[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
BUSINESS CHECKING FREEDOM ACT
OF 2003--H.R. 758 AND H.R. 859
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
FINANCIAL INSTITUTIONS AND CONSUMER CREDIT
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
MARCH 5, 2003
__________
Printed for the use of the Committee on Financial Services
Serial No. 108-8
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2003
87-234 PDF
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana MAXINE WATERS, California
SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice JULIA CARSON, Indiana
Chairman BRAD SHERMAN, California
RON PAUL, Texas GREGORY W. MEEKS, New York
PAUL E. GILLMOR, Ohio BARBARA LEE, California
JIM RYUN, Kansas JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois CHARLES A. GONZALEZ, Texas
WALTER B. JONES, Jr., North MICHAEL E. CAPUANO, Massachusetts
Carolina HAROLD E. FORD, Jr., Tennessee
DOUG OSE, California RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois KEN LUCAS, Kentucky
MARK GREEN, Wisconsin JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania WM. LACY CLAY, Missouri
CHRISTOPHER SHAYS, Connecticut STEVE ISRAEL, New York
JOHN B. SHADEGG, Arizona MIKE ROSS, Arkansas
VITO FOSELLA, New York CAROLYN McCARTHY, New York
GARY G. MILLER, California JOE BACA, California
MELISSA A. HART, Pennsylvania JIM MATHESON, Utah
SHELLEY MOORE CAPITO, West Virginia STEPHEN F. LYNCH, Massachusetts
PATRICK J. TIBERI, Ohio BRAD MILLER, North Carolina
MARK R. KENNEDY, Minnesota RAHM EMANUEL, Illinois
TOM FEENEY, Florida DAVID SCOTT, Georgia
JEB HENSARLING, Texas ARTUR DAVIS, Alabama
SCOTT GARRETT, New Jersey
TIM MURPHY, Pennsylvania BERNARD SANDERS, Vermont
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
Robert U. Foster, III, Staff Director
Subcommittee on Financial Institutions and Consumer Credit
SPENCER BACHUS, Alabama, Chairman
STEVEN C. LaTOURETTE, Ohio, BERNARD SANDERS, Vermont
Vice Chairman CAROLYN B. MALONEY, New York
DOUG BEREUTER, Nebraska MELVIN L. WATT, North Carolina
RICHARD H. BAKER, Louisiana GARY L. ACKERMAN, New York
MICHAEL N. CASTLE, Delaware BRAD SHERMAN, California
EDWARD R. ROYCE, California GREGORY W. MEEKS, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
SUE W. KELLY, New York DENNIS MOORE, Kansas
PAUL E. GILLMOR, Ohio CHARLES A. GONZALEZ, Texas
JIM RYUN, Kansas PAUL E. KANJORSKI, Pennsylvania
WALTER B. JONES, Jr., North MAXINE WATERS, California
Carolina NYDIA M. VELAZQUEZ, New York
JUDY BIGGERT, Illinois DARLENE HOOLEY, Oregon
PATRICK J. TOOMEY, Pennsylvania JULIA CARSON, Indiana
VITO FOSSELLA, New York HAROLD E. FORD, Jr., Tennessee
MELISSA A. HART, Pennsylvania RUBEN HINOJOSA, Texas
SHELLEY MOORE CAPITO, West Virginia KEN LUCAS, Kentucky
PATRICK J. TIBERI, Ohio JOSEPH CROWLEY, New York
MARK R. KENNEDY, Minnesota STEVE ISRAEL, New York
TOM FEENEY, Florida MIKE ROSS, Arkansas
JEB HENSARLING, Texas CAROLYN McCARTHY, New York
SCOTT GARRETT, New Jersey ARTUR DAVIS, Alabama
TIM MURPHY, Pennsylvania
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina
RICK RENZI, Arizona
C O N T E N T S
----------
Page
Hearing held on:
March 5, 2003................................................ 1
Appendix:
March 5, 2003................................................ 39
WITNESSES
Wednesday, March 5, 2003
Abernathy, Wayne A., Assistant Secretary for Financial
Institutions, Department of the Treasury....................... 8
Auerbach, Robert, Professor, Lyndon B. Johnson School of Public
Affairs, University of Texas................................... 28
Bent, Bruce R. Sr., Chairman and Chief Executive Officer, Reserve
Management Co.................................................. 26
Hammock, Rex, President, Hammock Publishing, Inc., on behalf of
National Federation of Independent Business.................... 24
Kohn, Hon. Donald L., Member, Federal Reserve Board of Governors. 5
Maus, Edwin R., President and Chief Executive Officer, Laurel
Savings Bank, on behalf of America's Community Bankers......... 20
Menzies, R. Michael Stewart Sr., President and Chief Executive
Officer, Easton Bank and Trust Co., on behalf of Independent
Community Bankers of America................................... 23
APPENDIX
Prepared statements:
Oxley, Hon. Michael.......................................... 40
Bachus, Hon. Spencer......................................... 42
Gillmor, Hon. Paul E......................................... 44
Royce, Hon. Edward R......................................... 45
Toomey, Hon. Patrick J....................................... 46
Abernathy, Wayne A........................................... 47
Auerbach, Robert............................................. 51
Bent, Bruce R. Sr............................................ 56
Hammock, Rex................................................. 60
Kohn, Hon. Donald L.......................................... 65
Maus, Edwin R................................................ 79
Menzies, R. Michael Stewart Sr............................... 84
Additional Material Submitted for the Record
Kelly, Hon. Sue W.:
Hon. Alan Greenspan, Chairman, Board of Governors of the
Federal Reserve System letter, April 2, 2001............... 89
Coalition of Independent Community Banks letter, March 5,
2003....................................................... 91
Maloney, Hon. Carolyn B.:
State of Utah, Department of Financial Institutions letter,
March 10, 2003............................................. 128
Toomey, Hon. Patrick J.:
John D. Hawke, Jr., Comptroller of the Currency letter, March
4, 2003.................................................... 129
Donald E. Powell, Chairman, Federal Deposit Insurance
Corporation letter, March 3, 2003.......................... 130
James E. Gilleran, Director, Office of Thrift Supervision,
Department of the Treasury letter, March 3, 2003........... 132
Menzies, R. Michael Stewart Sr.:
Written response to a question from Hon. Sue Kelly........... 133
BUSINESS CHECKING FREEDOM ACT
OF 2003--H.R. 758 and H.R. 859
----------
Wednesday, March 5, 2003
House of Representatives,
Subcommittee on Financial Institutions and
Consumer Credit
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to call, at 2:14 p.m., in
Room 2220, Rayburn House Office Building, Hon. Spencer Bachus
[chairman of the subcommittee] presiding.
Present: Representatives Bachus, Royce, Kelly, Gillmor,
Toomey, Fossella, Hart, Kennedy, Hensarling, Garrett, Murphy,
Brown-Waite, Barrett, Sanders, Maloney, Sherman, Kanjorski,
Waters, Lucas of Kentucky and Israel.
Chairman Bachus. [Presiding.] The Subcommittee on Financial
Institutions and Consumer Credit is convened. This is a hearing
on two bills, the Business Checking Freedom Act, by
Representative Toomey; then H.R. 859, which is a sterile
reserve bill which is introduced by Representative Kelly.
On panel one, we have two rookies that have never testified
before the Committee before, but not rookies to the issue and
to financial matters. I am going to wait on my opening
statement and go right to the testimony. The first one is the
Honorable Donald Kohn, Governor, Federal Reserve Board; and
second witness is Wayne Abernathy, who is the Assistant
Secretary for Financial Institutions at the Department of
Treasury. Gentlemen, we welcome you and look forward to your
testimony. Have you decided on whether to go left or right?
Do you have an opening statement?
Mr. Sherman. A short one.
Chairman Bachus. Okay.
Mr. Sherman. I think it is important that we allow banks to
pay interest on checking. I look forward to the two bills
somehow being merged into one. I look forward to the bills
being modified so that they cover industrial loan banks as
found in California and some other states. I am glad that this
bill provides for a one-year phase-in, because we are passing
it a year after we wanted to pass a two-year phase-in.
With that, I yield back.
Chairman Bachus. Actually, I thought the bills had been
merged.
Mr. Sherman. They may have already been merged.
Chairman Bachus. No, they have not.
Mr. Sherman. They have not? But I look forward to them
being merged.
Chairman Bachus. We have been approaching this as a package
deal, but they are separate bills. I think they both have the
same title.
Mr. Sherman. They could be merged, packaged, fused.
Chairman Bachus. Although they deal with two different
subjects, they are interrelated. We consider them as a package.
Mr. Sanders, do you have an opening statement?
Mr. Sanders. I am sure we are in agreement. I will just be
repeating what you say.
[Laughter.]
Not really.
Chairman Bachus. No. I am aware of that.
Mr. Sanders. My apologies for being late.
Chairman Bachus. We just started.
Mr. Sanders. Thank you for holding this hearing. I look
forward to working with you as the new ranking member of the
Financial Institutions and Consumer Credit Subcommittee.
Mr. Chairman, according to revised estimates by the
Republican-controlled House Budget Committee, the record-
breaking federal deficit could soar to $400 billion if
President Bush's tax cuts are approved on a full course this
year, funded to tens of billions of dollars, according to the
New York Times. The national debt is over $6.3 trillion. The
cost of war with Iraq could cost between $100 billion and God
only knows if we occupy that country for 10 years. President
Bush's tax cuts will cost us trillions over the next decade.
Given this reality, the question is, should the Federal
Reserve be giving what amounts to corporate welfare to some of
the largest banks in this country through interest on so-called
sterile reserves? Unless this money would go toward reducing
the record-breaking $435 billion trade deficit by expanding
employee ownership, addressing the affordable housing crisis,
expanding health insurance for the 42 million Americans who are
uninsured, and addressing some of our increasing social needs,
I think the answer should be a resounding no.
Without going into great detail right now, the bottom line
for me is this country has a huge deficit. We have huge unmet
social needs in health care, education, veterans needs and so
forth and so on. So I should tell you that I walk into this
hearing today with some skepticism about the proposal, but I
look forward to further discussion.
Thank you, Mr. Chairman.
Chairman Bachus. I appreciate that.
Ms. Kelly, do you have an opening statement?
Mrs. Kelly. Yes, I do, Mr. Chairman. Thank you. I want to
thank you and the ranking member for holding a hearing today.
Though this is a familiar discussion for many of us today, I am
glad to be here talking about the bill and talking about it
early in this session.
Getting straight to the matter, my bill, H.R. 758, contains
three initiatives. First, it allows the banks to increase money
market deposit and savings account sweeps from the current 6 to
24 times a month. This gives the bank an increase in their
sweep activities, enabling them to sweep every night, thereby
increasing the interest that businesses can make on their
accounts. Second, to give the Federal Reserve the authority to
pay interest on reserves, banks keep within the federal system.
This is a good thing to do economically because it will bring
stability to the federal funds rate, which is subject to
volatility when reserves become too low. This is also useful
since these reserves have functioned as an implicit tax on our
banks, and would offset the costs of repeal of the prohibition
on business checking.
Finally, my bill gives the Federal Reserve the additional
flexibility to lower reserve requirements. This will give the
Federal Reserve greater control at maintaining reserves at a
specific and consistent level. It is a good measure and one
that this Committee and this House have passed before, with
broad support. I hope we can get the job done this year, and as
I said, I am encouraged by the Committee's willingness to make
this an early priority once again in this Congress.
I anticipate that Mr. Toomey's bill, H.R. 859, will be
merged with my bill later in the Committee during this month.
In doing this, I think we have to be mindful of the importance
of a proper transition period. We must make sure that banks and
businesses have sufficient time to unwind their current
relationships. My goal continues to be to assist our main
street banks which are so essential to our communities, and I
think this is a good step forward in this effort.
Again, I thank the chairman and ranking member, and I yield
back the balance of my time.
Chairman Bachus. Thank you. I am going to ask unanimous
consent that we limit the opening statements to two on each
side.
Mr. Sanders. As long as one statement is in opposition.
Chairman Bachus. How about three on each side?
Mr. Sanders. Can we put opening statements into the record?
Chairman Bachus. No, just to have oral opening statements.
We will have three on each side, and Mr. Royce and Mr. Toomey
with unanimous consent. And on your side, is there a member
that wishes to make a statement? Ms. Maloney? We will limit
those to three more opening statements.
At this time, Ms. Maloney is recognized. Well actually, we
have had two on this side, so I am going to go to Mr. Royce and
then back to you. And then Mr. Toomey, you will conclude the
oral statements.
Mr. Royce. Mr. Chairman, I thank you very much. Just to go
to the crux of my opposition here, I believe that the
underlying legislation is long overdue. It is necessary, but I
have got to qualify my support. I believe that by not providing
interest on business checking parity to industrial loan
companies, many of which are chartered in my home state of
California, this legislation will subject these well-regulated
institutions at an unfair competitive disadvantage in the
financial services marketplace. I strongly believe that this
oversight must be addressed before the Committee sends this
bill to the House floor for a final vote on its passage.
I thank you very much for allowing me the time to make that
statement, Mr. Chairman.
Chairman Bachus. The gentlelady from New York?
Mrs. Maloney. I first want to compliment my colleague Sue
Kelly for her work on this issue, not only in this Congress,
but I think for the past several congresses this has been an
area of concern on which she has worked. Last Congress, it
passed the House by voice vote unanimously. We know that it
really removed the Depression-era prohibition on the payment of
interest on business checking accounts. The prohibition on
interest for business checking was instituted to prevent larger
city-centered banks from attracting deposits away from smaller
institutions during the Great Depression. Given the global
nature of financial services, interstate banking and advances
in technology, consumers and businesses can now enjoy the full
range of bank services no matter where their physical location.
This legislation will allow businesses of all sizes to
accrue interest on their checking accounts, but it will most
dramatically level the playing field for small and medium
businesses that do not currently have access to sweeps and to
sweep account programs. The small business community in my
district and in others has been pushing for this legislation
for years. Banks have sought ways around the prohibition such
as cutting prices on services to pay implicit interest, or
offering the sweep account option.
Passage of this legislation will increase efficiency by
moving banks away from such bookkeeping maneuvers after a
transition period. At the same time, we are considering
legislation that allows the Federal Reserve to pay interest on
sterile reserves and increased flexibility with regard to
setting bank reserve requirements.
While I am very respectful of opinions on both sides of
this issue, the language in the bill tracks last year's
legislation and was supported by this Committee and the full
House. So I look forward to the testimony today.
Thank you.
Chairman Bachus. Thank you.
Mr. Toomey?
Mr. Toomey. Thank you very much, Mr. Chairman, and thank
you for holding this hearing today on my bill, H.R. 859, the
Business Checking Freedom Act, as well as Mrs. Kelly's bill,
H.R. 758, and for helping to put this legislation on a fast
track, which I think is appropriate given its history in the
House.
H.R. 859 is a very straightforward and simple bill. As I
think many people may know, it simply eliminates a Depression-
era prohibition on banks paying interest on demand deposits--an
idea which I would suggest was probably not a very good one at
the time, and certainly if it was, has long since outlived any
useful purpose, in my judgment.
I want to thank the other sponsors of this bill--Mr.
Kanjorski, Mrs. Biggert, Mr. Gonzalez, Mr. Shays, Mrs. Hooley,
Mr. Ney, Mr. Paul and Mr. Sherman--for their support. Mr.
Chairman, if I could, I would like to insert into the record
letters that I have in support of this legislation from the
Comptroller of the Currency, the FDIC, the Office of Thrift
Supervision, each of which outlines why they believe this is
important legislation.
Chairman Bachus. Without objection.
[The following information can be found on pages 129
through 133 in the appendix.]
Mr. Toomey. With that, I will yield the balance of my time.
Chairman Bachus. Thank you, Mr. Toomey.
At this time, Governor Kohn?
STATEMENT OF HON. DONALD L. KOHN, GOVERNOR, FEDERAL RESERVE
BOARD OF GOVERNORS
Mr. Kohn. Thank you, Mr. Chairman. I will read excerpts
from my testimony and ask that the full statement be included
in the record.
Mr. Chairman, members of the Committee, I appreciate this
opportunity to testify on behalf of the Federal Reserve Board
on issues related to H.R. 859 and H.R. 758. The Board strongly
supports the provisions in these bills that would eliminate the
prohibition of interest on demand deposits, authorize the
Federal Reserve to pay interest on balances held by depository
institutions at Reserve Banks, and provide the Board with
increased flexibility in setting reserve requirements.
As we have previously testified, unnecessary restrictions
on the payment of interest on demand deposits and/or on
balances held at Reserve Banks distort market prices and lead
to economically wasteful efforts to circumvent these
restrictions. Those efforts are more readily undertaken by
larger banks, especially for their larger business customers.
Moreover, these bills would enhance the tool kit available
for the continued efficient conduct of monetary policy. In
addition, the provision of increased flexibility in setting
reserve requirements would allow the Federal Reserve to reduce
a regulatory burden on depository institutions to the extent
that that is consistent with the effective implementation of
monetary policy.
H.R. 758 would authorize the payment of interest on three
types of balances held by depository institutions at the
Federal Reserve: required reserve balances, contractual
clearing balances, and excess reserves. I will discuss each
briefly in turn. The purpose of reserve requirements is to
facilitate the implementation of monetary policy. Reserve
requirements achieve this by providing a predictable demand for
balances held by banks at the Federal Reserve over a two-week
period of averaging. This predictable demand for balances helps
the Federal Reserve hit its target for overnight interest
rates. However, required reserve balances pay no interest and
largely for that reason banks spend resources to avoid reserve
requirements, such as through arrangements that sweep deposits
into non-reservable accounts or market instruments.
Authorization of interest payments on required reserve balances
would substantially reduce the incentives for banks to engage
in these socially wasteful reserve-avoidance activities, and
would thereby improve the efficiency of our financial sector.
Contractual clearing balances are additional balances that
banks may hold at the Federal Reserve beyond the level of their
required reserve balances. Banks contract in advance to hold
such balances in order to pay checks or make wire transfers
without running into overdrafts. These clearing balances do not
earn explicit interest, but they do earn implicit interest for
depository institutions in the form of credits that may be used
to pay for Federal Reserve services such as check clearing.
Like required reserves, contractual clearing balances are
maintained on a two-week average basis and are known in advance
of the maintenance period. These balances also therefore
facilitate the implementation of monetary policy. Explicit
interest payments on these balances would make them more useful
for monetary policy purposes because it would tend to boost
their level and make them more stable over time by removing the
link to a bank's use of Federal Reserve services.
Excess reserve balances are balances that banks hold at the
Federal Reserve beyond the level of any required reserve or
contractual clearing balances. They also earn no interest.
Authorization of interest on excess reserves would add a
potentially useful tool for the implementation of monetary
policy. The interest rate on excess reserves would tend to act
as a floor on overnight market interest rates. A bank would not
lend balances to another bank at a lower rate than they could
earn by keeping the excess at the Federal Reserve. While not
currently needed, this floor for market interest rates could
also potentially help the Federal Reserve hit its target for
overnight interest rates.
H.R. 758 would also grant the Federal Reserve increased
flexibility in setting reserve requirements, allowing the
possibility that reserve requirements could be reduced below
the minimum levels currently allowed by law, and even
conceivably to zero at some point in the future. The Federal
Reserve could make use of this flexibility, however, only if it
were granted the authority to pay explicit interest on
contractual clearing balances to ensure a stable and
predictable demand for their remaining deposit balances at the
Federal Reserve. If the Federal Reserve were granted the
additional authorities included in H.R. 758, we would carefully
study the new range of possible strategies for implementing
monetary policy in the most efficient possible way for banks,
the markets and the Federal Reserve.
The efficiency of our financial sector also would be
improved by eliminating the prohibition of interest on demand
deposits as provided for in H.R. 859. This prohibition distorts
the pricing of transactions, deposits and associated bank
services. In order to compete for the liquid assets of
businesses, banks set up complicated procedures to pay implicit
interest on compensating balance accounts. Banks also spend
resources and charge fees for sweeping the excess demand
deposits of larger businesses into money market investments on
a nightly basis. Such expenses waste the economy's resources
and they would be unnecessary if interest were allowed to be
paid on both demand deposits and reserve balances.
H.R. 859 would delay for one year removing the prohibition
of interest on demand deposits. The Federal Reserve Board
believes that a short implementation delay of one year or even
less would be in the best interests of the public and the
efficiency of our financial sector.
A provision of H.R. 758 would in effect allow interest to
be paid on demand deposits without any delay through a new type
of sweep arrangement, but this provision would not promote
efficiency. It would authorize a new interest earning account
on which 24 transfers a month could be made to other accounts
of the depositor. At the end of each business day, a bank could
sweep demand deposits into the new account, pay interest, and
then return the funds to the demand deposit the next morning.
These sweep arrangements would allow banks to earn additional
fees and perhaps be more selective about, in effect, paying
interest on demand deposits in the one year before explicit
interest payments were authorized. However, these sweeps would
be another example of socially wasteful expenditure, and for
this reason the Board does not advocate the new 24 transfer
account.
The payment of interest on demand deposits would have no
direct effect on federal revenues, as interest payments would
be deductible for banks, but taxable for the firms that receive
them. However, the payment of interest on required reserve
balances would reduce the revenues received by the Treasury
from the Federal Reserve. The extent of the revenue lost,
however, has fallen over the last decade as banks have
increasingly implemented reserve avoidance techniques. Paying
interest on contractual clearing balances would primarily
involve a switch to explicit interest from implicit interest,
and therefore would have essentially no cost to the Treasury.
The payment of interest on excess reserves could also be
authorized without immediate effect on the budget because the
Federal Reserve does not expect to use that authority in the
years immediately ahead.
H.R. 758 includes a provision that transfers some of the
capital surplus of the Federal Reserve banks to the Treasury in
order to cover the budgetary costs of paying interest on
required reserve balances. The Board has consistently pointed
out that such transfers are not true offsets to higher
budgetary cost. A transfer would allow the Treasury to issue
fewer securities, but the Federal Reserve would need to lower
its holdings of Treasury securities by the same amount to make
the transfer. Thus, the level of Treasury debt held by the
private sector would be unchanged. Treasury's interest payments
net of receipts from the Federal Reserve would be unaffected.
In summary, the Federal Reserve Board strongly supports the
proposals in H.R. 859 and H.R. 758 that would authorize the
payment of interest on demand deposits and on balances held by
depository institutions at the reserve banks, as well as
increased flexibility in the setting of reserve requirements.
We believe these steps would improve the efficiency of our
financial sector, make a wider variety of interest-bearing
accounts available to more bank customers, and better ensure
the efficient conduct of monetary policy in the future.
Thank you, Mr. Chairman.
[The prepared statement of Hon. Donald L. Kohn can be found
on page 65 in the appendix.]
Chairman Bachus. Thank you.
Assistant Secretary Abernathy? We note that you have
brought a former staffer of ours.
STATEMENT OF WAYNE A. ABERNATHY, ASSISTANT SECRETARY FOR
FINANCIAL INSTITUTIONS, DEPARTMENT OF THE TREASURY
Mr. Abernathy. I needed some help in walking through these
different parts of the building that I have not walked in
before. It is a pleasure to have Mr. Zerzan with us as our new
Deputy Assistant Secretary. We appreciate all the training you
have given to him.
Chairman Bachus. Thank you.
Mr. Abernathy. I now would ask that my full written
statement be included in the record, and I will just provide a
summary here.
Chairman Bachus, Representative Sanders, members of the
subcommittee, I appreciate this opportunity to present
Treasury's views on legislation repealing the prohibition on
the payment of interest on business checking accounts, and
permitting the payment on interest of reserve balances at
depository institutions maintained with the Federal Reserve.
The Treasury Department supports permitting banks and
thrifts to pay interest on business checking accounts. We are
also sympathetic to the arguments in favor of permitting the
Federal Reserve to pay interest on reserve balances, and we
support the goals of the legislation. However, inasmuch as the
potential budget impact of the provision is not included in the
president's budget, we are not prepared to endorse that
proposal at this time.
The prohibition on paying interest on demand deposits is a
relic of the Great Depression. Many policy makers in the 1930s
had the belief that limiting competition among banks would
reduce bank failures, even if that resulted in fewer options
and higher costs for consumers. Therefore, among other
competition-limiting measures, Congress prohibited the payment
of interest on demand deposits. Experience has shown that
limiting consumer choice is a sub-optimal strategy for bank
regulation. The market has a way of asserting itself.
In recent decades, competition for money market mutual
funds worked to undermine deposit interest rate ceilings. At
the beginning of the 1980s, Congress allowed banks to offer
deposit accounts free of interest rate controls. Repeal of the
prohibition on paying interest on business demand deposits
would eliminate a needless government control. Banks could
reduce the resources that they spend on procedures to get
around these restrictions. Repeal would benefit the nation's
small businesses by allowing them to earn a positive return on
their transaction balances.
We favor the repeal of the prohibition such as that
contained in the bill authored by Representative Toomey, H.R.
859, that would be effective one year after enactment. The bill
introduced by Representative Kelly, H.R. 758, would authorize
an increase in the allowable transactions between demand
deposits and interest-bearing money market accounts. Combining
these two proposals, as the House of Representatives did in the
last Congress, would help ensure that banks are immediately
able to offer the equivalent of interest-bearing checking
accounts to their business customers before the repeal of the
prohibition entered into effect. In any event, the Treasury
Department continues to prefer a relatively quick repeal of the
prohibition.
H.R. 758 would also allow the Federal Reserve to pay
interest on reserve balances. The Federal Reserve Act requires
depository institutions to maintain reserves against certain of
their deposit liabilities. Institutions typically meet these
requirements through vault cash and a portion of their reserves
held at Federal Reserve banks. The required reserve balances do
not earn interest, therefore sometimes referred to as sterile
reserves. Governor Kohn presented the arguments and reasons and
concerns that current limitations may affect the conduct of
monetary policy. We share those concerns.
In addition, permitting the payment of interest on reserve
balances would promote economic efficiency. Uncompensated
reserves act as a tax upon tanks, while serving no public
policy interest. To avoid this tax, banks have engaged in
otherwise uneconomic activity. These costs harm the
competitiveness of banks, not only with foreign institutions,
but also with other financial services providers. H.R. 758
provides an offset to its budget costs by transferring a part
of the Federal Reserve surplus to the treasury. Yet over time,
transfers of the surplus do not result in budgetary savings. In
transferring a portion of its surplus to the treasury, the
Federal Reserve would reduce its portfolio of interest-earning
assets. This would, in turn, decrease the Federal Reserve's
future earnings and remittances to the Treasury. Budgetary
receipts in the near term would increase, but only at the
expense of foregone long term receipt.
In conclusion, we welcome action by the Congress to repeal
prohibitions on paying interest on business checking accounts.
Repeal would eliminate unnecessary restrictions on banks'
ability to serve their commercial customers and would level the
playing field between them and other financial services
providers. Repeal would especially benefit the nation's small
businesses. The ability to pay interest on reserve balances
maintained at the Federal Reserve may improve the effectiveness
of the tools that the Federal Reserve has to implement monetary
policy. Financial system efficiency would likely improve.
Thank you for the opportunity to appear before your
subcommittee, and I am prepared to answer any questions.
[The prepared statement of Wayne A. Abernathy can be found
on page 47 in the appendix.]
Chairman Bachus. Thank you.
According to our rules, we are going to call on members as
they arrive. Some members have indicated they do not have
questions, so I will not call on them. I am going to yield my
five minutes to the first person on our side, which is Mrs.
Kelly.
Mrs. Kelly. Thank you, Mr. Chairman.
I have got a couple of questions here. One of my questions
is to you, Mr. Kohn. It seems to me that there has been a
change in the attitude on the part of the Fed with regard to
this bill. I am not sure, but it seems to me that last year
when we passed this bill, the Fed was comfortable with the 24
sweeps. Now, you say you are not. That seems to me to be a
change in attitude, and I would like you to explain why.
Mr. Kohn. I think the 24 sweeps are something we can live
with, but do not prefer. Our preference is to go directly to
paying interest on demand deposits. The 24 sweeps, which you
could think of as an interim measure, as Secretary Abernathy
was talking about, for the one year, does involve more
avoidance techniques for the payment of interest on demand
deposits. It involves setting up the sweeps. It involves
maintaining them, and it just seems to us that it is much more
direct, much more efficient, much less costly to go directly to
the payment of interest on demand deposits. Not that we would
object to the 24 MMDA sweep provided it was reservable as it is
in your bill, but it does not seem the best way to go since it
does involve these extra expenditures.
Mrs. Kelly. We are already doing six sweeps.
Mr. Kohn. Right.
Mrs. Kelly. What I am doing is making it 24. One of the
reasons for doing that is to help encourage the banks to go
ahead and give the money that is earned with the sweeps and
with allowing interest on sterile reserves, give them back
something that they will be giving out to their customers, so
it balances out. That is the way I see the bill, and I am just
interested in why that change on your part.
I also have another question, and that was brought up by my
colleague Mr. Royce. It has come to my attention that the ILCs
want to offer businesses NOW accounts as they are authorized by
their state. I understand the Fed has some concerns about that
and I want to know if you would elaborate on that. Mr.
Abernathy, I would like to have you comment on that as well.
Mr. Kohn. I would be glad to elaborate, Congresswoman
Kelly. The proposal as I understand it is to authorize the
ILCs, the industrial loan corporations, to offer business NOW
accounts. Industrial loan corporations are institutions in a
select number of states, I think about a half dozen states.
They differ from commercial banks and other depository
institutions in two ways. One is they cannot offer demand
deposits or business checking accounts. The second way is that
they are not subject to the same regulations and restrictions
that commercial banks are in terms of who they can affiliate
with. Industrial loan corporations can affiliate with
commercial organizations. For example, in Utah you have such
corporations as BMW, Volvo, Gateway, other commercial
corporations who own these industrial loan corporations.
So this would be mixing banking and commerce. If you allow
the industrial loan corporations to offer business checking
accounts, you are in effect giving them all the powers of a
commercial bank. They would be equivalent to the commercial
bank in terms of the services they can offer, but unlike
commercial banks, unlike savings and loans, they could
affiliate with commercial institutions. Moreover, banks when
they affiliate even with financial institutions, are subject to
certain regulatory oversight under Gramm-Leach-Bliley. That
regulatory oversight is called an umbrella supervisor, so the
bank holding company is subject to supervision. Even if the
industrial loan corporation were to affiliate only with a
financial firm--for example, Morgan Stanley owns an ILC--that
would not be subject to the same regulation than if Morgan
Stanley were affiliated with a bank.
Congress spent a lot of time a few years ago trying to draw
these borders between financial, banking, and commercial and
decided to keep commerce and banking separate. The board
supported that position very strongly. The Congress also
decided to subject the financial holding companies to umbrella
supervision, as it happens by the Federal Reserve. That is not
as important as the fact that somebody is doing it. The Federal
Reserve supported that decision very strongly.
We believe that allowing ILCs to offer business checking
accounts would in effect undermine the restrictions and the
regulatory apparatus that Congress put into place under Gramm-
Leach-Bliley.
Mrs. Kelly. Mr. Abernathy?
Mr. Abernathy. I think ILCs are a great example, emblematic
of the strength of the constitutional federal system of
government that we have. They are emblematic of the kind of
variety that we have in financial institutions because of the
innovation that our dual banking system allows. We have federal
institutions, we have state institutions that offer different
kinds of services to meet the needs of consumers, whether they
are individuals or businesses.
With regard to the specific issue of whether or not demand
deposit authority should be extended to ILCs, because that was
not in the bills that we looked at while we prepared for this
hearing, the Treasury has not examined that issue. So we would
need to go back and consider that. We have been listening to
some of the comments that have been raised about it. I think we
want to look at it closely, but we do not have a position on it
at this time.
Mrs. Kelly. Thank you.
Mr. Chairman, I wonder if I could have unanimous consent. I
have testimony from a coalition of over 1,800 independent
community banks that are opposed to the repeal on the ban, and
I would like to have that be included.
[The following information can be found on page 91 in the
appendix.]
Chairman Bachus. Without objection.
Mrs. Kelly. Thank you.
Chairman Bachus. That was partially as a result of Wal-Mart
trying to buy an ILC in California.
At this time, Mr. Sanders?
Mr. Sanders. Thank you, Mr. Chairman and welcome gentlemen.
Mr. Abernathy, if I could begin by asking you a couple of
questions. In your judgment--I sometimes find it strange that I
am the conservative around here worrying about the federal
deficit, with my free-spending colleagues here not worrying so
much about it. Can you give me an estimate perhaps as to how
much you believe it would increase the federal deficit if the
Federal Reserve were paying the interest we are discussing
today? My understanding is that last year the Fed gave $24
billion to the treasury, which ultimately lowered what
otherwise would have been the case with the deficit. How much
less would they be giving if the Fed were paying interest on
reserves?
Mr. Abernathy. I think the last time that the CBO examined
this issue, which was a couple of years ago, they estimated
that the five year cost would be somewhere in the neighborhood
of about $500 million. That was, of course, with different
economic assumptions. We now have a lower interest rate
environment. Whether that would reduce the cost to the Federal
Reserve because they are paying less, or would that mean that
more reserves would be placed with the Federal Reserve--it is
hard to tell.
Mr. Sanders. Okay.
Mr. Abernathy. The best number we have would be the old
number of about $500 million over five years.
Mr. Sanders. Or roughly $1 billion over a ten-year period.
Mr. Abernathy. I think the ten-year number came closer to
about $800 million, for some reason.
Mr. Sanders. Okay. Now, we are going to hear testimony
later on from Professor Auerbach, who in fact comes up with a
much, much higher estimate. His estimate is I believe $16
billion over a ten-year period.
My second question is, as everybody in this room who is
over 12, most people are over 12 knows, that when legislation
is introduced, somebody wins and somebody loses. Usually there
are beneficiaries. Probably people sleeping out on the street
who are homeless are not going to gain much out of this. People
who cannot afford prescription drugs are not going to be major
winners out of this. Veterans who do not have health care
probably are not going to get too many benefits out of this
legislation. If I were to tell you that my office spoke to the
Congressional Research Service and they said that the major
beneficiaries would be the Bank of America, who last year made
over $6.7 billion in net income; Wells Fargo, who made over
$3.4 billion in net income; J.P. Morgan Chase, who made over
$1.69 billion in net income; and Citigroup, which made over $14
billion in profits--would that make sense to you? Would you
argue with CRS on that?
Mr. Abernathy. Is this with regard to the payment on Fed
sterile reserves?
Mr. Sanders. Yes.
Mr. Abernathy. Without looking at the numbers, I could not
comment in favor or opposed to them.
Mr. Sanders. That is what the CRS said. Does this sound to
you like a reasonable proposition?
Mr. Abernathy. I have not looked at the numbers. I presume
that if banks maintain deposits with the Federal Reserve and
they are going to receive interest payments on those, they will
benefit from that. Exactly which ones those are, we have not
done an analysis.
Mr. Sanders. But these are some of the largest banks in
America, and everything being equal, we would expect the
largest banks would be the major beneficiaries. Is that a fair
assumption?
Mr. Abernathy. If you base it just upon the reserves, the
larger the bank you are, the greater the reserves you hold in
the Federal Reserve. That is correct.
Mr. Sanders. Right. Mr. Kohn, if the CRS gave my office
that information, does that make sense to you, that the Bank of
America, Wells Fargo, J.P. Morgan Chase, and Citigroup might be
the major beneficiaries out of this legislation? Does that
sound roughly right? Mrs. Kelly's bill I am talking about, H.R.
758.
Mr. Kohn. I think the major beneficiaries out of this
legislation would be the customers of the banks who are holding
these sterile reserves. I think in effect that the competitive
market system passes through these costs to the customers, in
some cases directly for businesses holding compensating
balances with banks. When banks calculate the implicit interest
on the compensating balances, they directly subtract the cost
of the--
Mr. Sanders. Do you think the average person would be aware
of lowering his fees? Would all that stuff really impact
heavily on the ordinary working person in this country?
Mr. Kohn. I do not think it would impact heavily on
anybody, because we are talking about a very small amount of
money relative to the size of the banks, to the financial
system. But I do think the direction would be that the average
person would see slightly lower costs for services and slightly
higher returns.
Mr. Sanders. That would certainly be a nice thing to see
with fees soaring all over the country, wouldn't it be, Mr.
Kohn?
Mr. Kohn. Yes, it would.
Mr. Sanders. Okay. The point that I wanted to make--first
of all, I want to thank the Bush administration for not jumping
on support of this, for trying to retain some credibility and
concern about our deficit, because this ultimately will raise
our deficit. That is number one. Number two, from what I can
see, the major beneficiaries will in fact be the largest banks
in this country in terms of H.R. 758.
With that, Mr. Chairman, I yield back.
Chairman Bachus. Thank you.
Ms. Brown-Waite?
Ms. Brown-Waite. Thank you.
Actually, my question is for Governor Kohn. In your
testimony, you indicate that one year would be a sufficient
time for the phase-in of the repeal of the ban on paying
interest on business demand deposits. The bill also calls for a
year's period of time. Some in the banking industry have said
that it should take three years. Help me to understand why you,
as well as the sponsor of the bill, obviously believe that one
year is sufficient time.
Mr. Kohn. I think the banks' systems are set up in such a
way to accomodate that, and this bill has been debated and
passed by the House for several years. None of this should come
as a surprise to the banking industry. I think the banks'
computer systems are set up in such a way that they should be
able to implement this fairly rapidly. I think you will have
some bankers you are talking to on the second panel, and you
should certainly ask them, but my understanding from talking to
a few bankers, is that implementing this is really not going to
be a problem, and the sooner the better.
Ms. Brown-Waite. Thank you.
Chairman Bachus. Thank you.
Ms. Maloney?
Mrs. Maloney. Thank you, Mr. Chairman.
I really wanted to comment on an aspect of the bill that my
dear friend and colleague Mr. LaFalce said in the last bill
that we passed in the House, H.R. 1009. It contained a
provision that we had worked on together that would require the
Federal Reserve to perform an annual survey of checking, NOW
accounts, ATM transactions and other electronic transactions.
As I notice, this provision has been omitted from H.R. 758 and
859. I wanted to ask our two representatives what you think of
that. Would you object to having that added back in? What is
your position on that particular aspect of the law?
Mr. Kohn. The Federal Reserve would not object to having
that added back in. I do think it is important for the Congress
to consider carefully what the objective is and why they want
to get this information, and to keep the data collection and
the requirements targeted tightly to what you want and the
objectives you have for this. This will keep the burden down,
both on the banks and on the taxpayers through the Federal
Reserve, but we have no objection to including such a study in
the bill.
Mrs. Maloney. Mr. Abernathy, do you have any objection to
it?
Mr. Abernathy. We like to look at a lot of numbers. The
more data you have, I think the better you can make policy. My
experience has been there are a lot of reports that nobody
looks at; a lot of data that is collected that no longer serves
a particular function. While I think that the particular data
points that you are suggesting might be helpful, I would like
to look at it in a larger context of the data that is
collected, and then maybe we could focus on the things that
would be most helpful for policy, and eliminate some of the
report requirements that no longer meet any needs.
Mrs. Maloney. Thank you.
Chairman Bachus. Mr. Toomey?
Mrs. Maloney. Could I very briefly--I am supporting the
bill, but I would like to ask Mr. Kohn, you mentioned earlier
that the customers were the ones that were going to benefit
with the checking account interest rates. How can we be assured
that banks will pass through interest on sterile reserves to
their customers in the form of higher interest rates or reduced
fees? Historically, the fees paid or interest rates paid on
checking accounts have been incredibly low. How can we be
assured that this will be passed through to customers, as you
mentioned in your dialogue?
Mr. Kohn. Right. I think there are some direct ways, as I
noted in my answer to Congressman Sanders, that it would be
passed through. That is, compensating balances are
automatically adjusted for reserve requirements. So for at
least I think that about one-third of demand deposits that are
held as compensating balances, to the extent that the reserves
on those earn interest, that interest would automatically flow
through to the customers. I think for the rest of it, we can
rely on a very rigorous competition for banking services. We
have banks, we have S&Ls, we have non-banks such as money
market funds offering services to customers. We have finance
companies offering loans. I think a bank, offered the
opportunity to gain a little bit more of an advantage in
offering these services by not incurring this particular tax,
would be competing very strongly with all these other financial
institutions to increase market share. So I think the market
system will do this.
Mr. Sanders. Would the gentlelady yield?
Mrs. Maloney. I just wanted to follow up on it. Consumer
checking account interest rates have really severely lagged
behind other market rates. A lot of my constituents tell me
they do not even keep money in consumer checking accounts
because of that, or very little. So do you anticipate that this
will be the same with business checking accounts as well? If it
is true that there is going to be such competition for their
accounts, then it would be true for the consumer checking
accounts too, would it not?
Mr. Kohn. I think there is competition for the accounts.
The interest rates are very low in part because the Federal
Reserve has very low interest rates right now.
Mrs. Maloney. But even when it has not been the case, it
has been low.
Mr. Kohn. That is right. There are a variety of accounts
and a variety of ways that banks deliver services to their
customers. Some of the accounts have higher interest rates on
them for less active accounts; other accounts might have a
lower interest rate or a zero interest rate account if you are
very active, and you do not get charged for the activity in the
account. So I think there are just a whole lot of dimensions
along which banks compete for this. I think the competition
will remain there. I think the customers will see this.
We are talking about very small amounts of money. I
recognize, along with Congressman Sanders, that if you add it
up over a long time, it looks like a lot of money. But $100
million or $150 million a year is going to be very hard to
track through. That is less than one-tenth of one percent of
the income of the bank. It would be very hard to track through.
But I think it goes in that direction, and I think I would rely
on the market to do it.
Mrs. Maloney. I yield to Ranking Member Sanders, who
requested the time.
Chairman Bachus. Actually, your time is expired.
Mrs. Maloney. My time has expired. Okay. Sorry.
Chairman Bachus. Mr. Toomey?
Mr. Toomey. Thank you, Mr. Chairman.
Just to follow up on this for just a moment, maybe starting
with Mr. Abernathy. Would you say that it is widely accepted,
if not universally accepted, among economists that it is not
unique to the banking industry, but rather to any competitive,
mature industry, the structural savings that occur by and large
gets passed on to the consumers of that service? Is that a
generally accepted principle of economics?
Mr. Abernathy. That is one of the things that the
marketplace does. It in essence, reaches a balance between your
cost of providing a service, and the demand for your particular
service.
Mr. Toomey. Right. So this is not a unique circumstance or
a unique theoretical exercise. Any industry in which there
would be a reduction of a government-imposed tax, any mature
industry, anyway, that is truly competitive, we would always
assume automatically pretty much that most, if not all, of that
benefit would be passed on to consumers. Is that correct?
Mr. Abernathy. And I think it is not just theoretical.
There has been study after study that has demonstrated that
that is exactly what happens.
Mr. Toomey. Thank you.
Mr. Kohn, do you agree with that?
Mr. Kohn. Yes, I do, Congressman.
Mr. Toomey. Thank you.
A quick question--do either of you have any reservations
whatsoever that the repeal of the prohibition on interest
payments would introduce any kind of safety and soundness
concern to our financial infrastructure or individual
institutions, for both of you gentlemen?
Mr. Abernathy. I do not know of any safety and soundness
concerns that would be heightened. There might be some
arguments that could be made that you would be introducing some
elements of stability, which would improve safety and
soundness.
Mr. Toomey. Could you just give an example and elaborate on
any improvements to safety and soundness that might result?
Mr. Abernathy. I think inasmuch as banks engage in certain
types of uneconomic activity to try to work around these
restrictions, they are doing things that are imposing
unnecessary costs on them. To the degree that you can reduce
costs on their activities, you improve their profitability,
which is an important element of safety and soundness.
Mr. Toomey. Mr. Kohn, would you like to add anything to
that?
Mr. Kohn. I would agree with Secretary Abernathy on that. I
do not see any adverse effects on safety and soundness here.
Another added benefit for small banks would be an ability to
reach out for deposits, where they are currently restricted, at
least on the demand deposit dimension right now. So I think it
would help them manage their liquidity. They have demonstrated
over a long period of time that they can live in a deregulated
environment. The supervisors and examiners would be sure to be
careful that they were not engaging in activities that would
endanger the safety and soundness. I see no problems in that
dimension.
Mr. Toomey. My last question, Mr. Chairman--do either of
you feel that the repeal of the prohibition on interest
payments would or could be fairly characterized as in some ways
leveling the playing field between the small banks and the
large banks?
Mr. Abernathy. I think particularly, large banks have been
able to access a lot of these work-around products. Smaller
banks cannot always access those. There is a certain cost
involved with them, and the smaller your institution, the less
willing you are to engage in that cost. So in many cases, you
just do not compete in that field at all.
Mr. Kohn. I agree. I think not only would it help to level
the playing field between small and large banks because of the
costs that were just discussed, but also between banks, and
small banks in particular, and non-depository institutions.
Small banks are at a disadvantage when competing with Merrill
Lynch or another firm offering a money market fund that can
attract the transaction deposits of businesses, particularly
small businesses. So I think it levels the playing field in
several ways.
Mr. Toomey. Gentlemen, thank you very much for your
testimony today and for answering my questions.
Mr. Chairman, I will yield the balance of my time.
Chairman Bachus. Thank you. I appreciate that.
Mr. Garrett?
Mr. Garrett. Thank you, Mr. Chairman.
Am I correct to understand that since this bill was
considered a couple of years ago that the reserve levels have
actually not been going down, but been slightly going up? If
that is true, do we know why that is?
Mr. Kohn. That is correct, Congressman. They have gone up a
little bit over the last couple of years. Primarily, it is
because interest rates have declined. When market interest
rates are low, people are less careful about keeping their
transaction deposits down, which earn little or no interest. So
as market interest rates go down, we find that demand deposits,
NOW accounts and these reservable liabilities tend to go up. As
a consequence, the reserves against them tend to go up. So yes,
reserve balances have risen a little bit over the last few
years.
I think one question which I raised in my testimony is,
what happens when interest rates go back up again? I think we
would see those balances go back down.
Mr. Garrett. Just a second question, then, following maybe
in some sense where Congressman Sanders was going--the
differences between the large banks and the small banks. My
understanding is the various small banks, their reserve
requirements are small to maybe nonexistent as far as what they
have to put in there and what they may actually have on hand
may satisfy that. So is there a disparity, then, on how this
legislation impacts upon the two size banks as far as that
goes? Is there a benefit to the small bank, other than just a
larger economic issue as far as the economy is concerned.
Mr. Kohn. I think it is true that structural reserve
requirements is that the first $6 million or so of transactions
deposits have no requirement on them. The next $37 million or
so have a 3 percent requirement. Only after you get over $42
million, I think it is, that you get to the full 10 percent
requirement. So the small banks tend to have smaller required
reserves even relative to their size.
Having said that, there are what was to me as I looked at
the tables, a surprising number of small banks that hold
deposits at the Federal Reserve--hold required reserve balances
at the Federal Reserve. I think partly this is because they are
not large enough to afford the sweep programs that the medium
and larger size banks use to get rid of even the transactions
deposits that they have. So if you look at the structure of who
holds the deposits, yes, obviously in dollar number is it
overwhelmingly the larger institutions, but there are some very
small institutions that hold deposits. The medium-size
institutions that get to a critical size so they can afford
these sweep programs hold very few; and then the big ones hold
more. So some small institutions would benefit.
Mr. Garrett. Okay. Thank you.
Mr. Abernathy. If I could add, currently, probably the
number one reason why smaller institutions do not have their
deposits with the Fed is because they keep it in vault cash,
mainly because of the demand at ATMs. That is only a temporary
phenomenon. We have all these predictions as we develop new
types of ways to carry money, such as money cards, cash cards
and other instruments, where it could not be long before people
are not carrying lots of cash and the demand for vault cash
declines. And then you could see small institutions putting
more money into the Fed because they do not satisfy with their
vault cash needs.
Mr. Garrett. Thank you.
Chairman Bachus. Thank you.
Ms. Hart?
Ms. Hart. Thank you, Mr. Chairman.
I am sorry I missed most of the testimony, but I did have a
couple of questions, actually one main one. I was not here 20
years ago when I understand that this issue was discussed
before. At that point, I understood that opponents of paying
interest on business checking accounts went to the U.S.
Government archives and reviewed the minutes of the Depository
Institutions Deregulation Committee--it was about 10 or 11
years ago--where they discussed permitting banks to offer
interest on business checking. The Committee decided not to
permit banks to engage in this activity because of negative
economic impact they believed that would result. In 1983, the
chairman of the Fed expressed reservations about this change.
Since that time, I am interested in knowing what has
changed? Is there something specific that you can cite in the
last 20 years that has changed the position of the Fed on this
issue?
Mr. Kohn. I am not sure the Depository Institution
Deregulation Committee had the legal power to authorize
interest payment on demand deposits. I think that is part of
the law. So I am not sure exactly.
Ms. Hart. They must have just not recommended it then.
Mr. Kohn. That is possible. First of all, I can actually
recall helping Governor Partee write testimony on this issue in
1984 or 1985. I have been at the Fed for some time. We were in
favor of paying interest on reserves and interest on demand
deposits.
Ms. Hart. It changed from the prior couple of years, then?
Mr. Kohn. Is that right? I do not recall why it changed,
but I know that we have had the same position for at least 18
years.
Ms. Hart. Okay.
Mr. Kohn. I am not sure why it changed. I think right now
the situation is that the banks have managed to get around a
lot of the required reserves by instituting the sweeps. It is a
socially wasteful and unnecessary kind of thing. It does, if it
continued and intensified, make the implementation of monetary
policy a little more difficult. So we can see no reason not to
pay interest on required reserves. In so far as demand deposits
are concerned, I think the same kind of reasoning goes.
Increasingly over time, banks have found ways of, in effect,
paying interest on demand deposits. It costs money to avoid the
prohibition. The folks that are left behind are the small banks
and the small businesses. I do not recall what the Board's
reasoning might have been in 1983, but it makes no sense today.
Ms. Hart. Would it be possible to try to check out what had
maybe changed that opinion? We will double check to make sure
that our information is good--that that was the position. I
will have my staff definitely catch up with you.
Mr. Kohn. Sure. Okay.
Ms. Hart. One other question, and you may have answered
this in your testimony, and I apologize if this is being
redundant. Has there been some effort to determine the actual
impact that this will have on the economy--the changes on the
current institutions that have created that system that you are
saying, the elaborate method that they have now to in a
backdoor way provide that interest? Has there been a study done
as to what that will mean to the economy?
Mr. Kohn. As far as I know, there has not been an empirical
study done, but people have given this considerable thought.
The answer, I believe, is that there would be, as somebody
mentioned, some winners and losers here. I think the winners
would be people holding deposits, particularly the small
businesses. Perhaps as interest on demand deposits rose, some
services would cost a little more because they are now being
subsidized by the people holding the deposits. But the overall
effect, I think, would be positive for the efficiency of the
economy. Services and deposits would be priced closer to their
costs. The dead weight loss of all this activity to avoid the
regulation would go away, and those resources--the lawyers, the
accountants, the consultants, the computer programmers--could
put their efforts into doing things that were more socially
productive.
Ms. Hart. I would not argue with that, but what about the
reality that these institutions are going to have to be paying
out where they have in the past were less clearly paying out,
or less directly paying out. Was there any thought or
consideration given to the possibility that they might have to
increase other fees?
Mr. Kohn. I think they might have to increase a few of the
fees to the extent that they are under-pricing services now, in
order to attract, quote, ``free demand deposits.'' So yes, some
fees might rise a little, but deposit rates will rise a little,
so that depositors will finally be receiving something without
going through all the convolutions of avoiding the prohibition.
I think net-net, it has got to be a plus because you do get rid
of this dead weight loss. By avoiding the costs that the banks
and the businesses now go through to avoid the regulation, the
returns to depositors are going to go up more than the increase
in the fees.
Mr. Abernathy. If I may, what we would be saying to banks
is, here is one more area on which you might compete with each
other. Under current law, we are telling banks, you may not
compete with regard to interest on business deposits. If this
became law, we would be saying, here is one more element that
you can put into your competition with one another. Banks have
prospered, the more that they have been subject to competition.
Ms. Hart. Thank you. I yield back, Mr. Chairman.
Chairman Bachus. Thank you.
This concludes the first panel's testimony. The first panel
is discharged. If the second panel will take a seat. Two of the
members wish to introduce members of the panel.
Governor Kohn, we appreciate your testimony.
Mr. Kohn. Thank you.
Chairman Bachus. And thank you, Assistant Secretary
Abernathy.
Mr. Abernathy. Thank you.
Chairman Bachus. We want to welcome the second panel. At
this time, I am going to recognize Mr. Toomey to introduce one
of the panelists.
Mr. Toomey. Thank you very much, Mr. Chairman.
This is a pleasure for me today to introduce this gentleman
because we have with us today before the subcommittee, Mr.
Chairman, really one of the great post-war innovators--in fact,
I would say a visionary--in the financial services industry.
Bruce Bent is the CEO of the Reserves Fund. He is a great
leader and a believer in the capitalist system, in the free
enterprise system, and he is a man whose opinion I respect
enormously. We have a slight difference of opinion on this
particular bill. There are very few things on which we disagree
in the economic realm, and as I said, I respect his opinion.
I say he is a visionary because this is a gentleman who
created the first money market mutual fund back in 1971. Mutual
funds today, as we all know, are enormously important, holding
over $2 trillion in investments. Mr. Bent's creation has been
described as one of the 10 most important financial advances of
the 20th century. I would say that it is an innovation that has
democratized the capital markets of America in a way that no
other innovation has, making investments possible, and in fact
easy and convenient for millions and millions of Americans who
would never otherwise have had the opportunity to invest and be
stakeholders in our economy.
So it is a great pleasure for me to welcome to our
Committee today Mr. Bruce Bent. Thank you for being here.
Mr. Bent. Thank you, Congressman.
Mrs. Kelly. [Presiding.] Thank you, Mr. Toomey.
It gives us great pleasure today to welcome our second
panel here today--Mr. Edwin Maus, President and Chief Executive
Officer of the Laurel Savings Bank, on behalf of America's
Community Bankers; Mr. Michael Stewart Menzies, Sr., the
President and Chief Executive Officer of the Easton Bank and
Trust Company, on behalf of the Independent Community Bankers
of America; Mr. Rex Hammock, President of Hammock Publishing
Company, on behalf of the National Federation of Independent
Businesses; Mr. Bruce Bent, Chairman and CEO of Reserve
Management Company; and Mr. Robert Auerbach, Professor at the
Lyndon B. Johnson School of Public Affairs at the University of
Texas.
Thank you, gentlemen. We look forward to your testimony.
Let us begin with you, Mr. Maus. Without objection, all of
your written statements will be made part of the record, and
you do understand the light system here. When the yellow light
comes up, you can sum up your testimony. We would appreciate
that.
Thank you. We will begin with you, Mr. Maus.
STATEMENT OF EDWIN R. MAUS, PRESIDENT AND CEO, LAUREL SAVINGS
BANK, ON BEHALF OF AMERICA'S COMMUNITY BANKERS (ACB)
Mr. Maus. Thank you.
Madam Chairman, Ranking Member Sanders, and members of the
subcommittee, my name is Edwin Maus. I am President and Chief
executive officer of Laurel Savings Bank, the $270 million
savings bank located in Allison Park, Pennsylvania, which is
suburban Pittsburgh. I am testifying today on behalf of
America's Community Bankers. I appreciate the opportunity to
testify before you on the Business Checking Freedom Act of
2003, legislation whose subject matter was first brought to the
attention of Congress by ACB nearly a decade ago.
ACB strongly supports allowing banks to offer interest-
bearing checking accounts, and urges the 108th Congress to pass
H.R. 859. We also support authorizing the Federal Reserve to
pay interest on sterile reserves, as reflected in H.R. 758. The
existing ban on interest-bearing business checking accounts is
the last statutory vestige of a Depression-era law that in the
words of the federal banking regulators no longer serves a
public purpose.
Instead, it has created an anti-competitive business
environment allowing a limited number of financial
conglomerates to corner the market for cash management
services. It has diminished the ability of community banks to
lend to our neighbors and communities. It has prevented many
small businesses from earning interest on their deposits.
Historically, the major beneficiaries of the ban on banks
paying interest on business checking accounts have been a
handful of large financial institutions. Unlike most community
banks, those institutions have the financial resources to
circumvent the prohibition by conducting so-called "sweep"
arrangements. Sweep arrangements can be costly and cumbersome.
In fact, many institutions that offer sweeps today do so only
because they are not allowed to provide the more efficient
service of paying interest on business checking accounts.
The interest on business checking option would also provide
a stimulus for America's small businesses and the economy as a
whole. Many small businesses do not earn interest on their
demand accounts because they cannot afford to maintain the
relatively high minimum level of deposits required to maintain
a sweep account. By lifting the ban on interest-bearing
checking accounts, Congress can give these small businesses the
opportunity to finally earn a market rate of return on their
demand deposits. For many mom and pop businesses, this could
mean the margin of difference from surviving a weak economy. In
addition, it would open up the entire segment of potential new
deposits for community banks to lend to our neighbors and our
communities.
Given the current debate in Washington over how best to
revive the economy, doesn't a revenue-neutral economic stimulus
tool like H.R. 859 make more sense?
ACB is pleased to be joined in our support for this
legislation by a host of organizations that supports small
businesses, and by both the Federal Reserve and the Treasury
Department. The legislation was passed not just once, but twice
by the U.S. House of Representatives during the 107th Congress,
and three other times before that. We hope that the House will
follow suit again this year with a strong vote in favor of this
much-needed legislation.
I would also like to address the critical issue of timing.
Much of the past opposition to this change in law has been
camouflaged under the guise of unreasonably long transition
periods. Institutions have had ample time to make any needed
changes to their systems, operations and business plans. In
1980, the law authorizing banks such as Laurel Savings Bank to
pay interest on consumer checking accounts took effect in a
mere nine months after it was signed by the president. That was
a major change for financial institutions to implement the
interest on regular checking accounts back then. To make a
similar change to business accounts today would be a very, very
minor change for us to implement. While ACB would strongly
prefer the legislation lift the ban immediately upon enactment,
we believe that the one-year phase-in contained in H.R. 859 is
an acceptable transition period. We strongly urge Congress not
to extend this phase-in beyond one year.
I would also like to take this opportunity to express ACB's
support for authorizing the Federal Reserve Board to pay
interest on sterile reserves held at the Federal Reserve Bank.
ACB commends Representative Kelly for introducing H.R. 758. ACB
strongly endorses H.R. 859, the Business Checking Freedom Act
of 2003--an important step for community banks, small
businesses, and the American economy. We thank Representatives
Pat Toomey and Paul Kanjorski for their sponsorship--both
fellow Pennsylvanians, I might add--of this critical
legislation and urge Congress to pass it immediately.
Thank you again for the opportunity to testify before this
subcommittee, and I look forward to any questions you may have.
[The prepared statement of Edwin R. Maus can be found on
page 79 in the appendix.]
Mrs. Kelly. Thank you, Mr. Maus.
Ms. Hart, I understand that Mr. Maus is perhaps from your
district. Maybe you would like to say something.
Ms. Hart. Thank you, Madam Chairwoman.
I am sorry, but I had to run out of the room to do a vote
in Judiciary, or I would have actually introduced you before
you gave your testimony. But I did get to hear it, and I thank
you for it.
For those of you who are not familiar with this guy, he is
I would say it is safe to say one of our local bank wizards. He
has really been with several successful organizations, and for
the past probably--what?--15 years or so, with Laurel.
Mr. Maus. Fifteen with Laurel, yes.
Ms. Hart. Fifteen with Laurel, and it has gone really from
a very little tiny, you pass up the office, then there aren't
anymore, and you never hear of them again, to a very well
respected and much larger financial institution under his
tutelage. He is also, of course, a fellow University of
Pittsburgh grad, and that is a really good thing. You probably
do not know how close I really live to you, Bud.
[Laughter.]
Mr. Maus. I have a pretty good idea.
Ms. Hart. We are pretty much in the same community. I think
that is safe to say. I have just been watching your career, and
it is a pleasure to have you here to share your wisdom with the
Committee.
Thank you, Madam Chairwoman.
Mr. Maus. Thank you.
Mrs. Kelly. Thank you, Ms. Hart.
We go now to Mr. Menzies. Is there some kind of a
Pennsylvania cabal going on here, with the three of you here?
STATEMENT OF R. MICHAEL STEWART MENZIES, SR., PRESIDENT AND
CEO, EASTON BANK AND TRUST CO., ON BEHALF OF INDEPENDENT
COMMUNITY BANKERS OF AMERICA (ICBA)
Mr. Menzies. Actually, I believe you are thinking of
Easton, Pennsylvania, and regretfully much of my mail goes from
Easton, Maryland to Easton, Pennsylvania by accident.
[Laughter.]
Madam Chairman, thank you. Madam Chairman and Ranking
Member Sanders, and members of the subcommittee, I am Mike
Menzies from Easton Bank and Trust in Easton, Maryland, which
is known as the wild goose capital of the world. I manage a $90
million community bank in Easton, and I am also honored to be
the Vice Chairman of the Independent Community Bankers of
America, Federal Legislation Committee. I am pleased to appear
today on behalf of our nearly 5,000 members, and share our
views on payment of interest on business checking and payment
of interest on deposits at the Federal Reserve.
Madam Chair, as you know, repealing the bank on paying
interest on business checking accounts, has been highly debated
among community banks for many years. Frankly, they remain
divided. Proponents of repealing the ban argue that it would
increase economic efficiency and simplicity in business
practices and assist in retaining their best customers and
allow them to remain competitive. They believe that the current
prohibition has been competitively damaging because of
brokerage firms and others who are otherwise taking core
deposits away from banks that banks could use to compete for
loans in their marketplace.
Opponents, on the other hand, argue that repealing the ban
would squeeze their margins and they oppose the financial
burden that could jeopardize their ability to compete with the
bigger banks, who can afford to pay more interest. They fear
the loss of business customers, and that is their concern.
Because our membership is split, we very much advocate the
alternative that Congresswoman Kelly has put on the table. We
believe bankers on both sides support this alternative. Under
this alternative, the ban on paying interest on business
checking would remain in place, but the number of allowable
transactions for money market accounts would go to 24, up from
the current limit of six. Banks would be allowed to conduct
daily sweeps between non-interest-bearing commercial accounts
and interest-bearing money market deposit accounts. This would
give banks the option of paying interest on commercial checking
accounts at a cost that is significantly lower than the
alternative repurchase sweep account, which the Fed has
referred to as incredibly inefficient--and it is.
Community banks are the primary source of credit for small
businesses. Commercial depositors are looking for ways to get a
return on their demand deposits. Increasing the number of
allowable transactions from money market deposit accounts will
allow community banks to remain competitive in providing cash
management services to their commercial customers, and would
enable commercial customers to earn a return on their funds and
have funds readily available in a liquid deposit account. This
is the only alternative that we are aware of, Mr. Chairman,
that has not raised objections from banks on both sides.
Therefore, we strongly urge you and the subcommittee
members to give this proposal very serious consideration.
Should the prohibition be repealed, we would strongly support
and urge a transition period of not less than two years or
more. The transition period would be necessary to allow banks
to reconfigure long-term business arrangements, certainly not
the operational aspects, with commercial customers, and phase
in the relative economic impact of this change, and there will
be one.
Mr. Chairman, I would also like to note for the record
ICBA's historical and staunchly held support for maintaining
the wall between banking and commerce, which was so strongly
reaffirmed in the Gramm-Leach-Bliley Act. Thus, any effort in
the context of this legislation to add provisions related to
industrial loan companies would raise strong opposition from
our membership, since ILCs can be owned by commercial firms. As
Chairman Greenspan noted, this legislation should not be the
vehicle for expansion of ILC powers.
With respect to interest on sterile reserves, let me say
that we certainly have no objection to this proposal. Many
community banks have transaction deposits in the lower tranche,
and this was mentioned before. Many communities do not have
deposits at the Federal Reserve. Easton Bank and Trust does, as
a matter of fact, have deposits at the Federal Reserve. We keep
about $175,000 on deposit there right at this moment. But many
small banks, in fact, would not be the beneficiaries of paying
interest on those reserves. We do not oppose this legislation,
however.
It has been my honor to testify on behalf of the community
banks of the ICBA and I look forward to answering any questions
you may have.
[The prepared statement of R. Michael Stewart Menzies, Sr.,
can be found on page 84 in the appendix.]
Chairman Bachus. [Presiding.] Thank you, Mr. Menzies. I
will say that Easton is on the eastern shore, and it is a
beautiful city.
Mr. Menzies. Yes, sir. Thank you. We are very proud of
Easton.
Chairman Bachus. Mr. Hammock?
STATEMENT OF REX HAMMOCK, PRESIDENT, HAMMOCK PUBLISHING, INC.,
ON BEHALF OF NATIONAL FEDERATION OF INDEPENDENT BUSINESS
Mr. Hammock. Thank you. While I am not from Pennsylvania, I
am a native of Alabama and went to college in your district, so
I make that connection.
Chairman Bachus. Where did you go to school?
Mr. Hammock. I went to Samford in Birmingham.
Chairman Bachus. My wife taught at Samford.
Mr. Hammock. Well, good. We will compare notes afterwards.
[Laughter.]
I appreciate the chance to just summarize what my testimony
is, and put the actual written testimony in the record. I
appreciate the opportunity of coming this afternoon, and I
thank Congressman Toomey for introducing H.R. 859. As I will
tell you in a few minutes, I had an opportunity to testify
about this, not even knowing it was an issue a couple of
congresses ago. I feel like Chevy Chase on Groundhog's Day--you
know, that sort of re-living some of these things. I have done
this before.
My company was started in 1991 and had five employees, and
I actually went in and opened a business checking account, and
was amazed to learn that I could not earn interest on that
checking account. I fortunately knew my banker, and so in a
good-natured way asked him why the archaic kind of thing was in
place that did not allow me to earn interest on the checking.
He suggested immediately about two or three alternatives that I
could do to get around not earning interest on checking. In his
case, he suggested I set up a money market fund that Mr. Bent
developed, which they call a liquid asset account. So I did.
However, at that time, it was few years before online
banking, I had to call the bank. That was before we had a
bookkeeper. I was doing it myself. The accounting professor at
that university we mentioned would be shocked to know that I
was doing the accounting of our business. However, I did that
for several years and would have to call my banker each night
to transfer funds to make sure that money was not parked in the
checking account, so we could earn interest on the liquid
investment account. I continued to complain about this, and
every once in a while I would wake up in the middle of the
night and realize that I had not transferred monies from one
account to the other account. You can imagine if you had to do
this with your consumer account, which you would kind of think
of in the middle of the night what you have paid and what you
have not paid.
Fortunately, our business has grown and a few years into it
we hit a level, frankly I have forgotten what the level was,
that the bank suggested a sweep account might be a better
alternative. So we have that in place today. However, I do want
to stress that for a small company without a financial staff--
we do have a couple of people in our bookkeeping department
now--but managing a sweep account is not as seamless as it
appears, because I discovered that in the early days, and still
the case, you have to reconcile the account every day, or the
bank reconciles the sweep account every day. You receive in the
mail, just like we receive on a monthly basis at home for your
checking, we get that on a daily basis because of the sweep
account reconciliations. So in a typical year, there would be a
stack about this high of reconciliations that a typical small
or medium-size business with a sweep account gets. A lot of
that is done online now, but still it does add to the confusion
of doing business, the reconciliations.
I will finish by saying that about four years ago, actually
to the day four years ago, five days ago I was able to testify
on this issue for the first time, and frankly, why is a long
story. But I complained about this and somebody heard me
complain and said here is your chance to say something about
it. There was a story about it that appeared in a national
publication and used me as the small business owner poster
child, or whatever, to complain about this. I received hundreds
of calls from around the country, from stockbrokers and
financial planners--everyone telling me how I could solve my
problem of not earning interest on my checking account. I
received one yesterday--not related to that--but I received--
these are small business owners, daily almost, calls or weekly
at least from any number of types of financial services
providers who can tell me how to solve this.
So my complaints have more to do with just common sense,
and just if there is something that small business owners hate
to do is park money and resources in something that they are
not earning money on. If there is a way around it, they are
going to get around it. If there is a legal way, even the bank
is encouraging that they are going to follow that. So I just
think repeal of this prohibition makes sense, and I am happy to
support it on behalf of the National Federation of Independent
Business and its members.
Thank you.
[The prepared statement of Rex Hammock can be found on page
60 in the appendix.]
Chairman Bachus. Thank you.
Our next witness--Mr. Bent, Mr. Toomey, although he is
sponsor of the bill, introduced Mr. Bent and invited him to
come. Although he opposes the legislation, that speaks well of
Mr. Toomey, and our belief that everyone has a right to be
heard.
Mr. Bent. So much for democracy.
Chairman Bachus. Thank you.
[Laughter.]
STATEMENT OF BRUCE R. BENT, SR., CHAIRMAN AND CEO, RESERVE
MANAGEMENT CO.
Mr. Bent. My full statement would be filed for the record.
Number one, I thank you, Chairman Bachus, for allowing me to
come. I would particularly like to thank Mr. Toomey and Mrs.
Kelly for raising the awareness of the Congress to exactly what
is happening out there as far as the disservice to injuries to
businesses as far as lacking interest on their deposits.
Surprised, right?
I take great pride in the fact that I invented the money
fund. It is a $2 trillion industry today, and many, many people
have been helped dramatically by it. My father said to me--I
get a little bit emotional--that if it were not for the money
fund, and not because I was giving him money, because he would
not take it, he would not have been able to survive on his post
office pension, except for the interest he got on the money
fund. Okay. Now, that is very good and I am very proud of it,
and my father is emblematic or symptomatic of a lot of other
people that are out there--tens of millions of people. In fact,
I would bet the vast majority of the people in this room, one
way or the other, have benefited by the money fund and the
competition that it created within the banking system.
But some things happened that were not so good, and I think
in order to survive, and I have survived now for over 30 years
in business, one must be objective. The things that I did not
like were the fact we had the collapse of the S&Ls and a cost
to taxpayers of $200 billion. I attribute that to the creation
of the money funds which precipitated the first crack at
regulation Q, which was the elimination of interest limits on
deposits. Today, we are talking about the second one.
The second thing that I did not like about it is that
balances moved out of communities. They were no longer in
Fishkill or Allison Park or Defiance. They came to New York,
which is great because I live in New York, but I am also an
American. They went to London, which I do not really like. They
went to Tokyo, which I did not like. And they went to Hong
Kong. And they are still there, by and large. I would say that
if I got down and did an equation on it, I would say except
from New York, there is a net loss to every community in the
United States, from balances moving into money funds. I do not
like that.
Now, that provided me with motivation, and my son, who is
with me today, to create a thing called reserve return sweep.
Reserve return sweep provides interest on checking balances for
businesses in the community where the balance arises, so the
balances stay in Allentown or Fishkill or even in Queens, where
I was born, since everybody is looking for a hook here today--
Jamaica Hospital.
[Laughter.]
Mrs. Maloney. In my district.
Mr. Bent. Thank you.
And I think that that is critical. This reserve return
sweep I am very proud of. I am so proud of it and so objective
about it that I feel that the vast majority of balances that
are in money funds will switch over to this new product. It is
safe. It is simple. It is controlled and it is a cost-effective
way of paying interest on checking. There is no limitation on
the size of the people who could benefit from it. Right now, we
have about 40 banks in our process and we have another 40 banks
that are coming on right now. We have banks with as low as or
as little as $300,000 with this process, and we have banks that
have as much as $200 million in the process. So it is broad-
based and it serves the people.
I have been very concerned about this bill because of the
fiat elimination of the second half of regulation Q, i.e.
interest on balances. I am concerned that this again creates
tumult in the marketplace for the cataclysmic introduction of
interest on balances. Whether it is interest on balances or 24
transactions, it is instantaneous. Twenty-four transactions is
a euphemism. That means it is happening today, because the
banks will move the balances into the money market account
where they do not have to pay any reserves on it, and it will
be implemented instantly. So there is no transition period, and
to discuss that it is, is spurious totally. It will not happen.
So 24 transactions do not exist. It is effective
instantaneously.
I am very, very pleased at the effectiveness of this
product. The problems that these gentlemen have had are all
addressed, be it banks or my capitalist next to me--the bank is
a capitalist, too. I think that what it does is avoid the
crisis potential that would have if we simply made a fiat
change in paying interest.
Right now, our economy has lots of problems. We need hugs
and kisses, not shocks, and I think the implementation of this
bill could be a major shock for our economy.
Thank you.
[The prepared statement of Bruce R. Bent, Sr., can be found
on page 56 in the appendix.]
Chairman Bachus. Thank you.
Let me say this, when you mentioned your dad, I think that
is a generational thing, and I am now in your generation when
we talk about our dads, if we have lost them or we are losing
them, it is hard to do so without emotion. That is something
that the younger generation sometimes does not understand, but
I identify too well with it.
Mr. Bent. Thank you.
Chairman Bachus. Mr. Auerbach, we want to welcome you back,
as a staffer.
Mr. Auerbach. Thank you.
Chairman Bachus. You may want to recognize Mr. Auerbach.
Mr. Sanders. We do welcome you back and thank you for being
here. Mr. Auerbach today is a Professor of Public Affairs at
the Lyndon B. Johnson School of Public Affairs at the
University of Texas. We thank you very much for joining us.
STATEMENT OF ROBERT AUERBACH, PROFESSOR, LYNDON B. JOHNSON
SCHOOL OF PUBLIC AFFAIRS, UNIVERSITY OF TEXAS
Mr. Auerbach. Thank you, Mr. Chairman, and the wonderful
members of this Committee who I had the privilege of working
with.
I want to take you back to 1980--I had two different stints
here--when I was working with Henry Reuss and there was chaos
in the banking system, 16.5 percent reserves on deposits. You
had Tom Ridge on the Committee, Henry Hyde, Charles Grassley--
we were all very upset about this huge amount of reserves.
These banks said they would all leave the Federal Reserve. So
we lowered the reserve requirement to 12 percent. The Fed was
screaming as they always do--we will lose control of the money
supply without these required reserves; you cannot do it. Well,
they did not. In fact, as soon as we finally settled at 12
percent, the Fed lowered it further to 10 percent.
Then the Fed initiated something that I am very surprised
did not come up today. We put in the Monetary Control Act
supplemental reserve requirements. The Fed has the power to
raise in time of national emergency, which they declare, they
have the power to raise reserve requirements by four percentage
points and to pay interest on the reserves. That is in the
legislation. Why would not the Fed mention that? If they are
worried about money control, they just put in supplemental
reserves and pay interest on it. How come that has been left
out of this? Curious. We also raised the insurance rates in
order to get the banking groups in town here to support the
bill. They raised it from $40,000 insurance to $100,000--a
tremendous gift to the small banks that they received at that
time.
Now let me just--I am jumping over because if I am talking
against the wonderful bill that some of you have, I have got
two suggestions. Later you can ask me, and I think it will
improve the bill, but I will leave those to the end--something
that Don Kohn, wonderful Governor--we used to work together at
the Fed; he is a personal friend--told me, I think it would
make the bill a bit better.
What happened to the reserves in the system? The reserves
are tremendous in the Federal Reserve system today. There is
are $76 billion worth of reserves sitting there. There is only,
as of February, about $9.6 billion held at the Fed. So I think
it is rather irrelevant. It is a very small distortion for the
system to start paying interest on those reserves. Let me tell
you why. If you start paying interest on reserves, the thing
that is going to happen is there will be more reserves. I
learned this in my studies under Milton Friedman at the
University of Chicago. You subsidize something, you are going
to get more of them.
Now, Don Kohn had in his testimony $28 billion that they
had. I told him, no, if you look on the chart I have here, they
had in the early 1990s $35 billion at the Fed. But a lot of
these banks took the cash, which they can use to meet the
reserve requirements, and they put them in ATMs. Remember, as
Governor Kohn said, if you have less than $41 million, the
small banks, the reserve requirement is only 3 percent. Under
$5 million, it is zero. So small banks are not going to benefit
from interest on reserves. They will be injured.
So how many more reserves will flow in? First of all, what
is the interest that the Fed will pay? Well, I picked the
federal funds rate and I drew a chart of it. For the last 30
years, up until March 2000 when the bubble broke, we started to
crash, the average federal funds rate has been 7.7 percent.
That would kind of be a worst--and remember in 1980 the federal
funds rate was over 20 percent, when Ronald Reagan came into
power. I worked in the Reagan administration for the first
year, in the Treasury. It was a mess.
Chairman Bachus. Wasn't that when Carter was in office?
Mr. Auerbach. Carter was in--it happened right at the
transition. I was with the Committee and then I went over in--
you are right.
[Laughter.]
Chairman Bachus. That was just so big, I just could not--
[Laughter.]
Mr. Auerbach. You are absolutely right. But we had that
problem, you know, with the double-dip recession and we had a
terrific problem.
So I would say, look, let's not--say, 7.7 percent will be--
this is--for 30 years the average federal funds rate was 7.7
percent. Let's not make a worst-case scenario. Let's just say 5
percent. We do not want to take the current distress period. I
do not expect the interest rates to be at 1930 Depression
levels for a while. I would expect if you pay more for
something, you are going to get more. I was telling Don Kohn, I
think it will probably go up to about $20 billion. So at 5
percent, you would be giving an annuity of $1 billion a year to
the banks. That annuity, if you discount it at 6 percent, is
worth--a guaranteed annuity from the government is worth about
$16.7 billion, using a 6 percent rate of discount. This is a
huge payment to the banks, and who would get it? Primarily the
large banks which have a lot of reserves.
Let me just answer one other question. Would it be passed
through, as Don Kohn said? Would it be passed through to the
depositors? The truth is, the banks have a system of parallel
pricing. They have a national prime rate. That is a whole other
story. The Fed's own research in 1980 when we were fighting
about this shows that they have the same prime rate all over
the country and they practice price discrimination. The larger
borrowers can get loans at money market rates. The same thing
would occur. You are not going to pass through all this. The
main benefit--I do not have time to go into the way banks
price--the main benefit would be the stockholders of the big
banks. They get a very respectable increase.
One other last point--Bruce Vento, the late Bruce Vento, in
his last period here, he collected information on the
concentration of banking in the United States. It was sent to
him by the Federal Reserve. I had a chance to look at it.
Although we have got a lot of small banks out there, the
Federal Reserve has let the concentration of banking in the
metropolitan areas heighten. You have got places like New
Orleans where a couple of banks control much of the deposits in
there. You do not have a model of free competition. It does not
exist in the large urban areas. Banks will all charge the same
price. What do they charge now? What do they pay--.02 percent
on an account unless you are one of the lucky people that gets
in on the sweep accounts.
So I have two things that would make the interest paying
thing, but my time is up. If you want to ask me--I am sorry I
talked past my time.
[The prepared statement of Robert Auerbach can be found on
page 51 in the appendix.]
Chairman Bachus. Thank you.
Mr. Gonzalez would have probably calmed you down.
[Laughter.]
Ms. Kelly, I am going to yield my time to you.
Mrs. Kelly. Does that mean that I get no time of my own?
Chairman Bachus. No, you get no time--or I will yield 2.5
minutes to you and 2.5 minutes to Mr. Toomey.
[Laughter.]
Mrs. Kelly. I want to make one remark to you, Mr. Auerbach.
I am not looking and I do not think Mr. Toomey is looking at
this legislation as a tool for social engineering, regarding
your remarks that the large banks get the most on the reserves.
Of course, they do, because they put the most in. So I think my
real question here is to you, Mr. Menzies. I asked the earlier
panel to comment on the proposal to allow the ILCs to offer
business NOW accounts, as they are authorized to, some of them
by their state. Would you be willing to discuss the ICBA's
position on this proposal?
Mr. Menzies. I do not profess to be an expert with respect
to ILCs, but I believe the basic issue is that if it walks,
acts and talked like a duck, it ought to be a duck and not
something else. If they are going to act like a bank and be
like a bank, then they should be operating and regulated like a
bank. Our primary objective is to adhere to the Gramm-Leach-
Bliley spirit of separating banking and commerce, and not
allowing this effort to do an end-run on that objective of
separating banking and commerce. So that is the number one
position, I believe.
The other position that was referenced by the Federal
Reserve and by Chairman Greenspan is that if they are going to
be a bank, then have them subject to the Bank Holding Company
Act and have them subject to the Federal Reserve regulations,
and have them subject to all of the laws associated with
banking and not be an exclusive, limited-purpose, limited-
objective financial institution.
Mrs. Kelly. Mr. Menzies, I wonder if you would be willing
to talk--you say you are not an expert on this--would you be
willing to discuss this in a letter and get a letter back to
us?
Mr. Menzies. Absolutely. It would be our honor. We would be
happy to get together more information on this to you.
[The following information can be found on page 133 in the
appendix.]
Mrs. Kelly. Thank you very much.
I am going to yield back and hope that you will give me my
own time.
Chairman Bachus. I do not think we stopped the clock, so I
do not know how much time you have--I think about a minute
left.
Mr. Toomey. Thank you, Mr. Chairman.
My first question-comment is for Mr. Auerbach. Do you agree
that the use of money has an inherent value, or to put it
differently, that money has a time value?
Mr. Auerbach. The time value of money--do you mean is the
interest rate?
Mr. Toomey. Yes, and that money has an inherent time value,
that it is standard; that an individual or an institution that
has use of money pays for that use of money, and we call that
interest, and that is a norm.
Mr. Auerbach. Right.
Mr. Toomey. I reject the idea that to pay interest on bank
sterile reserves is a subsidy. I do not think when a
corporation borrows money from a bank that it is subsidizing
that bank. I think it is simply paying the going rate for the
use of the bank's money. I think when a consumer borrows money
to finance a mortgage, I do not think the consumer is
subsidizing the bank. I think it is just paying for the use of
the bank's money.
Similarly, I think when banks have reserves with the
government, if the government refuses to pay interest on that,
in fact that is a tax because it is choosing not to pay the
market value for the use of that money. Isn't that a fair way
to characterize it?
Mr. Auerbach. I agree with you 100 percent, but let me just
answer this way. At present, there is hardly any money in those
accounts. It is a very small distortion. But if the interest
rates rise again, as they have throughout the last 30 years,
you are going to be paying huge amounts of money and you will
have money transferring--you are a good free enterprise
Congressman. You know what is going to happen. You are going to
have money transferred into those accounts. What would happen
in 1980 when they were paying 21 percent federal funds?
Mr. Toomey. But of course the rate that they were paying
will be in line with current market conditions. So there will
be other available alternatives that also pay high rates if
interest rates generally go up. If the Federal Reserve is
paying 21 percent, God forbid, at some point in the future,
there will be other interest rates available, other vehicles
available. It would not be that we would have a current
interest rate environment and the Federal Reserve would be the
only one paying.
Mr. Auerbach. But if the government is sending out a $1
billion a year to the banks, that is what I find is a subsidy.
Mrs. Kelly. Will the gentleman yield on that point?
Mr. Toomey. I would just like to go back. I will yield in a
second.
Chairman Bachus. Your time is just about up.
Mr. Toomey. I would just say again, I think you just said
what I thought you agreed was not the case. I just do not think
that it is a subsidy if the government is paying a market rate
for the use of funds that belong to someone else.
Mrs. Kelly. Your point, Mr. Auerbach--
Chairman Bachus. I think we went over. I am not sure where
the clock is--we cannot figure out what happened to the clock,
but I am sure we are over.
Mr. Sanders?
Mr. Sanders. I am not quite sure what Mrs. Kelly meant when
she talked about social engineering, but what I do know is that
if the federal deficit goes higher, there are at least some
people who use that as an excuse to cut back on Medicare,
Medicaid, education, infrastructure improvement, affordable
housing. So I worry about a deficit being very high, because it
means many low income and middle class workers are going to see
cutbacks in programs which are very often of great necessity to
them.
Mr. Auerbach, if I could ask you, what is your guess if the
Fed were paying interest on reserves, what impact would that
have on the federal deficit, say, over a 10-year period?
Mr. Auerbach. On this point, I agree with Governor Kohn
that the surplus is a meaningless change from one bank account
to another. The federal deficit properly estimated would
decline by the amount of money paid to the banks--about $1
billion a year.
Mr. Sanders. The federal deficit would--
Mr. Auerbach. Would get bigger--excuse me.
Mr. Sanders. By about $1 billion a year.
Mr. Auerbach. Right.
Mr. Sanders. So over a 10-year period--
Mr. Auerbach. But that is not a worst-case scenario. If
interest rates went over 5 percent, it could easily get--
Mr. Sanders. I recognize that. No one can predict when
interest rates will go up, but you are guessing that it might
increase the deficit, if you like, by $10 billion over a 10-
year period. Is that what you are saying?
Mr. Auerbach. It has to. Yes.
Mr. Sanders. Again, I do not know what Mrs. Kelly was
referring to in terms of social engineering, but if the deficit
goes up by $10 billion, I suspect there are some people who
would cut back on Medicaid, Medicare, affordable housing. That
concerns me very much.
Mr. Auerbach, and then I will ask the same questions to the
other members. I think you touched on this. Again, in your
judgment, I am hearing that the major beneficiaries of this
would be some of the largest banks in America. I do not think
there is much doubt about that. Yes, they are the ones who have
the money, and they are the ones who would benefit. So we are
talking about--and again, I appreciate no one can make an exact
prediction, it is a guess game--but you are suggesting a $10
billion increase in the deficit over a 10-year period, with the
primary beneficiaries of that being the largest banks in
America. I, for one, have an objection to that, but I would be
happy to ask other distinguished members of the Committee if
they would--is anybody up here? Any good conservatives worried
about increasing the deficit, or am I the only conservative who
holds that? Mr. Menzies?
Mr. Menzies. I am very worried about increasing the
deficit. In that regard, I believe that with all due respect to
the professor's position, it presumes that banks are not
reinvesting those reserves in their depositors, in their
borrowers, in those receiving dividends from the banks.
Mr. Sanders. But what does that have to do with it? I
understand that, but what does that have to do with the
deficit?
Mr. Menzies. I believe in our system, the more we increase
our economy by increasing money flowing through our economy,
the prosperity of our system.
Mr. Sanders. Trickle down.
Mr. Menzies. Unless you presume that all of the money goes
into the salaries of executives, in 401(k) plans where the tax
is deferred.
Mr. Sanders. I do appreciate that, but you are not denying
that the immediate effect--what you are saying is it
stimulates--
Mr. Menzies. But I believe that the professor said that the
economic impact was exactly the interest that was paid by the
Federal Reserve to the banks. I am not an economist by trade,
but I question that business model.
Mr. Sanders. That is kind of like when we give hundreds of
billions of dollars in tax breaks to the richest 1 percent in
the long run really is going to help us all.
Anybody else want to comment on that? Mr. Maus?
Mr. Maus. I do not know that it is a fair assumption to say
that whatever amount would be paid out by the Federal Reserve
to banks on sterile reserves would equate to a specific number,
because in doing so there is an assumption being made that the
amounts that the Federal Reserve are turning back into the
treasury, they would do nothing else to increase that amount.
So it is not just that we are going to pay out all of this
money and they are not going to do anything else in their
structure to either increase income, decrease expenses or
whatever, to offset some of the money that they would be paying
out on the sterile reserves.
Mr. Sanders. Thank you.
That is about it for me. Thank you, Mr. Chairman.
Chairman Bachus. Ms. Kelly?
Mrs. Kelly. I simply want to go back to what Mr. Auerbach
said. You know, you talked about the money being reduced that
is in the reserve accounts. I think it is fair to say that one
of the reasons that money has been reduced is the banks can
make more money by putting it in the ATMs. So if there is
interest paid on the reserves, some of those reserves, yes,
there might accrue a larger amount in there, which would not
necessarily be a bad thing, given the volatility of the
economy. Isn't that correct?
Mr. Auerbach. You are absolutely right. What would happen
with the payment of reserves is that many, many banks would
give less services through ATMs and put them in the Fed.
Mrs. Kelly. You cannot assume that they would give less
services. It just means that they may perhaps pack less money
into those ATMs, but that does not necessarily mean they are
going to reduce their services in order to get some sort of
interest on their sterile reserves.
Mr. Auerbach. Instead of having $30,000 in, they might put
$20,000 and they would run out maybe on the weekends, because
there would be a--
Mrs. Kelly. You cannot project that. I am sorry, sir, I do
not agree with that. I think they are smarter than that. I
think they can figure out their weekends.
Mr. Auerbach. If you are paying for them to take money and
invest it with the Federal Reserve, then they will have less
money in their vault cash in the ATMs.
Mrs. Kelly. Perhaps, but they may find other ways to work
with their money. That is what banks do. I think that we have
had for a very long period of time much discussion, as we have
heard today, over perhaps 20 years about the possibility of
allowing those banks to earn something on the sterile reserves.
It is not bad monetary policy. Maybe I have just a greater
trust in the bankers than you do.
I yield back.
Chairman Bachus. Thank you.
Let me ask one question. Mr. Menzies, your organization is
neutral on paying interest on business checking accounts?
Mr. Menzies. The position of the organization is that we
recommend the 24 transaction a month in a money market account
as an alternative to interest on checking. That is the position
of the divided interest. That is a preferential solution to,
frankly, the archaic law that you all are dealing with.
Chairman Bachus. Let me point out something in Mr. Maus's
testimony. This is actually for Mr. Menzies, but it is your
testimony, which I agree with. Mr. Maus points out that
repealing the current prohibition would not force banks to pay
interest on business checking accounts. It just gives them the
right to do that.
Mr. Menzies. I totally agree with that, and there is a lot
of logic to that statement. The counter issue, as opposed to
argument, is that the money market account traditionally is a
much more stable account. By definition, it is a savings or it
is an investment account. It is an account in which monies
reside for hopefully a longer period of time than a, quote,
``demand deposit account'', which is subject to demand.
The question was asked a while ago about 1983, why it is
that we were not paying interest on commercial accounts. I
recall talking to the regulators about that question and was
told, well, it is because if commercial accounts received
interest, they may chase the highest rates and it would
volatize possibly the core deposit base of the banking industry
and cause corporations to move their money quickly to the next
highest rate, and those deposits are used to make loans, and we
do not wish to volatize the liability side of the bank, which
generates loans to small businesses, so let's not pay them
interest. That, as I recall, was an excuse or was an argument.
Thanks to Mr. Bent, we have entered into the next century
with respect to paying interest on liquid funds. The argument
to consider the 24 transaction sweep is that it may not be
quite as volatile as the demand deposit account, which is a
checkable account. True, you can write 24 checks, I guess,
under the current legislation or do 24 transfers, so there
clearly is a level of volatility. But you are not depositing 80
or 90 checks per day in that money market account if it is a
sweep account. You are putting those in your checking account.
There may be merit with respect to the safety and soundness
question of whether the money market account is a more stable
solution than interest on demand deposits. I do not truly know
the economic answer to that question.
Chairman Bachus. What this legislation does, Mr. Toomey's
legislation, is just give the banks a choice to be able to
offer those services to their customers if they so choose. It
is just another choice.
Mr. Menzies. And banks should be grown up enough to price
their products relative to the risk and relative to the cost of
those transactions. It is a true statement.
Chairman Bachus. I think in our free market society, you
would agree that that is just one more choice for the consumer?
Mr. Menzies. Absolutely.
Chairman Bachus. Mr. Bent?
Mr. Bent. In 1980, we gave savings and loan associations
the opportunity to pay more than 5.25 percent. They leaped at
it because it was not an option, it was a requirement because
it was in a competitive marketplace. Both the representative of
the Federal Reserve and the Treasury both talk about
competition going in this. Believe me, I am in favor of
competition, but I am not in favor of disrupting our banking
system, particularly in this economy.
As far as the money market account being more stable, when
you have 24 transactions in a money market--maybe I should not
tell the banks how to figure out, but I will figure it out for
them--all the checks go in and out of the DDA account; the
excess cash swings over to the money market account; it stays
there. At the end of the day, the bank computer, because this
is not people-intensive, tells the MMDA account, the money
market account, how much money it has to send over to the DDA
account, the checking account, to pay the checks. So it is
instantly full of liquid funds. It is an active account. It is
not a savings account. It is not doing what was contemplated
when the MMDA account was originally created back in 1982. It
is definitely not.
Chairman Bachus. Of course, the savings and loans, that is
an issue we have discussed ever since I have been here in 1992.
The main factor was they were borrowing short and lending long,
and got caught in the squeeze.
Mr. Bent. But why? To compete. If they could not pay more
than 5.25 percent, they would have not gone through that
exercise.
Chairman Bachus. That is right, but what I am saying is
banks are in a different situation. I do not see how this being
able to offer interest rates, low interest rates--
Mr. Bent. It is low interest rates today, but if we go back
to the Carter Administration--
Chairman Bachus. In this case, you are lending on a short-
term basis.
Mr. Bent. I am sorry?
Chairman Bachus. You are just paying interest on a short-
term basis.
Mr. Bent. But in order to be able to pay interest on
deposits, you have to invest it someplace.
Chairman Bachus. But you would not have it in 30-year
mortgages.
Mr. Bent. If you go back to in the 1980s, the S&Ls could
have put their money out in the marketplace, theoretically.
They could have gone into 30-year treasuries and gotten 17
percent. They could have gotten T-bills, which were even more
than that. But they did not. They went out and bought long-term
mortgages and that is where their exposure was. Fear and greed,
fear and greed--they got the greed.
Chairman Bachus. This concludes our hearing. No, I am
sorry. We have two unanimous consent requests.
Mrs. Maloney. I have one. I ask unanimous consent that a
brief statement from the Commissioner of Utah's Department of
Financial Institutions regarding the subject matter of today's
hearing be made part of the hearing record. I hope that you
will accept that unanimous consent request.
Chairman Bachus. It is from the ILC?
Mrs. Maloney. It is from the Commissioner of Utah's
Department of Financial Institutions.
Chairman Bachus. On the industrial loan company?
Mrs. Maloney. He did not say what he wanted to talk about.
Chairman Bachus. Yes.
[The following information can be found on page 128 in the
appendix.]
Mrs. Maloney. Anyway, my first question is to the NFIB.
Chairman Bachus. I am sorry. You had not been recognized?
Mrs. Maloney. No.
Chairman Bachus. I apologize. This does not conclude.
[Laughter.]
Mrs. Maloney. One of the often-cited reasons for allowing
the payment of interest on sterile reserves is that small
businesses do not have access to these sweep accounts. How
often do you hear this complaint? Is that a major concern of
small businesses?
Mr. Menzies. I know in my case, and I can only speak from
my case, that I did not have access to a sweep account until we
got to a certain size. It is off the radar screen of, frankly,
most small business owners. But there are work-arounds that
almost any small business owner will do, that are quite legal.
They are usually suggested by the bank.
Mrs. Maloney. Really. Well, the Fed has argued that it
needs additional flexibility in their reserve requirements for
the sake of setting monetary policy. I would like to ask any of
the members of the panel to comment if they would like,
generally, on the Fed's reasoning that the payment of interest
on sterile reserves and the elimination of the floor on reserve
requirements will enhance its ability to target monetary
policy. If anyone would like to comment on that--anyone?
Mr. Auerbach. That is an argument they have used for many
years whenever we have lowered reserve requirements. I do not
think it has any substance. If they are worried about control
of the federal funds rate or the money supply, they have
supplemental reserve requirements that pay interest on the
reserves that they could put in at any time. We wrote that into
the Monetary Control Act. I do not know, has someone taken that
out of the bill? It is already there. I think at present, and I
talked to Governor Kohn about this, they have had no trouble
controlling the federal funds rate. It is not an issue at
present. He was talking about, if something happened, maybe
they would have trouble in the future.
Mrs. Maloney. Anyone else like to comment on it?
Mr. Bent. I would like to go back to the question that you
addressed to Mr. Hammock, as far as the availability of sweeps
to small businesses. I would be very pleased to set up a sweep
arrangement for Hammock Publishing, and every member of the
NFIB, which I think is something like 600,000, so that they
simply had one account on the bank and everything happened
automatically through reserve return sweep, and you would get
interest on your balances.
Mr. Hammock. I would like to have that option, or the
option to just not to park my money in a checking account. That
would be great. If you had a product that could compete and I
would like, that is great. That is all I think that small
business owners want, is just something that is logical and
that anyone can compete for.
Mrs. Maloney. Thank you.
Thank you, Mr. Chairman.
Chairman Bachus. Ms. Kelly?
Mrs. Kelly. Thank you, Mr. Chairman.
I have a unanimous consent request. When Mr. Greenspan
testified before our Committee a few weeks ago, he testified
about the NOW accounts. I have here a letter actually sent on
April 2, 2001, that reiterates that kind of testimony, that I
would like to put in the record.
Chairman Bachus. Without objection.
[The following information can be found on page 89 in the
appendix.]
Mrs. Kelly. Thank you.
Chairman Bachus. Are there any more requests for time or
for consent requests? If not, the hearing is concluded.
[Whereupon, at 4:14 p.m., the subcommittee was adjourned.]
A P P E N D I X
March 5, 2003
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