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PR-40-76 (5-11-76) FOR IMMEDIATE RELEASE 0 SUBJECTING THE FDIC TO THE APPROPRIATIONS PROCESS A © ""Colorado Springs, May 11 — Chairman Robert E. Barnett, addressing the Conference of State Bank Supervisors, expressed opposition to the amendment to Senate Bill S.2304, which would subject FDIC to the appropriations process. He stated that his opposition to the proposal is based on his belief that the Corporation’s independence is imperative to its effective operations.. Chairman Barnett emphasized the importance of maintaining the authority FDIC has to make its own decisions on an objective, nonpolitical basis, and the flexibility it has in financing expenditures which may be unpredictable. He also pointed out that confidentiality is essential to the budget process of the FDIC. "If we decide, for example, that we should hire one hundred more liquidators to administer closed bank receiverships that we see might be developing (as we did about two years ago), we can do that without publicity. With publicity of such a decision, confidence in the banking system would be shaken. The Chairman advised that, I'More important, however, is a deep concern for the integrity of the deposit insurance program and the independent dedicated fund which supports that program, and a fear that public confidence in deposit insurance might erode if the finances of the Corporation were to become politically controlled. The Corporation feels that the annual GAO financial audit already received by FDIC, combined with the GAO operational audits to be permitted under the recent agreement reached by the two agencies, will provide thorough oversight ability to Congress and to the public without the ancillary dangers associated with subjecting the IDIC to the appropriations process." Digitized for FEDERAL FRASER DEPOSIT INSURANCE ###1 # CORPORATION, 550 Seventeenth St. N.W., Washington, D. C. 20429 • 202-389-4221 The banking problems of the last couple of years have been accompanied by m assive p u b licity. The problems and the publicity have created an interest, particularly in C o n g re ss, to do something about reform of the financial system or the bank supervisory system . I believe the problem has been slightly overstated, and the proposals advanced somewhat off the mark. I want to focus on one particular proposal th a t, in my opinion, not only seems totally unrelated to any problem that e x is t s , but also threatens to erode public confidence in the banking system . That is the proposal to subject the FD IC to the po litical appropriations procedure. I want to spell out why that is undesirable in terms of its impact on our operations and, more importantly, why I think it may be damaging to public confidence. I would like to start by analyzing the causes of the bank problems of the last couple of y e a r s. I w ill argue that our traditional powers to deal with these causes are rather lim ited, and that we would be unwise to seek the kinds of powers necessary to control them. This leads to the need for confidence in our system as it stan ds, and I want to explore with you why the fis c a l independence of the Federal Deposit Insurance Corporation, and more importantly, the Federal deposit insurance fund, is an important element in maintaining that con fid en ce. It is no news to this audience that the problems of the banking system have been particularly severe in the last couple of y e a r s . The number of banks on our problem list and yours has increased su b stan tially. bigger banks on the problem list than we used to . We now have The number of bank failures last year was the largest number since the aftermath of the depression of the '3 0 s. - 2 - Bank loan lo sse s showed a huge increase last year to $3 .2 b illio n , up from 0 only $1.2 billion in 1973 and $2.2 billion in 1974. All the public attention devoted to these problems has led to the view that something be done about the matter, and done in W ashington. I want to deal today with the causes of the problems as I see them, the real obligations this puts on bank supervisors and the need to oppose actions which seem to meet the ca ll to "do something" today but which may have undesirable impacts tomorrow. The C a u ses of Bank Problems I believe that the major factor in causing the increase in bank problems and lo sse s in the last couple of years has been the recent rece ssio n . It is important that we not underestimate the relationship between the economy and bank performance. I It is an unreasonable standard to expect that banking should be immune to the general trends and problems of the economy. The 1974-75 recession was much more severe than anything our economy has experienced since World War I I , and since banks play such a major role in our economy, we must expect the health of banks to mirror that of the economy as a w hole. In periods of economic d e clin e , the profits of business firms fa ll and the number of firms encountering financial difficu lties and failure always in cre a se s. This w ill be reflected in nonaccruing loans and loan charge-offs at commercial banks. If this were not the ca se — if banks were only making loans to firms whose financial condition was so solid that even a severe recession would not affect t their ability to pay — then the banks would not be doing their jo b . Thus, it is not surprising to me that during the period of our most severe post-w ar re ce ssio n , we should have a significant increase in bank loan lo sse s and a sign ifican t increase in the number of banks on our problem l i s t . In addition to the problems caused by the general decline in business a c tiv ity , we have had to cope with such unusual occurrences as the tremendous increase in energy c o s t s , rapid rise in food p rice s, record high interest rates, and very severe problems in the real estate market. Many of our failed banks and problem banks of the past two years have had severe real estate loan problems. I think banks as lenders and as managers of REITs through holding companies deserve a considerable share of the blame for their real estate lending problems. High rates on construction loans and REIT fee arrangements that encourage volume purchases and sales undoubtedly contributed importantly to a lo ss of perspective on loan q uality. In many c a s e s , bank real estate lending officers were too young and inexperienced to remember past periods of real estate lending problems. For several reason s, the lender's traditional restraint on the developer's perpetual optimism was not present. Many banks have had problems with loans to REITs and real estate developers. A smaller number of banks have been affected by other particular problems, such as lo sse s on foreign operations and loans on oil tankers, though it appears that some of these problems have been greatly exaggerated. N evertheless, these special problems, combined with the decline in the economy and the increased vulnerability of some banks, have led to increased loan losses and a larger number of problem banks. But I would not attempt to blame all of the problems on the recent recession or even these associated even ts. The extent of bank problems reflects some more b a sic and lon g-lastin g ch a racteristics. I think there has been a shift in the last several years in the direction of a more a ggressive, riskier posture of the banking industry, and on the part of large banks in particular. Since the early 1960s, many banks abandoned their traditional conservatism and began to strive for more rapid growth in a s s e ts , dep osits, and incom e. "Liab ility management" became the essen tial phrase in the modern banker's le xico n . The larger banks also began pressing at the boundaries of allowable activ itie s for banks. They expanded into fields which some felt involved more than the traditional degree of risk for commercial banks. These activ itie s included direct lease financing, credit card s, underwriting of revenue bonds, foreign operations, and others. The holding company movement of the 1970 s certainly accelerated these developments, though most of the a ctivities of bank holding companies could also b e, and were in fa c t, engaged in by banks d irectly. I am assured by our FD IC examiners that this increased aggressiveness showed up in lowered credit standards as w e ll. During the 1960s, banks generally were not noticeably harmed by the diversification of a c tiv itie s , the movement toward greater risk in their own financial structure, and lowered credit standards. After a ll, the early and mid-19 60s represented a fairly extended period of relatively stable growth and - 5- moderately stable p rice s. The first half of the 1970s proved to be a much tougher economic environment in which to operate. Even apart from the recession of 1974-7 5 , we should not minimize the impact on banks of operating in periods of very tight credit, very high money c o s t s , and extremely erratic movements in commodities and other p rice s. These facto rs affected not only the banks d irectly, but also the stability and predictability of business operations, and th at, in turn, had its impact on the repayment of bank lo a n s. The experience of the last several years raises several important questions of public p o lic y . The most important question for us as supervisors is simply th is: Could better regulation and supervision have prevented banks from reaching a condition which required closer supervision by bank regulators? It is my view that bank supervision as we know it in the United Sta te s, as opposed to its characteristics in other countries, is limited in its ability to dictate the soundness of the banking system . It appears that a considerable part of the bank problems of the last couple of years has been due one way or another to the general state of the econom y. control of the process of bank supervision. That is clearly a matter beyond the Some of the problems have been due to sp e cific unpredictable events like the rapid increase in oil prices and a resulting decline in the demand for oil and oil tankers. It would have been nice if we had been able to anticipate and prevent the debacle of the REITs, for exam ple. In view of the vast number of financial experts who failed to foresee these problems, I do not think it is surprising that bank supervisors failed a ls o . - 6 - There is one area, however/ in which we do have an ability to lessen the impact of the business c y c le . That is the matter of bank attitudes toward risk and the w illingn ess of bankers to increase loan volume and decrease capital ra tio s. We are giving more attention to these matters at the present tim e, and we w ill continue to demand more capital from banks inadequately ca p ita lize d , as w ell as demand that loan, investment/ and operating policies and practices be reasonable o n e s. W e are looking much harder at management and are w illing to step in quicker with formal orders requiring action on management's part. W e have asked Congress for more powers to deal not only with dishonest bankers but grossly negligent o n es. W e must be very careful in this area, however. W e recognize that banking is a risk-taking business and we must rely on market fo r ce s , on management, and on owners, in addition to our supervisory judgment to determine the appropriate degree of risk for individual banks. I do not believe that even the most outspoken critics of banking and bank regulators want the regulators to run the banks rather than the bankers. We can all agree that that is not our fun ction . If we are too intent upon preventing all bank failures in our regulatory posture, we may have some su ccess in shortening our problem l i s t s , but the banking philosophies we would have to adopt would retard the progress of the economy. So attemtping to prevent all bank failures is not our function either. In some c a s e s . Government p o licy , which I endorse, has encouraged a shift toward a riskier banking posture. We have i&sued regulations on "leew ay investm ents" which have broadened the types of investments that can be made. - 7By disapproval of redlining and promoting the concept of equal credit opportunity, we have actively pushed banks into lending that they may feel (though I do not n ecessarily agree) is more risk y . Public Confidence in the Banking System After recounting this story of bank problems, our limited ability to control or prevent these problems, and the widespread publicity about these problems f one factor of particular sign ifican ce stands out in my mind: despite all the bad new s, despite the largest bank failures in the history pf the country, public confidence in the banking system is extremely high. We have considerable evidence for this statem ent. There has not been a general shift on the part of the public toward holding currency or government securities in preference to deposits in the banking system . Failures of particular banks have not led to runs either on neighboring banks or on banks identified in the public's mind with the failed banks. As a matter of fa q t, in most c a s e s , substantial adverse publicity about particular banks has not even led to significant deposit outflows from those banks. I was very interested in the recent Gallup poll which found that the American public has a high degree of confidence in the banking system . S p e c ific a lly , 90 percent of those with bank accounts felt their money was safe in those accou n ts. Gallup summarized the poll as indicating that "For the overwhelming majority of all adults 'bank safety' is not a con cern ." There are, of cou rse, several reasons for this confidence. There is the actual record of sound, generally conservative performance of the nation's - banks. 8 - There is our system of State and Federal supervision of banks. Finally# even with a ll the p u b licity, there are only sligh tly over 2 percent of the nation's banks on our problem list and considerably le ss that 1 percent which we fe el are serious problems. All of these are sound reason s. I am sure 1 w ill be forgiven, however, if I focus upon our system of Federal deposit insurance and our sizable and sound Federal deposit insurance fund. To me, th is plays the most crucial role in creating and maintaining confidence among bank custom ers. Even in the ca se of banks whose failing condition is public and notorious, any deposits that have fled have been uninsured d e p o sits. Insured deposits stay with the banks. To use just one exam ple, even with a ll the adverse publicity that the Franklin National Bank suffered over a period of many months, its insured deposit volume remained sta b le . That is an overwhelming display of public con fiden ce. confidence has been ju stifie d . And that During the last two and on e-h alf y ears, banks which have failed have had over 1.3 million depositors on their books and less than 1 percent of them (all uninsured) lost anything because of the failu re. In the p a s t, State bank supervisors, individually and as a conference, have raised questions about the appropriate role of Federal agencies in the bank regulatory and supervisory p rocess. Many of you have been critical of the role in that process of the Federal a g e n cie s, particularly the Federal agencies that supervise State-chartered banks. This is a subject in which I have considerable interest and to which I intend to devote significant attention over the next several y e a rs. - 9- But with respect to deposit insurance, regardless of our view s on the relationship between State and Federal resp o n sib ilities, I believe that all of us agree that this is and must be a Federal resp on sib ility. It is not only the need to spread the risks geographically that requires th is , but also the need for national uniformity and equity. I doubt if any of your State Governors or Treasurers want to get into price and product competition with other States on deposit insurance; nor do any of us want to see a repetition of the many State deposit insurance system failures that preceded the original proposals for Federal deposit insurance. Federal deposit insurance provides an umbrella of confidence under which all of us can supervise State b an ks. W e have a mutual and not a competitive interest, in the maintenance of a sound system of deposit insurance. That cannot be maintained unless the pu blic's confidence in that system of deposit insurance is maintained. A few months a g o , I would have thought these comments on the importance of public confidence in deposit insurance to be too obvious to be worth mentioning. Lik ew ise, I would have thought the possiblity of the public losing confidence in that system to be too remote to bother this gathering w ith. Times have changed. I now fe el I must raise this is s u e . I now feel there is a p o ssib ility that depositor confidence in the Federal deposit insurance program might erode, difficu lt though it might be to b e lie v e . The cause for my deep concern is the recent vote of the Senate Banking Committee to make the ^ FD IC subject to the political appropriations p ro cess. By a seven to five v o te, - 10 - the Committee on April 29 approved an amendment to S .2 3 0 4 , a b ill originally designed to expand the enforcement authority of the agencies in dealing with grossly negligent bankers, to make the F D IC , the Comptroller of the Currency, and the Credit Union Administration (but not the Federal Reserve System) subject to the appropriations p rocess. I agree wholeheartedly with the Senate Banking Committee that Congress and the public must be assured that the financial affairs of the F D IC are managed in an efficient manner, even though it is not tax dollars that are being spent. W e are unaware, however, of any feeling in Congress or by the public that the F D IC has been inefficient or in e ffe ctiv e . GAO audits the Corporation annually, and we appear constantly before Congressional committees on many subjects and, as far as we know, our integrity and openess has not been raised as an is s u e . W hy, then, should there be a b a sic and serious change affecting the deposit insurance system when the F D IC has been free from serious criticism ? The fact is that Congress now has the tools to get even more assurance of the correctness of our operations without resorting to the dangers of the appropriations avenue; however, more about that in a moment. M y major concern in this matter was w ell summed up in M r. Faris' testimony for CSBS on the Financial Reform Act of 1976, when he stated that subjecting the Corporation's administrative expenses to Congressional appropriations would be "an unnecessary politicizin g of the Corporation." The p o ssib ility for personal financial gain for someone who can improperly influence any agency is rea l, and for someone who can improperly influence a banking agen cy, State or Federal, the p o ssib ility is intoxicating to som e. That's w hy, periodically, we read of indictments and convictions of individuals using improper influence to get charters, or branches, or other favors. - 11 - If the p o ssib ility were opened to permit a cce s s through the p olitical appropriations process to the F D IC , the temptation for w ell-intentioned as w ell as corrupt individuals to try to reach the Corporation's decision making process would be overwhelming. Frank W ille , who was the Superintendent of Banks in New York State before becoming Chairman of the F D IC , commented on this point in his last Congressional testimony: It is no accid en t, in my judgment, that the three Federal bank agencies have remained over the years relatively untouched by political scandal or intim idation. I fear, however, that this track record could be substantially altered if the proposed Federal Banking Commission and the FD IC were to be placed on an appropriated funds b a s is , subject in the first stage of the process to the tender mercies of the W hite House and the O ffice of Management and Budget and in the second stage to the varied interests of individual Congressm en. The practical effect of the appropriations process would be to give the political operatives of the W hite House and the Congress substantial control over the personnel, the d a y -to -d a y operations and the legisla tiv e positions taken by the Com m ission and the F D IC , and I need not remind you how sen sitive many of these agency decisions can b e . . . . .1 think we must have accou ntab ility, but I truly believe that with the thousands of very sen sitive and important decisions made by the bank agencies on which many financial interests ride, that it would be a mistake to go through the p o litical process of appropriations reviewed by the W hite House and then by the Congressional com m ittees. I believe that this w ill lead to control over personnel and le gisla tiv e positions and possibly even regulatory decisions th em selves. It was no secret during the years of this past administra tion and the affairs of the W atergate, significant efforts were made on the part of the W hite House to place particular personnel in some of the agencies of government, who were loyal above all things to the incumbent President. I think it is clear that the O ffice of Management and Budget has used its power to recommend budget levels in an effort to control the policy direction of a g e n cie s. And, in many c a s e s , I think this is appropriate. When you have a regulatory agen cy, I have severe question that this is appropriate. - 12 I also believe that the temptation may exist to try to influence the actual decisions that the agency must make on individual ap p lication s. The reasons for distinguishing the FD IC from other government departments and agencies were made even more strongly by Senator Vandenberg in a Senate floor speech in 1947, delivered as he led a su ccessfu l fight against subjecting the FD IC to the appropriations process: . . . .N o one has yet had the temerity to propose that the Federal Reserve System should be robbed of its independence and subordinated to a p olitical bureau of the Government. Y e t, here is an institution [ the FD IC] which is even more sen sitive with respect to the n ecessities for its independence , , . W e ll, by now some have had that tem erity, but the Senator's point is still valid as to the relative needs for independence of the F D IC . Even apart from concern about p o liticization , however, there are other good reasons for searching for some alternatives to the appropriations p rocess. Our present budgetary process allows us to budget and plan on a long-range basis for programs with long-range b en efits. For exam ple, we have developed over a period of many years a training program for bank examiners of which we are very proud. Such a program does not n ecessarily provide a payoff in the very beginning, but the present need for more and better trained examiners underscores the correctness of the judgment which initiated this program before the need was obvious. Many of you have been beneficiaries of that program, but can we be sure that Congress would always appreciate the wisdom of Federal agency expenditures to aid in the training of State examiners? - 13 W e are able immediately to increase our expenditures over budget estimates if an emergency involving a large bank failure o ccu rs. W e do not have to wait for a sp ecial supplementary appropriation nor do we have to build an unpredictable and probably m isleading contingency fund into our budget estim ates. If we decid e, for exam ple, that we should hire one hundred more liquidators to administer closed bank receiverships that we see might be developing (as we did about two years ago ), we can do that without pu blicity. To again quote Senator Vandenberg: . . . .I f the F D IC is doubtful about the year to come and has to build up a large budget in anticipation of its doubts, I know of no surer way to precipitate a crisis in the United States than to have the budget of the FD IC n ecessarily increased in anticipation of bank failures made public to the world on New Year's each year. This brings us to the heart of the matter and that concerns general public confidence in the Federal deposit insurance system . I believe that confidence is crucial to the banking system — without the p u blic's confidence and trust, the system simply would not work. There is no way any bank in the country can immediately meet the legitim ate demands of a ll of its depositors presented at the same tim e. Depositors must be confident that this w ill never pose a problem to them , or banks could not function. Many banks and Government o fficia ls misinterpret confidence in the banking system and in the F D IC , however, as some sort of m ystical fa ith . No bank charter was carved in stone oh M t. S in a i. the FDI A c t. N either, I must add, was The public has confidence, not out of blind fa ith , but because the solid substance of sound performance has been apparent. - 14 - It is not a happy thought, particularly in this year of our bicentennial, that the American public has a higher degree of confidence in our deposit insurance system than in other institutions of our democratic system . I can believe that 90 percent of the American public believes their money is safe in our banks. I do not believe that this confidence is fra gile . But it is not unbreakable. Senator Vandenberg commented on th is very issu e: (T)he fundamental importance and value of the Federal Deposit Insurance Corporation is psych ological; it is the faith . . . that America has demonstrated in this institution . . . If the American people read th a t, at long la s t , in W ashington something is going on which indicates that the p olitical powers are restless and w ill remain restless until they can get their hands upon this great institution, the effect w ill be most deplorable. Let me speak for a moment or two about the possible erosion of the fund, or just as important, the belief that the fund could be reached for purposes other than deposit insurance. Currently we have approximately $7 billion in the deposit insurance fund, a large amount but not o u t-o f-lin e with the requirements of the deposit insurance system . The amendment its e lf does not cover directly expenditures out of this fund, or at least we do not think it d o es. N everth eless, the kind of expenditures which may be made from that fund conceivably could cover a wide range of programs which many of us might find unrelated to the deposit insurance program. The decision to make or not make particular expenditures has always been made by the Board of Directors of the FD IC immune from "ideas" or "suggestions" - 15 made by those who w ould, under the amended S .2 3 0 4 , control the administrative expenditures of the a ge n cy . That has worked in the p a st, and that is the way it should remain for the future. Resolving the very complex problems of the U . S . National Bank failure or the Franklin National Bank failure was difficu lt enough without third party su ggestio n s. Liquidating the a ssets of those banks is likew ise difficu lt enough without such su g ge stio n s. Let me repeat: Federal deposit insurance has worked. That the American public has confidence in its banking system and knows that its deposits are safe in the nation's banks is due in large measure to the existence of Federal deposit insurance. The integrity of the fund out of which those deposits w ill be paid ip the event of a bank closin g is unquestioned; each succeeding Board of Directors of the Corporation since its beginning has proved to be excellent guardians of the fund. Any change in the fin an cial operations of the Corporation or the methods by which the Corporation receives its money to conduct its business may w ell erode the public's confidence in the fund. W e might note in this regard the recent concern being voiced about the soundness and solvency of the Social Security fund. Whether ju stified or not, similar concern about the integrity of the deposit insurance fund could prove to be un settlin g. Without some overwhelming need, carefully and com pletely delineated, it seems reck less to expose the public's confidence in the banking system to the danger of such erosion of (confidence. - 16 - The answer I would suggest to the problem of oversight is a thorough and periodic performance review by G A O . GAO has professionals who can make reasonable and considered judgments on the performance of the FD IC and the other a g e n c ie s. W e would welcome such a review and entered into an agreement with GAO three weeks ago to have them perform such a review . Because of publicity about Federal Reserve objections to a GAO audit, you may be unaware that the F D IC for many, many years has been subject to a full financial audit by the General Accounting O ffic e . W e believe that the GAO has always found the Corporation helpful in a ssistin g it in its annual audit, and we have found the audit helpful to u s . There have been no instances to my knowledge of GAO raising any questions of irregularity or irresponsibility in the fin an cial dealings or budget expenditures of the F D IC . There has been one traditional disagreement between the GAO and the F D IC which is relevant here. That disagreement has concerned the desirability of predicting bank failures and possible lo sse s to the deposit insurance fund. W e have felt that this sort of an alysis is inappropriate and we have been reluctant in the past to permit a review of our examination reports for that purpose. This issu e of GAO a cce s s to our examination reports has been an issu e of contention for many y e ars. I share the F D IC 's traditional reluctance to see predictions of bank fa ilu re s, but I can see no harm from review of our examination procedures and examination records by the professional staff of the G A O . The safeguards which have been agreed to in our current agreement for confidentiality and privacy provide adequate protection for u s , the banks and bank custom ers. - 17 I may be unduly concerned about this matter — it may be that we can put the deposit insurance fund under ordinary political control without affecting the p u b lic's confidence in i t . But I cannot see any potential gain that would appear to be worth that risk . Let me summarize: banking has had problems in the last few years. Much of the problem has been related to the general economy or events which we cannot control. Public confidence has been maintained, however, in a generally sound banking and supervisory system . Since the F D IC has performed its functions w ell over these y e ars, subjecting it to the appropriation9 process as a response to a desire to do something about the banking system seems inappropriate. Our opposition to including the F D IC under the appropriations process is based on a strong desire to continue the present ability of the F D IC to make its d e cisio n s, many of w hich are extremely se n sitiv e , on an o b je ctiv e , nortpolitical b a s is , and a need to maintain fle x ib ility in our finances to cover expenditures which may be unpredictable. More important, however, is a deep concern for the integrity of the deposit insurance program and the independent dedicated fund which supports that program, and a fedr that public confidence in deposit insurance might erode if the finances of the Corporation become p o litica lly controlled. The Corporation fe els that the recent agreement reached with the General Accounting O ffice permitting operational audits by.GAO provides thorough oversight ability to Congress without the ancillary dangers associated with subjecting the FD IC to the appropriations p ro cess. - 18 - I hope that each of you recognizes that what I have been d iscussin g here is not a matter of intramural bookkeeping or bickering within the Federal establishm ent. This is ait issu e that w ill affect your ability to do your job in your respective S ta te s. Copfidenpe ip the banking industry and in bank supervision may not survive a loss of confidence in Federal deposit insurance. # # #
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