If the bank gets in trouble, the creditors can simply seize all of the assets. So the bank is actually a better credit risk. The same reason the FDIC says the subsidiary is preferable for safety and soundness, it is also better for credit risk. There are many instances if they put the or at least in some instances, if they put the assets in the subsidiary rather than putting them in the affiliate, because if so, then the creditors can't grab them.

Now, on the other hand-how much of a funding advantage that would be I don't know, Mr. Chairman.

On the other hand, there may be other banks that would have just the opposite incentive, because they may have a holding company, which is where a lot of the financing gets done, that is doing financing at unattractive rates because the creditors are concerned that the flow of funds from a subsidiary could be interrupted by a bank regulator. So what they might like to do, what the creditors of the holding company would like to see, is a larger portion of the assets be in the affiliate. So in that case, that might actually be an incentive for the bank to take its capital and put it in the affiliate to engage in the new activities. So it is a very complicated subject cut either way.

But in the cases in which there is a funding advantage by putting assets into the subsidiary, conducting activities in the subsidiary, this has zero-nothing-to do with passing along a subsidy; it has everything to do with simply being a better credit risk.

Mr. OXLEY. The Chairman said that he, along with the other members of the Board of Governors, had made an extensive study and indicated some numbers that you could actually get ahold of. That is, he indicated that it was a 10 to 12 basis point advantage. Mr. RUBIN. Mr. Chairman, if there is, it is simply because it is a better credit risk because that is how they operate. But let me ask Mr. Carnell to respond.

Mr. CARNELL. If I could just put it in context and then respond to the specific point about the differences.

The typical bank holding company has a tremendous reliance on its subsidiary banks for its assets and its earnings. The banks are most of the holding company's assets. And the holding company is typically completely dependent on those banks for money with which to pay its own debt. The reason that holding companies pay more than their banks to borrow money is that creditors price in the risk that-if the bank gets into trouble-the bank regulators or even the prompt corrective action statute will cutoff the flow of dividends from the bank to the holding company. That is the key to the pricing difference.

Chairman Helfer in her 1997 testimony before the Banking Committee spoke specifically about this point. The FDIC staff did a study where they talked to the rating agencies about why the banks and the holding companies had different credit ratings which reflects this different cost of capital, the different costs of funds here. And the answer that the rating agencies gave was that there was a greater risk of this interruption of dividends.

Let me point to another risk, in addition to the risk of interruption of dividends, and that is that if there were to be any failure of the bank, the creditors of the holding companies are going to wait in line last, they are going to wait in line after the FDIC and

the depositors of the bank, they are going to wait in line, so they are really in the same position as stockholders of the bank, because they don't get anything unless the holding company, as a stockholder of the bank, gets something. So it reflects the structural weakness of the holding company rather than any transmission of subsidy.

Mr. RUBIN. Very good.

Mr. OXLEY. The Chair's time has expired.

The gentleman from New York, Mr. Towns.

Mr. TOWNS. Thank you very much, Mr. Chairman.

Let me begin by saying, can we be guaranteed-well, I won't use the word guaranteed, but "assured" of competitive equality if we adopt an operating subsidiary provision?

Mr. RUBIN. I think, Mr. Towns, that you can be assured of absolute competitive equality, except to the extent that-which is the issue we were just discussing except to the extent that the bank is actually a better credit risk and safer and sounder, which obviously is to the benefit of the taxpayers, because the assets have been put in a place where they can be reached by the FDIC and the creditors. So I think there is zero difference with respect to transfer of a subsidy. Zero. But to the extent that creating the subsidiary structure actually makes the bank a better credit risk, then that is in the interests of the taxpayers and might create some funding advantage for the bank.

Mr. Towns. Can we maintain functional regulations of securities and insurance activities under an operating subsidiary structure? Mr. RUBIN. We have provided-or I shouldn't say we have provided, I apologize. H.R. 10 provides that functional regulation of the op-sub is to be identical to functional regulation of the affiliate. Now, we did not actually put as you know, H.R. 10 does not put insurance underwriting in the op-sub, but with respect to securities underwriting and merchant banking-which would be done there— functional regulation would be absolutely identical, and this is specifically so provided in H.R. 10.

Mr. Towns. What else other than the comments that you have made, do we need to do, do you feel, to really fix this bill?

Mr. RUBIN. I think

Mr. Towns. You know we have been trying to do this for 65 years.

Mr. RUBIN. The Congress has been trying to do it for a while, but not everything happens immediately.

Mr. TOWNS. You were not here all 65 years.

Mr. RUBIN. That is a long time, I agree. I think you are on the verge of a good bill, Mr. Towns, I really do. I think the confluence of forces that have come together have come very close to producing a good bill. I would urge, this is my view, at least, that we take a look at the Federal Home Loan Bank provisions in the sense that I mentioned. FHLOB serves a very important purpose, but I think that the fact that there is so much focus on arbitrage and overnight loans is an issue that ought to be dealt with. There are some consumer protection issues that I think should be taken care of. We very much share the SEC's concerns about certain issues with respect to functional regulation that we would like to work with the

SEC and the committee on to improve, but I think you are close to a very good bill.

Mr. TOWNS. Thank you very much, Mr. Chairman. I yield back. Mr. OXLEY. The gentleman yields back.

The gentleman from Illinois, Mr. Shimkus. I am sorry, the Vice Chairman from the State of Louisiana, Mr. Tauzin.

Mr. TAUZIN. Mr. Secretary, how can you say that there is no competitive disadvantage, that the competition is equal, except? "Except" means it is not equal.

mean, if Mr. Greenspan is correct, weighing in all of these factors of greater creditor position and cheaper capital as against the possibility of a bank regulator stepping in because of some problems at the bank, weighing in all of those features, you have a 10 to 12 basis point advantage, and if you are giving the banks opsub access to the payment system that other securities and insurance firms don't have, how can you say that the competition is equal?

Mr. RUBIN. Well, the op-sub would not have access to the payment system, and any benefit that the bank gets by access to the payment system can be transferred equally to the op-sub or to the affiliate.

I don't know what advantage any particular institution would have with respect to its overall funding by using an op-sub, but one thing I am sure of is that each of these cases is going to be different. I have no doubt, since most of the funding for these institutions is done at the holding company level, that there will be many instances that the institution will actually think its economic advantage lies in putting its assets into the affiliate.

But unfortunately-I shouldn't say unfortunately-the holding company is in a weaker position for funding, and if assets can be put outside of the reach of the bank regulators, that is better from the point of view of the holding company and the holding company's funding rates.

In the instances where the subsidiary does create an advantage, it is simply a better credit risk. It is safer and sounder for the taxpayers.

Mr. TAUZIN. You said in some instances the bank is a better creditor. You obviously would make room for the fact that in some instances it is not.

Mr. RUBIN. No. Oh, no, no. All I was saying is that if there is a funding advantage, it is solely-100 percent-solely because the bank is a better credit risk due to the fact that the assets are someplace that can be reached by the bank's creditors.

Mr. TAUZIN. Isn't that going to be different from bank to bank? I assume if you have a bank that is in an excellent position, it may indeed enjoy a heck of an advantage with a op-sub provision in this bill. If a bank is in a more tenuous position where in fact_there may be fear of Federal banking regulators disrupting the flow of dividends, then that may be that may not be such a good idea to go with the

Mr. RUBIN. No, I think it actually cuts the other way, Mr. Tauzin. If you have a very, very strong bank, then the creditors aren't going to be concerned about the possibility of the failure of the bank. Therefore, keeping the assets within reach of the creditors

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isn't going to matter. But it may be, in fact it could well be, that the creditors

Mr. TAUZIN. It may well be that

Mr. RUBIN. Wait a minute. The creditors of that institution could be concerned about the holding company and might like to see the holding company strengthened, in which case the cost of money actually is benefited by taking the assets and putting them into the affiliate.

Mr. TAUZIN. I grant you that. I grant you it may be I see that. But the point is it is going to be different, depending upon the position of the bank, and in some cases the bank, I think, is going to have a very clear advantage over a nonbank insurance or securities firm. And the question we are going to have to face in this committee is whether or not, as Mr. Towns alluded to, whether or not that is really fair competition or we are creating an old, traditional, unlevel playing field again.

Mr. RUBIN. Oh, I don't agree with that. I think what you have got is that where a bank is a better credit risk—and it can be a better credit risk for an enormous number of reasons-then it should be able to borrow more cheaply. That is how the credit markets work. There are all kinds of reasons why it might be a better credit risk, and one of them might be that it has taken a bunch of its assets and decided to do securities underwriting or dealing or whatever through a subsidiary and kept those assets subject to the claims of its creditors.

Mr. TAUZIN. I know my time has certainly about expired, but I would like very much, Mr. Secretary, if you would specifically address the 10 to 12 point basis points study and indicate for us, perhaps in writing, why you think it is flawed in any respect. Because if that is a real number that we have our hands on what Mr. Greenspan has supplied to us that is still sitting out there unchallenged, except in theory, without a specific refutation, the concerns are real.

Mr. RUBIN. I would be delighted to respond, we would be happy to respond. But one thing I can assure you of, Mr. Tauzin, is that if there is an advantage and I suspect every institution will be different. I know, I used to do this for a living. If there is a difference, it is solely for the same reason that all other companies have different rates as amongst themselves: because of credit differences.

Mr. TAUZIN. That is the way it should be. It should not be because of language in this bill. That is what concerns me.

Mr. RUBIN. That is the point, I agree. This bill should not restrict a banking institution from finding the way that makes it the most creditworthy borrower and therefore having the best rate, and that is in the taxpayers' interest, and that is why the Chairman of the FDIC says there should be choice, to enable banks to do that which will-that structurally, make them safest and soundest. That is exactly the point.

Mr. OXLEY. The gentleman's time has expired.

The gentleman from Michigan, Mr. Dingell.

Mr. DINGELL. Mr. Chairman, I certainly want to welcome my old friend Mr. Rubin back to the committee. We always enjoy his visits

here and find them enormously valuable and informative. I would like to welcome my good friend back.

Mr. RUBIN. Thank you, Mr. Dingell.

Mr. DINGELL. I have been very much impressed, Mr. RubinMr. RUBIN. I can't quite hear you.

Mr. DINGELL. I have been very much impressed with the comments you made about how allowing a bank to have an operating sub which would do all of these things would be a benefit to the bank, would be of benefit to the bank in terms of its liquidity, in terms of its earnings, in terms of its credit risk, and a number of other things.

I am curious, I am curious-the bill also gives, however, to the bank the ability to do these things in a wholly owned affiliate, but none of the advances and advantages appear to apply to the affiliate, and I am just curious; why would a bank choose to utilize the affiliates if there are such huge advantages to the bank by going through the operating subsidiary?

Mr. RUBIN. I didn't mean to imply, Mr. Dingell, that in all or even in most instances a subsidiary would be preferable. I think there would be many instances in which a bank holding company, which is where most of the financing is done for these institutions, will determine that it is preferable to take the assets and put them into the affiliate, because the problem that the bank holding companies have is that, in effect, the creditors of the bank holding companies come behind the creditors of the bank. I am just telling you things you know. So what the creditors of the bank holding company like to see are assets that lie outside of the reach of the bank regulators. So I actually think that in many instances, the affiliate would have the advantage, not the op-sub, in terms

Mr. DINGELL. That would be particularly true where you had a weak bank, and it would be particularly true where you had a holding company that was apprehensive about the weakness of the bank, its credit ratings, and also about the fact that that bank might go under.

Mr. RUBIN. Well, you know, it is funny. I think it could actually cut both ways, because if you have a weak bank and the holding company is worried about the weak bank, they have competing considerations. But it seems to me by giving them their choice and allowing them to do what is best for them, I think they will probably do what is best for the taxpayers and the FDIC. But if they have a weak bank, Mr. Dingell, it may well be that they will decide the thing they have to do is to take those assets and keep them where it most reassures the creditors of the bank, and that would be to put them in the op-sub.

On the other hand, they might say, no, we want to make sure that our holding company is in the best position possible, and therefore put them in the affiliate. I think every business situation is going to be different.

Mr. DINGELL. Well, now, here we have

Mr. RUBIN. I might say that if the bank is actually weak, then you can't have a sub in the first place. There is a capital requirement to have these new activities, as you know.

Mr. DINGELL. Here you note that, in the case of operating subsidiaries, that to keep these banks or rather to keep the assets of