[Senate Hearing 107-659]
[From the U.S. Government Publishing Office]
S. Hrg. 107-659
PROTECTING RETIREMENT SAVINGS:
FEDERAL DEPOSIT INSURANCE COVERAGE
FOR RETIREMENT ACCOUNTS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
ON
PROTECTING RETIREMENT SAVINGS: FEDERAL DEPOSIT INSURANCE COVERAGE FOR
RETIREMENT ACCOUNTS
__________
NOVEMBER 1, 2001
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
U. S. GOVERNMENT PRINTING OFFICE
81-713 WASHINGTON : 2002
___________________________________________________________________________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
PAUL S. SARBANES, Maryland, Chairman
CHRISTOPHER J. DODD, Connecticut PHIL GRAMM, Texas
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii JOHN ENSIGN, Nevada
Steven B. Harris, Staff Director and Chief Counsel
Wayne A. Abernathy, Republican Staff Director
Martin J. Gruenberg, Senior Counsel
Dean V. Shahinian, Counsel
Sarah Dumont, Republican Professional Staff Member
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
______
Subcommittee on Financial Institutions
TIM JOHNSON, South Dakota, Chairman
ROBERT F. BENNETT, Utah, Ranking Member
ZELL MILLER, Georgia JOHN ENSIGN, Nevada
THOMAS R. CARPER, Delaware RICHARD C. SHELBY, Alabama
DEBBIE STABENOW, Michigan WAYNE ALLARD, Colorado
CHRISTOPHER J. DODD, Connecticut RICK SANTORUM, Pennsylvania
JACK REED, Rhode Island JIM BUNNING, Kentucky
EVAN BAYH, Indiana MIKE CRAPO, Idaho
JON S. CORZINE, New Jersey
Naomi Gendler Camper, Staff Director
Michael Nielson, Republican Professional Staff Member
(ii)
C O N T E N T S
----------
THURSDAY, NOVEMBER 1, 2001
Page
Opening statement of Senator Johnson............................. 1
Opening statements, comments, or prepared statements of:
Senator Bennett.............................................. 3
Senator Miller............................................... 4
Senator Allard............................................... 4
Senator Stabenow............................................. 4
Prepared statement....................................... 25
Senator Carper............................................... 21
WITNESSES
L. William Seidman, Chief Commentator, CNBC-TV, and Former
Chairman, Federal Deposit Insurance Corporation and Resolution
Trust Corporation.............................................. 5
Prepared statement........................................... 25
Response to a written question of Senator Miller......... 40
Howell E. Jackson, Finn M.W. Caspersen and Household
International Professor of Law and Associate Dean for Research
and Special Programs, Harvard Law School....................... 8
Prepared statement........................................... 26
Glenn C. Dahlke, President, Dahlke Financial Group............... 12
Prepared statement........................................... 33
Additional Material Supplied for the Record
Prepared statement of America's Community Bankers................ 37
Letter to Senator Tim Johnson from Fred R. Becker, Jr., President
and CEO, National Association of Federal Credit Unions, dated
October 29, 2001............................................... 41
Letter to Senator Tim Johnson from Daniel A. Mica, President and
CEO, Credit Union National Association (CUNA), dated October
29, 2001....................................................... 42
(iii)
PROTECTING RETIREMENT SAVINGS:
FEDERAL DEPOSIT INSURANCE COVERAGE
FOR RETIREMENT ACCOUNTS
----------
THURSDAY, NOVEMBER 1, 2001
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Subcommittee on Financial Institutions,
Washington, DC.
The Subcommittee met at 2:32 p.m., in room SD-538 of the
Dirksen Senate Office Building, Senator Tim Johnson (Chairman
of the Subcommittee) presiding.
OPENING STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. The Subcommittee on Financial Institutions
is called to order.
I am pleased to convene the Financial Institutions
Subcommittee for this second in a series of hearings to
consider comprehensive deposit insurance reform. It is critical
that we continue on with the business of America, and I would
like to thank my colleagues here in the Senate for their
commitment to this work.
Today, we will consider the topic of protecting retirement
savings. So many of our retirees have spent their lives saving
to make sure that they can remain independent in their later
years, especially given some uncertainty about the long-term
viability of Social Security. Many have put those savings to
work for them in a variety of investments through tax-deferred
accounts and have watched their balances mount.
Over the past few months, however, we have been reminded
that while equity markets can provide unparalleled
opportunities for economic growth, those opportunities do come
with volatility. And while many younger investors have enough
time to ride out the ups and downs, those of us who are closer
to retirement age have to make sure that we have enough savings
in secure investments to ensure a comfortable retirement.
Yet while Congress has created significant incentives to
encourage Americans to save for their retirement, we have not
taken the necessary steps to let our retirees keep their life
savings safe in their local communities. We are just waking up
to the fact that our current deposit insurance coverage of
retirement savings is simply inadequate to support the cost of
retirement in the year 2001.
As many of you know, I have been very interested in
comprehensive deposit insurance reform and I am convinced that
this issue continues to grow in importance. The current deposit
insurance reform system is dangerously procyclical, and in a
softening economy, banks are at real risk of having to absorb
severe insurance premiums. Those who resist a comprehensive
reform package assume that the funds will never dip below the
1.25 percent range. To those individuals, I would simply point
them to the latest FDIC Review Board report, which projects the
BIF ratio possibly dipping to 1.23 percent for the first time
since 1996.
The Senate Banking Committee, under the able leadership of
Chairman Sarbanes, recently looked into the failure of Superior
Bank of Illinois, which the FDIC projects will cost somewhere
in the $500 million range and could cause fund ratios to dip
still
further. And we see daily reports of softening loan portfolios
among our financial institutions, which provide the lifeblood
of our economy.
Deposit insurance provides the rock-solid foundation that
keeps our financial system healthy by giving depositors the
confidence they need to keep their money in the bank. And those
deposits, in turn, fund lending activities that finance our
Nation's commerce. We must take great care to ensure that our
system remains healthy and make any revisions proactively, so
that we do not find ourselves in the position of having to act
in a crisis mode.
Today, we will be looking at a very narrow slice of what I
hope will be a comprehensive deposit insurance reform package.
We are privileged to have a distinguished panel of experts who
will help this Subcommittee think through the issues related to
deposit insurance coverage of retirement accounts.
We have heard a great deal of discussion about the
appropriate level of Federal deposit insurance coverage, and
that debate continues. But I was struck at our August 2 hearing
by a question that Chairman Sarbanes put to our witness panel.
Senator Sarbanes asked how it is we should approach the
question of what the ``right'' level of coverage is?
Senator Sarbanes' question, I believe, can be answered in
the context of retirement savings, and judging from the very
thoughtful written testimony that we have received from today's
witnesses, I am hopeful that we will leave this hearing with
some real insight into the matter.
Retirement accounts constitute a small proportion of
deposits in FDIC-insured institutions. According to FDIC data,
as of June 30, 2001, insured banks and thrifts held $219
billion in retirement accounts, 72.9 percent of which are
insured. The remaining $59.3 billion of these retirement
account deposits are uninsured, and this Subcommittee should be
concerned. The safety of our retirees' savings should be a top
priority for this Congress, especially as our citizens live
longer and want to remain independent of outside assistance.
I had a chance to visit yesterday with FDIC Chairman Don
Powell, who has earned his very distinguished reputation. He
told me he strongly supports the recommendations the FDIC
issued earlier this year with respect to comprehensive deposit
insurance reform. And directly related to today's discussion,
Mr. Powell urged me yesterday to consider raising deposit
insurance coverage of retirement accounts to $250,000. My
understanding is that such an increase would have a relatively
small impact on the ratio of a combined insurance fund, in the
neighborhood of two to three basis points.
I am sure the Banking Committee will have the occasion to
hear directly from Mr. Powell on this topic. But today, we turn
our attention to our distinguished witnesses, and I would like
to take just a moment to introduce them.
It is a great privilege to introduce Bill Seidman, who is
so well known he probably doesn't need much introduction. Mr.
Seidman is perhaps best known for his Chairmanship of the FDIC
from 1985 to 1991, as well as his Chairmanship of the
Resolution Trust Corporation. He has seen our financial system
through some of its darkest hours, and he brings an important
historical perspective to this discussion. Mr. Seidman has also
found time to participate very successfully in the private
sector, and we have all appreciated him in his current role as
Chief Commentator on CNBC-TV.
Mr. Seidman, welcome.
Mr. Seidman. Thank you.
Senator Johnson. Our next witness is Mr. Howell E. Jackson,
who is the Finn M.W. Caspersen and Household International
Professor of Law at Harvard Law School. Professor Jackson has
expertise in the areas of regulation of financial institutions,
secur-
ities regulation, investment companies, and pensions and Social
Security.
Professor Jackson received his bachelor's degree from Brown
University, followed by a JD and an MBA, both from Harvard. He
joined the faculty of Harvard Law School in 1989, and just last
week was appointed Associate Dean for Research at the Law
School. It is an honor to welcome him before the Subcommittee.
Finally, I would like to introduce Mr. Glenn Dahlke,
President of the Dahlke Financial Group of Glastonbury,
Connecticut, a family-owned sales and asset management company.
Mr. Dahlke began his career in 1977 as a representative of
the Connecticut General Life Insurance Company in New Britain.
In 1990, he went into partnership with his father, Gerald
Dahlke, also a Connecticut General representative. Together
they formed an independent sales and asset management company
in Glastonbury that became the Dahlke Financial Group. Mr.
Dahlke represents a critical sector of our Nation's economy,
the family-owned business. It is a privilege to have him before
the Subcommittee today.
I now turn to our very distinguished Ranking Member,
Senator
Bennett, for any opening comment that he may wish to make.
STATEMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you very much, Mr. Chairman.
I do not have a great deal to add to your comments. I
appreciate the witnesses and appreciate your holding this kind
of a hearing. It is not as glamourous or sexy as some of the
things that we do, but, in the long run, it may be more
important than some of the things that have a higher profile.
The financial services industry and the underlying economy
have both changed dramatically since the last time Congress
addressed the deposit insurance system. Fortunately, we are in
a position where we are not talking about trying to save the
system. There have been hearings on that subject in the past.
We have seen the system get healthy enough that, over the
past several years, highly-rated institutions that were
assessed very high premiums in the 1990's to help recapitalize
the insurance funds have not been required to pay any premiums
at all over the last several years.
We are talking about examining the system to see whether it
needs just a technical fix, all the way to a complete
restructuring. A hearing of this kind that is more
informational and less adversarial is a very logical thing to
do in that kind of an atmosphere.
I congratulate you for pursuing your interest in this and
for putting together the kind of panel that we have before us
today.
Thank you.
Senator Johnson. Thank you, Senator Bennett.
Senator Miller.
COMMENT OF SENATOR ZELL MILLER
Senator Miller. I do not have an opening statement. I am
looking forward to hearing from the witnesses.
Senator Johnson. Senator Allard.
COMMENTS OF SENATOR WAYNE ALLARD
Senator Allard. Mr. Chairman, just a brief comment. I want
to thank you for holding this hearing on deposit insurance for
retirement accounts.
I am a cosponsor of legislation to increase deposit
insurance on accounts and I am therefore very interested in
this topic. Unfortunately, I won't be able to stay here during
the entire testimony because I have a Conference Committee I
would like to attend, but I will stay as long as I can.
The $100,000 per account level was set in place in the
early 1980's and has not been increased since that time. I
think we should take a look at a variety of approaches on this
issue. These include an increase in the level of deposit
insurance, indexing the level, so that it at least keeps up
with the level of inflation or simply increasing the level of
insurance on retirement accounts.
This last option is the topic of today's hearing and I look
forward to hearing from our witnesses.
Senator Johnson. Thank you.
Senator Stabenow.
COMMENTS OF SENATOR DEBBIE STABENOW
Senator Stabenow. Thank you, Mr. Chairman. I want to thank
you first for your leadership on this very important issue and
welcome all of our panelists that are with us today. I think
this topic is extremely important and I will submit my opening
comments in their entirety, Mr. Chairman, if that is
permissible.
But I would just indicate that I agree that we need to
reform the Federal deposit insurance coverage for retirement
accounts. There is ample evidence that the current system does
not promote adequate savings for retirement. And indeed, there
are structural barriers that unnecessarily complicate and
impede effective planning for retirement.
When the deposit insurance coverage for retirement accounts
was last raised, as everyone has indicated, about 23 years ago,
$100,000 went a little bit farther than it does today. No one
today could credibly contend that such an amount would be
sufficient to provide for the long-term needs of retirees. It
is past time for us to review this coverage level.
And so, I want to thank the Chairman again and I look
forward to working with you and I believe that we can come to a
consensus and move this important policy issue forward.
Thank you.
Senator Johnson. Well, thank you, Senator.
Without objection, the written testimony from the three
witnesses, along with written submissions from America's
Community Bankers and the National Association of Federal
Credit Unions, will be included in the record.
Welcome to the panelists. Because we have focused on three
panelists who are among the leading experts in the Nation on
this issue and have simply the one panel, I think we can take
the luxury of affording each of them a little more time than is
sometimes the case.
The Chair would suggest a 10 minute period of time to
either read or summarize your statement would be available to
each of you. And then, at the conclusion of the discussion from
all three of the panelists, we will open it to the Committee
for any discussion and questions that would follow.
Welcome, Mr. Seidman, and why don't you begin.
STATEMENT OF L. WILLIAM SEIDMAN
CHIEF COMMENTATOR, CNBC-TV, AND FORMER CHAIRMAN
FEDERAL DEPOSIT INSURANCE CORPORATION AND
RESOLUTION TRUST CORPORATION
Mr. Seidman. Thank you, Mr. Chairman, and Members of the
Subcommittee. It is nice to be back here after all these years.
It is always a real privilege to testify.
I have here an editorial on this subject that I wrote for
Bank
Director magazine, of which I am the publisher. So, I have that
as a written statement.
The essence of my view is that I believe that deposit
insurance coverage has been reduced during the last 20 years by
inflation and it clearly ought to at least keep up with
inflation.
We have just seen another demonstration in recent tragedies
and strain that the system has been under that deposit
insurance prevented the kind of runs on banks and so forth that
sometimes take place when there is potential for panic. I think
we have once again seen the value of deposit insurance.
As far as increasing the amount is concerned, as I say, it
ought to at least keep up with inflation, if not more than
that, and that goes a fortiori for retirement accounts, which
have a special benefit to those who use them.
I would like to start by saying that when this kind of
thing was suggested, there were immediate arguments by some of
our leaders that any kind of increase was a very bad idea,
including the Chairman of the FED, the then-Chairman of the
Senate Banking Committee, and others.
As I read their arguments, one was, it seemed, that there
was a potential for great increased cost to the Government by
increasing the amount of insured accounts.
First, I would like to point out that deposit insurance for
banks has never cost the taxpayer a penny. The deposit
insurance fund of the bank has been totally, since 1933, funded
by the banks and taxpayers have never been asked to pay any
amount of money.
Now, you all know that we had large losses back in the
1980's on deposit insurance. That was in the S&L industry. The
losses there, I think we cannot go into the total analysis, but
resulted from all kinds of mistakes, bad regulation, and other
things, which I will be happy to talk about if you would like.
But a well-administered bank insurance fund handled over a
thousand bank failures and the taxpayer did not have to pay a
penny.
I think, while there is always the potential when you
guarantee something that you will have to pay, we have now an
almost 70 year history that says that this fund can be self-
supporting if it is properly administered.
A second thing that was raised was that this would be
another distortion of the free market, would create moral
hazard, and therefore, was undesirable. My response to that is
that almost everything the Congress does distorts the free
market. That is their purpose, which is to make the free market
work better by providing the kind of distortions which allows
it to operate.
And I have always said the difference between a regulated
market and a nonregulated market is like the difference between
a prize fight and a barroom brawl. In a prize fight, you have
competition, but it is under rules, and even though you can
slug the guy, you cannot pick up the chair and you cannot hit
the referee and so forth. In a barroom brawl, you can do
whatever you want and the whole place gets destroyed.
So the free market is wonderful. I am one of its strongest
supporters. But if you look at what the Congress does, it is
continually trying to adjust things to make the free market
work better.
I must say that Chairman Greenspan runs probably the
biggest intrusion in the free market in the financial area in
the operation of the Federal Reserve System.
I simply take that argument and say, that cannot be the
real question. The question is whether this intrusion in the
free market will benefit the system or not. And the argument
that it, per se, is wrong because it is a further intrusion in
the market I do not think is going to carry the day.
So, we get to the question of is it good for the system to
increase deposit insurance, at least keep it even with
inflation and especially provide for retirement accounts? And I
think it is good on several grounds.
First, having a sound banking system and one that is
supported by deposit insurance is probably the single biggest
base that we could have for a sound economy. And one only needs
to go to Japan where I have been working for the last few years
to see how true that is. They have a banking system which is in
real trouble. They have no real deposit insurance, and they
have, as a result of that and other things, a very sick
economy.
So, I think a soundly-based banking system, and one of the
things you have to have in a soundly-based banking system is
some protection against losses and particularly by those people
who have no real way to judge the financial strength of a bank.
For the average citizen, judging the financial strength of
a bank is probably beyond any training that he or she has.
Maybe in the biggest banks, they can look at the rating system
and get ratings from big agencies. But for our community banks,
even the regulators have some trouble knowing when banks are in
trouble, as we have seen many times over history. I think that
the idea that the citizen will regulate the system through
judging the strength of banks is one that is not supported by
the real facts. Therefore, you have to rely upon regulation
rather than the consumer to regulate the system. And that is,
of course, what we have done.
I would also point out that for the small depositor, and in
today's world, $100,000 is certainly not a big depositor, the
ability to get a Government-guaranteed deposit, this is about
the only way that they could do it. They could go out and buy
Government bonds. That is more difficult. It is not as liquid.
They cannot use it for other things. So for the small
depositor, let's just say the average citizen, it is a great
benefit to their personal finances.
It is also of great benefit to small banks. Deposit
insurance was not put in for the benefit of small banks. It is
very clear it was for depositors. But it has become, in my
view, essential for the survival of small banks, community
banks as they are called, because the very large banks, no
matter what you say and whatever legislation we have, have
always been too big to fail as far as depositors are concerned.
They can fail, and they do fail, but all depositors have
been covered in every major bank failure that we have had in
the United States and that any of the developed countries has
had anywhere in the world.
The day that the regulator is born who will see one of
these major banks about to fail and announce that he is going
to clip all depositors, I do not think the regulator is yet
born that will be willing to do that when he has to face the
issue.
Too big to fail is out there. That gives the big banks a
tremendous advantage over small banks because small banks not
only have failed, but also we have in many, many cases had to
penalize the depositors for their over $100,000. I think that
it is almost, you might say, essential for small banks to have
deposit insurance, to have it at least keep up with the present
levels for their safety and soundness. And I would put to you
that small banks are a very essential part of this Government's
economic system. They decentralize the decisionmaking, and I
think they are very important to maintain. So, I come to the
conclusion that it is important to increase deposit insurance,
at least with inflation, and to have some special provisions
beyond that for retirement accounts.
Thank you.
Senator Johnson. Thank you, Mr. Seidman.
Professor Jackson, welcome, and why don't you proceed with
your testimony.
STATEMENT OF HOWELL E. JACKSON
FINN M.W. CASPERSEN AND HOUSEHOLD INTERNATIONAL
PROFESSOR OF LAW AND ASSOCIATE DEAN FOR
RESEARCH AND SPECIAL PROGRAMS
HARVARD LAW SCHOOL
Mr. Jackson. Thank you.
Chairman Johnson, Ranking Member Bennett, Members of the
Subcommittee, I am pleased to be here with my copanelists to
continue the discussion of reforming deposit insurance that
began, I would say, more than a year ago with the FDIC staff 's
release of their quite excellent Options Paper.
I thought I would begin my comments by saying a few words
about deposit insurance in general, and then turn to the
particular topic of today's hearing, which is retirement
accounts. As Bill Seidman indicated, there are really three
reasons why we have Federal deposit insurance.
First, is that there is a certain group of depositors who
need
to have a certain amount of assurance that there is a risk-free
investment vehicle that they can take advantage of. This is a
paternalistic consideration, I think it is a valid one, and it
is one that has justified deposit insurance in the United
States and many other countries. Without deposit insurance,
individuals would have to make this inquiry that Mr. Seidman
referred to, trying to distinguish between banks and would
often make mistakes in deciding where to make their
investments. So that is one valid purpose.
Second, another traditional purpose of deposit insurance is
to prevent macroeconomic consequences, such as runs or other
irrational behavior in times of financial panic. That has been
a justification and I think it is a valid one.
Third, I think is regarding issues of political economy, a
desire to have a certain kind of financial services sector,
including a large number of smaller institutions that might, in
the absence of deposit insurance, not be able to compete. So
three different considerations. All have been mentioned so far
this afternoon.
The debate over expanding deposit insurance at this point,
as I understand it, is largely proceeding under the assumption
that it is the first and third of these considerations that
have changed.
There are not arguments about macroeconomic considerations
and I think evidence of the last month shows that we did not
experience runs on banks when the events of September 11
occurred. In fact, there was probably money flowing into the
depository institutions as opposed to out of the institutions.
What we really have now is a set of arguments about the
need for insurance being increased to protect individuals, and
I think in a lot of the testimony you have heard before,
arguments that small banks need to have higher levels of
coverage in order to compete effectively in the current
marketplace.
Now in terms of these general arguments, I guess I would
say that one should be cautious about expanding deposit
insurance in general for a variety of reasons. It is a costly
program. There are potentially moral hazard problems. I think
it is possible to make a case for expanding coverage and I
think, actually retirement savings is a good example of a case
for that. But I think the burden should be on the proponents to
increasing the levels. In terms of the political arguments, I
think there are also valid arguments and they have been made
effectively in a number of forums.
It is not entirely clear to me that we need to freeze the
structure of the financial services sector the way it was in
1980, for example. So the mere fact that deposits have declined
in relative proportion in the financial services industry is
not compelling evidence in my mind that we need to increase the
level of insurance.
But, still, I think, the concerns of the small bankers are
a valid consideration and one that I think should be factored
into this Subcommittee's analysis.
In terms of the underlying ultimate question of the
appropriate level of insurance coverage, this is a hard
question and a difficult question and one that has been taken
up earlier.
I do not have much to add to that, except to say that I
think near reference to levels in 1980 or 1970 or 1933 is not
particularly helpful. It is better to have a normative baseline
of some sort.
The IMF has recently done a study which I cite in my
written testimony, that suggests two times GDP per capita is
one benchmark. That would suggest a level of $70,000, $75,000
in the United States today. We are at or above that level right
now. And if one looks comparatively around the world, most
countries are either below or just at that level. Very few
countries are ahead of where we are in the United States.
That does not mean that we do not want to have higher
coverage in the United States. There may be reasons about our
political economy that argue for higher coverage. But it would
give me pause to have a general increase much above the current
levels, or at least I think the burden would be very much on
proponents.
Now today's hearing is about retirement savings. And I
think if there is an area that justifies potentially increasing
coverage, it is the area of retirement savings.
There have been changes in the United States. The
demographics have changed. Life expectancy has changed, length
of time in retirement has changed. There is clearly a demand
for retirement savings or a need for retirement savings.
And if one accepts the premise that the Government has a
role in creating a safe vehicle for certain individuals who
want a risk-free investment vehicle, then I think expanding
deposit insurance in this area can be supported as a
theoretical matter and as an
equitable matter. So, in general, I think the idea of a higher
level for retirement savings is appropriate.
The difficulty, of course, is figuring out what that level
would be. And in my written testimony, I tried to take a stab
at how I would set it. I started with a similar assumption that
it should somehow be tied to GDP per-capita or household
income, that we should be thinking in terms of replacement
rates for income, which is how financial planners think.
The usual rule of thumb is that one should have 70 to 80
percent of preretirement income as your base in retirement. So
if one takes the median income, household income in the United
States, that is about $42,000 today. That is the middle. Half
are beneath, half are above that. I think it would be plausible
to think about that as the person to protect. Individuals who
are wealthier than that, have more income than that, will have
retirement savings needs, but
I think we should be focused on the bottom end of the spectrum,
people who are not sophisticated, in all likelihood, and need
our
assistance.
I worked through the calculations of what you might
reasonably expect such a person to require for retirement
savings and if you factor in Social Security coverage under
existing levels, or more or less existing levels, it works out
that someone at the median income would need about $250,000 of
retirement savings on the eve of retirement to fund their
retirement at the sort of target level of 80 percent.
Now there is a lot of heroic assumptions that I have made
in coming up with that number. But it gives you a rough cut of
what a plausible level would be, if you accept my assumptions
that we should be shooting not for Bill Gates. We are not
trying to insure his retirement savings, or people at the 95
percentile. But if we take the middle-income person, this is a
reasonable amount of retirement savings and you might think in
terms of setting the coverage level at that amount.
It is 2\1/2\ times the $100,000 level. Coincidentally, I
did not do this. This overlaps with what Chairman Powell
suggested a few days ago. And it also is the same ratio we saw
in the 1970's when we had special coverage higher levels for
retirement savings. So there is a precedent for this that you
could see historically and I think it could be justified
empirically.
Having sort of thrown out this $250,000 level, I think
there is a couple of points that I should make aside from the
fact that it is based on some debatable assumptions. The main
point to make is that this is an aspirational level which the
vast majority of Americans currently do not reach.
If you look at the information about the savings, the
financial assets of most Americans, it is not close to $250,000
in retirement savings. In fact, the median net worth in 1995,
according to census data, was something like $110,000 total net
worth. And most of that net worth was in household equity, home
equity, not in savings accounts or any other kind of financial
asset. So there is a gap between the reality of where Americans
are with their retirement savings today, especially if you are
talking about the median and lower income individuals in this
aspirational level of $250,000. Now that is not to say that we
shouldn't set it at $250,000, and my testimony suggests that I
think this is plausible. But it is well above where most people
are, and I think that that should factor into the analysis.
In my testimony, there are a number of other points that I
mention, technical points. Just let me quickly run through them
today.
We have been talking generally about retirement savings. It
is not clear what that concept means. The term that we use, a
lot of the discussion has been IRA's and Keogh plans. But that
is a special subset of retirement savings. There are many other
kinds of plans, employer-based plans, like 401(k) plans. There
are more assets in these other plans.
It is not clear to me that if you are trying to make a
risk-free vehicle, you wouldn't want to use a broader category
of retirement savings than just IRA's and Keogh's. In fact,
when you begin to think about what the real retirement savings
of many individuals is, it is not the tax-preferred vehicles
like IRA's and Keogh's. It is home equity and other sources of
wealth.
It creates a little bit of a dilemma if you think of a
retired couple that has most of their wealth in a house, they
sell their house at 65, they put the proceeds in a bank account
to fund their retirement in a nursing home or in a smaller
apartment.
Are we going to say that those people who did not take
advantage of tax-preferred savings are not going to have a
higher limit for their bank account. But a wealthy person who
will have a roll-over IRA is going to get the higher level. I
do not have a solution to this problem, but I think we need to
think a little bit more about the definition of what a
retirement savings account is, rather than just picking up the
old IRA and Keogh definition.
In my testimony, I make two other points. One is
controversial, so maybe I should say it out loud so it doesn't
slip by. If you look at the testimony of the banking industry,
they are very interested in getting retirement savings
accounts. And one of the things that they say about these
accounts is they are stable accounts. They do not move around.
They are very good funding sources.
If you think of the reason why we want to expand coverage
for retirement savings, it is because certain borrowers are not
sophisticated. They do not shop around. They cannot evaluate
things.
This group of people are potentially subject to
exploitation and a banker could be tempted to lower the
interest rate paid to these IRA accounts and elderly
individuals may not move their money.
And so, I think one of the things the Subcommittee should
think about is if you are going to give a benefit to the
banking industry in the form of a higher retirement savings
level for these kinds of accounts, to wonder whether there
should not be some obligation on the banking industry's part to
pay at least some minimum rate of interest.
I would not propose rate regulation, but tieing the rate of
interest to inflation-adjusted bonds or some market rate, is
something that I think you should consider. Otherwise, there is
a possibility that some of these banks trying to improve the
bottom line, could give below-market rates, and I think that
would be unfortunate and certainly not help the goal of
retirement savings.
Finally, I think that one of the advantages of setting a
higher goal for retirement savings is the message it will send
to American citizens about the need to save for retirement.
As the Chairman mentioned in his opening comments, there is
inadequate retirement savings today. Social Security may not
cover that need as it has in the past. And it is very important
to send a message that more retirement savings is necessary.
And this notion of $250,000, which is six times final
income, is an important target for Americans to begin to think
about. And one might think of including an educational
component in this legislation, as well as coverage increases.
Thank you very much.
Senator Johnson. Thank you, Professor.
Mr. Dahlke.
STATEMENT OF GLENN C. DAHLKE
PRESIDENT, DAHLKE FINANCIAL GROUP
Mr. Dahlke. Chairman Johnson, Ranking Member Bennett, and
Members of the Subcommittee, I too would like to thank you for
inviting me here to testify.
Mr. Chairman, it is my strong recommendation that Congress
should substantially increase the value of Federal deposit
insurance for retirement accounts.
You have heard today, and I will be somewhat repetitious
here, in saying that, obviously, the cost of retirement has
skyrocketed since the last time limits have been set.
But also, I would like to talk a little bit today about a
system that has been created for some elderly Americans who
want to remain self-sufficient in their later years and how the
limitations to some extent has forced them through some
complicated and some potentially costly hoops just to protect
these savings. This afternoon, I want to make four points.
First, and again, this is going to be somewhat repetitious,
$100,000 in retirement savings is simply insufficient to
support most retired individuals, especially when we look now
at the increased life expectancy that we enjoy and overwhelming
medical costs, including the cost of convalescent care.
Second, it is rational for retirees with low-risk
tolerance, and those who need a predictable income stream to
invest savings in excess of $100,000, I think primarily, or
even perhaps exclusively, in insured deposits.
Third, many retirees who invest in insured deposits are
ill-equipped to cope with the Federal distribution
requirements--these are the required distributions past age
70\1/2\--that can become more complicated in figuring what your
minimum distribution might be when the accounts would be spread
across many different institutions.
And finally, I believe it is inappropriate to require
retirees to choose between the safety of their life savings and
banking with someone who perhaps they have had a relationship
with for many years and who they have learned to trust over
those years.
Over the years, Congress has created important tax
incentives to encourage people to set aside money for
retirement, recognizing the benefits to our society of
individual self-sufficiency.
I applaud Congress for recently increasing the amount that
Americans may save through tax-deferred programs such as the
IRA's, the ongoing increases in 401(k)'s, et cetera, which
recognizes, obviously, that the costs of retirement are going
up.
However, even without these higher contributions, if we
look at what used to be called the rank-and-file individual who
has put 20 or 30 years into a single company, has taken
advantage perhaps of their 401(k), the company match, the
profit-sharing plan, and has put money away in a disciplined
manner, you can easily amass over $100,000 in retirement
savings.
Up in Hartford, we have United Technologies, which was one
of the first companies to get involved in 401(k)'s. And it is
not unusual now to see several hundreds of thousands of dollars
coming out of their 401(k) plan.
Now in a lot of cases, what is being rolled over? And I
think Professor Jackson said it. This is not coming from IRA
money. This is coming from qualified plans that people have
taken out of their qualified plans at retirement.
But this is a major source of income other than Social
Security, and what we are seeing here is it becoming a major
asset of theirs, even a greater asset than their residence. And
$100,000 is just barely sufficient to cover basic living needs.
For example, if we take a 72-year-old widow, a woman who is
in the time period where she must now be taking required
minimum distributions, she has $100,000 in an interest-bearing
IRA account. Plus $10,000 of Social Security. Well, if you look
at the IRA earning her minimum distribution of the 5 to 6
percent range, she is living at an income of $15,000 a year.
This is not a lavish lifestyle. And she also is not in a
position where she can afford to take a lot of risk. She cannot
replenish this money, and she cannot take on the financial
shock she might get if she needs a new roof or she has some
kind of uninsured medical procedure. So she needs to save this
money.
I think this is a crucial point because there has been some
argument that $100,000 is a lot of money. Well, $100,000 simply
is not a well-off person at all. I think, on the contrary,
Congress should insure that those workers who have saved in a
disciplined and responsible manner for their retirement have a
completely secure investment option. Now there is a lot of
options here. But they should have a secure investment option
for an amount adequate to support themselves. I think that is
fair and I think, frankly, that is good public policy.
First, it is rational for retirees who have a low-risk
tolerance and need a predictable income stream to invest
savings in excess of $100,000, primarily or, again,
exclusively, in insured instruments such as certificates of
deposit. I do not think Congress should create disincentives
for this investment strategy.
Insured deposits are appropriate investments for retirees
who may be able to live comfortably off their interest on their
savings, but cannot afford to lose any of the principal. There
is also the point here of retirees who prefer these kinds of
instruments because they provide a predictable fixed income.
When we look at how IRA's are distributed and the method
you use, which, for somebody over 70\1/2\, is to take the
balance of
their IRA accumulations on December 31 of the preceding year,
apply a divisor for it, and that now determines the required
minimum distribution.
If we are sitting in front of a client and they want
predictable income, we have to then predict what these balances
are going to be from year to year. The only predictable
instrument that you can really use pretty much are certificates
of deposit. It is not going to happen with stock. We have seen
what has happened with stock balances and IRA's over the last
few years.
And even with Treasuries and any other interest-sensitive
vehicle, that will affect the December 31 balance, which will
affect the issue of predictable income. So I think that is a
crucial point here.
Finally, a lot of retirees prefer to keep their money with
people they know and trust, especially in small towns. I live
in Connecticut, which is supposed to be a populated town, but I
live in a town of 2,500 people and we do not have any banks. We
have a car dealership. We have a marina. We have a grange. But
we do not have any banks.
Personal relationships can develop between bankers and
their clients and this may be hard to believe for people that
live in an urban environment. These local relationships remain
an important feature of the community banking system that we
have heard about today.
Higher coverage levels for retirement accounts would
significantly reduce the risk that a retiree with over $100,000
in insured deposits would become subject to the 50 percent
penalty for undistribution of IRA savings. Again, the way you
make distribution from an IRA account, you do not have to take
it from IRA from IRA. You must take the distribution from the
aggregate among all the retirement accounts.
People with CD's tend to take the money from the CD with
the lowest-paying interest. So people who are in CD's tend to
play the shell game of where their money's coming from.
Well, with someone with, say, $250,000 of IRA savings who
want to be insured, being forced now to three different
institutions have to make this calculation and have three times
the chance of screwing up the calculation. And if they screw up
the calculation, that is fine. The IRS says, you owe me 50
percent of what you did not take for your minimum distribution.
And these are for people who haven't managed money in their
life, and just trying to hold on to what they have.
The risk is enhanced, obviously, as I said, when this
individual has to spread between institutions, and this is what
the $100,000 is doing. It is forcing them to spread their
$100,000 to different institutions. And again, there is the
talk of, well, you go to a bank that is $5,000--we are talking
about IRA's. That does not exist. You cannot have joint
accounts, et cetera. It is limited to the $100,000.
I have gone over the point that the retirees are, again,
forced to choose between the insured deposits and banking with
someone that they have had the relationship.
We in the financial community drill into our clients the
sanctity of diversification of their investments. But we do not
like them to get diversification of financial advice. We prefer
that they get that at one place, hopefully, our own office.
Again, moving the people to different banks again forces them
to different advice.
I think that Chairman Greenspan has wisely noted that
deposit insurance coverage limit is designed to accomplish
exactly this objective of spreading money across banks to
reduce the Government's risk at any institutional failure.
But in the retirement context of real people with real
money, it is my strong belief that this is really a bad trade-
off. The benefits from maintaining an adequate level of
insurance retirement savings pale in comparison to the
potential costs to retirees, like the under-distribution,
forced to maintain multiple accounts.
For these reasons, Mr. Chairman, I strongly urge Congress
to increase coverage levels that have not been touched in I
guess over two decades, and to take measures to ensure these
limits keep pace with the true costs of retirement.
And I thank you for the opportunity to present my views to
the Subcommittee.
Senator Johnson. Thank you, Mr. Dahlke.
I will lead off with questions. And I direct this in
particular to Professor Jackson, I believe.
Bank holding companies which permit a single corporate
family to maintain multiple bank charters appear to me to be at
a significant marketing advantage in offering clients more than
$100,000 in deposit insurance coverage, especially with respect
to retirement accounts.
As Mr. Dahlke has pointed out in his testimony, higher
coverage that could be structured within a single institution
with respect to general deposits is not possible with
retirement accounts, or is not advisable, because of
restrictions in the tax code.
According to the information provided by the Federal
Reserve Board, 21 bank holding companies have 10 or more bank
and thrift subsidiaries, 106 have five or more bank and thrift
subsidiaries. And so two questions occur to me in particular.
First, other than bank holding companies, is there any
other structure that would allow a bank to offer any given
individual more than $100,000 in retirement account coverage?
Professor Jackson.
Mr. Jackson. The coverage is limited to $100,000. There are
a variety of different ways that other accounts, joint
accounts, can be offered to increase the effect of coverage for
individuals at a particular institution, and the FDIC has
documented the rules there. They are quite complicated.
I have heard from some bankers that occasionally, they will
send deposits down the road to a sister bank or something, but
it is not nearly as effective as a bank holding company with
multiple sister banks to whom the deposits can be farmed out
sort of at will. I think you are absolutely right, that this
does put the single bank unit at a disadvantage with respect to
the holding companies.
Senator Johnson. Let me ask Mr. Dahlke and Mr. Seidman,
when we talk about retirement savings, there are clearly
different combinations of what could fall under that definition
for purposes of a different retirement amount coverage.
Today, we have been talking about IRA's and Keogh accounts
in which the FDIC maintains data. But Professor Jackson has
suggested that we should perhaps include more in the retirement
account category.
I wonder if you would share any thoughts that you might
have about the appropriate scope of retirement savings that
Congress should consider for this higher deposit insurance
coverage if we go down that road.
Mr. Seidman.
Mr. Seidman. Well, first, I think this discussion
highlights the problems you get into when you try to take a
particular kind of account and have that account have
additional coverage. If I had my choice, I would rather have
$200,000 across the board and let that handle at least a good
part of the retirement account privilege and it would make life
a lot simpler.
I think the last time I looked at the figures, about 80
percent of the uninsured deposits were by depositors who were
over 65 years of age. This amount is very much concentrated in
that group.
So, I would like to have the broadest definition you could
find. Let's just say, to start an argument, that anybody who is
over 65, his account is a retirement account, and given
whatever amount we decide upon.
I would like to just make a comment on the idea that we
ought to use the median as a way to judge what the size could
be. That seems to me a little bit like telling a nonswimmer to
go across a lake that has an average depth of 2 feet. But it is
10 feet deep in the middle.
We have a lot of people in this group that really need more
coverage. And I do not think we ought to be tailoring it for
just the median person.
It seems to me that we ought to be covering at least, let's
say, 75 percent of the population, would be a better way to
look at it, than the median group.
Senator Johnson. Mr. Dahlke, any thoughts about the scope
of retirement account coverage?
Mr. Dahlke. I think we have to distinguish between
individual accounts--the IRA's, the traditional Roth, what have
you--and money that is held within qualified plans with
companies, the 401(k)'s, profit-sharings.
But you start to get a little complicated, and I do not
have an answer for this, but many of these companies have so-
called pool accounts, where all the employees may be pooled
into, let's say, a stable value account as they might be
called. You might have thousands of employees into this one
account.
Well, what do you do with the coverage there, as opposed to
the company that has self-directed accounts and every employee
has their own stable value account?
I think if you are going to talk about raising this for
IRA's or individual plans, you have to build a bridge over to
the profit-sharing, 401(k) sector as well.
Senator Johnson. Thank you.
Senator Bennett.
Senator Bennett. Thank you, Mr. Chairman. Thank you to the
panelists. This has been very helpful, and I do not have a
whole lot of really penetrating questions. I am just going to
go over your testimony with great interest.
Do I catch the flavor that there should be a difference
between the deposit limits on a checking account that is held
by somebody who happens to have that much money, but is 35
years old and moving around, and somebody who is clearly using
this as a retirement vehicle? Are you saying that there should
be two tiers of deposit insurance?
Mr. Jackson. I think that is the weight of what I am
saying. There may be some disagreement on the panel on this
issue.
Senator Bennett. I picked that up, and so I wanted to focus
on that for just a minute because I had not heard that
suggestion
before.
Mr. Seidman. Well, having been an administrator of some of
these things, I am against complications. And every time you
get into that kind of tiering and so forth, it is remarkable
how much it costs to make it work and how many problems you get
into. I wouldn't think that we would try to distinguish between
checking accounts and CD's or any other kind of deposit.
Mr. Jackson. My reaction is this. It is a little bit
different. I certainly understand the point and I think
complexity is a problem. But I think the most powerful argument
for increasing the coverage, if you look at the discussions, it
focuses in on retirement savings. That is the really good case
in point of why $100,000 is not enough. My view is, if that is
the reason that $100,000 is lagging, deal with that and do not
increase every corporate checking account, every commercial
balance up to $200,000.
You are bringing a whole lot up. And again, my assumption
is coverage should not increase without a strong case. I think
the case is here for retirement, but not for everything else.
Senator Bennett. Okay. Now go back and reverse the
question. What does it cost you if you increase it for all
these other things? Is there increased risk? Increased
exposure?
Mr. Seidman. Well, I can tell you that we went back and
studied what it would have cost us if we had covered $200,000
instead of $100,000.
Senator Bennett. Yes.
Mr. Seidman. And the increased cost was minimal, very
minimal, almost nothing.
Senator Bennett. What about risk?
Mr. Seidman. What about what, sir?
Senator Bennett. Risk. Could you afford it, afford the
increased exposure?
Mr. Seidman. The cost in resolution, we took a bank that
had failed and had $100,000----
Senator Bennett. I see. That is factored in.
Mr. Seidman. Yes, we factored that in.
Senator Bennett. In your analysis.
Mr. Seidman. As I remember it, and I am sure that the FDIC
can dig this study out, but it was something in the
neighborhood of 7 or 8 percent. Not doubled by any manner of
means because when you handle these banks, by and large, you
are trying to get all the deposits covered by selling them off
and that is what happened in most of the cases. As a matter of
fact, the increased cost was very small.
Senator Bennett. All of the members of my family, including
me, are now in the category that you are talking about. And I
have been very interested to see one of my sisters who never
struck me growing up as being that sophisticated an investor,
now handling her money and watching the stock market with a
great deal of sophistication, all of which she has learned
since she has retired, or while preparing for retirement.
Having your retirement entirely in an interest-bearing bank
account strikes me as the most unsophisticated kind of
retirement savings. Do we have any kind of studies as to what
percentage of the retirees go that particular route, or how
many of them are like my sister, who will sit down with me for
the first time in our lives over dinner and talk about how her
high-tech stocks are doing, as opposed to some of the basic
manufacturing, and using words like diversification that she
never used in her life until she turned 60. As I say, she is
very sophisticated. Nobody taught her. She is entirely self-
taught.
Mr. Seidman. That is due to the good work of CNBC, Senator.
[Laughter.]
Senator Bennett. I went over to her house for dinner one
night expecting to have a polite, pleasant chat. She and her
husband both started to get nervous around 8 p.m., and I could
tell that she had something on her mind. She finally said,
would you mind if we watched television? That is very unusual
when we are getting together with family. And I said, no, I
would be happy to. I was expecting their favorite sitcom or the
basketball game. No, they watched Louis Ruckeyser for half an
hour with great concentration.
I am sorry for that little bit of family history, but I
raise the question--what percentage of the retirees have their
nest egg entirely in an interest-bearing bank account, for whom
this kind of protection would be important?
Mr. Jackson. Well, that is a good question. And I think one
of the things that more study needs to be done on is this
distribution of actual financial assets.
The figure about IRA and Keogh assets at $218 billion is in
banks, the total amount of IRA's and Keogh's is 10 times that.
So roughly 10 percent, in that category, is in banks.
In general, if you look at 401(k) plans--I should probably
defer to my colleague here--but the mutual fund sector has
been, I think, the most successful in attracting those. Of
course, the insurance companies have also been successful.
So, I think if you look broadly, particularly at the
wealthier, you will see them distributed outside of the
depository institution sector to a large degree.
Mr. Dahlke. Yes, I would agree that the investment at risk,
it takes a larger part, certainly, of the retirement plan
scenario. But I also think that people should have the right to
pick their own poison here, no matter what the percentages. And
how big your bag of gold is, is a perception that only you can
answer.
People who generally have low-risk tolerances need to be
protected against more sophisticated investors that put all
their money in pets.com and e-toys, who now have no money in
their retirement plans.
Senator Bennett. I do not know how sophisticated those
investors were.
Mr. Dahlke. I guess I am trying to turn the word
sophisticated on its head.
Senator Bennett. Yes. Okay.
Thank you, Mr. Chairman.
Senator Johnson. Thank you, Senator.
Senator Miller.
Senator Miller. With Mr. Seidman's experience on and around
Capitol Hill, and also the analogy you used and the difference
between prize-fighting and barroom brawling, I am tempted to
ask you to elaborate on your observations of what happens
around here. But I won't. I want to ask you something else.
Mr. Seidman and Mr. Dahlke, I would like you to respond to
something that Professor Jackson had in his testimony, in which
he raised various points about which tax-favored vehicles to
cover, expanding the definition of retirement savings, and
potential abuses with the retirement savings account.
Mr. Jackson you gave us quite a bit to think about.
I did not hear you say this specifically, but on the last
page of your testimony, you say: ``Compelling theoretical
arguments support the expansion of the FDIC insurance coverage
for retirement savings. However, the task of structuring an
appropriate extension--that is, an extension likely to reach
low- and middle-income savers--is not trivial. And it is
possible that the practical problems of implementing such a
regime will prove so substantial as to derail the entire
effort.''
What do you think about that, Mr. Seidman and Mr. Dahlke?
Mr. Seidman. Well, I think that is, Senator, what I was
referring to when I said I prefer not to go the route of trying
to specify accounts. And if I had my choice, I would much
rather see the system go to $200,000, and let that
substantially take care of the retirement program.
And I think, as the Professor has pointed out, it will be a
big technical problem to try to define retirement account,
administer retirement account.
Do not forget, when we go in to take over a bank, we have
to do all of this right away because we have to get it some
place else. So the more complicated it becomes, the more
difficult it is to resolve the bank in a hurry. And to resolve
the bank, you have to know what the insured amounts are.
So, I have a lot of sympathy for the thought that it will
be complicated, and that is why, if I could have a definition
of anybody 65 or over, or something like that, it would be a
lot easier and more practical and might do 90 percent of the
job.
Senator Miller. Mr. Dahlke.
Mr. Dahlke. I like simple. I think the tax code is pretty
clear on what is a qualified retirement account. And I think
when you start to get away from that, and you get into
nonqualified, deferred compensation, is that defined as a
retirement account? They are set up for retirements accounts,
but I think now you start to blur the line. I would leave this
to the tax code. And if the tax code defines something as a
qualified retirement account, the shoe fits.
Senator Miller. Let me ask you this, Professor Jackson.
In your statement, you suggest that if legislation is
adopted to include a higher level of FDIC coverage for
retirement savings, that the bill should include an educational
component. Would you elaborate on what you are talking about
there? Do you mean something like investor education, whereby
the individuals would be counseled on how the program works? Or
are you talking about something entirely different from that?
Mr. Jackson. Well, I think that there is a lot of reason to
believe that the private retirement savings in the United
States is too low right now and individuals are not adequately
saving for their
retirement.
And we are talking now about coverage levels, $200,000,
that are greatly in excess of what most people are saving.
There is a case to be made for doing it. But I think the more
important thing for enhancing retirement security is not so
much topping off the extra $150,000 that we are talking about,
but encouraging people actually to save more.
I think wrapped up with this increase, one could imagine
some sort of educational program akin to the tobacco education
that the Government sponsored back in the 1960's, to make
people aware of the dangers of tobacco.
One could here think about educating individuals about the
need to save for retirement, with some specific recommendations
about rough levels that are appropriate.
That is how I got to the $250,000 number and I think that
is what American savers need to know about. And I think the
Government could have a role in doing that.
Following up on one of the other points that has been made
earlier, I do not think we should be saying to the American
public that they should save for retirement exclusively in
FDIC-insured banks. I think that would be not appropriate for
many people. I wouldn't put this perhaps with the FDIC as being
solely in charge of the message, even though it has been a very
effective agency for many things. You would want to make it
more broad than that.
I think that is an important thing. And as I mentioned in
my testimony, some other countries are taking that as a public
charge for their regulators.
Senator Miller. Can I ask Mr. Seidman one more question? My
time is up?
Senator Johnson. Time is up, but go ahead.
Senator Miller. That is all right.
Senator Johnson. All right. We will come back around.
Mr. Seidman, perhaps more than just about anybody in the
country, you had a front-row seat at the savings and loan
crisis. Many opponents of increased deposit insurance coverage
expressed concern about increased moral hazard that would be
introduced into the system with higher coverage limits. And
they point to the S&L crisis as evidence that increased
coverage at that time exacerbated the costs of those failures.
My understanding is that brokered deposits were
particularly problematic during that time. Yet with an
inadequate coverage limit for retirement accounts, it would
seem to me that we are leaving some people with little choice
but to find alternative depositories if they really want
totally secure retirement savings.
So, Mr. Seidman, or anybody on the panel, I would be very
interested in hearing your analysis as to how an increased
retirement coverage limit, for example, in the range of
$250,000, how that relates, if at all, to brokered deposits and
increased systemic moral hazard.
Mr. Seidman. Well, first, the concept of brokered deposits
as developed back there in those days has been substantially
outmoded by the Internet.
Now the whole country is, in effect, a broker and deposits
are raised nationally on the Internet. So the limits on what
can be raised and the work of the broker is really not much
used any more, although some of it still is used.
But the point is that if brokered deposits were a hazard,
then the hazard today is much larger because deposits are
raised on the Internet. And any bank can go in today and raise
any amount of money they want within what the regulators will
let them do, simply by paying an interest rate that is
something higher than other banks are going to pay. That raises
some very substantial issues in the regulatory world, much more
difficult perhaps than the one we are talking about now.
When I was the Chairman, I said that I wanted all the banks
reviewed, and all of those that were paying an appreciable
amount above, quote, ``the market rate,'' would have a system
by which an electrical line would go to the seat of our chief
supervisor and give him a jolt, so he would immediately go to
those banks and find out how they could be paying these rates.
So just to get back to the basic problem of brokered
deposits, it is the problem of the Internet. How you handle
that is dependent upon the regulatory system.
Once you guarantee amounts and make them available
nationally and internationally, although those are not
guaranteed, but once you make them available, then the
competition does not regulate. The regulators have to regulate.
And therefore, it makes it a more difficult regulatory problem
than it has been in the past and one that I am sure the FDIC is
going to spend a lot of time looking at, because if they are
paying higher interest rates, they have to get a return by
taking riskier investments and that involves risking the whole
system. That is where regulation comes in.
Senator Johnson. I would simply observe that the higher
limit, it seems to me, makes it less necessary for people to
search out unfamiliar institutions if they can keep their money
local. And that is one of the benefits that might come of this.
Senator Miller.
Senator Miller. I will yield my time to my good friend,
Senator Carper, who has just come in, if he has any questions
or observations. I have never known him not to have.
[Laughter.]
COMMENTS OF SENATOR THOMAS R. CARPER
Senator Carper. I want to thank Governor Miller, my old
compadre, for yielding. That is very kind.
Mr. Seidman, great to see you.
Mr. Seidman. Nice to see you again, Senator.
Senator Carper. It is always great. In early life, he and I
used to go back and forth. Actually, we had a real good
relationship over when I was in the House and you were at the
FDIC. It is good to see you, and we welcome each of our
witnesses. Have you been over to Japan lately?
Mr. Seidman. Yes, I just came back from there.
Senator Carper. Have you talked about that already?
Mr. Seidman. Well, I only mentioned it, in saying that it
is clear proof of the fact that if the banking system is in
trouble, the whole economy is in trouble. In their case, the
banking system is in great trouble and their economy is in
great trouble. They have not been able to fix the economy until
they get the banking system fixed.
Senator Carper. Just take a minute, if you would. What do
they need to do, more specifically? What do they need to do to
fix their banking system?
Mr. Seidman. I have been going over there for 10 years. And
I guess for 8 of the 10 years, my speech was, if you do just
this, this and this, you will fix it. This time, it is so big
and so tough, that I had much more difficulty coming up with
the kind of statement that says, this is what will fix it,
because it is so pervasive now.
Nevertheless, what they have to do, in my opinion, is start
somewhere to take the bad loans out of the banking system so
that the banks can function as banks. In Japan, the banks do 80
percent of financing. In the United States, they do 20 percent.
So when their banking system is sick, they are really sick.
They are going to have to get started by separating these
things into good banks and bad banks and trying to put the good
banks back into the private sector, or keep them in the private
sector, and take the rest. And then the most difficult decision
that they have to make is which loans should be restructured
and which loans should be simply closed.
This is a decision that we make every day, sort of like the
doctor does, only in the financial world, who lives and who
dies. And they are substantially unprepared to do that. We had
10,000 people in the Government and 80,000 or 90,000 private-
sector people doing that. They essentially do not have any set-
up to do that.
So my speech there, and I talked with, I guess, all of the
people involved, was this is a huge task for which you are not
yet prepared. And you have to do this task in a way that the
citizens will support it, which means in public.
You remember how much we did to try to keep everybody
informed of everything we did, so we could get the support from
you to use more money.
So, they have a tremendous challenge. And when you combine
that with the fact that their national debt is now 140 percent
of GDP, or something like that, the highest in the civilized
world, so they do not have the resources at the government
level any longer the way they have had, it is a tremendous
problem.
Senator Carper. Right. Thank you for that candid
assessment.
Back to the subject of the hearing. Looking around the
world, are there other countries that have really set the
standard, maybe one that we ought to be emulating with respect
to deposit insurance? Are we the model?
Mr. Seidman. We are the model for the world. We send people
all over the world. Every system in the world that I know about
is modeled on the U.S. system, more or less. I do not think
there are any models out there that we would follow because
they have all followed us.
Senator Carper. I have just come from another hearing and I
apologize for missing your testimony. We were dealing with
infrastructure, protecting our infrastructure from terrorists
one floor down. But if you could each take 30 seconds and tell
me, in a nutshell, what should we do, if anything, with respect
to our current deposit insurance system as it pertains to
retirement accounts?
Mr. Dahlke, would you just kick it off ?
Mr. Dahlke. I think we should raise it to adjust it for
inflation. The cost of insurance, the cost of retirement is
much higher than it was when the limits were set. And I think
we have created a system for a lot of elderly Americans that
makes it more complicated than it does, forcing them to go to
numerous institutions to be fully covered for their retirement
savings.
Senator Carper. So, we ought to adjust the coverage for
retirement accounts to $100,000 plus inflation?
Mr. Dahlke. I do not have a number in mind. I would leave
that to my other colleagues to come up with. I would pull it
out of a hat.
Senator Carper. Okay. Good. Thank you.
Professor Jackson.
Mr. Jackson. Well, I guess I did pull it out of a hat
because I did recommend $250,000 as a level for retirement
savings.
I think the case is strong for increasing the coverage for
retirement savings. I think the case is less strong for other
kinds of
deposits. So, I would keep the general level where it is today
or
indexed to two times GDP, which is an international standard,
GDP per capita.
So have them both float up, but have the retirement savings
be higher. We were talking a little bit earlier about the
problem of hot money and the moral hazard of deposit insurance.
I think that is pronounced for general deposit insurance
where there is a lot of different kinds of people. But I think
the moral hazard problems or what trouble people about
expanding deposit insurance, are not strong for retirement
savings.
It is implausible to think that a lot of people are going
to put their IRA in a bank, which is kind of a cautious thing
to do, and then run around the country looking for a hot money
investment vehicle. I think the problems of expanded coverage
are limited for retirement savings and the case for it is
pretty strong. But I think that is the one area of increased
coverage that I would support. Others I think are more
problematic.
Senator Carper. Good. Thank you.
Mr. Seidman.
Mr. Seidman. I generally support indexing from the last
time that there was an increase.
Senator Carper. Any idea of what that would take us to?
Mr. Seidman. About $200,000.
Senator Carper. And would that be just for retirement
savings accounts or other accounts as well?
Mr. Seidman. All accounts.
Senator Carper. Okay.
Mr. Seidman. And I base that, as much as anything else, on
the fact that I am a strong advocate of trying to keep a
diversified banking system with small banks. We can start a new
bank in our country because we have deposit insurance. No other
country can do that, unless there is deposit insurance.
I think that is a very important part of the decentralized
system that we have. And that allows our economy to get
financing with decisions at the local level. I think it has had
much to do with the great period of prosperity that we had in
the 1990's.
So if for no other reason than to help small banks compete
with big banks, I would support the $200,000 figure. And on top
of that, I think for our citizens, certainly $200,000 is not an
exorbitant amount for people to be supported. It certainly has
proven to keep us from suffering from panic and all the rest.
And in the banking system, it has never cost the taxpayer a
penny.
I think that gets lost in all of this because of the S&L
debacle, which was due to a lot of things like outlawing
adjustable rate mortgages. We would never have had the S&L
thing if adjustable rate mortgages had not been outlawed.
So because there was a big cost there, I do not think it is
appropriate to use that in looking at the banking system, where
there has been a very good record of the banks paying for
insurance. It is really not even a Government subsidy because
the banks have paid for every bit of it.
Senator Carper. Thank you for your perspectives and thanks
for being here. And again, Mr. Seidman, it is great to see you
again. Thank you.
And thanks, Mr. Chairman.
Senator Johnson. I would observe to the gentleman that the
retirement account coverage has been at $100,000 since 1978,
and $100,000 in general since 1980. So it has been over a
generation now since we have dealt with these issues.
And while there is a certain arbitrariness, I suppose, as
to how high coverage ought to be increased if it is increased,
it would seem to the Chair that if you subscribe to the notion
that there ought to be a public policy which provides
protection for a certain level of savings, then you necessarily
almost have to follow that that level of coverage does
periodically need to be adjusted, which is something that we
have not done now for 20 years-plus.
I think the discussion from this panel has been very
helpful as we go through this.
Senator Miller, anything else?
Senator Miller. I do not have anything else except, Mr.
Chairman, thank you and to thank the members of the panel for a
very
good hearing.
Senator Johnson. Well, let me say, then, thank you to the
panel. I think your testimony today has been very, very
helpful. I am doubtful that, given all the circumstances the
country faces right now, that we get to the floor with FDIC
reform legislation this year. But I think you have helped us
set the stage for, hopefully, what is a constructive
legislative effort, if not this year, at least on into next
year.
I believe that there is a certain level of urgency relative
to FDIC reform in general. And I think focusing on the
retirement issues was a very useful exercise today.
Thank you.
Mr. Seidman. Thank you.
Mr. Jackson. Thank you.
Mr. Dahlke. Thank you, Mr. Chairman.
Senator Johnson. This hearing is adjourned.
[Whereupon, at 3:55 p.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF SENATOR DEBBIE STABENOW
Thank you, Mr. Chairman, for calling today's hearing. I want to
commend you for the leadership you have shown on the issue of deposit
insurance reform. I know that there are a number of serious policy
questions that we will be grappling with as we begin this discussion
and I am looking forward to working closely with you.
I believe today's hearing topic is extremely important and I am
glad that in the midst of this challenging work environment that all of
us are facing, we are moving forward with today's discussion.
Mr. Chairman, I agree that we need to reform Federal deposit
insurance coverage for retirement accounts. There is ample evidence
that the current system does not promote adequate savings for
retirement. Indeed, there are structural barriers that unnecessarily
complicate and impede effective planning for retirement. When the
deposit insurance coverage for retirement accounts was last raised
approximately
23 years ago, $100,000 went a lot further than it does today. No one
today could credibly contend that such an amount would be sufficient to
provide for the long-term needs of retirees. It is past time for us to
review the level of coverage.
Congress has shown wisdom in the past to create incentives for
additional savings. Indeed, earlier this Congress, we increased the
amount of money that individuals can save through IRA's. The current
cap on insurance coverage is at cross-
purposes with this recent action.
However, with that said, I want to be sure that we work through
this subject carefully. We must be mindful of the impact any change to
our deposit insurance would have on the insurance funds. It is also
worth asking the question of how changes to insurance coverage may
steer money from riskier, yet potentially much more profitable savings
instruments. Nonetheless, I think we can proceed in a reasoned,
methodical way and I think this is one area of reform where consensus
can be reached relatively quickly.
Mr. Chairman, I am looking forward to hearing from our witnesses
today and to the ensuing discussion. I hope that as we move forward, we
keep a few simple concepts in mind. First, we need to ensure that
Government policies consistently encourage savings. Second, we need to
remove illogical and artificial barriers that complicate financial
planning. Third, we need to keep in mind that the public's savings
needs evolve over time. And, fourth, we need to be sensitive to the
fact that individuals, in planning for their retirement, have different
tolerances for financial risk taking. I think if we keep all of this in
mind we can come up with legislation that effectively updates our
insurance coverage laws and serves the upcoming generations of
retirees.
Thank you, Mr. Chairman.
----------
PREPARED STATEMENT OF L. WILLIAM SEIDMAN
Chief Commentator, CNBC-TV, and Former Chairman
Federal Deposit Insurance Corporation and
Resolution Trust Corporation
November 1, 2001
The battle is on--in one corner there is the proverbial David in
the person of FDIC Chairman Donna Tanoue, and in the other corner,
three giant Goliaths--
Senate Banking Committee Chairman Phil Gramm, Treasury Secretary
Lawrence
Summers, and Federal Reserve Board Chairman Alan Greenspan.
Technically the conflict is over the FDIC's Deposit Insurance
Option Paper--published in August--which suggested--some said
foolishly--that deposit insurance coverage should be increased from
$100,000 to $200,000 per depositor. As the paper pointed out, such an
increase would compensate for the last 20 years or so of inflation
since the insurance level was set at $100,000. The new ceiling might
also help to meet an increasingly difficult problem for community
banks--obtaining sufficient deposits to meet growing loan demand. Core
deposits as a source of funding for community banks have steadily
declined and largely are being replaced by loans from the Federal Home
Loan Banking System.
Once this idea was floated, Senator Gramm, an ever-pure free
marketer, reacted with a resounding ``No way--not on my watch!'' At a
recent Senate Committee hearing--on an unrelated subject--Gramm gained
support for his position from the Secretary of the Treasury and the Fed
Chairman. Treasury said it does not agree with the proposal because it
increases risk taking and possible Government liability; Greenspan said
``no'' because he feels it is a subsidy for the rich. I guess he has
been in Government so long that anyone who has over $100,000 is really
rich. Do these opinions nix the possibility for a change in the deposit
insurance ceiling? I do not believe so. This is a complex issue that
will require Congressional hearings and much research, because it
relates to ``too big to fail'' policies and overall financial reform.
Here are some of the important points to be weighed in this debate: Do
these opinions nix the possibility for a change in the deposit
insurance ceiling? I do not believe so.
Increasing Deposit Insurance Brings More Financial Risk to
Government--Possible, but unlikely, since the bank insurance fund has
never cost the Treasury a penny--the thrift insurance fund is the one
that went broke. Even Chairman Tanoue and Fed Governor Meyer have
pointed out that the greatest risk to the fund is likely to be the
failure of a large complex bank. Moreover, the risk is much greater to
the Federal Government when it supports a huge home loan bank financing
institution--another quasi-governmental agency such as Fannie Mae or
Freddie Mac--where any trouble means big trouble.
It Distorts the Operations of the Free Market--This is also
referred to as creating a ``morale hazard,'' the idea being that FDIC
depositors won't have to worry about the condition of the bank. Of
course, the so-called free market is out of kilter anyway, what with
the Federal Reserve's discount window and the Treasury's bailout of
Mexico and half of Asia through the IMF. In fact, the Government seldom
does anything that does not impact the free market--think environmental
protection, antitrust, regulation of good drugs, bad drugs, and so on.
The issue of whether to increase the deposit insurance ceiling has less
to do with the distortion of the free market than it does with whether
this particular action in total is ``good for the country.'' In the
case of Mexico, for instance, the free marketers decided that a U.S.
bailout of rich U.S. business leaders was good for the country and the
world; bingo, the funds were granted.
It Is a Subsidy for the Rich--It is debatable whether FDIC
insurance is a subsidy at all. Most economists--though not Greenspan--
doubt that there is much of a subsidy because the banks have paid for
all of the insurance and the insurance fund has covered any losses.
Now that I have laid out the opposing views, here are several good
reasons for approving the FDIC deposit guarantee increase:
It Will Level the Competitive Playing Field--Historically,
governments have protected all bank depositors when very large banks
are in trouble, thus providing an implicit guarantee of unlimited
insurance for those institutions--that is, Japan, Saudi, Korea,
Thailand, and the United States Therefore, at the very least, the
increase to $200,000 tends to give community banks a better chance to
maintain their deposit base against a too-big-to-fail competitor.
The Increase Will Reduce the Risk that Smaller Banks and the
Communities They Serve Will Stagnate Due to the Banks' Inability to
Obtain Funding at a Reasonable Cost--It could also reduce future FDIC
insurance payments if these weak banks fail in the next recession.
Incidentally, an FDIC study shows that if the insurance level had been
at $200,000 during the problems of the 1980's and 1990's, it would not
have materially increased FDIC insurance costs.
The Increase Will Help to Maintain a Banking System that Is
Decentralized and Diverse--This type of system helps the economy,
boosts productivity, and promotes entrepreneurship--important factors
in our present prosperity.
It Provides a Savings Incentive--As more baby boomers retire with
savings in excess of $100,000, the increased FDIC insurance coverage
will provide a convenient and conservative savings option and will
encourage savings, which all economists agree would be good for the
U.S. economy.
You may have guessed by now that I am rooting for the corner with
little David (Chairman Tanoue) in this important policy showdown--and
the battle is far from over. Why? I will simply use the litmus test
that applies to all other proposed reforms: It is good for the country.
----------
PREPARED STATEMENT OF HOWELL E. JACKSON
Finn M.W. Caspersen and Household International Professor of Law and
Associate Dean for Research and Special Programs
Harvard Law School
November 1, 2001
Chairman Johnson, Ranking Member Bennett, Chairman Sarbanes and
Members of the Committee: I am very pleased to be here today to discuss
the reform of FDIC insurance coverage for retirement savings and to
join the expanding discussion of deposit insurance reform that the FDIC
launched more than a year ago with the release of its Options Paper.
Justifications for Mandatory Federal Deposit Insurance
Although the subject matter of this hearing is coverage levels for
retirement accounts, I will begin my testimony with a few general
comments about insurance coverage. In brief, mandatory Federal deposit
insurance serves three distinct public purposes.
First, deposit insurance provides individual borrowers a convenient
way to save that, for all practical purposes, is risk-free. Without
mandatory deposit insurance, members of the general public would have
to expend time and effort ascertaining and comparing the current
solvency and future prospects of particular depository institutions in
search of low-risk depositories. At a minimum, this process would
impose costs on many members of society. In addition, some
individuals--most likely the least wealthy and the least well-
educated--would make mistakes in evaluating the creditworthiness of
particular institutions and might expose themselves to unwanted risks.
Mandatory Federal deposit insurance eliminates this problem by
extending a Federal guarantee to effectively protect all deposits up to
the current coverage limit of $100,000.
Second, deposit insurance reduces the likelihood of irrational runs
on healthy depository institutions. Before the advent of deposit
insurance, financial downturns
occasionally triggered liquidity problems for depository institutions.
These panics caused problems for otherwise healthy institutions and
also had adverse macroeconomic consequences, most notably a rapid
contraction of the money supply. While other public programs also
combat liquidity crises, deposit insurance ameliorates the problem
because individuals with deposits of less than the FDIC coverage limit
have no need to withdraw funds from FDIC-insured institutions even in
the face of financial distress.
Third, Federal deposit insurance can effect visions of the proper
structure of our political economy. Throughout the financial history of
the United States, public sentiment and political leaders have favored
a decentralized and fragmented financial services industry. Federal
deposit insurance can advance this preference by helping smaller, less
diversified depository institutions compete with larger, national
organizations. The presence of Federal deposit insurance coupled with
many other legal rules--notably, historical restrictions on
geographical expansion--explain why the banking industry in the United
States is so much less concentrated than comparable sectors of the
financial services industry in other industrialized countries.
The Case for Increasing Current Coverage Limits
As I understand the current debate, proponents of higher coverage
levels base their case on an assertion that the current coverage of
$100,000 per deposit no longer satisfies the first--collective action--
and third--political economy--justifications for deposit insurance. At
this point, few are arguing that macroeconomic considerations warrant
higher coverage levels.\1\ The task of evaluating the two lines of
argument being advanced by proponents of expanded coverage is
complicated, and I cannot provide the Committee a definitive assessment
of either claim. I would, however, offer the following preliminary
thoughts.
---------------------------------------------------------------------------
\1\ The absence of attention to the macroeconomic role is sensible.
In modern times, similar
liquidity crises have occasionally occurred at the State level when
State deposit insurance systems run into financial troubles. However,
in the past two decades, these State systems have disappeared, and
almost all depository institutions are now insured at the Federal
level. To the best of my knowledge, there have been no recent, system-
wide liquidity crises at Federally-
insured depositories, even during the thrift and banking crises of the
1980's and early 1990's or the disruptions in stock markets after
September 11 or October of 1987. Indeed, during periods of financial
crisis, funds now tend to flow into depository institutions not out.
---------------------------------------------------------------------------
First, as a general matter, I think the burden should be on the
proponents of
expanded FDIC coverage to make a compelling case for the extension of
Federal
protection. I would not understand this burden to be overwhelming--
indeed, as
explained below, I believe that the burden may well be satisfied in the
case of retirement savings \2\--but I do think that a sensible premise
is that Government insurance programs should be maintained at the
minimum level necessary to achieve specific public goals. Placing the
burden of persuasion on proponents of expanded coverage helps effect
this principle.
---------------------------------------------------------------------------
\2\ Among other things, expanded Federal deposit insurance coverage
tends to raise the FDIC's costs when banks fail and may also increase
the moral hazard problems associated with Federal deposit insurance.
---------------------------------------------------------------------------
Second, I would accept the political case for expanded deposit
insurance coverage as a legitimate consideration. I would, however, be
mindful that Government intervention to maintain existing industry
structures can be costly--both in promot-
ing efficient financial services firms and in retarding innovation. In
addition, it is
possible that intervening developments--such as adoption of the
Community Re-
investment Act of 1977, expanded access to capital markets for small
companies,
and improvements in antitrust oversight--now address concerns over
monopolization of sources of credit that underlay public antipathy to
large-scale financial in-
stitutions in the past.\3\ So before accepting the political case for
expanding Federal
deposit insurance, I would recommend that Members of Congress consider
both the economic costs of such a decision and the possibility that
other statutory regimes adequately address the concerns underlying our
historical preference for local banking institutions.
---------------------------------------------------------------------------
\3\ I would further distinguish arguments in favor of expanded
deposit insurance that are based on a perceived need to offset the
``too-big-to-fail'' policy said to support larger financial
institutions. Enhancing deposit insurance coverage to counteract the
effect of the ``too-big-to-fail'' policy is, in my view, a dubious
proposition. First, there is considerable doubt that the policy remains
in effect. In 1991, the FDIC Improvements Act established important
procedural and political constraints on large bank bailouts. In
addition, a number of substantive reforms--from prompt corrective
action to heightened oversight of interbank lending--reduce the
likelihood of Con-
tinental Illinois-style bailouts. Moreover, to the extent that larger
banks are still implicitly
supported by a lingering ``too-big-to-fail'' policy, Congress could
consider addressing that pro-
blem directly rather than making a compensatory increase in deposit
insurance coverage for
small banks.
I would be similarly skeptical of arguments for expanded deposit
insurance coverage based solely on the fact that other sectors of the
financial services industry have grown faster than depository
institutions in the past two decades. It is by no means clear that
maintaining the market share of depository institutions in 1980 is an
appropriate goal of public policy. Indeed, growth in other sectors,
such as money market mutual funds, could well indicate that these
alternative forms of saving better suit the needs of an increasing
number of consumers.
---------------------------------------------------------------------------
Arguments that the current level of FDIC insurance is too low to
provide an adequate amount of risk-free savings for individuals are, in
my view, the most difficult feature of the current debate over expanded
FDIC insurance coverage. For the most part, recent testimony has
assumed that the coverage levels should be inflation-
adjusted, and then focused on selecting an appropriate historical point
in time to accept for determining an inflation-adjusted baseline for
future deposit insurance coverage.\4\ Analytically, this approach is
unsatisfying, as it provides no explanation why one should choose one
particular baseline as opposed to many plausible alternatives. As a
theoretical matter, one could imagine a number of considerations that
should influence the optimal level of deposit insurance coverage: the
financial sophistication of the general public, the level and
distribution of financial assets, the availability of reliable
information about the solvency of depository institutions, and a host
of other factors, including the cost and moral hazard impact of deposit
insurance. Over time, one would expect that these factors would change
and thus the optimal level of deposit insurance coverage would also
rise and fall.\5\ Balancing these evolving features of our financial
environment is a daunting task.
---------------------------------------------------------------------------
\4\ For example, if the current level of coverage ($100,000 per
deposit) were used as a baseline, the real level of coverage would be
much lower than if the value of deposit insurance coverage back in the
early 1980's were used. For a good review of the relative value of
Federal deposit insurance coverage, see FDIC Options Paper 31-43
(August 2000) (available at http://www.fdic.gov/deposit/insurance/
initiative/OptionsPaper.html). See also Alan S. Binder & Robert F.
Wescott, Reform of Deposit Insurance: A Report to the FDIC (March 20,
2001) (available at http://www.fdic.gov/deposit/insurance/initiative/
reform.html) (discussing indexing FDIC coverage levels to median
income).
\5\ For example, within the United States over the past 20 years,
the assets of depository institutions as a percentage of GDP has
increased from 56.6 percent in 1980 to 81.5 percent in 2000, suggesting
that an increase in real FDIC coverage may be in order. On the other
hand, financial sophistication of the general public and the
availability of information about depository institutions--via the
Internet among other sources--has probably also improved, suggesting
the need for less governmental paternalism and perhaps even less
deposit insurance coverage today than in the past.
---------------------------------------------------------------------------
In lieu of offering the Committee any original analysis of this
subject, I would propose instead to point Members and the Committee
staff to a paper on deposit insurance recently written by Gillian
Garcia, an economist with the IMF.\6\ In an effort to establish an
international benchmark for deposit insurance coverage, Garcia
recommends, as a rule of thumb, deposit insurance coverage equal to one
or two times per capita GDP.\7\ (Two times per capita GDP for the
United States would be approximately $70,138.80 in 2000).\8\ Elsewhere,
Garcia reports ratios of deposit insurance coverage to per capita GDP
for 66 selected countries, and finds that only 28 have explicit deposit
insurance coverage greater than two times per capita GDP. Of these,
only two countries have explicit deposit insurance coverage greater
than the current United States level (Italy and Norway).\9\
---------------------------------------------------------------------------
\6\ See Gillian Garcia, Deposit Insurance and Crisis Management
(IMF Working Paper, March 2000) (available at http://www.imf.org/
external/pubs/ft/wp/2000/wp0057.pdf ).
\7\ Garcia also contends that the coverage limit may be set with
more precision by examining the distribution of deposits by size,
proposing that coverage limit should be set to include the majority of
the total number of deposits (roughly 80 percent), but only the total
value of deposits of a minority (roughly 20 percent).
\8\ This figure is based on an estimated 2000 per capita GDP of
$35,069.40 as reported in the 2001 World Economic Outlook Database,
October 2001, available at http://www.imf.org/external/pubs/ft/weo/
2001/02/data/index.htm (last accessed 10/29/01). According to the WEO
estimates, two times per capita GDP for the United States would be
$67,953.60 in 1999, $72,024.80 in 2001, and $74,455 in 2002.
\9\ Gillian Garcia, Deposit Insurance--A Survey of Actual and Best
Practices (IMF Working Paper, April 1999).
---------------------------------------------------------------------------
While there is nothing magical about the Garcia analysis of deposit
insurance coverage, the work does suggest one informed analyst's view
of the issue, and also offers a comparative dimension to the topic,
suggesting that current FDIC coverage levels are at or near the top of
explicit governmental insurance schemes. To be sure, Garcia's survey
does not report implicit coverage levels--which may be substantial and
even unlimited in some countries. Moreover, it is possible that
considerations of political economy unique to the United States justify
coverage levels higher than those found in other industrialized
countries. Still, for me at least, the Garcia analysis raises questions
about the appropriateness of raising general coverage levels at the
present time.
Special Features of Retirement Savings
The one area in which I think a strong case may be made for raising
current FDIC coverage levels is the area of retirement savings.
Numerous trends increase the importance of retirement savings for
American citizens. Greater life expectancy, earlier retirements,
potential shortfalls in our principal public insurance program (Social
Security), all counsel for a greater importance of private savings for
retirement. It is, moreover, quite reasonable to posit that some
members of the general public will want to be able to place their
retirement savings in a simple, safe, and familiar investment vehicle,
such as a depository institution.\10\ Finally, if we accept the premise
that the Government has a role in ensuring the availability of such a
vehicle for amounts sufficient to provide adequate retirement security,
then I think the case for raising the level of FDIC coverage for
retirement accounts has been made. Essentially, the argument is an
extension of the first (collective action) justification for deposit
insurance in the special case of retirement savings.\11\
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\10\ The triple requirements of simplicity, safety, and familiarity
are essential to my argument because the general public already has
safe alternatives--investments in Government bonds or bond funds--that
are not familiar, as well as familiar investments--splitting retirement
savings among a number of banks--that are not simple.
\11\ Many experts agree that expanded coverage of retirement
savings is unlikely to create additional moral hazard problems as the
kind of person who is apt to invest retirement savings in bank deposits
is unlikely to seek out high-risk, high-return institutions. See Letter
from FDIC Chair Donna Tanoue (April 2001). See also Testimony of Jeff
L. Plagge before the Subcommittee on Financial Institutions of the
Senate Committee on Banking, Housing, and Urban Affairs
(August 2, 2001).
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The Amount of Retirement Savings Coverage:
Theoretical and Practical Considerations
But what level of coverage is appropriate for retirement savings?
Clearly an unlimited support for retirement accounts seems
inappropriate, both because there is no strong governmental interest in
protecting all of the retirement savings of the very wealthy and
because the extension of retirement savings coverage could distort
competition among different sectors of the financial services industry.
But is there a principled way to provide a benchmark comparable to what
Garcia advances for general coverage levels? Recognizing that there is
no clearly right answer, I offer the following rough cut at the
question.
I approach this problem with the premise that the Government should
offer sufficient deposit insurance coverage so that a household with up
to the median level of income should have access to an absolutely safe
investment vehicle for retirement. I would implement this concept as
follows. I start with the median household income in the United States,
which was approximately $42,000 in 2000.\12\
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\12\ For recent census data on median income of households in the
United States, see http://www.census.gov/hhes/income/income00/
incxrace.html (avail. October 31, 2001). I use household income because
retirement savings often must support a household rather than an
individual.
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Within the financial planning industry, a typical target for
retirement income is 80 percent of preretirement income. So, under this
measure, a household at the median level of household income would need
$33,600 of income per year during retirement. Although one could argue
that FDIC insurance for retirement savings should be set to cover
retirement savings sufficient to finance this full amount, I think it
is important to recognize that Social Security provides substantial
retirement savings for most Americans, particularly those at lower
income levels. For current purposes, I think it would be appropriate to
assume Social Security replacement rates of 40 percent of preretirement
income,\13\ leaving only 40 percent to be covered by private savings or
$16,800 of income per year.
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\13\ See C. Eugene Steuerle & Jon M. Bakija, Retooling Social
Security for the 21st Century 06 (1994) (reporting Social Security
replacement rates for different categories of workers).
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Formulated in this way, the question is how much retirement savings
would an individual need to supply $16,800 of inflation-adjusted income
in retirement? To answer this question, one must make assumptions about
life expectancy and real rates of industry. Using what I consider to be
plausible estimates of these factors, I have calculated that a
retirement savings balance of approximately $250,000 would be an
appropriate target level of coverage.\14\ To put this in relationship
to median household incomes, a $250,000 coverage level would suggest a
retirement savings coverage target of roughly six times median
household income. In comparison, our current coverage level of $100,000
is just a shade under 2.4 times median household income.\15\ The ratio
between the level of coverage I propose for retirement savings
($250,000) and current FDIC coverage ($100,000) is, coincidentally, the
same 2.5 to 1.0 ratio that prevailed between 1974 and 1980, the only
previous time that the FDIC has offered different coverage levels for
retirement savings.\16\
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\14\ For this purpose, I assume a real rate of return of 3.0
percent--roughly the current payment rate on inflation-adjusted long-
term Government bonds--and a life expectancy of 20 years. Obviously,
individual experience will vary, particularly on the dimension of life
expectancies. But for purposes of setting targets, I think these are
reasonable estimates. In addition, the use of the median household
income--as opposed to some lower level--is probably a generous
statement of the Government's obligation in this area.
\15\ Note that the methodology proposed in the text assumes that
deposit insurance coverage levels should be adequate to cover the
maximum balance necessary to finance a targeted level of retirement
income. For any particular savers, these balances would be present only
on the eve of retirement--before the balances would still be in an
accumulation phase and afterwards the balances would decline as
withdrawals occurred. One could imagine a lower coverage level that
would provide only partial protection of a $250,000 retirement savings
account at its point of peak accumulation. If, for example, the
coverage level were set at $200,000, much of the time, even our median
household achieving the proposed savings targets would be fully
covered, but for a certain number of years, up to $50,000 of savings
would be uninsured. In practice, such a saver would not be exposed to a
complete loss of this $50,000, as depositors typically only lose a
relatively small fraction of the balances of uninsured accounts and
legislative reforms of the past decade make it likely that these loss
exposures will remain small--perhaps on the order of 10 percent of
uninsured balances or less.
\16\ At that point, the nominal coverage levels were $100,000 for
retirement savings and $40,000 for general FDIC coverage. See Testimony
of Jeff L. Plagge before the Subcommittee on Financial Institutions of
the Senate Committee on Banking, Housing, and Urban Affairs
(August 2, 2001). In real terms, however, the coverage level for
retirement savings is quite similar to the one I propose.
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Having proposed a plausible target for retirement savings coverage,
let me immediately add several caveats. This back-of-the-envelope
calculation includes numerous assumptions about replacement rates,
assumed life expectancies, rates of return, and Social Security
coverage. All of these assumptions are subject to debate, and different
assumptions would generate different target levels. What I have offered
is my best guess of how a retirement savings coverage level might be
justified based on my own notions of the Government's appropriate role
in the field. Others--particularly those representing other sectors of
the financial services industry--may well have different views.
On a more practical dimension, I should stress that these coverage
levels dramatically exceed the current levels of retirement savings of
most Americans. According to recent Census Bureau data, middle-income
American households do not now accumulate anything close to $250,000 of
retirement savings. For example, the median net worth of householders
in early retirement years (65 to 69) was $106,408 in 1995, but the
largest median investment was in homeownership not financial
assets.\17\ Accordingly, the theoretical case for retirement savings of
roughly one quarter of a million dollars seems well beyond the current
capabilities of most average Americans.\18\ To some degree, this
unfortunate financial fact moots the debate over retirement savings
coverage. However, some individuals will have accumulations at the
level envisioned,\19\ and for others a governmental policy endorsing
retirement savings on the order of six times median household income
may offer some encouragement to increase retirement savings,
particularly if financial institutions publicize the level of coverage.
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\17\ See http://www.census.gov/hhes/www/wealth/1995/wealth95.html
(avail. October 31, 2001).
\18\ See, e.g., FDIC Roundtable Discussion of Deposit Insurance
Reform 22 (May 2000) (available at http://www.fdic/deposit/insurance/
initiative/transcript/index.html) (citing Federal Reserve Board study
indicating that bank retirement accounts of people making more than
$100,000 were typically only $2,400 and ranged up to only $93,000).
\19\ For example, the FDIC Options Paper suggests that ``several .
. . financially unsophisticated'' depositors in recently failed banks
had retirement accounts in excess of the current $100,000, see FDIC
Options Paper, supra note 4, at 36. The FDIC Paper does not, however,
indicate the extent of the losses imposed on these accounts. See supra
note 14 (discussing the relevance of loss rates on uninsured portions
of retirement savings accounts).
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Issues of Implementation in Developing a Separate Coverage
Level for Retirement Savings
To the extent that the Committee pursues the concept of adopting a
separate coverage level for retirement savings, there are a number of
additional issues of implementation that need to be addressed.
Which Tax-Favored Vehicles to Cover? First, there is the matter of
defining the concept of retirement savings. Most discussion of the
subject refers to Individual Retirement Accounts (IRA's) and Keogh
Plans, but it is not clear that these are the only categories to which
expanded FDIC coverage should extend. Historically, these plans were
individualized accounts, distinct from traditional defined benefit
pension plans. But Keogh Plans are a relatively minor component of
overall retirement savings. IRA's are much more important, but largely
because they are the depositories of roll-overs from employer-based
plans. (I would expect that the overwhelming majority of IRA accounts
that exceed the current $100,000 FDIC insurance coverage levels are
roll-over IRA's).\20\ If extended FDIC coverage is to reach these roll-
over accounts, it is not clear why it should not also extend to other
tax-favored individual account plans--most notably 401(k) and 403(b)
plans--that many employers maintain. After all, if the public needs a
risk-free investment vehicle for roll-over IRA's, a similar argument
\21\ should apply to extending such protections to comparable
retirements accounts maintained through employers, as well as
privatized Social Security accounts (should they ever be created).\22\
At a minimum, the Committee should carefully consider which tax-favored
savings vehicles are to be eligible for supplemental FDIC coverage for
retirement savings.
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\20\ Traditional IRA's have always been limited to relatively low
annual contributions. Even if an individual had invested the full
$2,000 annual contribution allowed for IRA accounts for most of the
past 25 years, that individual's account balances would only recently
have reached the current $100,000 threshold. Based on existing data
about the actual size of IRA accounts, I would expect that very few
individuals have been such active savings in IRA accounts. While recent
changes in tax laws substantially loosen restrictions on IRA savings,
it is unclear how many low- and middle-income savers will take
advantage of these opportunities. For a median income saver to get to
the $250,000 level proposed above, and annual contribution of roughly
$3,300 a year over 40 years would be required. That level of savings
assumes an annual contribution of approximately 8 percent of median
household income per year. For most workers, who start their working
careers with much lower levels of income, the savings rates would have
to be higher. For these reasons, I am not sure that I can concur in
FDIC Chair David Powell's assertion that ``middle-income families
routinely save well in excess of [the current $100,000 FDIC] limit.''
See Statement of Donald E. Powell before the Subcommittee on Financial
Institutions and Consumer Credit of the House Committee on Financial
Services (October 17, 2001) (available at http://www.fdic.gov/news/
news/speeches/chairman/sp170ct01.html).
\21\ One difference is that participants in employer-sponsored
enjoy some protection under ERISA's fiduciary rules. However, these
safeguards are limited, and do not ensure that employees will place
their retirement savings in low-risk, cost-effective savings vehicles.
\22\ To the extent that the Committee does consider extending
expanded FDIC insurance coverage to other tax-favored retirement plans,
some attention would have to be given to ensuring that the coverage
levels applied to beneficiaries of these plans and not the plan
trustees. Several years ago, after the failure of the Executive Life
Insurance Company, a wave of litigation arose over comparable questions
of coverage under State insurance guaranty funds. See Howell E. Jackson
& Edward L. Symons, The Regulation of Financial Institutions ch. 7
(1999).
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Retirement Savings in Other Forms. An analogous question arises as
to whether the extended coverage should even be limited to tax-favored
vehicles. While tying coverage extension to categories of retirement
savings already defined in Federal law and administered through the
ERISA agencies has some appeal, there are also several drawbacks to
this approach. To begin with, tax incentives are most important to
wealthy Americans, who have higher marginal tax rates and greater
proclivities to saving. If extended coverage is limited to tax-free
forms of savings, the benefit will be skewed toward upper-income
Americans, even though the justification for extending coverage is
largely based on concern for the less advantaged and less
sophisticated. Consider further that the principal source of wealth of
middle class Americans is home equity. For elderly households that sell
their homes upon retirement, this equity might easily be converted into
a bank account and used to support the households in retirement. But
retirement savings of this sort would not typically be covered through
expanded FDIC insurance coverage limited to tax-preferred retirement
accounts. Nor would it cover the proceeds from the sale of a small
business or many other kinds of savings.
Problems of Expanding the Definition of Retirement Savings. The
problem with
expanding the definition of retirement savings is that a liberal
definition could
threaten to convert extra coverage for retirement savings into an
across-the-board increase in Federal deposit insurance coverage, at
least for individuals. Particularly, if depositors could open
``retirement savings'' accounts at multiple institutions, the potential
for unlimited coverage would be real. One could imagine various ways to
deal with this problem--i.e., limiting individuals to only one
retirement savings account throughout the banking system or at least
throughout networks of affiliated banks. Drafting such rules would
require considerable care and likely delegation to the Federal Deposit
Insurance Corporation for implementing regulations.\23\
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\23\ The practice of financial conglomerates dividing deposit
balances among two or more affiliated banks is a problem that goes
beyond the issue of retirement savings coverage. To the extent that
Federal banking law increasingly disregards the corporate separateness
of affiliated banks, see Howell E. Jackson, The Expanding Obligations
of Financial Holding Companies, Harv. L. Rev. (February 1994). I
believe there are strong arguments for treating affiliated banks as a
single unit for purposes of deposit insurance coverage. (The larger
question of whether all insurance coverage levels should be based on
total individual accounts or on the current bank-by-bank basis is
beyond the scope of this testimony.)
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Potential for Abuses with Retirement Savings Account. On the
assumption that the technical issues of designing a viable system of
expanded FDIC insurance for retirement savings can be overcome and
balances in these accounts grow over time, the Committee should be
mindful that these accounts may become the subject of unscrupulous
business practices. For a variety of reasons, bank-based retirement
savings accounts are likely to attract less sophisticated individuals,
who may be less inclined to keep track of prevailing interest rates or
move accounts--particularly retirement savings accounts--to other
institutions.\24\ Knowing these characteristics of bank-based
retirement savers, bankers may be tempted to lower the interest rate
paid on retirement savings accounts. To the extent that the Federal
Government would be implicitly endorsing bank-based retirement savings
through the expansion of FDIC coverage for retirement accounts, I think
attention should be given to ensuring that these accounts offer an
appropriate rate of return. While direct regulation of interest rates
would be excessive, one could imagine a statutory requirement that, to
be eligible for expanded FDIC insurance coverage, retirement savings
accounts would have to pay an interest rate no lower than an inflation-
adjusted Government bond. Such a floating average would set a floor
beneath with interest payment could not fall, but would leave ample
room for free market competition above that level. Again,
responsibility for implementing regulations to establish an appropriate
minimum rate of interest could be delegated to the FDIC.
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\24\ As others have noted, holders of IRA and Keogh bank accounts
are unlikely to engage in aggressive shopping for higher rates. This is
the principal reason why experts believe that expanded coverage for
retirement savings is not likely to increase moral hazard problems of
deposit insurance.
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Educational Aspects of Expanding Retirement Savings Coverage. As
mentioned above, an ancillary benefit of expanding FDIC coverage for
retirement savings accounts is the possibility that such a reform could
encourage the American public to save more for retirement--even
suggesting a target level of six times preretirement income as an
appropriate savings goal. Financial supervisors in other
jurisdictions--most notably the new Financial Services Authority in the
United Kingdom--have recently been given explicit charges to educate
the general public on such matters. In my view, it would be desirable
if legislation adopting a higher level of FDIC coverage for retirement
savings also included an educational component--either to be conducted
directly by Government agencies or through some public-private
alliance. While expanded FDIC coverage may marginally strengthen
retirement savings in the United States, the primary mechanism for
solving the problem will have to come through personal decisions made
by millions of individual savers. Government sponsored education can
help Americans meet that challenge.
Retirement Savings and the Debate Over Deposit Insurance Coverage
Let me conclude with a few words about the relationship between
retirement savings and the broader debate over deposit insurance
coverage. As explained above, compelling theoretical arguments support
the expansion of FDIC insurance coverage for retirement savings.
However, the task of structuring an appropriate extension--that is, an
extension likely to reach low- and middle-income savers--is not
trivial. And it is possible that the practical problems of implementing
such a regime will prove so substantial as to derail the entire effort.
At this point, I can offer no clear prediction as to how these
tradeoffs balance.\25\ However, to the extent that the Committee can
devise a sensible approach to extending FDIC coverage for retirement
savings, I think the case for raising the basic coverage levels is
greatly reduced. As I mentioned earlier, the strongest argument for a
general increase in FDIC coverage is that the public's needs for
deposit insurance have increased over time. The most compelling
component of this argument relates to an increased need for risk-free
investment vehicles for retirement savings. To the extent that expanded
FDIC coverage addresses this concern, the need for a general increase
in FDIC coverage is much diminished and the appropriate level for
indexed general deposit insurance perhaps even somewhat reduced.
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\25\ An important area of future research is the actual
distribution of current and potential bank-based retirement savings
accounts. In my view, the best argument in favor of expanded insurance
coverage for retirement savings is based on the notion that substantial
numbers of unsophisticated and lower-income savers need this
protection. As indicated above, relatively few such individuals appear
to have retirement accounts at or in excess of current FDIC insurance
levels. According to the testimony of industry representatives, some
bankers believe that there are substantial amounts of retirement
accounts in excess of $250,000 that will be attracted into depository
institutions if insurance coverage increases. Most likely, however,
these funds are from wealthy and more sophisticated individuals.
Providing additional FDIC insurance coverage to such individuals does
not advance the interests of low- and middle-income savers, although it
might improve the competitive posture of certain depository
institutions.
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Thank you very much.
----------
PREPARED STATEMENT OF GLENN C. DAHLKE
President, Dahlke Financial Group
November 1, 2001
Introduction
Mr. Chairman, I appreciate the opportunity to testify today before
the Senate Banking Subcommittee on Financial Institutions on the topic
of Federal deposit insurance coverage of retirement accounts. I am
Glenn Dahlke, President of the Dahlke Financial Group of Glastonbury,
Connecticut, a family-owned sales and asset management company.
Mr. Chairman, it is my strong recommendation that Congress should
substantially increase the value of Federal deposit insurance for
retirement accounts. Congress should recognize that the cost of
retirement has skyrocketed since 1978, when retirement coverage was
last increased.
In addition, those Americans who take responsibility for remaining
self-sufficient in their later years should not be forced to jump
through complicated and potentially costly hoops to protect those
savings. I urge Congress to increase deposit insurance coverage for
retirement savings well in excess of the outdated $100,000 limit, and
to ensure that coverage keeps pace with the true costs of retirement.
This afternoon, I want to make four points:
First, without other assets, $100,000 in retirement savings is
simply insufficient to support most retired individuals, especially
given increased life expectancy and dramatically rising medical costs.
Second, it is rational for retirees who have low-risk tolerance and
need a predictable income stream to invest savings in excess of
$100,000 primarily or exclusively in insured deposits.
Third, many retirees who invest in insured deposits are ill-
equipped to cope with Federal distribution requirements that are made
vastly more complicated when accounts must be spread across
institutions.
And finally, I believe it is inappropriate to require retirees to
choose between the safety of their life savings and banking with
someone they trust.
Background
Getting Above $100,000
Happily, America's ``retirement years'' are lengthening: we are
living longer, and many Americans are retiring early to make way for a
new generation of workers in a low-unemployment environment. As a
result, however, careful planning is required to ensure self-
sufficiency during this period, although the amount needed to sustain a
comfortable lifestyle must obviously be determined on a case-by-case
basis.
Over the years, Congress has created important tax incentives to
encourage
people to set aside money for retirement, recognizing the benefits to
our society of individual self-sufficiency.
Several different pension and benefit plans exist, the better known
of which include Individual Retirement Accounts (``IRA's''), 401(k)
plans, and Keogh plans, among others. Under these plans, individuals
may invest pretax dollars, the earnings on which are tax-deferred until
the funds are eventually withdrawn, in many cases subject to a lower
tax bracket than when the money was earned.
In a resounding reendorsement of the principle that Americans
should save for retirement and a recognition that retirement costs have
increased dramatically, Congress earlier this year significantly
increased the amount that individuals may save through tax-deferred
programs such as IRA's. Over the course of the next several years,
annual contribution limits will increase from $2,000 to $5,000 for IRA
and Keogh accounts, with subsequent indexing for inflation, and $10,500
to $15,000 for 401(k) plans. Other defined benefit and contribution
programs are based on a percentage of income, and permitted deposits
often far exceed $5,000 annually.
Even without taking into consideration these higher contribution
limits, a middle class individual who works for 20 or 30 years and
saves in a disciplined manner will easily amass over $100,000 in
savings. According to the FDIC, a worker who sets aside $2,000 annually
at a tax-deferred 6 percent rate of return will reach $100,000 in
savings after 20 years. For those who set aside higher annual amounts
of retirement money through 401(k) plans and roll those funds into an
IRA, the time period required to exceed $100,000 in savings is
drastically reduced.
For purposes of this testimony, I focus primarily on IRA's, because
that would be the most pervasive vehicle through which an individual
would likely place retirement money into an insured depository.
Retirement Savings Vehicles
It is useful to review the fundamental rules governing tax-
preferred IRA's. All single workers not covered by an employer-
sponsored pension plan or earning less than $25,000 ($40,000 for
married filing jointly) are eligible to contribute to an IRA and deduct
the contribution amount from taxable income. Workers earning above the
$25,000/$40,000 limits are subject to a phase-out of deductibility.
Below the income thresholds, workers may contribute up to $2,000
per person or $4,000 per couple (or up to 100 percent of compensation,
if less than $2,000) to an IRA and deduct that amount from taxable
income. Those limits are set to rise to $3,000/$6,000 next year,
$4,000/$8,000 in 2005, and $5,000/$10,000 in 2008, with indexation
thereafter. Individuals over 50 years of age may take advantage of
special ``catch-up'' provisions.
Above income thresholds, individuals may contribute the same amount
to IRA's; however, they may not deduct the deposits from taxable
income. This may never-
theless be desirable because earnings on IRA's are not taxed until that
money is
eventually withdrawn, and accordingly savings compound more quickly
than many investments.
IRA's come with significant restrictions to ensure that these tax-
preferred vehicles are used to support people in their later years.
Withdrawals--for any reason except disability or medical costs--from
IRA's before an individual reaches the age of 59\1/2\, with some narrow
exceptions, are charged an excise tax of 10 percent on the amount
withdrawn, which is also subject to income tax.
Once an individual reaches 70\1/2\ years of age, certain prescribed
amounts, based on longevity tables, must be withdrawn from an IRA.
Failure to withdraw the prescribed amount results in a stiff penalty of
50 percent of the amount of the difference that should have been
withdrawn, which is also subject to income tax. For example, assume a
75 year old woman has $100,000 invested in an IRA, which is subject to
a 5 percent withdrawal rate in 2002. To avoid a penalty, she is
obligated to distribute $5,000 out of her account in 2002. However,
assume she distributes only $3,000. She owes a penalty of $1,000, for
example, 50 percent of $2,000. In
addition, she is taxed on the full $5,000 of ordinary income.
It is important to note that middle class retirees without the
benefit of professional financial advice are far more likely to fall
subject to these penalties. In
addition, while it may not be politically correct to point this out, in
many cases the surviving spouse of a traditional one-worker family may
lack an established understanding of the family's finances, further
increasing the risk of incurring penalties.
As the previous example illustrates, it is important to understand
that IRA holders are required to reduce the size of their accounts
gradually, based on established longevity tables. IRA's can be
understood to take the shape of a bell curve. In the early years,
individuals may contribute to, but not withdraw from, a retirement
account, resulting in a build-up of principal. Between the ages of 55
and 70\1/2\, individuals may, but are not required to, withdraw savings
as needed. After 70\1/2\, IRA's will eventually decline (though they
may stand still during years where distribution rates may equal rates
of return on investment).
Arguments
$100,000 in retirement savings is simply insufficient to
support most retired individuals, especially given increased life
expectancy and skyrocketing medical costs.
In some important respects, $100,000 is not worth $100,000 in the
retirement context. That is, where that money serves as the major
source of income other than Social Security, $100,000 may be barely
sufficient to cover basic living expenses.
For example, assume a 72 year old widow has $100,000 plus a $10,000
annual Social Security pension on which to support herself. From the
$100,000, assuming a 5 percent distribution rate (see discussion
below), she will receive $5,000, which is taxable as ordinary income,
along with the $10,000 in Social Security benefits, which may or may
not be taxed depending on her circumstances. In other words, this widow
has $15,000 annual income on which to support herself.
Mindful of the fact that many parts of America have lower cost of
living than Connecticut, I am nevertheless prepared to declare to this
Subcommittee that this woman is unlikely to enjoy a lavish lifestyle,
and in fact could not absorb predictable financial shocks that might
include anything from a new roof to an uninsured medical procedure.
This is a critical point, because many opponents of higher coverage
limits often argue that anyone with $100,000 is well-off and can do
without special favors. On the contrary, Mr. Chairman, Congress should
ensure that those workers who save in a disciplined and responsible
manner for their retirement have a secure investment option for an
amount adequate to support themselves. It is fair, and frankly, it is
good public policy.
It is rational for certain retirees with savings in excess of
$100,000 to invest primarily or exclusively in insured deposits.
Assuming an individual has over $100,000 in retirement savings
invested through an IRA, the question becomes why would he or she
choose to keep that money in a bank. During my career as a financial
adviser, I have observed three principal factors at play for clients
who choose to keep their money in a local insured depository: risk
tolerance, need for predictability and local relationships.
Risk Tolerance
When I advise clients on investment strategies, the most important
piece of information I gather relates to that individual's risk
tolerance, or willingness to put his or her savings at risk in exchange
for a possible higher rate of return.
Risk tolerance does not necessarily correlate to an individual's
wealth cushion, nor to his or her future income needs. As a general
matter, however, we expect risk tolerance to decline with age. In some
sense, risk tolerance is a function of how much a person wants to
increase his or her wealth, in addition to how much that person can
``afford to lose.''
For example, Charlie with $2 million may have a strong desire to
increase that base to $10 million because of his lifestyle aspirations,
and may be willing to risk losing some of his $2 million for the chance
of a higher return. At the same time, Addie with $200 million may
decide to pursue a no-risk investment strategy because she would have
no use for more money, even though she could certainly afford to take a
few high-risk bets without much risk to her future security. And Carol
with $200,000 may be perfectly happy living on $12,000 a year, and be
loath to risk that $200,000 for higher returns because she is content
with the lifestyle her savings can afford. Bags of gold come in
different sizes, and each individual decides what level of savings is
enough for a comfortable retirement.
I have found, however, that individuals with a smaller wealth
cushion tend to have a lower risk tolerance with respect to a wealth
accumulation that is just enough to meet their future needs with little
room for loss. In most cases, a con-
servative investment strategy where there is sufficient, but not ample,
savings is
a wise course, as recent stock market volatility has indicated. In
fact, the current
environment underscores the importance of increasing deposit insurance
coverage of retirement accounts, especially as the risk of bank
failures increases with economic softening.
Predictability
Individuals with a smaller wealth cushion may also prefer
investments that have predictability with respect to providing a fixed
income. While there are certainly secure investments, such as Treasury
securities, that provide safety for the principal of the investment,
these instruments are interest rate sensitive, and cannot be relied
upon to provide a fixed monthly income. I advise clients who want or
require predictability in their monthly income to invest in
certificates of deposit, because these are the only investment that,
assuming they are fully insured, can provide complete security of both
the full principal, as well as a fixed-income stream.
Local Relationships
Clients who express a desire to invest significant resources in an
insured depository often, but not always, want to keep their money with
people they know and trust. Especially in small towns, personal
relationships develop between bankers and clients, and while this may
seem anachronistic to urban dwellers, local relationships remain an
important feature of the modern banking system.
Many retirees who invest in insured deposits are ill-equipped
to cope with Federal distribution requirements that are made vastly
more complicated when accounts must be spread across institutions.
Higher coverage levels for retirement accounts would significantly
reduce the risk that a retiree with over $100,000 in insured deposits
would become subject to the 50 percent penalty for underdistribution of
IRA savings.
Because distribution requirements are based on an individual's
aggregate IRA savings, diversification of IRA money across several
accounts increases the risk of under-distribution, especially as an
individual grows older and perhaps loses some ability to manage complex
financial situations. This risk is enhanced when an individual needs to
spread money across several financial institutions, which is the
practical effect of the current $100,000 limit.
Because of ownership restrictions in the Internal Revenue Code, IRA
holders
typically need to spread accounts across different institutions to
obtain coverage
for more than $100,000. Unlike general accounts, IRA holders cannot
benefit from
higher coverage levels from multiple accounts at the same institution
because of ownership restrictions.
For example, whereas an individual with $200,000 in nonretirement
funds could secure full insurance coverage in a single institution by
opening two accounts in different legal capacities, the same owner of a
$200,000 IRA could not do so. Rather, the money would need to be spread
over two separate institutions to maintain coverage. This would also be
the case for a widow or widower whose spouse maintained an IRA at the
same institution as the surviving spouse. Once the 6 month grace period
had passed, the surviving spouse would need to transfer the account to
another institution or risk holding uninsured deposits.
It is inappropriate to require retirees to choose between the
safety of their life savings and banking with someone they trust.
For many retirees who prefer insured deposits out of loyalty to a
particular institution, this solution is unsatisfactory, and they are
forced to choose between maintaining insured deposits and banking with
someone they trust. For other retirees who live in small towns, there
may in fact be only one local bank, and we cannot assume that they have
access to a car or to the Internet.
And even when remote banking may be an option for rural Americans
who live in a one-bank town, it is my strong sense that:
On-line banking is unrealistic for Americans who are not
served by broadband
capacity;
Many elderly Americans are not comfortable with electronic
commerce and are less likely to take advantage of remote banking
facilities even if they have access; and
Elderly individuals with a strong personal connection to their
local bank are far more likely to risk uninsured deposits than to
trust an unfamiliar institution with their life savings.
As a general matter, we in the financial planning community
encourage inves-
tors to diversify their investments to reduce risk to their savings.
However, in all
candor, we do not necessarily encourage investors to diversify their
sources of financial advice.
But spreading insured deposits across several banks accomplishes no
risk-spreading for the individual investor other than staying within
the deposit insurance
limits. In fact, diversification of assets across multiple institutions
has serious
drawbacks, not least of which is a confusing array of financial
statements, which can lead to mistakes in planning, investing and tax
reporting.
From a systemic point of view, as Chairman Greenspan has noted
wisely, the deposit insurance coverage limit is designed to accomplish
exactly this objective of encouraging individuals to spread money
across banks to reduce the Government's risk in any given institutional
failure.
In the retirement context, however, it is my strong belief that
this is a bad tradeoff. The benefits from maintaining an inadequate
level of insurance for retirement savings pale in comparison to the
potential costs to retirees forced to maintain multiple accounts.
For all these reasons, Mr. Chairman, I strongly urge Congress to
increase coverage levels that have not been touched since 1978, and to
take measures to ensure that these limits keep pace with the true costs
of retirement.
I thank you for this opportunity to present my views to the
Subcommittee, and I welcome your questions.
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PREPARED STATEMENT OF AMERICA'S COMMUNITY BANKERS
November 1, 2001
America's Community Bankers (ACB) \1\ is pleased to submit this
statement on the need to increase Federal deposit insurance coverage
for retirement accounts. ACB testified on the overall topic of deposit
insurance reform on August 2, during which we presented the case for
several urgently needed reforms and recommended a substantial increase
in coverage for retirement savings. This statement focuses on
retirement savings coverage.
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\1\ ACB represents the Nation's community banks of all charter
types and sizes. ACB members pursue progressive, entrepreneurial, and
service-oriented strategies in providing financial services to benefit
their customers and communities.
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Last week, ACB's Chairman, David Bochnowski wrote in the American
Banker that, ``In uncertain times, one certainty remains: Americans
must still save for retirement.'' He went on to say:
The irony is that some Government policies are sadly out of
touch with the realities of the market. When retirement savers
moved away from equities and toward bank accounts to protect
their financial assets, they discovered that deposit insurance
coverage for tax-deferred retirement savings had fallen behind
the times and behind inflation. It is past time for Congress to
correct the imbalance. (full text attached) \2\
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\2\ American Banker, October 26, 2001. David Bochnowski is also
Chairman and Chief Executive Officer of Peoples Bank in Munster,
Indiana.
ACB is particularly pleased that FDIC Chairman Donald Powell
strongly endorsed increased coverage for retirement accounts in his
first statement on deposit insurance reform. On October 17 before the
House Subcommittee on Financial Institutions and Consumer Credit,
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Chairman Powell made these comments:
There is one class of deposits for which Congress should
consider raising the insurance limit, and that is IRA and Keogh
accounts. Such accounts are uniquely important and protecting
them is consistent with existing Government policies that
encourage long-term saving. When we think about saving for
retirement in this day and age, $100,000 is not a lot of money.
Middle-income families routinely save well in excess of this
amount.
Moreover, especially during this time of uncertainty when
Americans may be concerned about the safety of their savings, I
believe it is important for the U.S. Government to offer ample
protection to facilitate saving through vehicles that will
redeploy funds into the economy. In my view, we must do
whatever we can to provide for ongoing productive investment in
our economy and solid, sustainable growth. Higher deposit
insurance protection for long-term savings accounts could help.
There is some precedent for providing such accounts with
special insurance treatment. In 1978, Congress raised coverage
for IRA's and Keogh's to $100,000, while leaving basic coverage
for other deposits at $40,000.
The $220 billion of IRA and Keogh deposits currently at banks
and thrifts is not large compared to the volume of overall
deposits. Thus, if the coverage limit were raised for IRA and
Keogh deposits, the initial impact on the fund reserve ratio
would not be dramatic. The total volume of IRA's and Keogh's in
the economy, more than $2.5 trillion, is enormous, and
estimating the influx of retirement account deposits as a
result of higher-
coverage is subject to some of the same uncertainties that
apply to deposits in general. The FDIC is prepared to
investigate the implications of higher coverage for these
accounts and provide this information to the Congress and the
public. We would also note that a phasing-in of higher coverage
limits for retirement account deposits could allow for some
measure of control over the impact on the fund reserve ratio. I
urge the Congress to give serious consideration to raising the
insurance limit on retirement accounts.
ACB agrees with Chairman Powell that Congress should focus on
increasing protection for retirement savings. This is needed to provide
adequate coverage for the variety of tax-advantaged savings accounts
that have grown substantially over the years, as well as prepare for
any Social Security reform, including self-directed accounts should
Congress adopt that concept.
ACB agrees with Chairman Powell that retirement coverage should be
increased to an amount substantially above the general coverage level.
As he pointed out, this is not a new concept; in 1978 Congress provided
for $100,000 coverage for retirement savings accounts, two and one-half
times the then-current level for regular savings. Higher retirement
account coverage would provide a stable funding source for community
lending and is extremely important to retirees and those nearing
retirement.
Additional retirement account coverage would help implement an
important national policy. Congress has just provided substantially
enhanced tax incentives to encourage individuals to accumulate
retirement savings. These individual savings are often replacing
resources that employers previously provided through defined-benefit
pension plans. This shift in retirement funding has increased the
burden on individuals to manage their own assets. As individuals
respond to tax incentives, their retirement assets often exceed by
substantial amounts the current $100,000 coverage limit. Since planners
generally recommend that individuals shift these
savings into more secure and stable investments as they approach
retirement, a substantial increase in deposit insurance coverage for
retirement savings would be particularly helpful. These plans could be
easily defined by requiring that they meet the standards of the
Internal Revenue Code. The increased coverage would also be useful if
Congress adopts some version of private accounts under the Social
Security system.
As long as the fund is above its statutory minimum of 1.25 percent
of insured deposits, an increase in coverage for retirement savings
should not require an ad-
ditional minimal premium. Chairman Powell noted that these accounts
currently
represent a comparatively modest amount as compared to total deposits.
We agree with him that a phase in of the increase coverage might be
appropriate, since there is a substantial amount of retirement money
outside of the banking system. That would mitigate any adverse effect
on the FDIC's reserve ratio.
Notably, Chairman Powell did not recommend an increase in general
coverage levels. Instead, he recommended that Congress provide for
indexing coverage from the current $100,000 level. We agree with
Chairman Powell that, ``Protecting such an important program from the
effects of inflation strikes me as plain common sense.'' He went on to
say that, ``The FDIC is not recommending that the safety net be
increased. It is simply recommending that the safety net not be scaled
back inadvertently because of inflation.'' Depository institutions and
the economy have adjusted to the current level of coverage. Indexing
would effectively maintain that level without the need for more
Congressional action. Like the increase for retirement savings,
indexing general coverage from today's levels should not lead to the
imposition of premiums so long as the fund remains above the 1.25
percent level.
Conclusion
ACB appreciates this opportunity to present our views on proposals
to increase deposit insurance coverage for retirement savings. This
would be a welcome addition to a deposit insurance reform proposal that
would merge the deposit insurance funds and give the FDIC the
flexibility it needs to deal with the strains imposed by extraordinary
growth in insured deposits at a few institutions. We look forward to
working with the Congress on these important issues.
RESPONSE TO A WRITTEN QUESTION OF SENATOR MILLER
FROM L. WILLIAM SEIDMAN
Q.1. Mr. Seidman, yesterday in the hearing you said you agreed
with raising the deposit insurance coverage level to $200,000
and that doing so would cover retirement accounts. You also
said that a study undertaken when you were Chairman of the FDIC
showed the increased cost of covering $200,000 versus $100,000
per account in a failure was minimal. So, you are willing to
increase the moral hazard to the Government/taxpayer of
covering $200,000 per account when an institution fails?
A.1. Yes, weighing the moral hazard risk against the benefits
to the small community banks and its depositors, I believe the
benefits outweigh the hazard.