There are other crucial issues raised by H.R. 7539. First, would it serve its stated purpose of assisting cities and States by reducing revenue bond interest cost?

Second, would it lead to increased concentration of economic power on the part of a few giant metropolitan banks?

Substantial evidence on each of these points was presented at the 1963 hearings and in the interests of saving time, I shall not discuss those issues at length.

In 1963, commercial banks urged support of the bill on the ground that their entry into the revenue bond underwriting would lead to lower interest costs for issuers of revenue bonds. But they failed to present any significant evidence to support that view.

Since 1963 my friends in the commercial banking field have been doing some much-needed homework in economics. Many commercial banks now concede that the effects on the proposed legislation of interest costs benefiting revenue bond issuers would be minimal.

I would also mention that before the National Association of Counties, Mr. Goldberg stated that he was guilty of doing something that could be criticized and that is taking the full 10 basis points differential between revenue bonds and general obligations and applying it to the entire Port of New York Authority debt issued since the date specified. He said thenthat he didn't know what the differential was. Perhaps it was quite small. Whatever it was, peanuts or otherwise, he would like to have it but he backed away completely from the 10 basis points differential

The CHAIRMAN. This is off the record.

(Off the record.)

Mr. LAING. The interest of several important municipal organizations in the legislation rapidly disappeared when they realized the potential interest cost savings were of this minimal order. While you have heard from some organizations which endorse this bill, a number of others have refused to do so, the National Association of Counties, the Municipal Finance Officers Association, and the American Public Power Association, to mention a few.

I feel we feel that the stated purpose of this bill "To assist cities and States" might be appropriately amended to read "To assist commercial banks," and actually to assist only a handful of the largest commercial banks at that.

There are approximately 13,000 commercial banks in this country. Of this number only about 1 percent more or less have any interest in underwriting, and of these 100 or so banks with such an interest, there is substantial concentration of power among a few of the Nation's very largest banks. Testimony at the 1963 hearings showed this. The ability of a few large banks with large resources and corresponding economic leverage to dominate the municipal securities markets would in time tend to force many existing investment banking firms out of business.

The end result would likely be less effective competition as a result of domination of the market by a few large banks.

That this is not speculation but a substantial risk is shown by the experience of the twenties when the banks gained control of the general securities underwriting business. The consequent weakening of the investment banking structure would create serious problems for

those revenue bond issues which do not attract bank underwriting interest for one reason or another-for example, because the issue is relatively small in size or because the issue involves a new construction project which doesn't qualify for bank investment and hence would not be eligible for underwriting.

Yesterday Mr. Saxon testified that small banks would play an important role in underwriting small revenue bond issues. This represented a substantial shift in his position from 1963 when he testified that community pressure on small banks to underwrite revenue bonds would create serious problems for such banks. It was for these and other reasons that the National Association of Supervisors of State Banks charged with the responsibility of subscribing the Nation's 8,000 State-chartered banks opposed it last year, H.R. 5845, and we understand they have submitted to your committee a statement in opposition to H.R. 7539.

The State bank supervisors support the amendment to H.R. 7539 proposed by the Federal Reserve. I will stop at this point.

The CHAIRMAN. You may insert your entire statement in the record. (The statement of Mr. Laing follows:)

STATEMENT OF CHESTER W. LAING, CHAIRMAN, COMMITTEE FOR STUDY OF REVENUE BOND FINANCING

My name is Chester W. Laing. I am chairman of the Committee for Study of Revenue Bond Financing, an association formed in 1954 consisting of approximately 450 investment banking firms situated throughout the United States. Since its formation 11 years ago, this committee has been studying the financial structure and history of State and municipal financing in general and revenue bond financing in particular. I appreciate this opportunity to present the views of our committee on H.R. 7539 in its present form, which would amend the banking laws to permit commercial banks of deposit to underwrite and deal as principals in so-called revenue bonds; that is, bonds issued by political bodies which are secured solely by specified and restricted revenues rather than the full faith and credit and the general taxing power of the issuer.

We oppose this bill in the form in which it is now before this committee, but we would favor its enactment if it were amended as suggested yesterday by Governor Balderston of the Federal Reserve Board. We believe this amendment would resolve the conflict between the views of the Federal Reserve Board and the Comptroller of the Currency in this area, and constitutes the only solution which would not raise new and widespread conflict-of-interest problems.

H.R. 7539 is but the latest of a series of attempts on the part of a few big metropolitan banks to regain their former position of dominance in the securities markets of the United States. The Glass-Steagall Banking Act was enacted in 1933 and became effective on June 16, 1934. As early as 1935 an attempt was made to amend that law to permit banks of deposit to again enter the field of underwriting corporate bonds. In 1938 an attempt was made to permit commercial banks to underwrite any securities that they may purchase for their own investment. In 1955 it was apparently decided that an easier route to expanding commercial bank underwriting was offered through the extension of underwriting privileges first to so-called revenue bonds; legislation similar to H.R. 7539 was introduced at that time. Legislation of this same tenor was also introduced in 1957 and 1962. Your Banking and Currency Committee has not approved any of these efforts.

As introduced, H.R. 7539 differs in only two respects from previous bills to authorize commercial banks to underwrite and deal in revenue bonds—including its immediate predecessor, H.R. 5845 of the last Congress. As the members of this committee know, in the autumn of 1963 this previous bill was the subject of some of the most extensive hearings held on a banking bill since the GlassSteagall Act itself over 30 years ago.

(1) Industrial development bond exclusion is of no importance. H.R. 7539 excludes from the revenue bonds which commercial banks may underwrite those known as industrial development bonds. While many of these issues are

among the riskiest type of revenue bonds, the exception is of little or no importance. In 1964 municipal bond issues totaled over $10 billion, while industrial development bonds totaled only about $190 million-less than 2 percent of the total. The inclusion of this exception is nothing more nor less than a red herring, designed to detract attention from the basic issue.

Incidentally, while we are on the subject of revenue bond quality, I believe I detected some confusion at the hearings yesterday. While there are, of course, some revenue issues of higher quality than general obligations of the same issuer, I would like to make perfectly clear that revenue bonds as a class are of substantially lower quality and higher risk than general obligation bonds. This was made clear at the 1963 hearings (p. 723). In fact, there have been many cases of revenue bonds which did not turn out well at all, because the estimates on which anticipated revenues were based turned out to be wholly inaccurate. (2) Prohibition against trustee self-dealing adds nothing to existing law. The second change, and the one on which the most emphasis has been laid, is a provision that national banks engaged in underwriting may not sell revenue bonds from their underwriting accounts to their own trust accounts unless permitted to do so by court order. This provision is alleged to solve the conflictof-interest problem. In fact, it does no such thing, as Governor Balderston indicated yesterday.

For many years applicable regulations as well as State law have forbidden banks, like other trustees, to deal with themselves in buying or selling property to or from their own trust accounts. Prior to 1962, self-dealing of this type by national banks was prohibited by regulation F of the Federal Reserve Board; since 1962 when this authority was transferred by act of Congress to the Comptroller of the Currency, it has likewise been prohibited by the Comptroller's Regulation 9.*

Similarly, the Federal Reserve Board will still find the purchase of securities by a bank from itself, as underwriter or otherwise, for the benefit of its trust accounts to be so objectionable as to raise a question as to the bank's continued membership in the Federal Reserve System."

The new proviso concerning self-dealing which is contained in H.R. 7539 thus adds essentially nothing to the limitations imposed by existing law and applicable regulations. Furthermore, the new proviso easily might be circumvented by the simple expedient of having the trust accounts of a bank member of an underwriting syndicate buy bonds from other members of the syndicate instead of directly from the bank itself.

Members of underwriting syndicate have a joint interest in sales by any syndicate member. In municipal bond underwriting, each member of an underwriting syndicate is jointly and severally liable to the issuer for the full amount of the bond issue, whether this be $1 or $100 million of bonds. The underwriting and reoffering to the public is a true joint venture; the common objective is to place the entire issue as quickly as possible with investors at the announced public offering price. If this can be successfully done, the syndicate and its members make a profit; if the offering is a failure, there may be no profit or even a disastrous loss. In nearly all syndicates a sale by any member of the syndicate

3 That change is found on p. 3 of H.R. 7539, lines 8 through 11. The change would provide that the purchase of revenue bonds by "a national bank as fiduciary from such bank as an underwriter or dealer shall not be permitted unless lawfully directed by court order." Title 12, C.F.R. § 9.12 now provides: "89.12 Self-dealing.

"(a) Unless lawfully authorized by the instrument creating the relationship, or by Court order or by local law, funds held by a national bank as fiduciary shall not be invested in stock or obligations of, or property acquired from, the bank or its directors, officers, or employees, or individuals with whom there exists such a connection, or organizations in which there exists such an interest, as might affect the exercise of the best judgment of the bank in acquiring the property, or in stock or obligations of, or property acquired from, affiliates of the bank or their directors, officers or employees."

"For many years, the Board prescribed, as standard conditions of membership, a condition which, in general prohibited banks from engaging as a business in the sale of real estate loans to the public and certain conditions relating to the exercise of trust powers, including one which prohibited self-dealing in the investment of trust funds. The elimination of these conditions as standard conditions of membership does not reflect any change in the Board's position as to the undesirability of the practices formerly prohibited by such conditions; and attention is called to the fact that engaging as a business in the sale of real estate loans to the public or failing to conduct trust business in accordance with the applicable State laws and sound principles of trust administration may constitute unsafe or unsound practices and violate the condition set forth in this subparagraph." 12 C.F.R. § 208.7, fn. 6.

reduces the liability of, and contributes to the possibility of a profit by, every other member.

Banks claim no self-dealing occurs. Representatives of commercial banks testified in 1963 before this committee that there is no self-dealing by commercial banks. Typical of such statements was that of Alan K. Browne, vice president of the Bank of America N.T. & S.A., the largest bank in the country and as far as I know in the world, who said:

"Those familiar with banking laws know there can be no self-dealing. This is rigidly observed, so it eliminates the possibility of an abuse." Hearings before the House Committee on Banking and Currency on H.R. 5845 et al (88th Cong., 1st sess., p. 436 (1963) (1963 hearings)).

And Mr. Saxon said yesterday he knew of no instances of self-dealing since he has taken office.

There is in fact ample evidence of cross dealing between trust accounts of banks in an underwriting syndicate. I wish to draw your attention, and Mr. Saxon's, to a standard provision incorporated in underwriting syndicate agreements of the Bank of America in the management of its underwriting of large State of California general obligation issues. An example of such an underwriting syndicate agreement is that used to cover their management of the syndicate on $150 million State of California bonds sold on December 15, 1964. A copy of that agreement is attached as an appendix to my statement, and I ask that a copy of it be included in the record of these hearings. Included among many detailed and technical provisions is a list of priorities among customers for the bonds (bottom of p. 2 and top of p. 3). In addition to a priority for institutional investors, including specifically bank members of the syndicate for their own investment accounts, there are listed "trust companies and trust department of commercial banks, including bank members of the syndicate, for designated trust accounts."

In other words, the Bank of America standard syndicate agreement not only provides by its terms for sale of underwritten bonds to trust accounts of the underwriting banks, but actually provides priority for such sales. This is current practice under existing prohibitions against self-dealing which have been promulgated by the Comptroller of the Currency and the Federal Reserve Board, and it could plainly continue to be the practice under the terms of the proviso included in H.R. 7539.

Thus even as to trust accounts H.R. 7539 would not solve or even significantly affect the self-dealing problem. Furthermore, as was pointed out in the 1963 hearings, even an absolute prohibition against purchase of underwritten bonds by a bank's trust account would not really solve the problem, because, just to use one example, this in turn would put these accounts at an unfair investment disadvantage by arbitrarily excluding them from the opportunity of purchasing a successful offering unless they bought later in the secondary market at a higher price after the syndicate had sold all its bonds and disbanded.

Separation of commercial banking and securities dealing is the only way to avoid conflicts of interest. The only adequate solution to this dilemma with respect to bank trust accounts is the one on which the Glass-Steagall Act was based-separation of the businesses of commercial banking and investment banking. The only other complete solution to this aspect of the problem only insofar as trusts are concerned would be to prohibit absolutely banks which underwrite and deal in securities from acting as trustees.

H.R. 7539 does not deal with the conflicts of interests created by an underwriting bank's duties as a depositary, investor, correspondent, and lender. Furthermore, H.R. 7539 completely overlooks the problems created by the many other equally dangerous conflicts of interest discussed at the 1963 hearings. As was made clear in congressional hearings preceding the enactment of the GlassSteagall Act in 1933, and again in 1963, there are inescapable conflicts between a bank's interest as an underwriter and dealer in securities on the one hand and its duties as a correspondent, a depositary, an investor, and a lender, as well as a trustee, on the other. There is an inevitable tendency on the part of the large metropolitan banks to place their underwritten securities with their small country correspondent banks who rely on them for investment advice. Many of these small banks do not have the necessary staff to perform any exhaustive securities analysis; they rely heavily on the recommendations of the metropolitan banks. But when these metropolitan banks underwrite, their judgment of investments is bound to be colored by their own obvious interest in the quick profitable sellout of an issue. Similarly, depositors look to their banks for qualified and im

partial investment advice. A bank engaged in underwriting securities can hardly be expected to give a depositor such advice; rather, one might expect that a bank's depositors would be used as an obvious source of customers for underwritten securities.

Moreover, a bank has great potential leverage with which to further the sales of its underwritten securities arising from the fact that many borrowers can be naturally amenable to suggestions from the bank as to securities purchases. Similarly, a bank operating as an underwriter may be tempted to make overly liberal loans to securities dealers to further its own underwriting interests. Overextension of credit in order to further underwriting and dealing activities was widespread in the 1920's.

Finally, a bank's own investment policy may be affected by its obvious interest as an underwriter. If an underwritten issue is moving slowly, there may be an irresistible urge to tuck it away in the bank's investment portfolio, even though the issue might not have been bought on its own merits absent the underwriting interest by the bank.

A full discussion of these various conflicts of interest is found at pages 21 to 39 of the Blue Book of Cheever Hardwick's testimony as chairman of our study committee before your committee in 1963; it is reprinted at pages 685 to 693 of the 1963 hearings record.

The one effective way to avoid these inherent conflicts of interest is to continue the separation between commercial banking and investment banking which the Glass-Steagall Act established. This would be the effect of the amendment to H.R. 7539 suggested by Governor Balderston yesterday. Enactment of the bill with this amendment would provide a comprehensive statutory definition of general obligation bonds. Favorable action by Congress on this amendment would eliminate the conflict between two Government agencies as to what bonds may be underwritten and dealt in by commercial banks. It would accordingly provide a complete and definitive solution to the problem now before this committee and at the same time avoid the conflict of interest problem.

The argument that the abuses shown in the 1920's have not since been repeated and are no longer relevant is specious. They have not been repeated for two good reasons: The Glass-Steagall Act has been effective to put the banks out of the underwriting business except for a small group of generally high quality and relatively short-term municipal bonds; and we have fortunately not had a period of economic stress and strain in any way comparable to that of 1929-32.

The conflict-of-interest problem created for those charged with responsibility for regulation of this country's banks are forcefully illustrated by recent bank failures in several sections of the country. There, unfortunately, the events requiring regulation occurred before regulatory procedures became effective. In times of stress, when those involved in commercial banking place other interests ahead of sound commercial banking practices, the temptation to cut a corner may become overwhelming and problems are inevitably created. This is bad for the commercial banking system, and it is bad for the public, which is the eventual loser.

Chairman Martin of the Federal Reserve Board of Governors expressed these thoughts very succinctly at the 1963 hearings:

"[M]y experience in this area has taught me that there are others that get into the business when you remove the floodgates, when you open up this sort of thing, and that under stress this conflict of interest could prove too great. I went through the stress of the late unpleasantness in 1929 and 1932, and I think it was soundly conceived that we divorce the commercial banking from the investment banking business. ***

"Now, I know that a good many of my banking friends think that I am seeing ghosts in this, but I can't help but recall the period, and I won't start calling names, the period when men were put under real stress, and there was a real deterioration under the conflict of interest" (1963 hearing, p. 113).

There are other crucial issues raised by H.R. 7539. First, would it serve its stated purpose of assisting cities and States by reducing revenue bond interest costs? Second, would it lead to increased concentration of economic power on the part of a few giant metropolitan banks? Substantial evidence of each of these points was presented at the 1963 hearings, and I shall briefly discuss those issues with you.

Interest costs: In 1963, commercial banks urged support of the bill on the grounds that their entry into revenue bond underwriting would lead to lower