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Room 4047

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" A R E TR O S P E C TIV E V IE W
OF THE FD IC "

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Address by
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G E O R G E L e M A IS T R E
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Before the
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Graduate School of Banking, University of Wisconsin^
Madison, Wisconsin Augutf 177 T978~~

It is a pleasure for me to speak before The
Graduate School of Banking. As you may know,
I retired from the Federal Deposit Insurance
Corporation 2 days ago. Accordingly, tonight, I
would like to share my retrospective view of
the FDIC based on my 5 years of service on the
Board of Directors, first as Director and then as
Chairman. The events that occurred during these
5 years, the actions taken by the FDIC to deal
with those events, and the problems that remain
as yet unresolved are best understood in terms
of several broad-based trends that have been
taking place in our society and in our economy.
Although my remarks are directed to what has
happened, a discussion of my retrospective
views would really not be complete w ithout
including the problems that exist and that will
have to be dealt with in the coming months
and years.
Although I did not realize it at the time, the
tone for my 5 years at the FDIC was set
immediately on commencement of my term
of office on August 1, 1973. The FDIC at that
time was confronted with the impending
insolvency of U. S. National Bank of San
Diego — the Nation's first billion-dollar bank
failure. Little did I or others suspect at that
time that this failure was a prelude to other
large bank failures, and that the financial system
and the economy were about to undergo greater
stress than at any time since the 1930s.
During the last 5 years, our Nation has endured
double-digit inflation, a serious liquidity crunch
in 1974, a flood of petro dollars stemming from
the energy crisis, a real estate market collapse,
high loan losses, weakened earnings and capital
positions, and other problems. The banking
environment changed drastically during this
period. Competition increased between th rift
institutions and commercial banks spurred on
by the development of NOW accounts,
pay-by-phone, and other innovations.
Technological developments in the area of
Electronic Funds Transfer also served to
heighten competition among different types
of financial institutions. Bank holding
company developments during this period
contributed to increased competition by placing
banks in direct competition w ith nondepository
financial institutions in areas such as factoring,
mortgage banking, leasing, certain types of
insurance, and other financial services.
In the regulatory area, the FDIC was given
considerable responsibility for enforcing
consumer laws, a significant new responsibility
in relation to the Corporation's traditional
safety and soundness and insurance functions.




Finally, the strains and stresses of the last
5 years have revealed certain weaknesses in our
existing financial regulatory structure,
particularly in the area of bank holding company
supervision.
Before discussing some of these problems,
I would like to expound on four trends that
have shaped the events of the past 5 years and
that w ill be of continuing influence. These
include: (1) the condition of the economy,
(2) changes in the financial system, (3) changing
social values, and (4) changing attitudes toward
regulation and regulatory agencies.
TRENDS
Condition of the Economy

Probably the most notable change in the
condition of the economy (and the one that has
had the most far-reaching consequences) has
been the development and persistence of high
inflation rates. The problem began back in the
mid-1960s when Federal expenditures increased
sharply to finance the war in southeast Asia.
However, inflation did not take on serious
proportions until the early 1970s. Because of
the oil embargo of late 1973 and worldwide
shortages in key commodities and raw materials,
inflation took o ff like a rocket during 1973
and 1974, reaching double-digit levels. Although
the level of inflation has retreated, it still remains
at a level that in the long run will cause difficulties
to the stability of our financial system and
perhaps other sectors of our economy.
Partly as a consequence of high inflation rates,
partly as a consequence of the U.S. economy's
much closer linkage to world economies, and
partly because of other influences, our economy
has been subject to much greater instability
than at any time since the 1930s. This is
reflected in price volatility, international
weakness of the dollar, high unemployment
rates, fluctuating rates in the growth of our
economy, and numerous bank failures. The
prospect is that inflation and economic
instability will continue unabated.
Another factor that is bound to affect the
condition of our economy and the effects of
which are not yet clearly understood is the
changing demographic composition of the
American people and the labor force. Because
of sharp variations in the birth rate over the
last 40 years, the United States now faces the
prospect of a significantly older population
in the years ahead. This is bound to have
significant implications for the financial
system.

Changes in the Financial System

There are three discernible trends affecting
the structure of the financial system. These
trends have been at work for some time and
became particularly evident during the last
5 years. The first trend is growing competition
between financial institutions of all types
including not only banks and th rift institutions
but also insurance companies, finance companies,
mortgage banking companies, and other
providers of financial services. Among depository
institutions, there has been a movement toward
greater homogenization of powers. For example,
checking accounts and control over the Nation's
payments mechanism was once the sole domain
of commercial banks. With the advent of NOW
accounts, share-draft accounts, and other types
of third-party transaction accounts, th rift
institutions now compete directly with
commercial banks. This competitive climate
has implications for monetary policy control
as well as for relationships between various
types of financial institutions.
Technological developments — most notably
in the area of Electronic Funds Transfer—have
significant implications for the structure of
our financial systems. These developments have
led to the emergence of automated clearing
houses and regional and nationwide switching
networks to facilitate financial transactions.
By improving communications, such
technological developments have greatly
reduced geographical barriers to competition.
For example, an automated teller machine
allows a financial institution to enter a market
at far lower cost than if it had to erect a
brick-and-mortar office. In fact, point-of-sale
machines allow financial business to be
transacted in such places as grocery stores,
department stores, and the like. Although
this trend is evolving slowly, I expect that it
w ill eventually result in a substantial change
in the competitive and institutional structure
of the financial system. More and more States
have relaxed their restrictions on branching,
and I would not be surprised to see movement
toward interstate branching in coming years.
The bank holding company has already
provided a vehicle for interstate banking.
Change in managerial attitudes is a third
trend on which I would like to comment.
Bankers traditionally have been extremely
conservative and cautious about taking risks.
Such attitudes began to change during the
1960s as a new generation of bank managers
took over. The advent of the one bank holding
company in the late 1960s accelerated the




diffusion of the new aggressive, risk-taking
management style. Catchwords such as
"lia b ility management" and "go-go banking"
are illustrative. The severe recession of
1974-75, and the extreme liquidity pressures
that accompanied that recession, placed severe
stress on a great number of financial institutions.
The result was a movement back toward more
traditional banking attitudes. However, in my
opinion, this return to prudence has not been
accompanied by the excessive caution and
conservatism of the past.
Changing Social Values

During my term on the FDIC Board,
additional social legislation was enacted by the
Congress such as the Equal Credit O pportunity
Act and the Community Reinvestment Act.
This legislation mandates that regulators ensure
that financial institutions respond to the needs
of the Nation, particularly the needs of the
poor and ill-housed. This new regulatory mission
contains elements of consumerism, of civil
rights and social action programs, and of
traditional safety-and-soundness concerns. But
this new regulatory mission goes beyond this.
It amounts to a mandate to see that financial
institutions carry out their duties in the spirit
of public service.
This is particularly evident in the Community
Reinvestment Act. The Congress found that
regulated financial institutions have a
continuing and an affirmative obligation to
help meet the credit needs of their local
communities. The Congress required each
appropriate Federal financial supervisory
agency to use its authority when examining
financial institutions to encourage such
institutions to help meet the credit needs of
the local communities in which the institutions
are chartered.
Role of Regulation and Structure of
Regulatory Agencies

Federal regulation of banks has deep roots in
our Nation's history. The Federal role developed
originally in response to the need to fund the
Federal Government and to manage the Nation's
economy. This role grew over time as the
Nation's economy became increasingly complex
and more closely linked.
There is a growing consensus, however, among
those of all political persuasions that Federal
regulation of financial institutions may have
gotten out of hand. Yet, there is little consensus
on what to do about it. No one really favors
deregulation or regulatory reform in the abstract.
Rather, each one's position seems to depend on
the precise individual governmental action as

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it affects each person and that person's
perception of relative advantage or disadvantage
to be realized from the action.
I think we are all aware that regulation has
gotten out of hand. But, by this statement I do
not mean to convey the impression that the
scope of regulation can necessarily be reduced.
Rather, my concern is that given legitimate
regulatory objectives, we have not always
devised the most efficient regulatory mechanisms
to achieve those objectives. To complain about
paperwork is a way of venting frustration, but
that alone does not solve the problem. The
Federal supervisory role could be reduced if
effective alternative supervisory mechanisms
could be devised to accomplish those regulatory
objectives that are considered both necessary
and legitimate.
Another trend that seems to be gaining
momentum is reorganization of the Federal
financial institution regulatory structure. The
difficulties of the early 1970s and the failure
of several large banks prompted agency officials,
members of Congress, and others to join in
debate on restructuring the regulatory system.
Although such discussions have taken place for
decades, they have always waxed and then
j waned. This time, however, serious discussions
have been going on for nearly 4 years and,
I rather than interest lessening in various
structuring proposals, the prospect of serious
action is becoming more likely.
For example, the FDIC and the Office of
the Comptroller of the Currency have called for
consolidation of bank holding company
regulation and supervision. The FDIC has
suggested in recent testimony that the Federal
Reserve's monetary policy function may
interfere with its supervisory function and has
pointed out that there does not seem to be any
real reason to link the two. Senator Proxmire,
as you may know, has proposed that all bank
supervision be consolidated in a single Federal
agency. The financial regulatory agencies, in
fact, recognizing the need for more formal
coordination, have set up an Interagency
Supervisory Committee. This Committee serves as
a forum for discussing supervisory matters of
common interest and for working out jo int
solutions.
To the extent that the trend toward greater
homogenization of our financial institutions
continues, it seems inevitable that we will
move toward a simpler and more streamlined
Federal financial institution regulatory structure.




PROBLEMS

As I stated at the outset, there are many
problems in our present financial system that
have not yet been resolved. These problems are
linked generally to the four broad-based trends
that I have been discussing. I would like to
explore a number of these problems with you
and suggest to you my thoughts on appropriate
resolutions.
Interest Rate Ceilings

There was a time when the existence of interest
rate ceilings had very little effect on financial
institutions. However, the sharp increases in
inflation and interest rates during the last few
years have caused financial institutions
considerable difficulty. For example, lending
rates on loans frequently have bumped up
against State usury ceilings. The problem has
been particularly acute in th rift institutions.
Rates that these institutions pay on deposits
tend to adjust to market rates of interest very
rapidly, but rates that th rift institutions earn on
their assets adjust much more slowly, thus
placing them in a serious earnings squeeze.
One way of avoiding such an earnings squeeze
is setting deposit interest rate ceilings below
market rates. Interest rate ceilings, and
particularly the interest rate differential favoring
th rift institutions, have also been supported as
devices for allocating funds to the housing
industry. In my opinion, interest rate ceilings on
deposits simply do not work well as a device for
allocating funds to housing. Although ceilings
may protect th rift institutions from commercial
bank competition to a certain extent, they do
not protect th rift institutions from competition
from unregulated money markets. A t times of
high interest rates, such as in 1973-74, many
depositors take their funds out of depository
institutions and invest them directly into money
market instruments. As a result of such
disintermediation, the mortgage market dries up
and th rift institutions in particular suffer
earnings and liquidity pressures.
Even if ceilings an deposit interest rates were
effective in ensuring a stable flow of funds to
the housing market, ceilings would still be
highly objectionable because they constitute
a regressive and inequitable tax on small savers.
I have recommended on numerous occasions
that the appropriate policy is to select a date
when all interest rate ceilings will cease to
exist. The time for doing this is already running
short because nonregulated institutions such
as Sears and Merrill Lynch increasingly are

competing vigorously for the depositor's dollar.
I have also strongly recommended that the
prohibition of interest on demand deposits be
repealed.
It is my firm conviction that free competition
for deposits w ithout price controls w ill remove
an important need for regulation as well as
result in a much more efficient economic
system.
Capital Adequacy

Another direct consequence of inflation has
been declining capital ratios. These ratios
cannot continue to deteriorate w ithout eventually
seriously weakening the financial condition of
many financial institutions and w ithout impairing
their ability to absorb unexpected setbacks and
to strongly and aggressively compete.
Capital positions are supplemented prim arily
through retention of earnings. When the rate of
earnings retention is less than the rate of asset
growth, as is customarily the case during periods
of high inflation, capital ratios necessarily
decline. The best solution would be to get
inflation under control. Obviously this is easier
said than done. If inflation remains a persistent
problem, declining capital ratios could be
arrested by: (1) higher earnings rates on assets,
(2) slower growth in total assets, or (3)
additions to capital from sources other than
earnings retention.
The record to date indicates that none of
these solutions is particularly attainable. Thus,
I must say that I am pessimistic about the future
prospects for success. The best hope in the long
run is to solve the problem of inflation.
Bank Failures

Today, in the aftermath of the most severe
recession since the 1930s, and after 46 bank
failures in my 5 years on the FDIC Board of
Directors, including the 10 largest failures in
the Nation's history, it is clear that the FDIC
has succeeded in its mission to maintain confidence
in the financial system. We learned during this
period that disclosure of banking problems did
not shake public faith in banks. While the press
and even some bankers, Members of Congress,
and bank regulators fretted publicly about the
soundness of our banking system, the public
even in those areas where it was known that a
failure was imminent responded with confidence
and not with panic.
Notwithstanding my belief that the deposit
insurance mechanism has served the banking
system and economy well and that it represents
an example of governmental response that has
not proved unduly costly and burdensome—based
on the FDIC's experience in recent years, I




believe certain changes to the Federal Deposit
Insurance Act should be considered which would
increase the FDIC's fle x ib ility in responding
to unique situations, particularly those that
arise in very large banks. Where it is clear that
an insured bank is insolvent or likely to become
insolvent and where it is impossible to arrange
an acquisition w ithout FDIC assistance, there
are four options: (1) the FDIC may make loans
to purchase the assets of or make deposits in an
insured bank to reopen it or to keep it open,
provided that continued operation of the bank is
"essential to provide adequate banking service
in the com m unity," (2) the FDIC may assist
another bank with the purchase of assets and
assumption of liabilities of a closed bank or a
bank that is about to be closed, (3) the FDIC may
create a deposit insurance national bank (DINB)
to assume the insured deposits and the
fully-secured deposits of a closed bank, or (4)
the FDIC may pay o ff all insured deposits of a
closed bank.
Historically the FDIC has used either the
purchase-and-assumption method or the payoff
method. The purchase-and-assumption method
is used whenever feasible because it causes less
disruption in a community than does a payoff.
Deposit Insurance national banks have been
created only four times since 1945, and
assistance to an open bank has been extended
only four times since the authority was conferred
on the FDIC in 1950. Both of these methods
are seldom used because of extremely restrictive
requirements or conditions imposed by the
statutes. For example, the statutory test
"essential to provide adequate banking service
in the com m unity" in the case of assistance to
an open bank can seldom be met. A DINB is
in effect a soft-landing payoff. The bank has
limited powers and must be closed at the end
of 2 years if sufficient capital cannot be sold.
The deposit payoff and purchase-and-assump­
tion methods also have their disadvantages,
particularly in the case of large bank failures.
On the one hand, a straight payoff for a
bi 11ion-dol lar bank could cause hardship to
people who rely on an on-going relationship
with their banker, and who normally keep both
debit and credit balances. A straight payoff
could also disrupt the financial markets. On the
other hand, a purchase-and-assumption can
raise serious antitrust problems. Also a
purchase-and-assumption has to meet the "cost
test" described in the statute; that is, the
FDIC has to show that the takeover would
cost the Corporation less than would a simple
payoff.

It seems to me that Congress needs to update
the FDIC's powers to deal with failing bank
situations. Several possibilities should be
considered:
(1) Some Form of Corporate Reorganization

Under regular bankruptcy rules, a debtor
corporation can rehabilitate itself through a
corporate reorganization by having claims and
debts scaled down. Such a procedure might be
applied to the uninsured liabilities of large banks.
(2) Less Restricted Conservatorship Powers

A deposit insurance national bank provides
very restricted conservatorship-type powers.
Relaxing the existing restrictions could provide
the FDIC the fle xib ility it does not now possess
to rehabilitate a troubled institution.
(3) Emergency Access to the Federal Reserve
Discount Window

Emergency borrowings from the Federal
Reserve Discount Window could be made
available to a bank upon certification of the
FDIC that the bank is in danger of failing and
that such assistance is necessary for a temporary
period until a merger, a receivership sale, or some
other orderly resolution of the bank's problems
is arranged.
(4) Expanded Authority to Assist an Open
Bank

The FDIC could be permitted to provide funds
on a medium to long term basis to an open bank
subject to specified guidelines.
(5) Override the “ Cost Test" in Certain
Instances

The FDIC could be allowed to disregard the
cost test if it finds that its loss from a purchase
and assumption of a closed bank is clearly
outweighed by the public interest in preventing
disruption to the community, in preventing
substantial lessening of competition, or in
contributing significantly to the convenience
and needs of the community.
(6) Interstate Branching

The Comptroller o f the Currency could be
empowered to authorize branches across State
| lines when the FDIC certifies to the Comptroller
that the establishment of such branches is
essential to facilitate a purchase-and-assumption
transaction.
Obviously these and other proposals for
improving the techniques for dealing with
troubled banks should receive careful study
before Congress acts. Although the financial
system probably w ill continue to function
I adequately if the FDIC's powers remain as they
I are, it is my hope that serious attention w ill be
I given to streamlining and modernizing FDIC




powers for dealing with banks in danger o f
closing. Based on experience I can confidently
state that such streamlining and modernization
would greatly facilitate smoother functioning
of the financial system in times of d ifficu lty and
stress.
Other Problems

There are several other problems that if dealt
with properly would lessen the need for
regulatory oversight and would sim plify the
regulatory process. These include:
• Simplification of the Truth-in-Lending Law,
• Simplification of other statutes and
regulations,
• Supervision of all bank holding company
affiliates by’one Federal agency,
• Simplification of the Federal regulatory
structure,
• Improvement in the quality of State
banking departments,
• Extension of interest bearing transaction
accounts to all financial institutions,
• Broader lending powers for th rift institutions,
• Curtailment of insider abuse and adoption
of codes of ethics,
• More effective communication between
financial institutions and the communities
they serve,
• Management of structural change in the
financial system brought about by
technological changes in the payments
mechanism, and
• Resolution of Federal Reserve System
membership attrition.
This list is hardly an exhaustive one. It is my
hope that financial institutions, supervisory
agencies, the public, the Congress, and the
Government as a whole w ill address each of
these problems in considered fashion and
develop resolutions that enhance the
fle x ib ility and efficiency of our financial and
economic systems.
In closing, I would like to voice a note of
caution as articulated by James Madison more
than 2 centuries ago:
''I t will be of little avail to the people that
laws are made by men of their own choice
if the laws be so voluminous that they cannot
be read, or so incoherent that they cannot be
understood; or if they be repealed or revised
before they are promulgated, or undergo
such incessant changes that no man, who
knows what the law is today, can guess
what it w ill be like tom orrow ."




FEDERAL
550

DEPOSIT

1 7 1h S t r e e t ,

INSURANCE

N.W.,

CORPORATION

Washington,

D.C.

20429