ROBERT MASTERSON, PRESIDENT, MAINE SAVINGS BANKS, REPRESENTING NATIONAL ASSOCIATION OF MUTUAL SAVINGS BANKS, ACCOMPAINED BY MR. KLAMAN

Mr. MASTERTON. We have delivered a full brief, and I will be now presenting a summary brief. We would appreciate, however, the entire brief be placed on the record.

ELIMINATE STATE USURY CEILINGS

Our industry has consistently supported the nationwide extension of NOW accounts in order to permit consumers in every State to earn interest on their transaction accounts. It has been our longstanding view that more flexible lending and investment powers should be available to all thrift institutions as a means of strengthening their operations. And we have long held the view that elimination of State usury ceilings would benefit borrowers by increasing the available supply of mortgage credit in high-interest rate periods.

Each of these provisions of S. 1347 is desirable in its own right, and each should be considered on its own merits. However, these useful but relatively limited changes would hardly justify the revolutionary changes in the financial system that would be triggered by the provisions in S. 1347 to eliminate deposit interest rate ceilings on savings and time deposits.

In short, the savings bank industry strongly disagrees with the basic premise of S. 1347: that the transactions account powers and the limited expansion of asset powers granted to thrift institutions-together with the recent authorization of variable-rate mortgages for Federal savings and loan associations-would be sufficient to permit the proposed elimination of regulation Q. To eliminate deposit interest rate ceilings and the thrift institution differential would require much more than is, or that indeed could be, provided by S. 1347.

Above all, such action would first require convincing evidence that the climate of rapid inflation and high and volatile interest rates has been replaced by a fundamental shift to more stable economic and financial conditions. Clearly, this is beyond the scope of any financial legislation. If the elimination of regulation Q is contemplated in a climate of continued rapid inflation, on the other hand, a much more significant broadening of thrift institution asset and liability powers would be required than is provided in S. 1347, together with sufficient time for thrift institutions to adjust their balance sheet structures and operations to these new powers.

Thus, if the Congress decides to set in motion the elimination of regulation Q, it must also set in motion the forces that will enable thrift institutions to compete in such a climate. This would mean the authorization of commercial bank-type powers for thrift institutions. Only with such powers could thrift institutions pay market rates to savers in high-interest-rate periods.

Alternatively, the Congress could stop short of this step. It could preserve and strengthen the present system of thrift institutions, maintain regulation Q with the thrift institution differential, and still improve returns to savers through enactment of tax incentive

measures. Tax incentives would accomplish the objective of increasing rewards to savers without the major changes in our financial structure implicit in the elimination of regulation Q. The choice is up to the Congress. Before considering these and other critical issues related to the regulation Q question, however, we would first like to offer some comments on the transactions account provisions of S. 1347.

The savings bank industry has long advocated the availability of transactions account powers, including interest-paying NOW accounts, for all thrift institutions. With only a few exceptions, most savings banks today can offer at least one type of transactions account to consumers: NOW accounts; non-interest-paying NOW accounts-NINOW's; and personal checking accounts. And in some States, more than one type of transactions account can be offered by savings banks.

The NOW account, of course, originated in our industry in 1972 in Massachusetts and New Hampshire. We are pleased that it has since spread to all of the New England States and, more recently, to New York. We believe that consumers throughout the Nation should have the same opportunity to earn interest on transactions accounts that is currently available in New England and New York.

Accordingly, we strongly support legislation to remove the current Federal prohibition against NOW accounts in the remaining 43 States. We believe that such legislation should be considered on its own merits, without-as is the case with S. 1347-being encumbered by other financial measures. Earlier this month, we testified in support of legislation, H.R. 3864, before the House Financial Institutions Subcommittee which would accomplish this objective. There is no objective basis for the commercial bank argument. The differential is the most important competitive tool available to mortgage-oriented thrift institutions, and we remain strongly opposed to its elimination or erosion. Even if all thrift institutions gain consumer transactions account authority, full-service commercial banks will still have major competitive advantages. The differential will still be needed to offset these competitive advantages and to promote an adequate supply of funds for housing.

We would now like to turn to the critical question of phasing out regulation Q. As we stated at the outset, the authorization of NOW accounts and the modest expansion of asset powers provided in S. 1347 is hardly sufficient to justify such drastic action. Nor are these powers sufficient when combined with the recent authorization of variable-rate mortgage authority for Federal savings and loan associations. Many savings banks already have all these powers, yet they cannot compete with the open market, as indicated in recent savings and earnings trends.

ASSET POWERS

With regard to the expanded asset powers proposed for Federal thrift institutions in S. 1347, which most savings banks already have, it is clear that the volume of such assets will be small relative to total assets and that the earnings generated by these mortgage assets will not be sufficient to permit thrift institutions

to pay competitive rates in a deregulated deposit market. That volume will be small is guaranteed by the 10-percent overall limitation on these nonmortgage assets. And it will be extremely difficult, in particular, for most thrift institutions to build up their short-term consumer loan portfolios to anywhere near the theoretical 10 percent of assets limit.

In this regard, we applaud the action of the Federal Home Loan Bank Board in authorizing VRM's for Federal savings and loan associations, and we are gratified by the Federal preemption of State usury ceilings included in S. 1347. However, the fact that individual States could-and that most probably would-act to nullify the Federal preemption seriously undermines its potential value for thrift institutions in a deregulated deposit environment. Even with Federal preemption of usury ceilings and widespread authorization of VRM's, however, it would take years before a significant proportion of thrift institution mortgage holdings were converted into VRM's. And the political realities are strong that upside rate variability will continue to be limited by "appropriate consumer safeguards," as in the Federal Home Loan Bank Board regulations, thereby significantly limiting reliance on VRM's as a major justification for proceeding with deposit interest rate deregulation.

But the critical point to recognize is that although most savings banks have all of the powers that would be conferred by S. 1347, and although many have variable-rate mortgage authority, savings banks still do not have the basic earnings or upward earnings flexibility necessary to compete with commercial banks or the open market in a high-interest-rate deregulated deposit climate.

This is amply demonstrated by our industry's recent deposit and earnings trends. In April, savings banks experienced a $1.2 billion net deposit loss, excluding interest, the largest outflow for any month on record. And in May, the $300 million net deposit outflow at savings banks was the largest on record for that month. This unfavorable deposit experience occurred despite the fact that savings banks have been offering the market-linked 6-month CD's, which have grown rapidly to 16.5 percent of total industry deposits at the end of May.

At the same time, savings banks are experiencing major cost increases. Bottom-line net income was only 0.58 percent of average industry assets in 1978 and is expected to decline drastically this year as a result of the money market CD's, the new changes designed to benefit the "small saver" which become effective on July 1, and the costs incurred in connection with recent large-scale disintermediation.

Thus, savings banks now have the worst of both worlds: rapidly deteriorating earnings plus disintermediation. If deposit rate ceilings and the differential were not now in effect, both problems would be immeasurably greater. And it is this actual experience that should guide this subcommittee and the Congress when considering proposals to phase out regulation Q and the differential, as included in S. 1347.

Such proposals indeed raise a fundamental dilemma for public policy, which goes to the very basis of our present system of home mortgage finance. In the economic and financial environment that