$6.5 billion.

industry amounted to approximately $19.4 billion

By the fall of 1975, total assets of the REIT including

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nearly $10.4 billion in bank credit.

By the end of 1975, REITs were even deeper in debt to their banks and the quality of their loans had deteriorated substantially. One study found that approximately $1.75 billion of the REIT loans it surveyed had been compromised by the banks, that is, the loans had been restructured to bear a lower interest rate than the contractual rate, payments were being made on an interest-only basis, or the loans were otherwise not producing full income.

Thus, banks came to be publicly linked with the fortunes and misfortunes of their REITs. This development was promoted by a number of factors, including widespread use of names that identified REITS with their bank sponsors and the overlap of bank and REIT personnel. Because of the public identification of REITS and their bank sponsors, banks felt considerable pressure to rescue their REITs. Banks were compelled to invest their Own assets in REIT investments, provide their REIT affiliates with imprudent extensions of credit and subsidize REIT operations to an extent never envisioned.

Real Estate Investment Trusts and the Effect They Have Had and May Be Expected to Have on the Banking System: Hearings on S. 2721 before the Senate Committee on Banking, Housing, and Urban Affairs, 94th Cong. 2d Sess. 22, 23-24 (1976).

Rescue efforts took a number of different forms. The primary technique was the loan swap. When a bank-sponsored REIT began to suffer cash flow shortages, the bank would purchase its troubled loans. Chase Manhattan Bank eventually acquired $235 million in loans from its affiliated REIT, of which more than $130 million was non-earning. Chase also assumed an additional $34 million of unfunded loan commitments to borrowers. Another rescue mission involving swaps as well as straight cash payments took place in 1975 between First Wisconsin National Bank of Milwaukee and its troubled REIT. To settle claims brought by the independent directors of the REIT, alleging that the bank adviser had been negligent in placing certain loans, First Wisconsin agreed to purchase from its REIT participations in two mortgage loans valued at $14.48 million. It also agreed to reimburse the REIT up to $5.5 million for losses on other loans.*

Continental Illinois Bank also engaged in such a rescue mission, purchasing at least $61.2 million of loans from Continental Illinois Realty.** Continental's efforts to rescue its REIT also included swaps, in which the REIT traded property to the bank and, in return, the bank cancelled debt that was earning only token interest. Continental had the pick

Keefe, Bruyette, & Woods, Inc., Bank Loans to REITs: How Serious That Problem 81 (May 2, 1975) [Special Section of the 1975 Bank Stock Manual].

of the best property, which it managed and later sold at a Unfortunately, the REIT shareholders did not fare as

profit.

well with their investments.*

A number of banks became so deeply enmeshed in the problems of their REITS that the financial integrity of those banks was undermined, and a number of large banks were placed on the regulators' problem list.** In addition, even when the risks of real estate loans were assumed by an affiliate, rather than directly by the bank, there were serious implications for the

bank.

For example, in 1974, Beverly Hills Bank Corp., a one-bank holding company, found itself in trouble when a real estate developer defaulted on a loan. Immediately after news accounts of the default, customers of the holding company's affiliated bank withdrew 15 percent of their deposits. As a result of this on the bank, the Federal Reserve Board was forced to intervene, and the bank was ultimately sold to Wells Fargo, with a resulting loss of banking competition.***

run

**

Wall Street Journal, October 15, 1981, at 1 Col. 6.

"Citibank, Chase Manhattan on U.S. 'Problem' List,"

Washington Post, Jan. 11, 1976, at Al, Col. 2.

*** House Comm. on Banking, Currency and Housing, 94th Cong. 2d Sess., Financial Institutions and the Nation's Economy 268 (Book 1) (Comm. Print 1976).

The REIT experience clearly demonstrates the present-day relevance of the principles of the Glass-Steagall Act. Banks' ventures into this investment medium prove that the public will still invest in bank-sponsored investment funds in reliance on the reputation of the bank. It shows that, in the event there are problems with a bank's REIT, confidence in the sponsoring bank will be impaired because of the public association of the bank with the fund. It demonstrates that banks will give in to pressures to misuse their credit facilities to bolster the fortunes of their affiliates, and they are at least as likely as any money manager to invest in imprudent investments. Finally, the use of affiliates to engage in these activities does not alleviate the danger to the banks.

In short, the recent REIT experience proves again the wisdom of precluding banks and bank affiliation from activities that carry an unacceptable level of risk.

S. 1720, In Its Present Form, Will Exacerbate, Not Cure, Existing Problems

The Institute agrees that the Committee has identified a situation that Congress should address as promptly as possible

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the need for a comprehensive re-evaluation of whether the financial industry, and the federal regulatory systems which govern the industry, should be restructured. The interim solutions that have been proposed, however, are admittedly not the

comprehensive legislation that is needed.

Rather, S. 1720 is a concededly piecemeal approach to the problem, and it would defer, until next year, consideration of the most urgent problems and the most vital parts of the complete package of needed reforms.

What is needed is a comprehensive approach to a series of interrelated problems. The fragments of this kind of program offered for consideration this year will not cure existing problems but will, in fact, exacerbate them.

Further Concentration of Economic Power

We are submitting today for the Committee's consideration a research paper compiled by Lance Girton.* This research provides significant details on the present-day concentration of financial power in the hands of a relatively few money center banks, and the extent to which access to financial capital in the amounts needed by major corporations is now substantially controlled by a limited number of financial institutions.

The effect of that provision of the legislation now under consideration, authorize banks to organize

which would

Dr. Girton is a Professor of Economics at the University of Utah. A copy of Professor Girton's paper, "Concentration of Financial Power," is submitted herewith in Exhibit C.