days. to what do you attribute this growth of finance versus manufacturing in the economy? is this benefitting our country? give me thoughts on sort of how it happened and how federal policy may have contributed to it. >> well, relative to the manufacturing side, a whole host of considerations in terms of international competitiveness and all these sorts of things. but in terms of the growth of the financial industry, i think it's clear that if you provide a subsidy to an industry, as we have the financial industry in terms of these largest institutions, that is when we got past the act, we allowed these high risk activities, broker/dealer activities into the safety net, which is a subsidy, and allowed them to, number one, leverage up and to become larger than they otherwise would have because they could take on, number one,

greater risk, less capital required, therefore, they could balloon their pbalance sheets, and they did. and i think those are the kinds of things that contributed to their very rapid growth and very strong drive towards mergers, consolidation and the effect was concentration in the industry. it is partly the subsidy that's provided through the protection of the safety net that contributed to their advantage. we didn't have that same -- and i think wisely so, subsidies going into necessarily these other industries, although subsidies is a big issue in the united states, i realize, for other industries as well. but i think for the financial industry, it was a big factor allowing them to grow and take on greater risk. >> thank you. before i move on, dr. hoenig, i'd like to submit for the hearing a record of a speech dr.

hoenig gave in prague in 1999. you talked about the wave of mega mergers and the problem of too big to fail. your impressions was pretty accurate there. without objection, i'd like to submit that for the record, his speech. three years ago or so, dr. hoenig, you said that when gram laj -blily passed in 1999, you said this in 2009, the five biggest banks held 38% of the assets in the financial industry. that had then grown to 52%. i'd like to ask you both, each of you a three-part question. start with dr. hoenig. tell me what the greatest growth and consolidation has meant in three ways. one, for the management seeking to understand the companies they are running, so this huge growth, what it means to people actually in charge of running these institutions. second, to the authorities monitoring these risks. how have the regulators been able to both understand and

regulate these much larger entities. and third, what it's meant to the community banks that are competing with these ever-growing mega banks. dr. hoenig, start with you on the three questions and the three-part question, then dr. kroszner. >> if i can, senator, i'd go back to my confirmation hearing when it was pointed out that if a bank is well capitalized, well managed and well supervised, it won't fail. if you think about the decade following bramlage-blily, allowing these broker/dealer activities and institutions to be brought into the safety net, it encouraged through the safety net enormous increases in leverage and debt. we saw the capital levels of our financial institutions decline, or the leverage increase, so we had weaker capital, very thin capital levels when the crisis emerged in 2007 and 2008. secondly, we allowed the scope of management to i think go

beyond its capacity. it wasn't just these very important activities of lending and payment system intermediation that were there, now you had all these new risk-orisk risk-oriented activities. so the scope of management had to be able to cross that and that was an enormous additional level of responsibility that clearly was beyond management's ability to monitor and to control the risks. had they been able to, we wouldn't have had the crisis, so it was outside their bounds. i think in terms of bank supervision, if it's beyond the management and directors' ability to control this risk and monitor this risk, i think it's a lot to ask the supervisors to fill the gap when you are pushing this risk off balance sheet and other ways of doing it, it's a lot to ask of the supervisor. so what's the effect on the community bank? it's important because when you give one sector an advantage of

this very significant too big to fail safety net, then where are you going to put your funds as a major -- or as a medium-size company or corporation? you're going to put it with the institution that won't be allowed to fail and that's a nice advantage if you want to grow and become more, i would say, dominant in the industry. and the other thing about it is, in that sense it's unfair because it does make consolidation even more important to those largest institutions to maintain that too big to fail and that's a disadvantage to the regional banks and i think to the community banks as well. that's how i have judged it over the last decade watching this emerge. >> dr. kroszner. >> i'll try to be brief. on the management issue, going back to the examples that i had given of institutions that were very focused on a narrow set of activities, mortgage lending, that didn't necessarily make them better managed or less

risky. there's some very large, complex institutions that seem to have done well in the crisis internationally. both in the u.s. and outside of the u.s. more banks that have been more universal banks. you can find examples on either side, so i'm not saying that it's consistent that diverse banks are always better managed and focused banks are worse managed, that's certainly not the case. but i think it's very hard to generalize. i really think it depends upon the structure of the institution itself and the supervisory process over it. >> these banks aren't -- sorry to interrupt. but these banks, as i think dr. hoenig implied, if not said directly, in your mind are not by nature of their size too big to manage? >> not necessarily. we see that there were some smaller institutions that were more focused that i think were very poorly managed and badly managed. so there's certainly some institutions that were not very well managed that were very large so i don't want to say in all cases they had gotten it

right. >> they aren't -- in essence, they aren't too big to manage. >> not in principle too big to manage, that's right. but they certainly could be. just a small institutions could be very poorly managed, focused institutions like the ones that we're focused on the mortgage market, many examples where they were unfortunately very poorly managed. that brings us to the next step about the authorities and the regulators. this gets back to one of the issues that i had mentioned in my oral remarks about pushing things off into the shadows. so in principle, if you can make things very transparent, very simple, they're easier for the regulators to monitor. the challenge is that even if we try to do that for one set of organizations, that doesn't mean that the risks disappear. as tom hoenig made very clear in i think his very interesting proposal, he wanted to focus on not just the banking system but also the shadow banking system. when you put restrictions on one

piece, there's a natural tendency for some of those activities to occur elsewhere. we sometimes would joke about the problem that you push down the mole that pops up in one spot but it pops down somewhere else. the risk doesn't disappear even if you get it out of one set of institutions because of the interconnections. those activities typically are done either off balance sheet or very close to the bank, as other funders are funded by the banks. so it's not clear to me that we can actually make the system easier for the regulators if one set of institutions may have fewer activities but a lot of those other activities don't actually disappear but are taking place in the shadows. the issue of the community banks. i very much share tom hoenig's view that we should not be having subsidies to one type of institution versus another institution. to use the public fist to unbalance the competitive

landscape is inappropriate, inconsistent with free markets, unfair and not good policy. so we certainly want to try to rein in any particular subdiddies being given to one institution versus the other to maintain the robustness of the 6,000 community banks that continue to exist in the united states today. >> and do you agree, i wasn't clear on how far your agreement with dr. hoenig was, in terms of the advantages that large banks get over small banks in terms of the way the system has been built, the less expensive -- less expensive financial market, the advantages they get that way in borrowing and other things. >> i think the community banks are largely in different markets than the largest five or six institutions or three or four institutions that are really focused internationally on very large -- very large lending, so there's a lot of separation in the activities that they undertake.

there are concerns on both sides that there are some subsidies on the smaller bank side from some of the safety net as well as on the larger bank side. i think a careful cost benefit analysis should be done to identify where those subsidies may be and as much as possible eliminate them, because i think both it's unfair and not good policy. >> and do you agree that there are different consequences if a small bank fails versus a larger bank fails? >> there may well be different consequences. the key is whether you have a correlation of the risk. so if it's just an isolated institution, just something that there's a problem at that one institution, that's one issue. but if you have a thousand institutions that are all doing the same business, exposed to the same risks and if one goes down that's effectively the same as a thousand of them going down, then it may not make that much of a difference whether we have a few larger institutions or a thousand that may go down simultaneously. >> thank you.

senator corker. >> thank you, mr. chairman. thank both of you for being here and dr. hoenig, thank you for the time we spent yesterday, i appreciate it. i'm looking forward to the hoenig rule some day. look, you had made some comments earlier on, we had gone back talking about dodd-frank itself and i want to get to the model that you proposed to have. it's really glass-steegel on steroids in many ways. but you talked about dodd-frank and the fact that it actually made our banking system, financial system less safe. you said i don't see the system as more safe, i see it less safe. what about it has made it more safe. when you say that, what is it in particular that you're referring to, if you can generalize? >> what i'm saying to you is if we have the elements of the

resolution, which i think is extremely important, we also have the view that this new legislation will eliminate future crises that we have out there, and i think -- i said i'm skeptical, and i think skeptical is healthy in the sense that 30 years of asserting that we have no institution too big to fail and then bailing them out is something we need to be aware of. but the real advantage to it is it makes us more resolute to make sure that we do take them into either bankruptcy or receivership going forward. and i think that's extremely important. now, dodd-frank does give us the mechanism to do that. it's whether we have the will going forward. now we have even larger institutions accumulating greater risk and concentration, so the will part will be even more difficult to come forward. what the proposal i put forward says is let's take these

high-risk activities and let's move them out into the market and let the market be the judge there. and the part that was meant to be protected by the safety net, the payment system, the settlement system, the intermediation process, let's allow that to continue to be protected. but we take these others where the subsidy has allowed the leverage to move up and take that away, then dodd-frank becomes even more, i think, powerful in the sense of resolving institutions that in fact fail with the next crisis. and i think that's where we have an opportunity to strengthen our hand going forward. and i want to comment on the fact that if you -- people say if you take this away, we won't be as competitive, but in the '80s and '90s before the repeal of glass-steigel, the united states had the most vibrant banking and capital markets in the world. people came to us to get the financing. every bit as much as anywhere

else in the world. when i say move them out, i don't mean let's eliminate market marking, i'm not saying let's eliminate trading, i'm saying let's put it into the market where it can meet the market test and be competitive. and where the greatest innovation will come from by putting it together and putting that subsidy around it, i think you inhibit our ability to compete in the world today in a vigorous and in a capitalistic sort of way, and that's my whole point to this proposal. >> i know we had a lot of discussion around federal reserve rule 23-a and i know we're going to talk about that some more later because there is a firewall that's been created from the standpoint of money flowing back and forth and i look forward to future conversations there. but your approach is -- what you're saying is you don't think congress should even consider arbitrarily limiting the size of an institution. you think that separating one type of activity from the basic, you know, activities that banks

did originally, you think separating those two is probably the best route to take, and over time, because of that separation, the size issue will resolve itself. is that correct? >> yes. i'm saying that if you try and resolve it by arbitrarily putting a size limit on, what's your principle for that? is it antitrust? what is it? when you say let's move these out, if you take these high-risk activities and move them out and make them subject to the market where they can fail, i think that becomes its own, if you will, control system. in the commercial banking, we're going to have large institutions, we always have. but at least it allows the regional bank and the community bank to compete on a more equal footing. this country has always had very large institutions to very small in the financial side and it's paralleled our industrial side. large industrial to small. we've been able to meet a broad cross section of each. we're now moving into fewer and fewer institutions where everything has to take place and

i think that disadvantages the vibrance of the united states, our entrepreneurial spirits that come from local financing, and i think it compromises that because it focuses everything on fewer and fewer banks over time. that's what we want to avoid. and i think we will always have large institutions, but when you level the playing field, i think you also allow for a continuation of having small to medium to regional institutions competing and providing credit in the market. i think not -- not separating out the subsidy to the largest institutions handicaps the rest of the industry and i think handicaps, if you will, main street america. >> well, listen, thank you. again, i really enjoyed the time and look forward to furthering our conversations. i know the last two witnesses have referred to the resolution piece. and while it didn't end up perfectly, that's certainly an area that i know myself and senator warner spent a lot of time on and hopefully officials

will have the courage to put a bank out of its misery if it fails. i know the tools certainly have been given there. and i think there's some more evolutions that need to occur. some of the bankruptcy components that we were not able to get into the bill should be there. dr. kroszner, you spoke about in your testimony, you made comments about cost benefit analysis. i'm hearing out there in sort of the world of people dealing with regulators, that there really aren't appropriate cost benefit analyses being done on these rules and there are many people predicting a plethora of lawsuits down the road as these rules actually come into play because the regulators are not adhering to congressional mandates of ensuring that there are cost benefit analysis. i'm wondering if you are hearing the same thing? >> i think it's extremely important to focus on cost ben shut analysis.

it has bipartisan support. i was recently reviewing the executive orders from president reagan and president obama on this issue and it's really quite surprising how similar they look. i think there's agreement across the aisle that to make good policy, you have to think about the costs and the benefits. obviously there have been a number of lawsuits that some regulators have lost recently because they haven't properly done economical analysis. i think it's very important to do that. i think that should be the focus of both thinking about what the objectives are, thinking about what the relevant alternatives are and then doing as best a job as possible. it's never going to be perfect because you're going to predict the future. you don't have the future data. but you can draw on historical analogies, international analogies and different economic theories to try to get a feeling for what would make the most sense to try to address the objective that you have. i think that's very important because one of the disciplines that cost benefit analysis does, it asks you what are you trying to achieve.

sometimes people just have various objectives that are not well specified, not well focused, but it forces the policy process to address that. so the more that they do, the better it will be. >> let me ask you this, what do you think is driving many of the regulators that are promulgating these rules, what is driving them, especially around dodd-frank, not to be doing what they have been mandated to do as it relates to cost/benefit analysis. dr. hoenig, if you want to weigh in on that because i do think these rules are going to be on their way for years. we've done anything but create predict ability at a time when people talked about predictability. as a matter of fact, you'd have to wonder what congress' intent was with all of dodd-frank when it was put in place from that standpoint. but what do you think is driving regulators to ignore this cost/benefit analysis and set themselves up for major setbacks down the road?

>> i'm hoping that they're not. i'm not privy to the internal processes so i don't want to say anything specific about any particular process, but i think a lot of regulations -- a lot of regulatory processes, more than 100 i believe, were set in train by dodd-frank with a relatively tight timetable, so that perhaps may have put some constraints on the ability to take as much time to gather the data and do the analysis that's necessary. this is one of the issues that's come up with the many questions that were in the volcker rule proposal. a lot of them involved requests for data, which i think is exactly the right thing for the regulators to do. and if it need be that it takes a little bit more time to do the analysis to be able to draw the lines appropriately to really try to minimize un intended consequences and increase the robustness of the system, i would be sympathetic to allowing more time for that. >> i would offer this, i'm only getting involved in it in the last month.

but i would share this observation. there's two complaints that i see coming forward, that they're not moving fast enough and that they're moving too fast. and i do think that they're being very careful, because i think most of the regulatory authorities understand the law of unintended consequences, have seen it and are worried about it and, therefore, are trying to be very deliberate. i know from experience that cost/benefit analysis is very time-consuming and very slow. i think that's one of the reasons that for some this has been going slower than some people would like. so i think there is a sincere effort to get this right, but it is -- it is a big piece of legislation. there are a lot of moving parts in it. it's probably going to be hard to satisfy everyone when we get through with this. >> thank you both very much. >> thank you both for joining us, dr. hoenig. thank you and thanks for your service. dr. kroszner, thank you very much for joining us. >> thank you.

the third and final panel, thank you for joining us. thank you very much for your patience and for waiting through two panels. they were interesting, i know we all learned -- at least i think senator corker and i learned some things. tom frost is a lifelong banker, fourth generation of his family to oversee the frost bank, which was founded in 1868 in san antonio, texas.

he's the chief executive of the board of frost national with 78 financial centers across texas. marc jars lick is no stranger to the committee. he worked on the joint economic committee and was a senior staffer under chairman dodd under the crafting of dodd-frank. he currently serves as chief economist that promotes the public interest in the capital and commodities markets. james row sell is with a global financial services firm based in chicago. focused on regulatory change resulting from dodd-frank and broefs his firm's board of directors on these issues. before carfang, anthony carfang, is the director of treasury strategies. mr. carfang has helped some of the world's largest banks and securities firms to position their services in the marketplace. he's advocated for the interests of his clients with regard to regulatory issues and liquidity

management. thanks to all four of you. mr. frost, would you begin. >> well, thank you for inviting me. it's a real honor to have me here and i especially note that except for my come patriot from northern trust, we are the only people that are actually practicing in the industry that you're listening to. i would hope that you would in the future hear more from us who are in the business than just listen to educators and regulators, many of whom i agree with, but i think to hear practitioners, banking has been in my dna, as you said, for now five years. i am from san antonio, texas, and i served for 57 years, 26 of them as chief executive officer of a commercial bank, established by my great-grandfath great-grandfather. the institution grew and prospered through money panics, wars and depressions. now with $20 billion in assets and now 115 offices, all of them in texas. the frost bank did not take

government funds from the issuance of preferred stock in 1933 and was one of the first banks to refuse t.a.r.p. money in 2008. i personally survived the very difficult times of texas in the 1980s where many lessons were learned and the frost bank was the only one of the top ten commercial banks in texas to survive through a period when significant number of banks failed and most of the savings and loans were closed. i will start out with my first days as a young college graduate and a fresh employee of the institution i've just described. and i want to say as an aside, one of the things i'm going to be talking about here is a difference in cultures. and i want you to focus on that. we've all talked about where people came from, how big they are, what kind of people they were. we haven't talked about the culture in which they lived and worked. my great uncle joe, who was then ceo, this is 1950 when i got out of college. i was a young, inexperienced

banker. i had been there in the summers. he told me that the very first goal we had was to be able to return the deposits received from the customers. the first goal we had. our obligation was to take care of the community's liquid assets and to manage them in a safe and sound fashion for the use loans of the community to grow. uncle joe told me in 1950 that we were not big enough to be saved by the government, that we would need to always maintain strong liquidity, safe and sound assets and adequate capital. i was impressed by the fact that the need to make money was not high on this list, but does occur if sound banking practices are observed. uncle joe was not a fan of the fdic. he told me it took his money to subsidize his inefficient competition. i personally support the fdic as a protector for the depositor, but want to suggest that this

safety net apply only to banks which receive fdic-insured deposits. i am convinced that offering the safety net to other financial institutions which provide services not deemed appropriate for deposit loan commercial banking institutions is not sound public policy. the deposit facilities of financial institutions which provide primarily investment, hedging and speculative services should have no taxpayer safety net. these institutions should be governed by market forces with investors understanding what can be earned and what can be lost. this would involve the need to separate two cultures. the one which uncle joe articulated and our family has followed for 144 years, by establishing long-term customer relationships and building our community and preserving its liquid assets.

other financial institutions can provide the other services that are not authorized to insured deposit banks at a potential good profit, but without a taxpayer risk through a federal safety net. i would suggest that the two types of institutions have separate ownership, separate management and separate regulation. my conviction comes after seeing both systems, which were separated, but now have been joined to create a situation when in 2008 brought about the near catastrophe of collapse of the world financial systems. following the path that we're on currently will not only provide opportunity for the same occurrence to be -- consequences to be repeated, but also mean the end of a banking system consisting of many providers. it seems we are rapidly approaching a system which will be an aligopoly of a few systems

whose concerns will not have the same as evidenced by uncle joe. if they are separated, the clients of both will prosper but without the risk of a potential massive cost to the taxpayers. i thank you for giving me the opportunity to express my opinion, which has been developed over a half a century's experience and has led me to the conviction that the insured deposit banking system we had was effective, worked well and did not require any significant federal support until 2008. when other activities of large institutions involved in so-called investment activities nearly destroyed the financial system and imposed enormous costs on taxpayers to the present day. gentlemen, what we're talking about is the conflict of cultures and i would like you to even stop and talk about doing something differently than what's proposed to you in do