Remarks by

John D. Hawke, Jr.

Comptroller of the Currency

Before

America's Community Bankers

San Francisco, California

November 5, 2002

I want to thank Diane and the ACB leadership for inviting me to be with
you today. While I know that ACB's membership includes commercial banks,
this organization plays a tremendously important role as the leading
representative of the thrift industry.

There. I've used the "T" word, in full understanding that it's a term
that's largely been banished by the industry it once described. With
your forgiveness, I will use it occasionally in my remarks, but only in
order to make a couple of points: first, to distinguish the main body of
ACB members from the financial institutions supervised by the OCC, and
second, to aid in discussing the trend that has all but obliterated what
were once key differences between the two types of institutions.

My involvement with your industry spans about 40 years. When I was a
young associate at my old law firm, I cut my litigation teeth
representing S&Ls in branch office hearings before the old Federal Home
Loan Bank Board. And in the late 1960s I spent endless hours working on
S&L holding company legislation. I came to value the thrift charter, and
the unitary thrift holding company, as highly flexible formats for
carrying on the business of a depository institution, and I still feel
that way, even though savings associations and banks have come look much
more alike.

In those days, the differences between commercial banks and savings
institutions were still wide and fundamental. The two occupied very
different niches within the financial services industry; they
undoubtedly competed for some of the same customers, but generally not
in ways that the other could have easily replicated. Regulation Q drew a
significant line between banks and thrifts. Most people thought of the
two as distant cousins rather than competitors. Bank and thrift
regulators traveled in their own circles as did their respective trade
associations \-- and our interests diverged as often than they
coincided.

What is remarkable is the extent to which the two industries have
converged over the last quarter century. Today the public views savings
associations as virtually indistinguishable from banks. Indeed, most
savings institutions now explicitly hold themselves out as "banks," and
\-- for reasons we all understand \-- their old identification as
"savings and loans" has virtually disappeared -- as has the "benefit"
they enjoyed under Reg Q of being able to pay higher rates than banks.

Over the past several years, both sectors have seen significant
consolidation and restructuring, significant growth of assets and
deposits, and, most importantly, significant prosperity. Just since
1994, the number of federally insured savings associations has dropped
by approximately 30 percent, commercial banks by about 25 percent. Total
assets held by savings associations are up by a little more than 30
percent since 1994, commercial bank assets by just over 50 percent. Both
industries today operate from strong positions of equity capital.

The trend toward convergence between the two industries is also evident
from an examination of their respective balance sheets. At one time,
non-mortgage consumer loans were virtually the exclusive realm of
commercial banks. Today, consumer loans account for eight percent of the
loans held by savings institutions. That compares to about 11 percent of
all loans held by banks with under \$1 billion in total assets.

In other words, the differences between savings associations and
commercial banks -- especially community banks -- are increasingly hard
to find.

The same trend can be viewed from another perspective. Commercial banks
once held very few real estate-related loans, especially residential
mortgage loans. Today, one-to-four family mortgages constitute 25
percent of loans held by banks, and many more mortgages are originated
and then securitized.

Indeed, real estate lending is today a major pillar of the national
banking system, and a significant source of its strength. Today, at a
time when national banks are still making fewer non-real estate loans
than they did a year ago, real estate lending is up nearly ten percent.
Today, real estate loans constitute around 45 percent of total national
bank loans -- five percent higher than in 1994 and a whopping 20 percent
higher than in 1984.

Moreover, the securitization of residential real estate loans plays a
large and increasing role in the growth of noninterest income at
national banks. As of the second quarter of 2002, residential real
estate loans comprised nearly two-thirds of the total stock of
securitized loans outstanding at national banks, and income from
securitized loans rose by more than 30 percent -- a big part of the
reason why total noninterest income at national banks was up by more
than 8 percent over the same period last year.

What all this means, of course, is that the operational concerns -- and
macroeconomic trends -- that keep ACB members up at night are,
increasingly, many of the same trends and concerns that preoccupy the
average national bank. Indeed, the vast majority of the institutions
supervised by the OCC -- some 2000 of the 2200 banks that make up the
national system \-- are community banks, with under \$1 billion in
assets. Of those 2000, about half are under \$100 million in assets. You
can't get more "community" -- or more like the typical ACB member \--
than that.

More than 1300 OCC examiners -- nearly two-thirds of our total examiner
force -- are dedicated to community bank supervision. The issues that
our examiners focus on -- and the perspective they bring to those issues
-- have also changed to reflect the changes that have taken place in the
banks they supervise.

Two decades ago, for example, OCC examiners would almost certainly have
criticized any national bank with the kind of concentration in
residential real estate that is commonplace -- and that usually passes
without criticism \-- today.

Two decades ago, OCC examiners would probably have viewed the consumer
debt load and the condition of residential real estate markets as
relatively minor risk factors for the national banking system. Today
these are among the most important issues our analysts and examiners
face, precisely because they have become so important to the safety and
soundness of the institutions we supervise.

It's become a cliché in our present economy that the consumer is king --
or queen. We can go even further: consumer spending over the last two
years prevented what is so far the mildest recession in recent history
from becoming much more serious. The willingness of American consumers
to continue spending despite the dismal performance of many of their
investments represents a vote of confidence in the fundamental health of
our economy.

The combined effect of tax cuts and the dramatic decline in interest
rates has been significant for the economy. Successive cuts in
short-term rates -- the Fed implemented 11 such cuts in 2001 alone --
helped to keep auto sales brisk and to sustain one of the best housing
markets in history. Fixed mortgage rates hit all-time lows this summer,
and they have largely stayed there. New housing starts, sales of
existing homes, and mortgage refinancing have soared to record levels,
and property values generally risen with them. One estimate places the
rise in property values over the past two years at \$2.5 trillion --
making up for no less than half the total loss in equity wealth over the
same period. And mortgage refinancing has generated savings of about
\$150 billion in the form of cash-outs and lowered monthly payments.

That's \$150 billion extra in the pockets of American consumers -- a
windfall that has until now helped keep our shops busy, our factories
humming, and our employment stable.

The big question is whether we can sustain this level of activity. Is
the consumer in a position to continue supporting the economy until
business investment has rebounded to the point where it can bear its
share of the economic load?

These days, the evidence is inconclusive. If it's good news that you're
looking for on this front, you probably won't have trouble finding it.
Indeed, many retail indicators continue to reflect strength.

But bank supervisors are professional worriers. Something in their DNA
seems to cause them to find glasses half empty and to see dark clouds on
every horizon. Even after adjusting for this somewhat dour outlook, we
think there's legitimate cause for concern about whether consumers have
the wherewithal to carry the load for the economy through these
uncertain times.

A telling signal on the retail side is the drop in key indicators of
consumer confidence. Last month the University of Michigan's Consumer
Sentiment Index dropped to a nine-year low -- the fifth consecutive
monthly decline in that index. This appears to be no aberration; the
Conference Board's Consumer Confidence Index has declined for five
straight months, and is now at its lowest level since November 1993.

This trend has been in evidence in auto showrooms. Despite the renewal
of below-market financing deals, auto sales pulled back 5.2 percent in
September. Sales rose for durable goods, as consumers loaded up on
appliances and furniture for all of those new houses, but not enough to
offset losses in autos.

A particularly disconcerting fact is that despite rock-bottom interest
rates, debt service as a percentage of disposable income is higher than
it's been since the mid-1980s. That's partly a reflection of the rise of
consumer credit outstanding, and partly due to the decline in median
household income. In 2001, household income fell by 2.2 percent after
adjusting for inflation, and the poverty rate rose for the first time
since 1993. And there's little evidence of an impending turn-around,
given rising unemployment claims and continued weakness in the job
market.

It may be, in other words, that the consumer has already given about all
that the consumer has to give. Indeed, debt load statistics suggest that
consumers may have given too much, and that retail customers could be
especially vulnerable to an unexpected economic jolt \-- in the form,
say, of a spike in interest rates or energy costs, or what some believe
is a long overdue softening of the housing market.

There's widespread concern that in some parts of the country, the good
times in housing amount to a bubble that cannot last. The implications
for the issuers of high loan-to-value first mortgages and home equity
loans -- one of the fastest-growing categories of consumer loans by
national banks -- are obvious. Indeed, this summer, mortgage
foreclosures rose to the highest levels on record.

What are the other implications of a weakening consumer sector for
national banks and savings associations? More to the point, what is the
OCC doing to help the institutions it supervises manage the special
risks that this complex and sensitive situation present?

I say "sensitive," because, as I've emphasized, consumer spending -- and
borrowing -- is crucial to the health of the banking system and the
economy, present and future. Obviously, it's in our interest to preserve
the ability of banks to continue making prudent loans to business and
consumers alike.

Having said that, we know from experience that the best way to maintain
credit availability and healthy economic development is to safeguard the
safety and soundness of the institutions that supply it. And the way we
do that as bank supervisors is to assist lending institutions to
identify, control, and manage risk \-- both new and existing.

As a case in point, we and the other FFIEC agencies, including OTS,
recently issued proposed guidance on credit card lending. It was the
outgrowth of recent examination findings of inappropriate or weak
account management, risk management, and loss allowance practices at
some institutions -- practices that give us particular concern in
today's uncertain retail banking environment.

For example, we found that some institutions have been extending credit,
increasing existing credit lines, or issuing additional lines with
insufficient regard to the borrowers' ability to repay. In some
instances, issuers failed to evaluate and document the borrower's
creditworthiness; in others, institutions lacked adequate management
information systems to get their arms around borrowers' total exposure;
and some issuers have clearly paid insufficient attention to their
workout and collection arrangements.

We have been particularly concerned about subprime lenders, especially
those that freely grant credit-limit increases to cardholders -- or that
implicitly grant such increases by honoring over-limit charges and
carrying the excess forward month after month with substantial penalty
charges. Too often that leads to negative amortization, a situation in
which the minimum monthly payment is insufficient to amortize the debt,
and finance charges pile up to increase the amount owed. Subprime
borrowers frequently lack the financial capacity to service this
additional debt and the high fees associated with being in an over-limit
status. It's not uncommon for subprime borrowers to be current on their
debt, and yet, when finance charges and over-limit fees are added in, to
wind up owing their creditors more [after]{.underline} making the
minimum payment than they did before. This is obviously an untenable
situation for borrowers, but it also exposes lenders to the possibility
of large unsecured losses. The consequences for banks -- and for the
economy -- could be serious.

As supervisors, we believe it is important to avoid such an unhappy
outcome. The guidance put out for comment spells out our expectations
for prudent risk management practices for credit card activities. We
expect issuing institutions to manage credit lines prudently \-- to
fully test, analyze, and justify credit line assignment and line
increase criteria. We expect that over-limit authorizations for subprime
borrowers will be carefully considered, and that workout policies will
be properly managed.

And while we recognize that it will take some time for financial
institutions fully to phase in the policy changes that our guidance
contemplates, we want to see financial institutions making an early and
industrious effort to address those areas in which corrective action is
most needed. Much rides on the outcome for national banks, for ACB
members, and for all financial institutions -- as well as for our
economy.

That's another facet of the convergence of banks and savings
associations that I mentioned earlier in my remarks. During the early
1980s, while S&L losses multiplied, banks operated in relatively safety.

Those days, I suspect, are gone forever. Whatever happens tomorrow --
good or bad -- will undoubtedly affect ACB member institutions and
commercial banks without distinction. Now we're in it together.

That's why it's so important that we share views and insights across
industry lines \-- and why I so appreciate the opportunity to speak to
you this morning.

Before closing, let me speak to an issue that I know is on your minds,
and that is the future of the thrift charter and the Office of Thrift
Supervision. If, as some suggest, thrifts and commercial banks have
become increasingly difficult to distinguish from one another, then it's
logical to ask whether we need both charters. And even if the answer is
that we should retain both, then it's not unreasonable to ask whether we
still should have two federal agencies to supervise the two industries.

As I said before, I am a strong believer in the charter you hold, and I
want to see it preserved. Indeed, I had hoped that financial
modernization legislation would use the thrift charter as the model for
all depository institutions -- a kind of highest common denominator \--
and I regret that did not happen.

Some people have suggested that there is a compelling logic to merging
OCC and OTS. There is no question, of course, that the crazy quilt of
U.S. financial supervisory agencies offends some people's rigid
conception of bureaucratic orderliness. Contraction among savings
associations and attrition at OTS have fanned the consolidation flames.
Indeed, the most recently announced OTS staff reductions would bring
that agency's workforce below 1000 for the first time. By contrast, in
1994, the number of OTS staffers stood at over 1700.

You have all heard the line attributed to Mark Twain: "the report of my
death was an exaggeration." The same can be said of OTS. It's now going
on 14 years that OTS has been said to be on the verge of extinction.
Notwithstanding these predictions, OTS is fully discharging its
responsibilities under the law in a highly professional manner and
playing a very important role in the supervision of our financial
institutions. After several years of budget deficits, OTS Director Jim
Gilleran has not only balanced OTS's budget, but now projects a small
operating surplus. OTS continues to have a critical mass of institutions
to supervise, and I see no useful purpose to be served in merging the
two agencies. While it is true that banks and savings associations are
looking more alike than ever before, there continue to be significant
differences in the charters, in their holding companies, and in the
legal frameworks under which they operate. These differences also weigh
strongly in favor of the continuation of strong and effective
representation of this segment of the financial services industry in
Washington, such as that provided by Diane Casey and ACB. Any effort to
merge the regulatory agencies would not only be disruptive, but would
have to come to grips with these differences. Perhaps that's why no
significant public constituency seems to have developed in favor of an
OCC-OTS merger.

So let's hope that the next time a Comptroller of the Currency is
invited to address the ACB annual convention, it is as the supervisor of
a vibrant national banking system, vigorously competing with an equally
vibrant group of savings associations under the supervision of an
independent OTS. Freedom of choice for financial institutions is a goal
worth preserving; I assure you that the OCC is committed to working
toward that end.