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Remarks by
John P. Laware
Member, Board of Governors
of the
Federal Reserve System
at the
National Bankers Association Convention
Boston, Massachusetts
September 8, 1988

I have been asked in these remarks to comment on the
banking system or perhaps,

more broadly,

the financial

system, and on the current and future outlook for small and
medium-size banks, particularly minority banks.

I am happy

to do so, but I must impose some caveats, the purpose of
which I am sure you will understand.

You have before you today the oldest "new kid on the
block" in the Federal government.

I am still trying to find

m y way around the halls and remember the names of the people
I meet.

I would not presume, therefore, to speak in any way

2

for the Board of Governors.

In any case, the Chairman is

the proper spokesman for the Board, not I.

So, let it be understood that the opinions expressed by
me are mine alone, not those of the Board.

They have been

developed by me over thirty-five years of broad experience
in the banking system and represent m y best judgment of the
situation today and the outlook for the years immediately
ah e a d .

Let's start with the broadly defined financial system.
I would include in that

term commercial banks,

thrift

institutions, credit unions, non-bank banks, mutual funds,
investment banks, securities brokerages, finance companies,
and

the

securities,

exchanges.

commodity,

futures,

and

currency

In short, the financial infra-structure of our

economy and a large part of the world economy.

In the

last fifteen years or

so that system has

undergone enormous change and has been challenged more
severely than at any time in the last fifty-five years.

Consider with me the changes:

3

- First, instant global communications have integrated
our money and capital markets with those of every other
trading center around the world.

As a result, currencies,

securities, commodities and futures contracts of all kinds
are being traded on a twenty-four-hour basis.

If you miss

the closing bell in London, New York is open and if you
don't like the tone there, wait a bit and Tokyo will be up.

- Second,
underlined

integration

the

growing

of

financial

inter-dependence

markets
of

has

national

economies. A sluggish economy in West Germany or the United
States affects the major trading partners of those countries
and tends to upset equilibrium in trade and current account
balances as well as currency exchange rates.

Phenomena like

the two OPEC-induced energy crises in the seventies send
shock waves
private

around the globe and send governments

sector entities scrambling to restore

Incidentally,

one of

the side effects

of OPEC

increases was a glut of so-called petro-dollars.

and

balance.
price
Eventually

those petro-dollars were "recycled" in the form of loans to
developing countries — mostly in Latin America — and look
at what that altruistic efforts spawned.

Only a few years ago we could brag that the United
States economy was relatively self-contained.
Today with increased dependence on foreign markets
energy,

some

raw materials,

and

large

quantities

for
of

4

manufactured goods, America is no more isolated economically
than it is diplomatically from the rest of the world.

-

A third startling change is the degree of complexity

which has developed in our financial system.

Thirty-five

years ago the balance sheet of a commercial bank was a very
simple seven or eight lines on the asset side and two or
three on the liability side.

Assets were essentially cash,

U.S. government and municipal securities,
90-day

notes

of

companies

to

carry

loans

inventory

(usually
and

receivables), and a modest amount of fixed assets (typically
a fortress-like bank building built in the twenties and
almost fully depreciated).

The liability side of the balance sheet was essentially
demand deposits, some passbook savings and capital, all in
the form of equity.

And,

in 1953 the only United States

bank which had its stock listed on the New York Stock
Exchange was the Corn Exchange Bank in New York.

Even that

listing was removed in 1954 when the Corn Exchange was
merged into Chemical Bank.

In fact banks didn't have

outside accountants until the sixties and most didn't even
publish an income statement.

The negotiable certificate o£

deposit was created around 1960 by Citibank and publicly
held debt didn't appear in bank capital accounts until well
into the 1960's.

5

And,

just think of all the different,

imaginative

liability instruments we have created to replace demand
deposits and passbook savings in order to fund our banks.
Everything from federal funds through NOW accounts, MMDAs
and IRAs to Eurobonds and adjustable-rate preferred stocks.
Another thing,

management

of banks

is no

longer

inherited by the good-looking lending officer with the best
new business record.

Today bankers not only search out the

best managers outside their own organizations but they have
to grow them inside too through well thought out programs of
management development

which

identify,

early in

their

careers, the individuals with high potential for general
management.

Those potential stars must then be exposed to

the education and experience that will ensure that they are
ready when they are called.

If they aren't,

there

is

trouble with a capital T.

But, if the changes in commercial banking have been
dramatic, the changes in the other sectors of the financial
system have not been far behind.
creation of new financial

The hectic pace of

instruments has necessitated

creation of new markets to trade those instruments and
cadres of new classes of professionals who understand them
well enough to trade them:

Mortgage-backed securities,

interest-rate futures, interest-rate swaps, options, repos,
Eurodollars,

junk bonds,

and on and on.

In addition,

deregulation, particularly of interest rates, has not only

6

created new challenges for bank managers,
complicated the analysis,

it has also

formulation and execution of

monetary policy by the Federal Reserve.

While we can't examine in detail all of the changes
in the system in recent years we would be derelict if we
didn't look closely at the so-called thrift industry portion
of the system.
Mutual

savings

banks,

more

significant

in

New

England, New York and the Northeastern United States than
elsewhere, have been around for more than one hundred and
fifty years.

They were created to provide a safe place for

farmers and working people to keep money and earn a modest
return.
The savings and loan industry,

both mutual

and

stockholder owned, was fostered as a vehicle to make home
ownership more generally available by channeling the savings
of individuals into financing the building and ownership of
homes.

Ceilings were placed on the interest rates that

could be paid on those savings in order to assure low rates
of interest on the mortgages the thrifts provided — again
to encourage home ownership by all economic strata.

That,

of course, required ceilings on what commercial banks could
pay since it was thought that deposits in commercial banks
went only into business loans or loans to individuals for
purposes other than home ownership.

7

Those conclusions and the actions they prompted were
probably fairly accurate in the 1930s, but by the time
Congress and the regulators got around to taking off the
wraps, the game had long since changed.
had become

a major

factor

in

Commercial banks

home finance

and

the

uneconomically low rates on mortgages made the thrifts, with
most of their eggs in one basket, especially vulnerable to
deregulation of deposit interest rates.
Suddenly funds
assets.

costs

far

outstripped yields

on

In a knee-jerk attempt to ameliorate the thrifts'

plight, state and federal regulators permitted the thrifts'
broader

asset

powers,

greater

branching

freedom

and

unrestricted access to funding sources at whatever prices
the market demanded.

Faced with loan and operating losses,

mutuals converted to stock companies in order to replenish
decimated capital accounts, and pursued commercial lending.
S&Ls who couldn't raise funds in the market had to fall back
on Federal Home Loan Bank advances and FSLIC notes to remain
nominally viable.

As we all know,

the chickens have all

come home to roost at the same time.

The plight of the

thrifts was further aggravated by the farm belt problems of
three or four years ago, the rust belt problems of the last
five years or so, and the oil patch problems since the
collapse of oil prices in the mid 80s.

A once proud and

critically important industry is now on its knees.

-o-

8

Those then are some of the changes to our financial
system — and I emphasize s o m e .

I h a v e n ’ touched on the
t

computer and communications technology which has made much
of this change possible.

Nor have

I talked about the

qualitative changes which have injected new factors to the
equation.

For example, leveraged buy-outs, proxy fights and

competitive unfriendly tender offers.
comparatively

rare

birds

increasingly common today.

only

a

Those three were

few years

ago

but

And the accelerating geographic

consolidation as interstate banking becomes more widespread
presents

new

challenges

and

opportunities

for

those

institutions which choose to remain independent.

Let's turn now to the challenges to the financial
system about which I spoke earlier.

Deregulation. You may be surprised that I mention
deregulation as a challenge, but after 50 years of rigid
restraints on banks as to how they could raise liabilities
and how much they could pay for them, bank managers were
inexperienced in raising liabilities in a free and highly
competitive market.

Lots of mistakes were made.

High rates

were paid for market share which couldn't be offset with
earnings rates on high quality assets.

Maturity schedules

on liabilities were short in order to attract funds while
the market was demanding longer maturities for loans and
longer term investments were the only ones capable

of

9

justifying the cost of money.

Bank managements in a sense

were like a long-term peacetime army suddenly thrown into
combat in a world at war.

The first skirmishes are painful

and the losses in learning the differences between blank
cartridges and live ammunition are irretrievable.

The blurring of lines between banking and investment
banking and commerce have created competitive pressures hard
to deal with under the best of circumstances.

Non-bank

banks have sallied forth onto the field with a different set
of rules and different weapons not available to real banks.
Mutual funds have attracted deposits from banks and thrifts
with the lure of higher interest rates.

And those higher

rates are earned by redepositing the same funds back in
banks at money market rates of interest.

Foreign banks

operating at regulatory parity with U.S. banks

in the

domestic markets but with different regulatory and market
restraints at home have underbid U.S. banks until the rate
spread has narrowed markedly and U.S. bank earnings are
under severe pressure.
return on assets

For example, a bank with a

in Japan may

be considered a

.40

fine

performer, while a U.S. bank with that kind of return would
be

suspect in the securities markets

and a focus of

regulatory attention in the United States.
In addition, securities firms and insurance companies
have encroached on the lending and financing territory of
commercial banks, while on the other hand bank holding

10

companies have been expanding into certain parts of the
securities business through more liberal interpretation of
Glass-Steagall restrictions by the principal regulatory
authorities.

In the process of ”
leveling the playing field"

the shape and size of the field are also being changed.

Another challenge has been the sensitivity of the
system to external events not of the system's making.
example,

For

the crash of huge once invincible Texas banks

triggered by a softening of the state's basic industry —
petroleum. The oil price collapse made uncollectable other
loans on real estate and to businesses which were dependent
on oil to shore up the whole economic structure.
But, no economy is more a one-industry economy than a
farm town in Nebraska or Iowa or Kansas.
communities

agriculture

supports

structure from real estate

the

so too

whole

economic

to shopping centers

stations and municipal governments.
trouble,

In those farm

are the grocer,

to gas

When farmers are in

the pharmacist,

the

haberdasher and particularly the banker, who lends to them
all.

The collapse of farm prices triggered the collapse in

farm land values and put the loan portfolios of hundreds of
Great

Plains

banks

under

water.

Similarly,

generally

depressed conditions in steel, automobiles and other heavy
manufacturing industries seriously depressed the economies
of much of the northern midwest, even at a time when much of

11

the rest of the country was doing well.

The banks which

financed the economies of those states were under siege.

I have already mentioned the problems of the thrift
industry.

Those problems were certainly aggravated in

certain locales by the conditions I have just described.

. Another challenge arose in 1982, and is still with us
today. It is a crisis related to loans to lesser developed
countries and their inability to repay them given the
payment schedules imposed, the debt service uncertainties of
floating interest rates and the lack of deposit and capital
flows to the debtor nations.

Much progress has been made in

the last six years in building reserves, raising additional
capital and shoring up the defenses of the banking system to
sovereign defaults.

But the basic problem of restructuring

these huge debts in such a way as to give the debtors some
realistic chance of repayment has not really been faced, and
LDC debt remains a genuine threat to the integrity of the
system.

Perhaps

the most

dangerous

challenge

to

our

financial system was posed by the events of October 20,
1987.

In only a few hours, 25 percent of the values in the

stock market were extinguished and the experience was
repeated around the globe.

Statistically,

the crash was

12

worse than 1929.

By all historical precedent we should now

we in a blood-curdling recession.

Instead we are in the

sixth year of economic expansion with manageable rates of
inflation and almost full employment.

What does all this tell us about our financial system.
It tells us that it is sound and remarkably resilient.

We

have met enormous challenges and weathered them in style.
Certainly there have been casualties and genuine heartache
and economic imbalance related to those casualties.
financial system remains healthy and vibrant.

But the

The safety

mechanisms built into the system over the years have worked
well.
A few examples:

Insured depositors have not lost

their funds in spite of more

than 100 commercial bank

failures a year in recent times.

And through the "purchase

and assumption1 techniques developed by regulators and the
1
insurance funds,

financial services

rarely been interrupted

to communities have

even temporarily

and even

in

one-bank towns.

In striking contrast to its reluctance in 1929, the
Federal Reserve System stepped in promptly during

last

October's market debacle to make sure there was sufficient
liquidity to ride out the immediate crisis.

13

To level the international playing field and promote
greater capital strength the regulators and central bankers
of

the

leading

industrial

nations

have

joined

in

establishing standard risk-related capital requirements to
be phased in over the next four years.

This is a major step

in international cooperation and further illustrates the
global economic interdependence about which I spoke earlier,

-c i-

In general, then, I think our financial system is in
good shape.

It continues to be the most adaptable and

creative financial system in the world.

But some elements

still need attention.
Further orderly deregulation is a must if American
banks are to compete effectively with their international
counterparts.

While interstate banking is rapidly moving

toward nationwide acceptance through action of individual
state legislatures,

the states acting individually cannot

deal with the issue of securities powers,
brokerage, and insurance.
these areas,

real estate

The Congress must legislate in

and the most urgently needed are broader

opportunities for banks to offer securities services to
their customers

including underwriting and distributing

corporate debt instruments, municipal revenue b o n d s , and
commercial paper and sponsoring, managing and distributing
shares in mutual funds.

I believe the indications are that

14

Congress feels these are ideas whose time has arrived and
favorable action on much of that program is imminent.

I also believe the consolidation of the industry will
continue

at

intrastate.

an

increased

pace

both

interstate

and

At the same time, I believe more new banks will

be formed, including more minority owned and managed banks,
in order

to

fill gaps

in

customer

service

left

by

consolidations which create banks with strategies which, by
design or accident, ignore one or more market segments which
might be very profitable. The new banks I am talking about
the niche-oriented banks.

There have been several formed in

Massachusetts and New England in the last 18 months and more
are in the works.
In a special way, minority banks are classic niche
banks.

They were not formed to meet the needs of customers

abandoned by other institutions.

Rather they were formed to

serve a customer segment which had never been properly
recognized by the establishment banks. As minorities find
greater economic opportunity and larger rewards this should
be a lucrative niche indeed.

And the customers of minority

banks should be particularly loyal because the banks were
there when they needed them, there when no one else seemed
to care.

In

this

era

of

consolidation

there

are

great

opportunities for small and medium-size banks of all kinds.

15

Personalized service

for

all

kinds

of

customers

and

continuity of coverage are the two most difficult features
for the big guys to provide.

For many customers though,

those two features are more important than being able to say
that they bank with a household name.
Opportunity for small and medium banks abounds, but
there are obstacles to full achievement.
may be the most critical.

Access to capital

Big Wall Street houses a r e n ’
t

much interested in underwriting an issue for a $500 million
bank.

Ironically the expanded securities powers for the big

banks may be the best answer as a capital source for smaller
banks.

What a terrific addition to correspondent bank

services it would be to offer assistance in raising debt and
equity capital for your correspondent.
The second obstacle is the ability to attract the
best and the brightest to work in modest sized institutions.
But even there it is not all gloom.

Lots of bright young

high school, college and business school graduates prefer
smaller companies for the same reasons customers do

—

personal attention and personal opportunity as opposed to
being a number in some sprawling giant.

Finally I want to deal briefly with two major problems
which are lurking out there, which must be dealt with — the
sooner the better — and for which I have no easy answers.
They are the LDC debt problem and the crisis in the deposit
insurance funds.

16

The debt problem is less critical today than four or
five years ago.

Reserves are healthier, debt equity swaps

have helped a little and some portfolios have been written
off or managed down to less panicky levels.

But the fact

remains that most of these debtor countries can't make any
real progress in debt reduction until capital and deposit
flows begin again and their economies

grow enough to

generate the reserves to service the debt.

Unmanageable

debt

service

and

unstable

political

conditions are not conducive to fresh investment or more
lending.

But we may be edging toward some kind of solution.

Perhaps we should be thinking about exchanging short-term
notes at variable rates of interest for long-term bonds at a
fixed rate of interest with no principal maturities for 10
or 12 years in order to give these developing economies the
time to develop.

Under those conditions maybe interbank

deposit flows would be re-established and fresh capital
would be attracted.

Certainly it is time to re-think our

approach in some fashion, because what we have been doing
simply hasn't solved anything.

On the deposit insurance question, we need action by
the Congress, decisive action geared to long-term solutions,
not band-aid measures

such as the

last time

around.

Essentially the so-called thrift industry is obsolete, but
we can't wave a wand and wish it away.

There must be an

17

orderly

elimination

of

mortally

ill

liquidation or sale to healthy entities.

thrifts

through

Then there must be

a conversion of the remaining institutions to full-service
banks.

The process might take ten years or more but once

the policy decision has been made to move in that direction
it can be a coordinated development and need not threaten
the system or any individual part of it.
A seductive stop-gap measure would be to merge the
FDIC and the FSLIC.

I hope that will be resisted.

It would

only weaken the FDIC without solving the problems of FSLIC.
A possible non-cash solution might be to offer FSLIC
securities to the public with some sort of Treasury guaranty
rather than appropriate funds directly.

To the extent that

it buys time for FSLIC to liquidate foreclosed assets in an
orderly fashion rather than a fire sale, the guaranty might
never have to be funded.

-o-

I have talked too
assignment.

long,

but you gave me a big

I am honored to have been with you today.

Your

organization has a vitality and purpose which many of your
sister associations could use.

You have fought long and

hard for the things in which you believe.
some.

^ou have won

I think you are on the brink of winning a lot more.

Go get 1e m 1
Thank you.