economic conditions and high interest rates, well, then I cannot run a strong and successful financial institution. Because the strength and success of my financial institution is going to be the total success and strength of each customer I have, both borrower and depositor.

Having said that, I can go on and say that we as bankers, of course, are buyers and sellers of money. The rate at which we sell money is largely dictated by the rate at which we have to pay for it. In addition to that, the current prices or what you call the marginal prices of funds, i.e., what I am bidding for funds on any given day, versus what I am selling funds on any given day are only part of the overall financial picture for a financial institution.

For example, in 1981 Stillwater National Bank and Trust Co. had an average yield on loans of 15.02 percent. Now the prime probably at that time was about 172. But the average yield of all the loans I had in the bank were only 15.02.

For all banks in the United States from $100 to $300 million, the average yield on all loans were 14.78. That is the average yield on all loans for the year of 1981. Our average cost of interest bearing funds for my bank was 11.73. And for all banks in my peer group, it was 11.59. OK. So my bank had a margin of 3.29. That's the difference between the average cost of yield on loans and the cost of all interest bearing funds. The peer group had a margin of 3.19. So in 1981, which was a period in which we had very high interest rates and I think there was a perception maybe by some people in Congress and by the public at large that banks were privateering on rates, my margin rate was 3.29. All banks in my size group averaged 3.19.

Now I can add to that the following information: In 1980, the margin for all banks in my size group was 3.37, slightly more than either one of those margins in 1981. In 1979, the margin was 3.16 for all banks in my peer group. I can go back and give you 1978 and 1977 but it would take me a minute to figure it out.

But I think that the results would be essentially the same. The margin has not changed that much. And we are pricing our product based on what we think we have to do in order to cover our costs and make a reasonable return for our shareholders. So when you want to talk about the level of interest rates, you have to talk about the things you have been talking about because they all influence it. But the most important determinant is the cost of funds to the lender. Those funds are determined by the marketplace. And the biggest player in the marketplace is the Federal Government. When the Federal Government goes into the marketplace, they borrow their funds first. They always get their money. And then once they have paid whatever price the marketplace determines they have to pay to get their money, then the rest of the world has to bid more in price to get theirs.

So it's really the competition in the marketplace for funds that is determining what the rate is today.

Mr. NOWAK. So the deficit has some meaning in the whole scheme of things. Some of the supply side economists now say that we don't have to put the emphasis on the deficit anymore, we put the emphasis on the incentives and the deficit will take care of itself down the road.

Mr. MCCORMICK. I think theoretically that the supply side approach makes a lot of sense. But it has to be applied in a pragmatic way. I believe that we feel that it has been applied in sort of a doctrinare way and completely across the board. And because of that, there is a great deal of suffering in the economy that is not really necessary.

I think the banking industry and certainly our association would endorse the concept of reducing Government expenditures as a percentage of the gross national product. And would endorse the concept that encouraging a profitable private enterprise in order to increase tax collections is a good strategy. But maybe the specific way we are going about it hasn't worked out.

Mr. NOWAK. Well the other side of that coin, of course, is the monetarist point of view which I guess you could associate with former heads of Treasury such as Greenspan and Simon who emphasized the other side of the coin to control the deficit by controlling Federal spending. It is somewhat more moderate on the need for large tax cuts to go in through the system immediately and the adjustment of those two things are the conflicts that the present administration is struggling with. On the one hand we have postponed the tax cut, and that upset the supply side people. And on the other hand, the monetarists certainly haven't got the kind of cuts that they were looking for to signal the psychology to change in the country. It is a continuing point of confusion upon many. When you look at individual specifics, in and by themselves, it is easy to say, yes, we should cut taxes, yes, we should cut spending as a group. But when you look at the specifics, you see some real crumbling of that kind of support. And it comes from the administration as well as the Members of the Congress, especially the Senate.

Mr. MCCORMICK. Mr. Chairman, if I may respond to that. I think also that the banking industry and certainly our association very strongly believes in a balanced budget. Not only balance the budget, but to state and have a clear policy that we will balance the budget going forward. And it should be the policy of this country to operate under very close to a balanced budget year end and year out.

If we were to do that by whatever means, then I think you would have a dramatic drop in interest rates, and businessmen could begin to plan for the future. It is almost impossible today to have 5year plans, 10-year plans, 3-year plans, or 6-month plans. It is extremely difficult to have today because nobody knows what the level of economic activity will be, we don't know what interest rates are going to be, we don't really know anything about the future. And it has put one hell of a damper on the economy.

Mr. Nowak. The problem is that while we go through the reductions here, people are going to invest their money where they are going to get the highest possible return with the lowest possible risk.

When you look at the whole economy and say, yes, we have put some incentives on-you have increased the appreciations allowances. You can go out and buy a building today, and as I figure out the accelerated appreciation in my own mind I come up with about 11.666 or 7 percent that you can take. In 5 years, this is an un

heard of figure. But why isn't everybody building? Why isn't everybody investing? We have to look at the other side of that equation. If the demand is not equal to production, production is going to wane. We have seen the manufacturing sector today going back to 67 or 68 percent in many industries. And if you are at that level, and despite the incentives we put in, the demand for that product, for one reason or another, is gone. Some of the demand is dampened by the interest rate. Some of the demand is dampened by the price of the item itself. If we can force through the system more incentives on the supply side with the depreciation investment tax credit and other incentives, the system will deliver and more and more people will work.

But if that basic product demand isn't out there or if there are inventory problems, whatever we did last year doesn't seem to have that effect because we have got to balance the increase in production with the demand. You can't falsify that whole free market system. It will operate by itself.

And a big part of that, I guess, is this interest rate which dampens the demand. I am just very fearful that if we don't get that interest rate down, the demand won't be increasing. And if the demand doesn't increase, certainly production won't increase. Nobody is going to invest to build more of anything if the market isn't there for them to sell it. And if their capacities are 60-70, they are going to wait until they are back up to 85 before they reinvest into new equipment and new products.

How do we adjust all of this from the viewpoint of the interest rate? You know we say that if we bring down the deficit-as Rick mentioned, there are all kinds of statistics that show we had great growth in periods where the deficit was much higher as a percentage of the gross national product. As you know, we had the opposite reaction. Inflation was down, unemployment was up. It is such a mix out there it is difficult to try to focus in onto one policy.

The view that I am coming around to is that in the last year and a half we have really had a structural change that is going to be with us from now on. We are moving into pure competition in the financial markets, and we haven't even really felt the impact of that yet.

We are just in the beginning stages. You mentioned, Mr. McCormick, that the weight of deficit and Government borrowing starts that cycle. But isn't the cycle increased in terms of its force when you have savers going from the banking institutions to the money market funds? If you have got to compete with them, your margins aren't any different. If they are not any different, you are not making any more money despite the fact that everybody believes you are making a killing because of high interest rates.

This money market change, I think, is a different structure in and by itself that is going to be awful hard to compensate for and to assimilate in the whole system. And it is going to take us a much longer time to do that.

In the meantime, you are facing total deregulation in your industry. You have got the interest rate problem, you have got the money market competition, and now you are going to have competition from some of the new financial "supermarkets." I assume that it is not going to be the banks that are going to be your com

petition. I assume it is going to be Sears and others. If you have got a plaza with a Sears store, that is where your competition is going to come from in the next year or two as this total deregulation goes through. I wonder if you could comment on that. I'm sorry I rambled on.

Mr. MCCORMICK. Well, I certainly can. I guess maybe the last first. The competition from people like Sears and Roebuck, of course, will be very strong. But I think we are fairly clear that if we were allowed to compete and pay money market rates for funds, then Sears would carve out a small piece of our market and we would all compete and go on.

But if the banking business is left with an inability to compete with companies like Sears, well, we are really going to be strapped. And it is going to be hard on us. And Sears will not refund the funds back into our market and lend money to our customers. That's not the way they are organized.

Further, as far as I don't know whether to call it getting the interest rates down or getting the country going or what have you-but again I think I have got to emphasize that we have got to have some sort of long-term program that gives people confidence in what is going on.

You talked about that buildings aren't being built like you would expect them to because of depreciation. Well, when you go and borrow money to build a building today, you don't know what the interest rate is going to be in the future. No one is willing to contractually commit that because of the instability that we have had. And if you try to lease the building nobody will lease the building today for a set price, anymore. You get a floating square foot charge that is going to be indexed to the price index or to the cost of operating the building or something else. All those unknowns cut an awful lot of people out of the marketplace.

If I were going to rent a building today in a modern office building, I am going to have to have one heck of a factor in there for what my rent might be in 2 or 3 years because I can't tie that down today. You can just take that and carry it to every financial decision that has to be made in the economy. It is having a devastating effect.

Mr. Nowak. But if we acknowledge the structure has changed, that is going to be the modus operandi forever now. Plus, you are going to get the competition from the banks. What stability we had was provided by 30 year mortgages at a rate of 82 or 10 percent. If that is gone, all the leases that are out there, when they are rewritten, and all the new leasing-I think you are right. This causes the instability. Where else is it coming from?

Mr. MCCORMICK. Well, I think it comes from national economic policy as a combination of what the Federal Government is doing in financing its activities and what the Federal Reserve is doing in response to them. And until the two institutions get together and come out with a long-term program that encourages economic stability and a certain rationalization of what is going on over an extended period of time, it is not going to be changed.

I don't think, for example, a reinstitution of a regulation Q or a Government mandated interest rate on both the wholesale and retail level or anything like that would get the job done because

you would have other inefficiencies that would develop in the economy as a result of the regulation that you went to.

Mr. NOWAK. The long-term guarantee, deficits or anything else, probably could not be instituted unless you had a constitutional convention.

Mr. MCCORMICK. I'm not talking about constitutional amendments. I'm really talking about trust level. Trust level is a very difficult thing to obtain. Bankers are very sensitive to it. We know that we have got to have a high trust level with our customer because he comes in and gives us our money and he believes we are going to give it back to him when he comes back and asks for it. And if we price a loan that it is a fair price, and what have you. Well, the Government and the economy has a trust level problem. And you have to address that on a number of different levels. I am not qualified to tell you what all the levels are, but until we reestablish a trust level, I think we are faced with a problem.

Mr. NOWAK. Well, I appreciate your testimony and for taking the time to prepare a very complete statement. And I think your statement does express a concern of the small business sector of our economy-your own banks. You are certainly to be congratulated for putting forth that effort, and we certainly will try to bring your testimony to as many members as we can, not only of this committee but of the Congress.

We have another vote on the floor in a couple of minutes.
Again, thank you very much for your statement.

Mr. MCCORMICK. Thank you very much, Mr. Chairman.

Mr. NOWAK. Thank you.

We will recess again for 10 minutes and then we will have our last witness, the U.S. League of Savings Associations, testify. Hopefully, we will get you out so that you can have your lunch. Be right back.

[Recess.]

Mr. NOWAK. The next witness will be for the U.S. League of Savings Associations, Mr. Howard T. Glover. Do you want to come forward, Mr. Glover?

Mr. Glover is the chairman of the league's Committee on Development for Smaller Associations. He's also president of Conneaut Savings and Loan Co. We appreciate your patience. Your complete statement will be inserted into the record, and I will let you proceed.

TESTIMONY OF HOWARD T. GLOVER, CHAIRMAN, COMMITTEE ON DEVELOPMENT FOR SMALLER ASSOCIATIONS, U.S. LEAGUE OF SAVINGS ASSOCIATIONS

Mr. GLOVER. Thank you, Mr. Chairman. I am here today as a representative of the U.S. League of Savings Associations which I serve as the chairman of the Committee for Development of Smaller Associations. And also I am president of the $40 million Conneaut Savings and Loan Co. in Conneaut, Ohio.

Speaking for the savings and loan industry as a whole, the conduct of the deregulation of depository institutions has been nothing short of a disaster, and not just for our institutions, but for the