This is not merely, it seems to me, a sole choice on the part of banks. While there is no legal responsibility or duty as such, it seems to me a banking institution enjoys a preferred status in any community. It obtains its resources largely from that community. It assists its community best when it makes the most effective utilization of those resources consistent with sound banking practice.

This area includes assistance in the form here prescribed in participation in the financing through revenue bonds. Of course, we see a problem, or some see a problem referring back to the early twenties. We could cite many other instances of this sort. We did not have at that time the management we have in banking institutions. We did not have the kind of effective bank regulation we have today by any means. It was loose. Today we have tight and far more efficient regulations.

I do not see that in any event the standard or the difficulties that might have occurred in the twenties are a precedent for today's standards any more than such standards in other areas could be based on standards of the twenties, whether in the financing of oils, chemicals, or whatever else it is, or our international policies, whatever they might be deemed to be necessary at a given point in time.

A given bank may at times be tempted to engage in a practice which may be questionable. This can occur in many areas, in the lending areas, in any number of areas in which banks engage. It is the responsibility of the regulatory authorities to negate this temptation, and where it finds an example of a transaction violating this standard, the statute of this regulation to take action promptly to prevent it.

The mere fact that a temptation may exist while we are speaking of a great many banking institutions in this country it seems to me cannot be a reasonable warrant for denying the banks the opportunity to extend the benefit to their communities which it is their moral, at least, responsibility to provide.

Mr. BARRETT. Thank you Mr. Saxon.

My time has expired. I want to come back later if I may.

The CHAIRMAN. Mr. Widnall.

Mr. WIDNALL. Thank you, Mr. Chairman.

Mr. Balderston, in your remarks you made no comment on the first section of the bill, H.R. 7539, as applied to the agreement between the public housing agency and the State. Do you take any position with respect to that first section?

Mr. BALDERSTON. We agree.

Mr. WIDNALL. Mr. Saxon, I think you agree with that, too.

Mr. SAXON. Yes, sir.

Mr. WIDNALL. So that is not in dispute at all.

Mr. SAXON. No, sir.

Mr. WIDNALL. I think that all of us on the committee agree that we are in sort of an untenable position right now where there is an area of neither fish nor fowl and interpretation has been loosened through your efforts, Mr. Saxon, as to what has taken place in the past.

I would like to ask this question of you, Mr. Saxon. If in view of the legislative history that will be established by this committee, and possibly on the House floor, with unfavorable action with re

spect to a change, would your position as Comptroller of the Currency change in the future in your interpretation of existing law? Mr. SAXON. I think this is a difficult question to ask, Mr. Widnall. If the Congress, the entire Congress, taking the most obvious position-if the entire Congress took the position that our interpretation is not in the interests of sound public policy either by formal resolution or the adoption of the amendment proposed here by the Federal Reserve Board, of course we would follow.

As to what the attitude or the policy of the office should be in the case of some lesser action than that, I do not know.

Mr. WIDNALL. I personally believe that the reason we have legislation proposed before us right now is because of the dispute between the Comptroller of the Currency's office and the Federal Reserve as to interpretation of existing law.

We certainly should do something of benefit in this field so that the people will know exactly what to do and what is legal in these particular areas.

Mr. Balderston, do you believe that at the present time there are adequate funds available for municipal security financing under the existing arrangements?

Mr. BALDERSTON. Adequate funds?

Mr. WIDNALL. Yes.

Mr. BALDERSTON. That may be tapped?

Mr. WIDNALL. That may be tapped.

Mr. BALDERSTON. As I indicated in my testimony, there is a limit on the funds available for tax exempt securities. The total volume has grown until, as Mr. Saxon testified, it was $10.5 billion last year, compared with $10.2 billion in the year before that. So I would say the volume is adequate, but it is not unlimited. The tax exempts appeal, of course, primarily to those who pay high income taxes.

Mr. WIDNALL. One of the arguments made for this bill, section 2 of the bill, is that today with the increased demands for municipal bond financing, you are reaching the point where there will not be sufficient funds available and that there will be a far broader base and more funds if the national banks or the commercial banks can enter this field.

How do you react to that argument?

Mr. BALDERSTON. With revenue bonds representing 35 percent of the total last year and 40-odd percent the year before, the percentage of the total represented by revenue bonds is higher now than it was prior to 1960, much higher, and probably the percentage will continue to grow. But the more cheaply cities and governmental units can borrow through the revenue bond route, the more they may have to pay on their general obligations if my original assumption is correct that the total amount that can be tapped by tax exempts is

somewhat limited.

Mr. WIDNALL. What is your reaction, Mr. Saxon?

Mr. SAXON. Mr. Widnall, banks are already large investors in revenue bonds, the eligible type of revenue bond of which we are here speaking. Without the availability of bank funds through present investment, I have to ask myself the question where would the source of replacement funds come from? Banks are an indispensable market for these very obligations today. They are the largest single

taker in this country. And if banks do not invest in these, I do not know where the communities could find the funds, and certainly could find them at existing rates. Certainly the rates, if they could find other sources, would greatly increase.

I have another question by way of comment on this matter; namely, that if banks are to be denied-on the ground of quality or other such considerations, economic considerations the right to underwrite these very obligations which they are now and have long been entitled to invest in, then I think there is raised the serious question whether our office ought to consider denial of investment eligibility for banks, because the two are indistinguishable in essence. If the quality is there, and the great risk lies in investment and the much narrower risk in underwriting, then I think one cannot logically and reasonably distinguish the one from the other.

I repeat what I said at the outset. Where would the communities find the funds to replace the investment in these obligations now being made by the banks of the country?

Mr. WIDNALL. My time is up, Mr. Chairman.

The CHAIRMAN. Mrs. Sullivan.

Mrs. SULLIVAN. I will be very brief, Mr. Chairman.

I would just like to ask Mr. Balderston when he suggested in his testimony on page 5 that we amend the bill, where in the bill would you want the wording deleted and where would you want the other wording substituted?

Mr. BALDERSTON. The note at the bottom of page 5 suggested that the amendment be placed at the end of the seventh paragraph of section 5136 of the Revised Statutes. Perhaps, Mrs. Sullivan, you are looking at the bill before us today?

Mrs. SULLIVAN. I am; H.R. 7539, yes.

Mr. BALDERSTON. The amendment that we suggest would be an amendment to section 5136 of the Revised Statutes, and the portion that we would suggest deleting would be the lower half of page 2 and all of page 3 of the bill that is before us today.

Mrs. SULLIVAN. In other words, your wording would be a substitution for the wording in this bill, and this was merely to clarify the difference of opinion between the Federal Reserve and the Comptroller of the Currency; is that it?

Mr. BALDERSTON. Substitution for the second half of the bill before you, and the intention would be to clarify the misunderstanding between the Comptroller of the Currency and the Federal Reserve System.

Mrs. SULLIVAN. And by amending in that way then, it would delete any permission of the national banks or any bank in question underwriting these revenue bonds; is that it?

Mr. BALDERSTON. That is correct.

Mr. SAXON. That is true.

Mrs. SULLIVAN. That is all. Thank you.

The CHAIRMAN. Mr. Reuss.

Mr. REUSS. Thank you, Mr. Chairman. I am somewhat relieved at this hearing this morning with two representatives of the executive branch giving us diametrically opposed advice. It is sometimes said this is a rubberstamp Congress, just following the administration, but

here obviously we are not in the position to do that. I have found that my idea of the truth lies somewhere between you two fine gentlemen. I am impressed, Mr. Balderston, by what you have to say about the necessity of sound banking practice that avoids conflict of interest. However, I find you a little blithe about getting interest rates down. Equally, in the case of Mr. Saxon, I approve your fundamental approach to getting as low interest rates as possible by getting as many underwriters in the revenue bond picture as possible. But I find my doubts not completely answered by what you say about conflict of interest.

I wondered if we couldn't perhaps get together on this.

Mr. Balderston, would you have your very able counsel prepare for me some amendments to H.R. 7539 designed to meet the conflict-ofinterest point. Let me tell you what I have in mind:

(1) How about patching up that trust self-dealing section by prohibiting purchases from other members of the underwriting syndicate as well as from the underwriting bank itself?

(2) Prohibit sale to people or institutions with whom the bank might not be at arm's-length relationship. I think one should mention borrowers from the bank and correspondent banks.

(3) As to all others, require as to all other people to whom the bank may be in a position to sell, that there be a disclosure of the fact that the bank is an underwriter.

Would you have your counsel prepare suitable language on those three points?

Mr. BALDERSTON. We will be happy to, Mr. Reuss.

Mr. REUSS. I would appreciate that. And would you send Mr. Saxon a copy.

Mr. BALDERSTON. I would be happy to.

Mr. REUSS. And would you, as soon as you can, give us your comments on that, Mr. Saxon?

Mr. SAXON. Yes; I will, Mr. Reuss.

Mr. REUSS. Now, it is my view, Mr. Balderston, that if we did those three things, it would, unless one is straining at gnats, rather well cover the conflict-of-interest point here. If we did that, could we not meet the Fed's objection, as I believe mine would be met?

Mr. BALDERSTON. Mr. Reuss, when I want completely objective advice, I do not go to someone who has stock on his shelf that he wishes to sell me, and so your suggestion of amendments to the bill that might diminish conflict of interest here or there I think would require a little thought.

Mr. REUSS. Well, when you send up those amendments, if you have reservations about the bill as so amended, if you think the amendments do not go far enough, so state. I do not think it is fair of me to try to get a final answer right now.

(The information requested follows:)

BOARD OF GOVERNORS,
FEDERAL RESERVE SYSTEM,
Washington, May 24, 1965.

Hon. WRIGHT PATMAN,

Chairman, Banking and Currency Committee,
House of Representatives, Washington, D.C.

DEAR MR. CHAIRMAN: At the hearing before your committee of April 26, 1965, with respect to H.R. 7539, Representative Reuss requested the staff of the Board of Governors to prepare a draft amendment designed—

(1) To prohibit a bank from purchasing, for any of its trust accounts, securities that it is underwriting;

(2) To prohibit a bank from selling such securities to its borrowers or correspondent banks; and

(3) To require all sales of such securities to be preceded by disclosure of the bank's position as underwriter.

A draft of amendment along these lines is enclosed. A similar draft was furnished Mr. Reuss prior to the decision of the committee to table consideration of H.R. 7539 on April 27, 1965.

Mr. Reuss also requested that I submit comments on the draft amendment for inclusion in the record. Those comments are enclosed.

Sincerely yours,

C. CANBY BALDERSTON,
Vice Chairman.

DRAFT AMENDMENT TO H.R. 7539 PREPARED BY THE STAFF OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BASED UPON A REQUEST OF REPRESENTATIVE REUSS OF APRIL 26, 1965

On page 3, line 8, strike out beginning with "the" and continuing through the period in line 11, inserting in lieu thereof the following: "no association that is engaged in underwriting such obligations (including general obligations of a State or a political subdivision thereof) shall (a) purchase any of such obligations for any account with respect to which the bank acts in a fiduciary capacity, or (b) sell any of such obligations to any borrower or to any bank with which it has a correspondent relationship, or (c) give investment advice as to any of such obligations to any person without first disclosing directly to such person, in writing, the extent and nature of its underwriting interest with respect to such obligations, and (3) no association that is engaged in dealing in such obligations (including general obligations of a State or a political subdivision thereof) shall purchase any of such obligations from itself for any account with respect to which the bank acts in a fiduciary capacity." COMMENTS OF C. CANBY BALDERSTON, VICE CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, ON PROPOSED AMENDMENT OF REPRESENTATIVE REUSS TO H.R. 7539, 89TH CONGRESS

This memorandum analyzes a proposed amendment to H.R. 7539 to avoid certain conflicts of interests that could arise when banks engage in the business of underwriting and dealing in securities. The amendment was prepared by the staff of the Board of Governors at the request of Representative Reuss.

1. SELF-DEALING

A bank would be prohibited from purchasing any obligation that it is underwriting for any account with respect to which the bank acts in a fiduciary capacity. It would also be prohibited from purchasing from itself, for any such account, any obligation that it deals in. A bank would not, however, be prohibited from purchasing for its own account obligations that it underwrites or deals in that is, a bank could transfer such securities from its bond trading account to its investment securities account.

Consequently, the conflict between the bank's interest as seller and its interest as purchaser would continue to exist in an important area, insofar as potential loss to stockholders is concerned. A loss in a trust account would affect the interests of stockholders or depositors only if a surcharge were imposed by a court for a failure by the bank as trustee to act properly in connection with the cause of the loss. A loss arising from securities held by the bank for its own account would, however, affect adversely the interests of its depositors and stockholders.

To eliminate entirely the conflicts of interest that are involved in self-dealing would require a prohibition against a bank purchasing, either for its fiduciary accounts or for its own account, any obligation that it underwrites or deals in. To do this, however, would mean that a bank and its trust accounts would be deprived of the opportunity to invest in securities that objective analysis might indicate were desirable investments.