[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]



 
                         A REVIEW OF REGULATORY
                       PROPOSALS ON BASEL CAPITAL
                       AND COMMERCIAL REAL ESTATE

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
               FINANCIAL INSTITUTIONS AND CONSUMER CREDIT

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                               ----------                              

                           SEPTEMBER 14, 2006

                               ----------                              

       Printed for the use of the Committee on Financial Services

                           Serial No. 109-120

               A REVIEW OF REGULATORY PROPOSALS ON BASEL

                   CAPITAL AND COMMERCIAL REAL ESTATE
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                         A REVIEW OF REGULATORY
                       PROPOSALS ON BASEL CAPITAL
                       AND COMMERCIAL REAL ESTATE

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
               FINANCIAL INSTITUTIONS AND CONSUMER CREDIT

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                               __________

                           SEPTEMBER 14, 2006

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 109-120

                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 BARNEY FRANK, Massachusetts
RICHARD H. BAKER, Louisiana          PAUL E. KANJORSKI, Pennsylvania
DEBORAH PRYCE, Ohio                  MAXINE WATERS, California
SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
EDWARD R. ROYCE, California          NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma             MELVIN L. WATT, North Carolina
ROBERT W. NEY, Ohio                  GARY L. ACKERMAN, New York
SUE W. KELLY, New York, Vice Chair   DARLENE HOOLEY, Oregon
RON PAUL, Texas                      JULIA CARSON, Indiana
PAUL E. GILLMOR, Ohio                BRAD SHERMAN, California
JIM RYUN, Kansas                     GREGORY W. MEEKS, New York
STEVEN C. LaTOURETTE, Ohio           BARBARA LEE, California
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, Jr., North          MICHAEL E. CAPUANO, Massachusetts
    Carolina                         HAROLD E. FORD, Jr., Tennessee
JUDY BIGGERT, Illinois               RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       JOSEPH CROWLEY, New York
VITO FOSSELLA, New York              WM. LACY CLAY, Missouri
GARY G. MILLER, California           STEVE ISRAEL, New York
PATRICK J. TIBERI, Ohio              CAROLYN McCARTHY, New York
MARK R. KENNEDY, Minnesota           JOE BACA, California
TOM FEENEY, Florida                  JIM MATHESON, Utah
JEB HENSARLING, Texas                STEPHEN F. LYNCH, Massachusetts
SCOTT GARRETT, New Jersey            BRAD MILLER, North Carolina
GINNY BROWN-WAITE, Florida           DAVID SCOTT, Georgia
J. GRESHAM BARRETT, South Carolina   ARTUR DAVIS, Alabama
KATHERINE HARRIS, Florida            AL GREEN, Texas
RICK RENZI, Arizona                  EMANUEL CLEAVER, Missouri
JIM GERLACH, Pennsylvania            MELISSA L. BEAN, Illinois
STEVAN PEARCE, New Mexico            DEBBIE WASSERMAN SCHULTZ, Florida
RANDY NEUGEBAUER, Texas              GWEN MOORE, Wisconsin,
TOM PRICE, Georgia                    
MICHAEL G. FITZPATRICK,              BERNARD SANDERS, Vermont
    Pennsylvania
GEOFF DAVIS, Kentucky
PATRICK T. McHENRY, North Carolina
CAMPBELL, JOHN, California

                 Robert U. Foster, III, Staff Director
       Subcommittee on Financial Institutions and Consumer Credit

                   SPENCER BACHUS, Alabama, Chairman

WALTER B. JONES, Jr., North          BERNARD SANDERS, Vermont
    Carolina, Vice Chairman          CAROLYN B. MALONEY, New York
RICHARD H. BAKER, Louisiana          MELVIN L. WATT, North Carolina
MICHAEL N. CASTLE, Delaware          GARY L. ACKERMAN, New York
EDWARD R. ROYCE, California          BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma             GREGORY W. MEEKS, New York
SUE W. KELLY, New York               LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas                      DENNIS MOORE, Kansas
PAUL E. GILLMOR, Ohio                PAUL E. KANJORSKI, Pennsylvania
JIM RYUN, Kansas                     MAXINE WATERS, California
STEVEN C. LaTOURETTE, Ohio           DARLENE HOOLEY, Oregon
JUDY BIGGERT, Illinois               JULIA CARSON, Indiana
VITO FOSSELLA, New York              HAROLD E. FORD, Jr., Tennessee
GARY G. MILLER, California           RUBEN HINOJOSA, Texas
PATRICK J. TIBERI, Ohio              JOSEPH CROWLEY, New York
TOM FEENEY, Florida                  STEVE ISRAEL, New York
JEB HENSARLING, Texas                CAROLYN McCARTHY, New York
SCOTT GARRETT, New Jersey            JOE BACA, California
GINNY BROWN-WAITE, Florida           AL GREEN, Texas
J. GRESHAM BARRETT, South Carolina   GWEN MOORE, Wisconsin
RICK RENZI, Arizona                  WM. LACY CLAY, Missouri
STEVAN PEARCE, New Mexico            JIM MATHESON, Utah
RANDY NEUGEBAUER, Texas              BARNEY FRANK, Massachusetts
TOM PRICE, Georgia
PATRICK T. McHENRY, North Carolina
MICHAEL G. OXLEY, Ohio


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    September 14, 2006...........................................     1
Appendix:
    September 14, 2006...........................................    57

                               WITNESSES
                      Thursday, September 14, 2006

Antonakes, Steven L., Massachusetts Commissioner of Banks, on 
  behalf of the Conference of State Bank Supervisors.............    18
Bair, Hon. Sheila C., Chairman, Federal Deposit Insurance 
  Corporation....................................................    11
Bies, Hon. Susan Schmidt, member, Board of Governors of the 
  Federal Reserve System.........................................     9
Colby, Robert L.D., Acting Director, Division of Market 
  Regulation, U.S. Securities and Exchange Commission............    16
Dugan, Hon. John C., Comptroller of the Currency.................    13
Garnett, James M., Jr., Head of Risk Architecture for Citigroup, 
  on behalf of the Financial Services Roundtable.................    36
Lackritz, Marc E., President, Securities Industry Association 
  (SIA)..........................................................    38
McKillop, James H. III, President and CEO, Independent Bankers' 
  Bank of Florida, Lake Mary, Florida, on behalf of Independent 
  Community Bankers of America (ICBA), Washington, D.C...........    37
Meyer, F. Weller, Chairman, President, and CEO, Acadia Federal 
  Savings Bank, Falls Church, Virginia, and Chairman, Board of 
  Directors, America's Community Bankers, Washington, D.C., on 
  behalf of America's Community Bankers..........................    35
Mueller, Glenn R., Ph.D., Professor, University of Denver, 
  Franklin L. Burns School of Real Estate & Construction 
  Management and Real Estate Investment Strategist-Dividend 
  Capital Group, Inc.............................................    42
Petrou, Karen Shaw, co-founder and Managing Partner, Federal 
  Financial Analytics, Inc.......................................    39
Reich, Hon. John M., Director, Office of Thrift Supervision......    15
Simmons, Harris H., Chairman, President, and CEO, Zions 
  Bancorporation, on behalf of American Bankers Association, Salt 
  Lake City, Utah................................................    33
White, Robert M., Jr., President and founder, Real Capital 
  Analytics, Inc., New York, NY..................................    41

                                APPENDIX

Prepared statements:
    Bachus, Hon. Spencer.........................................    58
    Waters, Hon. Maxine..........................................    62
    Antonakes, Steven L..........................................    68
    Bair, Hon. Sheila C..........................................    78
    Bies, Hon. Susan Schmidt.....................................    96
    Colby, Robert L.D............................................   113
    Dugan, Hon. John C...........................................   117
    Garnett, James M. Jr.........................................   138
    Lackritz, Marc E.............................................   155
    McKillop, James H............................................   162
    Meyer, F. Weller.............................................   185
    Mueller, Glenn R.............................................   214
    Petrou, Karen Shaw...........................................   239
    Reich, Hon. John M...........................................   244
    Simmons, Harris H............................................   253
    White, Robert M., Jr.........................................   281

              Additional Material Submitted for the Record

Bachus, Hon. Spencer:
    Responses to Questions Submitted to Hon. Sheila C. Bair......   293
    Responses to Questions Submitted to Hon. Susan Schmidt Bies..   299
    Responses to Questions Submitted to Hon. John C. Dugan.......   306
    Statement of Institutional Risk Analytics....................   377
    Letter from The Real Estate Roundtable.......................   427
    Statement of the Risk Management Association.................   430
Fossella, Hon. Vito:
    Responses to Questions Submitted to Hon. Susan Schmidt Bies..   319
Frank, Hon. Barney:
    Letter from the Office of the Comptroller of the Currency....   443
Statement of the National Association of Realtors................   452


                        A REVIEW OF REGULATORY
                       PROPOSALS ON BASEL CAPITAL
                       AND COMMERCIAL REAL ESTATE

                              ----------                              


                      Thursday, September 14, 2006

             U.S. House of Representatives,
             Subcommittee on Financial Institutions
                               and Consumer Credit,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 11:03 a.m., in 
room 2128, Rayburn House Office Building, Hon. Spencer Bachus 
[chairman of the subcommittee] presiding.
    Present: Representatives Bachus, Royce, Kelly, Feeney, 
Hensarling, Garrett, Price, McHenry; Sanders, Maloney, Sherman, 
Moore of Kansas, Frank, Carson, and Crowley.
    Chairman Bachus. Good morning.
    The Subcommittee on Financial Institutions and Consumer 
Credit holds its sixth hearing today on Basel reform since the 
106th Congress.
    Today's hearing will focus on the current status, recent 
developments, and potential impact of proposals from the 
financial regulators on Basel capital reform and commercial 
real estate lending guidance.
    All of the regulators have worked hard to develop the 
proposals we will be discussing.
    Governor Susan Bies deserves special appreciation for her 
dedication and leadership on the Basel accord.
    Governor Bies has created an open dialogue with Members of 
Congress and the financial services industry. She understands 
the concerns that members of this committee have raised with 
past proposals, and has worked diligently to address those 
issues.
    To the other agencies and regulators, let me say this, I 
very much applaud your efforts. I think you've been very 
responsive to the industry.
    There's not a consensus among the regulators. There are 
still some important differences. But we're so far away from 
where we were last year, and we're very, very close, and I 
applaud all of you.
    I was pleased this month when the regulators met and 
approved the notice of proposed rulemaking on Basel II that 
requested comment on whether the so-called core banks and opt-
in banks should be able to use the standardized approach.
    Alternative compliance options are a feature of the 
original accord, and banks outside the United States are 
provided this option.
    I've lost a page of my opening statement. Actually, this 
isn't the one I wrote. This was an early one. We'll try to find 
it.
    Well, I tell you what I'm going to do. I'm going to let Mr. 
Sanders give his opening statement, and I'm going to come back.
    Mr. Sanders.
    Mr. Sanders. I haven't lost my paper. I still have it.
    Mr. Chairman, thank you for holding this important hearing, 
and I look forward to hearing from our witnesses.
    In the interest of time, I'll make my remarks very brief, 
and then hand the ranking member responsibilities over to Ms. 
Maloney, who has worked on this issue for a number of years.
    This hearing will review both the recent Basel II and 
commercial real estate proposals put forward by the ranking 
regulators.
    This subcommittee has held several hearings on the Basel 
capital accords, and I would like to applaud the chairman, 
Ranking Member Frank, Ms. Maloney, and others for their 
leadership on this issue.
    The Basel accords determine the process by which banks 
determine the capital they must hold in reserve to meet 
regulatory requirements.
    The Basel II accords apply to the 10 largest banks, while 
the Basel I accords apply to the smaller banks.
    In my opinion, it is extremely important that big banks are 
not given an unfair advantage over smaller banks in this 
process, and I'm not convinced that has happened to date.
    Mr. Chairman, I'd like to ask for unanimous consent to 
insert into the record a statement by the National Association 
of Realtors.
    Chairman Bachus. Without objection.
    Mr. Sanders. Mr. Chairman, I share the concerns of the 
National Association of Realtors that both the proposed 
regulations and the proposed guidance on commercial real estate 
lending underestimate the strength and stability of the 
commercial real estate market and do not sufficiently recognize 
the diverse performance traits of the different classes of 
commercial real estate.
    The combined effect of these two regulatory proposals may 
prompt banks either to avoid making loans for sound real estate 
ventures or to increase the cost of capital required for 
commercial real estate.
    I am also concerned that if the regulatory parameters are 
not appropriately set, the flow of capital to commercial real 
estate would be diminished, leading to a weakening of the 
commercial real estate market. Mr. Chairman, we must not allow 
that to happen.
    We must ensure that the final guidelines on commercial real 
estate, risk management guidelines, preserve and strengthen the 
safety and soundness of the banking system while not unduly 
harming the flow of capital to commercial real estate.
    Again, I thank the Chair for holding this hearing and I 
look forward to hearing from our witnesses.
    Mr. Chairman, is it appropriate to give the microphone over 
to Ms. Maloney for a few words at this point? Can I yield to 
Ms. Maloney to complete my statement?
    Chairman Bachus. Actually, I'm going to recognize--oh, for 
part of your time?
    Mr. Sanders. Yes.
    Chairman Bachus. Okay.
    Mrs. Maloney. Thank you, Mr. Chairman, Ranking Member 
Sanders, and Ranking Member Frank.
    I first would like to welcome all of the witnesses, 
particularly one who is a constituent from my district, Mr. 
James Garnett of Citibank, who is testifying today on behalf of 
the Financial Services Roundtable.
    As a representative from New York, the financial capital of 
the Nation, I have been deeply interested in the development of 
the Basel II capital accord since its inception.
    The concept of adjusting capital requirements to reflect 
risk more accurately than the present regulatory system does is 
a tremendous opportunity for the American financial services 
industry and for the U.S. financial regulatory regime, but also 
it is a great risk.
    The process of financial services regulation in this 
country is more complex and involves many more players than in 
most nations, with different agendas and powers, and our 
regulatory system is by far the most robust in the world.
    We have a more diverse and multi-faceted industry in many 
nations with different needs and concerns.
    As I have said at many stages of this process, if we are 
not careful, these factors can drive us to a new regulatory 
scheme that disadvantages our financial services industry 
rather than making it more competitive, while not improving 
safety and soundness.
    We can end up with a situation in which the new capital 
requirements provide incentives to increase, rather than 
reduce, risk, and thus threaten the safety and soundness of the 
system.
    Congress is certainly not well-equipped to legislate a 
regulatory scheme of this complexity, but it is our job to 
guide regulators toward policy goals.
    Our goals are the same as those of the Basel Committee, to 
continue to promote safety and soundness while enhancing 
competitive equity and instituting a more comprehensive 
approach to evaluating and addressing risk.
    I have to say that I am not confident that the present 
proposal is well designed to achieve that end.
    As I am sure we will hear from the industry witnesses, 
financial institutions, even the biggest ones who are up now, 
have been presumed to be the biggest beneficiaries of the new 
rules. Many are very apprehensive that the new rule will leave 
them at a significant disadvantage as compared to foreign 
financial institutions.
    The regulators have taken the position that the revised 
formulas are necessary to maintain overall capital in the 
system and respond to the concerns raised by the results of the 
last quantitative impact study, the QIS.
    I am sure that the regulators also want a competitive U.S. 
industry, but they do not appear to have the confidence of 
their industry, and they have put our banks in as good a 
position as those of other nations.
    One point that I hope the witnesses address is the apparent 
gap, the gap between the practices mandated by the proposed 
U.S. rules to measure risk and those used by the financial 
institutions at present.
    Large banks already have very complicated and sophisticated 
internal risk models and risk management systems, all subject 
to oversight.
    According to some of the financial institutions I've talked 
to, the proposed U.S. rules mandate systems that are so 
different that banks will have to keep literally two sets of 
books, one to measure what the regulators want to know about 
risk, and one to measure what the banks think they know to do 
the job.
    As a policymaker, this is deeply disturbing, since it 
suggests that either the markets or the regulators are missing 
the boat and measuring irrelevant variables.
    I also hope the witnesses will address the cost of 
compliance and the return in terms of better risk management. 
We cannot institute a system that is not cost effective because 
it will unnecessarily hamper our financial institutions and 
make them uncompetitive in the global market.
    Chairman Bachus. Ms. Maloney.
    Mrs. Maloney. I have a lot more to say, but I'll put it in 
the record.
    Chairman Bachus. Thank you.
    Mr. Frank.
    Mr. Frank. Thank you, Mr. Chairman.
    I appreciate our having the chance to talk about both of 
these events.
    Let me start on the question of Basel, and I appreciate 
Governor Bies's diligence in working with us.
    You know, there is a view that says that when Congress 
intervenes in something, particularly if it is complicated and 
technical, we either muck it up or corrupt it, that we are 
either looking to benefit some undeserving group or we will get 
in over our heads; and that is not always untrue, but neither 
is it true as often as people say, and I really want to hold up 
the Basel issue as an example of an extremely constructive 
Congressional intervention.
    I believe that the result of the process we've had, it's 
been conversations back and forth. I think we have a better 
proposal. We are still working on it.
    I think, frankly, we were the catalyst for there being 
better cooperation among the regulators. I think we had a 
situation when we first got into this where the relationships 
among the regulators were dysfunctional and I think our impact 
has been helpful.
    And so I want to say that I think this is a case, on a 
bipartisan basis, where we have played a constructive role. Of 
course, since it has been both bipartisan and constructive, it 
is rarely chronicled, and so that is why I thought it was worth 
underlining.
    I will say to the regulators, particularly to the Federal 
Reserve, which has had a major initiative, I am skeptical of 
the resistance to the notion about the standardized approaches.
    You know, sometimes, when all the people in industry get 
together, you get nervous. As Adam Smith said, when all the 
people in the same trade get together, you have reason to 
worry.
    In this case, I think the consensus that has emerged among 
the banks is a constructive and helpful thing. This is not a 
case of the banks versus the public interest. It's not a case 
of the banks versus the consumers or the banks versus the 
securities.
    In this situation, I don't think we have the concern that 
this is a group of people who have a common economic interest 
in contradistinction to others in the society, and in fact, as 
we all know, many of the problems we had were the differential 
impact that capital standards could have within the banking 
industry.
    I am impressed by this consensus. I congratulate the people 
in the banking industry for a very responsible effort to come 
together on this, and I would say to the regulators, this is a 
case where, in my mind, the burden of proof is on those who 
would say, ``No, that's not going to work given the commonality 
of interest.''
    The next area is the real estate guidance.
    First of all, I have to say I don't mean to impugn motives. 
We're not talking about personal stuff here. But I think it 
would be disingenuous for the regulators to say, ``Oh, this 
doesn't have any real impact, this is just kind of generalized 
guidance.''
    In the first place, when someone says to me, ``Oh, listen, 
you know, I just want to point out to you that being extremely 
badly dressed is a great defect in your business, and having 
clothes that are ragged and dirty and mismatched, you know, 
that is something that you certainly don't want to fall into, 
oh, and by the way, nothing in what I said suggests that you're 
at all guilty of this or that you have to change your 
pattern''--no one would believe anybody who said that.
    I mean, there are a lot of things in the world to say, and 
the very fact of singling something out to say it has a great 
impact, particularly, frankly, when you are you, the 
regulators. You are enormously powerful people with great 
impact.
    And so I think we have to begin by saying the fact that you 
have singled out this kind of real estate lending for guidance, 
I mean, whenever someone says to me, ``Oh, by the way, I want 
to tell you not to be stupid and not to be dangerous, but 
please don't be offended,'' I'm offended, because the fact that 
you felt the need to tell me not to be stupid doesn't make me 
think you think I'm all that bright. So let's be clear about 
that.
    I am therefore worried, because, yes, I understand that 
there is an increase in the lending, but by your own figures, 
there is no increase in risky lending. There does not appear to 
be a problem.
    And there is a negative side to this. Clearly, if I am a 
bank, I would rather not have you give me explicit guidance on 
something. That is not a good sign.
    I have to say this to cover up my own staff. If I get a 
letter from somebody saying, ``By the way, Congressman, I just 
would like to point out to you that it would not be a good idea 
for your staff to be rude or forgetful or make any enemies; by 
the way, nothing in this suggests''--I would call in the staff 
and say, ``What is this? What happened? Who did what to whom?'' 
I mean, anybody would do that.
    So I am afraid you will discourage some of this, and there 
are two areas.
    One, we work a lot with mayors and municipal officials. 
Downtown lending is very important for them, the commercial 
development, but even more for me, the fact that multi-family 
housing is included in here.
    We have a terrible social crisis in America with housing 
that is far too expensive for a lot of working people. We have 
municipalities where police officers and firefighters and 
teachers and sanitation workers can't live in the city where 
they work.
    I would hope that you would be extremely loathe to do 
anything that might diminish the construction of multi-family 
housing. We have too little of it in this country. We have 
local prejudices expressed through zoning that are problems, 
etc.
    And I believe that you, by your guidance, you have really 
discouraged to some extent that kind of lending, and unless 
you've got a pretty good reason, the fact that there is more 
lending absent anything shouldn't be the reason, and at the 
very least--and I appreciate the time, Mr. Chairman, I'll close 
with this--you've already done that, you say to us, ``Well, 
this doesn't mean they should cut back.'' Then I would hope 
that would be part of the official statement.
    Everybody has gotten that guidance. You ought to write to 
them and say, ``By the way, nothing in here suggests that you 
have done anything wrong, that you have been in any way 
imprudent, or that you should in any way be cutting back on 
this area.''
    That would at the very least reassure me. A failure to do 
that would reinforce my nervousness.
    Thank you for the indulgence, Mr. Chairman.
    Chairman Bachus. Thank you, Mr. Frank.
    Now I'm going to give the remainder of my opening 
statement.
    I want to apologize to the staff first for doing the 
impossible, and that's that I wrote out my speech, my second 
draft, in longhand, and I neglected to give it to them.
    [Laughter]
    Chairman Bachus. So it was pretty impossible for them to 
include the additions.
    The goal of Basel is to develop a more flexible and 
forward-looking capital adequacy framework that better reflects 
the risks facing banks and encourages them to make ongoing 
improvements to their risk assessment capabilities.
    Over the past 7 years, the United States Federal banking 
regulators have been engaged in negotiations with their foreign 
counterparts about improving the standards that govern the 
capital that depository institutions must hold against their 
assets.
    We must ensure throughout this process that we do not 
include a framework that is too complex or too costly to be 
followed.
    There is a wide variety of views expressed in the testimony 
that we will receive today.
    On one hand, the Federal banking regulators are testifying 
that they have developed a Basel II rule that is intended to 
produce risk-based capital requirements that are more risk-
sensitive than the existing rules.
    On the other hand, industry witnesses will testify that the 
current U.S. version of the Basel II rule is less risk-
sensitive than the internationally negotiated Basel II accord 
and that the differences between the U.S. rule and the accord 
creates serious competitive issues, both within and outside the 
United States.
    This suggests to me that more work needs to be done on the 
rule.
    I was pleased this month that the regulators met and 
approved the notice of proposed rulemaking on Basel II that 
requested comment on whether the so-called core banks and opt-
in banks should be able to use the standardized approach.
    Alternative compliance options are a feature of the 
original accord and banks outside the United States are 
provided this option.
    In addition to the issues arising from Basel II, our 
hearing today addresses a January 2006 interagency guidance on 
concentrations in commercial real estate proposal by the bank 
regulators. The proposal seeks to address high and increasing 
concentrations of commercial real estate loans at some banks 
and savings associations.
    The agency suggests recent examinations show that risk 
management practices and capital levels of some institutions 
are not keeping pace with their increasing CRE loan 
concentrations.
    In return, the guidance sets forth thresholds for assessing 
whether an institution has a CRE concentration that should 
employ heightened risk management practices. The guidance urges 
those institutions with elevated concentration risk to 
establish risk management practices and capital levels 
commensurate with the risk.
    Some institutions have expressed the concern, however, that 
the proposed guidance is too much of a ``one size fits all'' 
formulation, and is effectively a cap on commercial real estate 
lending. They instead urge that the regulators utilize the 
examination process that identifies lending weaknesses in 
particular institutions.
    They contend that the data does not support the proposition 
that real estate lending, per se, is more risky than commercial 
and industrial lending, for example.
    Further, there is concern that the proposed guidance is 
unfairly burdensome for community banks that do not have 
opportunities to raise capital or diversify their portfolios 
like larger banks.
    It is my hope that, by the end of this hearing, we may all 
be working for the same set of underlying facts with respect to 
how the real estate works. In turn, I would hope that this will 
help ensure better regulation that will protect the taxpayer 
while not arbitrarily discouraging sound lending.
    In closing, I want to thank Chairman Oxley, Ranking Member 
Frank, and all of the members of the committee for their 
interest in working to ensure that we get Basel right.
    I look forward to hearing from the witnesses today.
    At this time, I recognize Mr. Hensarling.
    Mr. Hensarling. Thank you, Mr. Chairman.
    First, let me thank you for holding this hearing. I frankly 
think it's one of the more important hearings that your 
committee could hold. It's a very, very tough issue that we 
have to deal with.
    On the one hand, as somebody who represents a district in 
Texas, although I was not in Congress at the time, I still have 
a very firm memory of the late 1980's and early 1990's and the 
S&L meltdown, and how an over-concentration of real estate led 
to an incredible economic contraction and a massive taxpayer 
bailout. So my memory of that incident in American history is 
still quite clear.
    On the other hand, today we're enjoying one of the best 
economies that we have enjoyed in America, with historically 
low unemployment rates, 5 million new jobs, we're awash in tax 
revenues, we've got the highest rate of home ownership we've 
had in the history of America, we have many other good and 
favorable signs, and a very good case can be made that real 
estate has helped lead to this economic boom.
    So anything that would provide onerous burdens on further 
loans to commercial real estate concerns me, and as many on 
this panel know, and share with me, I have a concern about the 
future of community banking in America, which with the help of 
almost everybody on this committee, we put together what I 
believe is a very good regulatory relief bill that would be 
very significant for community banks.
    But if we don't, if the regulators don't get it right, that 
burden is going to increase even further, and I am led to 
believe that this particular niche in the marketplace is a 
very, very important niche to their profitability and their 
survivability.
    So I look forward to hearing from all the witnesses, but as 
always, I come into these hearings with a very strong bias in 
favor of free people and free markets, and I always put the 
burden of persuasion upon those who are proposing further 
restrictions upon loans and loan limits, and I look forward to 
hearing what compelling case might be made in this regard.
    And again, Mr. Chairman, I thank you for holding this 
important hearing and I yield back.
    Chairman Bachus. Thank you, Mr. Hensarling.
    Are there any other members who wish to make opening 
statements?
    Ms. Kelly.
    Ms. Kelly. I thank you, Chairman Bachus, for holding this 
hearing.
    I, too have shared the interest in this committee in 
learning how the Basel II accords will impact our local 
communities.
    Unfortunately, we now have the evidence that there is such 
evidence, and it's negative.
    On January 10, 2006, an interagency guidance was issued 
regarding commercial real estate lending. This has been 
followed by weeks of reports from community banks that 
examiners are now questioning bank investments in their own 
communities that have never before raised any concern.
    While there's a legitimate concern that banks not over-lend 
in any category, commercial real estate is a single name for a 
very broad range of activities. Everything from factories, 
hotels, golf courses to warehouses, office buildings, and 
parking lots is contained in the category of commercial real 
estate.
    Unlike housing, which moves broadly to interest and 
employment rates regionally and nationwide, each class of 
commercial real estate responds differently, and to lump them 
together for the purpose of bank examination doesn't seem to 
make a whole lot of sense to me.
    Community banks exist to serve their communities, to 
understand their needs, and to provide capital for worthwhile 
investment. By definition, they invest where their customers 
are. They invest also for the long term and have a very large 
stake in the success of their neighbors.
    Unlike capital from large institutions, they provide a 
continuity which can often be the difference between the 
success or failure of a whole town or even a county.
    To require an artificial diversification out of the 
communities that they serve doesn't really benefit them or the 
taxpayers.
    The guidance issued by the banking agencies, if confirmed, 
I believe will eliminate the small bank as a viable 
institution. Commercial lending, like credit cards, home 
lending, and deposits will be dominated by large banks and 
conglomerate financial institutions.
    I urge these witnesses that are going to be before us today 
to take a look at community banks and their portfolios as 
individual institutions rather than lumping them together just 
to save regulators time and effort.
    I thank you and I yield back the balance of my time.
    Chairman Bachus. Thank you, Ms. Kelly.
    Are there any other members? Mr. Price, did you have an 
opening statement? Okay. No other opening statements.
    All right. At this time, I'd like to introduce the first 
panel, which needs no introduction.
    Mr. Frank wanted to introduce Mr. Antonakes, but I'll 
introduce all of them, I think.
    The first panel consists of: the Honorable Susan Bies, 
Governor, Board of Directors of the Federal Reserve System; the 
Honorable Sheila Bair, Chairman, Federal Deposit Insurance 
Corporation; the Honorable John C. Dugan, Comptroller, Office 
of the Comptroller of the Currency; the Honorable John Reich, 
Director of the Office of Thrift Supervision; Mr. Robert Colby, 
Acting Director, Division of Market Regulation at the SEC; and 
Mr. Steven L. Antonakes, commissioner, Massachusetts Division 
of Banks. And you're testifying on behalf of the Conference of 
State Bank Supervisors; is that correct? Okay.
    We welcome all of the panelists and look forward to your 
opening statements. Thank you.
    Governor Bies.

    STATEMENT OF HON. SUSAN SCHMIDT BIES, MEMBER, BOARD OF 
            GOVERNORS OF THE FEDERAL RESERVE SYSTEM

    Ms. Bies. Thank you, Mr. Chairman. I want to thank you, 
Representative Sanders, and members of the subcommittee for 
this opportunity to join my colleagues to discuss both the 
recent developments in regulatory capital and our proposed 
guidance on sound risk management for commercial real estate.
    Let me begin by just saying that the completion last week 
of the draft NPR for Basel II for comment reflects a lot of 
hard work across all of the agencies and active input from many 
constituencies, bankers and non-bankers, and Congress. We 
really appreciate all of the effort that people put in; I think 
all of us know it was important in achieving this milestone.
    I want to make one comment before I get to Basel II, about 
the market risk amendment that was also put out for comment. 
This is an update of an old rule that we've had that deals with 
trading book risk, and this is applicable to all U.S. banks 
currently that have big trading book activity.
    What's remarkable about this is that it's based on the 
framework that was jointly agreed to by the Basel Banking 
Committee and the International Association of Security 
Commissioners. What we're proposing here is both an update that 
reflects new risk-taking, but more importantly, will help to 
level the playing field between investment banks and commercial 
banks who are subject to the similar regulatory environment for 
capital. We've been working actively with the SEC and we 
appreciate their support on that; so we look forward to those 
comments, too.
    Let me turn to Basel II. As you know, as we've been working 
through this, we have tried to emphasize not just the Pillar 1, 
which has gotten most of the attention, but also Pillars 2 and 
3.
    The Pillar 1 proposal that we have put together in this NPR 
proposes that only the most advanced organizations are required 
to adopt it, and it uses the most advanced approaches of the 
Basel 2004 Accord. I want to compare that to what you're 
hearing from other countries and what they're doing.
    There's a difference here, because in other countries, when 
Basel II becomes effective, Basel I goes away. We've chosen, in 
the United States, to listen to the smaller community banks and 
to retain Basel I, which we are working to amend.
    What this means is that since Basel II applies to all banks 
of all complexity and size globally in those countries, there 
are three general varieties of approaches to risk to reflect 
the differences in size and complexity of those organizations. 
Again, we in the United States have only focused on the most 
advanced approaches.
    But it's also important to realize that Pillar 2 is very 
important in all of this, because it requires that an 
organization look beyond credit and operational risk to look 
broadly at their risk through the cycle, and make sure it 
agrees with their business strategy.
    Finally, Pillar 3, which ensures additional disclosure, is 
important because it reflects that we want market discipline to 
differentiate risk.
    We at the Federal Reserve have been consistently supporting 
the most advanced approaches because today's Basel I does not 
reflect the changes in risk for these big organizations; it 
doesn't reflect the operational risks that have led to a lot of 
publicly charged off events and some of the legal problems that 
banks have encountered that required chargeoffs; it doesn't 
reflect the fact that under Basel I a certain portfolio could 
have very different kinds of risk exposures across banks, and 
we think a bank who chooses to take on more risk of a certain 
type should hold more capital.
    Finally, we've got the safeguards in the proposal, both in 
terms of parallel runs and transition periods, but we also have 
listened to comments, done analysis based on QIS studies, and 
strengthened elements in this NPR to deal with weaknesses that 
we've already identified, and we'll continue to do that as we 
move forward.
    Finally, on commercial real estate. Commercial real estate 
has our concern. As a banker, I lived through the hard side of 
working through the southeast real estate problems in the 
1980's. We know today that community and mid-size banks have 
exposure to commercial real estate relative to capital twice 
what it was in 1990.
    What we intended in this guidance, since we don't have a 
lot of information on the call reports, is to indicate to our 
examiners that they need to focus on the portfolio management 
of these banks, not just the individual loan underwriting, and 
that they need to begin a dialogue at the screen levels, which 
would not be ceilings.
    And we do want our examiner to look at how the bank looks 
at the types of real estate loans they have, and how they 
monitor the markets, and to consider the broader aspects of 
portfolio concentration management which we find is not 
developing as quickly as banks increase their concentration in 
this line of business.
    Thank you, Mr. Chairman, for your comments, and I'll wait 
for further questions.
    [The prepared statement of Governor Bies can be found on 
page 96 of the appendix.]
    Chairman Bachus. Thank you.
    Chairman Bair.

  STATEMENT OF HON. SHEILA C. BAIR, CHAIRMAN, FEDERAL DEPOSIT 
                     INSURANCE CORPORATION

    Ms. Bair. Thank you, Mr. Chairman. I would also like to 
thank you, Ranking Member Sanders, and the members of the 
subcommittee for the opportunity to testify on behalf of the 
Federal Deposit Insurance Corporation concerning the Basel II 
international capital accord and Federal banking agencies' 
recent draft guidance on commercial real estate lending.
    Basel II and the commercial real estate guidance share one 
important feature, a focus on the importance of risk 
management. At the outset, I would like to emphasize that we 
all support moving ahead to the next step in the Basel II 
deliberative process.
    The FDIC board of directors recently voted to publish the 
Basel II notice of proposed rulemaking for public comment. U.S. 
bank and thrift regulators also are developing a more risk-
sensitive capital framework for non-Basel II banks, known as 
Basel IA, which we hope to publish for comment in the near 
future.
    While it is important to move ahead with the process, 
there's also agreement that we must not do so in a way that 
will result in significant reductions in capital or in the 
creation of competitive inequities among different types of 
insured depository institutions.
    The agencies' most recent quantitative impact study 
suggested that the Advanced Approaches would result in a 
substantial reduction in risk-based capital requirements. The 
results also showed wide variations in capital requirements for 
similar risks.
    The agencies found these results unacceptable, and as a 
result, included a number of important and essential safeguards 
in the NPR to address these issues.
    I look forward to receiving comments on the NPR and I will 
approach those comments with an open mind. I particularly look 
forward to comments on the question of whether the regulators 
should allow alternatives to the Advanced Approaches.
    We have had a number of requests to allow any U.S. bank to 
use the Standardized Approach to capital regulation that is 
part of the Basel II accord. The United States is the only 
country proposing to make the Advanced Approaches mandatory for 
any group of banks.
    The Standardized Approach includes a greater array of risk 
rates than the current rules. It is simpler and less costly to 
implement than the Advanced Approaches. In addition, because 
there is a floor for each risk exposure, it does not provide 
the same potential for dramatic reductions in capital 
requirements.
    On the other hand, there is the argument that only the 
Advanced Approaches would provide an adequate incentive for the 
strengthening of risk management systems at our largest banks. 
Whether our largest banks should be required to use the 
Advanced Approaches is a fundamental issue, and again, I look 
forward to public comment on this question.
    Before concluding my remarks on Basel II, I would like to 
say a few words about the leverage ratio. The FDIC has 
consistently supported the idea that the leverage ratio, a 
simple capital-to-assets measure, is a critically important 
component of our dual capital regime. I am very pleased that 
all the bank regulators have expressed their support for 
preserving the leverage ratio.
    I understand that banks in most other Basel Committee 
countries are not constrained by a leverage ratio, and that 
effective capital standards around the world vary widely as a 
result. For this reason, I believe that the United States 
should ask the Basel Committee to initiate consideration of an 
international leverage ratio.
    The leverage ratio has provided U.S. supervisors with 
comfort that banks will maintain a stable base of capital in 
good times and in bad times. Similarly, the establishment of an 
international leverage ratio would go far in strengthening the 
liquidity and stability of the international banking system and 
help limit the consequences of reduced risk-based capital 
levels with Basel II implementation.
    The committee also asked us to discuss the proposed 
guidance on commercial real estate exposures. The need for this 
guidance stems from the substantial growth in commercial real 
estate lending at community banks in recent years.
    At the end of March 2006, commercial real estate loans 
accounted for more than 42 percent of all loans at institutions 
with less than $1 billion in assets. Six years ago, these loans 
represented less than 28 percent of all loans at these 
institutions.
    Loan concentrations add a dimension of risk that needs to 
be appropriately identified and managed, and some examinations 
have revealed that portfolio management practices may not have 
kept pace in this growth.
    The goals of the proposed guidance were to increase 
awareness of commercial real estate exposures, reinforce 
existing regulations and guidelines for real estate lending, 
and remind institutions that strong risk management practices 
and appropriate levels of capital are necessary to mitigate the 
potential concentration risk.
    The FDIC and the other banking agencies have seriously 
considered commenters' views on this proposed guidance. We 
appreciate the importance of CRE lending, particularly for 
community banks, and do not intend to limit CRE lending 
activity that is prudently underwritten and appropriately 
managed.
    In particular, we agree with the need to emphasize that the 
stated thresholds are not limits, but rather are designed to 
trigger heightened scrutiny to assure adherence to sound credit 
principles and best practices. Once these perspectives are 
reflected in the final guidance, it should provide a useful 
tool for both examiners and banks.
    This concludes my statement. The FDIC appreciates the 
opportunity to testify regarding Basel II and the CRE guidance. 
I look forward to any comments or questions the subcommittee 
may have.
    Thank you.
    [The prepared statement of Chairman Bair can be found on 
page 78 of the appendix.]
    Chairman Bachus. Thank you, Chairman Bair.
    Now, Comptroller Dugan.

  STATEMENT OF HON. JOHN C. DUGAN, COMPTROLLER OF THE CURRENCY

    Mr. Dugan. Chairman Bachus and members of the subcommittee, 
I appreciate the opportunity to discuss two important 
initiatives of the U.S. banking agencies--our proposals to 
enhance our regulatory capital program under Basel II and our 
proposed commercial real estate guidance.
    The U.S. implementation of Basel II is, at its core, an 
effort to move away from the simplistic Basel I capital regime 
for our largest internationally active banks. The inadequacies 
of the current framework are pronounced with respect to these 
banks, which is a matter of great concern to the OCC because we 
are the primary Federal supervisor for the five largest; these 
institutions, some of which hold more than $1 trillion in 
assets, have complex balance sheets, take complex risks, and 
have complex risk management needs that are fundamentally 
different from those faced by community and mid-size banks.
    Because of these attributes, Basel II is necessarily 
complex, but it would be mandatory for only a dozen large U.S. 
institutions. The new regime is intended not only to align 
capital requirements more closely to the complex risks inherent 
in these largest institutions, but, just as important--and this 
is a complete departure from the existing capital framework--it 
would also require them to substantially improve their risk 
management systems and controls. This would be accomplished 
using a common framework and a common language across banks 
that would allow regulators to better quantify aggregate risk 
exposures, make more informed supervisory decisions, disclose 
more meaningful risk information to markets, and make peer 
comparisons in ways that we simply cannot do today.
    Last week, as you've heard, the agencies took a critical 
step forward in this process by approving the NPR. In addition 
to establishing the basic Basel II framework in the United 
States, the NPR addresses two key issues about implementation.
    The first concerns the reliability of the framework itself. 
As you know, last year's quantitative impact study of the 
potential impact of an earlier version of Basel II predicted 
substantial drops and dispersions in minimum required capital. 
These QIS-4 results would be unacceptable to all the agencies 
if they were the actual results produced by a final, fully 
supervised and implemented Basel II rule. But they were not. 
Some changes already made in the proposed rule and others that 
will be considered after the comment period, should mitigate 
the QIS-4 results. More importantly, we believe that a fully 
supervised implementation of a final Basel II rule, with 
examiners rigorously scrutinizing the inputs provided by banks, 
is likely to prevent unacceptable capital reductions and 
dispersions.
    We cannot be sure, however. That's why the proposed rule 
will have strict capital floors in place to prevent such 
unacceptable results during a 3-year transition period. This 
will give us time to finalize, implement, supervise, and 
observe ``live'' Basel II systems. If, during this period, we 
find that the final rule would produce unacceptable declines in 
the absence of these floors, then we will have to fix the rule 
before going forward, and all of the agencies have committed to 
do just that.
    The second issue concerns optionality. The NPR asks whether 
Basel II banks should have the option of using a simpler 
approach. This is a legitimate competitive question, given that 
the largest banks in other Basel II countries have such an 
option, although, as a practical matter, all such foreign 
competitors appear to be adopting the advanced approaches. We 
are very interested in comments about the potential competitive 
effects of providing such an option to U.S. banks.
    The OCC has been a frequent critic of many elements of the 
Basel II framework, and we've worked hard to make important 
changes to the proposal that we thought made sense. But at 
critical points in the process, the OCC has supported moving 
forward toward implementation. Our reason for doing so is 
simple. An appropriate Basel II regime will help both banks and 
supervisors address the increasingly complex risks faced by our 
largest institutions.
    While we may not yet have all the details right, and we 
will surely make changes as a result of the public comment 
process, I fully support the objectives of the Basel II NPR for 
the supervision of our largest institutions. Likewise, for non-
Basel II banks, I fully support our interagency effort to issue 
the so-called ``Basel IA'' proposal in the near future as a way 
to more closely align capital with risk without unduly 
increasing regulatory burden.
    Let me turn now to the proposed interagency guidance on 
commercial real estate lending, which the agencies proposed for 
three reasons.
    First, although circumstances are different today and 
underwriting standards are much improved, we know from the 
painful experience of just 20 years ago that commercial real 
estate lending has the real potential to fail banks.
    Second, during the last 5 years, we have seen a dramatic 
surge in the concentrations in commercial real estate lending 
in community and mid-size banks, to levels beyond what they 
were in the 1980's.
    And third, our examinations revealed that risk management 
practices in many of these banks have not kept pace with the 
surge in concentrations.
    While we believe that commercial real estate concentrations 
can be safely managed, they must be effectively managed in 
order to be safe. Accordingly, the basic message of the 
proposed guidance is not ``cut back on commercial real estate 
loans.'' Instead, it is this: ``You can have concentrations in 
commercial real estate loans, but only if you have appropriate 
risk management and capital to address the increased risk.'' 
And when I say ``appropriate risk management and capital,'' 
that does not refer to expertise or capital levels that are out 
of reach or impractical for community and mid-size banks. 
Indeed, at its core, the proposed new guidance amplifies 
guidance the agencies developed in the wake of the widespread 
bank failures of the 1980's.
    In addition, the overwhelming majority of banks affected by 
the guidance already hold capital significantly above the 
regulatory minimums, so these institutions generally would not 
be affected by the capital adequacy part of the proposed 
guidance.
    The proposed guidance would establish thresholds to help us 
determine where enhanced risk management and adequate capital 
are needed. I know some banks worry that the thresholds will 
turn quickly into caps. But I can tell you categorically that 
this is not what the guidance says and not how it would be 
implemented. The OCC is emphasizing this very point--that these 
are thresholds for better prudential practices, not caps--in 
discussions with our examiners in every region of the country.
    In closing, let me emphasize that as we move forward with 
these proposals, the agencies will continue to foster an open 
process, consider all comments, heed good suggestions, and 
address legitimate concerns.
    Thank you very much.
    [The prepared statement of Comptroller Dugan can be found 
on page 117 of the appendix.]
    Chairman Bachus. Thank you.
    Director Reich.

  STATEMENT OF HON. JOHN M. REICH, DIRECTOR, OFFICE OF THRIFT 
                          SUPERVISION

    Mr. Reich. Thank you, Chairman Bachus, Ranking Member 
Frank, and members of the subcommittee. I appreciate the 
opportunity to be here this morning. Borrowing a phrase often 
repeated in Washington, that everything has been said and not 
everybody has had an opportunity to say it, I'm going to make a 
few brief comments and be quiet.
    Let me say that OTS is supportive of the Basel II advanced 
approach and we are supportive of considering the standardized 
approach. Also, I'm very supportive of the safeguards that we 
have included within Basel II.
    I believe that the longer implementation process will 
provide us with ample information, ample time over the next few 
years between now and the end of 2011 to have the opportunity 
to make any changes that we feel may be necessary.
    Regarding Basel IA, I'm very supportive of dating Basel I 
but I also expect to be supportive of permitting the very well-
capitalized banks who have indicated a preference to continue 
operating under the present Basel I framework to be able to do 
that.
    With regard to the proposed commercial real estate guidance 
proposal issued in January, we're supportive of the general 
purpose and intent to remind institutions that credit 
concentrations can pose risks and that these risks should be 
assessed and addressed, further, that risk management practices 
should be commensurate with the level of concentration of 
commercial real estate loans within the portfolio. The guidance 
has drawn substantial negative reaction, particularly to the 
specific thresholds which are included in the guidance.
    As a former community banker, I'm keenly sensitive to these 
issues and highly cognizant of the magnitude of the public 
comment received and the nature of that comment.
    My expectation is that the guidance should be viewed as a 
set of guidelines by the industry and our examiners. The 
proposed guidance is not a rule.
    As we continue to work on the guidance, I'm hopeful that it 
can be modified to address the comments that we have received 
and to clarify the Federal banking agencies risk management 
expectations for the industry and to make sure the guidance 
conveys this intent more clearly.
    I look forward to working with my colleagues on this panel 
in finalizing the guidance.
    Thank you very much, and I'll be happy to answer questions.
    [The prepared statement of Director Reich can be found on 
page 244 of the appendix.]
    Chairman Bachus. Thank you.
    Acting Director Colby.

 STATEMENT OF ROBERT L.D. COLBY, ACTING DIRECTOR, DIVISION OF 
   MARKET REGULATION, U.S. SECURITIES AND EXCHANGE COMMISSION

    Mr. Colby. Chairman Bachus, Ranking Member Sanders, and 
members of the subcommittee, I'm very pleased to have the 
opportunity this morning, on behalf of the Securities and 
Exchange Commission, to describe the Commission's program for 
monitoring capital at U.S. securities firms.
    While the Commission has applied a conservative net capital 
rule for many years to broker-dealers, as the securities 
business has expanded and broker-dealers became part of 
international financial conglomerates, the Commission became 
increasingly concerned about the risks that a broker-dealer may 
fail, due to the insolvency of its holding company or 
affiliates.
    Therefore, in 2004, the Commission amended its net capital 
rule to establish a voluntary alternative method of computing 
net capital for well-capitalized broker-dealers that have 
adopted strong risk management processes.
    This alternative method permits a broker-dealer to use 
mathematical models to calculate net capital requirements for 
markets and derivatives-related credit risk.
    As a condition to that method, the broker-dealer's ultimate 
holding company must consent to group-wide Commission 
supervision, thus becoming a consolidated supervised entity, or 
CSE.
    Formally supervising the financial condition of the broker-
dealer holding company and its affiliates on a consolidated 
basis allows the Commission to monitor better and act more 
quickly in response to any risks that affiliates and the 
ultimate holding company will pose to regulated entities within 
the group or to the broader financial system.
    The Commission's program to supervise the CSE's also 
responded to concerns of the U.S. investment banks regarding 
the application to their activities in Europe of the European 
Union's financial conglomerates directive.
    The directive requires that firms active in Europe be 
supervised at the group level under a regulatory approach 
equivalent to those applied in the European Union or face 
significant restrictions on their activities.
    The European Union has recognized the broad equivalence of 
the Commission's CSE oversight program.
    Currently, five U.S. investment bank holding companies are 
supervised as CSE's. Under the Commission's program, the 
ultimate holding company must provide the Commission with 
information at the group level covering its global businesses 
whether or not these activities are conducted in functionally 
regulated entities.
    Those affiliates that do not have a principal financial 
regulator as well as the holding company itself are subject to 
examination by the Commission.
    The CSE rule requires monthly calculation at the holding 
company level of a capital adequacy measure that's designed to 
be consistent with the standards adopted by the Basel Committee 
on Banking Supervision.
    In requiring a holding company calculation of capital in 
accordance with the Basel standard, the CSE rules do not 
specify that capital adequacy be calculated using the original 
framework, Basel I, or the revised framework, Basel II. 
Likewise, the rule does not prescribe the use of advanced 
approaches contained in Basel II.
    Nevertheless, four of the five CSE firms have elected, with 
Commission support, to satisfy the CSE capital calculation 
requirement by applying Basel II in its advanced approach to 
credit risk exposure.
    The fifth firm, who because of its fiscal year was 
confronted with a period of only 6 months between publication 
of Basel II and the effective deadline imposed under the E.U. 
financial conglomerates directive, opted to apply Basel I, but 
this firm is now in the process of preparing to implement Basel 
II.
    When the CSE firms began in earnest to implement Basel II 
during the latter part of 2004, the only complete description 
of the standard was the mid-year text. Thus, this text served 
as the basis for implementation of Basel II by these firms.
    This is not to say that implementation of Basel II by the 
CSE forms has been simple. The Commission staff has worked 
collaboratively with our banking colleagues to address issues 
that are central to the CSE firms, and we believe that the CSE 
firms have implemented Basel II in a manner that's conservative 
while also reflective of the fundamental nature of the 
securities firms and their business model.
    Looking ahead, with the U.S. banking regulators' formal 
issuance of their notice of proposed rulemaking, Commission 
staff will review the document carefully to apply the proposed 
approaches to securities firms in the context of their history, 
risk profile, and business mix.
    Where further modifications to the calculation 
methodologies used by the CSE firms are warranted, the 
Commission has authority to require their adoption. The CSE 
firms understood, when they elected to apply the Basel II 
standard in 2005, that the standard was still very much a work 
in progress and they were likely to have to make various 
adjustments as the broader U.S. implementation process 
proceeded.
    In summary, we're confident that the CSE firms are 
currently calculating capital adequacy measure consistent with 
Basel II in a manner appropriately sensitive to the risks 
assumed by the firms.
    To the extent that further modifications of the 
calculations become necessary, and to achieve to the maximum 
extent possible consistency with national and international 
regulatory authorities, the Commission has the commitment and 
the authority under the CSE rules to ensure that appropriate 
changes are made.
    Thank you.
    [The prepared statement of Mr. Colby can be found on page 
113 of the appendix.]
    Chairman Bachus. Commissioner Antonakes.

STATEMENT OF STEVEN L. ANTONAKES, MASSACHUSETTS COMMISSIONER OF 
  BANKS, ON BEHALF OF THE CONFERENCE OF STATE BANK SUPERVISORS

    Mr. Antonakes. Good morning, Chairman Bachus, and 
distinguished members of the subcommittee. My name is Steven 
Antonakes, and I serve as the commissioner of banks for the 
Commonwealth of Massachusetts. I also currently serve as the 
chairman of the State Liaison Committee to the FFIEC.
    I'm pleased to testify today on behalf of the Conference of 
State Bank Supervisors. CSBS is the professional association of 
State officials responsible for chartering, supervising, and 
regulating the Nation's 6,230 state-chartered commercial and 
savings banks and 400 state-licensed foreign banking offices.
    While Basel II and the commercial real estate, or CRE, 
guidance are clearly very important regulatory proposals, both 
have the potential to impact the domestic financial system and 
could do particular harm to community banks by altering the 
competitive landscape and leading to the shifting of risk among 
business lines.
    The role that a small bank plays in a local economy cannot 
be overstated. I'm sure that each of you is well aware of the 
benefits that are added to your districts by healthy, well-
capitalized banks of all sizes.
    It is our responsibility as regulators and legislators to 
ensure that regulatory proposals are prudent and do not create 
a competitive imbalance.
    CSBS is pleased with the inclusion of several of the 
safeguards discussed already today that have been incorporated 
into the Basel II NPR. While we're encouraged by the 
incorporation of these safeguards, we do have process concerns.
    Despite our status as the primary supervisor for the vast 
majority of banks in the United States, State supervisors have 
not been included in the drafting process of Basel II. State 
regulators, through CSBS, should have a seat at the table when 
rules that affect our institutions to such a substantial degree 
are being considered.
    Additionally, the Basel II NPR does not provide a defined 
rule for the States during the qualification process. There are 
10 States, including my home State of Massachusetts, that 
charter potential Basel II banks. For these banks, the State is 
their primary regulator and must have a role in the 
implementation of Basel II.
    Once Basel II is adopted and implemented, the States will 
be responsible for ensuring that our affected institutions are 
Basel II compliant. In order to do so, we must be able to 
compare the data of all Basel II institutions regardless of 
their chartering agent. Accordingly, information sharing with 
the Federal bank regulatory agencies will be essential for 
States to properly supervise our Basel II banks.
    In reference to the proposed CRE guidance, we share many of 
the worries that motivated its drafting. However, as 
regulators, we must not be overly prescriptive in how risk is 
managed.
    In our opinion, the benefits of the guidance do not 
outweigh the potential negative impact on competition and our 
communities. Moreover, the guidance could have unintended 
consequences upon the health of the community banking system 
and the availability of credit.
    The implementation of either the Basel II NPR or the 
proposed CRE guidance could significantly impact our Nation's 
financial system. Sufficient capital must be maintained to 
ensure safety and soundness and economic stability, and 
competition in the industry must be preserved.
    Our fear is that the impact of one or both of these 
proposals will result in damage to community banks and a dual 
banking system as a whole.
    CSBS seeks to sustain the economic vigor of the local 
communities we serve. Certainly we share that goal with every 
member of the subcommittee.
    The vast majority of U.S. banks are state-chartered and it 
is critical that State regulators are given a full role in the 
regulatory process as these and other proposals are discussed, 
debated, drafted, and adopted.
    I commend you, Chairman Bachus, and the distinguished 
members of the subcommittee for addressing these matters, and 
on behalf of CSBS, I'd like to thank you for the opportunity to 
testify.
    [The prepared statement of Mr. Antonakes can be found on 
page 68 of the appendix.]
    Chairman Bachus. Thank you.
    I appreciate the first panel's testimony. I think it 
certainly helps us understand where we are. I'm going to ask 
two questions.
    First of all, it's my understanding that large banks in 
Europe and Asia will be subject to the Basel II rules in more 
or less the same form that was agreed to internationally, but 
I've been told that the U.S. proposal is significantly 
different in the advanced capital approaches, different from 
the advanced approaches that have been implemented abroad, and 
that for similar asset portfolios, U.S. banks will likely have 
significantly higher minimum capital requirements.
    First of all, is that correct? And if it is, would this not 
be a competitive advantage for foreign banks over our domestic 
banks? First of all, are there going to be greater capital 
requirements for our banks, and if that's the case, won't that 
disadvantage us from the competitive standpoint?
    Governor?
    Ms. Bies. Mr. Chairman, let me respond in two ways. We have 
had more time than some of the other national regulators to 
look at the analysis of the QIS-4, and the QIS-5, which was 
done in other countries but not the United States, because 
they're on a faster timetable.
    We've included in our NPR some strengthening from the 2004 
mid-year agreement, where we did see some weaknesses. For 
example, we have a placeholder in the NPR that acknowledges 
that models that we saw were not strong enough for downturn 
loss estimates, and so it's a methodology to use, because what 
we saw in QIS-4 and QIS-5 is, when banks didn't know how to 
measure their downturn loss, they just used zero.
    Well, in our view, your downturn loss should be higher than 
your best loss of zero; and yet, when you look at the QIS-5 
report that came out of the Basel Committee, they acknowledge 
that it's something that still has to be looked at by other 
countries, and we're anticipating that they will also make some 
adjustments as the banks are observed in the parallel run. So 
some of these, I think, are timing differences.
    Chairman Bachus. What if they don't? What if they don't 
make those adjustments? What I hear you saying is that you're 
using this international agreement to strengthen or to increase 
capital requirements domestically.
    Ms. Bies. We're doing it in our national implementation, in 
our NPR. There are several areas where the Basel Committee 
knows we have further work to do on Basel II, and we've all 
agreed to continue to work on that together as we get more 
information.
    Chairman Bachus. But are you saying that you anticipate 
some of the other countries raising their capital requirements, 
but they haven't done that yet, but you're almost raising ours 
anticipating that they'll raise theirs?
    Ms. Bies. What I'm saying is that what we've done so far is 
to implement specific changes that respond to risks in the 
existing 2004 mid-year agreement. Those weaknesses other 
countries acknowledge, but they have not yet done anything to 
move forward at their national level to implement any change.
    Chairman Bachus. Now, if they don't implement those 
changes, though, it leaves us at a competitive disadvantage, 
does it not?
    Ms. Bies. Well, it could. But on the other hand, we've had 
differences all along in capital rules.
    Chairman Bachus. Yes.
    Ms. Bies. Part of this deals with differences in accounting 
rules. We still don't have global accounting. Some of that will 
make a difference.
    Chairman Bachus. I'm not sure that an international accord 
is the proper place to unilaterally raise our capital 
requirements.
    Ms. Bies. But as a U.S. regulator, my first priority is to 
make sure banks in the United States have strong capital.
    Chairman Bachus. I understand that. But to say it, to say 
you're doing it as a part of an international process, but, you 
know, that it needs to be done for Basel II wouldn't be 
correct, I mean, not necessarily. You're saying it--
    Ms. Bies. We're doing it in the U.S. NPR, but I'm saying 
the issues that we're concerned with are shared globally around 
the table for Basel, and we know that there will be work in 
train to address some of the issues.
    Chairman Bachus. But you understand what I'm saying?
    Ms. Bies. Yes. But we need to move forward and deal with it 
in the United States.
    Chairman Bachus. But would you acknowledge that, you know, 
if you came to Congress and said, ``We need to do these things 
because of Basel II, but we're going beyond what we're required 
to do in an international agreement,'' then it wouldn't be a 
requirement.
    It would be as if you're telling me the Fed may be going 
beyond what it's required to do, or that we're going beyond 
what we're required to do in raising our capital requirements.
    In other words, starting 2 and 3 years ago, I think our 
institutions were told, as a part of an international 
agreement, you know, we're going to implement certain 
requirements, but in fact, if our foreign competition, those 
requirements are not--if their countries, their regulators 
don't require them to do that, then I see that as a 
disadvantage, and I know Mr. Feeney and Mr. Hensarling and Mr. 
Price, several of us on both sides of the aisle have actually 
expressed concerns that these international agreements don't 
disadvantage our banks in the global marketplace.
    Ms. Bies. I think we are very proud that in the United 
States we consider our capital standards to be the strongest in 
the world, and we're not going to weaken them.
    Chairman Bachus. Sure.
    Ms. Bies. And this has not disadvantaged our banks. They 
continue to have the strongest capital and the highest 
profitability, if you look at financial institutions elsewhere, 
and I think it's because we've been pushing a balance between 
capital and enhanced risk management, and you need to look at 
all of these together, and I think the results are that our 
banks are very effectively managing through this.
    We need to always aspire to make sure that our banks are 
seen as a source of strength.
    Chairman Bachus. I think you could say there's a sense of 
pride in that our capital requirements are strict, but I think 
that anytime a capital requirement is higher than justified, 
then it raises costs, and, you know, there are unnecessary 
costs then.
    And I don't want to debate the philosophy. What I'm simply 
saying is, if we're doing this as a part of Basel II, because 
it's necessary as a part of the international agreement, but, 
you know, what we've sort of been told is that it's going to 
happen overseas, in other words our competition is going to--
these requirements are going to be put on those so we won't be 
disadvantaged.
    Now, I appreciate your candidness, I mean, in saying that 
you're anticipating that they're going to catch up with us, but 
if they don't, I'm just saying there could be some problems.
    Mr. Dugan.
    Mr. Dugan. Mr. Chairman, I do want to say that I think most 
of the provisions of our version of the advanced approaches and 
what the Europeans have adopted are pretty similar. There are 
some safeguards that I mentioned in my testimony that we put 
in, particularly on a temporary basis, because we were 
concerned when we did our study that the drops in capital were 
a lot bigger than we thought they would be. We put in some 
capital floors during a 3-year transition period, but if we get 
comfortable with the rule and it doesn't produce those kinds of 
declines once it is fully implemented, then those floors should 
come off. And of course, there is always the leverage ratio 
that applies in the United States but does not apply outside 
the United States, and that is a difference.
    Chairman Bachus. Okay.
    Ms. Bair. I would just, I would agree with everything that 
my colleagues have said, and re-emphasize that's one of the 
reasons why I think it would be good to engage the 
international community on an international leverage ratio to 
the extent we may confront competitive inequities.
    I agree with Governor Bies, I'm not sure low capital is a 
competitive advantage for the United States. I think our high 
capital levels have been a strength of the U.S. banking system 
and have certainly been an important buffer for the Federal 
Deposit Insurance Corporation in protecting the funds against 
bank failures.
    So I think the premise of the question, I think we need to 
think hard about whether low capital really is a competitive 
advantage, and also, to the extent we do have differences, that 
we should engage the international community in an 
international leverage ratio.
    Chairman Bachus. Thank you.
    Ms. Kelly.
    Ms. Kelly. Thank you, Mr. Chairman.
    I'll address this to you, Comptroller Dugan.
    You note in your testimony that guidances are often 
interpreted as caps by bankers. In the recent experience of 
this committee, guidance on the MSB's was also, de facto, 
turned into caps by examiners in the field, despite regulator 
assertions to Congress of the contrary.
    I'd like to ask each of the regulatory agencies here if 
their small bank examiners have specialized training in 
different types of commercial real estate and the commercial 
real estate cycle.
    So I'm asking this basically of you first, Mr. Dugan, and 
then I'd like to hear from the other regulatory agencies.
    Mr. Dugan. Mrs. Kelly, we take great pride in the training 
that we provide our examiners at the OCC. At the heart of what 
examiners learn from their first day on the job is safety and 
soundness supervision, and although there are many things that 
we have to supervise institutions for, credit is at the heart 
of much of what examiners learn as a core skill.
    I absolutely think we have the expertise. It's something 
that all of the agencies have focused on because of the 
problems that occurred in the 1980's when we sat in this 
hearing room, in front of the subcommittee members, because of 
all the bank failures that were caused by concentrations of 
commercial real estate lending.
    And I want to emphasize that. What we're talking about here 
is not that commercial real estate lending is bad, because it's 
not. But a prime principle of bank supervision is not putting 
all your eggs in one basket, and we have seen such a dramatic 
rise in concentrations that we want to make sure institutions 
are appropriately managing those risks.
    Ms. Kelly. Who's going to pick that up next?
    Mr. Reich. I'll be happy to. I have a little bit different 
perspective.
    I share Comptroller Dugan's comments about the training 
that our examiners receive in all of our agencies, and I share 
his views about their abilities to examine various types of 
commercial real estate loans. But my perspective as a former 
community banker, and I've been away from it for quite a few 
years now, but as a former community banker, I am keenly aware 
of the power of the bully pulpit which we occupy as the heads 
of our regulatory agencies, and I do have concerns that the 
degree of proscriptiveness that is in the current proposal for 
commercial real estate lending may have some consequences that 
we do not necessarily want to see.
    And so I am hopeful that, as we continue to work on the 
guidance before it goes out, that we modify it to be clear 
about our intent and not to suffer unintended consequences.
    Ms. Kelly. That's certainly refreshing.
    It's a very big concern that the examiners get out in the 
field and they don't have clarity of what the intent truly is, 
and then they will take a guidance, turn it into caps, as we've 
seen that before.
    I'm also concerned that asset class concentration levels 
issued in the preliminary guidance are discriminatory against 
commercial real estate as opposed to other types of bank 
assets.
    In particular, the ILC's often have 100 percent of their 
businesses in unsecured credit card debt and vehicle payments, 
but the FDIC defends their safety and soundness, so how secured 
or partially secured debt, how can secured or partially secured 
debt for real estate combined with holding company supervision 
be any more risky than holding a portfolio that's made up 
entirely of credit cards that are marketed to teenagers? I want 
to know why you're not mandating portfolio diversity for these 
institutions.
    Ms. Bair. Congresswoman, I don't think by issuing the CRE 
guidance that we were suggesting that other types of risk 
exposures don't also need to be appropriately managed.
    I think the overall--I would be happy to--I'm uncomfortable 
to try to get into institution-specific situations, but I think 
overall, the safety and soundness record of the ILC industry 
today has been a good one, and yes, diversification is a 
fundamental principle of lending, and to the extent there are 
concentrations in those types of depository institutions as 
well as others that perform service in niche markets, they need 
to have more stringent risk management systems and procedures 
in place.
    But again, I don't think just because guidance was issued 
on CRE, that does not mean to suggest that other areas don't 
need to also be appropriately managed.
    And as you know, we have a moratorium in place right now, 
and we will offer comment on some of the broader issues 
regarding the adequacy of holding company oversight and other 
unique issues presented by the ILC charter, and we have not 
completed that review, but should be trying to move forward 
with some of these issues early next year.
    Ms. Kelly. I would hope that you would look at some of 
these institutions where they're marketing heavily to young 
people, and evaluate the quality of that risk vis-a-vis the 
quality of a local bank holding a risk-based mortgage on 
commercial property.
    Thank you for your answer.
    Yes, Ms. Bies.
    Ms. Bies. Let me just add a couple of things.
    One, to make you aware that we are working inter-agency on 
the training program for our examiners on the new guidance to 
make sure that we are sending the right message and that we 
will be consistent not only within our agencies but across our 
agencies on how the new guidance will be implemented, and that 
will be in train very quickly, too, to address your concern on 
the knowledgeability of examiners.
    The other point I want to make about commercial real estate 
is, there are certain asset types where an individual bank can 
do a wonderful job in underwriting their credits, but they get 
contagion from poor underwriting by others, and it's really 
true in commercial real estate.
    A bank can do a great job of underwriting, but if projects 
in their market are getting funded and create excess capacity 
so there are a lot of vacancies or they're poorly underwritten 
for cash flow, so the maintenance and the property values go 
down, it can negatively affect the bank because those other 
projects could, through rent concessions and other things, 
attract tenants to competitive projects.
    And so what we're really emphasizing here is that the bank 
has to go beyond individual loan underwriting and look 
externally and make sure they're always aware of what's going 
on in the market, because unlike other types of credit, bad 
lending can really affect their good credits.
    Ms. Kelly. Thank you, very much.
    Ms. Bair?
    Ms. Bair. I just wanted to add one more thing.
    Our examiners also go through a very rigorous training 
program through our corporate university, so I just want to get 
the flag up for our examiners as well.
    I'm also advised that 2\1/2\ years ago we issued internal 
guidance to our examiners on commercial real estate exposures 
to remind them about what best practice is in terms of risk 
management and to differentiate that obviously within that 
broad category there are some types of assets that are more 
risky than others.
    So yes, I have very--I've actually been told by several 
community bankers that they've had positive experiences 
actually when our examiners have come in and reviewed their CRE 
portfolios.
    Ms. Kelly. Thank you.
    Mr. Hensarling. [presiding] The time of the gentlelady has 
expired. The Chair would now recognize the ranking member, Mr. 
Frank of Massachusetts.
    Mr. Frank. Thank you. I apologize. We have a bill on the 
Floor that I had to speak on.
    I want to focus in on again on the CRE. And the regulators 
did respond, the four banking regulators, before Chairman Bair 
was there, her predecessor, her acting predecessor did it, but 
all four of the agencies signed it, and it's a response to 
questions that were raised. And here's what troubles me.
    I got on this committee because of my interest in urban 
issues. I've broadened it some. Being ranking member means a 
lot of perks, but it means losing one significant perk, which 
is the ability to ignore things you're not interested in. You 
now have responsibility for a whole lot of other stuff. So I 
accept that. But housing is still very important to me.
    Multi-family housing is a great, serious social need, and I 
worry, and I really regret the fact that you appear to have 
swept multi-family lending into this guidance without, it seems 
to me, a basis.
    What troubles me is it may be cultural--I don't know if you 
have the letter you sent me, but on page 5 of the letter, in 
chart 5, it has net chargeoff rate by loan type. I ask that 
this be put in the record, Mr. Chairman.
    Mr. Hensarling. Without objection.
    Mr. Frank. In 1991 and 1992, multi-family--let me just ask 
my colleagues, please, could I--I'm sorry, could you not be in 
the way here?
    In multi-family, in 1991 and 1992, chargeoffs for multi-
family were significantly higher than the average of all loans, 
2.10 to 1.61 in 1991; 1.63 to 1.28 in 1992. Then you began to 
get parity between the multi-family and the average up until 
about 1996.
    Beginning in 1997 and through 2005, multi-family chargeoffs 
have been 25 percent or less than the average to the point 
where, in the past couple of years, in 2005, multi-family 
chargeoff, .04 percent. Similarly, in 2004. In 2004, that's a 
15 to 1 ratio. It's 1/15th as much for multi-family as all 
loans. It's 1/16th in 2005. In 2003, .03 to .91.
    There does not appear to be any reason that multi-family 
homes have been swept in here. Again, it's cultural. Yes, they 
were a problem, and you say this. Well, we had these problems 
in the 1980's, late 1980's, and early 1990's. I went through 
it. It was a terrible problem. But that's no reason to deal as 
if things hadn't changed.
    And so given this--and by the way, none of the categories 
here, all loans, .54 percent chargeoff in 2005. For multi-
family, .04. For non-farm, non-residential, .05. For 
construction and land development, .03.
    In fact, by your chart, for the last 8 or 9 years, the 
loans about which you are worried have been significantly lower 
in chargeoffs than the other loans, so that when you single 
those out, that's why people get nervous.
    Could you address that? I mean, why did you put multi-
family in here when it has performed so well for the last 10 
years?
    Let me ask any of the regulators.
    Mr. Reich. Well, Mr. Frank, I would plead guilty to signing 
onto a letter that I didn't necessarily agree with everything 
in it. I agreed with--
    Mr. Frank. The letter to me?
    Mr. Reich. I believe that's the letter that you're 
referring to. That letter.
    Mr. Frank. Mr. Supervisor, that is very odd behavior.
    Mr. Reich. Well, let me elaborate.
    I share your concern about multi-family lending. We at OTS 
have been working with our regulatory colleagues to try to make 
some progress in this area.
    I totally agree that lumping multi-family loans with 
shopping malls, strip shopping centers, office buildings, and 
warehouses, with the experience that you just cited that has 
taken place over the last 10 years, is inappropriate.
    Mr. Frank. Thank you.
    Mr. Reich. And I would like to work with my colleagues in 
the days and weeks to come to--
    Mr. Frank. Well, I appreciate that.
    We are also talking about activities which are not all of 
equal social worth, and if people think that's an irrelevancy, 
let me cite the law called the Community Reinvestment Act.
    And I do not think that items that will get a bank 
Community Reinvestment Act credit are to be treated identically 
with items that don't.
    You know, to some extent, we're pushing them with one hand 
and pulling them with another, and telling them they got to do 
this for CRA credit, but then make--I wonder if any of the 
other regulators would tell me why they think multi-family 
should continue to be treated the same as everything else in 
here, although I have to say in fairness to construction and 
land development and non-farm, non-residential have also been 
low, though not as low as multi-family.
    Let me ask Mr. Dugan.
    Mr. Dugan. Mr. Frank, if you go back and look at those 
losses in the 1980's, they were in a family of risk exposures 
that did share some correlation. They track each other over a 
long period of time, and they depend on rents, whether it's 
residential or non-residential.
    We've gotten a lot of comments about not just multi-family, 
but residential real estate construction over time having been 
less risky than office rentals. But both are part of a family 
of exposures where we have seen the risks move somewhat in the 
same way.
    But the main thing I want to come back to is, and I know 
you had concerns that you expressed in your opening statement, 
we're not telling people not to do this. We really aren't. 
We're saying--
    Mr. Frank. Do you really think that this has no effect of 
that sort of a discouraging kind?
    Mr. Dugan. I didn't say it would have no effect because I 
think it should have an effect. That's why we're putting it 
out. We want--
    Mr. Frank. A discouraging effect? Do you think, everything 
else being equal, that they may say, ``Well, you know what? 
Maybe we'll do less here and more there''?
    Mr. Dugan. I think that when institutions have 
concentrations, and we say they're going to have to pay more 
attention to it because concentrations have failed institutions 
in the past, and they have to do more, yes, that can be--
    Mr. Frank. Okay. But then again--and you know, you say, 
well, they're all in the same bucket. You made the bucket. I 
mean, you know, God didn't decide that all these--that 
construction and land development had to be the same as multi-
family.
    The fact is that the numbers do differentiate. Other 
buckets, other types are, it seems to me, treated in a more 
risky way. But there's a real difference. C&I loans do appear 
to have been more risky in some ways.
    But, you know, it's been 13 years. Not in 13 years have 
multi-family loans been subject to a higher chargeoff rate than 
others. And so when you tell a bank, ``Be careful about these 
and not about the others,'' or ``Be more careful about these 
than the others,'' you have the negative effect, and I would 
hope you would reexamine that. It doesn't have to all be in the 
same bucket. You can have more buckets.
    You know, if we need to appropriate more buckets for you, 
we'll do it. You don't have to put them all in one thing. And 
when things are not--you know, maybe you should watch Sesame 
Street, Mr. Comptroller. One of these things is not like the 
other, you take that into account.
    Thank you, Mr. Chairman.
    Mr. Hensarling. The Chair now recognizes himself. And as 
the father of a 4-year-old, and a 2-year-old, I actually do 
watch Sesame Street. I'm very familiar with that routine.
    I would like to follow up somewhat on the line of 
questioning of the ranking member, because it's a consistent 
theme that I hear from bankers in the Fifth District of Texas, 
and that is that they feel that the CRE guidance is essentially 
a single bucket that does not account for the diversification 
of various CRE product types, geographical diversification, and 
variance in loan to value ratio.
    So I would like a little bit more specificity in addressing 
the concerns of the bankers that I deal with in how do you plan 
to treat these variances and will we see many buckets as 
opposed to one bucket.
    Whoever would like to hop in here first.
    Ms. Bies?
    Ms. Bies. Congressman, let me put in perspective what we 
intended with these 100 and 300 percent benchmarks. We didn't 
intend these to be ceilings.
    When we scope out exams we try to, from afar, look at a 
bank and look at what's changing in its risk profile. We use 
our call reports to do that; and unfortunately, our call 
reports today classify loans by collateral, not business 
purpose.
    So what we are trying to say to our examiners is, because 
of where we are in the credit cycle, we want to make sure that 
we're getting more information on the kind of commercial real 
estate that's there. They can only do that by engaging directly 
with the bank.
    So for example, we know that some of the loans that are 
classified as commercial real estate are really loans that were 
made to small businesses and middle-size companies, and in an 
abundance of caution, the banks takes a mortgage lien on the 
property in case the business cash flow doesn't work.
    That is not the commercial real estate we want to describe, 
but today's call report lumps it in as commercial real estate. 
We are looking to change the call report classification so we 
get better surveillance. One of the challenges we've got is 
trying not to create too many buckets in the call report and 
make it difficult to handle.
    But what we want the examiners really to do is to step back 
and meet with the bankers and say, ``What is the mix of your 
lending, what kind of projects are you in, what varieties do 
you have, how do you monitor that?''
    They have to have that conversation by engaging with the 
bank. That was the intention, to say, ``You need to begin to 
have these conversations when the concentration on the call 
report gets above that level.'' It wasn't intended as a 
ceiling. It was intended as the beginning of more conversation.
    Mr. Hensarling. Anyone else want to pick up the bucket 
metaphor?
    Mr. Dugan. The thing I would amplify is that part of what 
we're asking is that bankers be able to show that they have 
those different levels of risk. That's exactly the kind of 
reporting and risk management that we'd like to see, a 
demonstration that they know where their risks are. When we 
examined some of the institutions, they couldn't tell us much 
about their risks, not even in some cases what was owner-
occupied and what wasn't, which is a pretty basic thing. And so 
the guts of this is, if you want to be in commerical real 
estate in a bigger way, you have to have more sophisticated 
ways to look at it to make these kinds of distinctions, and 
that's the kind of thing that will give comfort to examiners.
    Mr. Hensarling. As a firm believer in anecdotal evidence, 
would anybody else on the panel care to elaborate what they're 
hearing from their field examiners, and what might be lacking 
in certain risk management or reporting problems that you're 
hearing and seeing regarding the CRE concentrations?
    Mr. Reich. Congressman, I would simply like to state that I 
think that putting out a reminder to the industry of the risks 
of concentration is a good thing. I'm totally supportive of our 
doing that.
    But I do believe that being as proscriptive as we are, I 
hate to be the skunk at this garden party, putting out the 
guidance as proscriptive as it presently stands does run the 
risk of unintended consequences.
    As a former community bank CEO, I well remember how I used 
to sort of hang on the words of the Comptroller of the Currency 
when I operated with a national bank charter.
    The power of the bully pulpit is very strong, and when 
there are more than 3,000 bank examiners around the country 
trying to implement the guidance and supervise the institutions 
according to the guidance that we issue, I do have a concern 
that they will view these limits as caps and that consequences 
will be not what we as regulators intend for them to be.
    I think that expressing the guidance without the numbers 
will be--is a good thing for us to do, and that in our speeches 
and outreach meetings with bankers we can express our concerns 
and those will be heard.
    In fact, I'm under the impression that there are already 
some institutions that have assumed the guidance is the law of 
the land and they're already changing their policies 
accordingly.
    I'm also concerned about anecdotal evidence that I'm 
hearing that there are one or more financial analysts who are 
making buy and sell recommendations of financial institutions 
based upon whether or not they have reached these thresholds 
that are in the proposed guidance.
    Mr. Hensarling. Thank you, Mr. Reich, and also thank you 
for your work on regulatory relief in your previous capacity.
    The Chair's time has expired. At this time, the Chair will 
recognize the gentlelady from New York, Ms. Maloney.
    Mrs. Maloney. Thank you, and I thank the panelists. There 
was a bill I had to go to the Floor for. I apologize.
    I'd like to ask Susan Bies and Mr. Colby and anyone else 
who would like to comment, the QIS-4 led the regulators to add 
their additional safeguards to the U.S. version of the accord. 
And do you think the QIS-4 is an accurate measure of risk?
    Ms. Bies. Let me put QIS-4 in perspective. As the plan of 
work was put together several years ago for moving to Basel II, 
what we tried to do through the Basel Committee was encourage 
countries to take a measure periodically through the process to 
help us identify where banks are in risk management, what 
issues are there around the proposals, so that we could change 
them as we go.
    QIS-4, and I would say the most recent one that was done 
globally that we didn't do, QIS-5, that was released in May, 
continue to find areas where we need to strengthen the 
framework.
    Keep in mind that that's the goal, to help us do 
diagnostics on what needs attention, and it also allows the 
banks a way, in a consistent framework with other banks, to get 
feedback from regulators so that they may know where they're 
lagging behind in the development of the risk models.
    Now, as the Comptroller said earlier, and my other 
colleagues mentioned, the way QIS-4 was actually done, none of 
us would have accepted QIS-4 as a standard we could use for 
banks. The models were too early. We didn't have our completed 
guidance out. There wasn't a track record to build the 
databases. There were a lot of issues.
    So QIS-4, per se, if that was going to be reality, I don't 
think any of us would be wanting to use this as the framework, 
but it was meant to test where we are and look at how quickly 
we could move and what we needed to do.
    So from that perspective, it generally reinforced that the 
kinds of things we're trying to do were moving in the right 
direction, and the quality of the work in QIS-5, for example, 
is better than what we saw in 4, and so we're seeing progress 
being made as we move forward.
    Mrs. Maloney. Would anyone else like to comment?
    No? Okay.
    I am concerned that if the present proposals are adopted, 
we will have one risk management standard for large banks and 
then a different one for small banks, and yet a different one 
for the securities market; and shouldn't we be concerned that 
this will create the same problems that Federal Reserve 
Governor Meyer was concerned about in Basel I back in 1991 when 
he said, and I quote--
    I'm sorry, we're being called for a vote. We're not 
supposed to be called for a vote, so I don't know why they're 
calling us.
    But anyway, to quote Governor Meyer on Basel I, he said: 
``Banks are engaging in capital arbitrage to move their higher-
quality, lower-risk assets to the security markets or similar 
arbitrage issues with the result being through the total 
capital charges are not proportional to the total risk.'' And 
capital arbitrage was the reason given for many for moving away 
from Basel I, but aren't we heading in a similar direction in 
creating a similar problem with Basel II?
    And I'd like to ask Mr. Robert Colby and the Honorable 
Susan Bies.
    Mr. Colby?
    Mr. Colby. Well, the implementation of the CSE rules was 
done at a time when the securities firms were working off an 
early Basel II text, and the story is not over.
    Once the banking agencies move forward on their notice of 
proposed rulemaking, we plan to work with them to try to bring 
the two in as close alignment as we can.
    Mrs. Maloney. Honorable Susan Bies?
    Ms. Bies. Thank you. First, let me address the small banks.
    As we've been doing this exercise, we've done, as you know, 
at the Federal Reserve a series of white papers. Other folks 
have been doing research trying to look at competitive issues.
    We're still working inter-agency on our Basel I proposal, 
but I think you'll see when that comes out in a few weeks that 
we are addressing those portfolios where the competitive impact 
is likely to be the greatest, and in putting it out, we're 
going to be asking the bankers, are we focusing on the 
portfolios that we should have?
    So we are very conscious of it, and have been spending time 
trying to craft that, while also listening to the smaller 
bankers who want to make sure that the framework to measure 
risk is not so burdensome that it adds to regulatory burden for 
them.
    Mrs. Maloney. I'm really very sympathetic to competitive 
equality, but what I'm concerned about is we're in a global 
competitive market, and I'm concerned that American financial 
institutions, large or small institutions, not be put at a 
competitive disadvantage to foreign banks and financial 
institutions because of the capital standards, and at the same 
time, I'm very concerned about safety and soundness, and 
striking that balance to it.
    But I keep hearing concerns from institutions that they 
feel the capital requirements are going to be heavier and more 
onerous on American institutions.
    Ms. Bies. To keep the tie to American institutions, one of 
the things that we are moving toward is again, if you look at 
the more sophisticated products of the larger organizations and 
the historically different approach that securities regulators 
and bank regulators have had to capital, one of the things in 
that new market risk proposal that also came out with the Basel 
II NPR as a separate issue, we have been working very closely 
with securities regulators to try to make sure that a similar 
kind of position, similar kind of, say, subordinated debt 
tranche, whether it's held in a commercial bank or a securities 
firm, would have similar treatment.
    What was being proposed is something that globally we 
worked on, and the United States here, I think we're getting 
closer as a result of this effort to similar treatment not just 
globally, but more importantly, between commercial banks and 
securities firms for those firms who do the risk-based kinds of 
capital.
    So we are concerned about competitive issues, but we try to 
address them in the framework of safety and soundness and keep 
it strong.
    Just as the U.S. bank regulators have very strong capital 
requirements and our banks have thrived in that environment, 
our securities firms also have a very strict capital 
requirement and they've thrived.
    Mrs. Maloney. Do you feel that our banks and securities 
firms are put at any competitive disadvantage in the Basel II 
because of the capital requirements?
    Chairman Bachus. If you could wrap this up fairly quickly.
    Ms. Bies. There are some places where we've felt, as U.S. 
regulators, that we wanted something stronger, but those issues 
have also been discussed around the Basel table, and I really 
think many of these issues will be addressed long-term on a 
more global basis by other national regulators, too.
    So there could be a timing difference, but in terms of the 
Basel II risk framework, I think we are getting closer.
    Going to international accounting standards that are more 
harmonized is going to go a long way, also, to make the impact 
of capital rules more similar across countries. A big part of 
the world has never had capital on an off-balance sheet. They 
are finally getting it. We've had that for years. So I would 
say they've moving up to our standards.
    That was a big missing piece in the global capital standard 
that we're picking up and that, too, is moving us closer 
together.
    Mrs. Maloney. Mr. Chairman, if I could get one brief 
comment from the New York banking supervisor and 
superintendent, Diana Taylor.
    She indicated that she had not been called in on any 
conversations on this debate, and would appreciate it if the 
committee would listen to superintendents of banks across the 
country, that they have a point of view that they feel needs to 
be heard, also.
    Chairman Bachus. Thank you, Congresswoman.
    Let me just wrap up with one question, which is what you've 
heard most of these questions are about.
    I mean, we all agree that real estate lending ought to be 
done prudently. We further agree that, as a regulator, one of 
their primary duties is to see that it's done in a safe and 
sound manner and to examine portfolios, loan ratios, and all of 
these factors.
    That having been said, you heard the concern expressed by 
Mr. Frank, Mr. Hensarling, and even, I think, Director Reich, 
that the guidance doesn't take into account the 
diversification, and that even though it's your intent that 
these are guidances to the examiners, that it may create as a 
practical matter arbitrary ceilings that don't relate to actual 
risk, and that by setting number thresholds, the concern is the 
examiners in the field may assume that these ceilings are 
absolute.
    We've been assured, I mean, even today, that that's not 
going to happen, and earlier in correspondence, but there's 
certainly a lot of anecdotal evidence to show that the concern 
is justified.
    You were mentioning a Wall Street analyst, Director Reich, 
and a lot of our banks are saying they're afraid that the 
examiner is going to treat it this way.
    So my question is this. What plans do you have to address 
this concern and to ensure that the examiners are open to 
getting into the actual condition and diversification of a 
bank's CRE portfolio rather than simply assuming there's a 
problem?
    Or maybe another way, just to say that in a simpler way, is 
how do you plan to address these concerns in order to ensure 
that the guidance will be implemented appropriately by these 
examiners?
    Mr. Dugan. Mr. Chairman, we have already heard those 
concerns loud and clear from the industry as bankers have come 
through and talked to us, and I think it's a legitimate 
apprehension that we have to always be vigilant about. But we 
have embarked on a campaign with our examiners, in every region 
of the country, with every examiner who examines community 
banks, to deliver the messages that you've just described, and 
we will follow up on that.
    We encourage bankers to come to us with specific examples 
of where that's not occurring, and we will address the issue. I 
think we have to be sensitive, we have to keep repeating it, we 
have to monitor to make sure that it's clear, and that's 
exactly how we will approach it.
    Chairman Bachus. Thank you. I might want you all, maybe in 
the weeks to come, to write a letter to us, telling us in a 
little detail what you have done, or plan to do, in that 
regard.
    I'll close by saying that we've talked about commercial 
loan, lending money for commercial projects, and we haven't 
mentioned residential as much, but I did read the new Chairman 
of the Federal Reserve's book on the causes for the Great 
Depression, and I'm not going to try to paraphrase him, because 
I'd be incorrect. He did say there were a lot of failures to do 
some things that you all are doing, but he also, one of the 
themes of that was the failure to lend money.
    So sometimes a recession, depression, or bank failure can 
be because of imprudent lending. On the other hand, you can 
have a recession or depression based on too tight money, or the 
banks not lending money.
    So I would hate to think that actually we end up with a 
downturn in the economy because of guidance which restricts 
commercial lending and therefore depresses the economy, and 
then, as a result of that, depresses commercial property 
values. So you might want to pull out his book and read it. 
Thank you very much.
    We're going to recess for an hour and 15 minutes, because 
we have 45 minutes worth of votes on the Floor in actual 
minutes, so I don't think we can be back here before 2 o'clock, 
so we're just going to recess until 2 o'clock.
    The first panel is discharged, and I very much thank you 
for your attendance and testimony.
    [Recess]
    Chairman Bachus. Good afternoon.
    First of all, I appreciate your patience in waiting.
    I have read some of the testimony of the second panel, and 
I think it will be very valuable to us as we proceed.
    At this time, I'm going to formally introduce the second 
panel, starting from my left. Mr. Harris Simmons, chairman, 
president, and CEO, Zions Bancorporation, on behalf of the 
American Bankers Association. Mr. Simmons, where is that 
located?
    Mr. Simmons. Salt Lake City.
    Chairman Bachus. Salt Lake City. Okay. We welcome you to 
the hearing.
    Mr. Weller Meyer, chairman, president, and CEO of Acacia 
Federal Savings Bank on behalf of America's Community Bankers. 
1And that's located in?
    Mr. Meyer. Falls Church, Virginia.
    Chairman Bachus. Falls Church, Virginia.
    Mr. James M. Garnett, head of risk architecture, Citigroup, 
on behalf of the Financial Services Roundtable. We know where 
you're located.
    Mr. James McKillop, president and CEO of Independent 
Bankers' Bank of Florida, on behalf of Independent Community 
Bankers of America. And where in Florida are you?
    Mr. McKillop. Orlando.
    Chairman Bachus. Orlando. Okay.
    And then Mr. Marc Lackritz, president, Securities Industry 
Association. Marc, it's good to have you back before the 
committee.
    Mr. Lackritz. Thanks, Mr. Chairman.
    Chairman Bachus. Ms. Karen Shaw Petrou, co-founder and 
managing partner, Federal Financial Analytics. It's good to 
have you back before the committee. Ms. Petrou has testified 
before the committee on at least four or five occasions since 
I've been chairman.
    Mr. Robert White, Jr., president of Real Capital Analytics. 
Where is that located, Mr. White?
    Mr. White. New York City.
    Chairman Bachus. New York City. We're glad to have you.
    And finally, Dr. Glenn Mueller, professor, Burns School of 
Real Estate and Construction Management at Denver University. 
And we all know where Denver University is. Thank you.
    So at this time, we'll proceed from my left to right, 
starting with Mr. Simmons, and I think opening statements are 
going to be limited to about 3 minutes, although, you know, if 
it's 3\1/2\ minutes, you won't be interrupted.
    Thank you.

 STATEMENT OF HARRIS H. SIMMONS, CHAIRMAN, PRESIDENT, AND CEO, 
      ZIONS BANCORPORATION, ON BEHALF OF AMERICAN BANKERS 
               ASSOCIATION, SALT LAKE CITY, UTAH

    Mr. Simmons. Thank you very much, Chairman Bachus, for 
holding this hearing. The ABA appreciates the opportunity to 
express our views on these two very important issues.
    Our Basel II message is simple. The current proposal will 
hurt U.S. banks that compete internationally. It requires 
compliance with the most complicated version of the 
international rules rather than allowing U.S. banks the same 
flexibility that banks have in other countries, and it adds 
layers of constraints that are completely at odds with the 
principle of tying capital to risk.
    As a result, Basel II has evolved into a risk management 
exercise disguised as a capital rule. This can be fixed if the 
agencies adopt an approach very similar to the international 
Basel II accord.
    To avoid creating a capital disparity in the U.S. domestic 
market, we believe it's critical that the regulators also 
revise the capital rules for all U.S. banks and implement those 
rules simultaneously. Without this, the contradictory capital 
rules will invariably lead to pricing advantages and shifts in 
market share.
    It's crucial that all banks in a given market competing for 
similar assets have similar capital charges, especially when 
implementing a menu of capital rules. A menu of options could 
address effectively the international and domestic competitive 
issues.
    We encourage the regulators to consider both the so-called 
Basel IA approach and the standardized approach under Basel II.
    Regardless of the options provided, banks of all sizes and 
levels of sophistication should be able to select an approach 
that is both appropriate for them and that doesn't place them 
at a competitive disadvantage relative to one another.
    Turning to the guidance on commercial real estate, I'd like 
to leave you with one point. The guidance as proposed could 
inappropriately choke off the flow of credit.
    How many commercial real estate loans a bank makes is not 
the issue, it's how well that bank manages the risk, and a 
``one size fits all'' approach as proposed simply doesn't 
address the risk management issue.
    Moreover, there's a danger that an examiner will require 
more capital, regardless of how effectively a bank is managing 
the risk. This could tie up funds that otherwise would be 
supporting additional lending and it could also lead a bank 
into riskier activities to earn a return on that capital.
    Community and regional banks are likely to be hit the 
hardest by this guidance, as commercial real estate lending is 
a particularly important activity for them.
    It's not enough to soften the tone of this guidance. 
Examiners, hoping to avoid being second-guessed with problems 
that arise in their banks, may apply the guidance more harshly 
than the agency heads intended. To avoid this, the regulators 
should instead deal with problems on a bank-by-bank basis.
    If, however, final guidance is issued, it should first be 
changed to clear up questions concerning the scope of the 
guidance and the role of capital when a bank has a commercial 
real estate concentration, and the bosses in Washington must 
ensure that the examiners in the field understand how the 
guidance is to be applied.
    The ABA remains committed to working with the agencies on 
both the capital rules and CRE lending issues. I appreciate the 
opportunity to appear before you on behalf of the ABA and I 
look forward to answering any questions you may have.
    Thank you.
    [The prepared statement of Mr. Simmons can be found on page 
253 of the appendix.]
    Chairman Bachus. Thank you, Mr. Simmons.
    Mr. Meyer.

  STATEMENT OF F. WELLER MEYER, CHAIRMAN, PRESIDENT, AND CEO, 
   ACADIA FEDERAL SAVINGS BANK, FALLS CHURCH, VIRGINIA, AND 
  CHAIRMAN, BOARD OF DIRECTORS, AMERICA'S COMMUNITY BANKERS, 
   WASHINGTON, D.C., ON BEHALF OF AMERICA'S COMMUNITY BANKERS

    Mr. Meyer. Chairman Bachus, my name is Weller Meyer, and I 
am chairman, president, and CEO of Acacia Federal Savings Bank 
in Falls Church, Virginia, but I appear today on behalf of 
America's Community Bankers, where I serve as chairman of the 
board of directors. Thank you for this opportunity to present 
our views.
    Let me thank the committee for its substantial oversight of 
the Basel rulemaking process. Your interest has been 
instrumental in the progress made in ensuring the public 
interest is served. We also appreciate the thoughtful 
modifications made by the agencies to the initial proposals.
    However, ACB remains concerned about unintended 
competitive, safety, or soundness consequences that might arise 
from the rulemaking. Basel II should not be implemented unless 
changes are made to Basel I to more closely align capital with 
risk for other depository institutions.
    We are pleased that a proposal on Basel IA will soon be 
released by the agencies in response to this concern. We hope 
that the final capital standards will not add significant new 
regulatory burdens.
    Flexibility is key to creating a successful new capital 
regime. This flexibility should include the option for Basel II 
banks to chose between the standardized approach and the 
advanced approach as contemplated in the international Basel II 
accord.
    It also must include the establishment of a Basel IA 
standard that would permit the majority of banks to more 
accurately manage their risk and capital requirements, 
including additional risk buckets to more accurately measure 
credit risk. In short, the system must result in banks of all 
sizes having equivalent capital charges against equivalent 
risk.
    Moreover, Basel I banks should have the option of 
continuing to comply with the current capital requirements, 
because that will be less burdensome for many community 
institutions.
    Finally, we strongly support the regulators' intentions to 
leave a leverage requirement in place. A regulatory capital 
floor must be in place to mitigate the imprecision inherent in 
internal ratings-based systems.
    Turning to another topic of today's hearing, we are 
concerned that the CRE guidance could create competitive 
burdens for community banks with substantial commercial real 
estate assets.
    In particular, we see no need for potential capital 
surcharges for institutions that are well managed and well 
supervised. Any changes in capital requirements should be 
considered only as part of the Basel rulemaking and not through 
guidance.
    We also have suggested two other substantial adjustments to 
the guidance. First, the threshold test for commercial real 
estate concentrations must be adjusted to focus only on those 
types of lending that are likely to reflect significant risk 
exposure. Second, the guidance should not establish a ``one 
size fits all'' standard for management of commercial real 
estate lending.
    We thank the committee for its attention to these important 
issues, and I will be pleased to answer any questions.
    [The prepared statement of Mr. Meyer can be found on page 
185 of the appendix.]
    Chairman Bachus. Thank you.
    Mr. Garnett, I'm going to recognize Ms. Maloney just very 
briefly.
    Mrs. Maloney. Thank you so much. It is an honor to 
introduce Mr. Garnett, whom I have the honor of representing in 
New York. He is the head of risk architecture for Citigroup, 
where he is responsible for the oversight of group-wide market 
and operational risks. In addition, he is responsible for 
Citigroup risk performance reporting and measurements for all 
risks, including economic capital and credit risk rating, 
processes risk systems and implementation. He also receives all 
market risks for the Global Consumer Group, and we're delighted 
to have him here today.
    I look forward to your testimony. Thank you.
    Chairman Bachus. Thank you. Mr. Garnett, that's why I 
didn't go into where you were from.

 STATEMENT OF JAMES M. GARNETT, JR., HEAD OF RISK ARCHITECTURE 
  FOR CITIGROUP ON BEHALF OF THE FINANCIAL SERVICES ROUNDTABLE

    Mr. Garnett. Thank you very much. Chairman Bachus, and 
members of the subcommittee, my name is Jim Garnett. Thank you 
for inviting me to testify today. I'm responsible for the 
implementation of Basel II for Citigroup, but I'm here today on 
behalf of the Financial Services Roundtable.
    I would like to begin my testimony by emphasizing that the 
Roundtable strongly supports the implementation of Basel II in 
the United States. The Basel II accord is intended to better 
align regulatory capital to underlying economic risks. It is 
also intended to promote equality in the international 
regulatory capital standards.
    Last month, the Roundtable wrote to the Federal banking 
agencies expressing concern over inconsistencies between these 
goals and the proposed U.S. version of the accord. In its 
current form, the Roundtable believes that the U.S. version of 
the accord: one, is not appropriately risk-sensitive; two, 
disadvantages American banks against foreign competitors; and 
three, creates significant compliance cost issues.
    The answer to our concerns is twofold. First, harmonize the 
U.S. version of the accord with the internationally negotiated 
text. Second, offer all U.S. banks the same options for 
compliance that are available internationally.
    Harmonization of the accord would prevent foreign banks 
from gaining a competitive advantage over U.S. banks and better 
align risk and capital. Offering U.S. banks compliance options 
such as the advanced approach, the standardized approach, or 
Basel IA is equally important.
    Giving all American banks, large and small, a choice of 
methods for risk-based capital compliance has several benefits. 
Choice gives banks of all sizes access to simple and 
transparent methods. Choice assures a competitive marketplace, 
both domestically and internationally.
    And finally, choice promotes safety and soundness by 
ensuring appropriate minimum regulatory capital requirements.
    In summary, the Roundtable supports the development of 
modern risk-sensitive systems. The international accord is such 
a system.
    The proposed U.S. version of the accord, however, is 
inconsistent with the international accord. This creates 
significant risk, competition, and compliance concerns.
    We urge the harmonization of the U.S. version of the accord 
with the international version and we recommend that all banks 
be given a choice of compliance options. We hope Congress can 
endorse these objectives as the rulemaking progress moves 
forward.
    Thank you.
    [The prepared statement of Mr. Garnett can be found on page 
138 of the appendix.]
    Chairman Bachus. Mr. McKillop.

    STATEMENT OF JAMES H. McKILLOP, III, PRESIDENT AND CEO, 
 INDEPENDENT BANKERS' BANK OF FLORIDA, LAKE MARY, FLORIDA, ON 
  BEHALF OF INDEPENDENT COMMUNITY BANKERS OF AMERICA (ICBA), 
                        WASHINGTON, D.C.

    Mr. McKillop. Thank you, sir. Mr. Chairman, Ranking Member 
Maloney, and members of the subcommittee, I am Jim McKillop, 
president and CEO of the Independent Bankers' Bank of Florida, 
but I appear today on behalf of the Independent Community 
Bankers of America.
    ICBA appreciates this opportunity to testify on the bank 
regulatory agencies' proposed guidance on commercial real 
estate lending and on the agencies' proposal to implement Basel 
II rules. I want to compliment the subcommittee for taking up 
these difficult regulatory issues so late in the Congressional 
session. These proposals deeply affect community banks in their 
ability to serve their communities.
    IBB, my bank, serves over 270 community banks in Florida, 
the southern portions of Georgia and Alabama. We have CRE loans 
in excess of 600 percent of capital. As a bankers' bank, we 
serve only community banks, not the general public. This unique 
focus gives me an opportunity to hear and address the business 
challenges faced by community banks throughout the region.
    ICBA believes that the proposed commercial real estate 
guidance is seriously flawed, and we have strongly urged 
banking agencies not to go forward with its current form. 
Nearly 1,000 commenters filed letters with the agencies 
expressing grave concerns. Many community banks see it as a 
call to cut back on CRE lending.
    If a community bank must cut back, it means cutting back on 
one of its more profitable business lines, but we fear that it 
will also lead to an artificial credit crunch in the CRE 
sector, with less money being available to support community 
growth. A mentor of mine once said, ``You grow your community 
to grow your bank, not vice versa.''
    Existing real estate lending standards, regulations, and 
guidelines are sufficient to guide banks through any weakness 
in the CRE market, and have already provided examiners with the 
tools needed to address any unsafe and unsound practices.
    Banking regulators state that they have identified problems 
in some banks, yet they would apply this guidance across the 
entire industry. Instead, examiners should identify and address 
these problems bank-by-bank.
    The proposed thresholds of 100 percent of capital and 300 
percent of capital are seriously flawed; they do not give a 
clear picture of the risk; they do not take into account 
underwriting, risk management, and other practices of 
individual banks; and they do not recognize the different 
segments of the CRE markets that have different levels of risk. 
Market analysts could misapply the guidance from these sorts of 
CRE ratios, giving investors an inaccurate picture of a bank's 
level of risk.
    Community banks conservatively underwrite and manage CRE 
loans, requiring more and more down payments or taking other 
steps to control collateral. They must carefully inspect what's 
going on at all steps of the occasion. They know their 
community and they know how to underwrite.
    I thank you for the time, sir.
    [The prepared statement of Mr. McKillop can be found on 
page 162 of the appendix.]
    Chairman Bachus. Thank you.
    Mr. Lackritz.

 STATEMENT OF MARC E. LACKRITZ, PRESIDENT, SECURITIES INDUSTRY 
                       ASSOCIATION (SIA)

    Mr. Lackritz. Thank you, Mr. Chairman. Mr. Chairman, 
Ranking Member Maloney, and members of the subcommittee, on 
behalf of the SIA and the securities industry, I appreciate the 
chance to testify today on Basel II as incorporated in the 
SEC's framework for consolidated supervised entities, and we 
commend the subcommittee for holding this timely hearing.
    As the number of large financial conglomerates has grown 
steadily over the last several decades, regulators and market 
participants realized that a form of consolidated supervision 
was necessary to obtain a comprehensive view of the entirety of 
a firm's activities and not just individual lines of business. 
Consequently, a Joint Forum on Financial Conglomerate was 
formed to focus on the oversight of those institutions, 
financial conglomerates.
    In turn, the European Union's financial services action 
plan used portions of the Joint Forum's work to develop a 
directive, the financial conglomerates directive, and that 
mandates that any financial firm with significant operations in 
Europe demonstrate that it is subject to and in compliance with 
a regime of consolidated supervision.
    Under the terms of this directive, any non-E.U. firm must 
prove that it's subject to consolidated supervision by its home 
regulator that is, ``equivalent,'' to that required of E.U. 
firms, and a failure to demonstrate that equivalency would 
require that that firm's European operations would be fenced 
off or ring fenced, as the term is used, from the remainder of 
its global activities. In response to this initiative, the SEC 
undertook to craft a new regulatory framework for consolidated 
supervision of major independent investment banks not otherwise 
subject to consolidated supervision; this is so that they could 
compete in Europe.
    Under the CSE framework, the SEC supervises certain broker-
dealer, their holding companies, and affiliates on a 
consolidated basis, focusing on the financial and operational 
status of the entity as a whole.
    Parallel with the requirements of other global consolidated 
supervisors, the CSE framework incorporates significant 
elements of Basel II. In reviewing a CSE application, SEC staff 
assess the firm's financial position, the adequacy of the 
firm's internal risk management controls, and the mathematical 
models the firm will use for internal risk management purposes 
and regulatory capital purposes.
    Following approval, the SEC staff reviews monthly, 
quarterly, and annual filings containing financial, risk 
management, and operations data on the CSE registrant. To date, 
the SEC has approved five CSE applicants.
    Shortly after publication of the final framework by the SEC 
in July 2004, the E.U. provided general guidance indicating 
that the framework is equivalent to the form of consolidated 
supervision required under the financial conglomerate 
directive, and with the U.K.'s financial services authority 
acting on behalf of the E.U., that finding has been 
subsequently affirmed in its having made equivalence decisions 
for each of the individual CSE registrants.
    We congratulate the SEC on the implementation in a timely 
fashion of this framework and all the work that went into it. 
It required an enormous effort by the agency in a relatively 
short period of time, and we regard it as an excellent example 
of prudential supervision.
    The CSE firms also wish to thank this committee, Mr. 
Chairman, and members of the Administration, particularly the 
Treasury, for their interest in learning about the CSE 
framework and, most importantly, in ensuring the process of 
finding of equivalency by the E.U. was both fair and timely. 
That permits our firms to compete globally and specifically to 
compete in Europe.
    Thank you, Mr. Chairman, very much.
    [The prepared statement of Mr. Lackritz can be found on 
page 155 of the appendix.]
    Chairman Bachus. Ms. Petrou.

    STATEMENT OF KAREN SHAW PETROU, CO-FOUNDER AND MANAGING 
           PARTNER, FEDERAL FINANCIAL ANALYTICS, INC.

    Ms. Petrou. Thank you, Mr. Chairman. It is a real honor to 
appear before this committee again. It's an honor to appear 
before you again on the Basel rules, having first been a 
witness at your first hearing, and to have seen the significant 
difference in the rules, as under the leadership of you, 
Chairman Bachus, Ms. Maloney, and the Financial Services 
Committee, the regulations have changed for the better, 
particularly with regard to the recognition now of the 
potential competitiveness impact.
    However, as this panel makes clear, there are some ongoing 
issues which I would like briefly to raise before you.
    All of them, I think, are occasioned by the unique nature 
of the U.S. financial system, and our rules must therefore be 
crafted to recognize our own reality, not some abstract set of 
rules devised who knows where sometimes.
    We've talked a lot about the risks of different provisions 
in Basel II. If I may, I'd like to point to another one, which 
is the risk of the United States staying too long under Basel 
I. We are now lagging behind everyone else towards adoption of 
a modern capital framework, and this poses significant risks, 
not just because of the competitiveness concerns that have been 
voiced, but actual risk ones.
    I would suspect that one of the reasons the banking 
agencies put the CRE guidance out as is, as you rightly said 
earlier today, Mr. Chairman, as a blunt instrument, is because 
we don't have regulatory capital standards that can 
appropriately distinguish between high risk and low risk forms 
of commercial real estate, so blunt asset limitations have been 
proposed instead.
    Similarly, I think because our rules do not recognize risk 
properly, we have seen a huge buildup in high-risk mortgage 
structures because our regulatory capital system does not well 
recognize those and the agencies are now scurrying to try to 
remedy this, in part again because our risk-based capital rules 
are woefully out of date.
    We must move quickly. I think we must adopt as much of the 
modern Basel II framework as quickly as we can, leaving the 
disputed pieces aside, resolving those quickly, because again, 
the longer we stay under Basel I, the greater our 
competitiveness issues, but even more distressing, the higher 
the risk our system will run as the business cycle starts to 
turn.
    Now, I know that many of the agencies testifying this 
morning discussed the leverage standard as one they think will 
allay some of the risks they see in Basel II.
    I believe that that would be a false safety net, and in 
fact, would make the financial system here riskier if their 
leverage standard is retained.
    This committee well remembers the thousands of banks and 
S&L's that failed in the early 1990's, and before that 
throughout the 1980's, when a leverage standard was fully in 
effect.
    A leverage standard, particularly if applied to the parent 
holding companies, creates incentives to take risk, not to 
reduce it, because banks must find a way to make regulatory 
capital and economic capital align as best they can, and an 
arbitrary leverage standard forces them to take on more risk.
    It also forces more reliance on complex off-balance-sheet 
assets that escape the leverage rule, exacerbating potential 
risky complexity.
    I've testified many times on the operational risk standard. 
I'd like again to remind the committee that it is an 
unfortunate aspect of both the Basel II accord and now of the 
U.S. Basel II NPR. Happily, it is out of the 1A proposal and 
should stay out.
    There is no agreement on methodology or measurement for 
operational risk and a capital charge will distract banks and 
supervisors from urgent work to ready our systems, our 
contingency plans, and disaster preparedness for the manmade, 
and sadly, for the terrorist risks we must continue to face.
    With regard to the standardized option, I would suggest 
that it be put on the table for U.S. banks. I think it is up to 
the banks to pick the capital regime right for them, not for 
the regulators arbitrarily to specify one or another for 
different types of banks based solely on size.
    If the banking agencies do not like the choice an 
institution makes, they have Pillar 2, safety and soundness, 
and Pillar 3, market discipline powers to review these 
decisions and, if necessary, reverse them, but an arbitrary 
distinction about which capital option should be provided to 
whom is, I think, top down decision making that exacerbates 
regulatory burden and competitiveness concerns.
    Thank you, very much.
    [The prepared statement of Ms. Petrou can be found on page 
239 of the appendix.]
    Chairman Bachus. Thank you, Ms. Petrou.
    Mr. White.

STATEMENT OF ROBERT M. WHITE, JR., PRESIDENT AND FOUNDER, REAL 
          CAPITAL ANALYTICS, INC., NEW YORK, NEW YORK

    Mr. White. Thank you, sir. Thank you for the opportunity to 
speak to this subcommittee and to address several concerns I 
have relating to the proposed guidance for CRE concentration 
risk.
    The premise of the proposed guidance is that real estate is 
among the most volatile of assets, but this premise is faulty. 
Real estate remains a cyclical business, but it is no longer 
subject to the extreme boom and bust cycles that were 
experienced in the 1980's. The capital market for commercial 
real estate has evolved into one that is sophisticated, 
transparent, disciplined, and national, if not international, 
in scope.
    Moreover, the transformation of both the debt the equity 
markets has occurred only recently, primarily in the past 
decade, and the changes are secular in that they have 
permanently changed the nature of this industry.
    The level of information currently available concerning 
real estate prices, mortgage terms, development activity, 
rental rates, and occupancies make the 1980's look like the 
dark ages.
    In the capital markets, this new level of transparency 
translates into greater liquidity and a diversity of capital 
sources, many of which did not exist in the 1980's.
    For example, real estate investment trusts, or REIT's, 
while created in 1960, only became a material component of our 
capital market in the mid-1990's. The growth of the REIT 
industry has not only expanded the investor base for real 
estate but brought a whole new level of scrutiny to the 
industry. In 1990, there were less than a handful of Wall 
Street analysts covering REITs and the commercial real estate 
industry. Now there are approximately 500.
    The introduction of public capital into the real estate 
debt markets in the form of commercial mortgage-based 
securities, or CMBS, has had an even greater influence. The 
CMBS market helps illustrate that a concentration of CRE loans 
is not inherently bad if the portfolio is intelligently 
underwritten and diverse geographically and by property type.
    Current subordination levels in the CMBS market approximate 
15 percent, meaning that up to 85 percent of the bonds secured 
solely by commercial mortgages would be awarded a AAA rating. 
The proposed 100 percent and 300 percent thresholds do not 
differentiate between a portfolio that is well diversified and 
a portfolio that is not.
    The CMBS market has also revolutionized transparency and 
imposed much-needed standards regarding underwriting, 
documentation, and reporting for commercial mortgages. There is 
also another aspect to the proposed guidance that troubles me. 
The 100 percent threshold for construction loans could impede 
economic growth and restrict capital for new housing and other 
development since commercial banks are the chief source of 
construction loans.
    Equity of all reporting bank holding companies totalled 
less than $1 trillion according to the latest out data from the 
Federal Reserve. However, private construction spending also 
equates to an annual rate of just under $1 trillion, although 
construction spending represents only a portion of overall 
development costs.
    Thus, the 100 percent threshold outlined in the guidance 
would be restrictive, even at current levels of construction 
activity, and may have unintended consequences of creating a 
problem where none currently exists.
    Thank you for your time, and I welcome any questions.
    [The prepared statement of Mr. White can be found on page 
281 of the appendix.]
    Chairman Bachus. Thank you, Mr. White.
    Dr. Mueller.

STATEMENT OF GLENN R. MUELLER, Ph.D., PROFESSOR, UNIVERSITY OF 
DENVER, FRANKLIN L. BURNS SCHOOL OF REAL ESTATE & CONSTRUCTION 
   MANAGEMENT AND REAL ESTATE INVESTMENT STRATEGIST-DIVIDEND 
                      CAPITAL GROUP, INC.

    Mr. Mueller. Thank you. My name is Dr. Glenn Mueller, and 
I'm a professor at University of Denver. I have a Ph.D. in real 
estate and I was called here by the Committee for Sound Lending 
and the Real Estate Roundtable to help educate you on some of 
the problems that we have today.
    The proposed banking agency guidance on commercial real 
estate lending concentration appears to be predicated on some 
fundamental misconceptions of how the commercial real estate 
industry functions today as opposed to 20 years ago when we had 
our major problems. Today, the commercial real estate industry 
is a very different one than existed in the 1980's and the 
early 1990's.
    The real estate asset class has two major groups--
residential home ownership real estate and commercial income-
producing real estate such as office, warehouse, retail, 
apartment, and hotel.
    Residential real estate markets and commercial real estate 
markets are fundamentally different. Residential ownership, 
housing, is not connected or highly correlated with commercial 
income-producing real estate.
    The commercial space market is local in nature, driven by 
local employers for demand and builders for supply. Demand and 
supply drive occupancy rates that drives rent growth. Occupancy 
rates and rents drive earnings that make mortgage payments.
    The real estate space markets today are different for every 
metropolitan market, for every major property type. Thus, a 
Chicago office market and a Chicago retail market are in very 
different places in their cycles and the Chicago retail market 
is in a very different place from the Miami or New York retail 
market.
    In my written testimony, I have a copy of the market cycle 
report that I do on a quarterly basis that goes out to most 
people in the industry, that explains those differences.
    The space cycle of the 1970's was 10 years long, peak to 
peak, while the next cycle was 21 years long, 1979 to the 2000 
peak. The current economic space market hit an occupancy bottom 
in 2003, but price declines and loan defaults did not happen in 
this down cycle as they did in the 1990's.
    Today's space market is still in the recovery phase for 
most property types and probably won't peak until after 2010. 
The growth phase of this cycle probably doesn't start until 
2008.
    The severe cycle downturn that occurred in the commercial 
real estate market during the 1980's and early 1990's was 
triggered by factors that are not present in today's 
environment, such as the changes in the internal revenue code 
that allowed people to make tax investment and tax shelter 
deals.
    These deals were not based on underlying profitability of 
the project as well as we had expansion of lending powers to 
thrifts that allowed commercial real estate loans to be made 
for the first time by people who were inexperienced in the 
marketplace. These factors led to over-building. Then 
regulatory guidance in the early 1990's shut down all capital 
flows to commercial real estate and the problem was 
exacerbated, and hurt a healthy real estate industry for many 
owners with good properties.
    The agencies should gain a better understanding of the 
changes in the marketplace today and develop guidance that 
addresses the diversity and low risk of today's real estate. 
They should also consider an analysis of property type and 
metropolitan area concentrations when they analyze risk.
    We hope that the committee will think about, or rethink, 
the need for these arbitrary thresholds that they are 
proposing.
    Thank you.
    [The prepared statement of Dr. Mueller can be found on page 
214 of the appendix.]
    Chairman Bachus. Thank you.
    Mr. Hensarling, thank you for your attention on this 
matter, and for your involvement. It's been invaluable.
    Mr. Hensarling. Thank you, Mr. Chairman. I offer an apology 
to almost every witness. I was on the Floor engaged in debate 
and frankly missed most of the testimony. I think I heard about 
half of yours, Mr. White, and much of Dr. Mueller's, which 
actually hit upon a key point that I wanted to explore with our 
regulators and ran out of time on the earlier panel. And that 
is really to compare and contrast the underlying conditions in 
our risk assessment tools we have today vis-a-vis roughly 15, 
20 years ago, in the late 1980's and the early 1990's.
    One thing I guess I heard you say, Dr. Mueller, which rings 
very loud to me, is that there was a lot of real estate that 
was built that was essentially tax code driven, and to me that 
is obviously a very fundamental difference we have in today's 
economy versus that which preceded the real estate bust of that 
time.
    But I'd be curious in exploring with any of the other 
witnesses, as we get concern from the regulatory community, 
what is it that your industry is doing differently today than 
it was 15 years ago that should somewhat ease the concerns of 
members of this committee? How do we know it's not going to be 
``deja vu all over again?'' Whoever would like to hop in.
    Mr. McKillop. I'd love to give it a try. In relationship to 
community banks, we are seeing that there is a much, much 
closer correlation to the banker understanding cash flow needs 
of the borrower, the cyclical needs of that borrower, and their 
capacity to pay.
    The community banker goes to church and the Rotary Club and 
the grocery store with these folks that they're making loans 
to. It's not mystique. But in this cycle, we are not driven by 
a tax-laden incentive to get things going.
    We have been driven, however, by a low interest rate 
environment, which helped spur the economy out of the economic 
decline following 9/11, which recognized that was the case.
    The Federal Reserve led us to very low interest rates. It 
spurred the economy along as prime dropped to 4. Prime is now 
back up to slightly above 8. And that helped the economic 
cycle. There will be some repercussions from negative cash flow 
as interest rates have gone higher.
    But the bankers are understanding the valuations, they're 
taking strong loan to value precautions, they are taking a 
guarantor or a co-borrower position behind the collateral in 
addition to that and monitoring on a monthly or quarterly 
basis.
    Mr. Hensarling. Anybody else?
    Mr. Lackritz. Yes, Congressman. We don't have a direct dog 
in this particular fight concerning real estate loan 
regulation, but talking about the capital markets and how 
that's changed significantly over the last 15 years, I can 
speak to the evolution of deep, rich, liquid capital markets 
that in fact help to finance all the mortgages and real estate 
loans that end up being made.
    While they're made at the front end by the banks, they end 
up being laid off back into the capital markets and sold in the 
capital markets and securitized, basically. And the capital 
markets have grown dramatically in the last 15 years to provide 
additional liquidity to the sector, but in addition to that, 
with the evolution of financial engineering, portfolio theory, 
and a number of other factors that go into managing risk more 
effectively, there are far better products in the marketplace 
now to hedge that risk. There are structured products to in 
fact try and provide some balance and some risk.
    And so while you've got evolution of technology and you've 
got evolution of marketplaces, you still have human nature, 
which hasn't changed, and which will still cause boom and bust 
cycles, but I think the capital markets have evolved in such a 
way that it helps to cushion those ups and down a lot more 
significantly than they used to.
    Mr. Hensarling. I'm being mindful of my time, and wanting 
to slip in at least one more question.
    Dr. Mueller, did you have one quick comment?
    Mr. Mueller. Yes. Very quickly. In 1990, there were very 
few real estate programs in the country. Today there are over 
30 of them. We have 500 students at the undergraduate and 
graduate level in our program. We have people who are well-
versed and understand the marketplace.
    In the 1970's, when I first went to work for a bank as a 
loan analyst, there were no standards for appraisal. Now we 
have appraisal licensing.
    And many times, banks didn't even have good information 
about the loans that they had made when they went bad. Today, 
we have much better standards and much better underwriting and 
we're underwriting economic deals that actually have tenants 
and leases in place.
    Mr. Hensarling. A second question.
    As I listened carefully this morning to the chairman of the 
FDIC, I thought I heard her say that with respect to the CRE 
guidance, that we do not have limits, we just have increased 
scrutiny. I'm not sure all the bankers in my district feel 
thusly.
    Do you feel that there is a de facto limit out there, and 
if so, what evidence do you have of it?
    How about you, Mr. Simmons?
    Mr. Simmons. I guess I'd say that we found regulators, 
starting about 3 years ago, really focusing on commercial real 
estate concentrations.
    We are very active through the Southwest, Texas, Arizona, 
Nevada, and Southern California, where it's a major activity, 
and I'd say first of all, to their credit, they have focused on 
strengthening risk management, and I think the industry is 
doing a much better job of that.
    But I do think that there is a risk when you try to get the 
word down to the examiners in the field, that it does turn into 
a very prescriptive kind of approach that has a risk of really 
shutting off credit to projects that are deserving of credit.
    And so that's--you know, we have yet to see how this will 
play out, but I think we're all nervous about the possibility 
of it really becoming a great tightening.
    Mr. Hensarling. With the chairman's indulgence, could the 
other panelists answer the question?
    Chairman Bachus. Yes, sir.
    Mr. Meyer. Mr. Hensarling, I would just add to that, not 
something different, but just a slightly additional 
perspective. And that is that, in the hands of an examiner, the 
tendency is to interpret guidance from Washington in the most 
severe fashion, and as I read through the guidance, in fact, I 
used a highlighter, because they make a very grand distinction 
between the word ``should'' and the word ``must,'' which on a 
regulatory basis has significant implications.
    If you count the number--I gave up. My yellow highlighter 
was wearing out in terms of the number of ``shoulds'' that were 
contained in the guidance. And I'm afraid what happens in the 
real world is that the examiners tend to read that as 
``musts,'' the ``shoulds.'' Also, I would say that beginning 
with an examination which we were undergoing when this guidance 
was first issued on a proposal basis, that the examiners who 
were examining our institution immediately started evaluating 
our performance using the thresholds outlined in the guidance, 
and while we protested, they said, ``You might as well look at 
it from this perspective, because here's what's coming.''
    So I think the real world application may be different from 
what is intended in Washington.
    Mr. Hensarling. Did anyone else wish to address the 
question?
    Mr. McKillop. I've been through an examination. I have 270 
banks that I work with. Since January when these guidelines 
went out, every banker that I've spoken with has been directed 
to be using the new guidelines. My most recent exam used the 
guidelines in August.
    Mr. Hensarling. Thank you. And I am very much out of time.
    Chairman Bachus. Thank you.
    Ms. Maloney.
    Mrs. Maloney. Thank you. I thank all of you for your 
insights. I'd like to ask Mr. Garnett, on the QIS-4, it led the 
regulators to add their additional safeguards to the U.S. 
version of the accord. And my question is, do you think the 
QIS-4 is an accurate measure of risk?
    Mr. Garnett. The direct answer to your question is no, and 
I think we probably heard that same answer from at least one or 
two of our regulators this morning, and let me describe why 
that is the answer.
    The QIS-4 was performed long before the practices in the 
various banks were in compliance with Basel II. We're still 
working on that as we speak. As I think Comptroller Dugan 
mentioned, there was no supervision to that exercise.
    Most importantly, there was no assessment of what we call 
Pillar 2, and that is a very important part of the Basel II 
process. This is the supervisory examination process where they 
sign off on your process. So I would describe QIS-4 as a dress 
rehearsal without the director in the house.
    Unfortunately, we've drawn some conclusions, or conclusions 
may have been drawn from that and have resulted in adjustments 
to the advanced approach from the Basel accords which are 
obviously now causing us some very serious competitive and cost 
burden concerns.
    Mrs. Maloney. Would anyone else like to comment?
    Ms. Petrou. I would. I would strongly agree with that. 
Indeed, initially, the regulators expected that the QIS-4 
exercise would be very flawed and they intended to have 
supervisors at everybody's side, double checking all the 
entries. That quickly became impossible and the survey results 
are just wholly unreliable as a result.
    Mrs. Maloney. I'd like to ask you, on your earlier 
statements, you said, Ms. Petrou, that many of the industry--
and you--stated and others stated that the fact that the United 
States is behind other countries in the implementation of the 
Basel II accord would put U.S. banks at a disadvantage. And can 
you quantify that? In other words, to what extent should we 
value implementing a rule quickly over making further 
adjustments?
    Mr. McKillop. I think it's impossible to quantify, because 
you're really asking me to judge when is the search for the 
perfect the enemy of the good. And I think the Basel exercise, 
from its inception, when your committee first held these 
hearings in 2002, until now, has often been one in which model 
builders wrestle each other to the ground on what a probability 
of default is on a Tuesday, and the larger scheme gets lost.
    I was very honored to testify before this committee last 
year that a lot of Basel debate has been among the ``how to'' 
people, both in the regulators and in the banks, and the 
``should we.''
    What does it mean for a financial system debate is only now 
coming out as again your committee has forced the regulators 
and the industry to really confront these issues.
    If foreign takeovers occur in the United States, or we have 
bank non-bank takeovers where institutions decide to lose their 
banking charters because they see this as a necessary market 
evolution, so be it, but if we have further consolidation or 
similar changes, more non-bank charters, for example, creating 
new risks solely because of an arbitrary regulatory capital 
charge, that I think would be a most unintended consequences of 
the search for the perfect capital accord.
    Mrs. Maloney. Building on what you said, are there parts of 
the accord that could be adopted now while leaving room for 
further adjustments, and would that make sense?
    Ms. Petrou. With modifications for the United States, yes. 
For example, the operational risk-based capital rule is ill-
designed and inappropriate around the world, and we should not 
impose it here, especially in light of the many non-banks that 
are key competitors in segments like asset management, and our 
leverage rule is problematic for the same reason.
    I would note that the SEC did not impose a comparable 
standard in the CSE charter, so big commercial banks like 
Citigroup are on day one against a competitive challenge with 
big investment banks like Goldman Sachs, as a result.
    Mrs. Maloney. Going to another point, I was really shocked 
at the testimony this morning by some of the regulators where 
they, if I heard them correctly, they said that if there were 
any problems, then they'd let the international community work 
it out. Now, I don't see the international community trying to 
protect the American financial interests. I found that very 
troubling.
    I also found it very troubling where no one would affirm or 
come forward--I said, are American banks disadvantaged in the 
capital requirements, and I got the impression that, ``Yes, but 
don't worry about it, the international community will work it 
out.'' Now, I found that a troubling statement, but I invite 
anyone on the panel to make a statement on it, or do you trust 
the international community to work out any problems that may 
be disadvantaging the American financial institutions?
    I'll go to Mr. Garnett. I'll pick on him, since he's my 
constituent. But I really invite anyone else to make a 
statement. But I found that, quite frankly, a shocking 
statement.
    Mr. Garnett. I think the approach to fixing a significant 
problem that is unearthed, and quite frankly, I have yet to be 
made aware of a significant problem that can't be corrected 
through the powers that the regulators have been granted in 
Basel II, particularly through Pillar 2.
    But if there is a particular flaw that is found after a 
period of time, we would obviously prefer that flaw be fixed 
universally, so that we don't find ourselves with an uneven or 
a disjointed regime for regulatory capital.
    I think that's about all I can add to your thought.
    Mrs. Maloney. And if I could add to it, there's significant 
differences between the proposed U.S. version of the accord and 
the version being implemented in the E.U. and other countries. 
I don't understand why we have this difference.
    But there's a different implementation schedule, there are 
overall more conservative rules leading to a harsher decision, 
no choice of compliance methods. There's artificial definition 
of default not consistent with current banking practices. These 
are a few differences that we pulled out, but why should we 
have these differences?
    As you said in your testimony, Mr. Garnett, why don't we 
harmonize it and move forward so that everybody is on a fair 
playing field and that everybody has a competitive equality?
    And my question to you, we should not put our banks at a 
disadvantage to foreign banks. At the same time, I am concerned 
about safety and soundness, and is it possible to strike a 
balance between these two policy issues? And again I'll start 
with Mr. Garnett, and if anyone else would like to add 
anything.
    Mr. Garnett. As you stated, in our testimony, we think it's 
extremely important to be operating from a consistent set of 
standards.
    Again, if there appears to be a significant flaw in those 
standards, I think that flaw ought to be resolved within the 
Basel community at large, so that if there are--I am not aware 
of any significant flaws. We are implementing as we speak, as a 
company, in many locations, and we are not at this point aware 
of any significant concerns that are being raised to us with 
regard to this implementation. So we feel, obviously, very 
comfortable with the safety and soundness. That was a critical, 
critical piece of the objective of Basel II, safety and 
soundness, and I want to underscore that, in level of 
importance.
    Chairman Bachus. I thank the gentlewoman from New York.
    Let me start by saying that the risk management procedures 
at banks must be working, because I don't think we've had a 
bank failure--we're at historic lows. No, we've had, you know, 
much advertised busting of the residential housing market in 
certain areas, although as the testimony has been, you know, 
it's different from area to area. But the banks are obviously 
doing something right.
    The regulators--the present regulatory scheme must be 
pretty good. That having been said, what is proposed--let me 
ask the bankers, I'm going to start with the bankers. This 
question will go to Mr. Simmons, Mr. Meyer, and Mr. McKillop.
    What the regulators are proposing as far as the regulatory 
model that they're setting up under Basel, how does it fit with 
the present-day banks' procedures, risk management procedures? 
Would it force a change in what you're doing, and what would be 
the cost or the result of those changes?
    Mr. Simmons. Thinking about different sizes of banks, I 
think you'll find that the very largest banks are well down the 
road toward developing economic capital models and risk 
management systems that are very compatible with the concepts 
underlying Basel II. As you get to community banks, that would 
be less the case.
    But nevertheless, I think the standards have risen across 
the board, over the last couple of decades, since we last had 
some real problems in the industry, in terms of the structure 
internally in institutions, the risk management checks and 
balances, and appraisal review functions as it pertains to 
commercial real estate, etc.
    But it's important, I believe, that we have options, that 
the very largest banks have a regime that's compatible with 
their complexity and the work that they've already done, and 
that the community banks, that we not add to the regulatory 
burden.
    At the same time, we believe that it's really important 
that we not create capital allocations and charges for 
different classes of assets that vary by size of institution.
    So at the end of the day, I think it's going to be really 
important that we allow every size bank to apply the same type 
of capital charge to the same type of asset. Otherwise, you're 
going to find a great deal of arbitrage, shifting of market 
share, and I think a great deal of risk that will arise as a 
result of that. So that's going to be important as we build new 
capital frameworks going forward.
    Chairman Bachus. Mr. Meyer.
    Mr. Meyer. I'm not sure that I would differ with anything. 
I would like to re-emphasize the point about similar charges 
for similar assets. I think that's terribly important.
    I think what's going to happen, and I think what has 
happened, as Harris was saying, is that we have seen a vast 
improvement and change in modeling that banks do in their risk 
management practices, and I think that is universal, to a 
higher degree perhaps in the more sophisticated larger 
institutions, and if you get to the smaller community banks, 
less so.
    But nonetheless, it has been a subject of concern and 
interest for virtually everybody, and I think that the longer 
the good times have gone on, and we've all enjoyed some pretty 
good times, I think that the degree of scrutiny within 
institutions has risen because we all realize that good times 
don't necessarily last forever.
    I think that the opportunity to have a bank choose the 
system that best fits its business model and its risk 
parameters from having available to them in the future Basel I, 
IA, and having the advanced approach as well as the 
standardized approach, it fits what I think institutions are 
gravitating towards, and that is, choose the model that best 
fits your institution and your risk model, your risk parameters 
going forward as an institution.
    And I think universally that will tend to strengthen the 
risk management practices even further than it has in the past, 
as people have broader opportunities.
    Chairman Bachus. Anyone else?
    Mr. McKillop. Yes.
    In trying to speak for community banks, I'd have to say 
that there is a tremendous uncertainty in regard to whether or 
not it's going to make sense for a $100 million or $200 million 
or $300 million bank to spend the money necessary on the 
computer side of the business, which they don't own--they don't 
have the DP system inside, they don't have the programmers 
inside. They have to go out to an advisor and get a program 
written and get it run and pay for it--the tradeoff. Where's 
the tradeoff? I'm going to spend $100,000 for this program to 
get $10,000 more in revenue, or not?
    So the community banker really needs the opt-out provision, 
the capacity to keep running like they're running right now, as 
long as they're well-capitalized and well-managed. If, down the 
road, there is a clear and directed economic bias that says 
that if I adopt these standards, I can make a better business 
plan, then that community banker could opt-in. They're smart 
enough to be able to do it, and hey're independent enough to 
want the choice.
    Chairman Bachus. All right. And Mr. Garnett, the larger 
institutions, do you have any comment on this?
    Mr. Garnett. As far as we're concerned, the most effective 
way of managing cost burden, or cost benefit we should be 
thinking about, and level playing field, competitive 
marketplace, is permitting options that fit the right shoe.
    And I think by having on the table Basel I, Basel IA, 
standardized and the advanced, and of course those last two 
approaches need to be consistent with the international accord, 
I think provide the marketplace here in the United States with 
the right balance of options.
    Chairman Bachus. All right. If we had not only advanced but 
a standardized approach option, would it in many cases for the 
banks--and I'll ask the bankers this again--would it reduce the 
cost, or what would be the--what do you see as a cost 
prediction?
    Mr. McKillop. If I could just start, the standardized 
option is clearly easier to adopt.
    Chairman Bachus. It's more cost-efficient?
    Mr. McKillop. That's correct.
    Chairman Bachus. And the smaller the bank, the more 
difference--
    Mr. McKillop. The more likely that they would move in that 
direction.
    Chairman Bachus. Mr. Simmons?
    Mr. Simmons. Yes, I would agree with that. The standardized 
approach is going to be much more cost-effective and lead to 
approximately the same kind of result.
    Chairman Bachus. Thank you. Let me shift to the analytic 
and our academic witnesses.
    I guess, Mr. Mueller, what you said is something a lot of 
people don't appreciate. I think they lump real estate 
together. They talk about a bubble, and they'll be talking 
about a residential housing bubble; in another place, there may 
be an overabundance of commercial property or over-building.
    But I would think that really, the people who can make the 
best judgment of that would be the local institutions that are 
loaning their money, as to whether it's profitable.
    I think that if you're a local bank, you're going to make a 
judgment on whether you think you get your money back, and it 
probably depends more on who you're lending it to and how deep 
their pockets are, and they may even lose their investment, but 
at least they would probably pay their loan off.
    But I just--what would you--I read your testimony. Would 
you elaborate on the difference in the residential market and 
commercial market again?
    Mr. Mueller. Sure. I guess one of the key things is that a 
residential loan to a homebuilder has a risk to it that, when 
the house sells, the bank gets paid off.
    In commercial real estate, and I put apartments in the 
commercial real estate income-producing category, you basically 
pre-lease space prior to building, and therefore you know that 
you have revenue coming in that will help pay the loan. As a 
matter of fact, of all the property sectors, of all the 
commercial property sectors, apartments have shown to be the 
least volatile of all the property sectors in history, and yet 
they're very different, and let me give you an example from my 
recent quarterly report.
    Orlando, Florida, has an apartment vacancy rate that is 
under 2 percent today. It is one of the strongest apartment 
markets in the country, because obviously the economy is doing 
well. A loan to an apartment building in Orlando would be 
perceived to be extremely low risk.
    On the other hand, if you look at Hartford, Connecticut, 
their vacancy rate is above 10 percent, and it's not a 
community that's growing, it's not a community that needs more 
apartments, and therefore a new building in Hartford, 
Connecticut, probably is not economically justified.
    Banks know that. Banks can look at it and say office 
buildings today can't be built unless at least 50 percent of 
the space is pre-leased. That's pretty standard in the banking 
industry today, so there is much better understanding of what's 
going on.
    Banks, when they are doing larger loans, typically will 
syndicate participations to other banks so that they aren't 
just concentrated in their own community, they actually are 
spread out.
    They can also sell their commercial loan if they're making 
a permit mortgage into the commercial mortgage-backed 
securities market and buy back the same amount of loan in the 
CMBS market that is a pool that's diversified across the 
country.
    So what happened in the early 1990's is very, very 
different from what's happening today.
    Chairman Bachus. I think in your testimony you mentioned 
that the Middle Atlantic region consists of both Washington and 
Philadelphia, although those markets right now are 
diametrically opposed--
    Mr. Mueller. That is correct--
    Chairman Bachus.--their characteristics.
    Mr. Mueller. That is correct. As a matter of fact, even 
here locally, the downtown Washington, D.C., market is 
literally the best in the country, and yet if you go out west 
towards Dulles Airport, that market, that sub-market, if you 
will, is still kind of coming through recovery and just 
beginning to go into growth. So even by sub-market, there can 
be major differences.
    Chairman Bachus. How do you generally define a CRE market? 
Is it a region? Is it a State? Is it a city?
    Mr. Mueller. It's typically done by metropolitan area, is 
the way that most people look at it, because the base 
industries that drive employment growth, for instance, between 
Seattle, Washington and Detroit, are completely different.
    As the oil industry goes, so goes Detroit, but Seattle is 
done by both technology and the airline and aircraft building. 
So metropolitan areas are driven by the local economics and 
employment, and the commercial property types follow those 
cycles, and that's why in the report it shows that they're 
very, very different.
    Chairman Bachus. But even a bank examiner trying to 
determine a threshold or a cap could make a mistake reviewing a 
loan portfolio.
    Mr. Mueller. Right. Well, I think if they looked at 
diversity of loans within different metropolitan areas and just 
by different property types as well--you can have a very good 
market for apartments in Chicago, but a not-so-good office 
market, and so the different cycles by property sector make 
sense.
    I think one of the biggest problems is that regulators and 
the general public, when they hear real estate, they think of 
that one thing, or the past 2 years every time, and on a weekly 
basis I get a call from a reporter, ``Will you give me some 
quotes for the real estate bust?''
    And my first question is, ``Do you understand that there is 
a difference between the residential home ownership and the 
commercial real estate market?''
    Chairman Bachus. Okay. Mr. White, you mentioned the condo 
converters. We obviously--I have a property on the Hill, and 
I'm constantly getting letters from these converters asking to 
buy my property. And I've noticed the regulators have actually 
expressed some concern about that.
    But, you know, in my opinion, it actually adds liquidity to 
the market, and I'm not getting as much--they've adjusted 
pretty well to the market, because I used to be getting two or 
three, you know, a month, and now I'm getting maybe once 
every--it's been probably 2 months since I've got a 
solicitation. But would you comment on that?
    Mr. White. Sure, I'd be glad to. The condo conversions 
reached a frenzied pace about a year ago. It was truly an area 
that everyone in the industry was looking at, and if there was 
a bubble in the commercial sector, it would probably be in that 
area, and the lending to the condo converters was the most 
aggressive out there, throughout the industry.
    But while we are all looking at that, and thinking back to 
the 1980's, it actually turned out to be a great example of the 
lender discipline that's out there.
    At the first sign that the housing market started slowing, 
condo conversion activity started to slow down, and it has come 
to almost a complete standstill in just a matter of months, and 
that is really a result of lender discipline out there.
    Chairman Bachus. So a lot of efficiency in the market is 
what you're saying?
    Mr. White. Very much so.
    Chairman Bachus. Okay. Based on your research, do you see a 
bubble in the commercial real estate market?
    Mr. White. Absolutely not. I don't. Prices, if you look at 
them, on a relative basis, relative to replacement cost, are 
still very much in line. Construction costs have been rising as 
fast, in fact faster, than properties have been appreciating.
    The yields on real estate, while low, and almost low on a 
historical basis, the spread between yields on real estate and 
10-year Treasuries, that risk premium there is not the lowest 
that it's been. There's still a healthy cushion there. I see 
the buyers and the investors being very rational.
    Chairman Bachus. Let me conclude. And this is not so much a 
question, but if anybody wants to respond to this bit of 
philosophy, they can. I know Mr. Hensarling, I know where he 
comes from, so I know he'll agree with me on this.
    But one of my greatest problems with these guidelines is 
that I think unintended, in an unintended way it will cause--it 
may cause banks to shift their lending pattern to comply with 
what the regulator wants them to do as opposed to what the 
market dictates, which could have consequences for the economy. 
It could actually dry up lending in an area where lending ought 
to occur.
    And I'm not sure that the government should be in the 
business of telling a bank where it ought to loan money. What I 
think it ought to be in the business of doing is reviewing the 
portfolio to see that it's sound and the default rate is low, 
and that each loan, on itself, is--or the percentage of loans 
are good loans. Any response to that?
    Mr. McKillop. I would just like to respond from the 
standpoint that CRE guidance has for the first time a capital 
kicker, a requirement, a possible requirement for capital.
    There are no other regulations or rules promulgated that 
direct the necessity of additional capital. The regulators have 
all the tools necessary to take care of these various aspects 
of CRE and portfolio management and risk control. The addition 
of this capital component really is quite bothersome, 
especially without clear guidance on how it would be 
administered.
    Chairman Bachus. Do any of you share my concern that it 
could actually drive the type of lending by the banks? And I'm 
not talking about, if they're concerned about interest only, or 
certain types of loans, or the number of adjustable rate 
mortgages, I can see that as a valid concern.
    But to tell banks that they may have too many commercial 
loans or too many residential loans, in and of itself, as long 
as those loans are being repaid, is to me an unnecessary 
intervention. Is this an imaginary fear on my part or is there 
any basis for it?
    Mr. McKillop. No, sir, it's not imaginary. Out of about 270 
banks, 10 percent have modified their policies and procedures 
implementing those caps and, in essence, mandating a change in 
their policies on where they are going to put loans.
    Mr. Mueller. If I may, you know, just a historic example. 
Back in 1991, when basically the banking regulators said, ``No 
more real estate loans, period,'' there were many very 
profitable, good companies. ChemCo would be one example out of 
New York City.
    It forced them to take their company public to get capital 
to pay off bank loans on loans that they had never missed a 
payment on that were in complete compliance, but because there, 
you know, was a 10-year loan that was coming due, and the bank 
couldn't redo the loan. They were forced by the regulators to 
foreclose on them and get out of it. It did change the real 
estate industry because of that.
    But that kind of thing potentially could happen again, and 
in many cases, it's a very unintended consequence.
    Chairman Bachus. Thank you. I've been advised that we only 
have about 5 minutes left on the vote.
    Ms. Maloney.
    Mrs. Maloney. I think you've raised a lot of issues that 
really merit another hearing on how financial policy impacts on 
the real estate industry, in many cases unfairly, in driving 
the markets.
    But fundamentally, this hearing is about Basel II and where 
we go from here, and I would like to ask the panelists, what's 
the next step?
    Chairman Bachus. Let me say this. What you can do is, we 
can direct a question to them, if that's okay.
    Mrs. Maloney. Okay. I'm directing a question right now.
    Chairman Bachus. All right, go ahead. Well, let me--
    Mrs. Maloney. If i could just say that it's clear that, 
from the testimony today, that the standard is a higher 
standard in capital requirements for the American financial 
institutions, which I think is unfair in a global market.
    We as a Congress, as a country, as a Federal Reserve, 
should be fighting to have our financial industry on the same 
playing field.
    But what we've heard today is that there's a different 
standard, a stronger standard, a higher standard for American 
financial institutions. I think that that's unfair. And we 
should be fighting to make sure that our institutions can 
compete fairly and equally. And so my question is, what is the 
next step? Where do we go from here? I hope that the Federal 
Reserve and the committee that is working on this will listen 
to the testimony and make the proper adjustments as we go 
forward in the implementation of moving forward with Basel.
    I welcome any comments, and maybe you should send them to 
me in writing, because I'm going to miss a vote if I don't go.
    Chairman Bachus. Thank you, Ms. Maloney. And I'll just 
conclude by this: I think what she asked is the very essence, 
where do we go from here?
    I would start by saying that this hearing has been very 
valuable. I think it's highlighted the need to develop a 
greater consensus on how to regulate particularly real estate 
commercial lending. I think Mr. Frank got to the bottom line in 
noting that the regulators need to be careful in defining their 
buckets and what should go into them.
    I would encourage the regulators to meet with some of the 
panelists--Dr. Mueller, Mr. White--in the process of refining 
their guidance, as well as with the bankers and the industry.
    The market seems to have changed significantly, and we want 
to make sure that the bankers understand that, understand the 
market as it exists today, and not as it existed in the past.
    Given their expertise and the experience in the commercial 
real estate market, I think this panel could play a significant 
role in further defining and advising the regulators as they 
develop the guidance.
    So I, for one, am going to try to encourage some discussion 
between the first panel and the second panel. So with that, I 
will conclude.
    That has been my basic policy as a subcommittee chair, is 
to try to get the parties together, and to communicate, to 
resolve some of their differences, if they can.
    I'm going to discharge this panel, but before I do so, I 
have to do two or three bookkeeping things.
    I'm going to introduce testimony--I see no objection--the 
institutional risk and analytics testimony--a statement by the 
Risk Management Association and a statement from the Real 
Estate Roundtable.
    The Chair notes that some members may have additional 
questions for this panel, which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 30 days for members to submit written questions to these 
witnesses and to place their responses in the record.
    This hearing is adjourned.
    [Whereupon, at 3:21 p.m., the hearing was adjourned.]


                            A P P E N D I X



                           September 14, 2006


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