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8.

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Do American banks have experience conducting
nonbanking activities through subsidiaries?

Со gress has specifically authorized banks to own Edge Act corporations, which are permitted to conduct a banking business outside the United States. Treasury contends that subsidiaries of national banks should be permitted to engage in a broad range of principal activities in the United States because Edge Act subsidiaries of banks have engaged in certain principal activities overseas in a safe and sound manner.

Only a handful of U.S. banks engage to a significant extent in activities overseas through Edge Act subsidiaries. In addition, the Edge Act subsidiaries of U.S. banks engage almost exclusively in commercial banking activities that the banks could conduct directly in the United States. In this regard, only 9 U.S. banking organizations account for more than 95 percent of the assets of all Edge Act and other foreign subsidiaries of all U.S. banking organizations. Less than 2 percent of the assets of the Edge Act and other foreign subsidiaries of these nine banking organizations is attributable to activities that a bank cannot conduct directly, such as trading in equity securities. Furthermore, the bank-ineligible securities activities of these Edge Act subsidiaries are subject to various size limitations and other supervisory limits.

Thus, there is very limited supervisory experience with Edge Act subsidiaries engaging overseas in the types of volatile activities - such as merchant banking - that Treasury would allow all national banks to conduct in the United States. The limited exception provided Edge Act subsidiaries overseas does not justity overturning the general principle that has served Congress and the American taxpayer well for decades,

Furthermore, Congress explicitly authorized the creation of Edge Act subsidiaries to allow U.S. banks to compete equally in foreign banking markets where the laws may permit local banks that are supported by a foreign government's safety net to engage in broader

14 range of activities than banks in the United States. The same principle that justified the creation of Edge Act subsidiaries - providing a level competitive playing field - does not justity authorizing operating subsidiaries to conduct a broad range of principal activities in the United States. Permitting the operating subsidiary structure in the United States would place U.S. securities and insurance firms that chose to remain independent of banks at a competitive disadvantage, thereby creating an unlevel playing field in the United States.

9.

Did the thrift debacle result from allowing new
financial activities in subsidiaries?

As the Treasury correctly points out, the thrift debacle had several causes. Unfortunately, Treasury's proposal would replicate certain of the mistakes that contributed to the costly savings and loan bailout.

In the 1980s, thrifts were permitted to engage indirectly through "service corporations” in risky principal activities, including real estate investment and development. The losses incurred by these service corporation subsidiaries contributed significantly to the costs of the bailout absorbed by the American taxpayer. Despite this experience, Treasury would now permit national banks to engage through an operating subsidiary in potentially volatile principal activities (such as merchant banking) that Congress has forbidden national banks to conduct directly.

In addition, the thrift crisis was complicated and extended by the use of special regulatory accounting principles that differed from GAAP. These regulatory accounting devices made thrifts appear-at least to the regulators—to be in better financial condition than they were in fact. Treasury's proposal, however, would create a similar regulatory accounting device through its proposed “capital deduction" procedure. This new regulatory accounting device would make a parent bank appear to have more capital and earnings than the bank may in fact have under CAAP.

15 10. Do bank holding companies face higher borrowing

costs than their banks?

The debt of bank holding companies generally has a lower credit rating than the debt issued by the holding companies' subsidiary banks, which tends to indicate that banks benefit from a subsidy due to their access to the federal safety net. In fact, for the 35 largest bank holding companies where comparable data is available, the debt rating of the holding company is always lower than the debt rating of the holding company's subsidiary bank. Since banks have higher debt ratings than their parent holding companies, they can raise funds at a lower rate than their parent holding companies.

The funding cost differential between banks and bank holding companies, moreover, is significant and appears to increase in periods of market stress—just as one would expect because the value of the subsidy increases during periods of financial turmoil. Even today, when economic times are good and the value of the subsidy should be relatively low, banks can raise debt capital, on average, at a cost that is 10 to 12 basis points lower than bank holding companies. This translates into a material advantage in those markets-such as the market for investment grade business loans—where gross profit margins may be only 20 to 30 basis points.

11. Is allowing new financial activities in subsidiaries

consistent with functional regulation?

According to Treasury, the operating subsidiary structure is fully consistent with functional regulation because the SEC and state insurance authorities would continue to have full supervisory authority over a broker-dealer or insurance company, respectively, that is an operating subsidiary of a bank.

Treasury's arguments again miss the point. No one contends that the SEC and state insurance regulators would not, or should not, continue to have regulatory responsibility for brokerdealers or insurance companies, wherever such companies are held in 16 a corporation's structure. The real issue is how best to minimize conflicts between the functional regulation of securities and insurance activities, on the one hand, and regulation designed to protect the safety and soundness of dep ory institutions on the other hand.

The Federal Reserve, the SEC, and the securities and insurance industries all agree that the holding company framework provides the better vehicle for minimizing conflicts between functional and bank regulation. That is because the holding company framework better insulates the bank-which is the subject of all bank regulationfrom the functionally regulated activities conducted by an affiliate. The current bills would further enhance these strengths by imposing reasonable limits on the Board's ability to examine, obtain reports from, impose capital requirements on, or take enforcement action against a functionally regulated nonbank affiliate of a financial holding company. These modifications would reduce overlapping examinations and the potential for conflicting capital requirements, and enhance coordination between the Board and functional regulators.

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The OCC has opposed the imposition of the exact same restrictions contained in the current bills on its authority over an operating subsidiary. The OCC argues - perhaps correctly - that it must have full and unfettered regulatory authority over an operating subsidiary because the subsidiary is directly owned by an insured bank. The simple fact that the OCC insists on having complete dominion over the regulation of all operating subsidiaries - including the authority to take actions against the subsidiary under the prompt corrective actions provisions of the Federal Deposit Insurance Act demonstrates the incompatibility of the operating subsidiary approach with true functional regulation.

12. What about the risk of a future Congress loosening

applicable safeguards?

Many of the safeguards that Treasury has proposed to protect a parent bank from its operating subsidiaries (e.g. capital deduction) must be imposed by legislative or administrative action and, thus, could be weakened or eliminated in the future.

On the other hand, many of the benefits associated with holding company affiliates (e.g. separation of the affiliate's and bank's financial statements) are inherent to the holding company structure and cannot be loosened by legislative or administrative action.

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Mr. OXLEY. Without objection, and all of the members' statements will be made part of the record should they choose to do that.

The gentleman from Massachusetts, Mr. Markey.
Mr. MARKEY. Thank you, Mr. Chairman.

It has now become increasingly clear that consumers are today at great risk on having their privacy totally compromised as the affiliations occurring in the marketplace and sanctified under this bill allows banks, brokers, and insurance companies to compile a detailed digital dossier of a consumer's most sensitive health and medical records, their credit cards, checking account transactions, their bank balances and loans, and their life and medical insurance information.

If we fail to act now, we will soon be facing big brother banking, financial institutions that can snoop into our lifestyles, our finances, other health records, our most personal family secrets. Now the financial services industry likes to tell us all about the wonderful synergies that will result when our personal secrets are sold and transferred to affiliates.

Let us just take a look into the future at what some of those synergies actually mean for our consumers. The next time you get cold called by a stockbroker, will he tell you, hey, I see that you have been buying Ritalin for your daughter. You know, there are a lot of kids on Ritalin these days for attention deficit disorder and the company that makes this stuff is about to have its stock go right through the roof; but right now, it is undervalued. So we are recommending to our customers that they buy now.

And oh, I see that you have been buying Depends for your 85year-old mother-in-law who lives at home with you. Well, our health sector analysts have projected continued growth in the incontinence market as the baby boomers reach their golden years. So now is really the time to get in on the stock of the companies that make those products.

Speaking of companies whose products are selling like hot cakes, I guess that I don't need to tell you how much that Viagra drug has taken off if you know what I mean.

Next day when you and your wife drop by to visit your friendly banker seeking a mortgage for the dream home that you just made an offer on, does he sympathetically shake his head as he reviews his computer data base saying he is so sorry to see that your wife has recently been under treatment for breast cancer. But the bank is just going to have to require a larger down payment and higher interest rates to reflect the increased risk they would dare if they were to grant this mortgage application given the fact that you will be relying on both of your incomes to make the mortgage payments.

And oh, by the way, we see that you have been charging quite a tab down at Joe's tavern over the last 2 months which I guess is understandable in light of your daughter's ADD, your mother-inlaw's incontinence problem, and your wife's breast cancer treatments. But we are just somewhat concerned about the impact of your recently increased drinking habits on your continued ability to pay back this mortgage that you are asking us to grant you.

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