint policy Statement outlining a capital forbearance
Program for "well-managed"
banks whose difficulties are "largely
&he result of external
and/or oil
problems in the agricultural
a~& gas sectors of the economy "
The practical effect of a
ink's admission into the program is that the banking agencies
will not issue a capital directive against the bank to enforce
" rm» capital standards. Banks in the program are required to
&986, under

released a

,
,

adhere to a recapitalization
terminated from the program.
The Competitive

plan; those failing to do so are

Equality

Banking Act of 1987

to further
loan-loss amortization
This Act allows eligible banks to amorti
years, losses from sales and/or reappraisals of qualified
agricultural loans between 1984 and 1991 inclusive and ]osse
and/or sales of agriculturally
related proper
from reappraisals
The
inclusive.
full
unamortized
1991
and
between 1983
portion
loan losses can be included in primary capital for regu]ato~
Requirements for admission to
supervisory reporting purposes.
those
outlined above for the capital
the program are similar to
forbearance program, except that only banks with assets less th;
$100 million may participate, and participating banks are
required to maintain specified percentages of agricultural loan,
to total loans.
program

As of year-end 1989 there were 168 banks with $6. 2 billion
in assets in the capital forbearance program and 47 banks with
$1.3 billion in assets in the Agricultural Loan-Loss Deferral
The average asset size of these 215 institutions
Program.
is
about $35 million.
Of all the banks originally admitted to the
programs, 21 have failed.

of Insured Depository Institutions
In most bank failure or assistance transactions, the FDIC
contributes an amount sufficient to cover the negative net worth
of the troubled institution; the acquirer or new investor is
responsible for contributing sufficient capital to meet the
capital requirement.
In some cases, however, part of the capita
requirement has been met by an FDIC injection of capital.
Under certain circumstances,
FDIC investment
in a bank counts as
capital under Generally Accepted Accounting Principles (GAAP)i
and under certain circumstances
is accepted by bank superviso rs
as capital. An FDIC investment does not, however, meet the
conceptual definition of »capital» from an insurer's point of
view. That is, it does not cushion the insurer against loss.
FDIC investment
is thus a form of capital forbearance. FDIC
investment creates potential conflicts of interest between the
FDIC's ownership and supervisory roles, creates potential
competitive inequities, and raises the question why the FDIC
should capitalize a private firm when private investors were
unwilling to do so. For these reasons the FDIC has always so~9"
to avoid contributing capital in connection with bank failure «
assistance transactions.
FDIC

Capitalization

In some instances the FDIC has judged that circumstances
required it to contribute capital in connection with a bank

failure or assistance transaction,
A major argument
for

mentioned.

despite the problems just

an FDIC

capital contributio»

that investors will generally require substantial protections
It is often argued that" since
against loss on problem assets.
the
investors
on the "downside,
protecting
should
is
the FDIC
interest
in
order
to share in potential
assume an ownership
windfalls to the acquirers.

In short, if the alternatives of paying off the bank or of
removing all problem assets from the bank appear sufficiently
costly, and if the returns demanded by acquirers for capitalizing
appear sufficiently exorbitant, the FDIC
the entire institution
is the
has occasionally judged that an FDIC capital contribution
This
FDIC's
alternative.
occurred
in
the
assistance
costly
least
to Continental Illinois where the FDIC assumed an 80 percent
equity interest and an option to purchase the remaining 20
percent; in the NCNB Corporation's acquisition of the banking
assets of First RepublicBank Corporation where the FDIC assumed
and in the BancOne acquisition of
an 80 percent equity interest;
the banking assets of MCorp, where the FDIC assumed a 75 percent
The acquirer of First RepublicBank has since
equity interest.
FDIC's
ownership positions.
bought out the
6. Treatment
Insured

of Parties in a
Depositors

Bank

and 8ecured

Failure
Creditors

Depositors are insured to $100, 000.
receive 100 percent coverage in any bank

Insured deposits always

failure.

other claims on a failed bank may be secured by the
of specific assets of the bank. If a bank fails, these
assets are used to satisfy the secured claims. Thus, at minimum,
or the value of their
secured creditors receive fullgayment
'„collateral, whichever is less.
Some

value

;

f„

Uninsured

Depositors

in a failed bank are paid off, either
', through
a payoff and liquidation or through an insured-deposit
':transfer, uninsured depositors receive only receivership
"certificates entitling them to their pro rata share of recoveries
cu the failed bank's assets.
They are thus likely to recover
In
one a portion of their funds, and only after several years.
'a modified payoff, described earlier, uninsured
depositors
"receive a cash advance at the time of failure equal to estimated
I'

If insured-depositors

~I'recoveries.

Payoffs have been used by the FDIC primarily in situations
&"ere both the failed bank is small and where potential acquirers
&re unwilling to pay a premium sufficient to pass the FDIC's
~statutory cost test.
Other FDIC assistance has been handled
I' i&her
through P&As or through direct assistance to open banks.
&'"&n all
such cases, uninsured depositors have been fully

protected,
deposits.

with the recent exception

of certain intra-BHC

There are several reasons the FDIC generally has provided
full coverage to uninsured depositors in P&As in preference tp
transferring only the insured deposits to another institution.
First, where the volume of uninsured accounts is small, it, is
often not worth the trouble of separating insured from uninsured
accounts. Second, the premium paid by the acquirer in a p&A is
likely to be somewhat higher than it would be in an insured
deposit transfer, since it is likely to be easier for the

acquirer to retain the core deposits of the acquired institutipz
Third, because the FDIC has provided full coverage
jn a p&A. '
to uninsured depositors in very large bank failures for the sake
of financial stability it is difficult from the standpoint, pf
fairness to inflict losses on uninsured depositors in smaller
banks.

"the cost test" does not require the FDIC to chpps
The FDIC's statutory cost test
the cheapest transaction.
requires that in the absence of a finding that the bank is
"essential" to its community, the FDIC may make uninsured
depositors whole if doing so is less expensive than a payoff and
liquidation of the bank. The FDIC may choose between a P&A in
which all depositors are made whole and an insured deposit
transfer, if both transactions are estimated to be cheaper than,
payoff and liquidation.
Then the FDIC need not choose the
cheaper transaction under the cost test.
Finally,

clarified existing

law, limiting the FDIC s maximum
category of claimants of a failed bank to the
amount these parties would have received in a deposit payoff.
Ii
addition, the legislation allows the FDIC complete discretion to
use its own resources to make additional payments to any
claimants -or categories of claimants in the interest of
maintaining stability and confidence in the banking system,
without obligating itself to make similar payments to all other
claimants.
FIRREA

liability to

any

This "pro rata" authority has affirmed the FDIC's
flexibility to settle the liabilities of failed banks. The FDIC
has used this authority to make only pro rata payments to
intracompany credit extensions in the failures of banks
affiliated with First RepublicBank Corporation and
Texas Amerip»
Bancshares.
If the FDIC had made the intracompany credit
extensions whole, many of the banks in these BHCs may not have
been declared insolvent.
Also, the value of the "package"
offered to acquirers would have been much less and the FDIC's
costs
much

greater.

The FDIC used its pro rata authority because these BHCs »&
operated their banks essentially as branch systems, in which ""

most
been
FDIC

affiliates channelled

to the lead banks which made
of the large loans. Since these intracompany deposits had
in funding the bad loans of the lead banks, the
instrumental
it was inappropriate that they be made whole
that
believed

smaller

with insurance

funds

fund money.

abzlity to protect itself in failures involvi
enhanced by a provision of FIRREA which permit
BHCs is further
liability on commonly controlled depositor
impose
to
FDIC
the
to
recoup
any losses resulting from hand] ing
institutions
failure of, or providing assistance to, an insured bank. The
the cross-guarantee provjsj
FDIC's experience in implementing
limited.
enforcing
is
very
cross-guarantees,
By
of FIRREA
however, the FDIC should be able to better protect itself from
losses stemming from interaffiliate transactions within a holding
The FDIC's

company.

Nondeposit

)eneral Ceditors and Contingent

Claims

For most of its history, the FDIC provided full protection
to nondeposit general creditors and contingent claimants in P&As.
These creditors suffered losses only in payoffs, which were few
in number and of negligible importance in terms of the volume of
The reason for the full coverage
assets and liabilities handled.
Given that a decision had
of nondeposit creditors was simple.
been made to do a P&A that included full payment to uninsured
depositors, the FDIC believed it was practically incapable of
measuring the pro rata share of other general creditors of the
bank.

In 1973, U. S. National Bank in San Diego failed and was
resolved with a P&A transaction.
However, the FDIC treated
claims arising from standby letters of credit as inferior to
The
those of general creditors and did not transfer them.
claimants took successful legal action against the FDIC (First
Em ire Bank
New York
et al. vs. FDIC). A California federal
court ruled that the plaintiffs had the status of general
creditor and that, under the circumstances of that case, the FDIC
~Quid not discriminate
classes of creditors.
among equivalent
Bank failed in 1982. Although it had deposits
million, Penn Square had sold loan participations with
~ominal value in excess of $2 billion.
The maximum cost of a
payout transaction was $250 million (the total of the insured
«Posits) minus the FDIC's share of receivership collections. It
&» anticipated (correctly) that purchasers of the participations
&ould file lawsuits against the receivership
for hundreds of
millions of dollars.
Therefore, any acquiring bank in a P&A
transaction would have also assumed massive contingent
»~bilities against which the FDIC would have had to provide
9~arantees.
Under the payoff that occurred, litigants who won

Penn Square

$470

their lawsuits became general creditors who shared in the
proceeds of the receivership with other general creditors.
In more recent P&A transactions, the FDIC provided
uninsured depositors with better treatment than other general
creditors. While uninsured depositors were kept whole, other
general creditors were given receivership certificates
representing their pro rata share of the receivership's
collections. This put them in a position equivalent to that pf
the FDIC. When this process was challenged in court, the
Tennessee Supreme Court upheld the FDIC's right to provide,
it's own expense, greater payments to uninsured depositors
without obligating itself to provide other creditors with simi]az'
subsidies. This authority was affirmed in FIRREA which gives tgq
among the receivership
FDIC the explicit ability to distinguish
claimants and provide specific parties with better treatment thaq
others (provided that each party receives at least as much as
In future failure
would have occurred under a payout).
resolutions, the presence of substantial contingent claims or
nondeposit claims therefore may no longer militate in favor of a
liquidation

and

payoff.

Other Parties
Other claimants of a failed bank generally lose their
investment.
Subordinated debtholders stand behind general
creditors in the receivership and generally receive little if any
recovery. Owners and stockholders of the bank--including its
holding company if applicable--stand
behind general creditors and
subordinated debtholders in the receivership, and also generally
do not recover any of their investment.
Creditors and
shareholders of BHCs are not protected by the FDIC if the failure
of an affiliated bank causes the bankruptcy of its holding
company.

There are other

parties who stand to lose a great deal in a
bank failure.
FDIC policy is to replace management,
directors
and officers of a failed bank who played an important role in the
development of the bank's problems.
The cost to these people in
terms of lost salary and reputations can be substantial.
The

also enters into lawsuits against entities it deems
for a bank failure, suits which can result in grea&
inconvenience and cost to these entities.
Special note should be made of the role of holding comp»i~~
in open bank assistance transactions.
When a bank is closed, t&~
bank's equity holders, including its holding company g«
receivership certificates from the FDIC. Owners and creditors 0
the holding company itself, however, receive nothing else fro+
the FDIC. In a transaction in which the bank receives assist»«
from the FDIC, but remains open, however, the consent of some
percentage of the holding company creditors is req ired in order
FDIC

responsible

This is because these creditors
tp consummate the transaction.
payment of their claims
may be asked to accept only partial
holding
company.
the
against
FDIC policy is that these holding company creditors should
more in an open bank assistance transaction than they
no
get
gotten had the bank been closed.
have
This amount is
would

gifficult to ascertain. In practice, the creditors may have to
offered somewhat more than this in order to obtain their
consent for a transaction which would reduce the FDIC's costs.
example where holding company creditors are
The most well-known
a]leged to have received more than they would have in a closure
invo]ved the FDIC's assistance to Continental Illinois National
Bank, where the holding company creditors were fully protected.
0bservers close to the transaction argue, however, that these
creditors would have recovered close to the full value of their
g].aims even had the bank been closed, because of the large volume
of non-banking assets in the holding company.
Another example
involves the FDIC's assistance to the banking affiliates of First
where arbitrageurs
purchased holding company
City Bancorporation,
debt at a discount and withheld their consent to the transaction,
betting that the FDIC would accept a lower threshold of creditor
concessions.
When this proved to be the case, the holdouts
received face value for their debt. In a more recent example,
when faced with a similar
situation involving the creditors of
Texas American Bancshares and National Bancshares Corporation,
the FDIC "called the bluff" of the creditors and closed the bank.
7. Asset Disposition in Bank Failures
How the FDIC handles
the disposition of assets from failed
banks greatly influences
its costs. In recent years, failureresolution costs for commercial banks have averaged about 15
cents per dollar of assets; for smaller banks those costs
typically range between 30 cents and 40 cents per dollar, but may
exceed 50 cents per dollar. 43 These are not insignificant
amounts given the volume of assets handled by the FDIC. The
~sset disposition problem as it relates to the handling of bank
failures is this: when the FDIC takes over an insolvent
institution, how should the transaction be structured to maximize
&he net present value of asset collections?
What

has been Done in the Past?

The economic value of a failed bank's "problem" assets is
«u&lly highly uncertain and therefore subject to risk. Someone
"~s to absorb that risk. Traditionally,
it has been the deposit
insurance agency.
Historically, the FDIC has handled failed
»nks though either a clean-bank purchase-and-assumption
(P&A)
transaction or a deposit payoff. In both cases the FDIC takes
o~er and liquidates any asset with uncertain value.

transaction or "P&A" a buyer
In a purchase-and-assumption
puz'chases some of the failed bank's assets and "assumes" its
of this transaction th
liabilities. In the "clean-bank" version
buyer only takes over the highest quality assets such as cash,
government securities (which are marked to market) and in some
cases, selected installment and real estate loans. The remainin
difference between the value of acquired assets and assumed
iabilities would be covered by a cash payment from the FDIC to
The FDIC retains all assets with uncertain values
the acquirer.
attempts to maximize its return on those assets in order to
zeimbuzse itself for some portion of its cash outlay.
In a deposit payoff there is no buyer and the FDIC "pays
All of the bank's assets are then
off&& insured depositors.
serviced by the FDIC in its capacity as receiver for the failed
bank.
advantage of a clean-bank P&A is that the acquirer can
get off to a clean start. That is, the buyer does not face the
risk of being burdened with difficult collection efforts or
existing losses in the asset portfolio. Losses that exist prior
to when the acquirer takes over should be absorbed by the
insurer. There are, however, two notable disadvantages
associated with an FDIC liquidation of problem assets. First,
there is a policy issue related to a large role for a federal
government agency in the disposition of assets.
As the number of
bank failures increased an FDIC asset liquidation workforce of
500 in 1981 had grown to over 5, 000 by 1985. Second, there is a
cost concern. There may be inefficiencies associated with a
government liquidation relative to having the private sector
dispose of problem assets. Such inefficiencies may exist if
there are information costs associated with bank assets that give
them a greater value in an ongoing institution
relative to a
liquidation, or if the government is a less efficient liquidation
agent than is the private sector.
An

%hat

Being Done

Now?

The disadvantages
associated with the FDIC handling a large
volume of troubled assets led to a reevaluation
and revision of

policy. Now, the FDIC's objective is to keep assets in the
private sector to the extent feasible. In 1985 the FDIC began
more vigorously experimenting
with alternatives to the clean-bank
P&A.
Certain "problem" assets were transferred to the acquiri~g
institution with a putback option. That is, within a specified
period of time these assets could be returned to the FDIC for
their original book value. During 1986, p&A transactions with
putback provisions became fairly routine.
Often, the putbacks
included a "haircut" or loss of five percent to ten percent «f
book value that had to be absorbed by the acquirer if assets were
returned to the FDIC after a specified time period.
In 1987 the
program was extended to incorporate all of a failed bank's

Rather than allow for putbacks, however, institutions
&enerally were encouraged to reduce their bid by an amount
reflecting the estimated difference between book and market
These transactions became known as
values of the dirty assets.

assets.

»whole-bank"

transactions.

the FDIC sells virtually the
is written to the acquirer to
difference between assumed liabilities and market

In a whole-bank
entire institution.

transaction

check

reflect the
of assumed assets, less any premium paid for the franchise
The acquirer recapitalizes the bank
va]. ue of the failed bank.
activity is complete.
and the FDIC s liquidation

value

P&A transactions
were conducted in 1987.
routine
policy to generally first attempt a
py 1988,
whole-bank transaction before resorting to alternatives
in which
fewer assets were passed on to an acquirer.
In 1988, 110 of 164
transactions;
in 1989, 87 of 175 P&As were
p&As were whole-bank
whole-bank transactions.
More recently the FDIC has begun
experimenting with "small-loan" P&As in cases where an acceptable
bid for a whole-bank P&A is not forthcoming.
In a small-loan
assumes a package of performing and
P&A, the acquirer
small loans, and the FDIC is responsible for
nonperforming
liquidating the remainder of the problem assets of the failed
institution.
Similar transactions had been effected as early as
1977, but in these older transactions acquires did not assume any
problem assets.
58 of 175 P&As in 1989 were small-loan P&As.

Nineteen

whole-bank

was

results appear positive so far. FDIC liquidation
were reduced from their peak level of over 5, 000 to
about 3, 500 as of mid-year 1989. However, one concern with
whole-bank transactions
is that the acquirer rather than the FDIC
accepts the risk associated with uncertain asset values.
This
may be acceptable
if the acquirer is large relative to the
acguired institution--hence,
the risks are not that significant.
However, in other situations
the acquirer may be taking on
unacceptably high levels of risk, or may demand such large
compensation for assuming risk that a whole-bank transaction
becomes less desirable than alternative
types of transactions.
The

personnel

Summary

This chapter has attempted
system as

th«eposit insurance

to familiarize the reader with
past 58
it has evolved over the
reviewed
how
The sections briefly

as it stands today.
deposit insurance system came into being in the 1930s; the
purpose and benefits of deposit insurance as well as the concerns
~nd criticisms of it; the financial
performance of federally
in&ured institutions
and the risk exposure of the deposit
insurance funds; information on the operation of the U. S. deposit
Years and
&he

insurance

failures.

system;

and

finally

how

this general background

the FDIC has handled bank

the reader should be better
able to understand how the following chapters in this study
relate to deposit insurance reform.
With

I-46

Endnotes
William Shakespeare,
134

Julius Caesa , Act

Scene

ii,

line

U. S. Department of Commerce, Bureau of the Census,
Historical Statistics of the United States: Colonial Times to
1970, Part 2, p. 1038.
For convenience, the word "bank" will be used to refer to
and thrifts, unless precision requires that a
banks
both
distinction be made.

Federal Deposit Insurance

oration:

Insurance
Federal Deposit Insurance
Co

National

First Fift

osit

D. C.

of the Federal Reserve System's attitude
. h t*,
4
d
of the United States 1867-1960 (Princeton, New Jersey:
Bureau of Economic Research, 1963), pp. 357-59.

Histor

Corporation,
edera De
Years (Washington,
Corporation, 1984, p. 36) .

The

discussion

'1t

See Carter H. Golembe, "The Deposit Insurance Legislation
of 1933: An Examination of its Antecedents and Its Purposes, "
Political Science uarterl , Vol. 75, No. 2, June 1960, pp. 181200.
For an in-depth

analysis

of the early state insurance

see Carter H. Golembe and Clark Warburton, Insurance of
Federal
Obli ations in Six States (Washington, D. C.
Deposit Insurance Corporation,
1958); and Clark Warburton,
De osit Insurance
in Ei ht States Durin the Period 1908-1930

programs,

Bank

(Washington,

D. C.

Federal Deposit Insurance

Corporation,

1959).

Murton, "Bank
For further discussion, see Arthur
Intermediation,
Bank Runs, and Deposit Insurance, " FDIC Bankin
Review, Spring/Summer
1989, pp. 1-10.

See Ben S. Bernanke, »Nonmonetary Effects of the
Financial Crisis in the Propagation of the Great Depression,
American Economic Review, June 1983, pp. 257-76.
Goodhart,

&ford Economic Pa

C. O. E. »Why Do Banks Need a Central
ers 39 (1987), p. 86.

Bank?

The term "moral hazard" as used by economists refers
&he incentive
an economic agent, (call him "Mr. A») may have
a« in a manner which is contrary to the interests of another
party (call him »Mr. B») whose well-being depends on Mr. A' s

to
to

cannot per f ectly control or monitor Mr. A ' s
«tions due to Mr. A's superior information.
For example, Mr.
»ght be a corporate manager with an incentive to consume

a«ions but

who

perquisites to the detriment of Mr. B, a stockholder of the firm
In ur context, Mr. A is a bank owner or manager and Mr. B is th
FDIC. Mr. A may have incentive to make speculative investments
which, if they succeed, will benefit the bank, but whose cost if
they fail will accrue to the FDIC.
grants authority to the FDIC to select
classes of uninsured depositors and creditors to protect fully
while providing only pro rata payments to other classes, pa~ent,
based on estimates of what these groups would have been entitle
The FDIC is using this authority to
to in a liquidation.
withhold full protection from nondeposit creditors and, in
special circumstances, certain classes of uninsured depositors.
The impact of this new authority on market discipline is
discussed in Chapter III.
FIRREA

Testimony of Alan Greenspan before The United States
Senate Committee on Banking, Housing 6 Urban Affairs, July 12,

1990.

contained

more complete

in Chapter XI.

discussion

of market value accounting is

are minimum levels
The statutory capital requirements
acceptable for a well-run bank. Riskier or more poorly-run banks
can, in theory, be required to hold additional capital.
Exceptions are

to the enactment of the

made

for affiliations

that existed prior

Bank Holding Company Act in 1956, and for
by subsequent amendments or as permitted by the

those allowed
Federal Reserve Board under Reg.

(12

CFR

225. 22).

In 1992 the European Community will authorize commercial
banks in all member nations to operate under a Single Banking
License which will permit banks to conduct in any member nation
any banking activities permitted by their home country

authorities.

during this period are
in Federal Deposit Insurance Corporation, ~De osit
Insurance in a Chan in Environment (Washington, D. C. : Federal
Deposit Insurance Corporation, 1983), pp. I-4 — I-6.
Banking and economic developments

summarized

Golembe, Carter H. , and Holland, David S. Golembe
Associates Inc. , Washington, DC, 1985 Federal Re ulation of

Bankin

1986-87.

To save space, the term "S&L"
"FSLIC-insured thrift. "

used in preference

See R. Dan Brumbaugh, Jr. and Andrew
Industry Crisis: Causes and Solutions, "
Econom'c Act'vit , 2:1987, p. 353.

" Ibid. ,

S.'n Carron, "Thrift
s Pa ers on

p. 354 '

See R. Dan Brumbaugh, Jr. , Thrifts Under Sei e,
1988.
Bollinger Publishing Co. , Cambridge, Massachusetts,
2.
Table
indicates
52,
that
FSLIC-insured
8, p.
Brumbaugh's
institutions had assets of $651 billion at year-end 1981. Table
2. 7, p. 50 indicates these institutions had a market value net
worth

of -17.3 percent of assets, or -$113 billion.

Alan S. McCall and Ronald A. Auerbach, "Permissive
Accounting Practices Inflate Savings and Loan Industry Earnings
lation (Summer 1985), pp. 17and Net Worth, " Issues in Bank Re
21 '

For a chronology of the
requirement see James Barth and
Deregulation and Federal Deposit
Bank Board Research Paper 4150,

December

expire.

capital
"Thrift
Insurance, " Federal Home Loan
November, 1988, pp. 14-20.
From Office of Thrift Supervision monthly data.
Ibid. Fully-phased-in requirements are those effective
31, 1994, after all transition periods granted by FIRREA

These figures

publication

annual
FDIC

S&Ls' regulatory
Michael Bradley,

are from various issues of the FDIC's

Statistics

on Bankin

See "Farm Bank Problems and Related Policy Options,
Staff Study, February 1986.

For further detail, see Maureen Prowley, "Playing Texas
Ro ulette:
the High-Risk Characteristics of these
Understanding
Commercial Banks, " Senior Honors Thesis, College of the Holy
Cross, 1990; and John P. O'Keefe, Causes and Conse ences of the

Crisis, FDIC Banking Review, Vol. 3, No. 2.
Office of the Comptroller of the Currency "An Evaluation
« the Factors
Contributing to the Failing of National Banks:
"
&h~se II,
uarterl Journal, Vol. 7, No. 3, p. 12.

Texas Bankin

This legislation

is described

fully in Chapter XVI.

Federal Home Loan Bank Board 1988 Annual
D. C. , 1989.

ort,

Washington,
Muldoon,

discussion see John F. Bovenzi and Maureen "
"Failure Resolution Methods and Policy Considerations,

For further

Review Vol. 3, No. 1 and Stanley C. Silverberg,
Losses be Imposed on Depositors in Large Bank Failures?. "
FDIC Bankin

"Can

51 Federal Register 15, 306.
information

For further

see Lynn Nejezchleb
Capital Forbearance at
Draft Report, March 1990.

"A Report Card on

William Morgan,
Commercial Banks,

Preliminary

Deposit Insurance Act prohibits the FDIC
from purchasing common or voting stock of an insured deposito
This prohibition does not apply to bridge bank
institution.
The Federal

stock.

liability of the bank is a deposit, then
the liability is protected to at least $100, 000 regardless of
value of the underlying collateral.
Even in these situations the FDIC need not pay off a
bank if it finds the bank is "essential" to its community.

a secured

the

In a P&A deposits are assumed by the acquirer, and
In an
deposit accounts automatically pass to the acquirer.
insured deposit transfer the acquirer is technically acting as
the FDIC s paying agent. Within a specified time after the
transfer, depositors must notify the acquirer that they wish to
retain their accounts with the acquirer. This reduces somewhat
the core deposits the acquirer is likely to be able to retain.
It is difficult if not impossible to measure the effect on the
premiums paid by acquirers due to this difference in difficulty
of retaining core deposits. This is because difference in
premiums between two failure resolution transactions
reflects the
differences in the franchise values of the institutions.
Moreover, institutions whose failures are handled as P&As are
likely to have considerably more franchise value than those
handled as insured deposit transfers.

It is important to note that a higher premium paid by
the acquirer in a P&A does not necessarily mean that the P&A
would be cheaper to the FDIC than an insured deposit transfer.
In fact, as described in Chapter III, the additional premium
would normally not be sufficient to offset the extra cost of
covering uninsured deposits, so that an insured deposit transfer
could often be cheaper to the FDIC than a P&A.
42
For further discussion see "Asset Disposition in Bank
Failures: Theory and practice, " by John Bovenzi, George French
and Arthur Murton, in Bankin
S stem Risk: Chartin
a New
Course, Proceeding of 198S Conference on Bank Structure and
Competition, Federal Reserve Bank of Chicago.

See Table 5 of Chapter X. The 15 cent figure is
obtained by dividing the total loss reserve for all banks in the
table by the total assets. For further discussion and analysis,
"Resolution Costs of
Bovenzi, John F. and Murton, Arthur
Bank Failures" FDIC Bankin

Review,

J.
Fall

1988, Vol. 1, No.

This figure includes some large bank failure
transactions in which the acquirer serviced assets under contract
to the FDIC. The term "whole-bank" P&A usually refers to
transactions in which the FDIC has no ongoing contractual
relationship with the acquirer.

Chapter

CAPITAL ADEQUACY

Introduction

Chapter II focuses on strengthening
the role of capital in
This chapter is
ensuring the stability of the banking industry.
the
in
following
manner:
Section B reviews the
organized
purposes and benefits of depository institution capital; Section
some perspectives
on bank capital ratios; Section D
C provides

discusses recent and continuing efforts to establish common
&~risk-based" capital requirements
across industrialized nations;
Sections E and F analyze two proposals for further changes in
capital rules--increasing the minimum capital ratio and
increasing reliance on subordinated debt; and Section G compares
risk-based capital standards with risk-based premiums.

the outset

that the issues of
capital adequacy and prompt corrective action or closure of
capital-impaired institutions are closely, even inextricably,
related. Thus, the connections between this chapter and Chapter
X are considerable.
At

should be emphasized

B. Purposes and Benefits of Capital
In a private, competitive market economy, the primary
purpose of capital is to cushion both equity owners and
debtholders from unexpected losses. Debtholders are protected by
the "equity cushion" that must be exhausted before the firm's
losses eat into their principal.
Equity holders are protected in
the sense that, in a world where bankruptcy is costly,
substantial equity reduces the probability that bankruptcy will
occur.

existence of the federal safety net for depository
institutions increases the importance of capital, since the
safety net adds taxpayers to private debtholders as potential
losers if an institution fails. Adequate capital holdings by
depository institutions therefore have the following positive
benefits: (1) lowers the probability of bank failure; (2) reduces
the incentive to take excessive risk; (3) acts as a buffer in
front of the insurance fund and the taxpayer; (4) reduces the
misallocation of credit caused by the safety net subsidy; (5)
helps avoid "credit crunches;" and (6) increases long-term
The

competitiveness.

course, firms can and do still fail even if they have
substantial capital cushions, and thus capital is not by itself
sufficient to protect taxpayers and debtholders--strong
supervision and risk-related insurance premiums are also
However, the "market discipline" exerted by owners
important.
with major portions of their own wealth at stake is significant
and is, in a very real sense, the first line of defense against
failure and excessive risk taking.
Of

Adequate

Capital Lowers the Probability

Bank

Failure

of a firm's capital is to cushion both
its equity owners and its debtholders, and thus taxpayers, from
unexpected losses. The more capital a depository institution
has, the more it can withstand unexpected losses without becoming
insolvent.
Capital therefore makes banks safer and decreases the
likelihood of failure, by giving a bank and its regulator time to
work through problems.
The benefit to existing shareholders of
sufficient capital is to help ensure that they will retain
control of the firm, even if unexpected shocks deplete the firm&s
The primary

purpose

profits.
2. Reduces Incentives to

Take Risks

of low capital and federally insured
deposits creates a "moral hazard" problem.
Owners with little of
their own money at stake have an incentive to take risk with a
virtually unlimited supply of funds. This incentive exists
because gains from excessive risk taking accrue to the depository
institution owners, but losses, if they exceed capital, are
shared with (or put to) the firm's debtholders,
the inSurance
funds, and then the owners of the safety net (taxpayers).
The combination

Other things equal, then, a larger capital cushion means
that an institution's owners must lose more of their own funds
before losses are imposed on debtholders or taxpayers.
Therefore, owners with a significant amount of their own funds a&
stake have a powerful incentive to control the amount of risk
their bank incurs. Some argue, however, that higher capital
requirements may increase risk taking as bank owners attempt to
maintain a desired rate of return on equity.
(For further
discussion, see Section E below. )

Acts as a Buffer Ahead of the Insurance
Taxpayer

Funds

and the

banks fail, every dollar in losses
by capital
less dollar absorbed by the FDIC or theabsorbed
From
the perspective of the insurer, capital serves taxpayer.
for bank owners to suffer losses first, just as asa acar"deductible"
owner
suffers losses on his or her deductible before the insurance

When

one

company

pays.

of Credit Caused hy the Safety Net
Large direct losses to taxpayers are not the only potential
and
costs imposed on the broader society by capital-impaired,
depositories
that
are
allowed
to
remain
A
insolvent,
open.
even
and
distorted
credit
of
competitive incentives also
misallocation
Allowing troubled
result from the behavior of such institutions.
institutions to remain open, to continue deposit-taking
activities backed by federal guarantees, and even to make new
loans circumvents the market mechanism whereby scarce funds are
shifted out of a low profit, or even an unprofitable, sector of
the economy and into more productive investments. The federal
their funds, and the
guarantee deters depositors from withdrawing
moral hazard incentive encourages troubled depositories to make
This tilt in the allocation of
new and even riskier loans.
when the number or
society's scarce resources can be significant
size of weak depositories is large. ~
It is often alleged that the administrators of the safety
net, depository institution regulators and elected officials,
have strong incentives to forbear in imposing strong sanctions on
institutions. ~ To the extent that
or closing capital-deficient
regulatory and political forbearance retard the flow of
investment funds out of unprofitable
sectors, then loan interest
rates will tend to be lower than otherwise in those sectors, and
If troubled
higher than otherwise in healthy sectors.
institutions begin to pay higher deposit rates in order to
attract even more funds, or perhaps because of market pressures,
then competitive incentives become even more distorted as healthy
institutions are forced to raise their deposit rates. ~
Capital can be viewed as playing a supporting role in
reducing the market distortions caused by the safety net.
Adequate capital lowers the moral hazard incentive and imposes
Managers wanting to
greater market discipline on managers.
must convince investors that the
expand their institutions
expected returns justify the commitment of risk capital.
Reduces Misallocation

5. Helps to Avoid »Credit Crunches»

institution
that suffers losses is more likely to restrict credit in an
effort to shrink so as to build capital ratios. A wellcapitalized institution can afford more losses and yet continue
Thus, adequate capital should
&0 lend in the same circumstances.
help keep credit flowing even during economic downturns.
In an economic downturn,

Increases Long

a poorly-capitalized

Term Competitiveness

Since capital helps ensure a bank's long run viability by
lowering its likelihood of failure, it helps an institution to
Capital
«velop and maintain long term customer relationships.

also aids in providing the time (by absorbing losses~ and the
financial resources to respond to positive, as well as negative,
changes in the economic environment.
balance, the overwhelming view among economists and
finance experts is that substantial capital significantl
both the probability of failure and the moral hazard of deposit
insurance, and thus s provides as well the other, secondary
benefits discussed.
On

Bank

Capital Ratios in Perspective

Historical Trends

It is clear

that equity capital ratios in the U. S. banking
some success in raising them in recent
despite
industry are,
years, at the low end of their broad historical range. This is
seen in Figure 1, which gives the book-value asset-weighted
average equity to assets ratio for the banking industry from the
1840s through the 1980s.
While the world has obviously changed radically over the
last 150 years, and care must be exercised when using such a long
time series, the chart is suggestive.
Over the last 150 years

the aggregate capital ratio of the banking system has generally
declined from a high of over 50 percent in the 1840s to its
current levels of well under 10 percent.
Contemporary levels are
1/6th the levels of the mid-1800s, and are less than one-half the
level some 50 years ago.

Capital ratios were declining long before creation of either
the Federal Reserve System or the FDIC. Indeed, much of the
decline both before and after the creation of the safety net no
doubt reflects the growing efficiency of the U. S. financial
system.
Nevertheless, the federal safety net is most likely a
key factor in explaining why bank capital ratios can remain
their current levels without weakening public confidence in the
system.
It is difficult to believe that
thrifts operating over recent, decades could have

banking

assets so

much,

with so

little

additional

banks and
expanded their
investment by their
many

not for the depositors' perception that, despite
the relatively small capital buffer, their risks were minimal.
Furthermore, the moral hazard problem has surely given many
owners the incentive let their firms grow without a corresponding
increase in their capital cushion.
owners,

were

Capital Holdings

institutions Not Under the Safety Net
Additional perspective on this point is provided by a
comparison of bank and bank holding company (BHC) capital ratios
with those of financial service firms not accorded safety n«
2~

Figure

Equity as a Percent of Assets
For All Insured Commercial Banks"

1840 - 1989

Percent

Creation of
Federal Reserve

Creation of FDIC

1933

1914

1840 1850 1960 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1989
Year

'Ratio of aggregate dollar value of bank book equity to
aggregate dollar value of bank book assets.

Source: Statistical abstract through 1970.
Report of condition thereafter.

For example, Boyd and Graham (1988) report that,
from 1971 through 1984, the median capital to asset ratio for a
sample of BHCs was 5. 8 percent; compared to 20. 1 percent for a
sample of securities firms, 20. 6 percent for life insurance
insurers.
companies, and 22. 1 percent for propertY/casualty

protection.

recent data, provided in Table 1, compares median
capital to asset ratios over the 1980s at the 50 largest banks,
national BHCs, securities brokers
and samples of publicly-traded
and dealers, life insurance companies, property and casualty
insurance firms, short-term business credit companies, and
While care must be taken in
personal credit companies.
interpreting these data, it is striking that the capital ratio
smaller for the
(based on book values) is always substantially
9
banks and BHCs.
Indeed, it seems reasonable to suggest that
these large differences derive, in part, from differences in
safety net protection.
More

Bank

Capital

Asset Size Class

final perspective on bank capital is given in Table 2,
selected statistical data for all insured
commercial banks by asset size class, as of December 31, 1989.
The last row of Table 2 shows average bank equity capital ratios
by size class of bank.
Clearly, bank capital ratios generally
fall as asset size increases. Indeed, as a percent of total
assets, average equity capital at the largest 25 banks (4. 8
percent) at the end of 1989 was only 57 percent of that at the
average bank in the smallest size class (8. 42 percent).
These differences may reflect in part the higher incidence
of failure at smaller banks, despite their relatively higher
capital ratios, due to risks associated with higher asset and
geographic concentrations.
In short, since smaller banks have
A

which provides

been viewed as "too-big-to-fail,
such banks needed a relatively large
help ensure their long run existence.

not generally
have

felt

" their

owners

may

capital cushion to

Risk-Based Capital

In July 1988, the central bank governors of the G-10
endorsed a system of risk-based capital guidelines for
banking organizations under their jurisdiction. " This socalled Basle Accord is currently in its phase-in period and will
be fully phased-in by December 31, 1992.

countries

of Risk-Based Capital
The primary purposes of the Basle Accord's risk-based
capital guidelines are to: (1) make
regulatory capital
requirements sensitive to differences in risk profiles
among
Purposes

Table

Assets Ratios"

Median Equity-to-Total
(In percent)

Large
national bank
holding

50 largest
banks

(1)

1980..
1981..
1982
1983.
1984..
1985..
1986.
1987.
1988..
1989..
~

order to make the nonbank

Life insurance

companies

Securities
brokers and
dealers

(2)

(3)

(4)

4.63
4.64
4.62
4.73
4.96
5.16
5.24
4.90
5.43
5.00

equity definition

5.60
5.67
5.70
5.72
5.83
5.94
6.01
6.03
6.21
6.27

more comparable

19.51
24.49
17.89

Property and
casualty
insurance

(6)

(5)

19.71
21.06
20.69
19.92
18.26
15.44
14.62
13.40
12.67
12.37

28.92
21.63
19.94
18.04
23.41
26.41
19.69

companies

Personal
credit
companies

23.12
24.20
24.42
23.08
20.48
16.85
22.98
21.91
20.51
22.29

to that of banks, the value of redeemable

19.53
20.42

14.85
14.71
15.32
14.22
12.66
12.34
12.51
14.26
13.49
13.30

22.28
20.42
19.66
19.16
20.73
17.04
16.07
13.76

preferred stock has been subtracted

from

nonbank equity.

Sources: Data in column

(1) are from bank call reports.

All

other data are for publicly-traded

firms and are from Standard

Service, Inc.

and Poor's Compustat

Table 2

Selected Statistical Data on

All

Federally Insured Commercial Banks Classified by Asset Size
(As of December

31, 1989)

(In millions of dollars)

Less than
$300 million

......................................

Number of institutions.
Total assets.
Total domestic deposits.
Nondeposit liabilities

Equity

capital

.........................-----

as a percent of total assets.

Source: Bank call reports.

11,741
$693,994
$613,083
$21,991
8.42

$300

m~llion-

$1 b'Ilion

588
$297, 811
$245, 676
$28,361
7.10

Greater than
$1 billion
except top 25

352
$1,278, 580
$899,426
$262, 907
5.98

Top 25

Total

$1,028, 919
$478, 294
$189,280
4.80

12,706
$3,299,304
$2, 236,479
$502, 539
6.22

organizations; (2) take off-balance sheet exposures into
explicit account in assessing capital adequacy; (3) minimize
disincentives to hold liquid, low-risk assets; (4) foster
coordination among supervisory authorities from major industrial
countries; and (5) reduce international competitive inequities
due to differences in capital policy.

banking

capital guidelines assign on- and off-balance
Each category
sheet items to one of four risk categories.
or
100
to
50,
20,
percent,
equal
0,
risk
weight,
given a
risk
of
a
given class of
depending upon the perceived credit
assets. Risk-weighted assets is defined as the sum of the dollar
values of on- and off-balance sheet items in each category
This risk-weighted
multiplied by a given category's risk weight.
assets measure is the denominator in the risk-based capital
ratios established by the Basle Accord.
2. Components of Risk-Based Capital
The Accord establishes two types of "qualifying" capital,
assets ratios.
and defines minimum capital to risk-weighted
Under the implementing
guidelines adopted by U. S. authorities,
Tier 1, or "core, " capital must represent at least 50 percent of
a bank s total qualifying capital, and consists primarily of
common stockholders'
equity, certain types of perpetual preferred
stock, and minority interest in the equity accounts of
consolidated subsidiaries, less goodwill.
Tier 1 capital may be thought of as a close approximation to
pure, tangible equity that is available to absorb unexpected
losses. Thus, when Tier 1 capital is exhausted, a firm is, for
all practical purposes, insolvent. Under the U. S. implementing
guidelines, Tier 2, or "supplementary, " capital consists
primarily of a limited amount of loan loss reserves, certain
types of perpetual preferred stock not included in Tier 1
capital,
intermediate-term
preferred stock, and term subordinated
'
The

risk-based

debt

capital, while it also stands between owners and
more debt-like
characteristics than does the core capital in Tier 1. For
example, various elements of Tier 2, such as subordinated debt,
are subject to loss only after Tier 1 capital has been exhausted.
The maximum amount of Tier 2 capital that may be included in an
organization's qualifying total capital is limited to 100 percent
of Tier 1 capital.
Tier
depositors

Minimum

(and the FDIC), includes

Capital Requirements

At the end of 1992, the minimum risk-based capital standard
for banks of Tier 1 capital to risk-weighted
assets is 4. 0
percent; and the minimum standard of total (Tier 1 plus
Tier 2)

capital to risk-weighted assets is 8. 0 percent. Elements of Tier
1 and Tier 2 capital are generally measured on an historical cost
basis.
In December 1989 the Office of Thrift Supervision (OTS)
adopted a set of risk-based capital guidelines for thrift
institutions that closely parallel those for commercial banks. "
This was, in part, a response to FIRREA, which mandated that
thrift capital standards generally must be no less stringent than
those that apply to national banks, with a few permissible
As with the bank standard,
statutory deviations.
the risk-based
for
ratios
thrifts
will
be
fully phased-in by the end of
capital
1992. To date, the National Credit Union Administration has not
adopted a comparable risk-based capital standard for credit
"
unions.

In addition to minimum risk-based capital requirements,
all
of the federal bank regulatory agencies and the OTS have either
adopted, or have announced their intention to adopt in the near
future, a minimum three percent total leverage ratio of Tier 1
capital to adjusted total (not risk-weighted) assets. The
agencies have required or will require any institution operating
at or near the three percent minimum to have well-diversified
risk, including no undue interest rate risk exposure, excellent
asset quality, high liquidity, good earnings and, in general, be
considered a strong organization with the highest possible
supervisory rating.
Indeed, banks and thrifts that have not
received the highest supervisory rating are expected to maintain
leverage ratios of at least 100 to 200 basis points above the
three percent minimum.

4. Interest Rate Risk

three percent minimum leverage ratio was adopted partly
that the risk-based guidelines are not, as
currently specified, sufficient in all cases to ensure the
capital adequacy of banks and thrifts. For example, interest
rate risk is not currently incorporated in the risk-based
guidelines. There has been no systemwide method for bank
regulators to monitor interest rate risk, and no established
An interest
method for adjusting capital to reflect that risk.
rate risk component is clearly an area that could lead to
substantial improvements in the risk-based capital standard.
The

in recognition

Progress is being made in this area. In December 1990, the
and
0TS issued for public comment a proposal for monitoring
OTS's
focuses
on
proposal
The
risk.
measuring interest rate
institution's
an
the estimated change in the market value of
sheet
Portfolio of assets, liabilities, and off-balance
" In addition,
bank
change.
rates
instruments when interest
under
the
aegis of
supervisors from a dozen countries are working
Settlements (BIS) to develop a
the Bank for International

detailed interest rate risk measurement system and capital
banks. U. S. bank regulators
standard for internationally-active
less
extensive
a
measurement
system that
aze cuzzently developing
identify banks with exceptionally large interest rate risk
positions. Once identified, such banks would be required to
maintain additional capital.

5. Potential Effectiveness of Risk-Based Capital
promulgated by the
As just noted, the risk-based standards
bank and thrift regulatory agencies are limited attempts to make
But to
bank and thrift capital costs sensitive to risk.
criticize risk-based capital as imperfect probably misses the
point. The key question is whether the risk-based system can be
expected to do a better job of protecting the insurance funds and
controlling moral hazard than the old system of essentially fixed
minimum capital ratios that included loan loss reserves in its
definition of "primary" capital.
This issue is addressed in a recent study of commercial
banks by Avery and Berger (1990). These authors attempt to
estimate the extent of statistical correlation between measures
of bank risk--bank earnings, earnings variability, nonperforming
loans, loan charge-off rates, and bank failure--with variables
representing the extent to which banks conform to the risk-based
capital standards and the previous capital standard.
Statistical models are estimated for both relatively small
(total assets less than $250 million) and relatively large banks
over the period from 1982 through 1989. The results strongly
suggest that the new risk-based capital standards are better
predictors of problem banks than are the old capital rules.
Also, this and other research indicate that bringing off-balance
sheet items into the risk-based capital computation helps to
identify relatively risky banks in advance of their imposing
losses on the FDIC. "

E. Responding to Arguments Against Increased Capital
This section discusses increasing the level of the minimum
capital ratio in order to increase market discipline on insured
depositories, and increase the capital cushion of protection for
the FDIC. Section F considers another possible way of achieving
this objective
through increasing reliance on subordinated
debt. 18 A third way, prompt corrective action
closure
of capital impaired depositories, is discussed orin timely
Chapter X.
Increasing the minimum required
ratio may be viewed
as a way of increasing the "insurance capital
deductible"
in federal
deposit insurance.
This shifting of risk to the private sector
could be expected to have a number of benefits, all of which were

Table 3
Banks That are Estimated Not to Meet Increased Risk-Based Capital Standards
(As of June 30,
Number

1990)
of Banks

Not Meeting/Number

Percent of Total Assets
Total Capital Deficiency
(ln mllfions of dollars)

Asset size dass

4% Tier 1
8% total

5'll Tier 1
9% total

8% Tier 1
10II total

(2)

(3)

602/3, 196

392/2, 737

$169

224/2, 737
8
$250

15
$406

606/2, 737
23
$660

218/2, 378
11
$660

398/2, 378
19
$1,219

653/2, 378
31
$2, 108

922/2, 378
43
$3,383

128/243
52

161/243
66
$2,059

94/3, 196

143/3, 196
4

230/3, 196
7

$96

$117

$159

Percent.

66/2, 737
2

121/2, 737
4

Amount.

$130
93/2, 378
4
$398

$25-$50 ..
Percent.

Amount.

$50-$100..

$100-$500..
Percent.
Amount.

$500-$1,000..
Percent.
$1,000-$5,000
Percent.

Amount.

$5,000-$10,000.

Percent.

..............

Amount.

Greater than

Percent.
Amount.

.
.

$10,000

Amount.
Note: The

53/243
22
$344

87/243
$722

$1,306

30/263
14
$723

70/263
31
$1,872

138/263
59
$4,053

172/263

14/60
25

$1,115

29/60
49
$2, 513

46/60
78
$4, 900

51/60
85
$7,910

19/45
52
$10,108

29/45
72
$18,453

41/45
95
$29,082

43/45

464/12, 479
27
$12,762

Total.
Percent.

$7,219

98
$40, 871

15
$171

19
$359

205/263
83
$10,882

56/60

93
$11,123
43/45
98
$52, 769

822/12, 479 1,406/12, 479 2, 193/12, 479 3,099/12, 479
77
71
64
44
$81,407
$60, 178
$40,476
$24, 198

1992 risk4ased capital standards are applied to June 30, 1990 call report data.

Source: Federal Reserve Board.

7
$91

10
$134

25/243

Amount.

(5)

387/3, 196
12
$235

242/3, 557

Amount.

(4)

504/3, 557

159/3, 557
5
$70

Percent.

8% Tier 1
12% total

367/3, 557
11
$124

123/3, 557
4
$59

$0-$25.

t t'll total

7% Tier

Table 4
Savings and Loans That are Estimated Not to Meet Increased Risk-Based Capital Standards
(As of June
Number

30, 1990)

Not Meeting/Number

of S&Ls

Percent of Total Assets
Total Capital Deficiency
(In millions of dollars)

Asset size class

$0-$25
Percent. .
Amount.

$25-$50
Percent. .
Amount. .

$50-$100.. .
Percent.
Amount.

$100-$500.
Percent

4% Tier 1
8% total

41/238
18

42/238

6% Tier 1
10% total

7% Tier 1
11% total

(3)

(4)

51/238

65/23I

137/366
38
$171

161/39

275/52!

$423

241/523
46
$517

371/790
48
$2, 346

416/790
54
$2,862

465/790
60
$3,439

497/780

73/121
60
$1,470

79/121
64
$1,779

88/121
72
$2, 119

93/121

94/123
77
$7,961

97/123
79
$9,005

105/123

13/15

$19

22
$27

83/366
23
$104

95/366
27
$122

113/366

155/523
30
$266

192/523
37
$338

215/523

319/790
$1,892

8% Tier I
12% total

56/238
25
$32

19
$23

Amount.

5% Tier 1
9% Total

31
$144
41

$3;

$20I

5:
82c

Q
$4, 057

$500-$1,000..
Percent. ...........
Amount. ............

62/121
50

$1,000-$5,000 .
Percent. ...............
Amount. .

86/123
$6,054

92/123
76
$6,970

$5,000-$10,000 .
Percent. ................

12/15
78
$2, 756

13/15
88
$3, 155

13/15
88
$3,558

13/15
88
$3,961

8/10
83

9/10
93

$5,245
766/2, 186
65
$17,528

$6,541

9/10
93
$7, 927

887/2, 186
72
$20, 965

990/2, 186
74
$24, 682

9/10
93
$9,338
1 „106/2, 186

1,218/2, 188

77
$28, 581

$32,823

Amount.

Greater than $10,000.
Percent. .
Amount.

Total

Percent.
Amount.

p&l standards
deducted from assets and capital.
Source: Office of Thrift Supervision.

subsidiaries

$1,193
71

are applied to June 30, 1 990 data. Thrifts in or targeted for conservatorship

$2, 484
88

$10,095
88

$4, 385
9/10
93

$10,748
80

are excluded. Investrrienls

It should be stressed that
discussed earlier in this chapter.
capital
requirements would be accompanied by a
any increase in
substantial transition period to avoid adverse effects on the
economy.

of increasing minimum bank capital requirements
to raise the Basle Accord's minimum risk-based capital
Tables 3 and 4 show estimated effects of one way of
ratios.
raising risk-based capital requirements--increasing
the Tier 1
requirement from the fully phased-in level of 4 percent to 8
percent in one percentage point intervals (the Tier 1 plus Tier 2
standard rises from 8 percent to 12 percent, and the 3 percent
minimum total leverage ratio is held constant).
Data are
asset
size
class, column 1 gives estimates for the
displayed by
current (4/8) standard, and the remaining columns show the
potential effects of progressively higher standards.
Each cell
table
shows:
the
the
number
of banks or savings and loans
of
(i)
(S&Ls) in the cell that would not pass the standard;
(ii) the
total number of institutions in the cell; (iii) the percent of
total bank or S&L assets in the cell that are in institutions
that would not pass the standard; and (iv) the dollar amount of
capital that banks or savings and loans that would not pass the
standard would have to raise to meet the standard.
For example, the &10, 000 row of column 3 in Table 3 shows
that if a 6 percent Tier 1 and 10 percent total capital standard
were in place in June 1990, 41 of the 45 largest banks would fail
the standard.
These 41 banks hold 95 percent of the largest
banks' assets and the aggregate capital shortfall of the largest
banks is estimated to be $29 billion.
It should be emphasized that the estimates in Tables 3 and 4
must be interpreted
with some care because they allow for no
portfolio adjustments by depositories in response to increased
capital requirements.
That is, the estimates in the tables
assume a constant depository size and portfolio composition as of
June 1990. In addition, many BHCs whose banks have capital
ratios below the 1992 minimums have consolidated BHC capital
ratios above the minimums.
This suggests that a redeployment of
least in some cases, assist
at
existing BHC capital can,
For all
subsidiary banks in meeting the risk-based minimums.
these reasons, the results should be considered high-side
estimates of the potential impact of higher standards. "
The results displayed in Table 3 suggest some interesting
conclusions.
First, it is estimated that 464 banks (column 1),
or 3. 7 percent of the total, would not pass the current 4/8
the incidence of banks not
capital standard.
Not surprisingly,
the
largest firms. Overall,
at
m~eting the standard is highest
it is estimated that banks will need to raise some $13 billion in
capital to meet the 1992 Basle standard, almost 5 percent of
current Tier 1 plus qualifying Tier 2 capital ($259. 0 billion).
One way

wou]d be

that 93 percent of the $13 billion
eficit consists of (relatively lower cost) Tier 2 capital.
Raising the standard to 5 percent Tier 1 and 9 percent total
(from 464 to 822) the
(column 2) increases by three-quarters
not
meet
would
the standard.
that
The
total number of banks
percentage increases in the number of banks with capital
deficiencies are smallest in the largest size class and the
smallest two size classes. This is because the largest size
class already has many banks that do not meet the Basle standard,
and in the smallest size classes many banks now hold capital
substantially in excess of minimum risk-based requirements.
In
the 5/9 experiment, the estimated aggregate capital deficit (last
row) is some $24 billion, or about 9 percent of current Tier 1
plus qualifying Tier 2 capital.
increase toward 8 percent Tier 1 and
As capital requirements
12 percent total capital, the increase in the number of banks
that would not meet the standard is fairly uniform, except for
the largest size class, where nearly all banks would not pass by
the 6/10 standard.
Indeed, most smaller banks currently have
sufficient capital to pass the 8/12 standard.
It is not until the $500 million to $1 billion asset size
class that more than half of the banks fail this high standard.
In part this is because most smaller banks have little or no offbalance sheet activities, and many have portfolios that are rich
in assets that have low risk weights.
Of course, they also tend
to have higher ratios of equity to total assets. Overall, the
$40 billion aggregate capital deficiency for the 6/10 standard is
fairly large, 16 percent of current capital. Most of this
deficiency is in the largest size class, which has an estimated
shortfall of $29 billion.
should be noted however,

1 of Table 4 shows that an estimated 766 savings and
loans, or 35 percent of all savings and loans that are not either
currently in conservatorship or targeted by the OTS for
conservatorship would, as of June 1990, not meet the current 4/8
capital standard. While the incidence of institutions not
meeting the standard is, as is the case with banks, highest at
the larger savings and loans, the percentage of thrifts not
meeting the standard is considerably higher than that at banks
Column

for all size classes.

The estimated aggregate capital deficiency at thrifts for
the current standard is $17. 5 billion, some 52 percent
of their
current $33. 9 billion of Tier 1 plus qualifying Tier 2 capital.
From these data alone it seems clear that many thrifts will have
a difficult time meeting the current standard, much less a higher
one. For example, if a 6/10 standard were adopted, it is
estimated (column 3) that 45 percent of thrifts would not meet
the standard, and the aggregate capital deficiency would rise

billion to $24. 7 billion. In contrast, this is 61
percent of the estimated aggregate bank capital deficiency
which
(column 3 of Table 3) of $40 billion for a 6/10 standard,
of
banks
percent
would
11
not
estimated
pass.
an
Still, there are some thrifts that would meet higher riskeven a standard as high as 8/12. As
based capital requirements,
the
incidence of such thrifts is highest
is the case with banks,
in the lower size classes.
Opponents of increased capital ratios cite four principal
concerns: (1) it would be very difficult and costly for many U. S.
banks and thrifts to raise more capital; (2) higher capital
for U. S depositories would hurt their domestic and
requirements
international competitive positions; (3) at some institutions
increased capital requirements may actually increase the
incentive to take risks as these institutions seek to maintain a
desired return on equity; (4) asset growth at insured
depositories would be slowed, thus engendering macroeconomic
effects comparable to the implications of contractionary monetary
policy; and (5) consolidation of the U. S. banking industry would
In
Each of these arguments is discussed below.
be accelerated.
addition, the issue of the appropriate level of capital ratios is
about $7

addressed.

1. Raising Additional Capital
issue

Would

Difficult

and

Costly

would be to
One way of meeting higher capital requirements
of the history of depository
new equity.
An examination

institution stock offerings gives some hint of the feasibility of
this approach.
A recent study by Berkovec and Liang (1990) found
that since the late 1970s, the dollar volume of new equity issues
has grown at a greater rate than the
by banking organizations
total dollar volume of new domestic issues by all domestic
corporate firms. Moreover, the dollar volume of new equity
issues in domestic markets by BHCs, as a percentage of both total
assets and total equity, has increased since the late 1970s. In
addition, the data shown in Table 5 indicates that new equity
issues by banking firms over the 1980s have been fairly
impressive.
Annual levels of $3 billion have not been uncommon.
However, annual issuance has been well below the aggregate
levels estimated to be required by the experiments summarized in
Table 3. In addition, the stock price of many BHCs has fallen
precipitously in 1990, greatly complicating efforts to raise new
equity capital in the near term. On balance, it would appear
that while BHCs have the demonstrated ability to raise
substantial amounts of new equity, it is also the case that any
increased capital requirements above the Basle standards now
being phased-in would probably also have to be phased-in over a
significant period of time. The need for a substantial phase-in
Period is even more compelling for savings and loans.

Table 5
hlew Equity

issues and Equity Capital-To-Assets Ratios for All Banks and for 19 Large Bank Holding
Companies, ' 1970-1989
All

New equity *
(in millions of

dollars)

1970.
1971

1972.
1973 .
1974
1975

1976.
1977.
1978 .

1979.
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

Number of
new equity

Equity capital-

ttHtssets
(percent)

Issues

30.3

243.3
319.8

40
43
25

89.2
23.0
172.9
370.1
407.4
483.9
45.5
398.6

211.9
1,770.6
3,239.7
1,196.8
2, 269.1
4,411.1
3,728.5
1,239.0
3,208. 1

tgitug

banking firms

8
8
12
11

23
8
29
18
41

75
60
89
134
94
11

6.58
6.33
5.96
5.67
5.65
5.87
6.11
5.92
5.80
5.75
5.80
5.82
5.85
5.99
6.14
6.18
6.17
6.00
6.27
6.20

New equily*
(in millions of
dollars)

0
0
0
0
75.0
278.6
277.8
99.8
0
186.6

0
1,161.4
1,780.9
452.5
986.6
962.7
1911.13
637.8
2,41 5.0

ki~~

Number of
new equffy

Equity

toess s

issues

0
0
0
0
0
1

3
1

0
2

0
8
10
4
13
5
10
4
12

5.5!
5.3
48&

4.3i
4.5
4.3i
4.8r
4.4i
4.2(
4. 1;
4.1!
4.Z
4.31
4, 72

4.9)
5.12
5.34
4.81
5.33
5.12

' These are the bank holding companies that, over this period, are continuously in a bank sample followed by Salomon Brothers. The sample is s mb
of both money center and regional i stautions.
Includes new equity issues in domestic markets. Data for 1970-87 are from Registered Offering Statistics, Securities and Exchange Commission
Data for 1988-1989 are from Federal Reserve Board staff.
December call report data aggregated over all banks.

'
'

Source: Federal Reserve Board.

need for a substantial phase-in period is reinforced by
the argument that new issues of common equity can be expected, at

least in the short run, to decrease the per share value of a
firm's common stock. This is a standard result for nonfinancial
in the few studies of the effect
firms, and has also been found
~~
organizations.
banking
for
The reasons for this effect are the subject of active debate
in the economics

and

is the differential

finance literature.

One

major explanation

tax treatment of debt and equity. Interest
while dividends on equity are not.
on debt is tax deductible,
of equity for debt increases, other things
Thus the substitution
equal, a firm s tax liability, thereby lowering the discounted
value of its future after tax earnings, that is, the price of its
shares.

Berkovec and Liang (1990) present models of the change in
stock price that rely exclusively on this tax effect. For a
small sample of large BHCs, they estimate that the price
elasticity of the change in BHC stock prices with respect to a
change in the stock of equity is essentially equal to minus the
corporate tax rate. That is, an increase in a BHC's equity equal
to 10 percent of the value of its initial equity could depress
the equity's price by about 3. 4 percent (assuming a corporate tax
rate of 34 percent).
While the

corporate tax deductibility

of interest creates a

bias in favor of debt financing, personal taxes may give some
Under current law, the top
advantage to equity investments.
marginal tax rate for ordinary income is 31 percent, compared to
This gives some investors a
28 percent for capital gains.
preference for capital gains over ordinary income, and a
corresponding preference for equity investments that generate
capital gains. Thus the bias of the overall system toward
corporate debt finance is reduced, and this may lower the loss
from issuing new equity that would be projected based on the
corporate tax effect alone.

Another hypothesis argues that equity issues may reveal
information that managers have heretofore kept confidential about
In theory this
firm performance and/or investment opportunities.
investment
for
example,
information could be good news, if,
opportunities are better than expected, or bad news, if, for
The
example, managers think the firm's stock price is too high.
are
considered
issues
that
be
equity
to
conventional view appears
to be bad news about the firm, and hence prices will fall for
reasons unrelated to leverage changes.

the practical importance of this effect for
increases in capital may well be minor, since
regulator-mandated
the information revealing content of such an increase would seem
to be small. This is especially the case if the same regulatory
However,

standard were imposed on many banks or thrifts simultaneously.
Spme evidence in support of the view that the negative impact on
stpck prices is smaller at BHCs than at unregulated firms is
of the issue
fpund by gansley and Dhillon (1989): "Announcements
with
a
significant
negative
pf cpmmpn stock are associated
effect
is
this
similar
of
to that found
magnitude
the
effect, and
»and
regulated
(another
industry)
utilities"
previously for
»
smaller than that found for industrial firms.

Increased capital may also decrease depository stock prices
subsidy to banks thrpugh the
by reducing the implicit government
insurance.
That is, higher capital
provision pf federal deposit
ratios lower the value of the deposit insurance put, option,
is clearly an asset to the bank or thrift, the value of which
accrues to the owners of the firm. Of course, reducing the value
of the deposit insurance subsidy would be a primary objective pf
increased capital standards, or any other deposit insurance
reform.

Positive Effects of Higher Capital on Stock Prices
Cost of Debt

and the

In the long run, the effect of increased capital standards
As discussed
depository stock prices may well be positive.
earlier, increased capital is likely to be viewed as
strengthening the long run competitiveness and viability of
depository institutions.
Even today it is often true that the
most nationally and internationally
competitive U. S. banking
organizations are also the best capitalized, compared to banks of
similar size. Furthermore, there is evidence that the best
capitalized banks also tend to earn the highest returns on
equity.
on

Even in the short run, a lower probability of failure would
decrease expected bankruptcy costs and likely reduce the cost of
uninsured debt. This should offset somewhat the negative effects
of increased capital on both stock prices and the overall cost of
capital. This latter possibility is often called the ModiglianiMiller effect, and refers to the argument that because a higher
capital ratio lowers the risk of debtholder loss, the cost of
debt should fall as the capital ratio rises.

In banking there is some evidence that the interest rates
paid on uninsured liabilities tend to rise with bank risk, at
least at those banks not considered too-big-to-fail.
It seems
likely that this pattern would become more pronounced if the
deposit insurance subsidy were reduced.
Indeed, in other sectors
of the economy an inverse relation between risk and the cost of
debt is well established.
As discussed later in the subsectipni
this pattern appears to be increasingly the
with respect to
interest rates paid by banking organizations case
on subordinated

debt.

Lastly,

any

other costs imposed on investors

by low

capital ratios, such as the need to monitor depository risktaking too intensely, would be reduced by higher capital ratios.
pther things equal, such cost reductions to investors should
stimulate investor demand for bank and thrift stocks.
Higher Capital

International
The

potential

international

Requirements

Competitiveness

Would Hurt

U. S. Banks&

impact of higher

competitiveness

capital standards on the
of U. S. depositories is extremely

difficult to assess. Although the short run net impact on an
institution s funding costs is ambiguous, in the long run there
is likely to be a net positive effect. Even the current
positions of U. S. depositories with respect to the 1992 Basle
standards relative to the positions of their major foreign rivals
is unclear.
committee of bank supervisors
The last time an international
assessed the situation (as of the end of 1989), it seemed likely
that by the end of 1990 most G-10 banks, including the largest
U. S. banks, would have achieved the final 1992 standards. ~6
Based upon these comparisons,
the capital positions of the
largest U. S. banking organizations were generally in line with
those of the other G-10 countries.
This is
However, even this conclusion must be qualified.
due to a number of differences across nations including reporting
procedures, sample selection procedures regarding what banks were
used in the test, and methods of calculation during the
transition period to the full Basle standard.
Finally, it should
be emphasized that the general issue of competitiveness,
both
domestic and international,
is not just a matter of capital
standards, but of the entire system of laws, regulations,
economic environment,
and culture under which U. S. depositories
operate. When viewed in this context, it would probably be a
alone.
mistake to focus attention on capital requirements
3. Higher Capital Requirements May Increase Risk Taking
Some observers have argued that increasing capital
requirements on insured depositories may cause them to increase
their portfolio risk in order to maintain a desired rate of
return on equity. ~7 An additional argument is that the
depository institutions
stockholders of large, publicly-traded
risk averse, or even risk neutral, since the
may be only slightly
equity of such firms tends to be widely held by a large number of

well-diversified

owners.

it is

are inclined to take excessive
especially in a world
these
arguments,
Others challenge
where failure is costly and deposit insurance has value to the
~ank.
For example, Furlong and Keeley (1989 and 1990)
risk-

Such firms,

argued,

the case of a publicly traded bank whose
examined (theoretically)
to maximize the value of the bank's
seek
owners and managers
stock. In their model, an increase in capital reduces the value
of the bank's option to sell (put) its insured liabilities to the
FDIC since now more of the owners' own money must be exhausted

before the FDIC can be exploited; this is sufficient to assure
that portfolio risk will not increase. However, Keeton (1988)
used a more general approach that includes the put option value
to show that it is possible that increased capital would result
in increased portfolio risk.
resulted in an increase
Even if higher capital requirements
does not follow that
it
bank's
portfolio,
of
a
riskiness
in the
The
effect of an
~rimar
the bank is more likely to fail.
increase in capital is, other things equal, to lower the
probability of failure. Indeed, a significant inverse
relationship between a bank's probability of failure and its
ratio is a standard result in empirical studies of bank
capital ~9
To date, no theory or example that includes the
failure.
facts that failure is costly and that deposit insurance has value
has been offered which shows that higher capital requirements
of failure.
would increase a bank's probability

Higher

Capital Requirements

Would

Slow Asset Growth

To the extent that banks and thrifts could not meet
increased capital standards, one option would be for such
institutions to grow more slowly or even to shrink. Indeed,
these responses appear to be how many thrifts have adapted to the
capital ratios mandated by FIRREA. Such responses are not
necessarily undesirable, since existing safety net subsidies have
almost surely allowed some banks and thrifts to grow in excess of
what they could have achieved without safety net protection.
That is, part of the desirable reallocation of resources that
would accompany a decline in the deposit insurance subsidy,
however achieved, would be a reduction in excessive growth at
some, and particularly
poorly capitalized, insured depositories.
Lower asset growth and asset contraction are not the only
possible responses of depositories that could not meet higher
capital standards.
Assuming that capital requirements
would
continue to rely on risk-based assets, depositories could also
shift their asset composition toward less risky assets. While
this would also no doubt restrict the availability of credit to
high-risk borrowers, the appropriate capitalization of risky
activities is one of the goals of both the risk-based capital
policy and policies to reduce moral hazard in banking. ' Also,
a significant phase-in period would allow for such decisions to
be made in a deliberate and prudent manner.

Nevertheless,

capital requirements

it is

possible that substantially higher
for banks and thrifts, or any other

significant reduction in the deposit insurance subsidy, could
tighten the terms on which credit is made available at insured
depositories by a sufficient amount to cause macroeconomic
concern. The likelihood of such an effect would be higher to the
extent that borrowers facing higher costs or reduced availability
pf credit did not have ready access to funding outside the
insured depository system.

is virtually equivalent to that expressed
to a perceived tightening of credit supply
banks.
In this scenario, depositories restrict

Such concern

recently with regard
conditions

of credit either voluntarily in response to changed
conditions, or involuntarily in response to tighter
regulatory standards.

the supply
economic

appropriate macroeconomic policy response to an undesired
tightening of credit conditions would be for the Federal Reserve
to ease monetary policy enough to allow an increase in credit
sufficient to support a sustainable pace of output growth
Indeed, in the
consistent with progress towards price stability.
context of this type of problem, the Federal Reserve has
indicated that it is well aware that it "must remain alert to the
possibility that an adjustment to its posture in reserve markets
might be needed to maintain stable overall financial
conditions. "~~
An

is important to realize that the execution of
However,
In practice
such a macroeconomic policy is difficult at best.
its success requires today, and would require in the future,
careful monitoring of the state of the economy and prudent
But to dwell on the
judgment by the monetary authority.

potential macroeconomic concerns of higher capital requirements,
or other reductions in safety net subsidies, is almost surely a
deposit insurance
mistake.
and administered
A poorly designed
system can clearly itself be the cause of macroeconomic
difficulties. Thus, successful reform of deposit insurance would
be expected to lower the probability that the central bank would
have to take action to prevent a financial crisis.
5~

Higher

Capital Requirements

Would

Result in Consolidation

possible reaction by banks and thrifts that would
have trouble meeting a stricter capital standard would be to
So long
better capitalized organizations.
merge with healthier,
or risk enhancing
as there were no significant anti-competitive
the stability of
strengthen
well
effects, such a reaction could
the U. S. financial system.
However, once again it is worth emphasizing the virtues of a
significant phase-in period for substantially higher capital
determine their
standards.
It would take institutions time to the
inevitable
and
optimal responses to the new environment,
Another

transition costs could likely be minimized by allowing such
decisions to be made in a deliberate manner.

How

High Should Minimum

The question

Capital Ratios Be?

of the appropriate

level for

capital
ratios for insured depositories is essentially the question
of
what is the maximum level of depository system risk that society
is willing to tolerate. That is, other things equal, a given
bank or thrift capital ratio implies a probability of failure for
that firm, and an accompanying contribution to systemic risk by
minimum

that firm.

levels of capital imply a lower probability of
failure, and a lower contribution to systemic risk. Setting a
minimum capital ratio for a given firm, or for all firms in the
industry, thus implies the choice of. a point, or set of points,
on this capital/risk
continuum. ~5
One way of estimating
such a continuum is to estimate a bank
or thrift failure model, in which the probability of failure of a
given institution is a function of a variety of factors,
including its capital ratio. Then, for a given probability of
failure, the appropriate capital ratio can be computed. + Note
that this procedure does not imply a common capital ratio for
every depository.
Indeed, it implies quite the opposite, since
the other factors in the failure equation, such as the ratio of
loans to assets and measures of nonperforming loans, vary across
depositories.
Thus, this system is really a type of risk-based
Higher

capital.

such "microeconomic" models do not account for the
of changes in aggregate regional or national markets, nor

However,

effects

do they incorporate the interdependencies
among depositories.
Thus they have virtually no ability to account for systemic risk.
Nevertheless, they do have the potential of providing useful, but
rough, approximations
of the level of capital consistent with a

given level of microeconomic

risk.

Another approach is to assume that a given level of the
deposit insurance premium e. cC,, , the rate in use today,
represents society's collective decision regarding the expected
level of deposit insurance losses it is willing to tolerate over
the term of the insurance contract.
Once this assumption is
granted, then measures of a bank's riskiness can be estimated,
for example the variability of portfolio returns, and a capital
ratio computed which sets the value of the deposit insurance put
option equal to the insurance premium. ~~

Again, note that this approach also does not imply a common
capital ratio for every depository, but a menu of ratios based on
an institution
s portfolio risk. Also, macroeconomic and

have not, at least to date, been included in
of this approach. And, as was the case
applications
practical
for the depository failure model, the "option model" approach has
potential to provide useful, if rough, approximations of the

risks

systemic

optimal

capital ratio.

Basle risk-based

capital standards attempt, in a less
practical way, to establish a
capital/risk continuum for banks and thrifts. Embedded in this
approach, as in the failure and option models, is an implied
The

elegant but no-doubt

level of acceptable

risk.

notion of the level of this implied risk in the riskis suggested in a recent study by Avery and
These
authors find, for example, that over their
Berger (1990).
sample period of 1982-1989, banks that failed any aspect of the
fully phased-in risk-based capital standards had a statistically
significantly higher probability of failure than did banks which
In addition, of banks that did not pass the
passed the standard.
risk-based standards as of December 1987, 32. 3 percent were
insolvent by the end of 1989; whereas only 1.1 percent of banks
that passed the risk-based standard in 1987 were insolvent by the
end of 1989. "
Some

based standards

Historically, bank regulators have been unwilling to rely to
degree on approaches such as the failure and
any substantial
In truth, the
option models to set minimum capital standards.
analytical and statistical complexity, uncertainty, and
limitations of these methodologies are powerful arguments for the
continued application of considerable judgment in the setting of
capital standards.
But technological and other advances in
economics, finance, and statistics make the application of such
techniques increasingly feasible.
At a minimum, estimates
derived from such models have the potential to provide useful
benchmarks against which to measure the results of more
judgmental

analyses.

final points regarding the setting and administration of
insured depository capital ratios.
First, there is no reason to
believe that ratios set for today's environment will be
Thus a flexible system
appropriate at all points in the future.
is required that can evolve with changing circumstances.
Second, both the complexity of the task and the need for
flexibility over time are strong arguments for Congress to
delegate, with appropriate oversight, the details of the process
to one or more regulatory agencies. Given the difficulties of,
and typically long time lags, in revising laws, too much
statutory specificity regarding capital ratios could easily lead
to a grossly inefficient system of capital standards for insured
depositories.
Two

P. Increased Reliance
issue

on Suhordinated

Deht

Some observers have proposed requiring banks and thrifts
some minimum amount of subordinated
notes and debentures

debt, as a wa of increasing market
(SND), or subordinated
discipline on insured depositories.
Requiring a minimum ratio
of SND to total or risk-weighted assets is another way of
the insurance

deductible in federal deposit insurance,
and thereby shifting risk to the private sector.
Thus arguments
for and against increased use of SND parallel those regarding
increased capital requirements.

increasing

Arguments

in Pavor of Subordinated

Debt

There are additional arguments that may be used in support
of SND. First, it has been argued that the risk preferences of
of the
SND holders would be similar to the risk preferences
holders
receive at most a
This is because SND
deposit insurer.
fixed return on their investment, but like the FDIC may suffer
losses in bad times. Thus the market discipline exerted by SND
holders would be consistent with the discipline that the deposit

insurer would like to see exerted.

Second, SND provides an extra cushion against FDIC losses
insolvency is determined by the value of equity capital.
Thus, SND would help to minimize FDIC losses, especially in a
world where the measurement of an institution's
true financial
condition can be highly uncertain. 4~

when

Third, because SND holders stand to suffer losses when an
is closed after its equity is exhausted, SND holders
have a strong incentive to pressure regulators to intervene
promptly with capital deficient depositories.
Thus the tendency
for regulators to forbear may be tempered by the SND hol'ders.

institution

Fourth, the marginal cost of SND to the depository
institution is lower than that of equity, and thus the impact of
increased capital requirements on insured depositories' cost of
capital may
be softened if SND were a larger part of the capital
44

account.

issues, especially if such issues were
would provide regulators with a
potentially useful signal of the market's view of a bank's or
thrift's financial future. 4~
Lastly, yields

required

on a

Required

on SND

serial basis,

Minimum

Subordinated

Debt Holdings

These advantages of subordinated debt could be achieved by
requiring insured depositories to maintain a minimum ratio of SND
to risk-based assets. The voluntary holding of SND is encouraged
today by the risk-based capital standards, which allow term SND

to count for as much as 25 percent of total capital at banks, and
up to 50 percent at thrifts.
argue that this provides sufficient incentive
for depositories to hold SND while simultaneously maintaining
to choose its capital
needed flexibility for an institution
However, others have proposed giving SND an even
structure.
Some

observers

larger role in disciplining

depository

risk taking.

of such a proposal is Wall's "puttable
" under which large banks would be required to
debt,
subordinated
issue puttable debentures, and must be declared insolvent if such
fell below 4 or 5 percent of risk-weighted
debt outstanding
47
a complex proposal:
banks and
Oversimplifying
assets.
thrifts operating under this plan would have 90 days after a put
is initiated by any debtholder to (1) reduce assets so that the
ratio of the remaining puttable debt to risk-weighted assets
(after the redemption of the debt that is put to the bank) would
still exceed 4 or 5 percent of risk-weighted assets; (2) issue
debt to maintain the ratio; or (3) in exchange for
new puttable
90 days to issue sufficient puttable new debt,
an additional
issue equity capital equal to the deficiency in puttable debt
that would occur after redemption.
One example

If at the end of 90 (or 180) days the puttable debt ratio
deficient, the depository institution would have to be
declared insolvent and recapitalized,
sold, or liquidated by
regulators.
Note that Wall's proposal truly uses market
Bondholders concerned about the solvency of the
discipline.
depository and hence the value of their bonds act on their own
initiative. If the depository s response does not satisfy the
meets the rule, the
market in such a way that the institution
regulator must act. The market identifies weak depositories, and
the regulator is forced to act if the firm cannot respond
satisfactorily.
3. Potential Problems with 8ubordinated Debt
There are at least five arguments that may be raised against
requiring increased use of subordinated debt.

were

of Debtholders
First, while the risk preferences of debtholders may be
similar to those of regulators when the bank or thrift is
~&althy, as equity capital goes to zero, and bondholders become
preferences may become more
the residual claimants, bondholders'
like those of the equity holders. That is, when equity
approaches zero, debtholders may become willing to let the
depository take big bets with federally insured funds 48in order to
increase the chance that they will not suffer losses.
Risk Preferences

Possibility of

Runs

Second, proposals

such as Wall's put optipn

approach

likely to substantially increase the probability of depositor
Exercise pf the put
runs, with possible systemic implications.
or perhaps even the indication that a put is likely
exercised, would be a clear signal that the insured deppsitpry i~
Uninsured depositors wpuld
most probably in serious trouble.
seek to withdraw their funds from such an
Indeed, other uninsured creditors, such as pthez
institution.
funds, might also run on the
SND holders and sellers of federal
on
a
running
put.
is
clock
news that the

almost surely

allowing private creditors to make the closure
decision for an insured depository assumes that private agents
know as much or more about the "true" financial condition of the
In a world of timely and thorough
firm as do its supervisors.
examination and other confidential and public monitoring by
supervisors, it is unlikely that private markets possess better
information.

In addition,

for insured

importantly,

a primary

reason for a federal safety net

depositories is to protect the process of financial

against the risks of deposit runs and bank crises
The timing of the closure decision
this policy goal, and thus giving
this policy instrument to the private market may be highly
inadvisable.
intermediation

having systemic implications.
is a key tool of implementing

Indeed, despite the massive deposit insurance losses of the
last several years, it may well be true that in some future
financial crises the least cost solution from society's point of
view will be to allow the deposit insurance system to suffer some
losses. This could easily imply allowing some depositories to
remain open that would in fact be closed by the market.
On balance,
it is reasonable to argue that the world is
uncertain enough, and financial crises idiosyncratic enough, that
complete removal of regulatory discretion regarding the closure
decision is not prudent public policyInflexibility of SND
Third, SND is an inflexible capital instrument in the sense
that the interest on SND is a contractual obligation of the firm.
In contrast, dividends on common stocks do not have to be paid
and therefore provide the firm with greater flexibility in a time
of financial stress. Moreover, the obligation to pay interest on
SND could inhibit
a bank or thrift from building capital via
retained

earnings.

Risk/Return

Relationship

Fourth, studies of the market discipline exerted by SND
holders under the safety net regime existing throughout much of
the 1980s do not suggest a strong relationship between risk and
For example, a study
the expected return demanded by investors.
debt
offerings by large BHCs in 1983 and 1984 by
pf subordinated
Avery, Belton, and Goldberg (1988) found no evidence of ex ante
However, Gorton and Santomero
market discipline by SND holders.
(1990) using Avery, Belton, and Goldberg's data, but a quite
different methodology, found weak evidence of market discipline
debt.
in BHC subordinated
Evidence regarding the market discipline potential of SND
holders that is contingent on the existence of current or
previous safety net arrangements
is, however, suspect. If
creditors really believe that some large banks are too-big-tofail, it would be rather surprising to find that creditors of
such large banks took the risk of failure seriously enough to
risk premiums on uninsured debt. Indeed, this
demand substantial
is probably why the empirical evidence in favor of market
discipline tends to be found at banks considered to be well
outside of the realm of too-big-to-fail. "

there is considerable evidence from other debt
that debtholders, when they are truly exposed to risk,
demand substantial
risk premiums. There are signs that this is
As bank regulators have made it
becoming the case in banking.
increasingly clear in the latter part of the 1980s that
subordinated debtholders are not protected, it appears that SND
yields have come to better reflect the relative riskiness of
banking organizations.
In addition,

markets

For example, beginning in late 1989, and continuing into
1990, the spread between average secondary market yields on BHC
SND issues and yields
on comparable-maturity
Treasury securities
widened significantly
for both money center and regional BHCs.
This seems to have been at least partly in response to the
continued slide in credit ratings of U. S. banking organizations.

the impact of rating downgrades and concern
the safety and soundness of banks is clearly evident in the
rates paid in 1990 by individual BHCs. The pronounced effect of
a below investment-grade
rating is most apparent in the very wide
spreads for SNDs issued by firms with such ratings.
Alternatively,
a major BHC that is viewed as improving its
financial condition, Bank of America, successfully raised $225
million in Tier 2 capital with 10-year subordinated note
offerings in June and July 1990.
~bout

In addition,

Uncertainty

about the Market for

it is

SND

unclear whether

a broad market for bank SND
No broad market exists today foz' bank SND,
would develop.
few
a
large BHCs, markets are quite thin foz
outside of
subordinated debt. In addition, it is not obvious that, private
investors would be particularly willing to be an explicit cushion
for the FDIC, especially if bank and thrift regulators make the

Finally,

closure decision.

In other words, it is uncertain whether SND holders would
think that either they could bring sufficient pressure on
regulators to close an insured depository in time to minimize SNO
holders' losses, or that the regulators would give SND holders'
interests a high priority. While it is possible that risk
premiums

sufficiently compensate SND holders, and a
that such debt be issued would certainly
it seems quite reasonable to argue that the
here, especially during the implementation period, is

would

requirement
help create a market,
government

uncertainty

great.
4. Current
Some

SND

perspective

Usage

the current use of

Table 6, which shows the current

usage of

SND
SND by

provided in
independent

banks and multi-BHC parents. ~~ Where relevant, data for
institutions which do not issue SND are also provided. The data
for independent banks shows that less than 3 percent currently
issue subordinated debt. Such debt tends to be floated by
relatively large banks, as may be seen by comparing the numbers
outside and within the parentheses in column 2.

For those banks that do issue SND, it averages 1.8 percent
of their total assets, with a considerably larger percent being
issued by the largest banks. Finally, SND can be a fairly high
percent of equity capital at those banks which issue SND--the
average across all such banks is 32 percent.
Again, this
percentage is highest at the largest banks, averaging 79 percent
A considerably
higher percent of multi-BHC parents issue
subordinated debt--164 out of 852, or about 19 percent. 5~ Once
again, relatively large firms dominate the issuance of SND. At

SND, the mean ratio of SND to total assets ls
higher than at independent banks; and this, on
average, represents 14. 7 percent of equity, much less than that
at independent banks.

multi-BHCs

8. 7 percent,

issuing
much

Additional perspective is provided by evidence regarding who
currently owns the SND of banks and BHCs. This is difficult to
determine, since no such data are collected, and the evidence
used here comes primarily from discussions with bank supervisors

Table 6
Notes and Debentures (SND)

Use of Subordinated

(As of December

Asset size

Mean total

quartile (total
number of
institutions)

assets (in
millions of
dollars)

(1)

(3)

25
(904)
26
(904)
25
(904)
25
(905)
101
Total (3,617)

31, 1989)
Mean ratio of
SND to total

assets (percent)

Mean ratio of
SND to equity
capital (percent)

(3)

(4)

1.2

19.5
(10.8)

18.4
16.6

46.2
(22.8)

88.8
(41.5)
535.4
(130.4)
171.2
(51.4)

Multi-Bank Holding Company

1.0

15.7

4.2

79.3

1.8

32.4

Parents'

7.1

9.8

20.5

(172)
41
(172)
41
(172)

(4.6)
27.3
(10.5)

9.7

14.1

7.8

10.3

7.4

13.8

8.7

14.7

(172)
164
Total (688)

221.7
(24.2)

4, 130.7
(479.3)
1,096.7
(1 29.7)

'Values for institutions without SND given
Source: Federal Reserve Board.

parentheses.

issue is important, however, because these are the agents
that would be expected to exert market discipline on depository
risk taking if subordinated debt played a more important role in
bank and thrift capital structures.

The

In the case of independent banks, it appears that existing
Such insiders
SND is held primarily
by insiders of the bank.
consist of existing shareholders, directors, and perhaps
and others with confidential knowledge of the bank.
management
While such debt provides added protection for the FDIC, it is far
from obvious that such agents have risk preferences and
incentives either close to or always consistent with those of the
FDIC.

Subordinated debt that is issued by a bank that is part of a
appears, in the vast majority of cases, to be held or
guaranteed by the BHC itself. In such cases, while the SND again
provides added protection for the FDIC, it is not clear that the
owners have as strong an interest in the prompt resolution of
problems at the bank as would independent third parties.
BHC

course, third-party holders of the BHC's debt would have
an incentive to pressure the firm to resolve problems at its
bank(s), since such problems could easily affect the BHC.
However, the incentives here are clearly less direct than when
the SND is held by independent investors at the bank level.
Of

5. Feasibility of 8uhstantial

8ND

Issuances

final perspective is provided by recent conversations
with selected market participants regarding the feasibility of
banks issuing substantial amounts of subordinated debt over the
next several years. These participants suggested that, to
attract investors, such issues should be as simple as possible,
A

without

complex contingencies

and ambiguous

covenants.

also argued that this may be difficult to achieve, as
the market has the perception that the legal standing of banking
organization debt is subject to considerable regulatory
caprice.
The market participants
also claimed that, prior to
FIRREA, the advantage to debt issuance at the bank level seemed
to be greatest for high quality banks that were part of a holdin9
company.
In such cases, it was claimed that it was possible to
achieve considerable cost savings by issuing debt at the bank,
not the BHC, level. However, the bank cross-guarantee provisions
of FIRREA have apparently reduced this advantage since, in the
event of insolvency, the FDIC can now lay claim to the assets «
They

solvent banks in the holding company.

II-24

Comparison of Risk-Based Capital
and Risk-Based Deposit Insurance

Chapter VIII of this Study ("Risk-Related Premiums" ) briefly
discusses why both a risk-based capital and a risk-based deposit
It is pointed out that a
insurance system might be desirable.
risk-based
premiums:
system of
(1) might provide for easier
incorporation of adjustments for non-credit types of risk,
especially because the Basle Accord is an international
agreement; and (2) would allow a depository institution greater
flexibility in responding to a change in its risk position. This
section reviews the relative merits of the two risk-based systems
in more detail.

first an "ideal" world where the insurer has: (1)
same
the
information as the bank or thrift regarding
precisely
the riskiness of the depository's activities; and (2) complete
flexibility to react immediately to any change in depository
risk. Several authors have shown that, under these stringent
conditions, risk-based capital and risk-based deposit insurance
can be designed to provide the same level of failure risk.
However, this does not mean that policy makers should necessarily
be indifferent between the two.
For example, the two policies
they allocate riskmay differ with respect to how efficiently
taking across firms.
Consider

Under

a pure risk-based insurance scheme with no capital
a depository would be free to choose its level

of
portfolio risk and its capital ratio; the FDIC would then charge
the depository a premium based on the implied insolvency, or
failure, risk. Ideally, the premium would recover the full value
of deposit insurance to the depository, or the value of the
depository's option to put part of its portfolio to the insurer
in the event of failure, and have the insurer pay the
depository's insured depositors in full.
requirements,

In addition, other insurer costs, such as expected
administrative
costs and the social cost of expected systemic
In
risk, should be included in the deposit insurance premium.
the resulting equilibrium,
institutions with the best risky
portfolio investment opportunities (i. e. those with a comparative
risk portfolios),
advantage in holding high expected return/high
least
risk aversion
the highest cost of raising capital, and the
raise the least capital,
would specialize in risky portfolios,
and have the greatest probability
of failure. Such depositories
would pay explicitly for this high failure risk through high
deposit insurance premiums.

institutions with comparative disadvantages in
holding risky portfolios, the lowest cost of raising capital, and
the greatest risk aversion would have the lowest probability of
Conversely,

failure and thus pay the lowest insurance premiums. Most
institutions, of course, would be somewhere between these
extremes.
A

pure risk-based

insurance

would

also

capital

scheme with
allow a bank or thrift

flat-rate deposit
to choose the

riskiness of its portfolio, but not its capital position nor its
probability of failure. Instead of explicitly pricing insolvency
risk, risk-based capital implicitly prices portfolio risk by
setting a minimum capital requirement for each depository that
equalizes the value of deposit insurance per dollar of deposits
That is, for any level of risk, a certain
across institutions.
amount of capital must be raised to offset it.
When looked at in this way, it can be seen that under riskbased capital the correlation between which institutions have a
comparative advantage in taking risk and which choose the
riskiest portfolios is looser than under risk-based deposit
insurance, since depositories with relatively high costs of
raising capital that are not related to portfolio risk (as may be
the case for closely held firms, or firms with high transactions
costs of raising capital), will nevertheless face a relatively
high implicit price for risk taking.

the amount of capital held and
the price of capital faced by each depository is also loosened
relative to risk-based insurance, since the capital standards are
not based on this price, and the only way to change the total
The correspondence

between

cost of capital is indirectly through changing portfolio risk.
between risk aversion and failure risk is also
loosened relative to risk-based insurance, since all insured
institutions must have the same put option value. Depositories
can only change their risk levels by holding capital in excess of

The correspondence

the

minimum

standards.

Another important difference between the two policies is
that under risk-based capital, more, and perhaps substantially
This is because some institutions
more, capital will be raised.
than
required as part of their own
may hold more capital
optimizing strategy, but none will (without facing supervisory
action) hold less. Under risk-based insurance, each depository
has a choice regarding whether to hold higher capital or pay a

higher premium.

final potential difference of risk-based insurance and
risk-based capital is that risk-based insurance allows for more
of deposits into insured
value creation from the intermediation
depository assets. It is often maintained that the
intermediation of insured deposits into such assets has extra, or
social, value over and above the gains that accrue to private
individuals.
Indeed, the preservation of this value is one of
the major reasons for deposit insurance.
Risk-based capital may
A

zesult in a higher average capital-to-assets ratio than does
zisk-based insurance, and therefore forces a lower average ratio
of jnsured deposits to assets. Thus, to the extent that these
deposjts create social value, more such value may be created
under risk-based insurance.

of risk-based deposit insurance becomes less
the
conditions
of the ideal world are relaxed.
clear
Cpnsjder the more realistic situation where the insurer is at a
significant disadvantage relative to the depository regarding
true portfolio risk. In this case,
knowledge of the depository's
acts
as
a
form
co-insurance
of
and gives depository
capital
owners a strong incentive to respond to their confidential
jnformation about risk, and to act to control it.
In addition, capital now helps to control moral hazard.
Capital
requirements may have the additional benefit of providing the
insurer time to gain more information about portfolio risk, and
This is because, for any
the time to act on that information.
given portfolio risk, a depository will take longer to fail if
capital is higher.
The dominance
when

in capital value or the
During this time, fluctuations
results of supervisory examinations may reveal information that
allows the insurer to take timely action.
In contrast, under
risk-based
with
insurance,
a
depository
pure
very low capital may
fail well before such information can be obtained and action
taken.

it may be argued that capital standards can
Additionally,
improve the pricing of risk-based insurance.
Flannery (1989)
shows that when portfolio risk is imperfectly
observed, there is
error in estimating the put option value to use in pricing riskbased deposit insurance, and this error increases as a
depository s capital ratio falls. The intuition here is that
lower capital ratios act to magnify errors in forecasting the
rates of return on assets into larger errors in forecasting the
rates of return on equity, which help determine the value of the
put option.
Since capital standards tend to increase capital
ratios, they reduce insurance pricing errors and result in a
better distribution of insurance premiums and incentives.
the situation when the deposit insurer is not
completely flexible in its ability to respond to changes in
depository risk. Clearly, this is a more realistic environment.
In this scenario, either risk-based premiums or risk-based
capital requirements are at best set with a lag determined by
In addition, government
reporting or examination intervals.
bureaucratic,
legal, or other
authorities may have to follow
and
rules for changing either premiums or capital requirements,
&hese rules may not allow for the full use of all information.
Consider

now

In terms of explicit flexibility, risk-based insurance
appear to have two possible advantages over risk-based
capital. First, the implementation lag for premiums may be
shorter--depositories
can probably be made to pay a revised
premium very quickly, except in extreme circumstances.
By
contrast, the implementation lag to meet increases in required
capital may be considerable, owing in part to the sometimes long
and sometimes difficult process of raising new capital.
Second,
risk-based insurance is more flexible since the premiums can
reflect differences in failure risk resulting from a much wider
range of capital ratios, rather than treating all firms above a
minimum capital ratio equally.

premiums

However,

capital has

insurance.
bureaucratic

in terms of implicit

flexibility,

risk-based

over risk-based deposit
Private sector agents are not bound by any

an important

advantage

or other rules that may constrain the ability of
insurer to respond to changes in risk. An increase
failure risk that is publicly known will result in some market
discipline through higher costs for raising equity capital,
subordinated debt, and uninsured deposits.

government

capital standards (risk-based or not), by requiring
greater amounts of equity capital or subordinated debt, have
implicit flexibility in the sense that the cost to a depository
of increasing risk is higher, the higher are these standards.
Even for the supervisor capital standards may have greater
Some observers argue that de facto capital
implicit flexibility.
standards are more easily changed, say in the course of an
examination, than are highly visible insurance premiums.
In conclusion, in the "real" world there is likely a role
for both risk-based deposit insurance and risk-based capital.
Capital standards, whether they are risk-based or not, can make
risk-based deposit insurance work better by putting owners at
substantial risk, directly reducing moral hazard incentives,
allowing the insurer time to gain information and take action,
and improving the accuracy of risk-based insurance pricing.
Finally, while risk-based premiums have greater explicit
flexibility, capital standards are implicitly more flexible,
inducing private agents to discipline risk-taking when the
insurer cannot, and possibly providing the supervisor with
greater flexibility.
Thus,

II-28

Endnotes

deposit insurance may be viewed as a
As is well-known,
the
written
FDIC, with an exercise price equal to
option
by
put
s
insured
the
bank
liabilities. The value of this
the value of
pption increases directly with the bank's portfolio risk and
inversely with the bank's capital ratio. For more on these
ppints, see Chapter VIII of this Study, "Risk-Related Premiums, "
and Kuester and O' Brien (May 1990).
the problems in the thrift
industry developed is in White (1989). Both the Congressional
Budget Office (1990) and the United States General Accounting
0ffice (1990) have recently estimated the extent of problems in
the banking industry
An

excellent discussion of

how

recent statement of this view in contained in Kane
(1989), "Changing Incentives.
4
Some evidence that thrifts and banks that are located in
economically troubled regions pay higher rates on insured
deposits than do depositories in healthier areas is presented in
Golding, Hannan and Liang (1989). Also, extensive anecdotal
evidence suggests that at least some troubled institutions have
used higher deposit rates to attract funds.
A

It is

useful to note here a contrast between equity and
debt which is subordinated
to insured deposits. Su/ordinated
debt, which will be discussed in detail later provides a cushion
for the FDIC. However, its effect on the probability of failure
is considerably smaller, if failure is defined in terms of the
exhaustion of equity.
A

Minneapolis

similar chart is presented

(1988).

in Federal Reserve Bank of

In December 1981 federal bank regulators issued numerical
guidelines for bank and BHC capital ratios, in part to "address
&he long-term
decline in capital ratios, particularly those of
the multinational
group. . . " (FR Bulletin (1982), p. 33). Wall
~nd Peterson
(1987) present evidence that these guidelines were
somewhat effective in increasing equity capital ratios at the
largest BHCs in the years of their study, 1982-1984.
All BHC and nonbank
Poor's Compustat tapes.
An

example

why

data are computed

considerable

care

from Standard

and

must be taken when

interpreting these statistics is that capital ratios of the very
largest securities brokers and dealers tend to be closer to those
« the banks and BHCs. However, this is not particularly the

case for the

largest insurance companies.

Also, sample sizes can

for the nonbank firms, and many of the business
and personal credit finance companies are affiliated with larger
organizations (e. g. Sears, American Express, General Motors, and

be quite small
ITT)

include Belgium, Canada, France,
Sweden,
Germany, Italy, Japan, Luxembourg the Netherlands,
StrictlY
Switzerland, the United Kingdom, and the United States
to
internationally
applies
active
speaking, this agreement only
banks. However, U. S. banking authorities have applied the
guidelines to all U. S. banks and BHCs. Non G-10 members of the
European Community and several other nations' supervisors have
agreed to apply the Basle capital accord to their banks as well.
The G-10

countries

The final risk-based capital guidelines were issued in
1989
and published in the March 1989 Federal Reserve
January
Bulletin (12 CFR 208, Appendix A for banks; and 12 CFR 225,
Appendix A for bank holding companies), the FDIC's "Risk-Based
Capital Regulations" (12 CFR 325, Appendix A), and the OCC's
guidelines are in (12 CFR Part 3, Appendix A).

For more detail on the precise definitions see Federal
Reserve System, "Capital; Risk-Based Capital Guidelines" (1989),
and the March 1989 Federal Reserve Bulletin.
OTS

and

See 12 CFR 567. FIRREA mandated that the Director of
establish a leverage ratio, a tangible capital requirement,
a risk-based capital requirement.

According to the National Credit Union Administration,
unions used banks' risk-based guidelines, the average
credit union would, as of December 1989, have a capital ratio of
about 11 percent, all of which would be Tier 1. For more on
these points see Chapter XIII.

if credit

The OTS published

See Federal Re

its

ister, Vol. 55,

proposal
No.

on December

31, 1990.

251, 53529-53571.

uses a computer simulation model to
interest rate risk exposure. The simulation methodologY
used by the OTS evaluates the options embedded in the mortgage
assets held by thrifts and, therefore, provides a better estimate
of the change in the value of those assets due to changing

estimate

The proposal

interest rates.

See Avery and Berger, "Risk-Based Capital and OffBalance Sheet Activities, " (1988).

In a preliminary OTS working paper, Bradley, Wambeke, and
Whidbee (1990) report evidence that the risk-based capital system
for thrifts (1) helps to identify thrifts with higher
probabilities of failure, and (2) has risk categories such that

risk "baskets" generally lower the cost of
failure resolution while the higher risk baskets increase it.
However, these authors do not test explicitly for whether the
risk-based system performs better than the previous capital
guidelines for thrifts.
items in the lower

Depositor co-insurance

obviously another way to
increase market discipline on banks and thrifts.
Use of the
capital account to increase market discipline does not require
increased depositor discipline, but increased depositor
discipline clearly assumes that owners and nondeposit creditors

risk.

are at

of public commentators to this Study
the issue of capital adequacy in any detail. To the
extent that commentators mentioned capital adequacy, they were
generally supportive of the view that adequate capital reduces
moral hazard and is the first line of defense for the FDIC. Some
banks argued that minimum capital standards should be raised, but
others claimed that current bank capital ratios are adequate.
Only a minority

addressed

ratios.

Basle Accord only establishes minimum capital
Each signatory is free to set higher standards.

The

of increasing bank (or thrift) capital
be to raise the minimum total leverage ratio.
That is, the current minimum of Tier 1 capital to total assets of
no less than 3 percent for federally
regulated banks could be
increased.
The potential impact of such action could be
Another
requirements

way

would

substantial.

For example, Avery and Berger (1990) estimate that raising
the minimum ratio from 3 to 6 percent would, as of December 1989,
more than double the number of banks estimated to not meet the
new capital standards.
These banks held some 56 percent of total
bank

assets.

increasing the minimum leverage ratio would be
with the broader movement to make risk-based capital
the primary measure of capital adequacy.
Indeed, if raised too
high the minimum leverage ratio could supplant the risk-based
ratios as the binding minimums for the overwhelming majority of
banks.
For this reason the discussion in the text is solely in
However,

inconsistent

terms

of risk-based

capital.

(1990) report results which suggest
that a fairly large number of banks may be able to meet riskbased capital standards in whole or in part via on-balance sheet
Portfolio changes. However, they find that the potential for
is more
meeting the standards by off-balance sheet adjustments
limited, except for the largest banks.
Avery and Berger

Nonfinancial firms are studied in Asquith and Mullins
(1986), and BHCs in Wansley and Dhillon (1989), Wansley, Pettway,
and Dhillon (1989), and Wall and Peterson (1988).

(1989), p. 232.
See Modigliani and Miller (1958), and Stiglitz (1974).
See Ellis and Flannery (1990), Hannan and Hanweck
and
Baer and Brewer (1986).
(1988),
All such data for specific institutions are considered
extremely confidential for obvious competitive reasons.
See, for example, Kim and Santomero (1988), and Koehn
and Santomero (1980).
See Furlong and Keeley (1989 and 1990).
See, for example, Avery, Hanweck, and Kwast (1985).
This point is discussed in more detail in Avery and
Berger (1990).
Some care must be taken here since, as was discussed
earlier, the Basle system does not fully account for all risks
and its asset categories are quite broad.
Thus, it is quite
possible for depositories to take excessive risk and still be in
compliance with the Basle Accord. This reinforces the point,
also made earlier, that higher risk-based capital would not be
sufficient, by itself, to solve the problems in deposit
insurance.
Other reforms, such as prompt corrective action and
risk
timely
monitoring by the supervisors and private agents,
Wansley

would

and Dhillon

also be needed.

(1990).
(1990), pp. 741-742.

See Greenspan
Greenspan

Risk could be increased if there were no diversification
gains from the merger, and certain other technical conditions
were met. For more on these points see Kwast (1989).

factors, such as competitive and political
concerns, may also of course be relevant.
This discussion
abstracts from such issues.
This is the approach taken by Avery and Belton (1987).
They assume a probability of bank failure equal to . 7 percent
over the next year, and estimate the distribution of bank capital
At the
ratios that would be consistent with this probability.
time of their study, a probability of failure of . 7 percent
Other

about 95 expected bank failures

implied

per year.

Competitive private insurers' prices are set so they
losses and other marginal capital and operating
expected
recover
e. the interval
costs over the life of the insurance contract,
The above assumption says that
between premium collections.
federal deposit insurance premiums are set the same way, at least
"cost" to account for
pn average, with perhaps an additional
systemic risk. Of course, in light of events over the past
decade this seems like an unusually heroic assumption.

This
(1989)

is the

approach

taken recently by Ronn and Verma

Kuester and O' Brien (May 1990), in their recent study of
the practicality of using the option model approach to compute
risk-based deposit insurance premiums, conclude, however, that
this model is not suitable, by itself, for implementing riskThe same conclusions would no doubt apply to
based premiums.
the
model
option
to compute risk-based capital. Another
using
possibility is to use the option methodology to establish a riskbased examination schedule whereby riskier institutions
would be
examined on a more frequent basis.
Such an examination schedule
would be consistent with prompt corrective action strategies
since it would relate the frequency of examination and closeness
of supervision to depositories' riskiness.
Kuester and O' Brien
(September 1990) demonstrate how a risk-adjusted examination
schedule could be derived.
As

noted already,

a crucial assumption

of the options

is that the chosen level of the deposit insurance premium
is the "correct" one. Obviously, this is a strong assumption,
and the risks in its use may be great.
For example, if the
existing premium is in fact too low, then capital ratios may be
implied that are so high as to drive banks out of business.
Conversely, if the existing premium is too high, the implied
capital ratios may be so low as to be irrelevant.
This does not imply that if all banks were at the riskmodel

the aggregate failure rate would have been 1.1
Percent. This is because forcing banks that failed the standards
to the capital minimum would not necessarily imply they would be
otherwise identical to banks that pass the standards.
Nevertheless, these data provide a rough upper bound on the
Potential extent to which the fully phased-in risk-based capital
standards could lower bank failure rates.
4ased minimums

Bank

See Wall (July/August
of Chicago)

1989),

and Keehn

(Federal Reserve

See Chapter XI "Market Value Accounting

and

Disclosure. "

This includes the potentially depressing effect of SND
issuance on bank share prices. Researchers have generally found
that new issues of SND either have no effect on or may actually
increase shareholder wealth, in contrast to the generally
See Wansley, pettway,
depressing effect of new stock issuance.
and Dhillon (1989), and Wall and Peterson (1988).
In a recent working paper, Schellhorn and Spellman
(1990) suggest that data on the risk-return characteristics of
an options pricing approach to
SND might help in implementing

risk-based
deposit insurance.

If this result

proves robust to further
testing, it would provide another rationale for increasing the
use of SND in bank and thrift capital accounts.
Since Tier 2 cannot exceed Tier 1 capital at banks, and
because SND eligible to be counted as Tier 2 capital cannot be
more than 50 percent of Tier 1 capital, SND that is counted as
risk-based capital cannot exceed 25 percent of total capital.
Amounts of SND in excess of these limits may be issued and, while
such amounts will not be included in the calculation of the riskbased ratio, they will be taken into account in the overall
assessment of a bank s funding and financial condition.
Thrift
institutions, however, can count SND without limit in Tier 2
capital--effectively 50 percent of their total capital
requirement.

See Wall (July/August

1989).

This possibility becomes more likely if subordinated
debt were required to be converted into equity prior to the
depository becoming equity insolvent.
This does not imply, of course, that less regulatory
discretion than has been allowed over the last several years is

undesirable.

fact that interest on SND is a contractual
obligation has led some observers to argue that if SND is to be
counted as capital, then supervisors should have the right to
suspend interest payments as part of a policy of prompt
corrective action. For more on this point see Chapter XI.
The

See, for example,

Hannan

and Hanweck

(1988)-

Data on the 4, 899 one-bank holding companies are
extremely unreliable for the purposes used here, and therefore
are not provided.
53

available

Data on 90 multi-bank holding
for the purposes used here.

companies

are not

issues of subordinated

debt must be approved by
regulators, and cannot be paid off before scheduled maturity
There are no such constraints on
without regulatory approval.
bank holding company issuance of SND.
Bank

liability for loss incurred by the FDIC
institution is
in connection with a commonly-controlled
subordinate in right and payment to: (1) deposit liabilities
other than those to affiliates of the depository institution;
(2)
secured obligations other than those to affiliates of the
depository institution which were secured after May 1, 1989; (3)
other general or senior liabilities unless they are expressly
described as subordinate to the cross guarantee liability; and
An

institution's

(4) obligations subordinated to deposits or general creditors,
except to the extent that they are subordinate to cross guarantee
liability. See 12 USCA 1815(e)(2)(C)(ii).
The
on Avery and
(1990). The

(1978) .

discussion in this portion of the text draws heavily
Berger, "An Analysis of Risk-Based Capital.
topic is also addressed in Avery and Belton (1987).

See Flannery

(1989),

Ronn and Verma

(1988),

and Sharpe

that the discussion in this
entire section abstracts from the issue of whether book (GAAP)
measures of capital provide the clearest picture of the true
financial condition of the bank. Whether market value accounting
would provide a better snapshot is discussed in Chapter XI,
"Market Value Accounting. " Another option is to use information
gained in bank and thrift examinations to adjust book equity.
Examination procedures are discussed in Chapter IX, "RiskManagement Techniques, " and Chapter XII "Role of Auditors. "
should

be emphasized

II-35

References
Acharya,

"Optimal Bank
Jean-Francois Dreyfus.
Reorganization Policies and the pricing of Federal Deposit
Insurance " Journal of Finance, December 1989, pp. 1313-1333.
Asquith, Paul, and David W. Mullins, Jr. »Equity Issues and
Offering Dilution, " Journal of Financial Economics, 1986,
pp. 61-89
Avery,

Sankarshan,

and

Robert B. , and Allen N. Berger. "An Analysis of RiskBased Capital and Its Relation to Deposit Insurance Reform,
Monetary and Financial Studies Section, Federal Reserve
Board, Working Paper, September 1990.

"Risk-Based Capital and Off-Balance Sheet
Activities, " Proceedin s of a Conference on Bank Structure
and Com etition, Federal Reserve Bank of Chicago, 1988,
pp. 261-87.
"Loan Commitments

and Bank Risk Exposure,

Monetary
and

Financial Studies Section, Federal Reserve Board,
Journal of Bankin and Finance, forthcoming.
and

Avery,

Robert B. , and Terrence M. Belton. "A Comparison of RiskBased Capital and Risk-Based Deposit Insurance, " Economic
Review, Federal Reserve Bank of Cleveland, Fourth Quarter
1987, pp. 20-30.
"Market Discipline
Robert B. ; T. Belton; and M. Goldberg.
in Regulating Bank Risk: New Evidence from the Capital
Credit and Bankin , November
Markets, " Journal of Mone
1988, pp. 597-610.

Avery,

"An Analysis
Robert B. ; M. L. Kwast; and G. A. Hanweck.
of Risk-Based Deposit Insurance for Commercial Banks, "
Proceedin s of a Conference on Bank Structure and
Com etition,
Federal Reserve Bank of Chicago, May 1985,
217-50.
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Benveniste, Lawrence M. , and Allen N. Berger. "Securitization
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k 1 h'
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th''1':'1t'

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d
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y

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Wall, Larry D.

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James

Valuation

, and Upinder

"Determinants

Chapter

III

SCOPE OP DEPOSIT INSURANCE

Introduction

The scope of deposit insurance coverage has greatly expanded
since the 1930s. The dollar amount covered has increased from
$2, 500 per insured account to $100, 000 per insured account (a
four-fold increase after accounting for inflation).
Regulatory
interpretations have expanded the number of insured "capacities"
Sothat each depositor may have in an insured institution.
"pass-through"
insurance
deposit
has
increased
coverage
called
investors.
Brokered deposits have increased
for institutional
the ability of individuals to take advantage of insurance
In addition, even uninsured depositors and creditors
coverage.
have often been fully protected by insurance coverage in failed
bank

resolutions.

This gradual and broad expansion of the scope of insurance
Proponents of increased
coverage raises competing concerns.
coverage argue that system stability is increased and more bank
loans are made.
Opponents contend that taxpayer exposure is
increased; that important market discipline is removed; and that
resulting bank failures over time decrease stability in the
system.
This chapter analyzes these concerns as well as specific
Section B
proposals to reduce the scope of insurance coverage.
discusses the trade-off between stability and depositor
discipline; Section C analyzes various proposals to reform the
current scope of federal deposit insurance coverage; Section D
explores the policy objectives of resolving bank failures;
Section E discusses the ability of depositors to discipline
depository institutions; Section F briefly presents the issues
involved in choosing between regulatory rules and regulatory
discretion; Section G notes the major public comments received on
the issues of concern to this chapter; and Section H contains an
of the various legal
appendix describing the legal underpinnings
a
method
rights and capacities and explains
by which they could

eliminated.

The Trade-Off

Between

Stability

and

Depositor Discipline

the scope of coverage necessarily involves
depositor discipline, which raises two significant and
interrelated issues: first, the extent to which an increase in
depositor discipline will increase bank runs; and, second, the
practical ability of reforms to reduce coverage effectively if
the "too big to fail" problem remains unresolved.
In general terms, the "ideal" amount of deposit insurance
coverage for maintaining financial stability in any economy is
that amount of coverage sufficient to prevent bank runs without
sacrificing any other type of market discipline. Stated
differently, an ideal amount of coverage would relieve market
participants of any need to price (or otherwise cope with) the
threat of bank runs. At the same time, however, it would not
interfere with the market's pricing of any other banking risks
(or any ' non-price market mechanisms for controlling these
Reducing

increasing

risks)

Despite its heuristic value, this abstract description
ignores the real world trade-off involved in attempting to reduce
the incidence of bank runs without reducing the vitality of
depositor discipline.
As noted in other chapters,
it is
reasonable to believe that reducing the threat of bank runs by
raising the level of deposit insurance coverage will cause a
simultaneous weakening of incentives for depositors to evaluate
banking risk. Risk becomes increasingly underpriced for
bankers--and thus risk-taking tends to become increasingly
excessive--as the scope of deposit insurance coverage increases,
unless effective controls are substituted for the discipline that
would have been exerted by depositors in the absence of coverage

increases.

potential trade-off of depositor discipline for a
of bank runs complicates the task of determining
the "optimal" amount of deposit insurance coverage for any realworld economy.
of choosing a point along the
Many implications
"trade-off curve" must be addressed, including: the likelihood
of bank runs under different levels and forms of coverage; the
magnitude of the threat posed by bank runs (the potential costs
associated with a real threat of runs, relative to the costs that
would be incurred under the alternative
(higher-coverage
arrangement)); and the comparative effectiveness of depositor
discipline vs. its substitutes (supervision and regulation) under
The

reduced threat

higher-coverage

regimes.

There are two broad types of competing perspectives on these
elements, and they produce different conclusions regarding the
favors lower insurance
One perspective
terms of the trade-off.
than
is now available; the
depositor
discipline)
coverage (more
other suggests that, as a rule, more coverage (for depositors) is

preferred to less. This section examines the competing
perspectives and their broad areas of disagreement.
The next
the
different
reviews
section
types of reforms suggested by them.
(Reform proposals involving brokered deposits and pass-through
deposit insurance are discussed in Chapters IV and V,

respectively.

)

Competing

Perspectives

on the

Trade-off

Given broad agreement that the present amount of coverage is
adequate to provide a safe haven for small savers' funds, and
given the likely prospect that the level of deposit insurance
coverage is likely to remain adequate for this purpose regardless

of the reforms selected, the issue of proper ~coverage turns
In determining
largely on the matter of financial stability.
amount
of
coverage,
makers
face
a possible
the proper
policy

trade-off between two potential sources of financial instability:
(1) the increased threat of bank runs (perhaps leading to
contagion) that accompanies lower levels of coverage, and (2) the
increased incentive for excessive risk-taking (by bankers) that
These potential sources
accompanies higher levels of coverage.
of instability underlie much of this section s discussion.
Background

It is clear

that runs by uninsured depositors remain a real
possibility under the present level of coverage, whenever a bank
Runs have occurred at
is widely perceived to be imperilled.
large banks despite an apparently broad perception of 3 a de facto
one-hundred percent guarantee of deposit liabilities.
This may
potential costs in the event of a
suggest that large-depositors'
bank failure remain sufficiently
high under perceived complete
insurance to cause withdrawals;
or it may indicate that, at the
time a big bank develops problems, the market perceives the
FDIC's guarantee of large deposits as "conjectural" (Flannery
(1986)), rather than de facto one-hundred percent. (This concept
is otherwise known as "constructive ambiguity. ") Some have
interpreted the finding of differential risk premiums for large
CDs as supportive
of the latter explanation (Macey and Garrett
(1988)), though the evidence is mixed (James (1988); Hannan and
Hanweck (1988)). Regardless,
it is apparent that currently a
real threat of runs remains.
It is also important to note that today's bank runs are
generally confined to institutions that are insolvent, or
virtually so. So-called "pure panic" runs by depositors, which
are not based on any determination of the bank's longer-run
viability, are not observed in the current setting. Recent
Nine of the ten largest
events in Texas provide a case in point.
banks in Texas were recapitalized during the 1980s, accompanied
failures. Despite these events and the
by hundreds of small-bank

otherwise

dismal

1980s, there were

economic circumstances in Texas during the
no deposit runs on healthy Texas banks.

impose deadweight economic losses on society,
or not the affected institutions are insolvent.
Nevertheless, some significant losses are avoided by sparing
healthy institutions the threat of contagion.
Present
arrangements clearly do not foreclose the possibility of bank
runs based on false information or occurrences unrelated to a
bank's true condition, but, the empirical evidence suggests little
to fear for institutions that avoid real financial difficulty

Bank runs

whether

(Kaufman

(1988)).

evidence on the effectiveness of depositor
discipline, as well as its consequent costs, is mixed. Studies
focusing on the extent to which uninsured deposits pay interest
The empirical

that reflect known risk characteristics of banks produce
varied results. Baer and Brewer (1988) find that average CD
rates are positively related to bank risk measures derived from
stock price data. In surveying previous research of this type,
however, Field {1985) finds little to suggest that depositors
should be relied upon to price bank risk. James (1988) reports a
positive relationship between the rates paid on large CDs and the
leverage ratio, and between CD rates and two measures of banking
risk. Other measures of banking risk show no significant
relationship to CD rates. Hannan and Hanweck (1988) report
similarly mixed results. Cook and Spellman (1989) look at CD
rates for FSLIC-insured institutions and find that rates are
higher at institutions with lower capital;4 but there are only
between CD rates and other financial variables
weak relationships
premiums

reflecting risk.

Hirschhorn (1990) improves upon earlier methodology by using
a measure of expected loss on CDs rather than measures that are
only indirectly related to depositor losses. He finds evidence
of depositor discipline: CD rates reflect differences in expected
return and risk. Ellis and Flannery (1989) use time-series
evidence to conclude that risk is priced in CD rates for the
largest banks. Randall (1989) does not look at CD rates directlY
but, examines various ways in which the market prices large bank
risks. Using a case-study approach for each of the forty large
bank holding companies that became "problems" (as defined in the
study) between 1980 and mid-1987, Randall finds that market
discipline was invariably too little and too late. He notes
that, in every case, the market did not reflect the problem until
the bank itself revealed its difficulty through an announcement
of higher loan loss provisions or nonperforming assets.
The weight of the evidence suggests that uninsured
depositors probably do provide some discipline through risk
premiums on CDs. But the evidence is not unequivocal
even
if this were the case, the issue of enhancing depositorand,

discipline would remain open to dispute

(1988)).
In fact, the different

Kaufman

(see Goodhart

(1988) vs.

views of these matters do not
over
the
disputes
factual consequences of bank runs and
reflect
depositor discipline so much as differing views about whether the
trade-off represented by the present level of coverage, which has
since the 1930s, is optimal.
expanded significantly
arise
in weighing the costs and benefits associated
Difficulties
In the direction of lower
with changes in either direction.
for
example,
perceptions
of
coverage,
the costs associated with
nonsystemic bank runs differ:
the costs associated with
isolated runs, as well as the probability of contagion, are hard
to measure objectively, despite rich historical experience.
The different perspectives
through which history is filtered lead
to the gleaning of different policymaking lessons from the same
Some view the pre-insurance
set of historical facts.
era as a
one
for
on
banking,
healthy
balance, and advocate more reliance
on the market, that is, on the threat of runs and depositor
discipline (Kaufman (1988); Schwartz (1988)). Others see the
period as excessively unstable due to the frequency and high
economic cost of bank runs (based on evidence such as Bernanke
(1983) or Tallman
(1988)). Neither ordinary historical facts,
nor empirical evidence can fully resolve the crucial issues.
Ultimately, the decision regarding coverage includes some
judgment about the merits of exposing depositors to greater risk.
issue is how this judgment should be made.
Thus, a fundamental
Two perspectives
merit consideration.
The

8pecial Nature of Banks

recognition of banks as "special" intermediaries creates
a predisposition
to avoiding any significant threat of bank runs
(Diamond and Dybvig (1983)). To oversimplify,
bank
intermediation
it
is viewed as special because
provides a vehicle
to transform short-term funds into longer-term illiquid
investments.
In this way, funding is provided for many viable,
productive investment projects that otherwise could not be
The

Information costs and monitoring problems for
lenders (savers) often preclude the direct funding of
innovative types of long-term investment projects via money and
capital markets (see Diamond (1984)). In other words, such
difficulties (distortions) make savers unwilling to commit
sufficient long-term funds to support such projects directly.
This is true even if the projects are financially viable and
Pro ductive for the economy.
Such a market failure arises most
noticeably when the prospective borrowers are small firms,
entrepreneurs,
or firms with no established reputation in the
Proposed line of business.
By issuing liquid liabilities to be
«ed for funding the illiquid projects, banks help to correct the
undertaken.

Potential

market

failure.

According to the "bank specialness~ view, any threat of bank
runs causes banks to forego the funding of some illiquid
investment projects that are economical]y viable. Where the
threat of runs exists, banks tend to hold more liquidity (and
make fewer funds available for illiquid projects) than would
otherwise be necessary.
Thus, productive investment and the
economy's output would be lower than they could be in the
presence of deposit insurance coverage that effectively removes
the threat of runs.
Note, however, that too much stability
will effectively subsidize bank intermediation and may lead to a
misallocation of resources, as more banks extend more credit than
they otherwise would under an optimal system. Riskier and
perhaps socially undesirable,
investments may result.

effect, if costly

bank runs are a real possibility,
irrespective of a depository's health, then banking's
contribution to economic activity will be nullified through the
defensive reactions of depositors (such as requiring bank-run
risk premiums in deposit yields). It follows that any form of
depositor discipline creating a susceptibility to bank runs is to
be avoided, absent convincing evidence that reliance on
alternative (nondeposit) risk controls is potentially more costly
than bank runs. Advocates of this view contend that there is "a
percent coverage than for
any
much stronger case" for one-hundred
'
rollback of deposit guarantees (Diamond and Dybvig (1986)).

Deposit Insurance

Distortions

perspective on banking views the cost of bank
runs as the short-run price that necessarily must be paid for
long-run stability. '" The crucial judgment here generally takes
is
one of' two forms.
First, the containment l'of bank risk-taking
'
't
'bl
'th
t
t
db
ll
y
~th
g
discipline, due to inadequacies in available analytical or
Second, without
supervisory tools or logistical impossibilities.
necessitates
insurance
substantial depositor discipline, deposit
reliance on forms ' of risk control that are self-defeating in the
t' g bl
tdbthby
l
d
t
coverage and institutional arrangements in public bureaucracies.
The issue of supervision is addressed in Chapter IX; the
incentive distortions of deposit insurance are examined below.
An

alternative

Incentives are distorted by insurance coverage such that
deposits tend to flow away from the most conservatively manag«
institutions toward the most risky. This occurs because insured
depositors can usually obtain higher returns from the latter with
little or no added risk. When coverage is extensive, the
insurer's supervision becomes essential to preventing (an
increasing) overexposure to risk in the industry.
According to
the "depositor discipline" perspective, such supervision is
unlikely to be successful without the aid of depositor discipline
(if not as a preventative, at least as an early-warning device).

it is

Thus,

supervisory

argued, the economic incentives inherent, in this
arrangement work against the effective containment

risk.

banking

Bankers have stronger economic incentives to take risks in
order to avoid regulatory constraints or guidelines than the
Such a conclusion
insurer has to prevent such risk-taking.
the
fact
that
the reward for bankers is more
follows from
directly at stake in the outcome than is the reward for
For example, the examiner's
government employees and management.
success, etc. ) do not depend nearly so much
rewards (promotion,
is, upon the actual frequency with which the
upon "results"--that

detects excessive risk-taking in time to avoid losses to
fund--as it does upon following prescribed
insurance
the
Bankers, or the stockholders for whom the bank is
procedures.
and directly by actually
managed, stand to gain personally
hide-and-seek
the
In
game
played with examiners.
winning
addition to avoiding constraints, bankers often seek out new,
examiner

tdf
yet been

'k-tk'd

f',

ttttt

expected to identify (Kane (1981))). The banker
has not
can try to remain one step ahead of the supervisor in this
manner. '~ Combined with the fact that incentives favor the
placement of insured deposits with the most daring bankers, this
suggests that excessive reliance on insurance coverage poses a
long-run

industry.

threat
to the stability
"3

(and

efficiency) of the banking

of this view would suggest that the costly
debacle in the S&L industry was the inevitable result of a
deposit insurance structure that shows little regard for the
importance of depositor incentives to control risk. Given the
unavoidably perverse incentives created by a deposit-insurance
structure, these proponents conclude that strong depositor
Some

discipline
industry

proponents

is necessary if

is to

be avoided.

an S&L-type

catastrophe

in the banking

Finally, critics of the "bank specialness" argument also
content that banks are far less "special" than they once were.
Financial institutions not covered by deposit insurance provide

increasingly large amount of intermediated credit--more now
This decline in "specialness, " they argue, severely
undercuts the need for expansive insurance coverage, given its
an

than banks.

attendant

risks.

Stability with Depositor Discipline
The two paradigms discussed above are logically complete and
internally consistent (see endnote 8). Consequently, the
depositor discipline issue is posed as a clash between these
particular views. While there are many views on both sides of
the question, each appears lacking in some way. The
insufficiencies of these views are discussed below.
Reconciling

for Deposit Insurance
Many who oppose greater reliance on depositor discipline
base their opposition on the possibility of system-wide runs to
currency or other money-supply consequences of bank runs. Such
views are deficient because deposit insurance is not at all
necessary for preventing problems like money supply contractions
A central bank with the powers of a last-resort
lender is
sufficient to counter most, if not all, significant money-supply
effects associated with bank runs. Thus, the stated view lacks
any economic justification for deposit insurance in the first
place. How can such a view then be used to justify some
particular amount of deposit-insurance coverage? It could never
be clear from this type of argument that any conclusions
'~
The Need

regarding

coverage are well grounded.

The special intermediation
view makes it clear why deposit
insurance (or its equivalent) might be necessary:
the unique
of
intermediation
type
conducted by banks is potentially
susceptible to information-based market failures that stem from
the threat of runs and sometimes take the form of actual runs.
: Deadweight losses associated with the threat of runs and with
actual, fire-sale liquidations of information-intensive
assets
"good"
cannot be avoided through last-resort lending based on
collateral. A last-resort lender cannot correct the market
failure unless it offers a credible, noncontingent guarantee to
depositors (i. e. , unless it effectively acts as a deposit
insurer). Because of the special nature of bank intermediation,
runs on insolvent as well as solvent banks may entail deadweight
(social) losses, as may the mere threat of runs itself. The
special intermediation paradigm clarifies this, thus supplying a
plausible economic basis for a deposit insurance system (or its

equivalent).

The Need

for Market Discipline

from Depositors

Similarly, there are many views favoring increased reliance
on market discipline from depositors; but most fail to explain
why depositor discipline
should necessarily be preferred to
increased supervision, namely, that depositors, and not
It is
supervisors, would be at risk and, therefore, vigilant.
necessary to demonstrate the essentiality of more depositor
discipline if the "special intermediation" argument is valid,
because the latter shows that depositor discipline can be
socially costly, that is, "special intermediation" gives ample
reason to choose supervisory forms of risk control over deposi&o&
discipline unless it can be shown that depositor discipline is
essential. Most arguments favoring enhanced depositor discipli~~
ignore this requirement imposed by the special nature of bank
intermediation and, to this extent, they fail to make their case

particular argument referred to here as ~he "depositor
discipline" approach is the argument that most directly meets the
requirement.
above-mentioned
It suggests that depositor
be
essential
because incentives are such that
discipline may
supervision is most unlikely to succeed in preventing the
excessive risk-taking that is engendered by deposit insurance.
which are described in the "public
The adverse incentives,
choice" literature and the economics of public bureaucracy (see
endnote 12), rig the regulatory game hopelessly in favor of risky
Because bankers have stronger incentives to innovate
bankers.
around regulatory constraints than regulators have to prevent
this, there may be no way to prevent excessive risk-taking (under
current structural arrangements)
except by exposing depositors to
greater risk. At a minimum, this approach suggests that
supervision alone will not be sufficient.
(Indeed, the inability
of extensive financial regulation and supervision to prevent huge
losses in the banking and thrift industries suggests that
enhanced depositors discipline may be not only desirable, but
necessary. ) However, this argument does not simply ignore the
possibility that bank intermediation is special; rather, unlike
other approaches, it shows why it may be necessary to expose
depositors to greater risk even if this entails the social costs
suggested by the special intermediation
argument.
It also
questions the very premise that bank intermediation
is as
"special" as some contend, given marketplace developments.
Thus,
this particular version of the depositor discipline argument
appears the most defensible.
Problems vith Both Theories
In any case, while the particular paradigms presented here
neither is completely convincing,
may be the best of their kind,
for each considers only one side of the trade-off between bank
runs and bank risk-taking.
The "special intermediation"
argument
presents a strong theoretical case against bank runs as a form of
discipline, but fails to establish convincingly that there are
any feasible alternatives
to bank runs that are better (less
costly, on net). The "depositor discipline" argument makes a
plausible case that some threat of bank runs may be a necessary
evil, but it fails to establish convincingly that the absence of
depositor discipline necessarily poses greater economic risks
than does the threat of runs; that is, it fails to prove that
other (honda&ositor) forms of discipline will necessarily be
inadequate. ' Neither approach can "prove" its case, because
the relative magnitudes of the potential costs are unknown, and
the probabilities of incurring such costs are not objectively
The

measurable.

Both approaches also ignore empirical realities that weaken
the support for their implications.
Most notably, the "special
intermediary" argument fails to consider that present coverage
has proved sufficient to eliminate runs on healthy institutions

or that the mar
marketplace
banks for intermediated

xs rapidly

credit.

developing

alternat»e

this reality~
difficult to argue that, the threat of runs
currently in««
with bank intermediation
to
any significant degree.
is little to be gained by increasing
coverage, or even y
maintaining the current level if a decrease
would no«esult
significant increase in bank runs.
Given

i»

Similarly, for the depositor discipline argument, exposing
the system to an increased threat of depositor runs may not be
required to achieve adequate control of bank risk-taking (except
again for the circumstantial evidence of huge depository
institution losses under the currently extensive safety net). '
Foreign countries apparently have not yet suffered serious
breakdowns in the control of banking risk; yet their bank safety
nets do not appear less wide than that in the U. S. (The
perception is that, in some foreign countries, there is a close
give-and-take relationship between the government and major
banking institutions. ) Regardless, the foreign-country evidence
to date does not support the popular notion that depositor
discipline is a sine gua non for deposit-insurance reform.
Recent Experience Suggests an Answer

Despite the theoretical arguments, recent experience
suggests the need for greater market discipline from depositors.
Since the 1930s, the scope of coverage has vastly increased,
directly enhancing systemic stability and decreasing depositor
discipline. Yet, at the same time, depository institutions
failures have risen dramatically, particularly in the last ten
years. This suggests that our current trade-off errs in the
direction of stability, at the expense of the health of the
system itself. '7 The breadth of the current safety net has
permitted depository institution owners and managers to engage in
risky activities, unchecked by depositors, who are almost
completely protected.
Common sense suggests that more market
discipline from depositors will curb risky institution behavior
and thereby reduce the rate of failure.
Common sense also provides an answer to those who contend
that the "too big to fail" problem must be solved before anY
"tinkering" with the scope of coverage can have an effect.
Uninsured depositors who have no pass-through coverage or have &
limited number of protected accounts will naturally choose their
institutions more carefully (especially in making time depo»ts)
and demand higher "risk premiums. " With constructive ambiguityi
many, although not all, uninsured
depositors will exercise this
discipline. Thus, at the margin, depository institution owners
and managers will operate safer and sounder institutions
to
maintain such accounts, even under a regime in which uninsured
deposits are sometimes protected.

Proposals

for

Reform

Various proposals for altering the current scope of federal
deposit insurance are considered below. These proposals have
been grouped into the following categories:
(1) increasing

discipline, (2) increasing stability, and (3) increasing
To appreciate and evaluate these proposals
depositor discipline.
critically, the existence of legal ownership rights and
Through such rights and
capacities must be understood.
capacities, depositors may expand their coverage and the
Therefore, reforms must control these
taxpayers' exposure.
of rights
A brief discussion
avenues of safety net expansion.
is
presented immediately below; an analysis of
and capacities

market

various

follows.

reform proposals

Legal Rights and Capacities

The explicit deposit insurance coverage provided to
depositors depends on the ownership of and beneficial interests
There are several broad categories of
in deposited funds.
ownership for which funds are separately insured:

individual
account;

joint

ownership,

0
0

wife;

and

husband

ownership,

revocable trusts,

such as a simple checking

such as the savings

account of a

in which the beneficiary

qualified relative of the settlor, and the settlor has
the ability to alter or eliminate the trust;
irrevocable trusts, where the beneficial interest is
not subject to being altered or eliminated;
interests in employee benefit plans where the interests
are vested and thus not subject to being altered or
eliminated;

public units,

municipal

governments;

corporations

unincorporated

individual
Keogh

that is, accounts of federal, state,

and

partnerships;

businesses

retirement

and

accounts

associations;
(IRAs);

accounts;

executor or administrator

accounts; and

and

accounts held by banks in an agency or fiduciary

capacity.

(A discussion of the legal underpinnings
of these capacities and
legislative changes that would be required to remove them are
provided at the end of the chapter. )

Generally, an individual will receive only $100, 000 of
deposit insurance for insured deposits under one name in a
particular capacity regardless of the number of accounts held
That is, the individual is insureg
within a single institution.
within a single institution for each account held in a different
Using the individual,
joint, IRA, Keogh,
ownership arrangement.
and revocable trust capacities, a family of three could place
more than $1 million under the safety net in a single
institution.
If the family owns a business, the coverage could

further.

be expanded

of deposit insurance protection may be increased
the use of multiple insured accounts in
different institutions and/or held in different capacities. The
above-mentioned
family of three could replicate their protection
at separate institutions, thereby rendering virtually limitless
the amount of protection they could derive from the safety net.
The ability of depositors to expand coverage in these ways
must be kept in mind when considering various deposit insurance
reform proposals, for the intent of many reforms may not be fully
achieved if capacities and multiple insured accounts are not
restricted. For example, reducing the $100, 000 ceiling would not
be a sufficient solution without restricting multiple insured
accounts. Similarly, restricting multiple insured accounts in
different instittuions may be only partially successful if
depositors remain free to maintain insured accounts in different
capacities. (A discussion of these issues within the context of
pass-through deposit insurance is provided in Chapter V. )
The amount

dramatically

through

capacities and multiple insured accounts do serve
goals. Retaining a separate business and association
capacity may further important social activities.
In addition,
irrevocable trusts permit landlords, lawyers, mortgage service
providers, and others to hold funds in escrow accounts where t~e
deposit insurance passes through the nominal depositor to the
beneficial owners of the funds (e. cC, , tenants with regard to
their security deposits). Presumably, such funds could be pla«d
in government securities money market accounts instead of
depository institutions.
The implications
of forcing such a
However,

important

behavioral

change,

however,

must be

considered.

Market Discipline

Increasing

Deposit Maturity

Approach

of the trade-off between bank runs and bank riskaltered favorably by insuring deposits on the
basis of maturity, rather than size (dollar amount).
deposit insurance has distinct
conceptually, maturity-based
Short-term deposits,
advantages over the present system.
transaction
in
accounts that are made available on
"particularly
"gemand, are the primary sources of bank runs. '
Restricting
"insurance coverage to short-term ("runnable") deposits,
"regardless of size, is clearly consistent with the primary
'subject of deposit insurance--to avoid the costs of bank runs
without inducing excess risk-taking--and
appears to have a
~clearer rationale on this basis than does coverage based on
deposit size. That is, while the threat posed by instantly
callable deposits is well established, there appears to be no
'such connection between the size of deposit accounts and the
probability (or social cost) of bank runs (Furlong (1984)).
The terms

taking might be

Moreover, coverage based on maturity could, in principle,
eliminate bank runs without the complete sacrifice of depositor
indiscipline entailed by one-hundred percent coverage, the latter
runs (with
being the only available option for eliminating
:certainty) when coverage is based on deposit size. Longer-term
deposits would be at risk under a maturity-based
system, thus
preserving some incentive for monitoring by depositors.

Despite

its

conceptual

appeal,

maturity-based

insurance

coverage would undoubtedly
entail transition costs and
implementation
The initial problem arises in selecting
problems.
the appropriate definition of a "short"-maturity
is
deposit.

deemed eligible for coverage
maximum maturity
allow sufficient time for determining the financial
condition of the bank, and thus the definition might reflect the
frequency of bank examinations
(Furlong (1984)). Beyond this
minimal constraint,
there is little to guide the decision, since
the degree of "runnability" of different maturities is not
obvious and probably would not be uniform across deposits of the
same maturity,
given the different conceivable terms for
withdrawal.
The final selection of a maturity limit may not be
significantly less arbitrary than the current dollar limit based

clear that the
should

size.
Switching to

deposit

system would also
of bank deposits, as more funds

a maturity-based

insurance

affect the maturity structure
«uld be expected to flow to short-term accounts. This could
encourage maturity mismatching to excessive degrees, thus
increasing bank risk and making bank supervision more difficult.
task would be
Although it is not clear that the supervisory
impossible under such a system, it is probable that a greater

of supervisory resources would be necessary- Of
perhaps greater concern are the uncertain macroeconomic
consequences of providing an effective government subsidy to
commitment

short-term

accounts.

It is also possible, in principle, to use interest rate cap
to reduce the risks inherent in the provision of full coverage
for an entire class of deposits. For example, full coverage of
transaction accounts (and other short-term deposits) might be
combined with a floating interest rate ceiling for these account
interest rates on transaction accounts could not exceed
(y~,
T-bill rate by more than x percent, oz
the equivalent-maturity
penalties could be charged for excessive interest earnings).
This would limit banks' ability to abuse the deposit insurance
system by attracting "hot money" in times of stress.
(A variap
of this idea is discussed below. )
Floating Interest Rate Limit on Insured Deposits

The current $100, 000 limit on insured deposits, and the
various proposals by which to tighten that limit, all constitute
variations on a quantity-rationing
approach to scaling back the
aggregate level of deposit insurance and, at the same time,
allocating available insurance among depositors. One drawback 0.
quantity rationing is that it fails to ensure that the rationed
good--in this case insurance coverage--finds its way to the
consumer that values it most highly.
An alternative
method of limiting the aggregate quantity of
deposit insurance available and allocating it among depositors i'
to use the pricing mechanism. Specifically, a federal regulator
could impose caps on the rate of interest payable on insured
demand accounts and certificates of deposit.
The regulator woult
set the caps at levels projected to attract a sufficient volume
of bank deposits to allow for efficient bank intermediation.
appropriate interest-rate limits would presumably be no higher
than the rates payable on Treasury securities of corresponding
terms. Like Treasury securities, insured accounts would be risk'
free, but unlike Treasury securities, the accounts would entitle
the holder to banking services such as check-writing, statement
preparation, and convenience of deposit and withdrawal.
This would not, of course, be the first time the Federal
government imposed an interest-rate
ceiling on bank deposit~
did so under Regulation Q until these limits were fully phased
out in 1986. Regulation Q, however, imposed a flat-rate limit oj
deposits without regard to the interest rates prevailing in the
market.
As a result, when market interest rates rose in the
1970s, depositors withdrew their deposits from banks and
reinvested them in money market funds and other financial

instruments.

In contrast, the current proposal would permit the limit to
float with the market by expressing the ceiling as a function of
the rate payable on a specified Treasury security.
For example,
the maximum rate payable on a three-year CD would be a function
rate paid on three-year T-bills, and the
Of the prevailing
rate
payable on a five-year CD would be a function of the
maximum
five-year T-bill rate. This floating interest, -rate cap would
therefore, produce the adverse effects of Regulation Q.

to the interest-rate caps, depositors would
bank accounts and re-allocate their funds among
risk-free insured bank accounts, riskier uninsured bank accounts,
available outside the banking system. A
and instruments
depositor's decisions would reflect his or her preferences for
risk, return, services, and convenience.
a given
Consequently,
aggregate level of deposit insurance coverage would presumably be
allocated to maximize depositor welfare.
In response

review

their

aggregate level of coverage under this system would be a
function of the schedule of interest-rate caps set by the
All other factors being equal, higher caps would
regulator.
increase the volume of insured funds, and lower caps would
decrease the volume of such funds.
Indeed, the caps could serve
to a limited extent as a policy lever by which to influence the
availability of intermediated credit.
The

This price-rationing
approach should not, however, be seen
of having the market determine the optimal volume of
funds available for bank intermediation.
In the absence of
deposit insurance, information failures regarding the safety of
as a means

and the "prisoner's dilemma" facing depositors considering
level of
combine to provide banks with a below-optimal
insurance
to
combat
the
deposits. The introduction of deposit
failures of the bank-depositor market, however, renders
depositors indifferent to the risk of bank portfolios and
The
consequently results in an above-optimal level of deposits.
would
interest-rate approach would not resolve this dilemma.

banks,
a run,

price lever rather than the quantity
lever with to influence the scope of deposit insurance.
In
not
that
banks
do
ensure
have
to
addition, the regulators would
evade the caps by offering in-kind benefits (~e. . by providing
toasters) to depositors.
Another virtue of the interest-rate cap is that it would be
«latively easy to implement gradually, thereby allowing
regulators to monitor its effect on the availability of credit.
Interest rates could initially be set only slightly below current
levels and reduced slowly thereafter.
In addition, in order to
ensure that the scope of deposit insurance is not inadvertently
enlarged, the current rules regarding the $100, 000 limit could
~emain in place at least initially in order to help control the
simply

give the regulator

experiment.

Finally, 1f depositors choose whether to have their deposit
insured or uninsured, uninsured depositors
sustain losses
will not aPPear to be the victims that they who
often appear to be
under the current system.
Consequently the pressure to payoff
uninsured depositors in the absence of systemic risk will be
reduced.
There are, however, potential drawbacks to the interest-rat
cap concept. It could result in arguably unfair competition
between the insured accounts of community banks and the uninsure
accounts of large banks. The large bank would have an advantage
in the' following' two respects: first, it would have the benefit
p't tb
b'gt f 't,
b "t
t 1
gg
effects of the constructive ambiguity doctrine; and, second, eye

aside from the "too-big-to-fail" perception, depositors could us
size as a proxy for safety in subjectively evaluating the riskreturn profile of a large bank. In addition, like any system in
which a depositor can easily move funds from insured to uninsure
status, this concept could cause increased volatility of deposit
Furthermore, capping
from insured to uninsured accounts.

interest rates

accounts alone would not significantly
reduce the use of brokered deposits or pass-through coverage,
of multiple insured accounts and
however.
The availability
different legal capacities would be relatively unaffected by
on insured

interest rate caps.

Depositor Preference
In simple terms, depositor preference means that, in the
event of bank failure, depositor claims have priority over those
of other creditors. Depositors, in other words, receive full
payment of their claims before any liquidation proceeds are
advanced to other creditors.
Alternatively,
in the absence of
depositor preference, depositors and other general creditors
share the liquidation proceeds on a pro rata basis. At presenti
depositor preference laws, applicable to state-chartered banks,
exist in some 23 states, but no equivalent federal statute exist
for national banks.
When

depositor preference

is applicable, the

FDIC general&y

tried to effect P&A transactions whereby only deposits are
assumed by the acquiring bank.
Nondeposit creditors are onlY
entitled to receive liquidation proceeds after depositors are
fully paid, and since the FDIC stands in the place of deposit«~
nondeposit creditors do not receive anything until the FDIC is
fully repaid for any cash advanced or payment made to effect t&&
P&A. Their subordinate
position effectively subjects nondeposit
creditors to greatly reduced protection.
Depositor preference gas been particularly effective in
cutting off contingent claims related to lawsuits, letters of
credit, and loan commitments, which in some instances could gay&

has

substantial

costs

the FDIC.

Most of the affected
failed banks have not had significant unsecured, nondeposit
financial liabilities, and they have generally been too small to
off-balance-sheet activities. When the FDIC
gave substantial
sought federal depositor preference legislation in 1986, it was
They argued that in
the larger banks that objected strenuously.
creditors
whose
failure,
claims
derived
from letters of
a bank
credit and other guarantees might expect to recover little, if
and the same would apply to foreignanything, from liquidation,
&ranch deposits if the preference applied to domestic deposits or
This, they maintained, would
deposits subject to insurance.
substantially hamper their ability to compete with foreign banks
institutions in these markets.
and nonbank financial
imposed

In principle,

this

problem

could be avoided

certain of their activities to the holding
or disadvantages
removing them from the advantages

moved

large banks

company,

thereby

of deposit

However, many bank holding companies have little
insurance.
(frequently negative) equity apart from their investment in their
principal bank. Few would be able to compete without their lead
bank.

of nationwide depositor preference legislation
positive effects. It could reduce the FDIC's
failure-resolution costs because the FDIC would be reimbursed on
its claims before nondeposit creditors. It might make it easier
to adopt failure-resolution
policies that enabled creditors to be
treated more consistently.
Depositors could be protected for
banks of all sizes, while nondeposit creditors could be subject
to losses more often. Market discipline might thus be increased
without resorting to an increase in depositor discipline.
There
would be fewer concerns over the stability of the system if
depositors were not likely to incur losses.
The magnitude of the deposit insurer's gains from depositor
The enactment

could have many

preference laws is uncertain because nondepositors can be
expected to react to such laws. Hirschhorn and Zervos (1990)
their claims when
found that nondepositors
move to collateralize
depositor preference is introduced.
In some cases,
collateralization has been sufficient to fully offset the
benefits of depositor preference to the insurer.
Thus, the
(The
likely impact of national depositor preference is unclear.
issue of collateralized deposits is discussed in Chapter XIV. )

the biggest drawback of the
Aside from this consideration,
Proposal appears to be related to the substantial increase in
costs for banks competing in certain markets. These additional
costs may drive banks, particularly larger banks, out of certain
activities of 3;arger banks
businesses.
Many off-balance-sheet
The prospect of greatly
presently offer low profit margins.
reduced returns (due to the effects of depositor preference laws)
nondeposit creditors may increase costs enough to drive U. S.

banks out of some of these markets.
While
is not clear
offsets
concern
the
a
whether such
potential benefits associateg
with depositor preference, the FDIC's "~r ~taii authority
provides a resolution method which retains most of the available
benefits from depositor preference without imposing such high
costs on nondeposit creditors: transactions can be arranged in
which all deposits are assumed by another bank, but general
creditors receive their pro rata share of recoveries. Such
transactions have been utilized successfully to deal with
situations where cost otherwise would have prohibited P&A

transactions.

3. Increasing Stability
statutory coverage limit is indicative of the scope of
the safety net only in the absence of implicit types of coverage
for depositors. Recognizing this, some have concluded that the
FDIC's handling of bank failures (whereby depositors typically
avoid losses and, in large-bank failures, some general creditors
also do) has effectively reduced depositor discipline to
minuscule proportions and has weakened several nondeposit sources
of market discipline in the process. "9 In other words, this
view suggests that the current operation of the deposit insurance
system reflects essentially a trade of market discipline at the
bank level for virtually complete protection against runs on
solvent institutions, despite appearances created by the
statutory limit.
The

This type of argument typically leads to a conclusion that
explicit, one-hundred percent coverage is appropriate. ~' It
suggests that there is virtually nothing to lose in the way of
depositor discipline, and there are several gains to be made.
First, full coverage could result in somewhat greater stability
than is now common, eliminating some uncertainty and perhaps
providing an environment that would allow for a more orderly
resolution of failures. Recalling that a major function of
deposit insurance is to remove the economic inefficiency
associated with the threat of runs, full coverage does this most
certainly and completely
Second, it would produce a more
equitable system in that large depositors would be treated
equally regardless of the circumstances surrounding a bank
failure, and small banks could compete for large deposits on m«~
equal footing with big banks.
Third, although full coverage
could completely eliminate depositor discipline, it could
increase market discipline overall if nondeposit creditors face&
certain loss in the event of a bank failure. Finally, full
coverage would not change the FDIC's failure-resolution
costs
appreciably under current methods of handling large-bank failures
and, with minor changes in failure-resolution
procedures under a
full-coverage scheme, the fund's risk exposure could probably b~
reduced (FDIC (1989) and Silverberg (1988)). (As noted above,
insurance, interest rate caps might be used under a full-coverage

for abuse. Banks might be
scheme to limit the potential
prohibited from (or fined for) paying more than x percent above
T-bill rate on insured deposits. )
the equivalent-maturity

difficulty 'twith the
d'

~11

argument' for full coverage is
'Pl'
tt
ineffective in the current environment.
Although the evidence is
there are periods during which CD
mixed, as noted earlier,
markets appear to be fairly sensitive to bank-specific risk and
act as a constraint on banks wishing to pursue riskier
This constraint may be necessary for control of
positions.
risk-taking
in a deposit insurance environment, given the
bank
incentives
to take on risk.
artificial
Even in the absence of this evidence, however, it may be
argued that constructive ambiguity provides some net benefits to
First, though after-the-fact discipline may come too
the system.
late to help the affected institution, it may still act as a
deterrent to other banks pursuing similarly risky positions.
Second, the after-the-fact flight of funds from floundering
institutions may alert supervisors to problems that deserve
closer attention or to institutions that require closing. Absent
such runs, troubled institutions
for some time,
may go unnoticed
thereby increasing eventual losses to the insurance fund.
Finally, such liquidity pressures may force chartering
authorities to deal with problems (in the form of bank closings)
In effect,
they might otherwise be reluctant to address.
uninsured depositors may act as a check on regulators,
forcing
them to deal with problems once they are identified.
These considerations suggest that, despite a standing
failure-resolution policy that has generally provided full
The major

Pt'

tt t

d P

for depositors whenever possible, there is still market
discipline from depositors.
Thus, the proposal for one-hundred
percent coverage may amount to a trade-off of discipline for
little additional protection against damaging runs. Moreover, it
may be important
to note that government protections, such as
deposit insurance, are often difficult to roll back once they are
extended.
There is a danger that expanding explicit coverage to
to
one-hundred percent would foreclose all future opportunities
enhance depositor discipline.
This could prove costly if greater
reliance on depositor discipline becomes even more feasible in
the future.
By the same token, the benefits of depositor
&iscipline could prove insufficient to justify the costs
resulting from incomplete coverage. This argues against any
binding commitment to a particular amount of depositor discipline
or any institutional
structure that precludes the possibility of
Providing one-hundred percent coverage for deposits.
coverage

Increasing

Depositor Discipline

far the most common type of deposit-insurance reform
proposal would expose large depositors to greater risk. These
~~haircuts" for uninsured depositors (a certain loss of X percent
on balances over $100, 000), reductions in the statutory coverage
limit (below $100, 000), reductions in the number of accounts
eligible for insurance ger person and/or ger institution,
reductions in the maximum dollar amount of coverage attainable by
(a systemwide maximum for any given point in time
any individual
or a maximum for the individual's lifetime, or both), graduated
decreases in the percentage of deposit balances insured above a
losses for specific
given size, certain (i. e. , nondiscretionary)
long-term
CDs), and
corporate,
large,
,
types of deposits (~e
many others.
question
As stated earlier, the first and most fundamental
for policymakers' consideration is not how to expose depositors
to greater risk but whether to do so. Each of the proposals
would reduce coverage for at least some depositors and thereby
create a greater probability of bank runs as compared to present
The resulting potential costs, as described in
circumstances.
the "special intermediation" paradigm, form the basis of the main
It has been suggested that the
objection to all such proposals.
potential losses to depositors could be kept small enough that
But, as
bank runs would not constitute a significant threat.
noted earlier, there is little factual evidence (and no
~4
By

conclusive

analytical

argument)

supporting

such an opinion.

In short, the primary arguments for and against these
proposals are similar to those concerning the fundamental tradeoff (as conveyed by the competing paradigms considered above).
Differences among these proposals will not help to determine
whether depositor discipline is the right kind of depositinsurance reform, but they will become paramount if exposing
depositors to greater risk is found acceptable.
For example, there appears to be a logical inconsistency in
proposing a single, lifetime deposit-insurance
entitlement of
000
$100,
ger person. If an individual s deposit-insurance
entitlement will be reduced in the event of his bank's failure,
the individual retains a clear incentive to run on the bank
whenever there are doubts about its condition.
Such an
entitlement appears to offer none of the benefits that deposit
insurance is intended to provide.
Depositors can be expected to
continue to protect themselves from the threat of bank runs under
such a system, incorporating a bank-run risk premium in the
yields they require on bank deposits. It is difficult to see ho&
this improves upon a banking system with no deposit insurance Ori
if it does, it is not clear how the benefits could be large
enough

to justify the administrative

costs.

illustrate

of the practical consequences of
depositor discipline, the individual features of a few popular
proposals are considered in more detail below.
To

further

American

some

Bankers Association

Proposal

This proposal introduces a new failure-resolution
procedure
referred to as "Final Settlement Payment. " Failed institutions
would be placed in receivership
at the close of a business day
a determination would be made as to which
and, overnight,
deposits are eligible for insurance coverage. New computer
systems and data bases would be required in order to make this
feasible for large banks. The following business day, a new
entity either an acquiring institution or a bridge bank--would
assume all insured deposits as well as a specific percentage of
uninsured deposits.
This percentage would reflect the FDIC's
average rate of recovery on failed-bank assets in the recent
past, as updated over time.

—

Based on the experience of the 1980s, the "haircut" to be
on uninsured depositors would be about 10 percent under
the American Bankers Association (ABA) proposal.
Any gain or
loss on the disposition of assets in the receivership would
remain with the FDIC; that is, if the FDIC collected more (less)
than average in a particular case, it would keep the excess
(absorb the loss). Uninsured depositors would have no further
claim on receivership assets after "final settlement payment. "
imposed

To supplement
depositor discipline, the ABA proposal also
calls for strengthening the corps of examiners, closer scrutiny
of charter applications and of newly chartered banks, and an
international agreement to institutionalize
depositor discipline
for industrialized
countries. But the truly novel feature is the
final settlement payment, which is supposed to provide depositor
If enforced,
discipline without risking systemic instability.
this feature would equalize the treatment of uninsured depositors
at large and small institutions and, if systemic instability is
avoided, it would reduce the cost of failure resolution.

is that there will be greater
The crucial assumption
stability under the ABA plan than under circumstances in which
uninsured depositors are uncertain of their potential loss (as
now).
This seems intuitive, but it is not evident that the
volatility of a deposit base is a function of the fractional loss
Rational depositors will
that would be felt in a bank failure.
so
long as the transaction
choose to participate in a bank run
costs incurred by transferring funds appear smaller than the
expected loss incurred by remaining in the bank. Thus, the
impact of the ABA solution may reduce aggregate losses, but it
of runs.
may not reduce the incidence

would be more prone to run under the ABA plan,
then both healthy and problem institutions may suffer adverse
consequences. ~~ Problems at one bank may produce runs on
similar or neighboring institutions, and the fact that runs may
effects.
may have some negative industry-wide
be self-fulfilling

depositors

In particular, the ABA plan may impair the ability of banks to
Lock-box
provide services involving large flows of funds.
non-credit
source
of revenue for
operations, which provide a
lock-box
a
arrangement,
one
example.
(In
a firm
provide
banks,
a
to
office
box
send
post
payments
which iz
directs customers to
controlled by the firm's bank. The bank continuously collects
the check payments, credits the firm's account, and immediately
enters the checks into the collection system. ) If corporate
lock-box customers are subject to loss, they may be inclined to
Such a loss of
take such business outside the banking industrybusiness would not necessarily reflect a form of discipline
it may follow solely from
directed at poorly run institutions;
from
unexpected bank
losses
resulting
the desire to avoid

failures.

Another example involves correspondent relationships.
such relationships
are based on check-clearing activities

Many

which,

involve large sums of moneyIf the ABA plan
effect during a severe regional economic downturn, such
as the Texas collapse of the 1980s, it is easy to imagine a
community bank shifting its check-processing
arrangements
from

by their
were in

nature,

large,
experience
fact that
impact of

one

failing

The community

bank may

several haircuts in the process so that, despite the
haircut may be inconsequential,
the combined
several may impair the health of the small
~6

scheme also raises questions concerning
of the payments system. In particular,

ABA

efficiency

to another.

a given

institution.
The

bank

the

seems

to expect that, given the inevitable haircut that will
be imposed in the event of a failure, banks, or their checkclearing agents, would wish to protect themselves from the risk
of accepting checks on banks that are about to fail. They may
refuse items drawn on such banks, given that Regulation CC
prohibits the alternative of imposing long delays before making
funds available, and the checks may be returned to the depositor
for manual collection. In this manner, the efficiency of the
payments system may begin to deteriorate. ~7
Finally, there is the issue of cost
the cost
of developing and maintaining the systems (specifically,
required to implement
the ABA plan) and there are potential legal issues concerning
"final settlement payment. " As noted elsewhere,
it may be
costly to accomplish the computer programming and recording
of
accounts (for determining insurability)
would be necessarY
to ensure a final settlement payment on that
the day following a
large-bank failure.
Before implementing such a system, it shoul&
reasonable

clear that the operational costs will not be overly burdensome
since, ultimately, the health of the banking industry is likely
to be an important determinant of deposit-insurance
losses.

earlier, final settlement payment differs from
failure-resolution
methods in that depositors and
previous
unsecured creditors may sometimes receive less than would be the
case in an insured-deposit
payoff. It is not expected that the
FDIC would make a profit across all resolutions
(since the
»average" could be adjusted as necessary to reflect current
conditions), but there would doubtless be a profit for the FDIC
resolutions.
The constitutionality
on several individual
of
in
excess
of resolution costs (from depositors
taking property
needs to be established before building
and unsecured creditors)
a new deposit insurance framework based upon this proposal.
$100, 000 per Institution an4 $100, 000 per Individual
It has been proposed that insured accounts at different
institutions and the use of different legal capacities be
restricted or eliminated, so that individuals would be limited to
a total of $100, 000 in federal deposit insurance.
Even under a
"too big to fail" policy, constructive ambiguity will reduce
exposure at the margin.
Proponents believe these proposals would not affect the
"average" depositor, because the average size of a U. S. bank
deposit is in the neighborhood of $8, 000. Such statements are
partly true. However, to the extent that such measures might
occasion more bank runs or otherwise produce more financial
instability, all depositors (and everyone else) may be affected.
Second, the data suggest that a sizable percentage of U. S.
could be affected by
household deposits, if not all households,
households
of limiting
these measures.
The real impact on
insurance to $100, 000 ger institution may be a mere payment to
brokers, who could parcel the uninsured funds in $100, 000 bundles
across different institutions.
Limiting coverage to $100, 000 ger
individual would obviously have a greater impact.
The latter proposal also would require greater
administrative
expense and, depending upon how it is structured,
There are
this scheme may raise complex technical difficulties.
to
insurance
two basic structural
$100, 000
for
limiting
options
in
advance
ger individual.
Either individuals must designate
are to be insured,
which specific accounts at which institutions
or accounts at all institutions
currently in receivership would
(similar to the process
be combined and analyzed for insurability
currently used within a single institution).
If accounts are to be designated in advance, controls would
or inadvertent designation
be needed to prevent the intentional
of funds in excess of $100, 000. This task is complicated by the
As

suggested

Not only do customers change
nature of bank deposits.
funds
among accounts within the
institutions, they also switch
balances
addition,
In
within accounts vary
institution.
same
over time.

dynamic

Perhaps

most important

would

be the provisions

allowing

to switch designations among institutions.
As concer„
we
mounts,
would
s
viability
bank
expect
specific
a
over
depositors with time accounts to switch designations as necessary
to cover any uninsured funds in the troubled institution.
Because such designations would be changing continuously,
banks
probably would need to report any changes electronically in order
to keep the FDIC's data base up to date. The cost of reporting
requirements would be reflected in deposit yields and loan rates,
functions
and the FDIC's cost of data support and maintenance
insurance
be
reflected
in
deposit
premiums.
would
Because individuals would be responsible for the accurate
designation of account balances, they may need access to
information kept on the FDIC's master file. This would raise
potentially significant privacy and security-related concerns.
The potential for fraudulent use of the released data may be
considerable, and while information requests could be channelled
through individual banks, depositors may not wish a bank to know
about accounts being held at competing institutions.
The alternative
structure, in which accounts at all
institutions in receivership are combined and checked for
insurability, entails similar administrative costs and raises
similar privacy and security-related issues. In addition, the
time required to sort out accounts could extend the time a failed
institution is held in receivership (or equivalently dormant
status). The franchise value of an institution tends to diminish
the longer is the delay (Bovenzi and Muldoon, 1990).
Further problems may arise if depositors have accounts at
multiple failed institutions,
and the sum of the deposits exceeds
the insurance limit. Under this scheme, a person with a $100, 000
deposit in each of three banks ($300, 000 total) would have
$200, 000 uninsured in the event that one bank failed, and no
deposit insurance would be available for this person until the
failed bank is taken out of receivership.
The timing of the
closures and the length of the receiverships then become
important in determining the extent of coverage for such
depositors.
Depositors could accuse the insurer of keeping a
given bank in prolonged receivership in order to reduce potential
liability in other institutions that are about to fail.
Similarly, in the event of a regional banking calamity affecting
all depository institutions and, hence, all three insurance funds
(~e ~, SIF, SAIF, and NCUSIF), there would be an incentive for
each insurer to wait until another began forcing the closure of
institutions.
Insurers of institutions closed the latest would
depositors

the least risk of
depositors.

have

liability for accounts of

common

risk of a destabilizing deposit flight is most apparent
scheme. When a bank is put into receivership,
this
its
under
depositors having more than $100, 000 in the banking system would
lose part or all of their protection at other institutions until
This clearly creates an incentive to
the failure is resolved.
that may be subject to similar
remove funds from any institutions
It is easy
problems (and perhaps from all banking institutions).
economic
how
regional
see
instability
be
intensified
might
to
by
the effect. (See Goiter (1990) for details. )
One variant of this approach may substantially
reduce
(enforcement)
costs.
administrative
A system of spot-checking,
that is, selecting a manageably sized subset of the failed bank's
depositors to check for violations of the systemwide limit, may
be effective if combined with stiff penalties for violators.
Relatively few resources would be required for enforcement, and
there need be no delay or interference in the resolution of the
failed bank. Auditors would determine the dollar amount of
systemwide deposits for the randomly selected depositors as of
the failure date, and the auditors would deal with violators
The failure resolution could proceed independently
individually.
of this process. It may be possible to avoid costly, real-time
reporting of accounting balances in a centralized computer and
instead to focus on periodic reporting of the openings and
It remains to be seen whether such
closings of insured accounts.
an arrangement
might be feasible, but with or without it, this
approach to enforcing a systemwide limit may be the least costly.
The

Lower

8tatutory

Limit and/or

Graduated

Coverage

of proposals are designed to reduce the
A great variety
$100, 000 statutory limit or to graduate the levels of deposit
insurance coverage (full coverage for the first $100, 000, 50
percent coverage for the next hundred thousand, etc. ) or both
(full coverage for $10, 000, 75 percent coverage for the next
The primary arguments for and against such
$50, 000, etc.
proposals have already been covered. Thus, this section focuses
of deposits) that may
on the available data (size distribution
of changes in the
effects
first-order
indicate some of the
Brief
businesses).
statutory limit (on households and small
summaries of the relevant data are accompanied by references to
may
more complete analyses in the event that further information
be needed.

The only complete

data set concerning the size distribution
is the 1983 Survey of Consumer Finances

of household deposits
(SCF). (See Greenspan (1990), Appendix I, for more details and
references. ) The information from this survey is dated and, due
to inflation, it is possible that the nominal value of deposits

in any given category is vastly larger now than is reflected by
the 1983 data. Preliminary information from the 1989 SCF is not
yet available but will be soon. Clearly, the 1989 survey should
be consulted before any final decisions are made.
Table 1 shows selected characteristics of 1983 household
account holders, classified by the size of the householders
Table 2
largest individual account at an insured institution.
of
estimated
household
percentage
the
shows
same
the
on
page,
deposits that would be covered under various hypothetical deposit
The data are rough, even without considering
insurance ceilings.
that household deposits represented only
also
Note
their age.
37. 6 percent of total deposits in 1983. Nonetheless, the data
For example, only one percent of 1983
may be suggestive.
households had a deposit account equal to or greater than
$100, 000. In addition, less than three percent had an individual
account of $50, 000 or more. Furthermore, as Table 2 indicates,
lowering the level of deposit insurance coverage will affect
Lowering the deposit insurance level
relatively few households.
however.
According to Federal Reserve
have
other
costs,
may
Board Chairman, Alan Greenspan, the $100, 000 level has been in
place long enough to be fully capitalized in the market value of
depository institutions and incorporated into the financial
decisions of millions of households.
The 1988 Survey of Small Business Finances gathered
information from 3, 404 businesses and weighted the responses to
develop appropriate estimates for the population of small,
nonfinancial businesses (some 3. 5 million
nonagricultural,
firms). The results showed that large-balance accounts were
relatively infrequent among these firms (246, 000 firms (7. 1
percent) had accounts of $100, 000 or more), but nearly 63 percent
of all small business deposits were held in accounts that
exceeded $100, 000. Several small businesses also have accounts
at more than one institution.
Tables 3 and 4 summarize the
relevant information from this survey (see Greenspan (1990),

Appendix

II,

for more details and qualifications).
Note that
deposits represented only a tiny share of total
(3.5 percent) in 1988.

small business

deposits

The information

on households and small businesses together
accounts for less than half the total of U. S. deposits.
Absent
data concerning the majority of deposits, it is difficult to
anticipate the broad first-order effects of changes in the
statutory insurance limit and/or graduated coverage schemes.
Nonetheless, it is relevant to consider that, since a majoritY «
small business deposits already exceeds the statutory coverage
limit and since many small businesses have multiple accounts,
restricting the number of insured accounts or setting a
systemwide coverage limit per depositor may be more effective in
reducing the government's
liability than reducing the dollar
limit ger account. The same could, perhaps, be said for

Table
Household Account Information:

1983 Survey of Consumer Finances

Size of largest individual account at an insured depository institution

$25, 00 to
$49,999

Under

$25, 000

80.3
379.2
15.0
40.0

Percent of all households.
Amount of deposits (in billions of dollars)
Percent of all deposits held.
.. . .
Percent of all household deposits

Source: Greenspan

...

.......... . .

(1990), Appendix

Table 2

Deposits Covered by
Federal Deposit Insurance

Estimated Percent of Household
("Individual account"

definition

as used for size categories

Table 1)

Deposit insurance ceiling

$25, 000

$50,000

$75,000

$100,000

Percent of
household
accounts
COvered

........

Source: Greenspan

71.3
(1990), Appendix I.

83.5

88.2

91.3

4.5
197.9
7.8
20.8

$50,000 to
$74, 999

1.5
109.8
4.4
11.6

$75,000 to
$99,999

0.4
40.9
1.6
4.3

$100,000 and

above

1.0
221.0
8.8
23.3

87.3
948.8

37.6
100.0

Table 3
Deposit Account Ownership

by Small

Businesses: 1988 National Survey of Small Business Finances'
Size of largest individual account at an insured institution
Under

$25, 000

$50.000 to
$74, 999

19.4
14.9
0.5

10.9
8.4
0.3

3,255

331

191

as accounts at one institution

were combined

Amount of deposits (in billions of dollars) ...
Percent of small business deposits. . ............

Percent of all deposits.
Number of accounts held (in thousands). ....
Note that for any given respondent,

$25, 000 to
$49,999

$75,000 to
$99,999

7.0
5.4
0.2
83

$100,000 and
above

82.0
63.0
2.2
297

into one deposit account. This biases the estimate

4, 1
pf

unl~

deposits upward.

Source: Greenspan (1990), Appendix II.

Table 4
Estimated Percent of Small Business Deposits Covered by Deposit Insurance:

1988 National Survey

pf $ftt8li

Business Finances
Deposit insurance ceiling

$25, 000

41.9
88.3
32.2

Insured deposits (in billions of dollars) .
Uninsured deposits (in billions of dollars). .
Percent of small business deposits covered.
Note that for any given respondent,
deposits upward.

all

Source: Greenspan (1990), Appendix II.

accounts at one institution

were combined

$50, 000

58.8

71.4
45.2

$75, 000

69.7
60.5
53.5

into one deposit account. This biases the estimate of

52
5g
uninsur

deposits (although this is not certain from the data
presented), since a substantial majority of these deposits would
remain covered even as the dollar limit falls to $50, 000 or to
liability
$25, 000. The final impact on the government's
adjustments to the new rules,
Obviously depends upon depositors'
but restricting the allowable number of insured accounts or
enforcing a systemwide coverage limit has the additional virtue
that no amount of brokering can help the depositor to increase
his coverage (and thereby expand the breadth of the safety net).
and businesses to
Note also that the ability of individuals
divide their funds among depository institutions within numerous
capacities without restriction will counteract the intended
effects of a lowered deposit insurance level.

household

Exclusion of Deposit Classes from Coverage

final feature for consideration pertains to reforms
that
losses on select classes of depositors. + In
particular, the proposal to impose larger (or more certain)
losses on large (over $100, 000), long-term deposits by
sophisticated investors (perhaps corporations) appears to have
The
fewer drawbacks than the other proposals in this category.
proposals--that they
usual objection to depositor-discipline
heighten the threat of bank runs unacceptably--would
appear to
have less force in this instance, since the target class of
deposits represents a decided minority of deposit liabilities for
Even if runs were prompted by the enactment of
most banks.
this proposal, they would be confined to a relatively small
component of deposits.
It does not seem likely that the
viability of the average bank (regardless of size) could be
seriously threatened by the actions of this class of depositors
(especially given the leeway to define "large" and "long-term"
Meanwhile, regulators may get early-warning
appropriately).
signals from the reactions of this class, including changes in
the risk premiums embedded in the deposits
yields. While the
ultimate result may in fact be the disappearance of the targeted
class of deposits, it is not clear that this possibility
represents a compelling argument against the proposal.
A

would

impose

Policy Objectives in Resolving Bank Failures
There are several policy objectives that must be weighed
against each other in determining the most appropriate failureresolution method.
First, the FDIC must resolve institutions in
a manner that maintains public confidence and ensures the
stability of the banking system. Thus, it has avoided using
failure resolution methods it believes would unnecessarily risk
destabilizing the banking system.
Second, there is a need to encourage market discipline
against risk-taking.
The methods used to resolve bank failures
D.

for the amount of discipline exerted by market
participants against risk-taking by other banks. Failure
resolution policies influence the probability of loss and the
size of loss that claimants may incur. In turn, these factors
influence the degree to which any particular group of claimants
will monitor and attempt to control a bank's risk-taking.
Third, failure resolution procedures should be
cost-effective. By law, unless the troubled bank's services are
found to be "essential" to provide adequate depository services
to the community it serves, the FDIC is required to meet. a »cost
test" in which it must be reasonably satisfied that the
alternative pursued is not more costly than a liquidation and

have implications

deposit payoff (although the law does not require the
resolution to be less costly than an insured deposit transfer).
insured

failure-resolution policies should be as equitable
In recent years, the most prominent
and consistent as possible.
equity issue has been the treatment of uninsured depositors and
creditors in large versus small banks. Fifth, it is desirable to
minimize the government s role in owning, financing, and managing
financial institutions and financial assets. Finally, it is
desirable to minimize disruption to the community where the
insolvent institution is located.
The objectives outlined above are not always mutually
compatible.
The most basic trade-off exists between stability
and market discipline.
While some degree of market discipline is
necessary to help control insurance costs, too much market
discipline could lead to greater instability and increased
insurance costs by encouraging depositor runs. A second inherent
conflict exists between equity and cost-effectiveness.
Consistency and equity considerations suggest that all bank
failures should be handled in the same manner. However, this may
reduce the insurer's flexibility in obtaining a less costly or
less disruptive transaction in any given situation.
These and
other possible conflicts among policy objectives make the
selection of appropriate failure-resolution policies a difficult
process.
Fourth,

The choice of a failure-resolution
transaction is suggested
the priority given to different policy objectives.
If
stability was the overriding concern, the FDIC should commit to
handle all bank failures in a manner that fully protects all bank
by

creditors; no bank runs would result. If market discipline
and/or cost were the only concerns, the FDIC generally should
restrict coverage to insured depositors. That is, banks would
either be closed and liquidated or insured deposits
would be
transferred to another institution, which might pay a premium a&&
even purchase some of the failed bank's assets.
For any given
amount received by the FDIC on the failed bank's assets (either
through a P&A or a liquidation),
transferring only the insured

deposits must virtually

whole uninsured

"Too Big To

be cheaper to the FDIC than making
or other uninsured creditors. '

always

depositors

Fail"

Equity considerations have played an important role in
determining the resolution methods used by the FDIC. As a result
pf providing full protection to the depositors and creditors of
became "unfair and
Continental Illinois National Bank in 1984,

inappropriate" for the FDIC to continue its modified payoff
experiment in which uninsured depositors and creditors received
Only a cash advance for their expected pro rata share of
The unfairness,
of course, was that
receivership collections.
transaction
Continental
had
demonstrated
that uninsured
the
depositors in the largest banks would not be subject to this

"haircut. "

As noted, an important
obstacle facing depositor-discipline
If reductions in
proposals is the "too big to fail" problem.
coverage are likely to be ignored by policy-makers in the event
of large-bank failures, then discipline may not be as strong as
it otherwise would. Nevertheless, constructive ambiguity will
continue to enhance depositor discipline at the margin.

The phrase "too big to fail" refers to a situation in which
the FDIC (or some other governmental
unit) is unwilling to
inflict losses on uninsured depositors and even creditors in a
troubled bank (or bank holding company) for fear of adverse

macroeconomic consequences or financial instability
of the system
as a whole.
Illinois
The most clearcut example was Continental
National Bank, with liabilities at the time of the transaction of
The
$33 billion, of which only about $3 billion were insured.
FDIC (and the other banking agencies) did not consider paying off
Continental a feasible option.
To date, the largest failed bank
resolved through an insured deposit payoff is the Capitol Bank
and Trust Company of Boston, which had deposits of $438 million,
$25 million of which was uninsured.

In large bank failures, the FDIC is concerned with the
potential systemic instability which might result from depositor
losses, not with preventing the failure of the bank ger se. A
more accurate description
of the issue is not whether there are
some banks which are too big to fail, but whether there are some
banks which are too big to risk the systemic consequences of
allowing

such a

failure.

of creditors of large banks is not
context of the international banking
system.
As discussed in Chapter XXI, depositors at large failed
banks in foreign countries generally have received full
Protection (although not necessarily through deposit insurance).
There have been exceptions, and the coverage has been provided on
The FDIC's treatment
unique when viewed in the

an informal
on balance,

and

the

basis, rather than a statutory basis, but,
~large~o bank
safety net in foreign countries is at

least as broad as
What

it is

in the U. S.

a "too big to fail" approach?
have been if large bank failures

is the cost of

That

had been
the savings
transfers
or
This
insured-deposit
payoffs?
with
questiog
handled
is difficult to answer, primarily because the behavior of
depositors and other market participants would likely have
changed after the FDIC first used an insured deposit payoff to
resolve a large bank failure. On the one hand, by enhancing
depositor discipline, the payoff policy may have prevented some
of the problems that later brought down other large banks. On
the other hand, the greater incentive for depositors to run undez
the threat of payoffs may have raised the social cost of bank
failures by causing fire-sale liquidations of illiquid assets,

what would

and

may

occurred.

have produced

failures than

have actually

Despite this overwhelming caveat, it may be useful to
consider the liabilities that might have been available for losssharing with the FDIC in each of the six most recent large-bank
resolutions.
Table 5 shows uninsured deposits and unsecured
liabilities as taken from the call report filed prior to a major
news announcement
regarding the FDIC's resolution transaction for
each institution.
The third column shows the total losses that
would have been incurred by uninsured depositors and unsecured
creditors under a payoff policy, as determined from the
calculated value of receivership certificates that would have
been presented to subsidiary banks in these cases had the banks
been closed on the call-report dates.
(Assets and liabilities
were adjusted for secured claims, and assets were discounted to
reflect the differences between book and market values. ) The
call report data do not include offsets, such as loans, that maY
have reduced the losses to uninsured depositors and unsecured
creditors, so the potential savings obtainable from a payoff are
overstated by column three.
There is an additional qualifier that is important for
interpreting the figures in Table 5. The savings figure assumes
that the primary regulator (OCC) would have been able to close
these institutions at the chosen call-report dates. This may not
have been possible
given the OCC's closure policy (primary
capital insolvent)
at the time. Given the delay between the
call report dates and the probable times of closure,
there could
have occurred further runoffs of uninsured deposits and some
additional securing of unsecured liabilities.
This would have
reduced the potential for loss-sharing by the FDIC and, againi
the Table would overstate the potential savings associated wit&
payoffs.

Table 5

Too Big to Fail
(In thousands

Tob

a~t,

of dollars)
Uninsured

deposits and
unsecured
liabilities

Banc Texas. ...........

(1)

(2)

Losses on (2)
(potential
savings for
FD)C)

(3)

$1,128,286
First City. ............... 14,849, 781
First Republic ....... 40, 720, 857
MCorp ................... 18,776, 872

$195,090
3,550,953
8,650,239
4,377,387

$46,049
598,409
1,201,718
851,838

Texas American
Bancshares. ......

6,062, 392

1,214,509

187,900

....... 2, 889,030
Total. .............. 84,427, 218

542, 905

88,882

18,531,083

2, 974,796

National

Bancshares
Corporation

text for important qualifications and description
' See
Adjusted to reflect market value and secured liabilities.
' From call reports prior to major news announcements

of methodology.

concerning the
status of the institutions.
~ Assuming an insured deposit payoff or transfer, this column reflects
losses that could have been absorbed by uninsured depositors and
unsecured creditors, rather than by the Federal Deposit Insurance Corpo-

ration.

Source: Federal Deposit Insurance Corporation.

parties

seek protection in the event
that the FDIC embarked on a payoff policy, the total savings
Moreover,
figure of $2. 97 billion probably is not meaningful.
for the reasons suggested earlier, the figures for individual
institutions should be interpreted as reflecting the maximum
potential savings available if the given institution were
Because uninsured

would

~t'Ãllxpvff
tdf
viewed, these figures cannot be

summed

dp't&S

meaningfully.

in order to solve the perceived "too big to fail&&
problem, some reform proposals would force the FDIC to handle a]i
bank failures in a way that imposes losses on uninsured
depositors and creditors. The impact of these proposals on banks
is addressed below.

Finally,

Insured

Deposit Payoff Risks

payoff (or modified payoff) poses three sources of risk to
large banks. These risks include (1) payments system problems,
(2) possible "contagion" effects of large bank failures, and (3)
Each of these is discussed below.
systemic instability.
A

Payments

System Problems

failure of a major bank participant in the U. S. payments
raise systemic risk concerns from a number of
perspectives.
Major banks are typically actively involved in
privately operated clearing and settlement arrangements, such as
the large-dollar Clearing House Interbank Payments System (CHIPS)
and local check clearing houses.
In addition, they participate
as principal in various markets, such as government securities,
federal funds, mortgage-backed securities, commercial paper,
foreign exchange, options, futures, and so forth. Payment
obligations that arise in these markets are frequently discharged
over private payment and clearing arrangements.
Further, large
banks provide vital correspondent banking, custodial, and
securities services. Many large banks also extend and receive
billions of dollars of intraday credit through various payment
arrangements.
Thus, there are many interdependencies
among the
participants in the payments system.
The

system could

The following four possible
failure and the potential

scenarios involving a large
systemic ramifications of such
failure are reviewed below: (1) participation in CHIPSi (2)
provision of wholesale banking (payment) services; (3) provision
of custodial services; and (4) provision of credit to clearing
organizations or their participants.
bank's

CHIPS.

CHIPS

a multilateral

payment

netting and

settlement system, operated by the New York Clearing House
Association.
The majority of transactions
processed over

CHIPS

to the settlement of foreign exchange transactions
investment and trade activity.
international
and
Currently,
processes
payment
messages with a daily average value of
CHIPS
As payment messages are processed, the
a&out $1 trillion.
Bender's CHIPS balance is debited and the receiver's CHIPS
At the end of the day, the CHIPS processing
balance is credited.
each
participants's net debit or credit
center calculates
position. The payment messages exchanged among participants
during the day are then settled through the use of FedWire.
are related

The credit extended by CHIPS participants
to each other is
controlled through the use of bilateral credit limits. In
addition, each participants s aggregate debit position is
controlled through the use of net debit caps. In October 1990,
features to provide a facility
CHIPS changed its risk management
settlement
in
the event that a major participant on
to guarantee
CHIPS was unable to fund its settlement
obligation at the end of
the day. In such a case, each remaining participant would incur
settlement obligation (ASO), amounting to a pro
an additional
rata share of the defaulting participant's initial settlement
The ASOs are collateralized by securities held for
obligation.
If the ASOs are not promptly
the benefit of CHIPS participants.
settled, the collateral posted by the defaulting participant may
be sold to satisfy its obligation.
(At present, a total of $3. 3
billion of book-entry U. S. government securities is held in CHIPS
collateral accounts. )

guarantee, it is unlikely that
of one large CHIPS participant would cause other
participants to be unable to settle. Some participants, however,
problems in funding their ASOs. Additionally,
may face liquidity
non-settling participants could experience some problems.
Currently, fewer than ten banks settle for over 100 non-settling
participants.
If one of the settling banks did not settle,
participants normally settling through it would have to settle
If the non-settling
through another settling participant.
participants had pre-funded their settlement obligations at the
defaulting settling bank, the non-settling participants might be
unable to fund their settlement obligations.
Thus, the failure
of one settling bank could provoke multiple settlement failures.
Similarly, general instability in the banking system could
lead to multiple settlement failures.
If this situation were to
ASOs to
occur, CHIPS would assess the remaining participants'
Some
cover the combined deficit of the defaulting participants.
to
cover
their
ASOs
unwilling
or
participants might be unable
and, if the deficit exceeded the value of the collateral posted,
CHIPS would unwind all of the debits and credits of the
defaulting participants and recalculate new settlement positions.
Such an unwind could dramatically
change the net positions of the
and could possible lead to another round
remaining participants
In light of the settlement

the failure

of settlement

failures.

Pa ents Services. Major banks provide a variety
of collection and payment services to other banks. For example,
such
major banks collect checks and other non-cash instruments,
bankers'
acceptances,
and
act
and
as
the
as bond coupons
settlement point for a variety of payment and investment
In connection with
transactions for respondent institutions.

lrholesale

obtaining

these services, respondent institutions typically
deposit accounts with the correspondent bank.

maintain
Respondent institutions periodically draw down funds from these
accounts to make payments or request the correspondent bank to
make payments over FedWire or CHIPS on their behalf.

a major correspondent bank were to fail, a large number
of respondent institutions might lose the funds they have on
These losses could result in
deposit with failed correspondent.
the respondent institutions'
being unable to make payments to or
on behalf of their customers.
Thus, the failure of a large
correspondent bank could seriously impair the liquidity, and

the financial stability, of many other banks,
depending upon the size of deposits held at the failed
correspondent bank.

potentially

In addition, some U. S. banks provide dollar clearing
services in other countries.
If a large U. S. bank providing such
services were to fail, its failure might affect the CHIPS
settlement on the day of the failure because some of the
participants in the service settle with Chase via CHIPS. For the
most part, however, such a situation should not have a direct
effect on other U. S. banks because the users of off-shore
clearing services are generally local institutions.

Services. Systemic problems can also arise from
custodial relationships.
If a large custodian were to fail
during the day, there could be a number of securities
transactions that were in the process of being settled. The
parties most affected by the failure of a large custodian bank
would be the sellers of securities or holders of matured
securities that had delivered securities in physical form and
were awaiting payment.
Such parties could be exposed to the loss
of the full value of the transactions.
While the establishment
of book-entry depositories has greatly reduced such intraday
deliver-versus-payment
risk, physical deliveries of securities
valued in the billions of dollars still occur daily, with
significant time gaps between delivery and receipt of payment.
Credit to Clearin Or animations.
Banks issue credit lines
to clearing organizations, such as the Participants
Trust
Company, which clears and settles transactions
in Government
National Mortgage Association securities, and to participants in
such organizations.
These credit lines are often relied upon to
provide emergency funds at settlement or as an alternative to
cash for margin payments or contributions to participants'
funds
Custodial

failure of a bank providing such lines could both
ability to assure settlement and
weaken a clearing organization's
reduce the liquidity available to it through its participants.
n the Chec
m act of Bank Failure
ion 8 te . In
genera]. , the risks to the check collection system associated with
failure relate primarily to the risks associated with the
fai]ure of an intermediary collecting bank. The risks associated
with the failure of a depositary bank or paying bank are
relatively insignificant.

intraday

If an intermediary collecting bank fails before the prior
collecting banks, which have deposited checks for collection with
the failed bank, have been paid (other than by credit to the
failed bank), the prior collection banks become general creditors
of the failed bank. Smaller banks, which typically use only one
intermediary bank for collecting checks, could be exposed to risk
for all checks in the process of collection at the time the
For small banks ($500 million or less
intermediary bank failed.
in assets), the average amount of cash items in the process of
collection is less than 15 percent of average equity capital. As
banks get larger, the average amount of cash items in the process
of collection becomes a higher percentage of equity capital,
rising to more than 100 percent for the largest banks. Larger
however, tend to collect checks through more than one
intermediary bank (or via direct presentment),
reducing their
risk exposure due to the failure of any one intermediary bank.
Banks can manage this risk through their choice of intermediary

banks,

collecting banks.

risk to the check collection system from the failure of
This risk would
a depositary bank is limited to returned checks.
fall on the collecting bank that handled the check immediately
after the depositary bank in the forward collection process (or
the paying bank, if no intermediary collecting banks were
involved in collecting the check). That bank could still protect
itself, however, by making a claim directly against the depositor
of the check. This right would most likely be exercised only
where the value of the returned check exceeds the expected cost
to obtain payment from the depositor.
A paying bank must either settle checks on the day of
presentment or return the checks by midnight of the day of
presenting bank
presentment.
If a paying bank settles with the
return
the checks
to
on the day of presentment,
the
right
it has
by midnight of the banking day following the banking day of
of the bank
Presentment.
If a paying bank fails, the receiver
of failure;
the
on
day
presented
checks
may either
(1) return the
that
checks
return
(2) settle for those checks and only
otherwise would not be paid. Generally, the FDIC follows the
approach for those checks presented on
second, less disruptive,
Presentment
the day of the failure prior to the time of failure.
The

The
of checks on days subsequent to the failure are returned.
interest
for
security
the
presenting bank;
checks are considered
thus, if the paying bank does not settle for checks on the day of
presentment, the presenting bank has a right to the checks that
Generally,
were presented so that the checks can be returned.
bank
relate
failed
to the
a
with
paying
associated
the risks
returned
checks
increase
in
that were
risks associated with the
drawn on the failed bank.
Possible »Contagion" Effects of Large Bank Failures
The second source of risk concerns the possible contagion
effects of a large bank failure. Depositors may treat the
failure of the bank as a signal of the condition of similar

For example, the failure of a bank with a heavy
concentration in energy loans may cast doubt on the condition of
other such banks. That the failure was handled as a payoff may
provoke uninsured depositors in such banks to withdraw their
funds.
In a regime in which the FDIC is prevented from stopping
such runs by "assurances" to uninsured depositors, this could
force the closure of viable banks with resulting unnecessary

banks.

costs.
Systemic Instability

insurance

The

third source of risk involves systemic instability.

Apart from the effects of a particular payoff, there may be a
tendency for the banking system as a whole to become more
unstable to the extent uninsured depositors perceive themselves
to be more at risk in the event of a bank failure. Such
increased systemic instability could increase the tendency toward
depositor runs and could force the closure of unrelated and
solvent banks, leading to greater insurance costs.

E. Market Discipline from Depositors
As noted in the section on depositor discipline,
there are
concerns about the ability of depositors and other market
participants to identify risky situations in advance. Increased
depositor discipline resulting from eliminating coverage of
uninsured depositors, in this view, would simply be after-thefact discipline, which already exists: under current bank failure
procedures, banks identified as experiencing difficulties soon
begin to lose access to uninsured and unsecured funding.
There is also a concern regarding the effect of eliminating
coverage of uninsured depositors on the international
competitiveness of U. S. banks. As noted previously, depositors
in large foreign banks have been fully protected in most bank
failures. The international
argument is similar
to protectionist arguments in competitiveness
other contexts. If foreign

governments
large bank

their banks by protecting depositors
should the U. S. do the same?

subsidize

failures,

direct ripple effects of a large bank
to the extent the loss suffered by
is
small. This would be the case, for
uninsured depositors
example, under proposals in which uninsured depositors in a
failed bank would be subject to a small "haircut. " (Recall,
however, that haircuts may prompt rational depositors to run on
the bank even if their potential loss is small. ) In any case,
the smaller the haircut the more tenuous the benefits of
increased depositor discipline, both in terms of behavioral
impact on banks and direct cost savings to the insurance funds.
The great unknown in the "too big to fail" debate is the
implication for systemic stability of putting uninsured
depositors at risk in a large bank failure.
In the Continental
failure, the banking agencies were unwilling to find out. Even
if those ultimately responsible for such decisions continue to be
reluctant to impose such losses, constructive ambiguity will
nevertheless enhance depositor discipline at the margin.
The FDIC's authority to provide pro rata payments to some
general creditors in a failed bank while fully protecting other
general creditors allows some flexibility in the decision of
which creditors to protect fully.
Depending on one's view of the
relative importance of market discipline and cost effectiveness
vs. stability concerns, all or some classes of uninsured
depositors might receive only pro rata payments.
The large bank
problem is considered below in the context of the choice between
policy rules and policy-maker discretion.
Concern over the

failure

may

be mitigated

vs. Discretion
In connection with proposals designed to
discipline (or market discipline in general),
Rules

depositor
often
by law or

enhance

it is

that the deposit insurer be prohibited,
regulation, from making good on any losses not explicitly covered
A policy of prompt corrective
by federal deposit insurance.
action if often discussed in this light.
(Chapter X analyzes
this issue. ) The preference for rules of this type derives from
a desire to avoid the large-bank incentives for risk-taking that
are generated by a "too big to fail" policy, to ensure
consistency and certainty in the treatment of failed-bank
depositors and, more generally, to establish accountability and
thereby prevent "regulator moral hazard. " While these goals are
noncontroversial,
there is considerable disagreement about the
~osts that could arise from the inflexibility imposed by binding
Policy rules.
recommended

In particular, it is difficult to specify a given class of
deposits for which losses would always be appropriate in the
In the case of large-hank failures
event of a bank's failure.
concerns over systemic
significant,
are
where large deposits
stability make it questionable whether losses should be imposed
on depositors regardless of the effect on the deposit insurer~s
If the large deposits are interbank
direct costs of resolution.
arise. It is perhaps conceivable
concerns
additional
balances,
even that nondeposit liabilities at large banks could be
sufficient to create stability problems if there were no
flexibility to deviate from the usual (pro gita) method of
In short, it may be difficult to specify
handling bank failures.
a rule which would prove optimal for all cases. Perhaps a rule
with some flexibility could be devised to cover most of the usual
exceptions, but unless the exceptions were limited by a welldefined set of circumstances, it would be difficult to prevent
policy-makers from justifying fully discretionary actions under
the terms of the rule.

it seems most unlikely that
Perhaps more importantly,
constraining the deposit insurer with a policy rule will prevent
the types of discretionary interventions that are at issue. If
financial stability is viewed as important by legislators and
other policymakers, they are likely to intervene (and override
deposit-insurance
limits) in place of the deposit insurer
whenever stability appears to be threatened
(say, in the case of
a large-bank failure).
There may be plausible arguments for
shifting the decision to intervene away from the deposit insurer,
but these are not the typical types of arguments offered to
justify a conversion to a system of policy rules. Typically, the
stated goal is to prevent the interventions.
It is unclear
whether any set of enforceable rules could serve as an effective
preventative, given the numerous possible sources of intervention
and the great variety of forms it may take. ~~
It does seem
clear, however, that the singular act of binding the deposit
insurer to a narrow set of rules would prove inadequate for this
purpose.

On the other hand, the adoption of policy rules could
provide for formal channels through which exceptions to the rules
must be validated.
While rules may not prevent policymakers from
exercising discretion, they may increase the frequency with which
policymakers are forced to acknowledge, explicitly, departures
from the rule. + To the extent that rules might reduce
uncertainty over failure-resolution
policy and might diminish
opportunities for "gaming" between market participants and the
deposit insurer, the social costs generated by the depositinsurance system could also be reduced. ~ Again, the decision on
policy rules hinges on the weighting of these advantages as
compared to the potential costs described above.

Public

Comments

In response to the Department of the Treasury's request for
public comment on this Report's topics, comments were received on
Most of those
many of the issues covered in this section.
commenting on "too big to fail" wished to see
~acro insurance
Commenters included the Federal Reserve Bank of
eliminated.
Cleveland, Merrill Lynch, Citicorp and several small banks, the
American Bankers Association, the Independent
Bankers Association
of America, and a few "think tanks. " Several commenters favored
some limit on the dollar amount of insurance
for a deposit, but
those who commented directly on the $100, 000 ceiling favored the
status guo (one of these responses was signed by 16 small banks
and a state trade association) . No direct comments were received

concerning

rules vs. discretion.
H. Appendix:

Legal Rights and Capacities

The Legal Underpinnings

The extent to which the FDIC insures deposits in financial
institutions~7 is governed by the Federal Deposit Insurance Act
With respect to the amount of deposit insurance
(FDI Act).
provided by the FDIC, the heart of the FDI Act is Section
3(m)(1).M That section defines the term "insured deposit" to
mean "the net amount due to any depositor
. . . for deposits in
an insured depository institution
. . . less any part thereof
which is in excess of $100, 000. "~9 Section 3(m)(1) further
provides that "[s]uch net amount shall be determined according to
such regulations
as the [FDIC] Board of Directors may prescribe,
and in determining
the amount due to any depositor there shall be
added together all deposits in the insured depository
institution
maintained in the same capacity and the same right
for his benefit either in his own name or in the name of others
In addition, Section 12(c) of the FDI Act provides
that the FDIC need not recognize, as the owner of a deposit, any
person whose name or interest does not appear on the deposit
account records of an insured institution that is in default.
Finally, Section 3(m)(1) of the FDI Act authorizes the FDIC Board
of Directors to clarify and define, by regulation, the extent of
deposit insurance coverage resulting from Subsection 3(m)(1),
3(p), 7(i), and 11(a) of the FDI Act. 43
Based on the above-noted statutory language, + the FDIC has
been insuring deposits according to the "rights and capacities"
in which they are owned.
To the extent that deposits are owned
in the same right and capacity, whether deposited directly by the
owner or by someone else on the owner's behalf, they have been
aggregated and insured up to $100, 000. Conversely, to the extent
that funds are owned in different rights and capacities, they
The
have been separately insured up to the $100, 000 maximum.

which were initially
FDIC's deposit insurance regulations,
revised
substantially
in 1990,47 enumerate
adopted in 1967 and
the various rights and capacities in which funds may be owned,
and thus separately insured, for deposit insurance purposes.
Prior to the adoption of the regulations in 1967, the various
rights and capacities in which funds were insured was determined
of the FDI Act.
primarily by informal FDIC staff interpretations

Revocable and Irrevocable

Trusts

Pursuant to Section 3(m) of the FDI Act, the FDIC has looked
to the persons with beneficial ownership interests, as opposed to
the named depositors, in applying the insurance limits. Undez
the FDIC s existing regulations, deposit accounts maintained by
fiduciaries (i. e. , agents, nominees, custodians, conservators,
guardians, or trustees) are insured in the amount of up to
$100, 000 for the 48interest of each principal or beneficial owner
in such accounts,
provided that certain recordkeeping
requirements are satisfied.
Because the insurance coverage
for such accounts passes through the fiduciary and is measured by
the interests of the beneficial owners of the funds, this type of
insurance coverage is commonly referred to as "pass-through"

insurance.
For instance, if the trustee of an irrevocable
express trust maintains a deposit account comprised of trust
funds at an insured depository institution and the trust has
three beneficiaries, the deposit insurance would pass through the
trustee to each beneficiary so that each beneficiary's interest
in the account is separately insured up to $100, 000.
In
addition, such insurance coverage would be separate from the
coverage provided for any other accounts maintained by, or for
the benefit of, the settlor, trustee, or beneficiaries in
different rights and capacities at the same insured depository
institution.
However, if a beneficiary has interests in more
than one trust account established pursuant to trusts created by
the same settlor, then all of those interests would be aggregated
and insured on a combined basis up to $100, 000. "
Most pension plans, profit-sharing
employee benefit plans are also insured

plans, and other trusteed
by the FDIC, under the
existing deposit insurance regulations, on a "pass-through"
basis. This means that they are insured in the amount of up to
$100, 000 for the interest of each beneficiary, provided that the
FDIC's recordkeeping requirements for fiduciary accounts (see
Endnote 48) are satisfied.
This insurance coverage is separate
from (and in addition to) the insurance coverage provided for anY
other deposits maintained by the plan sponsor, the trustee, or
plan beneficiaries in different rights and capacities in the sam~
insured
bank.

However, pass-through
insurance coverage is provided for
employee benefit plan deposits only when the value of each

participant's

interest in the plan's assets can be determined

without evaluation of any contingencies,
except for those
contained in the present-worth tables and rules of calculation
for their use (which concern life expectancy and interest rates)
that are set forth in the Federal Estate Tax regulations.
Therefore, while the deposits of an employee pension or profitsharing plan would, in most cases, qualify for pass-through
insurance coverage, the deposits of a health and welfare plan
generally would not qualify for such coverage because the present
interest in the assets of a health and
value of a participant's
welfare plan is contingent on an event (+e , illness or

that is not covered by the above-noted present-worth
This means that the deposits of a health and welfare
plan in an insured institution would generally be added together
as opposed to being
and insured up to $100, 000 in the aggregate,
basis. The insurance of such trust
insured on a per-participant
funds would, however, be separate from the insurance afforded to
deposits maintained individually be the settlor, trustee, or
beneficiaries of the plan.
accident)

tables.

Moreover,

pass-through

insurance is not provided for
the employees (participants) do
in the assets of the plans. One
is a deferred compensation plan

employee benefits plans in which
not have any ownership interests
example is the "457 Plan, " which
established by a state government,

local government, or nonprofit organization for the benefit of its employees, that~~
The
qualifies under Section 457 of the Internal Revenue Code.
"pass-through"
insurance
deposits of such plans are not accorded
coverage because, under Section 457 of the Internal Revenue Code,
the funds of such plans are required to "remain (until made
available to the participant or other beneficiary) solely the
property and rights of the employer (without being restricted to
the provision of benefits under the plan), subject only to the
This provision
claims of the employer's general creditors. "
local
enables the employer (i. e. , the state government,
government,
or non-profit organization) to utilize 457 Plan funds
for its own purposes and makes those funds subject to the claims
of the employer's creditors.
The employer, rather than the
employees, is thus deemed to be the sole owner of the funds until
deposit accounts at FDICthey are distributed.
Consequently,
457
Plan funds have been
insured banks that are comprised of
added together and insured in the amount of up to $100, 000 in the
aggregate together with other deposits of like kind maintained by
the same official custodian of the same public unit.
IRAs and Keoghs

to pass-through deposits insurance, the FDI Act
mandates that certain deposits be insured separately from other
deposits. For instance, Section 11(a)(3) of the FDI Act provides
that time and savings deposits of IRAs and Keogh Plans must be
In addition

separately from other accounts maintained by the
beneficiaries of such retirement accounts. Moreover, Section
insured

that when funds are held by an
in a fiduciary capacity, whether
institution
insured depository
own trust department,
another
held in the fiduciary institution's
or
in
another
institution,
insured
fiduciary
the
department of
institution, those funds are insured separately from any other
funds of the owners or beneficiaries.

7(i) of the

FDI Act provides

Public Units

Finally, Sections 3(m)(1) and 11(a)(2) of the FDI Act
require that each official custodian of government funds
(including the funds of the Federal, state, and municipal
of the
as well as certain territories/possessions
governments,
all
000
for
time
to
and
$100,
insured
United States) be
(1) up
same
state
savings deposits in an insured institution in the
where the public unit is located; (2) up to $100, 000 for all
in the same state where
demand deposits in an insured institution
the public unit is located; and (3) up to $100, 000 for all
deposits (whether time and savings or demand deposits) in an
insured institution outside the state where the public unit is
located. Although the official custodian is the nominal
depositor, it is the funds of the public unit that are insured.
Moreover, this provision provides more than $100, 000 to public
units since a public unit can have more than one official
custodian and can have both demand deposits and time and savings
deposits at the same in-state institution, which would be
separately insured, in the amount of up to $100, 000 each, for a
total of up to $200, 000.

2. Proposal for Eliminating

Different Rights and Capacities
In order to limit the total amount of deposit insurance
available to a maximum of $100, 000 per person or entity, per
insured institution, a number of statutory provisions, must be
added, amended or deleted.
Section 3(m) of the FDI Act must be
revised to eliminate the "same right and capacity" provision as
well as the provisions relating to the insurance coverage
provided for official custodians of public units.
Sections 3(p)
and 7(i) of the FDI Act, which provide separate insurance for
funds held by an insured depository institution
in a fiduciary
capacity, would have to be deleted in their entireties.
Section
11(a)(2) of the FDI Act concerning public unit funds and Section
ll(a)(3) concerning IRA and Keogh deposits would also have to be
deleted. Finally, Section 12(c) of the FDI Act, which concerns
the provision of insurance for the interests of persons not
identified on deposit account records, would have to be deleted.
In place of the amended and deleted provisions, statutory
language could be drafted to provide that each individual or
entity would be insured up to a maximum of $100, 000 for their
interests in all accounts maintained at a single insured

institution.

Under

this approach,

each individual

would

up to $100, 000 for the total of all his/her individuallyaccounts. Joint accounts would no longer be separately
They would simply be split
insured from individual 56 accounts.
and each co-owner's share would be
amongst the co-owners,
individual accounts for insurance purposes.
added to his/here

insured

pwned

In addition, the statutory amendments would have to
designate who is the owner of certain types of accounts in order
to clearly specify whose insurance limits those accounts should
In the case of revocable trust accounts, "payable on
cpme under.
death" accounts, "Totten" trust accounts, and other similar
accounts, the revocable nature of such accounts suggests that the
settlor should be designated as the owner of the accounts and
that they should be added to any other individually owned
accounts of the settlor for the purpose of applying the $100, 000
If there is more than one settlor, the account
insurance limit.
should be split, and equal portions should be allocated to each
settlor, to be included with that settlor s individually owned
funds for the purpose of applying the $100, 000 limit.
In the case of accounts established pursuant to written
irrevocable trust agreements, the trust itself is a separately
recognized legal entity and thus its accounts should be added
together and insured up to $100, 000, separately from the accounts
"Pass-through"
of the settlor, trustee, or the beneficiaries.
insurance would no longer be provided for such accounts, which
interests in such accounts would not
means that the beneficiaries
To prevent
longer be recognized and separately insured.
individuals from increasing deposit insurance by setting up
multiple trusts for the benefit of the same beneficiary(ies),
some provision
limiting insurance coverage for irrevocable trust
accounts established by the same settlor(s) for the benefit of
the same beneficiary(ies)
should probably be adopted.

similar approach could be taken with respect to the
all employee benefit plans, including pension plans,
profit-sharing plans, health and welfare plans, deferred
compensation plans, Keogh plans, vacation loans, and the like.
The deposits of all plans established
by the same employer or
group of employers would be added together and insured up to
$100, 000. The interests of the beneficiaries in such plans would
no longer be recognized and insured separately
up to $100, 000 per
be
treated as the
participant.
IRA accounts should, however,
individually owned funds of the person who established the IRA
since they are, in effect, individual accounts.
A

deposits of

respect to agency, custodial, nominee, and guardianship
eliminating pass-through insurance means that the
nominal owner (the agent, custodian, nominee, or guardian)
should
~e designated as the insured party, and any funds held by that
person as a fiduciary for one or more individuals would be added
to the fiduciary's personal (individually owned) funds and the
With

accounts,

to $100, 000. The obvious practical
problem with this approach is that a person may be acting in a
fiduciary capacity for the funds of numerous individuals and
those funds would be counted against the $100, 000 insurance limig
of the fiduciary, rather that the real owners (the principals).

total

would be insured

sole proprietorship should be addeg
funds of the sole proprietor (as
to any other individually
are
they are under the current rules), since sole proprietorships
entities
and
all
as
separate
legal
recognized
generally not
assets of sole proprietorships are owned by the sole proprietor.
and unincorporated
Accounts of corporations, partnerships,
continue
to
be separately insured
associations should probably
partners, and members,
from the accounts of their shareholders,
Accounts maintained

by a

owned

so long as they are engaged in an independent activity, because
they are generally recognized as separate legal entities.
Because unincorporated associations are, under most state laws,
fairly easy to establish (i.e. , do not have the same filing
requirements and other formalities necessary to establish a
corporation) perhaps the statutory amendments should define what
association" is for insurance purposes.
and "unincorporated
Without such a definition, any two individuals who pool their
purpose could claim they are an
money for a particular
unincorporated association.

for limiting deposit insurance
seems much easier to understand
and administer than some of the
other proposals to limit deposit insurance coverage. It would be
relatively easy to determine insurance coverage as long as the
statutory amendments attribute ownership of the various types of
accounts to one or more persons or entities involved in those
accounts for deposit insurance purposes.
There may be fairness
concerns, however, with attributing ownership of funds to nominal
depositors (i. e. , agents or custodians) when the funds really
belong to the principals.
If a lawyer or real estate agent is
holding funds in escrow for hundreds of clients/customers,
it is
the lawyer or real estate agent who would be the insured party
even though he or she did not have any ownership interest in
those funds but was merely acting as an intermediary.
Moreover,
the possibility of increasing insurance coverage by establishing
numerous trusts or corporation where all of the individuals
involved are the same, must be addressed if the effort to limit
insurance converge is to succeed. Finally, the possibility of
"straw men" being used to increase insurance coverage would also
have to be addressed.
The above-noted

framework

III-43

Bndnotos

interest rates that banks are charged for borrowing
of as including a market-determined risk premium
may be thought
one reflecting the threat of bank runs and
with two components:
elements)
many
reflecting all other types of risk.
(with
another
artificial
partitioning of risk premia, the ideal
Using this
of deposit insurance coverage may be described as the
smallest amount that is sufficient to produce a value of zero (or
nearly so) for the bank-run component without altering the value
of the other component (or any of its elements) in a material
The

way.

Other issues are relevant, such as FDIC costs in handling
failures and equity in the treatment of large- and smalldepositors. These issues may affect the decision to alter
coverage in a particular way, but they do not refer to the
original purposes of insurance coverage. The primary function of
deposit insurance coverage is presumably not to minimize FDIC
costs or redress inequities, but to correct a perceived market
failure, that is, to provide a setting that improves upon the
results of a free-market arrangement in a way that is agreeable
to all parties (in economic jargon, a "Pareto-efficient"
alteration of market arrangements).
It follows that, this primary
policy goal takes priority in determining the optimal scope of

bank
bank

coverage.

In virtually every failing-bank case, some uninsured
deposits leave the bank in the period immediately preceding
failure (defined by the declaration of the chartering authority).
Cases such as Continental
Illinois, First Republic, and others
demonstrate that such withdrawals may develop into runs that
create a terminal liquidity crisis for the affected institution.

Similar evidence

is reported

by Short and Guenther

(1988)

(1988).
The "level of coverage" refers to the total amount
Provided in an ordinary bank failure, and not just, the dollar
amount of the statutory
A lower value for the
guarantee.
statutory guarantee would not necessarily alter the level of
coverage if failure-resolution
policies remained unchanged.
Until specific proposals are discussed, any reference to lowering
the "level of coverage" means any reduction in de jure or de
facto coverage, or both, which effectively lowers the amount of
coverage that can rationally be expected by at least some
depositors in the case of an ordinary bank failure.
The fundamental
historical facts are well known. For
example, that there were seven or so discernable banking "panics"
(contagions of varied origin) prior to the establishment of
deposit insurance in the U. S. , and that, while not the norm, runs
and Von Drunen

and Nikstrom

orzgxnally confined to one bank did sometimes precipitate runs
other institutions even in the absence of a generalized panic.
See Kaufman (1988) and Schwartz (1988) vs. Goodhart
(1987) .
~

choice involves the conceptual framework, or
"paradigm,
that should be used for understanding,
evaluating, and selecting among alternative banking arrangements.
A paradigm
embodies two components:
a theory of economic
behavior (a system of reasoning by which the economic
implications of proposed arrangements are inferred), and a set of
prioritized policy objectives (a method of ranking the inferred
outcomes of the alternative arrangements).
Recognition of the
paradigm behind a policy proposal is necessary in order to
determine whether there is a defensible logic and a consistent
ranking system
e. , the elements of a coherent policy
strategy).
(The usage of "paradigm" follows that of Kuhn
The

analytical

(i.

(1970)).

the actual occurrence of runs produces
additional social costs. Bank runs force a sale of assets (in
particular, illiquid commercial loans) that are not ordinarily or
voluntarily traded -- they are not traded because information
costs are prohibitive for developing tradable paper claims —
and
thus the actual occurrence of bank runs produces deadweight
losses due to the market's inefficiency in valuing informationintensive assets. See Woodward (1988).
Moreover,

Implicit in this view is the suspicion that market-type
pricing of bank risks is likely to be misleading, since many bank
assets are information-intensive
and, hence, are not well suited
to valuation by market-type trading. The market's response to a
recent (September 1989) issue of subordinated debt by the Bank of
New England may be cited as a case in point.
Subordinated debt
virtually never avoids losses in the event of a bank failure.
»ospective purchasers therefore have clear incentives to assess
risks correctly, and perhaps moreso the longer the maturity of
the debt. Bank of New England's long-term debt issue was oversubscribed in September, when its stock price was in the
neighborhood of $28 per share.
Three months later, the stock was
selling for about $4, with no intervening economic shocks to
explain the sudden reversal of fortunes.
In fact, it was an
autumn bank examination that revealed problems previouslY
undetected by purchasers of subordinated debt.
Stated differently, the moral hazard problem is n«
containable in the absence of depositor discipline.
12
Diluted and conflicting incentives place the insurer's
management
at a similar comparative
as described ln
the economic theories of regulation disadvantage,
and public bureaucracy

(buchanan (1975); Tullock (1965); Stigler (1971); Kane (1981);
Gwartney and Stroup (1982)). Again, private wealth incentives
favor a long-run outcome in which banks successfully innovate
Moreover, public sector incentives are such
around constraints.
that regulated firms may have an advantage in the bargaining that
The incentives in the public sector
shapes regulatory policy.

are biased in favor of policies with clearly visible, short-term
benefits, but hidden or long-run costs. This ensures a record of
identifiable "successes" during the watch of the reigning
leadership, and such a record may be promoted to the leadership's
There is evidence to suggest that private
further advantage.
firms are able to exploit this public-sector bias (Gwartney and
Stroup (1982)). Thus, incentives are such that the "compromises"
worked out between regulators and regulated firms are likely to
produce policies with visible short-run benefits to the economy,
but at the risk of hidden or longer-run costs that grow out of
successfully negotiated by the
unconstrained profit opportunities

regulated

firms.

This is not to suggest that supervision cannot be
effective in combination with depositor incentives to monitor
risk. There is clear evidence that it can be. The argument here
refers to reliance on supervision in place of depositor
It is an argument against "too much" insurance
discipline.
coverage and not against deposit insurance ger se.
The same appears true for coverage arguments based upon
is
concerns and small-saver protections.
payments-system
never clear why a deposit insurance system should be viewed as
'4

the proper type

of institutional

either of these concerns.

arrangement

for addressing

that market discipline may emanate from many
sources other than depositors.
At the bank level, potential
sources of discipline include shareholders,
managers,
All
subordinated note-holders,
and other nondeposit creditors.
the
of these parties face a significant risk of loss under
failure-resolution methods employed by the FDIC. The analogous
parties at the bank holding-company level also provide
potentially important sources of discipline for the bank.
Holding-company
shareholders and creditors invariably suffer
losses when a bank fails within their system and, hence, they
also have incentives to constrain their banks' risk-taking. Since
effective market discipline can potentially be imposed through
can
any and all of these sources, and since bank supervisors
that
obvious
not
is
it
as
well,
presumably impose some discipline
a
without
the control of banking risk is necessarily unachievable
substantial strengthening of depositor discipline.
Endnote 15 shows why the necessity of depositor
discipline is not obvious as a logical matter. The casual
empirical evidence to follow is but one example of several types
Note

that also could be used to question the implications
depositor discipline paradigm.

of the

trade-off provides a useful
The inflation-unemployment
on the short-run Phillips
particular
point
analogY. There is no
preferred to all others.
curve that is unambiguously
costs generated by inflation
social
the
of
relative magnitudes
Thus
are not objectively quantifiable.
and unemployment
could never decide conclusively which point on the curve is the
we knew the shape and position of the
optimum selection, even
curve at any given moment (which we do not). A reasonable policy
response is to alter the terms of the trade-off so that, whatever
our current position on the curve, the consequences of the
associated inflation and unemployment are both less harmful than
they would otherwise be. Examples might include the provision pf

to speed the rehiring of displaced
to mitigate the real effects of inflation
and, more generally, the removal of distortions to facilitate
speedier, and more generally, the removal of distortions to

job information services
workers, tax indexation

facilitate speedier

and more

efficient

market

adjustments.

Longer-term deposits also can be the subject of "runs"
in that depositors may decline to "roll over" this type of bank
debt. This is different from the traditional notion of a bank
run and the associated deadweight costs may be more avoidable
than those which form the basis for deposit insurance protection.
For an opposing view see Goodhart (1989, Ch. 8).

latter conclusion is often supported by noting that
of all U. S. banking assets and 66 percent of all U. S.
deposits are held by 3 percent of all U. S. banks. Thus, it seems
reasonably safe to infer industry-wide
effects from the handling
of large-bank failures.
The

70 percent

In the framework of Endnote 17, it is alleged that the
present operation of the deposit insurance system amounts to the
selection of a "corner solution" on the curve, corresponding to a
maximum protection against runs and zero depositor discipline.
See Humphrey (1976), Field (1985), Silverberg and
Fleschig (1978), Leff (1976), and the references there cited for

details

alternative

The remainder

Nejezchleb
and

and

(1988).

arguments.

of this section borrows heavily from

See Baer and Brewer (1986), Hannan
and Flannery (1989).

Ellis

and Hanweck

(1989)i

To state the same point. dif ferently, if potential losses
are so small as to trivialize the threat
of
then it is
unclear why incentives would be sufficiently runs,
strong for
24

to price risks accurately (~g , to ensure a
significant strengthening of depositor discipline).
Recall that most banks, healthy or not, are probably
insolvent on a liquidation basis. They have many illiquid
assets and many perfectly liquid liabilities, so
(nonmarketable)
sales
(such as occur with bank runs) are not likely to
fire
that
Combined
produce revenues sufficient to meet all obligations.
and need not be
with the fact that runs can be self-fulfilling
based on any evaluation of an institution s viability, this
suggests that healthy banks could suffer consequences if
depositors are exposed to greater risk. A related point is that,
the troubled bank's viability ~de ends
once a run is underway,
behavior
of
depositors.
Potential lenders are unlikely
upon the
to trust that the run will cease if they make funds available to
the bank; thus, private sources of stability such as the Fed
funds market (mentioned in the ABA proposal) may not be reliable
in this type of crisis.
This assumes that the check-clearing business is not
simply passed to the local Federal Reserve Bank, a possibility

depositors

which would

reduce large-bank
system

The payments

responses to the
rule to be used.

ABA

plan

profits.
effects and depositors'

may depend

importantly

behavioral
upon the closure

in the process of a bank's borrowing (to
should the door be closed? An interesting
fund its obligations)
Question arises if, during the daylight hours preceding a
closure, the Fed would refuse Fedwire transactions to a troubled
institution that had exceeded its overdraft limits. What would
be the standing of depositors who requested funds before the
closure but did not receive them due to the Fed's decision (and
what should be their legal standing)?

Goiter,

When

cit.

authorizes the
of equal standing.

FIRREA

of creditors

Note

that

if this

FDIC

classes

to discriminate

among

for

particular

were not true

some

institution, it could not possibly be performing (as its primary
regarded as special to
function) the type of intermediation
banking.
(Long-term deposits that are uninsured cannot be raised
sufficient quantities to fund the types of loans we have
identified as characteristic for banking's special role in the
economy.
This is basic to the notion of why banks exist in the
first place. ) Thus, the primary purpose of deposit insurance
and leaving the
would not be relevant for such an institution,
Question of its viability to purely market forces would seem
appropriate (at least in the extreme case where such deposits are
the institution s only liabilities).

rare case could arise where the loss on the failed
bank~s assets is sufficiently small that the share of losses
borne by the uninsured depositors is less than the incremental
fzanchise value to the acquirer of retaining the uninsured
deposits.
Primary capital consists of equity plus loan-loss
reserves. Thus, a bank may be solvent on a primary capital basis
even if equity is zero, so long as reserves have not been
depleted.
Sources include the Treasury, Congress, the Federal
Reserve System, and other government agencies, and forms include
loans, direct expenditures, forbearance, tax breaks, and
transfers of many types.
Note, however, that skirting a policy rule may take
extremely subtle forms. Suppose the deposit insurer is directed
to impose losses on uninsured depositors with accounts
The insurer could
outstanding at the time of a bank's failure.
potentially avoid imposing losses by simply waiting (and perhaps
relying on the Fed to fund withdrawals), thus allowing time for
all uninsured depositors to escape. Policy rules would require
careful crafting in order to ensure that departures from the rule
are acknowledged explicitly.
A

An observation
of private business arrangements
certainly suggests that rules may offer mutual benefits over pure
discretion; in private dealings, contracts between parties are
the norm, and pure discretion is unusual (Barro 1986). A large
economic literature describes the features of optimal contracts.
It would seem that some form of contract (a binding commitment to
rules) could have similar value in the area of public policy,
provided that the appropriate features are know, articulable, and
enforceable.
Leijonhufvud
(198) draws an analogy using
professional basketball to counter the argument favoring pure
discretion for those presumed to be "in the best position to
know-" He notes that if the latter argument were valid, we could
do without rules for basketball
(except perhaps the forbidding Of
"deliberate mayhem"). To the extent that this seems
unreasonable, he suggests, so is the idea that pure discretion hY
"those in the know" should ~alwa s be preferred to rules.

This section is taken, in large part, from the FDIC's
"Findings and Recommendations Concerning Pass-Through Deposit
Insurance, February 1990.
12 U. S.C.

1811, et

12 U. S.C.

1813(m)(1).

Ibid.

~se

prior to the enactment of FIRREA, the definition
included the term "insured bank, " rather than the term "insured
"
40

institution.
12 U. S-C. 1813(m)(1).
12 U. S.C. 1822(c).
4
12U. S.C. 1813(m)(1), 1813(p), 1817(i), 1821(a).
The statutory authority has remained basically unchanged
since 1935, with only minor revisions, such as the substitution
pf the term "insured depository institution" for the term
&~insured bank" that was made by the FIKKA.

depository

basic example is that funds owned by an individual and
his or her individual name are insured separately
in
deposited
from any funds that that person owns and deposits jointly with
another person because funds owned by an individual are deemed to
be held in a separate right and capacity from funds owned and
deposited jointly with another individual.
4~

to be

The recently amended deposit insurance
codified at Part 330 of Title 12 of the

Regulations.

55 Fed.

~Re

12 C. F.R.

20, 111

330. 1(c),

regulations are
of Federal

Code

15, 1990).
330. 2(b), 330. 2(c),
(May

and

330. 10.

for fiduciary accounts
basic requirements of
the
ac49.
count
records of the
deposit
(1)
depository bank must indicate the fiduciary nature of the account
(~e. , that it is a pension loan account); and (2) the records of
either the bank or the depositor, maintained in good faith and in
the regular course of business, must indicate the name and
interest of each person in the account.
In order for each beneficiary's interest to be
separately insured, the value of the interest must be
determinable without evaluation of any contingencies other than
those contained in the present worth tables and rules of
calculation for their use (having to do with life expectancy and
interest rates) that are set forth in the Federal Estate Tax
regulations (26 C. F.R. 20. 2031-10).
12 C. F. R. 330. 10.
26 C. F. R. 20. 2031-10.
The recordkeeping

at
that section are:
are enumerated

requirements
12 C. F. R. 330. 1(b).

26 U. S.C. 457.

The

26 U. S.C. 457 (b) (6) ~

There is a "grandfather" provision for deposits Qf
existing plans in section 330. 16 of the FDIC's recently amended
deposit insurance regulations.

basis, unless otherwise specified in the
deposit account records.
Under Section 330. 9(c) of the FDIC's recently amended
deposit insurance regulations, an unincorporated association
defined to be any association of two or more persons formed fpz
religious, educational, charitable, social, or other
On

an equal

noncommercial

purpose.

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III-56

Chapter

BROKERED INSURED DEPOSITS

A. Introduction

requires this study to include an evaluation of
possible limitations on brokered deposits.
This chapter focuses
the use of brokered deposits as a means of
Qn restricting
limiting the scope of the safety net. Section B contains
including a review of historical trends
background information,
and a discussion of numerous empirical studies regarding
the
effect of brokered deposits. Section C discusses the major
public policy issues generally associated with the use of
Section D examines various alternatives for
brokered deposits.
limiting the use of brokered deposits.
FIRREA

B. Background
Brokered deposits are funds received by depository
through third party intermediaries,
collectively

institutions

referred to as deposit brokers. The Financial Institutions
Reform, Recovery, and Enforcement Act of 1989 (FIRREA) defined a
deposit broker as: "(A) any person engaged in the business of
placing deposits, or facilitating the placement of deposits, of
third parties with insured depository institutions or the
business of placing deposits with insured depository institutions
for the purpose of selling interests in those deposits to third
parties; and (B) an agent or trustee who establishes a deposit
account to facilitate a business arrangement with an insured
depository institution to use the proceeds of the account to fund
a prearranged
loan. " In addition, FIRREA broadened the
definition of brokered deposits to include solicitation of high
cost funds by "money desks" operated by depository

institutions.

Obtaining deposits through the services of outside brokers
or money desks is an alternative to raising funds through branch
The use of
operations or other more traditional methods.
brokered deposits is also an alternative to nondeposit sources of
funds.
For depositors, deposit brokerage reduces the cost of
learning about deposit placement opportunities as well as the
«st of actually placing the deposits, and thus greatly expands
the range of institutions
at( which they can place accounts.

of brokered deposits increased significantly when
deposit interest rates were deregulated following the enactment
of the Depository Institutions Deregulation and Monetary Control
of 1980. This occurred because deregulation increased the
extent to which rates could vary, particularly between
institutions in different regions. Increased rate variation, in
turn, increased the gains from moving deposits between
institutions to take advantage of higher rates.
The use

Concern over the use of brokered deposits has been prompted
the
degree to which some failed institutions have relied on
by
these funds; such reliance may be a means of avoiding market
discipline, which ultimately could increase resolution costs for
the FDIC. In response, regulatory agencies have attempted either
to limit access to brokered deposits or to increase supervision
In the midover institutions that make extensive use of them.
Insurance
Corporation
Federal
Deposit
1980s, both the
(FDIC) and
the Federal Home Loan Bank Board (FHLBB) considered rules to
limit the use of brokered deposits. FIRREA amended the Federal
Deposit Insurance Act to prohibit institutions that fail to meet
their minimum capital requirements from accepting brokered 3
deposits unless explicitly approved in advance by the FDIC.

Historical Trends
Figure 1 consists of two measures of the amount of deposits
placed by third party brokers at FDIC-insured commercial banks
from 1983 through 1989. Figure 2 shows these same measures for
federally-insured
thrift institutions from 1978 through 1989.
The "aggregate" ratio shows brokered deposits as a percentage of
total industry deposits, whereas the "avera