in talking about the separation of the cultures, the absence of a federal safety net for one, different regulations, different ownership and the market activity supported by one and to take a look at a different way to do things, because if we keep things doing the same way over and over and expecting different results, i think facetiously that's called insanity, and i think we're on the level of going to do the same thing over and over and over again with what we're proposing. thank you. >> thank you, mr. frost. appreciate your comments. mr. jarsulic, welcome back to the committee. >> thank you, chairman brown, ranking member corker. thank you for the invitation to testify today. let me start with the observation that the very largest bank holding companies, which for convenience we can think of as the ten largest, are now distinctly different from the rest of the banking

industry. they're more highly leveraged than other banks, they're far more likely to operate large and complex broker dealers and more likely to be directly dependent on unstable sources of short-term financing. each of these characteristics made the large bank holding companies vulnerable during the financial crisis and each of these characteristics needs to be addressed by effective implementation of relevant sections of the dodd-frank act. during the crisis, high leverage, that is a high ratio of assets toic quit, increase the likelihood that the large companies would become insolvent if asset prices declined significantly. during the period 19 90 to 2000, the ten large bank holding companies had a leverage ratio of about 21, which in itself is fairly high. by the end of 2000, the leverage ratio had risen to 34. this put the large bank holding companies at approximately the same level. the five largest stand-alone

investment banks who had a leverage ratio of 36. thus in 2007 large bank holding companies, like the large investment banks, could see their equity wiped out by a 3% decline in asset values. their funding sources and assets were not identical to the investment banks, but on the important dimension of leverage, they were in the same ballpark. proprietary trading made them less safe pause the speculative positions can quickly produce large, unexpected losses which may not be backed up by significant capital. i think the trading losses at citi group are a case in point. citigroup is one of the largest issuers and traders of cdos in the world, many of them backed by subprime mortgage-backed securities. but citigroup is unwilling to sell the so-called supersenior trenches of the cdos so between

2003-2007 they accumulated $43 billion of these securities, which they held in conduits and in the trading book. but in 2007 when the subprime mortgage market tanked, citigroup had to start writing things down. by the end of 2008, they lost $39 billion on the cdo-related positions. so very early in the crisis, proprietary trading did significant damage to a big bank holding company. a final area of instability comes from the dependence of the large bank holding companies on short-term, very up stable financing. this makes the banks less safe because creditor runs can force asset sales and realization of losses. during a crisis, there were runs on both repo borrowing and asset-backed commercial paper. the trading operations of the large bank holding companies investment banks are often highly depend ent on repo

funding which is collateralized short-term borrowing often for periods as short as a day. in 2007, the five largest investment banks funded as much as 42% of their assets on repo funding. that is they were borrowing every day to support their book. i don't think there's a good reason to believe that bank traders were operating differently. secondly, the banks commonly use conduits which issues short-term commercial paper backed by a pool of assets because it allows them to increase their lemplgve at a relatively low cost. but there was a run during the crisis and the federal reserve had to step in to rescue this market. given the scale of the large bank holding company, these vulnerabilities also threatened the financial stability of the system as a whole. no large bank holding company failed, but i think if you look back to the scale and scope of the rescue effort at citigroup, we can see that it was a very

close thing. so to prevent the recurrence of near catastrophes in the future, regulators need to use the tools created by dodd-frank to eliminate the threats to financial stability that are caused by large bank holding companies. in particular, we need one effective leverage limits for the largest bank. largest bank holding companies. section 165 of the dodd-frank act gives the federal reserve the option to impose much higher capital requirements on the banks. the fed is proposing three capital requirements an these for reasons we could talk about seem relatively inadequate. second, effective implementation of the volcker rule would do a lot to decrease the risks and i think there are two parts to this. one is a well-defined definition of market banking so that it can't be gamed and can't become a source of risk. but of equal importance are

significant leverage limits on trading operations because they are based on a funding model which is highly leveraged and highly unstable. and finally, there needs to be an effective regulation of shadow banking activity. in particular, aspects of the shadow banking industry that cause potential creditor runs on these big bank holding companies. for example, the behavior of the conduit market. taking these steps, i think will go a long way containing the risk imposed by the size and risk of the largest bank holding companies. thank you. there rozel, thank you for joining us. >> thank you, chairman brown, ranking member corker. i appreciate the opportunity to testify before you today on behalf of northern trust. northern trust supports the very positive efforts of congress and this committee to put in place

reform that say reduce risk to the financial system. many of those are included in the dodd-frank act. those are all very good reforms. however, it's essential that efforts to reduce risk are carefully calibrated so they don't inadvertently restrict or harm core banking activities that serve the needs of customers in the u.s. and around the world, that provide employment for our citizens and that promote the economy. i'd like to focus my testimony on specific provisions contained in the volcker rule to show why it's so important to consider the full impact of regulatory reforms in order to avoid unintended negative consequences for individual banks and for the economy more generally. northern trust does not engage in the types of activities the volcker rule intended to prohibit. in fact we heard from chairman volcker earlier, that he thought the proprietary trading rules would only impact maybe six to eight institutions. i wish that were true. specifically, northern trust does not engage in high-risk

proprietary trading and investment activities. because of the traditional nature of our core banking business, we anticipated the volcker rule would have little or no impact on our business. the rules as currently proposed will adversely impact traditionally low-risk business activity, that investors rely on for investment management purposes. if not corrected in the roll -- rule-making process, we will be adversely impacted which may impair the exit i'veness of u.s. banks in the business where we are the leaders. today i want to summarize three of the proposed rule that go beyond what the law requires and may significantly impact northern trust and our clients. first, the proposed rule unnecessarily includes a broad range of funds that banking entities will be restricted from sponsoring or investing in. the definition of a covered fund would capture nearly all foreign

funds as well as many other entities that don't have traditional hedge fund or private equity fund characteristics. this definition is important because if a bank is deemed to be a sponsor or an adviser to a covered fund, then the proposed rule -- then under the proposed rule the bank is prohibited from providing any credit whatsoever to the fund. ordinary custodial and administrative services provided to our clients must include the provision of intra day or short-term extensions of credit to facilitate securities settlement, dividend payments and similar custody-related transactions. these payment flows are expected in order for transaction settlements to operate smoothly and have been encouraged by global financial supervisors. nevertheless, these low-risk extensions of credit appear to be considered as prohibited transactions under the proposed rule. second, the proposed inclusion

of foreign exchange swap and forward transactions within the proprietary trading prohibitions will result in damage to a traditional and low-risk activity. with no offsetting benefit to our financial system. as a significant global custodian and asset manager, northern trust carries on an active foreign exchange trading operation that is directly related to our core client services. in essence, these currency transactions are simple cash management transactions used by our clients to efficiently manage cross-currency needs. the agency should exclude these transactions from the trading restrictions for the same reason that the treasury secretary proposed to exclude them from title vii of dodd-frank. third, the compliance requirements in the proposed rule are unduly burdensome and will unnecessarily increase compliance costs for banks with little or no offsetting benefit. the proposed rule essentially

requires the bank to prove that each transaction does not fall within the prohibited category. and requires banks to produce a large number of compliance metrics which will result in considerable systems expenditures and ongoing costs of compliance. we believe the agencies could carry out the intent of congress more effectively and with less cost to the banking system with a simpler rule that is supplemented by awe few key metrics and active supervision of bank trading risks and practices. we urge this committee to encourage the agencies to adopt final regulations that carry out congressional intent. to prohibit high-risk trading and investment activities, but not to adversely impact those traditional business activities that played no role in causing the financial crisis. preserving our business models will ensure that u.s. banks can operate effectively and competitively, while protecting against negative impacts on the broader economy and u.s.

employment. thank you, chairman brown, ranking member corker, for allowing me to present northern trust's views on this critically important topic. >> thank you mr. row cell. thank you. i'm delighted to be here today on the behalf of u.s. chamber of commerce, the three million members, each of whom are customers of banks, so we're representing the customer side this afternoon as well. my name is tony carfang and i'm a partner with treasury strategies. we are a leading consulting firm in the area of treasury and cash management. we help corporate treasurers day in and day out manage their risk, raise their capital, fund their accounts and meet their payrolls. we also work with financial institutions, large and small, in fact around the globe, who provide services to businesses to make productive use of their capital. i'd like to leave you with four messages today. number one is that the u.s.

economy is the most capital efficient in the world. none comes close. i'll share with you some statistics in a second. but i want to say that this is a delicate balance, and we need to make sure, as we move to the next generation of financial services we don't destroy the capital efficiency that we've worked two centuries to achieve. number two is that the u.s. financial system is a very delicate mosaic of banks, money market funds, securities firms, institutions large and small serving corporations large and small who have needs that in some cases are regional, some cases are global, some are industry specific, and what we have is actually a very beautiful mosaic of all of this coming together. we need to understand how this all works before we begin changing it. the third point i'd like to make

today is that risk is like energy in that it can neither be created nor destroyed. it can only be transferred. so please don't be lulled into thinking that if you eliminate a risk in a particular institution, that that risk goes away. it goes somewhere else. we need to understand where it goes. so, for example, if a bank is unable to help a client hedge commodities, let's say, then there's a farmer out there somewhere whose crop is at risk. so we've taken the risk out of the bank and put it back on the farm. we need to be careful about that. similarly, a manufacturer who cannot hedge foreign exchange, may shrink the size of the company. there's an interconnectedness that we need to be very careful to preserve. the fourth point i'd like to make is we're in the midst of an

uncontrolled experiment. now, we're not arguing against regulation at all, but what's happening is that there are a number of regulations being promulgated around the world right now that are directed at financial institutions, things like bozel 3, things like derivative regulation, new talk of another round of money market fund regulations. all of these are untested and they're all designed -- oriented toward financial institutions, but frankly they all land on the desk of the corporate treasurer. the financial institutions are the intermeadarys. it's the corporate treasurer that is dealing with all of these simultaneously. senator, you raised the question of cost/benefit analysisel e earlier. frankly, not only do each of these need a much more thorough cost/benefit analysis but they need to be an liesed in the

context of their interrelationship and what it means to simultaneously change a liquidity requirement, add a capital requirement, eliminate a trading business and throw in a little bit of risk management or whatever you want. we have an experiment that is moving out of control. i'd like to go back to the point of capital efficiency, because that is a hallmark of american business. u.s. companies are sitting on a record amount of corporate cash. i'm sure you see those headlines. $2.2 trillion at the end of the last quarter. that represents 14% of u.s. gdp. the similar ratio in europe is 21%. that is european corporations hold cash on their balance sheets equal to 21% of the total gdp of the eurozone. you might say we're 50% more efficient. should we lose this cap tal efficiency and companies move to this 21% range as a result of

some regulations that aren't totally thought through, that $2.2 trillion on americans balance sheets at 14%, 21%, that translates to $3.3 trillion. we are in effect taking $1.1 trillion out of the u.s. economy, putting it in cash on balance sheets and effectively sidelining it. so we have the potential here of destroying capital efficiency that has a magnitude that's greater than the entire stimulus program. $1.1 trillion. that's more than qe-2. that's more than the entire t.a.r.p. program. so i think we're playing with fire here and we need to be very, very careful. hence the point on an appropriate cost/benefit analysis. not only on one regulation, but across the board. we want to make sure that america's businesses can continue to have access to the capital markets and raise capital as efficiently as

possible so that they can grow their businesses, so that they can create jobs, so that they can manage their risks. i think the real threshold question and what we're putting at risk here is when a business's treasurer calls a bank to raise capital or to manage risk, is there going to be a u.s. banker there to answer the call? thank you very much. >> thank you, mr. carfang. i'm a little confused, i was going to ask -- go in a different place but i want to follow up with your last statement there. the $2.2 trillion, the 14% of gdp that sits as cash reserves, these aren't just banks, these are -- you were talking about all american companies? talking about alcoa and large manufacturing companies? >> i'm talking about all of america's nonfinancial corporations. this is published each quarter. >> okay, it seems -- i know of that. i think we hear that often. i guess i don't think that it's a regulatory issue as much as

it's these companies don't see for reasons of uncertainty or reasons of lack of demand, don't see it as good economics for their companies, good policy for their companies to invest back in job creation, invest in capital equipment. that's my understanding. >> well, and -- yeah, they also need that for working capital and precautionary needs, as you just pointed out. and my point is that the comparable number in europe is 50% higher. >> right, i got that, the 14 versus 21. i guess when i talk to my state, ohio, has a large number of major manufacturers, they tell me five years ago that a company that might have had $100 million in cash reserves now has $400 million. that's not a question of they need more in order to potentially protect themselves as much as it's they don't see the demand in the marketplace for them to reinvest in the company. or they use those dollars to buy other companies or stocks,

whatever. let me go somewhere else with this and thank you for that insight, mr. carfang. mr. frost, you had mentioned, i thought, importantly so, that you are the only people that are working actually in banks on any of the three panels of the seven of you here today. let me ask you a question based on that. you're $20 billion in assets. that's 1/115th the size of the largest bank in the state. the former executive of a trillion dollar bank told the financial crisis inquiry it's impossible to understand the balance sheet of an institution that size. 115 times your size on a daily basis. i asked about that.

do you think those institutions, are they too big to manage? we had that question the last panel. if your mind, from your experience of 60 years at the bank and your family's experience. are these too big to manage? >> i think because of the cultures, they're impossible to both be managed by the same manager. you read about good to best. they say the most effective corporations in all of america that were built to last did not have profit as a major objective of the company and the ones that went from good to best reduced the profit making. they deal only with transactions, whether transactions work out to a

direct impact on the pocket of the person. that's what investment banking does. and talking to me, profit was down at the bottom of the list. and our present mission statement is to grow and prosper by building long-term relationships based on good service and ethical standards. but the reason our mission statement is in the way has nothing to do with profit. it tells everybody what to do when they come to work every day. build relationships. we build them with customers to take care of us. when you have the transaction business. you have what he's going to gain by the dollars and cents that are coming down.

they kept them in st. louis -- i mean, missouri. there's two in kansas city. run beautiful banks. there's a man in oklahoma. when you're working to take care of the relationships with your customer for what will be value and benefit in taking care of them, the whole community. and profit comes if you do that well without starting out and saying i'm making a deal today because it's going to bring $500,000 into my pocket the end of this year. my answer is you can't have two cultures in one entity. we had big financial institutions, goldman sachs and others that were doing very well, taking care of big companies, internationally.

wean e we had big banks that we can compete with storily, and that system worked. so in answer to your question, i think if we have the cultures that don't understand that operate differently i think you can't possibly succeed. that's what 2008 brought us. 2008 brought us the disaster of the culture that put profit at the top of what they wanted to do. they didn't care who ended up with the mortgage bonds. they only cared about the interest of them. what we had was a disaster because everybody down the line was just making some money off of it and had no vigorous in the game. to me, my answer is you can't put the two together. that's what we've demonstrated

by getting away from blast eagle. you can't put them together expecting different result. that's the definition of insanity. >> thank you, mr. frost. 144 years of success is hard to argue with. >> thank you, mr. chairman. if i understand you, what you're advocating, generally speakly, basically dodd-frank did everything but address the core issue from your perspective. went around the world trying to address all the little things that at the end of day you think can be resolved by going back to glass eagle. or glass eagle on steroids. that's a generalization of what you're saying? >> yes, both of them are.

think had a big package of things that ought to be dealt with separately. the one with the safety net, which worked. we solve d every commercial ban failure. they had a few that weren't exactly perfect. not very if. but what we've done is we had a system that worked. and not a single penny of taxpayer money went to solve one of those banks. you, the the congress, allowed to take interest in entities to which they were lending. i'm saying we have a system that worked. that continued to work regardless of the size of if two, if you separate the cultures. let one have a sifty net and have a regulation that doesn't allow you to do certain things. the other had no government safety net, but has different

regulations that makes them lose money and not ruin the system. right now the dodd-frank is a real mismatch of things to do. protect consumers, protect mortgages. manage big banks. we've all been hearing about how to handle the big banks. the unintended consequence is what's happening to us in the smaller banks. you're not paying attention to many mosaic and the change of the mosaic. it ain't the mosiac that we solved. it's a different mosaic. we have 52% of the banking assets inside about four or five banks. they are at the at-risk part of investment banking. only one-half in deposit.

that doesn't make any sense at all we made a big mistake putting these two things together. i supported it. i made a few mistakes in my life. i'll make some more, i'm sure. this is because the cultures are different and you're trying to regulate them together with a thing that no human being can manage or regulate. >> you run a boring operation yourself. it's involved in different kinds of activities than was just described. you're the other true practitioner here. the others have a lot of wisdom. we're not going down the wrong

path. dodd-frank has a lot of very positive aspects to it. i think improvement of capital ratios, capital planning, resolution planning, lick we digs authority, improvements in government and risk management. those are all positive aspects. i think the financial system is much better off for many of those. but you did a great job in your testimony laying out some of those. frf the standpoint of mr. frost, real solution. even though we're not in a lot of the businesses, senator, i think it's a