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LIBRARY
MAR 81989
FED ER AI DEPOSIT INSURANCE CORPORATION
TESTIMONY OF
L. WILLIAM^SEIDMAN
CHAIRMAN
FEDERAL DEPOSIT INSURANCE CORPORATION
WASHINGTON, D.C.
\
THE ADMINISTRATION'S PROPOSED "FINANCIAL INSTITUTIONS REFORM,
RECOVERY AND ENFORCEMENT ACT OF 1989“
BEFORE THE
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0
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS SUPERVISION,
REGULATION AND INSURANCE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
UNITED STATES HOUSE OF REPRESENTATIVES
10:00 a.m.
March 8, 1989.
Room 2128 , Rayburn House Office Building
Good morning, Mr. Chairman and members of the Subcommittee.
I am pleased to
testify today on President Bush's proposed "Financial Institutions Reform,
Recovery and Enforcement Act of 1989" ("President's Proposal").
FDIC SUPPORTS PRESIDENT'S PROPOSAL
The Federal Deposit Insurance Corporation ("FDIC") supports the President's
proposed legislation for the savings and loan ("S&L") industry and the Federal
Savings and Loan Insurance Corporation ("FSLIC").
We believe it is a sound,
constructive and farsighted proposal that should be enacted.
The President's
Proposal provides for prompt action to resolve the S&L situation and proposes
structural and regulatory reforms designed to make the federal deposit
insurance system cost-effective.
Also, Mr. Chairman, your "Alternative Thrift
Recovery Proposal" ("Annunzio Alternative Proposal") is an important
contribution to the process.
Our only reservations about the President's Proposal concern a few provisions
relating to the independence of the deposit insurer.
As pointed out below,
these proposals would hamper the FDIC's ability to perform, at the very time
it is being asked to undertake major new responsibilities.
Before commenting specifically on the proposed legislation, we first would
like to describe the FDIC's recommendations for structural and regulatory
reforms to the deposit insurance system.
In addition, we will address the
size of the problem, the President's financing proposal and the ongoing
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interagency oversight effort relative to insolvent S&Ls.
Finally, we will
provide our views on the FDIC's current and future supervisory capabilities.
STRUCTURAL AND REGULATORY REFORMS
It has become clear that changes must be made to the federal deposit insurance
system to ensure that it is cost-effective and self-financed.
During the past year the FDIC has examined ways to improve the federal deposit
insurance system.
The product of that review —
our recently released study
Deposit Insurance for the Nineties: Meeting the Challenge —
numerous recommendations for reform.
is being submitted for the record.
contains
A copy of the study's Executive Summary
A draft of the complete study has been
provided to each member of this Subcommittee previously.
The FDIC study sets forth certain principles necessary for a sound deposit
insurance system for the future.
The first principle is that the deposit
insurer should be organizationally and financially independent.
Thus, the
insurer should be empowered to operate, as nearly as possible, like a private
insurer.
In accordance with this principle, the insurer needs control over
its revenues.
control costs.
1.
Also, the insurer must be given the basic tools necessary to
These requirements will be elaborated upon below.
Independence of the Insurer
The FDIC study recommends that the federal deposit insurer be made as
organizationally, operationally and financially independent as possible.
guard against conflicts-of-interest, the insurer should not be under the
To
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control of a chartering authority.
Translated in terms of the issue facing
the Congress today, this means the FSLIC should be separated from the Federal
Home Loan Bank Board.
In fact, in the three alternative plans for agency
structural reforms set out in our study, the one constant was that the FSLIC
was to be separated from the Bank Board.
The FDIC expressed a preference for
an independent FSLIC, but also recognizes the view of others that there are
potential benefits in an administrative merger of the FSLIC into the FDIC.
To ensure political independence, the federal deposit insurer should continue
to be funded by premium payments from insured financial institutions.
Thus,
the insurer should be independent from the Congressional appropriations
process —
as the FDIC is now.
While the insurer will be accountable to the
Congress on an annual basis, it should remain free frpm annual budgetary
controls since it receives no general tax revenues.
In this connection, we have recommended that the insurer's trust funds be
separately budgeted and not be part of the general operational federal
budget.
For decades, the insurance funds have been depositing their unspent
premium income into the U.S. Treasury.
These "deposits" are counted as income
to the Government rather than savings reserved for future problems in the
industry.
When funds are withdrawn from the Treasury to deal with a problem
institution, that action is counted as a Government expenditure.
Instead, it
should be treated as a withdrawal of money on deposit.
In fact, the treatment of trust funds —
like the FDIC fund ~
current federal budget system is affirmatively misleading.
under the
It provides
misinformation about operational revenues and expenditures of the federal
budget.
Thus, we have suggested that the Congress consider setting up a
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separate budget for the deposit insurance funds.
For macroeconomic purposes,
however, analysts could combine the new deposit insurance separate budget with
the general federal operating budget.
2.
Enhanced Control Over Revenues
To ensure that the deposit insurer has adequate resources, it should have
additional controls over its revenues.
Most importantly, the deposit insurer
must have the authority to adjust insurance premiums, within prescribed
limits, to reflect experience and costs on a continuing basis.
had such authority —
If the FDIC
rather than being subject to the 1/12 of 1 percent
assessment rate that has been in the law since 1935 —
1989 premiums would be
expected to increase significantly based on our 1988 loss experience.
Year-end results for 1988 indicate a net loss from operations of approximately
$4 billion to the FDIC insurance fund.
That means that the fund dropped from
$18.3 billion to about $14 billion last year.
Furthermore, the FDIC's fund
dropped from 1.1 percent of insured deposits to a little over .8 percent of
insured deposits during that one-year period.
This demonstrates the need for
a premium structure that can respond to the current environment and that has
sufficient flexibility to maintain an acceptable level of reserves.
Other powers are necessary to enhanced revenue control.
are secured by assets —
assets which otherwise would be available to the
insurer in the event of a bank failure —
base.
Borrowings that
should be part of the assessment
The insurer also should be able to require new institutions obtaining
federal insurance to pay an entrance fee in order to maintain an adequate
reserve-to-deposits ratio.
Finally, the FDIC should be specifically
- 5 authorized to borrow from both the Department of the Treasury and the Federal
Reserve.
3.
Improved Ability to Control Costs
The federal deposit insurer also must have additional tools necessary to
control costs.
In many respects, these mirror those that are available to
private insurers.
The fundamental tool is the ability to control the granting
and revocation of insurance.
At a minimum, the insurer should be able to set
standards for insurability which must be certified by the primary federal
supervisor as having been met.
The insurer also must have the ability to
promptly terminate insurance privileges when an institution is operating in an
unsafe and unsound manner.
The current procedures for terminating federal
deposit insurance should be streamlined to take no more than six months from
the start of a proceeding to removal.
The insurer also needs tools to determine whether an institution is posing an
inordinate risk to the fund and to require the cessation of any activities
that pose such risk.
institutions.
Thus, the insurer must be able to examine ¿11 insured
Furthermore, it must have the express authority to determine
that certain activities —
including more speculative activities authorized by
states for state-chartered institutions —
pose an undue risk to the insurance
fund and to require that institutions cease those activities within the
insured institution itself.
The insurer should be able to require that any
such activity be conducted outside of the insured entity, in an affiliate or
subsidiary, subject to "firewalls" designed to minimize the exposure of the
insured entity to the activity that is being conducted in the separate, but
affiliated, corporate entity.
Those firewalls should include: (1) a
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prohibition against the use of the insured entity's regulatory-required
capital to capitalize the subsidiary or affiliate; (2) assurances that
transactions between the insured entity and its subsidiary or affiliate are on
an arm's length basis and do not jeopardize the insured institution; and (3) a
requirement that the institution divest the subsidiary or affiliate if the
insurer determines that those requirements are not being met or that the
affiliated entity poses a threat to the safety and soundness of the insured
institution.
Additional tools also are necessary to enable the insurer to better control
costs when dealing with failed institutions.
It must have the power to
require that all federally insured institutions owned by a common parent
indemnify the insurer against any losses resulting from the failure of an
affiliated insured institution.
The FDIC believes this is preferable to the
proposal circulated last year that would have required the consolidation of
affiliated insured institutions within a holding company complex.
Indemnification for such losses is a more direct and efficient way of
accomplishing the same objective.
In resolving failures, the FDIC also should have the ability to distinguish
between depositors and other claimants.
Specifically, depositor claims should
be able to be transferred to another institution while other claimants share
on a pro-rata basis with the FDIC in asset liquidations.
All of the federal regulatory agencies also need enhanced enforcement
authorities.
The FDIC recommends that any legislative package adopted by this
Committee include enforcement authorities and penalties substantially similar
to those in the enforcement title from S. 1886, as passed by the Senate last
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year, and from H.R. 5094 as adopted by the House Banking Committee.
These
measures initially were submitted to the Congress jointly by all the federal
regulatory agencies.
PRESIDENT'S PROPOSAL
Ttie President's Proposal provides for funding the resolution of insolvent S&Ls
and extensive structural and regulatory changes to the deposit insurance and
thrift regulatory systems.
The FDIC supports the proposed legislation as a sound and viable measure that
should be enacted promptly by the Congress.
As noted, however, we have some
points of disagreement with the proposal, each of which bears upon the
independence of the FDIC.
While those points will be addressed in detail
below, in short, they involve (1) appointment and removal of the FDIC
Chairman; (2) restrictive limitations on the issuance of debt; and (3)
reporting requirements.
As might be suspected, the President's Proposal is not perfect from the FDIC's
perspective.
Clearly, some compromises had to be made along the way.
We
recognize that compromise is part of the process and none, in our view,
compromises the essential soundness of the proposal.
For example, in the area of increased insurance authorities over the banking
industry, the FDIC has been given substantially greater authority with respect
to thrifts previously insured by the FSLIC than it has, or will have under the
proposal, with respect to banks.
Another example —
state-chartered thrifts
could have followed the pattern of state-chartered banks and thus be placed
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under the primary federal supervision of the FDIC.
But they are not.
We
believe the legislation has reached workable solutions in each of these cases.
While we know this Subcommittee is acutely aware of the need for expeditious
legislative action to resolve the FSLIC situation, we would be remiss if we
did not stress that point.
Nothing of major substance can be accomplished
until the Congress acts to provide funding and guidance.
Now we would like to turn to more specific comments on the President's
Proposal for structural and regulatory reform.
In its most fundamental
components, the package incorporates most of the recommendations made in the
FDIC study.
It specifically provides for (1) the independence of the thrift
insurer subject to the problems noted; (2) enhanced deposit insurance revenues
and better control by the insurer over those revenues; and (3) additional
tools to better control the insurer's costs.
1.
Independence of the Insurer
The President's Proposal would separate the FSLIC from the FHLBB and
consolidate the FSLIC with the FDIC for insurance and case resolution purposes.
While providing a single management and administrative structure, it would
maintain the FDIC and FSLIC funds as separate insurance pools that could not
be commingled.
Each pool would have its own premium income stream and the
expenses and expenditures of their respective institutions would be charged
against their respective pools.
In separating the FSLIC from the Bank Board, the proposal also establishes a
new structure for the chartering of federal thrifts and the supervision of all
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federal and state-chartered thrifts and their holding companies.
The Federal
Home Loan Bank Board would be dissolved and replaced by a single Chairman of
the Federal Home Loan Bank System ("FHLBS") who would be under the Secretary
of the Treasury —
just as is now the case for the Comptroller of the Currency
("OCC").
Making the thrift insurer independent is an essential step in ensuring that a
situation like the one we are facing today does not recur.
As stated earlier,
from an agency point of view, the FDIC would have preferred to see the FSLIC
separate from the FDIC.
The judgment of the Administration has been that in
terms of start-up time and costs, administratively merging the FSLIC into an
existing insurance structure at the FDIC is more cost-effective.
We will work
diligently to ensure that result.
The President's Proposal does not provide for a separate budget —
recommended by our study —
as
for the FDIC insurance funds.
Although the proposed legislation would make important progress in ensuring
the independence of the former FSLIC, three provisions in the legislation run
counter to the principle of establishing an independent deposit insurer.
In
fact, in each of these instances, the proposal would make changes to the
existing independence of the FDIC that would limit its independence.
Attached
are suggested amendments to the applicable sections of the President's
Proposal that would make those three areas acceptable to the FDIC.
First, the bill would permit the President to appoint and remove, with or
without cause, the Chairman and Vice Chairman from those positions on the
reconstituted FDIC Board of Directors.
At present, the Board of the FDIC
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elects its Chairman.
10
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We believe such removal authority could compromise
significantly the independence of the FDIC, and recommend that it be deleted.
In fact, when that removal authority is coupled with the fact that two of the
other Board members are under Treasury, the FDIC Board, in effect, could be
controlled by the Administration.
If a change is needed, we would suggest
that a system similar to the Federal Reserve System —
appointment of the
Chairman and Vice Chairman for a term with the consent of the Senate —
adopted.
be
The attached amendment would accomplish this result.
Second, another provision of the President's Proposal would place limits on
the FDIC's borrowing authority.
We believe it ii appropriate to limit the
FDIC's ability to issue notes and other debt obligations.
However, the
proposed limitations are impractical and overly restrictive and could
seriously undermine the safe and cost-effective operations of the insurer in
the near term.
To put the proposed limit in perspective, under today's conditions it would
restrict the FDIC's obligations to $7 billion.
cap already.
We are almost at the proposed
Currently the FDIC has about $6 billion in obligations.
In each
case the liability was properly recorded with the appropriate charge taken
against net worth.
The FDIC's $14 billion of net worth represents the unencumbered assets
available in excess of that needed to satisfy all actual and contingent
liabilities.
In other words, the FDIC has not used debt because it does not
have the necessary resources, but because of other valid business reasons.
Examples of such reasons include providing failed bank acquirors additional
flexibility in markets with weak loan demand, avoiding untimely portfolio
11
sales and even maintaining some additional leverage to ensure buyers hold up
their end of the bargain.
We would hate to lose this flexibility.
Thus, instead, we recommend a very simple borrowing limit:
No notes can be
issued which will put the agency into a deficit net worth position.
attached amendment reflects this recommendation.
The
Thus, the FDIC would be able
to obligate neither itself nor the general government revenues in an amount
beyond the limits of the FDlC's resources as determined by GAO audit.
By
imposing the limit that we recommend, the insurer could not issue debt if it
does not have its own resources to repay that debt and, thus, could noi
obligate taxpayer funds.
Third, the President's Proposal would require the FDIC to submit quarterly
reports to both the Secretary of the Treasury and the Director of the Office
of Management and Budget on the FDIC's "financial operating plans and
forecasts . . . taking into account the Corporation's financial commitments,
guarantees and other contingent liabilities."
We believe it should be
sufficient to file such reports with the Administration through the Treasury
and, to save costs and paperwork, the documents should be the financial
reports prepared by the FDIC in the ordinary course of its business.
Finally, in connection with the issue of independence of the insurer, we
appreciate the objective of the provision in the' Annunzio Alternative Proposal
that would authorize $25 million of Treasury funds to hire additional
examiners.
We believe such special funding is unnecessary due to the
increased premium income the FDIC would receive under the President's
Proposal.
That increased premium income should be sufficient to offset the
additional costs generated by the FDIC's new responsibilities.
Importantly,
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the President's Proposal would grant the FDIC significant authority and
flexibility under prescribed circumstances to increase premiums when
necessary.
2.
Enhanced Revenue Provisions
The President's Proposal would establish a new insurance premium structure
that appears viable for both the FDIC and FSLIC insurance fund pools to be
designated for the present, respectively, as the Bank Insurance Fund ("BIF")
and the Savings Association Insurance Fund ("SAIF").
The insurance premium
paid by banks into BIF would increase to 12 basis points in 1990 and to 15
basis points in 1991.
Premiums on institutions in SAIF would remain at 20.8
basis points through 1990, increasing to 23 basis points for 1991 through 1993
and then dropping to 18 in 1994.
Furthermore, the FDIC would be provided with flexibility to raise the premiums
above these levels if extraordinary circumstances raised the specter of
serious future losses to the fund.
On the other hand, once the funds of
either BIF or SAIF exceed the target reserve level of 1.25 percent, then
assessments could be rebated to the institutions insured by that particular
fund.
The FDIC study recommended that premium rates be increased to more accurately
reflect loss experience.
and we support it.
The President's Proposal calls for such an increase
As discussed in more detail later in our testimony,
raising bank premiums from eight basis points to 12, and then 15, seems
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reasonable and prudent and very close to the result under the recommendations
contained in our study.
Furthermore, as the FDIC requested, the proposal
would provide the insurer with flexibility to increase rates under specified
ci rcumstances.
The FDIC also believes the premiums charged to FSLIC insured institutions ~
which rise to 23 basis points for a three-year period and then decline to a
point lower than current premiums —
are both reasonable and apparently within
the capacity of those institutions to pay.
cannot be evaluated in a vacuum.
However, those increased premiums
There should be careful consideration of the
effect on the industry's viability of these premiums coupled with the
significantly increased capital requirements and loss of income from the FHLB
System.
As we have consistently stated, the cost of resolving the S&L situation should
be borne to the greatest extent possible by that industry.
Just as
importantly, the banks should not be called upon to bear the cost of that
resolution.
Appropriately, under the President's Proposal, the revenues
generated from bank premiums will go to build BIF and not to pay for the
thrift problem.
Finally, the FDIC would be permitted, within its discretion, to charge a fee
for institutions moving from one fund to the other.
In its study, the FDIC
recommended that fees be permitted in order to maintain a specified
reserves-to-deposits level in the insurance fund.
14 3.
Improved Provisions to Control Costs
The President's Proposal provides for improved provisions to control insurance
costs.
As discussed above, the FDIC's study suggests numerous changes that
should be made to the deposit insurance system to enable the insurer to better
control costs.
A primary cost control mechanism is to permit the insurer to
operate more like a private insurer —
revocation of insurance.
with control over the granting and
The insurer also must be able to examine insured
institutions to assess risk to the fund.
be subject to adequate standards —
—
The insured institution itself must
such as capital, accounting and disclosure
and the insurer must have sufficient authority to enforce those standards.
An additional dimension to controlling insurance costs is requiring increased
capital.
In addition, when the insurer's resources have to be used to resolve
a troubled institution, there are measures that can be taken to minimize the
cost to the fund.
Finally, stronger enforcement provisions assist the insurer
in controlling costs.
The proposed legislation contains important new cost control tools in each of
these areas.
In fact, it goes a long way in providing the FDIC with the
necessary tools to allow it to better control costs.
The Annunzio Alternative
Proposal would go even further in providing the FDIC with those tools by
granting the FDIC authority over national and State member banks parallel to
its new authority over S&Ls.
As previously stated, this was an issue on which
we compromised with other regulators with different views.
- 15 Enhanced Ability to Control the Granting and Revocation of Insurance.
The
President's Proposal provides enhanced ability to control fund membership.
The FDIC would be able to deny insurance coverage to any S&L, both state and
federal.
As is the case currently with state-chartered banks, state-chartered
thrifts would be required to apply directly to the FDIC for insurance.
However, the FDIC also would be authorized to review and to deny any
application for a federal S&L charter that would result in eligibility for
insurance if the FDIC determines that specified statutory standards have not
been met.
While under the proposal insurance for national and state Fed member banks
will continue to be automatic, the OCC and the Federal Reserve Board ("FRB")
would be required to consider a new and additional standard —
deposit insurance fund —
risk to the
before granting a national bank charter or Federal
Reserve membership.
The FDIC would be provided with the authority to immediately suspend deposit
insurance if an insured institution has no tangible shareholders' equity.
Also, the FDIC would be able to promptly remove insurance from any insured
institution that is engaging in unsafe or unsound practices, operating in an
unsafe or unsound condition or otherwise causing undue risk to the insurance
fund.
Under current statutory procedures, termination proceedings can take
anywhere from two-to-three years to complete.
An expedited hearing procedure
would be established under the proposed legislation that would permit
revocation within approximately six months of the filing of a notice of intent
to terminate.
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Improved Ability to Assess Risk.
Under the President's Proposal, the FDIC
would be provided with the necessary tools to examine and assess risk in
thrifts.
The FDIC would be entitled to copies of all examination reports
filed with the FHLBS and would have the right, upon notification to the FHLBS,
to examine all insured thrifts for insurance purposes.
This examination authority is the same as the FDIC's current authority with
regard to national banks and state member banks.
However, since in the past
there have been some questions about the FDIC's authority to examine
independently such banks to protect the insurance fund, the FDIC would like to
have legislative history making this clear.
In addition to its new examination authority over thrifts, the FDIC would be
authorized to request that the FHLBS or a state supervisory authority take any
enforcement action applicable to any insured institution or its officers and
directors.
If the appropriate authority declines to take such enforcement
action, the FDIC would be permitted to initiate that action independently.
We
believe this additional authority will be very helpful.
Improved Regulatory Standards Applicable to Thrift Institutions.
The proposed
legislation appropriately applies bank-like regulatory standards to thrift
institutions.
It also provides additional powers to ensure safe and sound
operations.
Under the proposal, the FHLBS would be required to establish capital standards
for thrift institutions that are no less stringent than those for national
banks.
The standards would be required to be fully implemented by June 1,
1991 —
although thrifts would have ten years within which to amortize their
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goodwill.
Thrifts also would be required to conform to accounting and
disclosure standards now applicable to banks and the FHLBS would have to adopt
supervisory policies equal to those now applied to banks.
We support high and consistent capital standards for S&Ls and banks.
We must
be sure, however, that the S&L industry can satisfy the bill's requirements
within the time permitted without unduly damaging the viability of the weaker
segment of the industry.
Since this is a complex determination, appropriate
flexibility should be provided the insurer so that the proper time-frame and
balance can be assured.
The concept contained in the Annunzio Alternative
Proposal of a Capital Adequacy Review Board may be helpful in this respect
since it could provide needed regulatory flexibility with respect to the new
capital requirements on S&Ls, although we prefer that the flexibility be
provided to the regulators.
The FDIC would have additional risk-reduction authorities under the
President's Proposal relative to thrifts that it does not now have explicitly
—
and would not be given under the proposal —
with respect to banks.
Specifically, the FDIC would be able to prohibit or restrict the growth of
assets by a thrift institution that does not meet minimum capital standards
established by the FDIC.
We believe the authority for the FDIC to establish
such minimum capital standards is particularly important.
Furthermore, the FDIC would have the explicit authority to determine that
state-authorized activities that are not permissible for federally chartered
S&Ls pose an undue risk to the insurance fund and to require that the thrift
cease conducting those activities within the insured entity itself.
The FDIC
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believes that this last authority also is very important.
We suggest that
such activities be allowed in subsidiaries or affiliates of holding companies
with appropriate safeguards through tough firewalls.
Improved Ability to Buy Thrifts.
The President's Proposal takes steps toward
expanding the pool of private capital that would be available to rescue the
thrift industry.
First, additional nonbank holding companies may be
interested in acquiring thrifts once the cross-marketing and tandem operation
restrictions of the Competitive Equality Banking Act ("CEBA") are lifted.
Second, two years after enactment, bank holding companies would be permitted
to acquire healthy thrift institutions, without the imposition of the tandem
operation restrictions now imposed by the FRB.
While these two steps are helpful, the FDIC believes that bank holding
companies should be permitted to acquire failed or failing S&Ls immediately,
without the cross-marketing, activity and branching restrictions or any other
restrictions that have been routinely imposed by the FRB.
To date, when bank
holding companies are permitted to acquire failed or failing thrifts, the
Federal Reserve prohibits them from changing the thrifts name in any way that
would lead thrift customers to believe that the institution is a commercial
bank.
However, the FRB then also requires the thrift to operate as if it is a
bank, subject to bank branching and activity limitations.
The FDIC thinks
that the imposition of cross-marketing, activity and branching limitations on
the acquisition of failing and failed thrifts by bank holding companies
unwisely curtails the ability of banks to buy thrifts and, thus, raises the
insurers' costs.
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The Annunzio Alternative Proposal would take a positive step beyond the
President's Proposal by permitting a bank holding company, immediately upon
enactment of the legislation, to acquire a healthy thrift as long as the bank
holding company also acquired a comparably sized insolvent thrift.
After the
two years, the requirement that the holding company also purchase an insolvent
thrift no longer would apply.
Sound Protection for the Insurance Fund in Handling Failed Banks. The
President's Proposal contains the fund indemnification provision that the FDIC
believes is vitally important in dealing with failed insured depository
institutions that are commonly controlled.
The proposal would require that
all such institutions that are under common control guarantee the insurer
against loss in the event of a failure of any other insured institutions so
commonly controlled.
The proposal also includes another very important measure that would help the
FDIC to minimize the funds' exposure in failed bank resolution cases.
That
provision would allow the FDIC to distinguish between depositors and other
claimants in resolving failures.
Specifically, depositors claims could be
transferred to another institution while other claimants would share on a
pro-rata basis with the FDIC upon liquidation of the failed institution's
assets.
It is important to point out that this is not the "depositor
preference" measure that the FDIC recommended during the 99th Congress.
Under
depositor preference statutes, other claimants are subordinated to the FDIC.
Under this proposal, other claimants would share pro-rata with the FDIC.
Enhanced Enforcement. The proposed legislation also would include enhanced
enforcement provisions very similar to those included in the bill that was
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adopted by the House Banking Committee and the Senate in the last Congress.
These measures originally were proposed jointly to the Congress by all of the
federal financial regulatory agencies.
We believe that those measures, as
well as the enhanced civil and criminal penalties contained in the proposal,
are important to the agencies' ability to deal with mismanagement, waste,
fraud and insider abuse.
We question, however, whether the amount of some of
the new civil penalties are not too Draconian.
BUDGETARY IMPACT OF PROBLEM
We now will turn to the size of the S&L problem and the President's proposal
for financing that problem.
Size of the problem.
In order to estimate fully the budgetary implications of
the thrift problem, ascertaining the size of the insurance loss 1s critical.
At the beginning of 1988, there were approximately 500 insolvent thrifts under
generally accepted accounting principles ("GAAP") with assets over $200
billion.
During 1988, the Federal Home Loan Bank Board ("FHLBB") took action
on more than 200 S&Ls at a reported cost of over $39 billion on a present
value basis.
We understand that the General Accounting Office ("GAO") soon
will release a cost analysis of S&L transactions during 1988.
As of the end of the third quarter of 1988, there were about 220 thrifts that
were insolvent under regulatory accounting principles ("RAP"), not including
those thrifts handled by the FHLBB in 1988, and another 119 GAAP insolvent
thrifts.
In addition, there would be approximately another 100 insolvent S&Ls
under banking standards —
namely, if goodwill were eliminated.
Our latest
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21
estimates suggest that current operating losses at RAP and GAAP insolvent S&Ls
are about $200 million per month.
That figure will be higher as interest
rates rise or as S&Ls experience unusual deposit outflows, as they have
recently, and must fund with higher cost deposits.
We have stated in the past that reliable cost estimates of resolving the
insolvent S&Ls should be made by on-site examinations.
We are in the process
of making such estimates pursuant to the joint oversight effort discussed
below.
Our best estimates at this time are in the same range as the Treasury
Department's estimated cost.
See the attached Charts A and B.
When discussing cost figures, it is important not to confuse present value
with actual dollars spent over the life of the workout.
provide information on those cost figures.
appropriate figure to focus on —
Charts A and B
The present value is the
it represents the cost in today's dollars.
The actual dollar figure mixes apples and oranges because a dollar spent in
the future is worth less than a dollar today.
For example, consider buying a house that sells for $100,000.
either pay cash or finance it.
One could
If the purchase is financed with, say, a
30-year fixed rate mortgage at 10 percent annual rate, the monthly payment
will be approximately $875.
$316,000.
Over the thirty years, the payments add up to
Even though the person who finances the house outlays, over the
life of the mortgage, more than three times the number of dollars than the
person who pays cash, we do not say that the house costs three time as much
for people who finance.
-
22
-
The cost estimate which is projected by the President's proposal is based on
today's dollars.
If the rescue plan is financed, the actual dollars outlayed
will be substantially higher than that amount, but the cost will not be.
Financing proposal♦ Regarding the financing package contained in the
President's Proposal, the Treasury Department and the OMB are in the best
position to comment.
From our viewpoint, that financing proposal, while
complex, appears viable and sound.
It provides for what appears to be an
equitable sharing of the financial burden between the S&L industry and the
Treasury.
However, the plan should assure that ultimately the "Savings
Association Insurance Fund" be an independent, self-funded insurance fund.
The attached Chart C provides a pictorial of the sources and uses of funds
under the proposed financing plan.
Ability of banks and S&Ls to pav increased premiums. The President's Proposal
calls for increased insurance premiums for both banks and S&Ls.
The increased
premiums for the S&Ls will be used to partially offset the cost of that
industry s problems.
The banks' increased premiums will be used to strengthen
the FDIC insurance fund.
Both premium increases will add to general federal
revenues for budgetary purposes.
In our recently released study on deposit insurance, we concluded that FDIC
deposit insurance premiums should be adjusted for the risk and costs incurred
by the insurance fund.
The FDIC spent $7 billion dollars last year, and our
fund declined by about $4 billion, or over 20 percent.
Our fund's reserves at
year-end will be reduced to 83 cents per $100 of insured deposits, well below
- 23 -
desired levels.
Without regard to the S&L industry problems, the FDIC study
recommended that bank premium rates be increased to reflect more accurately
recent loss experience of the FDIC fund.
The President's Proposal calls for such an increase —
proposal.
and we support this
Raising bank premiums from their current level of 8.33 basis points
to 12 basis points next year, and then 15 basis points the year after, is
reasonable.
We estimate going to 12 basis points will increase premiums about
$700 million, and that 15 basis point will bring in almost $600 million more.
The increase in premium expenses translates to about 2.1 percent and 3.8
percent of pre-tax earnings at 12 and 15 basis points, respectively.
To some
extent, this increase probably could be offset by repricing of services, but
the ability to do this is constrained by today's competitive market place.
Assuming that all the increase resulted in earnings reductions, we estimate
that fewer than 100 institutions out of over 13,000 that are now profitable
would be made unprofitable.
The majority of the banks that would suffer the most significant decline in
profitability from higher assessments are located in the Southwest and Midwest
regions, the two regions that have experienced the greatest difficulties
during this decade.
Given recent FDIC loss experience, the increases are consistent with our
study's conclusions and should not pose an unreasonable burden to the banking
system.
Importantly, the revenues generated from these premiums will go
solely to build the new bank insurance fund.
- 24 -
Under the proposal, once the bank fund moves up from .8 to 1.25 percent of
insured deposits, banks can expect premium rebates.
Our preliminary estimate
is that rebates could begin as early as the mid-1990s under the President's
plan.
We recently completed an evaluation of the rebates the FDIC paid from 1950
through the early eighties.
We added all rebates from that period back into
our fund and applied the yield we would have earned on those funds.
We
discovered that, if no rebates had been paid during that time, the FDIC today
would have another $26 billion in its insurance fund.
This indicates that the current rate of eight basis points was more than
sufficient to meet costs if no rebates had been paid.
Thus, a return to lower
premiums may be indicated at some future date.
As to the increase in premiums on S&Ls, in and of itself, it will not unduly
damage the industry.
As previously stated, flexibility should be provided the
insurer so that it can act if industry viability is threatened.
INTERAGENCY OVERSIGHT EFFORT
I would now like to turn to the interagency oversight effort underway to deal
with the currently RAP insolvent S&Ls.
As part of the Bush Reform Plan announced February 6th, the President
requested that the FDIC lead a joint effort to evaluate and oversee most of
the RAP insolvent thrifts.
In addition to the FDIC and the FSLIC, the Federal
- 25 -
Home Loan Bank Board, the Federal Reserve, and the Office of the Comptroller
of the Currency are participating in this interagency initiative.
The purpose of this interagency effort is to limit the growth of problems in
our nation’s insolvent thrifts until a comprehensive reform of the deposit
insurance system and the necessary funding are authorized by the Congress.
Insured deposits will remain fully protected throughout this process.
Since the program was announced by the President, a joint task force of
regulators, led by the FDIC, has taken control of 73 of the RAP insolvent
thrifts and expect to assume oversight of the rest of the over 200 RAP
insolvent thrifts in the next four-to-six weeks.
The FSLIC has contracted with the FDIC to take control of these institutions
that are being placed in conservatorship or receivership.
That means the FDIC,
with the help of other regulators, will oversee operations of the insolvent
thrifts.
Managements of the various institutions are subject to the
regulators' authority.
From the customer's perspective, however, the only
visible difference will be a few more people in each institution.
Day-to-day
operations will continue to preserve basic services to deposit and loan
customers.
One of the first priorities of these oversight efforts will be to evaluate the
losses at each S&L.
Such on-site examinations are necessary to produce
accurate estimates of the cost of the thrift problem.
Once our estimates are
completed and GAO has issued its report on the cost of FSLIC's 1988 deals, the
total cost of this problem can be determined.
-
26
-
Another top priority is to identify and stop any abuse, waste, or fraud that
may be present.
A further priority will be to prepare a business plan for the
institution and seek cost reduction through consolidations and more efficient
operations.
While in control of these institutions, we and the other regulators will seek
to stop any unsafe or unsound practices.
We will limit their growth, and
downsize them through asset liquidations where possible.
However, we will
avoid firesales of assets and emphasize the need to sell at values that
reflect current appraised values.
Finally, we will develop longer-term solutions to these problems.
Our staff
will recommend different approaches —
from liquidating the institutions to
selling them to qualified purchasers.
But our current job is a holding action
only.
We will not issue notes or enter into income maintenance agreements.
The FDIC has established four task groups to address these responsibilities.
These task groups are designed to ensure stable operations in the insolvent
thrifts and to evaluate options for permanently resolving their insolvency
once funding is approved by Congress.
One of our most important task groups is our new Fraud Squad.
As President
Bush has said, "unconscionable risk-taking, fraud and outright criminality
have also been factors [in the thrift problem]."
this Fraud Squad will constitute a mobile unit.
Investigators assigned to
Whenever our on-site teams
discover evidence that fraud or insider abuse may have occurred, the Squad
- 27 -
will be sent to conduct a full-scale investigation.
This includes looking for
ways to get back misappropriated assets when possible, and helping send some
to jail when appropriate.
Our three other task groups have separate but complementary assignments.
Our Oversight and Evaluation task group will take control of these
institutions, assess their condition and take steps to reduce operating costs
where possible.
Our Planning and Restructuring task group will recommend steps to restructure
and consolidate institutions where appropriate.
And our Transaction and Acouisition task group will begin the process of
seeking out buyers for institutions, real estate and other assets.
He will
seek to reach agreements with purchasers subject to resources being made
available to provide assistance.
The FDIC and the FHLBB have agreed that, until the agencies review the status
of the insolvent thrift institutions placed under joint regulatory oversight,
only cash assistance transactions will be undertaken by the FSLIC.
We also must note that these additional responsibilities in addressing the S&L
situation will place some strain on FDIC resources.
We believe that this will
not substantially interfere with our responsibilities as a bank regulator.
are dedicated to this new task and will strive for success, but we do expect
to experience growing pains and recognize our need to climb a learning curve
in the process.
We
- 28 EPIC SUPERVISORY CAPABILITIES
In view of your recent formation of the Examinations, Audit and Review (EAR)
Task Force, Mr. Chairman, we would like to provide information on the FDIC's
deployment of bank supervisory/examination personnel under the current
insolvent thrift interagency oversight effort and what we anticipate under the
President's Proposal.
The FDIC has or will have two principal roles under the Bush Reform Plan.
The
first role involves the FDIC's additional responsibilities just discussed as
conservator/"management agent" of thrifts that are now RAP insolvent and those
to become insolvent before the Bush Reform Plan is enacted.
Hhile there is no
doubt that this new responsibility will have an impact on FDIC resources, we
anticipate that the large call on FDIC personnel will be for a relatively
short period of time, perhaps two-to-three months.
During the peak-time period we anticipate the need for approximately 1,200 to
2,000 interagency personnel.
Considering that we are receiving substantial
assistance from the other federal regulatory agencies and state supervisory
agencies, we anticipate that we will have to detail approximately 1,000 FDIC
employees to this task during that peak period.
Of these, approximately half,
or 500 employees, will be from our examiner force —
Bank Supervision ("DBS").
Liquidation ("DOL").
namely, the Division of
The other half will be from the Division of
After that peak period, when agency personnel in each
institution will be cut back to a minimum, we anticipate that the number of
FDIC employees being used will level off at around 400 to 500.
Since half of
- 29 -
those will be from DOL, we expect about 200 to 250 of our examiners —
about ten percent of our supervisory workforce —
or only
will continue to be detailed
to this effort.
During the two-to-three month peak period we have set priorities for our bank
examiners to assure that all banks will continue to receive adequate
supervision.
We believe the FDIC can handle this additional burden for a
time, in part because the number of problem banks is decreasing (currently
under 1,400 —
down from a peak of 1,624 in 1987), the number of examiners
continues to increase (our goal is 2,200 examiners by year-end 1989), and our
examination efficiency is improving.
In fact, we have been increasing our
examiner force as rapidly as it is practical to assimilate them —
from a low
of 1,389 in 1984 to 2,029 at the present time.
While no one should underestimate the enormity of the responsibility facing
the FDIC, we believe we are up to the task.
The sooner the Congress acts to
restructure the system and provide the necessary funds to resolve these
insolvent thrifts, the sooner the resource strain can be alleviated.
In the
meantime, we assure you that we will not let our major bank supervision
responsibilities slip.
The second major supervisory role envisioned for the FDIC under the
President's Proposal is essentially to back-up the Federal Home Loan Bank
Board (to be renamed the "Federal Home Loan Bank System") in its role as
supervisor of S&Ls, both state and federally chartered.
While insolvent
thrifts will become the responsibility of the Resolution Trust Corporation,
the FHLB System will continue as the primary supervisor of solvent thrifts and
its cadre of approximately 1,800 examiners will continue to function in their
current responsibilities.
The extent to which we will increase our workforce
depends in large part on the ability of the FHLB System examination staff to
effectively carry out its responsibilities as primary supervisor for the
healthy segment of the thrift industry.
We are in the process of developing
projections of the number of examiners needed for this back-up role under
various scenarios based on the magnitude of the responsibility.
CONCLUSION
With the exceptions noted, we believe the President's Proposal is sound,
constructive and farsighted, and we hope Congress acts on it promptly.
The FDIC stands ready to assist the Subcommittee and the EAR Task Force in any
way during the upcoming debate on the restructuring and financing of the
deposit insurance system.
I would be pleased, at this time, to answer any
questions the Subcommittee may have.
Suggested Amendments
Term of Chairman
Section 203(2) of FIRREA, amending Section 2 of the FDI Act, should read:
(2)
by deleting the second sentence thereof and inserting the following:
One of the appointive members shall be designated by the President, by
and with the advice and consent of the Senate, to serve as Chairman of
the Board for a term of four years, and one shall be designated by the
President, by and with the consent of the Senate, to serve as Vice Chairman
of the Board for a term of four years. Not more than two of the appointive
members shall be members of the same political party.
Debt Limitation
Section 216(2) of FIRREA, amending Section 15 of the FDI Act, should read:
(2)
by adding a new subparagraph (b) to read as follows:
(b)
(1)
The Corporation shall estimate the cost of all notes or similar
obligations issued by it, and all guarantees or similar obligations
incurred by it, prior to the creation thereof, and shall reflect
such cost in its financial statements, and make such adjustments
as are appropriate thereto no less frequently than quarterly.
( 2)
The Corporation shall not issue any note or similar obligation,
and shall not incur any liability under a guarantee or similar
obligation, with respect to either the Bank Insurance Fund or
the Savings Association Insurance Fund if the estimated cost
thereof would reduce the net worth of the respective Insurance
Fund to less than zero.
(3)
With the prior approval of the Secretary of the Treasury, the
Corporation may issue or incur up to $5 billion in the aggregate
of additional liabilities in excess of the limitations of (2)
above; Provided, that, any such additional liabilities shall
reduce, on a dollar for dollar basis, the amount which the
Corporation may borrow from the Treasury under Section 14 of
this Act.
(4)
For the purposes of this subsection (b), the net worth of an
Insurance Fund shall be calculated based upon the most recent
audit of such Fund by the General Accounting Office, as reduced
by the adjustments required in paragraph (1).
Reporting
Section 217(2) of FIRREA, amending Section 17 of the FDI Act, should read:
(2) By redesignating subsections (b), (c) and (d) as (c), (d) and (e),
respectively, and by adding a new subsection (b) to read as follows:
Prior to the beginning of each fiscal quarter, the Corporation shall provide
to the Secretary of the Treasury copies of the Corporation's financial
operating plans and forecasts, and as soon as practicable following the
close of each fiscal quarter, the Corporation shall provide to the Secretary
of the Treasury copies of the report of the Corporation's financial condition
and results of operations for such quarter. The plans, forecasts and reports
shall reflect the liabilities and obligations as provided in Section 15(b)(1)
of this Act. The requirement to provide the plans, forecasts and reports
shall not imply any obligation on the part of the Corporation to obtain
the consent or approval of the Secretary of the Treasury with respect
thereto.
NO.
Lo Ia I
Assets
Iotil
LU5*
Annual
Income
t&Lx
cosuri
Cost
SfcL Group
To Assets
tiix
Cq s L J Z
To Assets
Handled by FSLIC
in 1988
208
$103.2
$120.1
$-10.2
$38.9
.38
$42.9
.42
RAP - Insolvent
A Unprofitable
217
$56.9
$65.6
$-5.3
$22.8
.40
$25.0
.44
RAP - Insolvent
A Profitable
5
$2.5
$2x5
$0x0
$0x4
xl6
0x5
x24
430
$162.6
$188.2
$-15.5
$62.1
.38
$67.9
.42
RAP Solvent but
GAAP - insolvent A
unprofitable
72
$24.2
$23.7
$-0.3
$3.6
.15
$4.8
.20
RAP - Solvent but
GAAP - insolvent A
profitable
45
$12.1
$11.7
$0x2
$Lx6
xI3
$2x2
xlfl
547
$198.9
$223.6
$-15.5
$67.3
.34
$74.9
.38
RAP A GAAP - solvent
but tangible
insolvent and
unprofitable
69
$55.1
$53.2
$-0.5
$8.3
.15
$10.9
.20
RAP A GAAP
solvent but
tangible - insolvent
and profitable
52
$55x4
$52x5
$0x2
$5x0
xJO
$10x0
xJL6
668
$320.4$
$340.3
$-15.8
$82.4
.26
$96.7
.30
154
$101.1
97.6
$-0.7
$9.6
.09
$14.9
.15
882
$421.5
$437.9
$-16.5
$92.00
.22
$111.6
.26
Other:
SUBTOTAL
SUBTOTAL
SUBTOTAL
Marginally solvent
but unprofitable
TOTAL
1
2
with zero Toss assigned to residential mortgages and passEstimated Cost #1 :Failed-•bank cost formula 1
through securities.
Estimated Cost 02 :Fa i1ed -bank cost formula with 10% loss assigned to residential mortgages and
mortgage pass-through securities.
CHART A
3rd QUARTER SUHHARY SHEET DATA ON FINANCIAL TROUBLED SALs ($BILLIONS)
CHART B
stratiok ’s
A
Fir;A!;c::;G
proposal *
(in billions cf dollars;
Tine to Maturity
10 years
yi 0
*
C
20 years
30 years
1 0 0 - 1 2 5
1 1 5 - 1 * 0
1 2 5 - 1 5 0
■ 1 1 5 - 1 * 0
1 3 5 - 1 6 5
1 6 0 - 2 0 "
1 2 5 - 1 6 0
1 6 0 - 2 0 0
2 0 0 - 2 5 0
I t 0 - 1 7 0
1 9 0 - 2 3 C
2 5 Q - 3 Q Q
1 5 0 - 1 8 0
2 1 5 - 0 6 5
1
%
00
a t
0
I— 1
•C a s h
c o s t
flo w s
o f
i n t e r e s t
r e p r e s e n t
$ 9 0 -1 1 0
a c t u a l
b i l l i o n
r a t e s
show n
d o l l a r s
is
fin a n c e d
in
c h a r t .
I
3 0 0 - 3 5 0
s p e n t
o v e r
i f
n e t
d i f f e r e n t
p r e s e n t
t i n e
v a lu
period
in »D
6
ADMINISTRATION’S FINANCING PROPOSAL
SOURCES
OF FUNDS
USES
OF FUNDS
SOURCES
OF FUNDS
@FedFRASER