[Congressional Record Volume 140, Number 146 (Saturday, October 8, 1994)]
[Extensions of Remarks]
[Page E]
From the Congressional Record Online through the Government Printing Office [www.gpo.gov]


[Congressional Record: October 8, 1994]
From the Congressional Record Online via GPO Access [wais.access.gpo.gov]

 
   DEPOSIT INSURANCE REFORM, REGULATORY MODERNIZATION, AND TAXPAYER 
                         PROTECTION ACT OF 1994

                                 ______


                          HON. THOMAS E. PETRI

                              of wisconsin

                    in the house of representatives

                        Friday, October 7, 1994

  Mr. PETRI. Mr. Speaker, today I am introducing a fresh version of the 
Deposit Insurance Reform, Regulatory Modernization, and Taxpayer 
Protection Act of 1994. I expect that regulation of the financial 
services industry will be a major issue in the next Congress and I 
would like for the latest version of my bill to be available so that it 
may be examined and discussed by all interested parties over the next 
months.
  Briefly, this bill will, as the title implies, reform the Nation's 
deposit insurance system and substitute private regulation for 
Government regulation in what is already an industry-funded system. It 
will take the taxpayer completely off the hook for any future losses 
due to bank or thrift failures, and it will dramatically improve the 
efficiency of the banking industry through substantial regulatory 
relief and lower insurance premiums.
  An unwarranted increase in regulatory burdens and costs imposed on 
healthy banks and thrifts has caused an enormous shift in market share 
to the less taxed and less regulated channels of intermediation. 
However, these channels may, in fact, be less efficient and less 
capable of supplying credit to important sectors of the economy, such 
as small business. Additionally, Government regulation may have 
deterred banks and thrifts from seeking business in low-income and 
minority communities.
  My bill is designed to solve these problems and more. The Deposit 
Insurance Reform, Regulatory Modernization, and Taxpayer Protection Act 
of 1994 will create a 100 percent cross-guarantee system under which 
each bank or thrift institution will enter into a contract with an ad 
hoc syndicate of banks, thrifts, pension, or endowment funds, insurance 
companies and the like to guarantee all of its deposits. Premium rates 
and safety and soundness requirements will be negotiated contract by 
contract and will not require Government approval.

  The guarantors, who will have their own money at risk, will take over 
safety and soundness regulatory responsibility from the Federal 
Government. The specific contract provisions for this purpose will vary 
depending upon the condition and practices of the individual bank or 
thrift, effectively ending one-size-fits-all regulation.
  Each syndicate will employ an independent syndicate agent firm to 
oversee the performance of the guaranteed bank or thrift. The 
syndicate, through its agent, will be able to force changes in the 
guaranteed bank or even close or sell it if it runs into trouble. The 
agent's independence will prevent anticompetitive behavior.
  Various rules for the spreading of risk will ensure the safety of the 
entire system, including the mandating of minimum numbers of guarantors 
for each bank, limits on the amount of risk undertaken by any one 
guarantor, and the inclusion of mandatory stop-loss contracts under 
which guarantors will pass any excessive losses through to their own 
second tier of guarantors.
  The Government's principal role will be to make sure that contracts 
are in place and that all the risk dispersion rules are complied with. 
Backup Federal deposit insurance will be retained but never needed even 
in circumstances worse than the Great Depression.
  The entire system will have to meet a key market test before it can 
really get started, since no contracts will become effective until a 
critical mass of at least 250 banks with at least $500 billion of 
assets has chosen to participate and has contracts ready to go.
  Once the system is operating, banks' regulatory burdens will become 
far lighter, banks will have the opportunity to earn money as 
guarantors, and their own deposit insurance premiums will be far lower. 
Premiums will be lower because risk-related premiums will deter unsound 
lending and guarantors will act quickly to minimize losses if problems 
develop. For these reasons and many others, I expect this proposal to 
be attractive to all segments of the financial world.

  This legislation has several important benefits for the economy. The 
taxpayers will be protected in the event of any future loss due to bank 
failures. A more efficient banking industry will help promote economic 
growth. And this plan should encourage better risk sensitive pricing of 
loans, which should moderate future speculative bubbles.
  Finally, the cross-guarantee system will free banks and thrifts to 
better serve minorities and the poor. America and other industrialized 
nations have learned that volunteer armies provide a better national 
defense than armies of conscripts. The same should hold true for 
banking.
  The Community Reinvestment Act [CRA], however noble its intent, 
essentially attempts to draft bankers to do what logic says at least 
some bankers should be willing to do voluntarily--provide sufficient 
credit and other banking services to low-income and minority 
communities because it is profitable to do so. We ought to be able to 
do better than CRA.
  Never has this question been answered satisfactorily: What has 
deterred banks and thrifts from adequately serving these communities? 
Has it been discrimination or has it been something else, like the 
costs and inflexibility of federal safety and soundness regulation? The 
assumption behind CRA is that it's the former, or that the latter 
problem can't be fixed, and therefore compulsion must be the remedy. I 
believe it's the latter, burdensome regulation. I also believe that 
these problems can and must be addressed and that the profit motive 
will then produce far better service than compulsion ever can.

  It should come as no surprise that semibanks, such as check cashers, 
currency exchanges, pawn shops, and finance companies, have expanded 
rapidly in low-income and minority communities while inefficiencies 
imposed by one-size-must-fit-all banking regulation limit the ability 
of inherently more efficient full-service banks and thrifts to serve 
these communities. There clearly is money to be made providing 
financial services in these communities. However, while bank 
substitutes are meeting legitimate market needs, they can never do so 
as efficiently as real banks that voluntarily specialize in serving 
these communities.
  Modernizing banking regulation to give banks the same operating 
flexibility their nonbank competitors now have will bring more 
efficient banking services to low-income and minority communities. A 
volunteer army of banks--including some semibanks that today 
understandably will not subject themselves to burdensome banking 
regulation--will far better serve these communities than will 
compelling each bank and thrift to serve a sliver of these markets.
  The Deposit Insurance Reform, Regulatory Modernization, and Taxpayer 
Protection Act of 1994 will give banks and thrifts the operating 
flexibility they need to serve low-income and minority communities 
profitably while also strengthening taxpayer protection from future 
banking crises, which themselves have largely been caused by government 
safety-soundness regulations.
  Note that HR 3570 does not alter CRA in any way, so advocates of 
CRA's goals have nothing to lose in this bill. However, they have much 
to gain if it works as intended. If it works so well that CRA, by 
consensus, is no longer necessary, then so much the better for 
everyone.
  It is these positive effects on the economy as a whole that are 
really the most important reasons for taking a good look at this bill. 
If we're going to get our economy moving again and get a handle on our 
many difficult problems, we need to fundamentally reform the way we do 
things in a number of key areas. Health care, welfare, and education 
are a few of those areas, but financial services is certainly a crucial 
one. I believe deposit insurance and regulatory reform are important 
keys to improving the efficient delivery of financial services.
  Mr. Speaker, I ask that a short synopsis of the bill and an article 
from Bank Director magazine be printed in the Record at this point.

    Synopsis of H.R. 3570--the Deposit Insurance Reform, Regulatory 
           Modernization, and Taxpayer Protection Act of 1993


      inherent and irreparable flaws in federal deposit insurance

       As Roosevelt warned in 1933, federal deposit insurance 
     protects bad banks as well as good, it puts a premium on 
     unsound banking, and it has cost taxpayers billions of 
     dollars.
       As bank and S&L insolvency losses soared during the 1980s, 
     regulators moved too slowly to deal with failing 
     institutions. This inaction made deposit insurance losses 
     even worse.
       Deposit insurance mispricing caused a substantial 
     misallocation of credit in the 1980s that has prolonged the 
     recovery from the recent recession; the FDIC's new risk-based 
     premiums still overcharge good banks and thrifts and dampen 
     their willingness to lend. Consequently, some sound 
     businesses still cannot get sufficient credit.
       Deposit insurance must be priced to reflect the riskiness 
     individual banks, but the FDIC cannot properly set risk-
     sensitive premiums because accurate prices can be established 
     only in private, competitive markets.
       Banking has increasingly become a captive of government 
     regulatory micromanagement that cannot keep up with rapid 
     changes in a financial world driven increasingly by 
     electronic technology. Government regulation has become 
     counterproductive and harmful to good banks and thrifts and 
     to America's international competitiveness.


         basic principles of the 100% cross-guarantee solution

       End taxpayer risk and bailouts by ensuring that private 
     sector equity capital always protects ALL bank and thrift 
     deposits from loss.
       Let private markets set risk-sensitive deposit insurance 
     premiums, based on leading indicators of banking risk, that 
     will discourage unwise banking practices.
       Shift ``safety-and-soundness'' regulation for banks and 
     thrifts to those who bear the risk of loss, the owners of the 
     private capital protecting depositors.
       Also shift the bank closure decision to those guarantors 
     bearing the risk of loss. These guarantors have the strongest 
     incentive to minimize losses and therefore should control the 
     risks they have assumed.
       Use a ``stop-loss'' mechanism to spread the bank insolvency 
     risk widely, and therefore thinly, over the equity capital of 
     the financial world.
       Retain federal deposit insurance as a never-to-be-used 
     backup insurance, but only for deposits up to $100,000.


             specifics of the 100% cross-guarantee solution

       Each bank and thrift enters into a contract with a 
     syndicate of banks, thrifts and/or other well capitalized 
     entities that guarantees the original contractual terms of 
     all deposits and most other liabilities of the guaranteed 
     institution.
       Premium rates and other contractual terms are negotiated on 
     a syndicate-by-syndicate basis and are NOT subject to 
     government regulation or approval.
       Numerous safeguards protect taxpayers against another 
     deposit insurance bailout. A mandatory ``stop-loss'' 
     mechanism passes part of any large insolvency loss to the 
     guarantors' guarantors. Risk dispersion rules require a 
     minimum number of guarantors for any one bank or thrift and 
     limit both the aggregate risk assumed by a guarantor and the 
     amount of risk any one guarantor assumes for any one bank or 
     thrift.
       Cross-guarantee contracts cannot be canceled unless the 
     guaranteed bank or thrift first obtains a replacement 
     contract or is acquired by another guaranteed bank or thrift. 
     Once guaranteed, no institution can operate without a cross-
     guarantee contract in place.
       Each syndicate retains an agent to monitor the financial 
     condition of the bank or thrift it has guaranteed to ensure 
     adherence to all contractual terms and to act as a buffer to 
     protect the competitive secrets of the guaranteed 
     institution.
       A new agency, the Cross-Guarantee Regulation Corporation, 
     regulates the cross-guarantee process, primarily to ensure 
     that all guarantors are guaranteed with regard to their 
     cross-guarantee obligations and that they have sufficient 
     capital relative to the risks they have assumed. Safety-and-
     soundness concerns for individual institutions shift to the 
     syndicates. The bank regulatory establishment is then 
     downsized as banks obtain guarantees.
       A back-up fund (BUF) insures deposits up to $100,000, but 
     only on a back-up basis. It should never experience a loss. 
     Guaranteed banks can still post the FDIC insurance logo.
       Weaker banks and thrifts have ample time to raise the 
     capital needed to obtain a cross-guarantee contract or to 
     merge with another institution. The FDIC has ample funds 
     today to cover losses in the few institutions that might fail 
     in this conversion process.
       Phase-in provisions give smaller banks and thrifts up to 
     ten years to obtain a cross-guarantee contract. The first 
     contracts become effective when 250 banks or thrifts, with 
     total assets of at least $500 billion, have approved 
     contracts in hand.
       A competitive market with an ample pool of potential 
     guarantors protects against premium overcharges, ends 
     concerns about capital adequacy in the banking system, and 
     permits guarantors to accept or reject individual cross-
     guarantee risks as they see fit.
       Although there should be no bank runs, cross-guarantee 
     contracts protect any loan a Federal Reserve bank makes to a 
     guaranteed institution experiencing liquidity problems.
                                  ____


                     [From the Bank Director, 1994]

             Cross Guarantees: A Horse of a Different Color

               (By Representative Tom Petri and Bert Ely)

       Close your eyes and imagine a very different world than the 
     one in which banks are governed by a federal deposit 
     insurance system. Two prominent proponents of the cross 
     guarantee system say it will make banking a business again 
     while lessening the liability risk for bank directors.

       Banking is not a dying business. It only looks that way 
     because federal regulation is strangling banking while 
     favoring non-bank competitors with less regulation and lower 
     tax burdens.
       As Bill Seidman, former FDIC chairman and now publisher of 
     Bank Director stated in the Fourth Quarter 1993 edition of 
     Bank Director: ``Banks are losing market share because 
     regulatory burdens have made them high-cost operators.'' He 
     also could have said that banking regulations have made 
     directors' and officers' insurance more expensive and made it 
     harder for banks to recruit and retain directors.
       In fact banking is a good business, and one that is 
     important to the American economy. However, it needs to be 
     freed of its regulatory shackles so that banks and their 
     directors can conduct their banking business without fear of 
     another regulatory reign of terror that indiscriminately 
     treats all bankers as incompetents and potential crooks, 
     which unfortunately is the attitude that pervades FDICIA (the 
     Federal Deposit Insurance Corporation Improvement Act of 
     1991).
       The raison d'etre for much of this banking regulation is 
     federal deposit insurance. Therefore, there is little 
     prospect of relief for banks and their directors without 
     fundamental deposit insurance reform. Such relief would be 
     provided by The Deposit Insurance Reform, Regulatory 
     Modernization, and Taxpayer Protection Act of 1993 (H.R. 
     3570).
       This bill would enact the 100% cross-guarantee concept for 
     privatizing banking regulation and its attendant deposit 
     insurance risk. It does not eliminate banking regulation; 
     instead, it substitutes competitive, market-driven, customer-
     sensitive regulation for governmental edicts that often cause 
     more problems than they solve. Market-driven regulation will, 
     in turn, permit banks and thrifts to operate as real 
     businesses, and not as extensions of the federal government.


                     the deposit insurance problem

       Government banking regulation did not just happen; it has 
     evolved over several centuries. Its principal rationale has 
     been to prevent the failure of individual banks. Hence, 
     capital requirements, lending limitations, and other safety-
     and-soundness standards are almost as old as banking. But, 
     banking regulation has never eliminated bank failures; in 
     fact, banking has been swept by periodic panics that have 
     seen scores or even hundreds of banks fail because they were 
     insolvent, or perceived by the public to be insolvent.
       In the absence of deposit insurance, depositors and other 
     creditors bear the insolvency loss of a failed bank. Banking 
     panics also can cause widespread economic distress as bankers 
     dump their investments and call in loans to fund deposit 
     runs. In effect, bank failures can cause two kinds of 
     problems: cash losses to individual creditors of failed banks 
     and impaired performance of an entire economy.
       Banks, like any kind of business, should not be protected 
     from failure, yet the consequences of widespread failures are 
     understandably feared by politicians and the general public 
     alike. Hence the perceived need for deposit insurance. This 
     insurance not only protects widows and orphans, but it also 
     inhibits banking panics that can damage the entire economy.
       Deposit insurance attempts to isolate the depositor 
     protection problem by focusing insolvency losses on a deposit 
     insurer, and possibly on creditors of a failed bank who 
     supposedly can be stuck with their share of the loss without 
     causing a banking panic. Bank regulation then becomes a tool 
     for minimizing the deposit insurer's loss. So far, so good. 
     The problem arises when government regulators, using 
     government's police powers, attempt to prevent losses 
     suffered by a government deposit insurer.
       As Franklin Roosevelt observed during his first 
     presidential news conference: ``Government deposit insurance 
     will guarantee bad banks as well as good banks, cost the 
     [taxpayer] money, and put a premium on unsound banking in the 
     future,'' In other words, it is government regulation and a 
     government-run insurance program that is banking's problem, 
     not regulation and deposit insurance, per se.


          the failings of government regulation and insurance

       Government banking regulation/deposit insurance has an 
     inherent, irreparable failing that is the root cause of its 
     problems: It is a government monopoly. Monopolies can never 
     deliver goods and services as efficiently or as effectively 
     as private, competitive markets for the simple reason that 
     competition spurs better performance because customers can 
     decide with whom they will do business. Suppliers who perform 
     badly, give poor service, or treat their customers on a high-
     handed, officious manner simply do not get the business, and 
     fail, as they should.
       Government regulatory monopolies are even worse than 
     private monopolies, for several reasons. First, government 
     monopolies rely on uniform rules and regulations, rather than 
     custom-tailored and mutually agreed upon contractual terms, 
     to influence the behavior of their ``customers'' Given the 
     legitimate notion that all persons must be treated equally 
     before the law, government regulations become ``one-size-
     must-fit-all rules that barely fit anyone at all.
       In a fast-moving and complex financial world, government 
     regulations increasingly distort banking as they lag behind 
     rapidly changing realities. As Rupert Pennant-Rea, the Deputy 
     Governor of the Bank of England, readily admitted recently to 
     a group of bankers, regulators are always five years behind, 
     and that is good, according to Pennant-rea, for if regulators 
     tried to stay abreast of technology they would stifle 
     innovation. Of course, this delay means that government 
     regulators will always lag in evaluating new risks that 
     should be addressed in a more timely manner.
       Second, government regulatory monopolies cannot use the 
     pricing mechanism as a tool to influence customer behavior in 
     ways that optimize economic performance. Prices, like other 
     contractual terms, can be properly determined only in 
     private, competitive markets where both buyers and sellers 
     have choices. Banks have no choice, however, if they are 
     dealing with a government regulatory and insurance monopoly.
       The FDIC has implemented what it calls ``risk-sensitive'' 
     insurance premiums, but they lack true risk sensitivity 
     because of another failing of government monopolies: the 
     politically powerful who are unhappy with how the monopoly 
     has treated them will squawk, and get political relief. 
     Understanding this reality, the FDIC pulled its punch and 
     implemented premium rates designed not to offend. Hence, the 
     power of pricing to promote good economic behavior and deter 
     bad behavior will always by lacking in a government insurance 
     monopoly, such as the FDIC.
       Accurate, market-driven pricing is especially important in 
     banking because the risk of insolvency to a deposit insurer 
     should be incorporated in the interest rate a bank charges on 
     every loan it makes. Properly pricing this insurance risk not 
     only protects the insurer but also promotes the much greater 
     social good of ensuring that the bank is extending credit in 
     a manner that will not later cause broad economic distress. 
     To a great extent, badly priced deposit insurance was the 
     root cause of the recent, and still lingering, commercial 
     real estate crisis. Like any other economic good, though, 
     insurance can only be priced properly in a competitive, and 
     therefore, private marketplace.
       Third, government rule-making, by its very nature, is a 
     highly politicized process that often produces unintended 
     consequences worse than the problem that a particular rule or 
     dictate is attempting to solve. Often these rules are 
     simplistic or ignore economic realities. Two examples will 
     illustrate.
       Uniform capital regulations assume that all banks and 
     thrifts have the same risk profile, yet banks and thrifts 
     differ greatly in their appetites for and ability to manage 
     risk. Further, some believe that whatever ails deposit 
     insurance can be cured by imposing higher capital standards 
     on banks and thrifts. Yet higher uniform capital standards 
     serve primarily to drive out of banks and thrifts lower-risk 
     assets that the marketplace says do not need as much capital 
     backing. Consequently, the financial markets have become 
     active securitizers of these lower-risk assets.
       After the Great Depression, the federal government 
     encouraged S&L's to ignore economic reality by engaging in an 
     extreme form of maturity-mismatching; that is, using short-
     term, readily withdrawable passbook savings to finance long-
     term, fixed-rate home mortgages. This worked only in a stable 
     interest rate environment, yet the world is hardly stable--
     particularly when the country has a central bank, the Federal 
     Reserve, that set America up for record-high interest rates 
     in the early 1980s by depressing real rates of interest in 
     the 1970s. Understandably, then, the S&L industry was a 
     disaster waiting to happen by 1980 when interest rates 
     jumped.


                      The cross-guarantee solution

       Regulation and deposit insurance are not the problems for 
     banking. Government regulation and government deposit 
     insurance are the problems. Until now, though, a safe-and-
     sound private sector alternative has not existed. Numerous 
     private sector deposit insurance schemes have been tried, 
     but, with three noteworthy exceptions, these schemes failed 
     because they neither priced properly nor diversified 
     adequately the insolvency risk they assumed; worse, they 
     relied on government regulators to keep banks on the 
     straight-and-narrow.
       The three exceptions, the deposit insurance mechanisms that 
     operated in Ohio, Indiana, and Iowa before the Civil War, are 
     antecedents of a sort for the cross-guarantee concept for 
     privatizing banking regulation and its attendant deposit 
     insurance risk. Unfortunately, federal banking legislation 
     enacted during the Civil War effectively snuffed out these 
     three plans, thus aborting the development of a protection 
     mechanism that might have evolved into the cross-guarantee 
     concept reflected in The Deposit Insurance Reform, Regulatory 
     Modernization, and Taxpayer Protection Act of 1993 (H.R. 
     3570). As veteran banking consultant Carter Golembe once 
     observed, when Congress enacted federal deposit insurance in 
     1933, over the strong objections of President Roosevelt and 
     others who knew better it modeled the FDIC on the many state 
     deposit insurance plans that failed by then rather than on 
     the three that worked. Such is the wisdom of Congress.
       The cross-guarantee concept sounds complex, or even alien, 
     largely because it relies on market forces, rather than 
     government edicts, to promote safe-and-sound banking. H.R. 
     3570 creates a marketplace in which bank and thrifts will 
     freely negotiate contracts that guarantee all of each 
     institution's deposits and most of its other liabilities 
     against loss should the institution become insolvent. Most of 
     the guarantors under these contracts will be other banks and 
     thrifts who have voluntarily agreed to be guarantors under a 
     particular contract. Hence, the term ``cross-guarantee'' 
     describes a system which essentially is an industry self-
     insurance mechanism. To broaden the pool of potential 
     guarantors, the bill also authorizes non-depository 
     guarantors, such as industrial corporations, university 
     endowment funds, and very wealthy individuals.
       Figure 1 illustrates the parties to a typical cross-
     guarantee contract. Under the bill, an ad hoc syndicate of 
     guarantors will assume almost all of the guaranteed 
     institution's insolvency risk, thus eliminating any need for 
     depositor discipline. By protecting all deposits, the cross-
     guarantee system also eliminates the discrimination thousands 
     of small-enough-to-liquidate banks and thrifts experience 
     under the too-bit-to-fail reality of the industrialized 
     world.
       In return for providing insolvency protection, the 
     guaranteed institution will pay its guarantors a premium or 
     guarantee fee that will be determined under the terms of the 
     contract. Presumably, this risk-sensitive premium, based on 
     leading indicators of banking risk, will reflect the 
     guaranteed institution's insolvency risk more accurately and 
     timely than the FDIC's supposedly risk-sensitive premiums can 
     ever hope to do. The net cost of cross-guarantees, including 
     related compliance costs, should be much lower for banks and 
     thrifts than the present cost of being federally regulated 
     and insured, for two reasons. First, lower bank insolvency 
     losses under the cross-guarantee system will lead to lower 
     premium rates for most banks than will be likely under 
     federal deposit insurance. Second, market-driven regulations 
     will be much less costly to comply with than inappropriate 
     government regulations.
       Working through an independent, private-sector ``syndicate 
     agent,'' the guarantors will be able to monitor the 
     guaranteed institution's compliance with the safety-and-
     soundness provisions set out in its cross-guarantee contract. 
     These provisions will completely replace the government 
     safety-and-soundness regulations under which banks and 
     thrifts now operate. Hence, these provisions will reflect the 
     business strategy the bank or thrift has selected; no longer 
     will government regulation dictate banking strategies. 
     Employees of the syndicate agent, sensitive to the needs and 
     interests of both the guaranteed institution and its 
     guarantors, will replace officious government bank examiners.
       Of course, if the syndicate agent bungles or the guarantors 
     fail to respond in a timely manner to danger signs flashed by 
     the guaranteed institution, and it becomes insolvent, the 
     guarantors may suffer a loss. Under no circumstance, though, 
     will the federal government attempt to prevent the failure of 
     an individual institution or protect guarantors and syndicate 
     agents from their own follies. Of special importance to bank 
     and thrift directors, H.R. 3570 bars guarantors from using 
     the FDIC's extraordinary powers to sue directors for mistakes 
     the guarantors or the syndicate agent made in overseeing the 
     activities of a failed bank or thrift. The buck will stop 
     with the guarantors.
       Government regulation of the cross-guarantee marketplace 
     will focus only on maintaining the stability of the entire 
     banking system. Specifically, H.R. 3570 creates a small 
     regulatory agency, the Cross-Guarantee Regulation Corporation 
     (CGRC), to oversee the cross-guarantee marketplace. The CGRC 
     will approve every cross-guarantee contract before it takes 
     effect, but only to ensure that the contract meets certain 
     statutorily prescribed risk-dispersion requirements designed 
     solely to ensure that no failure of an individual institution 
     will shake people's faith in the strength of the cross-
     guarantee system or cause Congress to be concerned about 
     having to use taxpayer funds to bail out the system, as 
     happened with federal deposit insurance.
       The following, reasonably straightforward rules, which the 
     CGRC will enforce, will effectively construct a ``solvency 
     safety net'' under the entire banking system that will be 
     stronger financially than our increasingly indebted federal 
     government:
       Every guarantor must itself be guaranteed by other 
     guarantors. This inviolate requirement automatically 
     constructs the solvency safety net that is then strengthened 
     by the following requirements.
       Each guarantor will benefit from a uniform ``stop-loss'' 
     rule that will pass all of its losses as a guarantor over a 
     certain limit through to its own guarantors. This loss pass-
     through will spread a large insolvency loss widely but thinly 
     across the solvency safety net, thus ensuring that no loss 
     will puncture this safety net, even in conditions worse than 
     the Great Depression. The stop-loss limit has been set so 
     that no guarantor will fail by virtue of being a guarantor.
       The insolvency risk posed by each cross-guarantee contract 
     will be spread over many guarantors. For example, any bank or 
     thrift with more than $10 billion of assets must have at 
     least 100 guarantors, no one of whom can assume more than one 
     percent of the risk under that contract.
       Each guarantor will be limited as to the maximum amount of 
     risk it can assume under any one contract and in the 
     aggregate. Using premium income as a proxy for the risk 
     assumed, a guarantor's total premium income from all of its 
     cross-guarantee contracts on an annualized basis cannot 
     exceed 3% of its equity capital.
       Together, these provisions will create a puncture-proof 
     solvency safety net under all banks and thrifts, as 
     illustrated in Figure 2. Strictly as a political facade, the 
     bill creates a backup fund (BUF), that would honor the 
     present federal deposit insurance commitment. However, no 
     loss should ever reach the BUF. If such an event did occur, 
     the federal government already would be defaulting on its own 
     obligations because a horrendous disaster, such as a major 
     East Coast earthquake or a large meteor strike, had 
     devastated the American economy.
       The cross-guarantee system is premised on harnessing market 
     forces to deliver safe and sound banking to America. The 
     transition to cross-guarantees reflects the philosophy. The 
     cross-guarantee system, if enacted, will not activate unless 
     at least 250 banks and thrifts with at least $500 billion of 
     assets have first voluntarily obtained contracts approved by 
     the CGRC. Only if this critical mass is reached, will the 
     system activate.
       If most banks and thrifts decide government regulation is 
     preferable to the cross-guarantee system (certainly a dubious 
     proposition), then not enough banks and thrifts will obtain 
     contracts, and the system will not activate. Once it does, 
     though, banks and thrifts will have up to eight years (for 
     the smallest institutions) to become guaranteed institutions. 
     Those not able to obtain a contract (which should be very few 
     because of FDICIA) will effectively have failed. They will 
     immediately be taken over by the FDIC.


                 the many payoffs from cross-guarantees

       The cross-guarantee system will be a win-win proposition 
     for banking and for the economy because it will promote 
     sounder and more efficient banking that will properly reward 
     good bankers, and their stockholders/directors, while 
     discouraging bad banking practices that hurt everyone.
       Risk-sensitive cross-guarantee premiums, based on leadings 
     indicators of banking risk, will jump for credit being used 
     to inflate speculative bubbles that later will burst, causing 
     great losses to lenders and their insurers and guarantors. In 
     fact, had cross-guarantees been implemented years ago, 
     America would not have experienced the recent, painful 
     recession that it slowly exited. Specifically, cross-
     guarantee premium rates would have significantly reduced the 
     amount of credit made available during the 1980s to 
     developers of unneeded commercial real estate.
       Cross-guarantees also will improve the efficiency of the 
     financial system by eliminating incentives the marketplace 
     now has to engage in ``regulatory arbitrage;'' that is, using 
     electronic technology to lawfully circumvent banking 
     regulation, specifically uniform capital regulations. 
     Regulatory arbitrage has been the primary incentive driving 
     the growth of mutual funds, the commercial paper market, 
     asset securitization, hedge funds, and derivative products. 
     In effect, market-driven regulation of the cross-guarantee 
     system will quickly eliminate the regulatory inefficiencies 
     that foster such arbitrage. By escaping from regulatory 
     inefficiency, banks and thrifts will be able to recapture 
     much of the market share they have lost in recent years.
       In particular, the credit enhancement provided by the 
     cross-guarantee system (all guaranteed institutions will be 
     AAA+++rated) will permit banks and thrifts to profitably lend 
     to low-risk borrowers, such as high-quality corporations and 
     home owners. No longer will banks and thrifts feel compelled 
     to securitize their higher quality assets. Under cross-
     guarantees, they will be able to keep them in portfolio.
       While the cross-guarantee system will benefit banks and 
     thrifts of all sizes, it will be especially beneficial for 
     smaller institutions, for two reasons. First, the bill 
     requires that cross-guarantee contracts protect all deposits, 
     and not just the first $100,000. This provision means that 
     large depositors in small banks will not fear losing some of 
     their money if their bank fails. Second, compliance costs for 
     smaller banks and thrifts will drop substantially because 
     competition will produce cross-guarantee contracts for 
     smaller banks that will be much simpler than the existing 
     regulations under which these banks and thrifts must now 
     operate.
       Cross-guarantees also will give banks greater operational 
     freedom to pursue unique business strategies. One societal 
     benefit of this freedom is that some banks will find it 
     worthwhile to adopt an operating style suitable to serving 
     low-income and minority communities. No longer will the 
     federal government have to stiffen one set of regulations, 
     the Community Reinvestment Act, to neutralize the growing 
     negative effects of another set of regulations, one-size-
     must-fit-all safety-and-soundness standards.


                      Getting to cross-guarantees

       H.R. 3570 has been developed to the point that we are 
     confident it will work financially and legally. That is the 
     easy part. The hard part is enacting it, for it will reverse 
     the growing politicization of the banking system. In effect, 
     the bill will dramatically shift power over banking and 
     credit allocation from the political process to the 
     marketplace. This shift will be good for the country, and for 
     banking, but bad for those inside the Washington Beltway who 
     seek to direct the credit allocation process or otherwise 
     profit from the heavy hand of government banking regulation. 
     Consequently, those who will lose power or money under this 
     reform will vigorously oppose it.
       H.R. 3570 will become a reality only if bankers take the 
     lead in building grossroots support for this escape hatch 
     from increasingly irrational and harmful government 
     regulatory micromanagement of banking. Can bankers meet this 
     challenge?

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