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Remarks by

John P. LaWare
Member, Board of Governors of the Federal Reserve System
to the

Houston Rotary Club

January 20, 1994
Houston, Texas

I am very pleased to be in Texas today to address the
Houston Rotary Club.

I intend to begin by briefly reviewing the

performance of the economy last year and, on the basis of that
review, offer a few comments on the economic outlook for the
coming year.

I will then turn to a very important issue on which

I am spending a good deal of my time these days.

I refer to the

Treasury's proposal to consolidate federal supervision of the
banking system into a single federal agency.

As you may be

aware, the Federal Reserve is strongly opposed to that proposal.
Accordingly, after consultation with my colleagues, I have
advanced an alternative that would keep the Federal Reserve
directly involved in the supervision of banking organizations and
avoid other serious drawbacks in the Treasury's proposal.
same time, I believe

At the

my proposal would achieve most, if not all,

of the benefits of the Treasury's scheme.
-oThe economy ended 1993 on a relatively strong note.
Following a weak first half of the year, growth picked up to a
three percent annual rate in the third quarter and appears to
have accelerated further in the fourth quarter.

The consensus

view of economists, I understand, is that the pace was about four
percent or a bit higher.

If that estimate proves to be close to

the mark, the growth rate for the year will be about two and a
half percent, in line with the relatively modest pace set in
earlier years of the current recovery.
That pace of advance, relatively slow compared with
earlier periods of economic recovery, is the result of a number

of factors that have dampened the current rebound in economic

Many of these factors reflect corrections of

imbalances from the 1980s.

They include efforts by businesses

and consumers to reduce debt and restructure their balance
sheets, greatly diminished activity in the commercial real estate
sector because of past overbuilding, and a credit crunch in
certain regions where banking institutions reacted to substantial
losses in their loan portfolios that began to show through
clearly in the late 1980s and beyond.
Other factors have also worked to mitigate the strength
of the recovery.

Businesses have found it necessary to continue

to down-size their work forces and to cut other costs to improve
their ability to compete here and abroad.

Reductions in defense

spending have also caused costly transitions for firms and
individuals involved with that sector of the economy.

All of

these developments heightened consumer anxiety, particularly with
respect to long-term prospects in the job market.


weaknesses in the economies of our key trading partners,
including Canada, Germany, the U.K. and Japan with obvious
implications for the growth of exports, have been another
important factor responsible for the relatively slow recovery.
There are signs, however, that the negative effects of
at least some of these factors are waning, while more positive
forces are gaining momentum.

First, and from the perspective of

a central banker, perhaps most importantly, inflationary
pressures eased a bit further last year.

The steady success in

bringing inflation under control in recent years has been of
prime importance in promoting the economic recovery as it
reinforced confidence in the fundamental stability and fairness
of our economic system.
Low inflation has also paid another major dividend in
the form of the lowest U.S. interest rates in two decades.
Consumers have seen their mortgage costs decline substantially
either through a decline in rates paid on adjustable-rate
mortgages or through refinancings.

Businesses have also

benefited not only by refinancing their maturing and callable
debt at lower rates, in markets made more attractive by lower
interest rates but also by issuing significant amounts of new

These actions have helped both businesses and consumers

strengthen their balance sheets and have stimulated spending on
new homes, autos, machinery and equipment.
Low rates have also had a salutary effect on the
nation's banking system.

As rates have fallen over the past

three years, banks have been able to widen their interest margins
and at the same time make substantial progress in working through
their problem loan portfolios.

During 1993, these events enabled

the banking industry to exceed its 1992 record performance in
just the first nine months.

That, together with favorable

capital markets conditions, allowed the industry to strengthen
its capital base through retained earnings and new issues.


are now in a very solid position to provide credit when demand
for loans picks up.

On balance then, these factors just reviewed combined
to produce another year of moderate economic growth that not only
lifted incomes but also provided over two million new jobs.


all this was accomplished with inflationary pressures not only
held in check, but actually reduced to some extent.

There are a

number of indicators that suggest that growth is continuing in
the current quarter, though perhaps not at as brisk a pace as the
fourth quarter of 1993, now estimated by some to have been five
percent in terms of real GDP.

Favorable indications are new

orders for manufactured goods, automakers' assembly schedules and
durable goods production in the fourth quarter.
are also favorable.

Housing starts

Indicators of consumer sentiment also

suggest that consumers will support further growth in the

Retail sales are up.

Taking all these factors into

account, I think it safe to conclude that the economy will
continue a pattern of modest non-inflationary growth in 1994.


would expect real GDP to grow at a rate of 3-3.5 percent for the
year with inflation edging down to 2.5 percent barring any
The downside risks relate to job anxiety created by further
corporate re-engineering and defense cutbacks.

There are also

the possible dampening effects of higher taxes and the remaining
uncertainties about the Administration's health care proposal and
how it will be financed.

These are real concerns, but hard to

quantify in the current environment.

I would like to turn now to the subject of reform of
the bank regulatory structure and the Administration's proposal
for creating a single, monolithic regulator for the banking

Let me say at the outset that I find it disturbing that

the issue of consolidating the regulatory agencies is at the top
of the current banking legislative agenda.

There are other

banking reforms that would have more profound and salutary
effects on modernizing our financial system, while relieving the
regulatory burden on banks.
In particular, there is a great need to repeal
antiquated laws that prevent banks from efficiently competing in
the broader financial services area.

Banks should be permitted

to offer a broad range of securities and insurance products,
provided they have the financial strength and management ability
to carry out these activities in a safe and sound manner.


is no reason to think that they would not be able to do so.


multi-purpose financial institutions have been successfully
operating in Europe for years without major incident.


these lines we need to give serious consideration to a zero-based
reassessment of our financial system.

We should in my opinion,

not only permit but encourage the integration of our financial
system to permit affiliation under common ownership of financial
institutions of all kinds in order to remain competitive with a
rapidly integrating financial system in other countries.
There is a compelling need to allow banks to branch on
an interstate basis.

Interstate banking, through the holding

company structure, is already a fact of life in the United

In that established context it makes no sense to

prohibit organizations that wish to do business across state
lines from having the choice of selecting the organizational
arrangement that they believe will best enable them to serve the
needs of their customers while minimizing their operating costs.
Another piece of needed legislative reform would be the
lifting of burdensome regulations that are mandated by statute.
For example, there are important sections of the

Federal Deposit

Insurance Corporation Improvement Act that, while wellintentioned, tend to result in an inappropriate and unnecessary
micro-management of the way banks conduct their day-to-day

Even a cursory review of that onerous statute would

suggest a myriad of opportunities.
With those points made, let me now turn to the
regulatory restructuring proposal put forward by the Treasury.
To begin with, my colleagues and I share the view of the U.S.
Treasury that there is need for reform.

The current regulatory

structure of four separate agencies supervising insured
depository institutions undeniably results in duplicative
examinations and overlapping responsibilities that are not only
burdensome and inefficient but terribly confusing to the banks.
Something should be done to correct this situation.


the current environment, with its particular sensitivity to the
costs and burdens of government regulation, perhaps offers an
especially good opportunity to achieve that end and I sense that

Congress is willing to act favorably if offered a rational
The Treasury's proposal to address the shortcomings I
have just cited would combine the authority currently vested in
the four bank and thrift regulators —

that is, the Office of the

Comptroller of the Currency (OCC), the Federal Reserve, the FDIC
and the Office of Thrift Supervision (OTS) —

into a single

On the surface, the proposal has a seductive appearance

of simplicity and enlightened government reform.


examination, however, reveals that it is seriously flawed.
That proposal, by removing the Federal Reserve from the
bank supervision process, would seriously compromise the central
bank's ability to carry out its responsibilities for resolving
crisis situations in the financial system and to formulate and
conduct monetary policy.

My colleagues and I believe that a

daily hands-on involvement in supervisory matters is essential if
we are to be able to move quickly and effective to deal with
financial crises when they arise. In a time of financial crisis
there is no leisure to study someone else's analyses.


central bank must move quickly and decisively, often in a matter
of hours.

Penn-Central, Drexel, the 1987 market crash, and the

S&L runs in Maryland and Ohio are good examples.
We also believe that the Federal Reserve adds important
value to bank supervision because it brings to the process a
unique perspective gained from carrying out our other central
bank responsibilities.

I believe the framers of the Federal

Reserve Act recognized the important synergies to be gained from
having the central bank actively and directly involved in bank
supervision. In the Act's preamble they wrote that one of its
purposes was, "to establish a more effective supervision of
banking in the United States."

That says it all.

Another serious flaw in the Treasury's proposal is that
the single regulator would result in unintended but seriously
adverse consequences.

As Chairman Greenspan has noted, a

monopoly regulator would surely become entrenched and inflexible

as has proven to be the case with other monopolies.

And that

inflexibility would be all the more worrisome because the
regulator would not have responsibility for economic

Thus, it might well be inclined to swing between

extreme toughness and ease as it reacted to cyclical complaints.
Such swings in supervisory policy could tend to exacerbate
instabilities in the economy.

A review of one agendy's S&L

supervision is illustratsive of this point.
The establishment of a single federal regulator would
undermine our traditional dual banking system.

Indeed, without a

choice of federal regulators, the dual banking system would
become merely an historical artifact.

Under a single regulator

the opportunity for useful regulatory experiment and the safetyvalve protection against inflexible supervisory policies would be
In short, it is important that the central bank, with
its responsibilities for economic stabilization and crisis

management, have a significant and meaningful role in bank

While some consolidation of the banking agencies is

appealing creating only one supervisory agency could produce
inefficiency and rigidity and ultimately destroy the role of
states in bank supervision under a system which has served the
country well for 131 years.

Incidentally, we would oppose a

single regulator even if it were the Federal Reserve.
Taking these points into account, I have developed, in
close consultation with my colleagues at the Board, a proposal
that I believe will achieve most, if not all, of the goals of the
Administration's plan without having the adverse consequences
that we see.
My proposal essentially consists of five components.
First, merge the Office of Thrift Supervision and the Office of
the Comptroller of the Currency as has already been recommended
by many observers.

Currently, they both report to Treasury.

Second, remove the FDIC as an examiner of healthy institutions
and focus its energies on the insurance function —

that is, on

assuring that the fund's financial strength is maintained through
the collection of adequate premiums and by the prompt and costeffective resolution of failed banks and thrifts.
Third, reduce regulatory burden and duplication by
having one, and only one banking agency, responsible for
performing a comprehensive examination of each banking
organization —

that is a holding company parent as well as all

its bank and nonbank subsidiaries.

That change eliminates a

burden that many banking organizations find particularly

Responsibilities would be divided between the

Federal Reserve and a newly formed Federal Banking Commission
comprising the newly merged OCC and OTS.

The Commission would

examine any organization whose lead, or largest, depository
institution is a national bank or thrift.

The Federal Reserve

would examine any institution whose lead bank is state chartered.
Fourth, make an exception to the rule of only one
examining agency per banking organization in the case of a group
of banking organizations that are particularly important to the
stability of the financial system —

35 or so, perhaps.


those institutions, the Federal Reserve would conduct examination
of the holding company and its nonbank subsidiaries, as it does

Importantly, the insured depository institutions of these

organizations would still be examined by only one of the two
agencies depending on whether the lead bank has a federal or
state charter.
Fifth, keep the Fed as the rulemaker for bank holding
companies and the supervisor and regulator of foreign banks
operating in the United States.
For insured depositories, the Banking Commission would write
rules for national banks and thrifts while the Fed would write
federal rules for state banks with the requirement that both
agencies make their rules as mutually consistent as possible.
The key benefits of my proposal can be summarized as

First, it reduces the number of federal regulators from

four to two.

Second, it further reduces regulatory cost by

achieving one examiner per organization.

Third, it maintains the

healthy process of dynamic tension in bank rulemaking but with
fewer regulators, reducing the chance of delay and stalemate.
Fourth, it preserves the dual banking system by having separate
federal supervisors and regulators for state banks and national
banks and allowing banks to continue to have a choice of federal
supervisors through a change of charter.

Finally, it does not

dilute the ability of the central bank of the United States to
forestall and manage financial crises, to formulate prudent
monetary policy, and to influence the development of supervisory
and regulatory policy.
In conclusion, both the economy and banking system are
continuing to improve, and the near-term outlook is favorable for

However, we can be assured that there will be challenges

and crises to face in the years ahead.

Let us hope that when

1994 draws to a close we will have a central bank that is as
fully able to perform its role in the economy and in the
financial system as it is today.

We intend to make every effort

to assure that result.