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Fofrelease on delivery Statement by J. L. Robertson Vice Chairman, Board of Governors of the Federal Reserve System before the Committee on Banking and Currency House of Representatives April 18, 1969 I heartily endorse President Nixon's recent statement urging that one-bank Holding companies be brought under the Bank Holding Company Act of 1956, and largely for the same reasons he voiced - to avoid erosion of the traditional separation of powers between suppliers of money (banks) and users of money (commerce and Industry), and to preclude the concentra tion of economic. power in a few hands. Background Lest we forget the lessons of the past, it Is worthwhile to review the historical background. not new. The one-bank holding company device is In tho 1920s and early 1930s banks utilized the corporate device as a means by which to engage in forbidden nonbanking activities. This was dramatically disclosed in hearings conducted by the Senate Banking Committee from January 1933 to July 1934 - the so-called "Pecora Investi gation", after Ferdinand Pecora, Chief Counsel of the Committee. During that investigation, the heads of the largest New York City banks freely admitted that affiliates had been organized for the avowed purpose of enabling their Institutions to engage In operations that were prohibited to the banks themselves. The Committee's Final Report, refer ring to the use of the holding company device, concluded: "Possessed with this instrumentality that enabled these bank ing institutions to conduct a business and indulge in practices which governmental authority through legislative enactment had forbidden to commercial banks, these banking institutions, infected with speculative fervor, indulged in practices and transactions which had the direst consequences." Even before the Pecora Investigation was completed, provisions of the Banking Act of 1933 required the separation of member banks from securi ties companies and provided for limited regulation by the Board of Governors of so-called "holding company affiliates" of member banks. 2The regulation provided by the 1933 Banking Act proved inadequate. Except that it could not engage in the securities business» a holding com pany affiliate of a member bank was not precluded from engaging in a variety of nonbanking enterprises; the law required only that the holding company obtain a voting permit from the Board in order to vote the stock of banks controlled by it. In its 1943 Annual Report to Congress» the Board expressed concern over the growth of conglomerate bank holding companies. Among other things, the Board stated: "Accepted rules of law confine the business of banks to bank ing and prohibit them from engaging in extraneous businesses such as owning and operating industrial and manufacturing concerns. It is axiomatic that the lender and borrower or potential borrower should not be dominated or controlled by the same management. In the exceptional case, the corporate device has been used to gather under one management many different and varied enterprises wholly unallied and wholly unrelated to the conduct of a banking business". Two years later, in 1945, the Board recommended a bill to provide for control of bank holding companies, both with respect to their expansion in the banking field and with respect to their interests in nonbanking businesses. During the next 10 years, the Board consistently supported legislation based upon a one-bank definition of a bank holding company. In testifying on one of those bills in 1953, I made this statement regarding the logic of covering one-bank as well as two-bank holding companies: "If there is merit in the proposal that you should separate banking from nonbanking businesses, it is just as important that you do it In a 1-bank case as in a 2-or-more bank case. "For example, if a holding company controls, we will say, the largest bank in the world, and has nonbanking interests, it may be even more Important to cover that sort of a situation than one where a holding company has 2 or 3 or 4 little banks and some nonbanking businesses." -3- Nevertheless, as finally enacted in 1956, the Holding Company Act excluded one-bank holding companies from its coverage. As a matter of equity and logic, the Board, since 1956, has consistently recommended one-bank holding companies be brought under the law. Only in the past year or so, however, has the need for such action become con spicuously more than a matter of logic. Reminiscent of the situation spot lighted by the Pecora investigation, numerous one-bank holding companies have been organized by banks in recent months solely to enable such banks to engage indirectly in activities in which they cannot engage directly. Grandfather clause Both H.R. 6773 and H.R. 9385 would expand the scope of the Act to cover one-bank holding companies. However, the latter would permit such companies to retain nonbank interests held by them on June 30, 1968. In my opinion, such a "grandfather claase" has no justification - either in logic or from the standpoints of principle and practicality. Principle. Potential or actual conflicts of interests are present regardless of whether the holding company controls just one bank or controls two or more banks. To illustrate, a few years ago a large nonbanking corpor ation purchased a $1 billion bank. If that corporation had acquired, instead, two small neighborhood banks with aggregate resources of $30 million, let us say, the Act would have required it to terminate its nonbanking activities and to dispose of the stock of any nonbanking subsidiaries (except to the extent permitted under the exemptions prescribed in section 4(c) of the Act). -4- Certainly whatever risks to the economy inhere in common corporate ownership of nonbanking subsidiaries and two banking offices with $30 million of re sources are at least equally significant where a corporation with extensive nonbanking interests also controls one billion-dollar bank with scores of branch offices. In 1956 Congress required holding companies to divest themselves of nonbanlc enterprises that had been held long before the first whisper of the idea of Governmental regulation of bank holding companies. The reason was the threat of potential evils in common ownership, and that danger is equally present in one-bank holding companies. It might also be noted that in 1966 Congress expanded the Act to cover, for the first time, the Financial General Corporation system and certain trust situations (for example, the duPont Estate). Even though those organizations had expanded their nonbank interests during the preceding decade in reliance on their "exempt" status, Congress required them to divest all nonbank interests, without benefit of any permanent "grandfather" privileges. I can see no reason for adoption of a different policy in 1969. Practicality. It is questionable whether any effective grand father clause could be devised. For example, H.R. 9305 would forbid a company within the grandfather clause to engage in any "business or activ ities" other than those in which it was engaged on the cut-off date June 30, 1968. I have in mind an existing corporation that owns more than a 25 per cent interest in a large national bank, and is, therefore, a one-bank -5holding company. It also is engaged, through subsidiaries, in oil production, refining and marketing; natural gas production and processing; chemical manufacturing; producing paper board and packaging products. It also owns an office building, a commercial parking lot, and an insurance company. Being engaged in exploration for oil and gas in certain areas of Colombia and Nigeria, would the grandfather clause permit it to engage in explora tion in other parts of those countries, or in Ghana or Indonesia? Would its chemical manufacturing company be permitted to develop new products? May its insurance company, which presently engages in life, health, and accident insurance principally in one State, for the company’s employees, expand into new markets? If the answer to such questions is affirmative (and a negative answer to some of them would be ludicrous), the grandfather clause actually would constitute a broad exemption permitting holding companies to expand their nonbanking operations. Only if such a company sought to enter a line of commerce totally unrelated to its business last June might there be a problem with the Holding Company Act. On the other hand, if the answers to such questions were negative - that a company could conduct only those precise operations that it was engaged in on the cut-off date, or could engage in such additional business only with prior Governmental approval the situation would become operationally impossible from the standpoint of a company and its subsidiaries and administratively impossible from the standpoint of the Government. -6- Expahston of powers of banka and holding combanies I do not wish to imply that I believe banks or holding companies should be kept in a strait jacket. Certainly they should be permitted to offer new services - but such services should be banking services. For example, I believe that it is appropriate for banks to be in the credit card business. The use of credit cards represents a modern method by which credit is extended. Since banks are principally engaged in the business of extending credit, enabling legislation was unnecessary. However, when Congress has clearly limited the powers of banks, they should not be permitted to circumvent such limitations either through sub sidiary corporations or through affiliation in a holding company system. If the limitation is to be removed or modified, it should be by Congressional action. Before Congress does act to alter a limitation, it should decide whether the proposed activity is appropriate for banks to engage in directly. If so, the law should be changed in order that they may do so themselves, as well as through a subsidiary or through an affiliate in a holding company. In other words, I believe that it is undesirable to consider in isolation a proposed expansion of the types of activities in which a holding company may engage - which H.R. 9385 would do under a broad delegation of authority by the Congress to the supervisory agencies. Consideration should be given at the same time to whether the powers of banks should be expanded directly or through subsidiary corporations. The desirable procedure, from my point of view, for effecting any expansion of the business of banking that Congress might consider appropriate is to amend section 5136 of the Revised Statutes relating to the powers of national banks. To the extent any such amendment would authorize such banks to invest in stock, it would automatically remove Federal limitations on the investment powers of State -7- member banks and permit holding companies, under section 4(c)(5) of the Holding Company Act, to invest in stock of the kinds made eligible for invest ment by national banks. In determining whether additional banking activities should be permitted, the basic questions should be whether it (1) is part of the evolu tionary growth of banking and (2) yields benefits to the public interest in the form of more efficient and economical service. Before extending the powers of banks, Congress should assure itself that there are adequate safe guards against potential evils. This might require accompanying legislation designed to protect against such matters as undue concentration of economic power, anticompetitive tie-in arrangements - which are specifically covered in both bills here under consideration - and a decline in the quality of services or credit. After evaluation of the benefits and risks of a particu lar activity and the necessary safeguards, those areas in which the considera tions favor bank entry should be specified by statute - or, in the alternative, the task could be specifically delegated to an administrative agency, subject to whatever guidelines the Congress considers appropriate. Generally speaking, I personally do not favor forcing banks into a holding company system as a condition for engaging in an activity. Rather I believe that bank holding companies - like "operations subsidiaries" should be regarded principally as a convenient alternative organizational arrangement for performing activities that banks may perform themselves. If the activity is not one that banks should be permitted to engage in directly or through a subsidiary corporation, I question whether a bank holding company should be permitted to engage in the activity. As I pointed out last week in St. Louis, banks should not "foray from a protected sanctuary to compete - 8- (either directly or via an affiliate) with enterprises which operate in a free-entry environment and which must use banking services." There might be situations, however, where the only reason that an activity is inappro priate for a bank to engage in directly is the undue risk that would be placed on depositors' funds. In those situations I would favor permitting the bank to perform the activity through a wholly-owned subsidiary or an affiliate in a holding company system. Courts ordinarily respect the separate ness of corporate entities in the event of insolvency, and accordingly de positors' funds are less at risk when a bank engages in business through subsidiaries and affiliates. Fragmentation of administration of the Holding Company Act If I fail to convince you of anything else, I hope that I can succeed in buttressing what must be your reaction to the provisions of H.R, 9385 by which authority to administer the Holding Company Act would be fragmented among the Board, the Federal Deposit Insurance Corporation, and the Comptroller of the Currency. Perhaps the most important substantive legislation that the 91st Congress has so far enacted extends the President's authority with respect to reorganization of Federal agencies (P.L. 91-5). In that legislation, "Congress declares that the public interest demands the carrying out" of the following purposes (set forth in section 901 of Title 5 of the United States Code): "(1) to promote the better execution of the laws. . . and the expeditious administration of the public business; "(2) to reduce expenditures and promote economy to the fullest extent consistent with the efficient operation of the Government; "(3) to increas Government to the fu "(4) to group, tions of the Governm purposes; Æncy of the operations of the ^practicable; md consolidate agencies and funcy as may be, according to major "(5) to reduce the number of agencies by consolidating those having similar functions under a single head . . . ; and "(6) to eliminate overlapping and duplication of effort." These are the words of the Congress of the United States. Consis tent with the policy of that legislation I have for several years urged the unification of Federal bank supervision in a Federal Banking Commission. As Chairman Martin told you when we were here together last fall to discuss the Board's change of position on "operations subsidiaries" and "loan production offices", I would enjoy making a speech on the Federal Banking Commission, and I would be glad to come back here at any time and do so. Today, I shall limit myself to pointing out that the fragmentation of administration of the Holding Company Act that would result from enactment of H.R. 9385 is a step in exactly the opposite direction. It would be contrary to the policy and purposes of the legislation relating to executive reorganization. The fragmentation in H.R. 9385 is not made unobjectionable by the requirement that three agencies unanimously agree on the types of new activités in which holding companies may engage and by the requirement that the agencies act in accordance with guidelines agreed upon unanimously. The requirement for unanimous agreement as to activities of companies in which holding companies may invest and as to guidelines for approval of such investments would, in my opinion, simply lead to an impasse in many instances, with the result that no action could be taken and the purposes of the legislation could be defeated - or in desperation the agencies would work out a compro mise based on the lowest common denominator. Viewed realistically, a more fundamental shortcoming is that even the best regulations and guidelines are subject to interpretation. one agency would take a more "liberal" view than another. Inevitably, Despite the 10 requirements of unanimity on types of activities, and guidelines, in the end a single agency would have the authority to act. If the applicant were a one-bank holding company and did not like the result, it might convert the bank's charter and try another agency. If the applicant were a plural-bank company, it might be able to shift from the jurisdiction of one agency to another by converting one of its banks from State to national, or vice versa. In my view it would be umri.se for Congress to saddle the bank supervisory agencies with the responsibility of trying to make workable a fragmented administration of the Holding Company Act, such as is proposed in H.R. 9385. In 1963, in testifying before your Subcommittee on Bank Supervision on the proposed unification of Federal bank supervision, I asked: "Why should we continue to muddle along with such an awkward, inefficient, expensive arrangement, rather than adopt a simple and obvious solution that is better in every respect?" Surely Congress does not want to make Federal super vision even more clumsy and ineffective than it is already. It has been said that the dispersal of authority among the agencies merely follows the traditional pattern of legislation in the banking field. In fact, however, H.R. 9385 would introduce for the first time a fragmenta tion of authority for regulation of bank holding companies. Even if one subscribes to tripartite Federal supervision of banks, the division of authority proposed in that bill is not within that pattern. We are concernod here not with supervision of banks but with supervision of bank holding companies - a responsibility that heretofore has been vested in a single agency. -11 Conclusion To summarize my views on the major issues: (1) One-bank holding companies should be brought within the Holding Company Act; (2) There is no justification for a "grandfather clause"; (3) The powers of banks - as well as of holding companies - should be expanded to the extent Congress considers appropriate; and (4) Administration of the Holding Company Act should continue to be vested in a single agency. H.R. 6778 is consistent with these views. I recommend its approval with the modifications suggested in the last few pages of Chairman Martin's statement.
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