Mr. SHELBY. If they had to charge off and pay these loans, they could not carry them on the books as a performing loan, as a big asset as they are doing, and if they had to charge them off, that would eat their capital up.

Mr. ISAAC. It depends on how many loans you're talking about. Mr. SHELBY. We're talking about a lot of them. We're talking about, as I mentioned earlier, Citicorp 97 percent of their capital. Let's say that they charged off half of that.

Mr. ISAAC. If they were required to charge off half of their capital, certainly that hurts. But on what basis-

Mr. SHELBY. With Manufacturers Hanover, 110 percent.

Mr. ISAAC. On what basis would you make them take a 50-percent writedown?

Mr. SHELBY. That would depend on whether the loan was performing or nonperforming. I am not in a position to know. The regulators have to look at it, but obviously the regulators have been very lax in this regard.

Mr. ISAAC. The judgment as to whether the loan is performing or not itself is very difficult. These countries are paying interest and they're making principal payments and the like. The problem is they are also borrowing at the same time.

Mr. SHELBY. And a lot of times they're borrowing to pay that principal. It's just a merry-go-round, isn't it?

Mr. ISAAC. And that is why you are led to the question--
Mr. SHELBY. That's what I am getting to.

Mr. ISAAC. That's why you are led to the-a different kind of analysis. You cannot just look at the total debt and figure out whether they are ever going to repay it. What you have got to determine is are they able to service that debt reasonably or is the debt getting bigger and bigger and bigger in relationship—

Mr. SHELBY. You can say the borrower, a lot of them are

Mr. ISAAC. It has to get bigger and bigger and bigger in relative terms to worry you. In other words, if the economy of the country is growing and their ability to take care of the debt and service it is growing faster than the debt is, then you don't worry about it. That has not been the case in recent years.

Mr. SHELBY. There has been shrinkage.

Mr. ISAAC. The debt service burden has become more onerous with relationship to the size of the economy.

Mr. SHELBY. Do a lot of the foreign loans require special regulatory relief from some of the domestic loans? In other words, are there two different standards there?

Mr. ISAAC. There are people who would argue there are two different standards. I think-it is really hard to answer that. I am really not trying to avoid you on it, but it is so difficult. When you look at a loan to Bill Isaac, you can add up his assets and his liabilities and you can say-and you can look at his cash-flow, his earnings, and see whether he is going to be able to take care of the debt. And if he cannot take care of the debt, you can look at the assets and liabilities and see what the bank is going to be able to foreclose on to realize on it. You can come up with a net loss figure very easily. It is a very uncomplicated calculation to make.

When you start analyzing a country and a political system-because that is part of the process-the ability to take care of the

67-295 - 87 - - 4

debt properly depends a lot on what can be done politically in the country and the reforms that can be made and this sort of stuff and what is going to happen to the price of 100 different commodities that the country is dealing in. You are talking about a very, very complicated formula and you cannot just look at a balance sheet. There is no balance sheet.

Mr. SHELBY. But shouldn't we have the same basic regulations for everybody? Or should we treat someone, a foreign country, a lot more leniently than we would a big domestic debtor? Do you see what I am getting at?

Mr. ISAAC. I agree. If you can conclude that a given country that loans to a given country do not have and will never have the value that is shown on the books, then they should be written down. And that has been done in a number of cases.

Mr. SHELBY. Mr. Isaac, we appreciate your appearing before us today, and we will keep the record open for any-we have minority counsel that might have some statement. He is recognized.

Go ahead.

Mr. WILSON. Thank you, Mr. Chairman. I have just a couple of questions for Mr. Isaac.

Mr. Isaac, in your statement you were critical of the capital forbearance program but indicated that if participation was limited to banks with acceptable management and if the growth in activities of those banks was carefully monitored and controlled, then the cost to the FDIC would not be great. How would you modify the capital forbearance program to limit participation to those banks? Mr. ISAAC. I am sorry if it came across in my statement that I was critical of the capital forbearance plan, as formulated. I am not particularly concerned about it. It does not do much good for anybody, any of the communities involved, but I am not concerned about the capital forbearance plan, as formulated. I hope that it will be implemented and administered the way it is written. It is intended to be applied only to institutions that have acceptable management, where management errs and abuses have not caused problems, which is going to be-you know, that is open to a lot of interpretation. It is intended to apply only to institutions that have 3 percent or better in book capital or tangible net worth and those institutions are supposed to be operating under a very strict operating plan that shows how they are going to get out of that problem. If all of that comes to pass, I am not particularly concerned about the capital forbearance proposal that was put out.

Mr. WILSON. In your testimony you mentioned that you would like to "find a way to place some creditors other than the FDIC or FSLIC at risk when a bank or thrift fails." I am curious as to what other creditors you have in mind what ones you would like to place at risk and how would you go about placing them at risk.

Mr. ISAAC. The deposit insurance system has become more and more liberal over the years. It started off trying to insure depositors up to $2,500 per account. President Roosevelt opposed it, and so did the American Bankers Association, on the theory that you were just going to be asking well-run banks to subsidize the marginal, poorly run institutions, and that you were going to encourage excessive risk-taking with this Federal guarantee on the funds. It would be better to rely on the markets.

But nevertheless, the program came into being. I am glad it did. I think it is a very good program. But the deposit insurance limit has gone up and up and up over the years, and now it is $100,000. And if you put $100,000 in your own name, $100,000 in your spouse's name, and $100,000 in joint name, you have $300,000 in coverage at the same institution. If you have $600,000, you can go to two institutions and get that fully insured. That is no longer a deposit insurance system that is just protecting the ordinary working person. You're talking about big dollars when you're talking about $100,000.

Now, if you have more than that, you can go to the XYZ money brokering and storm door company and give them money, and they will put it out through computers in a whole bunch of institutions, fully insured. You can give the money broker $10 million, and they will go out and put it in 100 different institutions, $100,000 apiece. It will be fully insured by the Federal Government. The institutions that will get it are the ones that are paying the highest rates. The ones that are paying the highest rates are the ones that are getting ready to fail.

So the Federal Government pumps fully guaranteed money into troubled institutions through the money brokering activities. I can go on with that kind of explanation.

What I am saying is the deposit insurance system is becoming more and more and more liberal over the years. Bank failures are typically handled by merging a failed bank into another bank, all depositors, those who are insured and those who are uninsured are made whole. Continental, Franklin, U.S. National, San Diego, First Pennsylvania, all of those, all of the creditors in those institutions were made whole, and you're winding up with a system that nobody is at risk in except for the FDIC or the FSLIC. And that is a big part of the problem.

We started making a lot of noises about that issue back in 1981, 1980-81, saying that if you don't deal with it, you are going to have a crisis on your hands. Now it is 1986 and we still have not dealt with it, and we are getting closer and closer to that crisis. Unfortunately, it seems to take a crisis to get the Congress to move, and so I suspect we are going to have one before we deal with the issue. Mr. WILSON. In a FDIC-insured bank or FSLIC-insured savingsand-loan failure, is there any creditor at risk other than FSLIC or FDIC?

Mr. ISAAC. Not in the vast majority of cases. It is seldom that a creditor loses money in a bank or thrift failure, any creditor.

Mr. WILSON. What you would like to see is to have those insurance limits reduced. Somebody that has, say, $80,000 to $100,000 to put in a thrift or a bank are either sophisticated enough to make their own decisions or they have the money to hire somebody?

Mr. ISAAC. It is not quite that simple. First of all, you cannot-I do not believe that you can realistically reduce the $100,000 limit. We never called for that while I was at the FDIC, and I do not believe the FDIC would call for it today. But there are a lot of other things that can and should be done. I will give you one example. The FDIC made a proposal. We raised the idea in legislative forum. Why are we insuring deposits placed by federally insured depository institutions and other federally insured depository insti

tutions? In other words, why should a bank or a credit union or S&L that has-is a participant in a federally insured insurance program, why should it get insurance when it places money in another federally insured institution? The deposit insurance system was never intended to protect credit unions, banks and S&L's when placing their excess money in other banks, credit unions, and S&L's? And if there is anybody in this country that ought to be sophisticated enough in handling money to measure risks versus reward, I would hope it would be a bank, a credit union, or an S&L that is participating in the Federal deposit insurance system.

The FDIC, as I say, I cannot recall whether it was formally or informally, proposed to eliminate that, to say that a bank or a credit union or an S&L-and those institutions, incidentally, supply a lot of money to money brokers, particularly credit unions-that they should not be insured institutions, when they place their funds, that they ought to have to measure risks versus rewards. That has never moved one inch from the proposal stage, because the banks and credit unions and S&L's like the subsidy. You go out and give your money to a money broker, and they spread it around to the institutions that pay the highest rate, and there is zero risk.

That is a simple reform that could be made in the system. It would not cause any particular turmoil. It causes a lot of political heartburn, but no business problems to speak of. It would be a vast improvement in the insurance system, eliminate a lot of sources of abuse. But yet, the Congress has not even taken it up seriously.

Mr. WILSON. Would you say that the FSLIC and the FDIC are really a cash cows for these institutions?

Mr. ISAAC. Yes.

Mr. WILSON. You mentioned that the accounting system should be neutral for any loan restructuring. Human nature being what it is if FASB Standard 15 were repealed and if bankers could not defer writing off or writing down problem loans, there would be more or less restructuring and renegotiation of debt?

Mr. ISAAC. I think that FASB 15 is not neutral. It encourages people very, very heavily to try to rewrite a loan somehow rather than trying to foreclose or realize on it. I don't like an accounting system that is not neutral. I don't think the accounting system ought to drive business decisions.

Mr. WILSON. So do you think it is accurate to speculate that if FASB Standard 15 were repealed, there would be fewer renegotiations and restructurings?

Mr. ISAAC. I think that's accurate.

Mr. WILSON. Thank you, Mr. Chairman. I have no further questions.

Mr. SHELBY. Mr. Isaac, we got into the foreign loan problem a few minutes ago, and I recall that I said to you shouldn't the regulations be the same; in other words, you should look at the domestic and the foreign loans by the same basic regulations-are they going to be repaid and, if they are not, how are you going to charge them off, what are you going to do?

In other words, you are advocating, as I understand it, a tighter situation with the banking industry domestically. And I look at Manufacturers Hanover, Citicorp, Bank America, Chase Manhat

tan, and so forth. Isn't this really a fraud on the people to let them carry that at book value? I know you have hedged on it here. But shouldn't they start building up their capital? I know they have tried to, some. Shouldn't the Fed push them to do that and start writing these loans off? In other words, you want to carry them forever and ever when you know and I know that most of them will never be repaid? Get what you can, salvage what you can and move on, just like you would on the domestic situations? Why not? Mr. ISAAC. I do not believe that what is being done is in any way, shape, or form fraudulent. I think that people are trying to make some very difficult decisions and judgments as best they can.

But I think, as far as capital goes, not only have the large banks increased their capital in recent years, it has been a dramatic increase in capital in recent years.

off.

Mr. SHELBY. It's going to take a lot more to charge these loans

Mr. ISAAC. I think we should be building capital further and strengthening reserves further. And that is one reason why I am so concerned about the movement in the Congress right now to limit the deduction for bad debt reserves.

Mr. SHELBY. You recommend people, private investors, investing in these banks that have all of these loans in Latin America, some exceeding 100 percent of their capital? Do you think those are good investments in that stock?

Mr. ISAAC. I think, first of all, I would not give people investment advice like that, but I think the market, if you look at what has happened to the bank stocks, the price in relationship to book and earnings and the like, the market has already reflected a great deal of concern and those stocks have been taken down quite a bit from where they used to be.

Mr. SHELBY. Thank you for being with us today.

Mr. ISAAC. Thank you.

[Whereupon, at 1:32 p.m., the subcommittee was adjourned to reconvene at the call of the Chair.]