MR. GRAY: But let me go a step further here. The House Government Operations Committee report that came out, I believe, on November 5th of 1985, went into this whole subject in great detail over, I think, a matter of something like five or six months. And I think there was general recognition that there wasn't nearly as much data as they would like. Let me read to you what they concluded. They said that "As long as the FSLIC fund remains impaired" -- and no one can doubt that it remains impaired-"as long as the FSLIC fund remains impaired, the Federal Home Loan Bank Board's direct investment rule is an appropriate and necessary restriction."

And there was another part of the report which called the direct investment rule "a prudent precaution while the FSLIC is in a weakened condition." That's what we're really talking about here.

What kind of reasonable precautions are we taking when the FSLIC fund is in a weakened, and remains in a weakened condition, more weak today than ever before in my memory?

MR. BLACK: I think it gets back to one of the questions Board Member White asked. He says he wants to make a rational decision, which everyone agrees with, which involves, let's look at the net effect of direct investment. I see here evidence in what it causes in terms of failures, but let me look at the up side, too.

Let's look at the up side because I agree, and, particularly if you are distinct from an insurance company analogy, but even if you just talk about it from a government regulator's perspective, look at the up side.

Who was above 10 percent? Remember if you're below 10 percent, you can do it anyway, and we're not stopping you from doing it. So, our reg doesn't hurt you, doesn't stop you from that up side.

Who was above 10 percent? It's not a sample. It's the universe, these 37 institutions that were above 10 percent. What up side harm could we possibly have done if three years ago we had prohibited those institutions from going above 10 percent in direct investments? That's the up side that you might be losing.

I submit, if you look at it in those terms, it gets to be a relatively easy decision. For any insurer, it's a super-easy decision, but I think even academically, if you look at it on that up side versus the down side from the FSLIC cost numbers, it doesn't get to be that hard a decision.

MR. QUILLIAN: There is, of course, Bill, the additional consideration that we're not talking about a regulation which is a ceiling or a firm limitation or a prohibition, but rather a regulation which establishes a threshold for supervisory review.

This might be a good point at which to also say something about the nature of the proceeding. It's very unusual, at least in my experience of almost 20 years with regulatory agencies, in one proceeding or another for an informal rulemaking to result in a record which is so airtight that it's beyond all reasonable doubt.

This is not a judicial proceeding where the case has to be proved beyond a reasonable doubt in a criminal case or on a preponderance of evidence in a civil case. This is an informal rulemaking, and the test is whether there is a reasonable basis for the action of the Board based on the record as a whole.

As Bill has pointed out, and others have pointed out here, we on the staff believe that this is a very strong record; that it makes a very strong case for what the chairman has repeatedly characterized as a prudential limited rule, and it does not seem to me--there's certainly no doubt in my mind, that based on the record which is before the Board today, the Board could extend this rather mild, limited rule, including a threshold of supervisory review with firm confidence that it would survive any challenge on review.

MR. WHITE: Okay. I understand that, but also I am not only one of three Board Members running an insurance company, but also, in general, regulating the savings and loan industry and I've got to think about, well, maintaining my concern about the insurance least cost way of achieving. the desired goals, least social cost way of achieving our important insurance goal.

MR. QUILLIAN: We certainly share that orientation.

MR. GRAY:

Let me make a slight comparison with another regulation that was adopted by the Board the same day, January 31st of 1985. That was the regulation having to do with growth in deposits in the industry, and hence, growth in assets.

We, of course, knew at the time what the rate of growth was, but we could not have known the effect of that regulation. There would have been no way to predict it. The actual effect of the regulation enabled us to reduce the rate of growth in the industry as a whole down to the rough equivalent of the commercial banks.

In 1984, it was 20 percent; much, much higher in many institutions. That was a prudential action on our part, and it yielded very good results from the FSLIC's point of view.

And I haven't heard anything thus far today that would indicate that the Direct Investment Regulation--maybe, Mr. Henkel you would have some comments on this--that the Direct Investment Regulation has impaired the ability of strong institutions to go into direct investments at higher levels than 10 percent.

I haven't heard any damages thus far which have resulted from this Direct Investment Regulation on any party. Maybe I can hear some damages that have occurred as a result of this.

MR. WHITE: Following up on what Ed just said, I mean, this issue of the 30-day rule that a number of the commentators said, 30 days, that's a lifetime, I'm paraphrasing--that's a lifetime when it comes to these kinds of investments. You've got to hit the bid when it's there, and you wait 30 days, and it's just not going to be there.

MR. GRAY: I don't believe that. That's baloney. I'll tell you why I think it's baloney. I think that if an institution, an insured institution, wants to make an investment or do a loan, the idea of doing it summarily and instantaneously is the very reason why we have all the problems we have today.

MR. HENKEL: But what we're talking about you asked the question, Mr. Chairman, about what the damage out there is, if any. I don't really know, but I know this, from having been out there in that world and knocking around in business, if you're talking about a lot of deals and you're faced with, number one, the cost of preparing the thousands of dollars to prepare your business plan or whatever you've got to get together; that takes time, and then you've got 30 more days to wait. There's going to be a lot of deals that are going to be gone before you get there, and that's just a fact. And you're doing this, most importantly, on a principle basis. We've got state law that we're overriding and before we override state law, we do that cautiously and we do it carefully.

MR. GRAY: Yeah, but what State treasury picks up one penny of any loss? Not one penny, any treasury in this country ever pays for it. know who pays for it? The FSLIC.

You

MR. HENKEL: Mr. Chairman, I didn't design this system. We've got a state system and we've got a federal system, and sobeit, but we've got to operate within it.

Mr. GRAY: But on the other hand, we have to insure those deposits that those institutions operate their businesses on, here, in Washington.

MR. BLACK: With respect, I think this debate is about a regulatory provision that doesn't exist. The regulatory provision, in response to the comments back in December of '84 about precisely this point that we can't go investment-by-investment; we need more generalized authority in advance on the basis of a business plan. The staff considered those views, thought they were rational, brought a proposal to the Board to allow precisely that. The Board adopted that proposal. That is the rule. I don't think anybody -- at least I haven't heard anybody object to the concept that you ought to do a business plan in advance of exceeding what is, after all, a very high threshold.

MR. WHITE: Let me make sure I understand this. A thrift institution can come in with a business plan, say here's, in general, what we want to do; here's, in general, the levels of a direct investment we're going to be undertaking in general areas, without specifying, specific

MR. BLACK: That's right. Here are the personnel that have expertise in this kind of investment. Here we have underwriting standards that we follow when we consider investments, as well as loans. As you may know, our regulations don't really cover direct investments very well in terms of underwriting expressly.

Those are the types of things that the Principal Supervisory Agents or their delegees look at in determining whether to approve a generalized grant of authority to exceed ten percent, and they don't have to come back on individual investments.

MR. GRAY: This is why, I mean, I'm always afraid of instant decisions. They sometimes don't work out very well in our experience, but even if you want to make an instant decision because you might lose business if you couldn't, there's nothing in this regulation that says you can't, unless you're over the ultimate threshold that you want. Nothing!

If you want to make that kind of judgment and do a transaction like that and you have that within the amount that you've been approved, the level that you've been approved, then you can do that.

MR. BLACK: This Board, historically, different Board Members, have always taken the position that they had the ability to regulate on safety and soundness grounds, that it wasn't a matter simply of the state said you could do anything in the world and that meant that you could have no federal regulations addressed to safety and soundness.

But this one -- there really is a question what this sturm and drang is all about. The number of denials of applications are de minimis relative to system size. Of those denials, there is a right to appeal to the Bank Board and, of course, a right after that, to sue.

To my knowledge, there has been one appeal in almost two years of any denial--one, and no court challenge ever. I mean, there is no evidence in our experience with the waiver procedures, no evidence in the comments filed, that there is any problem being imposed by this threshold in application.

MR. QUILLIAN: It certainly would look different, Bill, it seems to me, if, instead of the record, which is about a hundred applications with nearly two-thirds of them approved if it were 500 applications and two-thirds of them denied, this kind of argument would make a whole lot more

sense.

You have received an expedited preliminary transcript of a meeting of the Federal Home Loan Bank Board held on Thursday, December 18, 1986. The meeting took up the issue of direct investments. Page 44 of the Board Meeting transcript you received incorrectly attributes four sentences to Board Member Lawrence J. White. The sentences should have been attributed to Bank Board Staff Member William Black.

Attached is a corrected version of page 44 of the transcript.

Attachment