How Free Should Banking Be? An International Comparison

0:00Thank you very much for inviting me to participate in your brown bag seminar series, it's a pleasure to be here. Jeff told me that this is a relatively informal group, it seems to be quite formal for one sitting around this table, therefore I prepared some informal comments about banking in the U.S. and some other countries and Jeff suggested that my purpose ought to be to try I want to try to stimulate you to think about banking, the way in which we ought to regulate banks in the context of an overall financial system. That's my assigned task, is to just talk about banking in general terms and then perhaps some of you to ask some questions, make some comments, so that perhaps I can learn more about banking, how it has been regulated in different countries, The Theory of Money and Credit

1:23in the United States, and in particular, I've looked at some of the bank regulatory systems in some of the EU, well, all the EU countries and the G10 countries, and if you take the non-overlapping countries, you come up with 19 separate and distinct countries, and so I've done some work with some people in trying to identify some of the characteristics of and the regulatory regimes in the different countries. So, in fact, if you look at the current issue of Businessweek, there's a piece talking about banking reform is back on the back burner. And as you know, there has been some interest in perhaps in reforming the financial system even further here in the United States in recent years.

2:12In fact, sometime soon, the Clinton administration will put forth its proposals for modernizing the financial system. It's probably not my choice of words, modernizing the financial system, but nonetheless, that's what the Clinton administration is talking about, is putting some proposals that would perhaps try to induce the Congress to make still further changes in the U.S. financial system. There is a report that has been prepared on behalf of the Clinton administration. In fact, I know the author of the report. He's a good friend of mine. I had been asked actually to help write the report. I declined for various reasons. And the report has been read by Secretary Reuben.

2:57He's worked, gone through, talked, spent many hours talking about the report, with the author of the report. Then, of course, you have an editor, a journalist, a very good journalist, and so on and so forth, and as well as to engage the likely reaction is going to be from all the affected parties, that would include the banks, insurance companies, securities firms, so on and so forth, as well as to engage the likely reaction to the report from members of Congress. And right now, the reaction from the Congress is not all that favorable to what I would call more sweeping regulatory change. Therefore, the Clinton administration is considering perhaps revising the report or pulling back from some of its initial proposals. That's not unusual.

3:58It's an interaction of politics and economics or finance, a combination of the three. So it's not yet clear what's going to happen in the report, what it's going to say and what the administration is going to do. An area of contention has to do with whether or not banks should be permitted to own stock in non-financial firms. That's a major issue. And indeed, it turns out that the Federal Reserve, Alan Greenblatt, has recently tested before a subcommittee, a house banking committee, opposing bank ownership of non-financial firms. And indeed, Chairman Leach, the chairman of the Full House Committee, testified before the subcommittee, which is not more than unusual, it's not all that common either. It turns out that he presented a lot of information about why it would be a bad idea, basically because he argues that there'd be not just potential conflicts of interest, but you'd have conglomerates, mega firms that would tend to dominate a particular segment of the U.S. society and potentially lead to oligopolistic, monopolistic type practices somehow in some

5:10way if non-bank, non-bank ownership and non-financial firms would be bad in other words for U.S. It's interesting that the people prepared all the tables, a company's report, where people work at the Federal Reserve system. So, Chairman Leach is very close to the Federal Reserve and it's not surprising that they share similar views about bank ownership and non-financial firms. Also, there's the issue of non-financial ownership of banks, which has been effectively restricted in this country. So, you know, it's an issue of talking about these things. I did bring, and then of course there's an issue, John Wells sent me an email just before I came here. We hear a lot about privatization of banking in different countries, former Soviet Union countries, I believe they were 15 or 16, as well as, here's a piece John sent me about the Romanian Senate approved bank privatization bill. So, you know, we have state banks in this country. Some people say what we What we ought to do in other countries is get the state out of state banks because in

6:18other countries they do have such a, there are indeed many government-owned banks or state-owned banks in the countries and those banks have performed somewhat poorly. You can look at one of the biggest banks in France, you can look at some of the banks in some other countries in issue of who should own the banks, should it be the state or the private sector. I brought a handout to sort of perhaps get us talking about these issues. I didn't bring all that many, but I figured that if necessary, two people could look at the same handout. And this is going to be very simple for some of you, and some of you clearly have studied many of these issues in the work that you do.

7:14I should admit to not being all that familiar with some of what's done by Austrian economists. I'm not intimately familiar with some of the writings of Austrian economists. I have looked at a couple of papers as a result of the recent Lew and Jeff and I said to invite me to attend some of the sessions of the conference in which people from different countries participated. So I did look at one or two papers. And there's an issue about fractional banking, a paper on fractional banking. and I'm sorry, I was looking through the paper and apparently von Mises has advocated or had advocated what is to my way of thinking as a neural bank.

7:59I don't know if that's correct. Maybe some of you know, Luland probably knows a lot about some of these things. But in any event, I have not read some of the works by some of the social, I guess, with the Austrian School. but maybe that's a perspective that you can enlighten about. It turns out that they look at this first figure and this is by way of trying to get you to think about some of the issues. Designing a financial system, I don't say who should design the system, probably not me, but we do have financial systems, different types of financial systems in different countries. So this is by way of getting you to think about the issues. You have obviously, and we teach this in economics courses, finance courses too, we have savers, people who save, and you go back to, most of us still teach, or some of us do at least, about Irving Fisher's sort of approach to the motivation for saving, and it's really

9:02postponed consumption. So we have these two-period diagrams that we typically use to talk about how people People can be happy by saving today or borrowing today as well as saving things like that. We have then a capital asset pricing model that we talk a lot about today and think about how people, if they do save, allocate their savings among different types of financial assets. These sorts of models are questioned by various people, the underlying assumptions in that and as to whether or not they really do adequately explain the real world and that's essentially So essentially what I'm trying to do is expose you to some, what I call, as I used to say with respect to these growth theory models that were quite prominent, is one observed in the real world, so-called stylized facts, and then one developed a model to explain those facts.

9:52It was a matter of trying to make some observations, say, how do we explain what it is we do observe in the real world? And that's effectively what I'm in the process of doing now, that is collecting some information, And hopefully facts. And then trying to see if we can explain why it is that we observe what we do, not just in the US but in other countries. So here basically we have savers and lenders and we have borrowers and investors. And basically the funds can flow from savers to borrowers in different ways or combinational ways. For example, you see down in the bottom there's a box that says financial firms. We think of banks, insurance companies, pension funds, a wide range of financial services from the United States, and funds can flow through them, and then in turn, the funds flow on to borrowers, basically.

10:45And we sometimes say that these are the intermediaries, banks can intermediate between savers and borrowers, and the question is, they then provide credit, and they do some things that the savers themselves don't have to do, The Theory of Money and Credit The Theory of Money and Credit Adverse selection problems, trend is to sort of intervene between good and bad borrowers.

11:33We talked about the more hazards sort of problems. The fact that what happens is once you lend money to a firm or an individual, you have to sort of monitor an individual, be sure that the individual or firm uses the funds in the way in which you intended. That can be done by individuals with pre-clients done by these other types of financial service

12:26in Encounters, in financial systems, most financial systems, and then perhaps ways in which these types of problems are overcome or resolved. And then you'll have to ask, are there failures in some place? We call them, at least I'm used to thinking in terms of market theories, the required government intervention. And are there costs of government intervention? Do they exceed the benefits or vice versa? So that's how I sort of start looking at the system and think of returns and risk associated with this entire system. So you can ask yourself, what do the systems look like? And this could be a country would have this type of diagram, or you can think of the whole world is being embodied in this type of diagram.

13:12That is, you can go from savers to bars in different countries and through different types of institutions or firms or capital markets. Okay, let me sort of move on so I don't take too much time. Then I just gave you a schematic, which I don't want to say too much about, but you're all familiar with this diagram. It just shows you the way in which the U.S., at least by my way of thinking, has been regulated. The banking institutions have evolved over time in the U.S. from, say, 1781 to the present time. and time. And progressively what we've done is we've increased the regulation of the government involvement in the banking system. The government's getting heavily involved in different ways over time so that we've become effectively a country in which banks are perhaps more heavily regulated here than in many other parts of the world and certainly more heavily regulated today than they were many years ago.

14:12And that's why some people are suggesting that we ought to deregulate our banks, more so than we did, say, in the early 1980s. I won't go through this, but you all familiar with how we got deposit insurance. And there's a lot of what I call interesting work being done in which people are going back and revisiting the 1800s, revisiting what's happening in other countries and sort of telling different sorts of stories today than were told some years ago in many of the traditional banking texts. That is that perhaps the last evil which separated investment banking and commercial banking really was premised, was based on an incorrect premise that really it wasn't, there wasn't really a conflict of interest between both commercial banking and investment banking being done within the same financial firm that we can attribute to the stock market crash and all the bank failures of the 1930s to a mixing of commercial banking and investment banking.

15:11Banking. That wasn't the case and there's some good evidence to support that point of view by some economists, natural economists, whatever we call ourselves or they call themselves. And progressively though, we really have in a major way, I think, intervened in the marketplace. We even got the SEC, which requires a release or public disclosure of certain information. You have to say, would that have happened? Did firms have an incentive to release information on their own, disclose information to establish to Reputation, which had value to them over time, or not, did we need the SEC requirement? And then of course now you can sue, and firms do, and I've been involved in some of those cases in which there are class action suits brought against firms arguing that they didn't disclose material facts, which usually those suits are brought after their losses sustained by investors, claiming they didn't know certain things, certain things weren't disclosed and that were material to their decision-making processes.

16:12In any event, this just shows over a period of time we've moved increasingly into regulating, I won't go through all this, but if you read, I think, contemporary documents or even past documents, a lot of people go through the debate, was wild-wide banking good or bad? Were there runs on institutions that were destructive to the payments and in the correctional system? How many runs? How severe were they? where then people now say that a lot of the so-called systemic, widespread banks have been overstated that the problems were as bad as they say. Private note issue, perhaps didn't have the sort of problems. National bank notes when they came into existence really didn't provide for a uniform currency. There were different exchange rates in different parts of the country, even for national bank notes, all those sorts of things.

16:58In any event, the U.S. Constitution sort of provides the rationale for the government, the congressional involvement in our banking system. It authorizes them to delegate authority, such as establishing a central bank, the Federal Reserve. It comes from the authority given to the Congress to get involved in banking. And that phrase there, it's not a period after thereof, but that phrase is sort of the rationale for government involvement. in the US, and it has a long history, as we all know, because it only goes way back to what has happened in other countries and goes back to medieval days and beyond, in which it's useful to be able to create legal tender to fund armies and bureaucracies, all those sorts of things.

17:46But in any event, you can look at a time series that has looked at the U.S. and talked a lot about the rationale or lack of rationale for government involvement in the banking system and financial markets in general. And incidentally, when you look, banks, for example, weren't permitted to branch, as we all know, throughout most of the United States. It's even with the recent legislation, the Regal Neal legislation, it turns out there are heavy constraints on the ability still to branch nationwide. There's a cap on the percentage of deposits that one can control in a single stake, and there's a nationwide cap on the percentage of deposits or assets that a single bank can control in the U.S.

18:33So it's not as if we've gone to nationwide banking and branching. The states have been permitted to opt out certain portions of the legislation. Let me tell you that some information I put together, and I was visiting the OCC in a document about the most useful part of the papers, the words maybe that we use to describe the tables, but the tables themselves, some of the information is nowhere else available, as far as I know, in any single place except this document. and why is that? Because we got, I was able to visit some countries, European countries and and talk to the bank registrars and sent us a questionnaire to them and they provided information which they wouldn't otherwise provide had I just been an academic. So they were quite cooperative and some of the information is quite useful and you're free if you wish you have any interest you can have a copy, I'd be happy to make one available to you. But the banks, Trent and Branch, so I made

19:25I'm not going to go into that sort of history, but you can think about why they couldn't branch, what were some of the issues. Banks couldn't own real estate, for example, even national banks, since the late 1800s. They were prohibited from buying stock in other firms. So that's where it limited their size and some people say that stimulated the growth in our capital markets and why it is that banks, for example, didn't grow and become much larger in this country than they actually did. So maybe it's why we have these boxes and I'll come back to this in a second, the financial firms are so much more banks in particular compared to the capital market and I'll give you some indices of what I mean by that in a minute or so. So, even in bank insurance companies, to turn of the century until they can't own stock firms any longer.

20:16So, if you look at portfolio insurance companies, you might say, why do they hold a lot of bonds and not much common stock? Well, what I'm suggesting is, don't look to market forces, don't look to competition necessarily in answering what we are trying to explain, what we observe. Frequently, you can turn to laws and regulations, and that's what I'm suggesting. It's not always market forces that explain what we observe in the real world, though So they can overcome regulatory impediments to competition and those sorts of things, the pursuit of profits, but frequently laws and regulations explain what we observe. And the key is to sort of ask, are those appropriate laws and regulations somehow defining what one means by appropriate? One way might be market efficiency criterion. In any event, so it's very interesting if you go through and look at the development I think it's phenomenally interesting. Some of you have spent more time than I have, so I take note.

21:13There's nothing original in laying out the laws and regulations in those sorts of things, but it's an attempt to try to tell you. A lot of people try to look at this history for the U.S. and explain it. Why do we observe all these laws and regulations? We have public choice people, we have political economy people, and a mix of others.

22:03as large as they have in some other countries, heavily restricted what they could do, insurance companies too. So, if you go to the next table, it's one just showing some comparisons in terms of world population, world GDP, world banking assets, so on and so forth. Lew has informed me that there are about 200 countries in the world, and I sort of agree with his figure. And if that's so, we've looked at 19 countries, EU and G10 countries, and you can see when you go down a total, you can't see it obvious, but if you go down, you find out that when you look at these countries, and the reason I wanted to look at them is that although these countries account for about 14% of the world's population, they account for about 77% of the world's GDP, 86% of world banking assets, and 96% of mutual funds.

22:58and assets, and 82% of the equity market capitalization. In other words, you can explain a lot of what's happening in banking and the design of financial systems looking at these countries. Because then what's happening now is you have the World Bank and the IMF trooping all around the world, trying to some degree to impose a particular financial system on a lot of emerging market countries. The question is, are they suggesting, if not requiring, a certain type of financial system that makes no sense to almost anybody who thinks about financial systems? Is it one that would be determined by market force, or is it one that somehow furthers the empire building of the World Bank or the IMF?

23:44Or are they looking for work, having now found themselves playing a diminishing role in providing credit because there's a lot more private credit flowing into some countries and looking for other things to do. And I don't say that with some seriousness, which is to say that they are indeed talking increasingly about global banking standards. I was at a conference in New York the end of last week and on the panel with me was The IMF has hired, within the past four years, approximately 125 to 150 financial economists.

24:34And the IMF reports that there are probably two-thirds of the 181 member countries, IMF, that have experienced banking problems, if not crises. So you try to look and say, well, when they go into these countries, and the World Bank does too, and they hire academic types to go into these countries, what sort of systems are they designing, and telling them to design? Are they stressing capital markets, are they stressing banking systems, deposit insurance, or are they relying more on market forces? Now, you might say, what type of system should they advocate or are they advocating, is an appropriate one? Well, when you look at these tables, what I'll sort of suggest to you is that, for example, what people now do is they categorize countries.

25:21We've all heard about the German universal banking system. We've heard about the Japanese financial system, which is under a great deal of stress today, a lot of non-performing loans at some of the big banks. The biggest bank in the world is Japanese, now price seven of the top ten are Japanese. We now have our biggest bank, Pales in comparison to the biggest bank in the world, measured by assets. We could do it other ways and our banks fare much better in terms of say market capitalization. But when you look at the data here, you find that we have what are called, some people describe as bank-based systems, financial systems, and some people then talk about what's a market-based financial system or an equity-based financial system and I won't go into the details.

26:06And let me give you an order of magnitude, you can't see it from this table and the market-based or equity-based systems for example, two countries would be the U.S. and U.K. Now why do we call the U.S. and U.K. equity market or capital market-based systems? Well, if you take the equity capitalization as a percentage of GDP, it's 110% in the UK and in the US it's 80%, that is, equity market capital is divided by GDP, it's 80% in the US, 110% in the UK. Now let's go to Germany and France as two other examples. When you do the same calculation, you calculate equity market capitalization and GDP in Germany, you can't see it from this table.

26:53It's 24% in France, it's 35%. So people say, gee, Japan for its financial system relies much more heavily on banks than in the United States. In the US, we rely much more heavily on capital markets than the banks or other financial services. So if you looked at that first diagram connecting savers and borrowers, savers go mainly through what? Banks in Germany Money, and in the U.S. they go mainly through the capital markets to the borrowers. Two different type systems, so the boxes, if you, were weighted differently, even though there are players in both at the top side and the bottom side, or the north and south of that figure. So it's just a weight, and why is it weighted that way? Is it market forces?

27:39And then you have to ask yourself, which I do, would the IMF advocate the German type system in a lot of emerging markets? Is that a more desirable system? So we have to ask ourselves, it seems to me, what do you mean by desirable? Why does that system exist? Is it a result of competitive or market forces or is it a result of laws and regulations? And it has something to do with corporate governance, which is frequently a term that, while it's associated a lot of work of financial economists, okay, I say that because I don't I don't always know. Sometimes people have PhDs in economics and they do finance. Sometimes people have PhDs in finance and they do economics, so it's a blend of the two. But that has to do with what's the way in which you induce firms to operate very efficiently.

28:28We have what's referred to as a fragmented ownership system in the United States. That is, there are very few individual large percentages of shares in companies. and a lot of the stock goes by very many parties and we call it a fragmented system, which means there's a separation sometimes between the owners and then the managers of the companies and we say they tend to be professionals and we say that creates agency problems, which is to say maybe the managers don't always act in the best interest of the stock or operate the firm as efficiently as they should. Well, there's ways in which that's corrected. One way is a hostile takeover. So you have market forces at work, even in a capital market-based system, that tries to induce firms to operate more efficiently, and we could go into Michael Melton's junk bonds, and we'll direct to Bernard Lambert and those things.

29:16But that's a way in which market systems can work, it's also a way in which you can spend some time in bars. It turns out that when you go to the German system on the other hand, it's mainly the banks.

30:02The Theory of Money and Credit

30:32are two different systems. In large part, it's laws and regulations. Our banks are told they can't own stock in companies. Up to five percent. But it has to be totally passed. You can't vote it. No controlling interest. And under some cases, you can go even higher than that. But almost without exception, that's not the case. Our banks don't really exert any control over firms with respect to their ownership of of Stocks. If there's any control, it's exerted through the loans that they make. So banks therefore go to the capital markets much more so because they can't go to the banks and let the banks grow. Don't forget the size because of, in large part, branching restrictions.

31:18They can't go to the bank and service the bank more fully, especially as a result of Glass-Steagall. So you say, is that now desirable? Should we let banks service firms more fully by Offering Securities Activities, not to say get involved in insurance and real estate. Well, that's a debate, and most, I believe, economists today would argue it's time to do away with Glass-Steagall. The Federal Reserve has been doing that since 87. It gave permission to some banks to set up subsidiaries within a holding company framework so that they could indeed engage to a greater degree in securities activities. And the Fed says, well, you can set up a subsidiary, The Office of the Control of the Currency has reinterpreted the laws under which national banks operated to permit the establishment of operating subsidiaries directly of national National Banks, and that opens the door for them to set up subsidies directly, bypassing the holding company framework.

32:31The Federal Reserve argues that the OCC, then once OCC did that, the Fed said, okay, 25% for fear that probably some banks, national banks, would decide to just open up an operating subsidiary of the OCC. The OCC has gotten two applications to set up operating subsidiaries, both the nation's bank, and now the Congress is very concerned. And it's probably about overture. Do you want the Federal Reserve to regulate banks and have bigger staffs, or do you want the OCC to regulate some banking activities than OCC? And then what do you do about the state banks that can't necessarily operate in subsidiaries? So the Congress is forced to do something just because of the preemptive strike taken by OCC. Mr. Ludwig, who has to recuse himself from a couple of these applications for operating It turns out though it is interesting times. Now let's go to the next table and in carrying on with what I just said, basically I tried to group the countries, me and my two co-authors

33:44The U.S. is the most restrictive country in the world with respect to regulating its banks, in every respect, when you include branching restrictions. Now you might say, is that, again, you can say is it good or bad, and we can debate what one means by good or bad and those sorts of things, but is this desirable? Should we do this? Should we? Are we? And we're out of step with the rest of the industrialized countries of the world. So you have to say, as an economist, if somebody asks you, well, you think we should change? Should we move more in their direction? Should we deregulate? What are the pros and cons? One thing that's interesting is that despite all our restrictions and the heavy government involvement and all the thousands of regulators, we've had problems.

34:38From 80 to 95, more than 5,000 federally insured depository institutions failed. And by that, I mean, they were taken over by the government, dismembered, liquidated, or sold to other financial firms, and it cost approximately $200 billion, $200 billion to resolve. The biggest probably financial disaster to strike the U.S. since the Great Depression. And indeed, the savings loans, which account for the bulk of those costs, which were shared by Taxpayers which is why it's probably considered the most egregious disaster. The savings vote fared much better in the Great Depression than they did in the 1980s, if you can believe it. The losses borne by uninsured deposits were smaller than the losses borne by the federal insurer in the 1980s.

35:28Interesting fact. It also turns out, so with all the restriction, and we really didn't get a lot of big bang for Buck, when you look at the crises in other countries. Furthermore, when you look at other countries, they had nothing. I'll make a blanket statement, it's up to you to disprove me with facts, okay? A blanket theory that when you look at all these other countries, the two-thirds IMF, you don't find that the problems with failed institutions, they're either associated with state-owned banks, or they're associated with the classic problems which are fraud or real estate problems, commercial real estate problems. It wasn't the securities activities, it wasn't insurance activities, It wasn't the non-commercial real estate activities, and it wasn't the commercial non-bank ownership of banks, that is, non-commercial firm ownership of banks, or the bank's ownership of non-commercial receipts.

36:23That didn't have anything to do with these sorts of problems, but the concern nonetheless on the part of our Congress is indeed that it would be concentration of power if we move too much like other countries. Conflicts of interest is usually used. With that means if a firm has a securities subsidiary, what happens is as you come to me as a customer, for example, I give you a securities advice, I say, oh, well, why do you want to underwrite? Why would you want to go out and raise capital, raise funds in the capital market? It's my bank. We'll make you a loan. So what you do is there's a conflict there. You could help the firm by underwriting the securities issuance or what you could do is make a loan. We say Bankers say that's a potential conflict. Well, banks, the whole world is a series of conflicts.

37:10The ordinary transactions, most of what they do involves potential conflicts. And that's why the regulators, presumably if they do anything, is to keep those conflicts in check. Concentration of power is always an issue. How do you determine whether there's excessive concentration of power? What's your market? Is it domestic, international? Well, Citibank operates in 98 countries of the world. It's more countries than any other bank in the world. The second largest bank is the England Chartered Bank, but it operates on a Hong Kong, and it operates in 80-some countries. So our banks are increasing globally. Exxon gets over 80% of its assets and its revenues come from outside the United States. Coca-Cola has had a press conference saying, we're not a U.S. firm. We have a headquarters. Our headquarters is in the U.S.

38:0080% of the revenues come from outside the United States, over half the revenues is City Corp, half Chase, half JP Morgan. You go on down the list. Are these US firms? What are they? How do we want to regulate them? Banks can do more in other countries than they can in this country if they're chartered here. So again, what do you want our banks to be? How would you change this table if you did? Also, some people say because of deposit insurance, you don't want deposit insurance subsidies or discount window subsidies

38:59St. Louis, basically said, well, there's a subsidy there, and he was asked why not eliminate it, he said, well, it's politically infeasible, therefore we need restrictions on powers, is an issue. Then the second, the next to last table, so I don't, I'll give you a chance to make your comments, is ownership form, you might say doesn't really matter. Well, the point is, why should the government, you have to ask yourself, tell banks you have to use a holding company to engage in certain activities? You can't choose your own corporate organizational form. It seems almost the height of absurdity to sort of say, we not only tell you what you can do with respect to the products and services you can offer, where you can offer them,

40:19and not, apparently, the preferred organizational form for firms given the choice in different countries across the board here. This information, incidentally, it's not unlikely, part of this exercise, you would have thought this information to be readily available. The Congress is debating issues, the regulatory authorities, without knowing what's happening in other countries. So, occasionally, people just elude while there are problems in Germany. Some of you were telling me the other day, congressional staffer, I said, well, tell me what those are, and wow, they're very complicated, but we still have to do something, and I said, well, wouldn't you like a few facts? So the fact of the matter is, is you would think the Federal Reserve or the OCC, some of the agencies, they just say, this is the situation in Germany, but everybody talks across purposes, so part of the exercise is you people are smart, You see, I'm not giving any text. You look at these tables. You conclude what you think is the way in which maybe the U.S. ought to go, if you are.

41:14It's actually me. I'm looking at the same table as you. And I can tell my story. But what I think is just occasionally, we all have the same facts. We say, this is the situation in these different countries. Now, I conclude, no, the U.S. should be restricted. And then I say, why? Why? Because all these other countries are... I asked Larry Meyer. I said, Larry Meyer, he heard some of what I talked about, and I've known him for years and that. And so I said, ask him. Of course, I said, like, look, based upon some information presented earlier by me, basically, when you look at these other countries, US is on a step. Would you conclude that maybe these other countries are all wrong? That is, they have a bad financial system, we should try to suggest to all these 180 other countries, you know, taking out the 19 here, that they should adopt a U.S. type system, or, and not adopt, say, the German

42:12system or one of these other systems. And he said, well, Jim, you know, Jim Barton, some good work, very informative work, unfortunately, we have to look beyond just these near-datas and what's going on in other countries. We have to think fairly broadly about these, what I call Greenspan-esque or speak or whatever we describe. Meaning, you're saying very good, very complicated, these are complex issues, we live in a world in which you have to balance political factors and economic factors and basically we have a very good system that has lasted and served us well for more than 200 years or something

43:23Well, I think the German system regulates in the Japanese, it regulates the capital markets, excessively. They tax things, you can't own shares and stocks without paying a heavy tax or issue them. So I'm not yet a thorough expert on all the different laws and regulations or tax systems, but you find that the Germans don't have the system they have solely because of the workings of the market forces in a competitive environment. And a lot of times the government and Benefits the Banks by Regulating the Capital Market. Now, we seem to do the reverse. So maybe, you know, we're going to move towards a better blend of the top and the bottom, the north and south of boxes, if you will, on chart one. So ownership is even issued. The last take, the U.S. and say, look at the U.S. organizational chart.

44:13When you look at the U.S. in table four, it says corporate organizational form. Look at the U.S. See, you can't put the U.S. on the same table as the other countries because there are too many boxes. Okay? And notice there, you say restricted, prohibited, here you have to say limited and various. Okay? To put this together required the attorneys, okay? I have a former student of mine, George Washington, who happens to be head of one of the divisions at OCC, so she's a very good attorney, and the general counsel. So they put a group of attorneys out, and the attorney said, we can't do it for the I said, look, should OCC issue a document so we can tell about, you know, what can be done in a holding company or a bank or a subsidiary bank for all these other countries?

44:5818 of the 19 are, well, we can't do it for the U.S. I said, OCC wants to admit publicly, we can't, it's too complicated. Does it suggest something's wrong if you can't tell what's being done where? And so the attorneys worked on it and they said, you have a point, I guess it would be embarrassing. See, to omit the U.S. and say, we can do it for every country but our own country. So all the footnotes here see are meant to provide the qualifications. Now I took a crack at it when they said we can't do it, then I filled out the box and I said, well, this will, we won't say source OCC, and it turns out it's interesting when you look at what happened. We priced it based upon failures of banks, state and national banks from the 1860s all All the way through the 1930s, that's how we decided how we were going to price it and we set the price a bit low thinking that never again with all the good regulatory apparatus

45:52in place, the losses would be a bare minimum. See once we had depositors, when we established the federal bank system, it feels like after I said, with all these great people and the government now supervisor regulated, we wouldn't have losses again. That would amount to anything until the 1980s, honestly. So all the countries now are running fairly rapidly to do what? Adopt Federal Deposit Insurance systems, regulatory systems, beefing up their staffs and those things. So what we have is a mad dash, I would say, with the encouragement of the IMF, the World Bank and just about everybody else to establish a system that works. Even though there are some countries in which they haven't had deposits, there have not been government deposits, which they and so you have to ask yourself is the deposit insurance system in some sense a way in which to minimize banking type problems or is it a way to exacerbate or precipitate banking type problems and when you look here you find that we have who supervises is even an issue

47:01should it be the central bank should they also be involved in regulating supervising of Banks, if you have deposit interest and therefore you argue that's a rationale to regulate and supervise banks, if there were no other rationales. Well it turns out in some countries, about 50% of these countries, the central bank is involved in regulation and supervision to examination, like in the U.S. and other countries. That's not the case, but we have the most regulators, okay, we create more jobs for the regulators because of the dispersed nature of regulation in this country. probably doesn't make a lot of sense, we don't need as many regulators. Now some say it's good to have multiple regulators because they compete with one another. Sometimes it's the benefit of the marketplace. I think of the example of Wisconsin, the state regulatory authorities provided their institutions with the ability to offer just-to-write mortgages and it wasn't so with the federal government, largely because in the mid-1970s what happened, William Proxmire, then chairman of the Senate banking committee, got a notice that his

48:01mortgage payment was being increased. He got outraged. He says, why is it? He says, you have what's called an arm, an adjustable rate mortgage. He says, what is that? He said, I thought there was nothing but fixed mortgage. Why should homeowners have to pay more, as say, market interest rates go? That's outrageous. That destroys the ability of people to stay in their homes. If their payments can go up, it might be that they, you know, it takes away from the food budget, other budgets, they might default. That's bad. We want to promote homeownership. So the Congress, he and his colleagues and more. No adjust rate mortgages for any institutions nationwide. Then of course that was the mid-19th century. So lo and behold, interest rates went up, fixed rate mortgages, savings loans went into the tank. Who benefited? Homeowners. Who suffered? We just shifted the risk from the people who got the mortgages to the institutions. They finally said, gee, why did that happen? Do you think those institutions were being run by fools? They would not have

48:58have offered adjusted rate mortgages or Gerber. They were prohibited from doing so, and they got other benefits, presumably, and they didn't have to in a stable interest rate environment. But that tells you how we got fixed rate mortgages. It wasn't just the institution's desire to do so. And when you look here, look at who administered the insurance scheme, the funding is at Exxon TX Post, and the dollar amount. Now, the INS says the amount of insurance should be three times per capita income. That's the rule of thumb. And they want every country of the World, all 200 countries, if that's how you do it, to have three times, they want all to have federal deposit insurance, they want the central bank to be involved in regulating institutions, and they want it to be three times per capita income and increase. Now, you have to say, why three times per capita income?

49:45How do you price it? And they want all schemes to be ex-ante, I'm sorry, ex-post, no way, I'm sorry, ex-ante, No Exposed Deposit Insurance, all government-administered, and they want, of course, the IMF to play one of the key agencies in international or global bank regulation, which makes sense, if you're there to do those sorts of things, and I think it's an idea. I don't know that it's yet an issue that... My only point would be it merits public discussion, an airing of a debate among the Congress and others saying, well, what about global regulations? But about the time we get to debate, they already will have been imposed and we won't already have these systems in place and all these other.

50:32It is as fast as I am in Afghanistan and we're back. They've gotten their troops all over the globe imposing. And it's not bad. I haven't done it. I've been offered the opportunity to go to some of these countries and do their system, And it's amazing how many banking experts there are now in different institutions who tell me, I just came back, boy, it was fun setting up with the positive insurance system. I read a few papers, went over there and told them what to do. And that's the mentality. I'm not saying it's bad, these aren't smart people, but you wonder if that's what we should be doing, if it's the right way here in other countries. And the last thing I'll close on is, you can get into trouble talking about things, I made the fine comment, somebody who said, well you know banks get a lot of insured deposits, those insured deposits help house America, all those sorts of things, and I said well look, it turns out only about 50% of all the assets of all depository institutions in this country, and they have about 5-20 million assets, are funded with federally insured deposits, meaning they're not absolutely central. It used to be much higher going back in time.

51:40So about 50% of federal, meaning they can fund half their assets with non-federal insured deposits, and in some banks, big banks, only 20% of their assets are funded with federal insured deposits, suggesting that they really need those federal insured deposits. And only approximately 15% of all the assets of all financial firm and service in the United States are funded with federal insured deposits. and then the question is have we reached this stage which maybe we should do away with federally insured deposits. A mutual fund is not unlike, is effectively, you can do banking transactions with a mutual fund and if you give them access maybe to the Fed wire, you know, the federal clearing system, you have 100% capital and it turns out you don't have federal deposit insurance.

52:30But I made this kind of passing reaction to another person who was speaking about the 15% being funded and a financial institution person, a big, mid-sized institution company, he says, well, he says, you know, I'm really troubled by your talk, I said, oh, my talk, he said, yes, well, yeah, you kept on, you were harping about the fact that we don't need to federalize, I didn't say that, no, he said, well, you said that 15% of the aspect, he says, now, by your saying that, You're going to frighten or you're going to give the impression to people that institutions don't need federally insured deposits. He says, and I said, well, do you? He says, we get it. Yes. I said, well, why? Now, of all the things you heard me say, I'm Mitch Ipat and he was very irritated with it. He said, you know, it's people like you, you know, typical academic, you don't know the real world and that.

53:18I went through that for a few minutes as we were fortunately having a drink so I could better tolerate it. But it turns out, and I said, you know, notice everything, I said, he forgot about the multi-component because he runs an institute. He says, we're men's size. He says, we get a subsidy. I said, oh, you do. And I said, I'm helping pay for it, others. He says, well, that's not my point. He says, my point is we get a subsidy. He says, our return is about 50 basis points on assets, let's say. And I said, well, what's the subsidy? He said, about 50 basis points. And he said, so if you take away the insured deposits or you do away with the subsidy,

54:23And guess what? Some people are saying this subsidy really doesn't exist. Is there a subsidy? Well, he comes blatantly out and that's newsworthy to say, I wouldn't exist without the subsidy. But in any event, it is an issue. And the question is, we have to ask, should that particular institution be getting that subsidy? Is it appropriate or not? Do we think because of that, they're attracting funds and funneling them to public goods, merit goods, housing as a merit good. Is that what we want to say? Is there some failure that is being corrected with offering that type of insurance today? Well, I've gone on, you've been patient and let me sort of semi-spiel listening to me, but I would encourage all of you.

55:12I think this is a very interesting area, and for me, to be quite honest, you can see there are no equations, no statistics, I mean, statistical analysis, which I used to like to do a lot of. But unfortunately, this is an area in which I've come to appreciate the fact that not everything can be easily quantified in a model, or easily, no offense to some of you, but easily use econometrics, and Metrics, which is my, at one time I always thought if it was anything I did, it was viewed as scarily, there had to be equations, but I found in this area, trying to talk about corporate governance, and there are, as Clara well knows, a lot of people do some good work in this area, and Clara works in this area too, in corporate governance, but it turns out that part of it is, I can't get my hands on some of these issues without some simple

56:36Obviously, people in this room, Leman obviously knows more about many of these things than I do and many others and knows clearly the history and the writings of many others better than I do. When you go back though, you can't but they appreciate the fact there are so many people who have written and told some of the stories that I now try to tell, long before me. Long before me, that is, look at the writings in the 1930s and earlier ranks, you'll be impressed that they identified issues and talked about many of these sorts of problems. And it's nice to look at other countries, but always appreciate the fact that others have written about these issues. But sometimes we overlook the fact that if I didn't see a model, I didn't see some statistics, I may not have done some of that reading.

57:21Banking. So all of us, I think, occasionally have a professional response, going to try to identify those who came before us and wrote about similar issues. So when I was looking at the same loan problem, I was impressed reading some of the literature of the 1930s and in the journals. The people wrote and identified the problems. They didn't use the exact language, but they really had very insightful analysis. And nothing was a surprise in the 1980s, that is, moral hazard, problems with banks and what happened. That all had been written about. Now, some of the modern-day writers ignore a lot of it, and you don't see a lot of citations or references to their earlier literature. That's sometimes a bit of a shame. But I would encourage you, those of you who are interested to look broadly at what's going on in these other countries and to go back. I'm very interested.

58:11See, in the U.S. I can go back and look there, but I don't know what happened in England in Germany, why they got the systems they did, the regulation. It's profoundly interesting because what we're trying to do is look out there and observe things and say, how do we explain them? Can we tell a coherent story as to why we see the things that we do? Is it market forces, you know, through competition that have propelled these financial systems in one direction? Or is it laws and regulations that have shaped the financial system? And Do we want to try to shift the system in some way? What's an ideal system? It's almost going back to what I call that phrase, first principles, trying to just say, well, you know, I used to say, saving goes to borrowers, you know, like it was so easy.

58:59And then, but then that's a relatively profound statement. Well, how do you go from saving savers to borrowers? How do the ones get there? And does it matter? Do they go through financial firms or capital markets? And why do we have differences in different countries? and it started to be pretty darn interesting to me and so I started to spend a lot of time leading some legal type guide and it's what other people have said and it's really sort of interesting and a lot of people, I think, or more people are interested and it attracts, incidentally, some of the people who work in this area are now a lot of attorneys. I think of Jonathan Macy, the guy named Mark Row at Glendale University's Wall School. There's Jonathan Macy at Cornell's Wall School. Some other people at Stanford University's Wall School.

59:46So a couple of people I know in the law faculty that I communicate with, a bunch of interesting people, because it does involve laws and regulations, finance and economics. Okay, Jim? Well, I'm afraid we're out of time, but thank you very much. No questions?