[House Hearing, 110 Congress]
[From the U.S. Government Printing Office]

                           SYSTEMIC RISK AND
                         THE FINANCIAL MARKETS



                               BEFORE THE


                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION


                             JULY 10, 2008


       Printed for the use of the Committee on Financial Services

                           Serial No. 110-127

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                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            DEBORAH PRYCE, Ohio
CAROLYN B. MALONEY, New York         MICHAEL N. CASTLE, Delaware
LUIS V. GUTIERREZ, Illinois          PETER T. KING, New York
NYDIA M. VELAZQUEZ, New York         EDWARD R. ROYCE, California
MELVIN L. WATT, North Carolina       FRANK D. LUCAS, Oklahoma
GARY L. ACKERMAN, New York           RON PAUL, Texas
BRAD SHERMAN, California             STEVEN C. LaTOURETTE, Ohio
GREGORY W. MEEKS, New York           DONALD A. MANZULLO, Illinois
DENNIS MOORE, Kansas                 WALTER B. JONES, Jr., North 
MICHAEL E. CAPUANO, Massachusetts        Carolina
RUBEN HINOJOSA, Texas                JUDY BIGGERT, Illinois
WM. LACY CLAY, Missouri              CHRISTOPHER SHAYS, Connecticut
CAROLYN McCARTHY, New York           GARY G. MILLER, California
JOE BACA, California                 SHELLEY MOORE CAPITO, West 
STEPHEN F. LYNCH, Massachusetts          Virginia
BRAD MILLER, North Carolina          TOM FEENEY, Florida
DAVID SCOTT, Georgia                 JEB HENSARLING, Texas
AL GREEN, Texas                      SCOTT GARRETT, New Jersey
EMANUEL CLEAVER, Missouri            GINNY BROWN-WAITE, Florida
MELISSA L. BEAN, Illinois            J. GRESHAM BARRETT, South Carolina
GWEN MOORE, Wisconsin,               JIM GERLACH, Pennsylvania
LINCOLN DAVIS, Tennessee             STEVAN PEARCE, New Mexico
PAUL W. HODES, New Hampshire         RANDY NEUGEBAUER, Texas
KEITH ELLISON, Minnesota             TOM PRICE, Georgia
RON KLEIN, Florida                   GEOFF DAVIS, Kentucky
TIM MAHONEY, Florida                 PATRICK T. McHENRY, North Carolina
CHARLES WILSON, Ohio                 JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              ADAM PUTNAM, Florida
JOE DONNELLY, Indiana                PETER J. ROSKAM, Illinois
BILL FOSTER, Illinois                KENNY MARCHANT, Texas
ANDRE CARSON, Indiana                THADDEUS G. McCOTTER, Michigan
JACKIE SPEIER, California            KEVIN McCARTHY, California
DON CAZAYOUX, Louisiana              DEAN HELLER, Nevada

        Jeanne M. Roslanowick, Staff Director and Chief Counsel

                            C O N T E N T S

Hearing held on:
    July 10, 2008................................................     1
    July 10, 2008................................................    57

                        Thursday, July 10, 2008

Bernanke, Hon. Ben S., Chairman, Board of Governors of the 
  Federal Reserve System.........................................    10
Paulson, Hon. Henry M., Jr., Secretary, U.S. Department of the 
  Treasury.......................................................     7


Prepared statements:
    Kanjorski, Hon. Paul E.......................................    58
    Neugebauer, Hon. Randy.......................................    60
    Bernanke, Hon. Ben S.........................................    61
    Paulson, Hon. Henry M., Jr...................................    67

              Additional Material Submitted for the Record

Bachus, Hon. Spencer:
    ``Remarks by U.S. Treasury Secretary Henry M. Paulson, Jr., 
      on the U.S., the World Economy and Markets before the 
      Chatham House,'' dated July 2, 2008........................    69
Hinojosa, Hon. Ruben:
    ``Contents of Letter Sent to ED with Notice of 
      Participation''............................................    76
    ``On-going Barriers to Continued Participation in FFELP for 
      Not-for-Profit Lenders.....................................    78
    COSTEP Letter................................................    80
    Memo to Texas Congressional Staff from Jimmy Parker, PPHEA, 
      dated July 8, 2008.........................................    81

                           SYSTEMIC RISK AND
                         THE FINANCIAL MARKETS


                        Thursday, July 10, 2008

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10:05 a.m., in 
room 2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Members present: Representatives Frank, Kanjorski, Waters, 
Maloney, Watt, Ackerman, Sherman, Moore of Kansas, Capuano, 
Hinojosa, McCarthy of New York, Lynch, Miller of North 
Carolina, Scott, Green, Cleaver, Davis, Hodes, Ellison, 
Perlmutter, Donnelly, Speier, Childers; Bachus, Castle, Royce, 
Paul, Manzullo, Biggert, Shays, Feeney, Hensarling, Garrett, 
Neugebauer, Campbell, Bachmann, Roskam, Marchant, and Heller.
    The Chairman. The hearing will begin. We have an overflow 
room, I believe. Is that true?
    The Clerk. Yes, sir.
    The Chairman. Okay, so there is an overflow room for people 
who can't find seats. We have gotten the agreement of the 
Chairman and the Secretary, preliminary to any opening 
statements, to stay until 1 p.m. We will probably have some 
votes, so we will maximize our time.
    Let me remind the members that Chairman Bernanke will be 
before this committee next week for the Humphrey-Hawkins 
hearing on the economy. Members are obviously free to raise 
anything they want today, but it is my hope that we would focus 
on these very important questions of financial regulation. I 
know there are members who want to review what happened with 
Bear Stearns and then what we do going forward, but I 
personally believe the best use of the committee's time today 
would be to focus on those structural questions and regulatory 
    We will have the Chairman before us for 3 more hours next 
week to talk about the economy and Humphrey-Hawkins; and, 
again, I would urge members to do that. All members are free, 
as we know, to bring up whatever they want, but that would be 
our hope, because I did note that some of the members of the 
committee had asked previously for a hearing to look into what 
happened with Bear Stearns. And I said at the time that I 
thought that was very important. I believed it was best to do 
that in this broader context. Members want to get a new context 
because the experience regarding Bear Stearns is clearly the 
context in which much of this hearing is and much of what we 
will be talking about is what happens if that should occur. So 
those are the parameters.
    Given the importance of this, and given the interest of 
members in speaking, we are going to hold pretty firmly to the 
5-minute rule. And, obviously, we are not going to completely 
finish in 5 minutes, but no question can be asked after the 5 
minutes have expired. We will allow the answers to conclude. 
But I am going to have to restrain myself and others from 
asking any questions after the 5 minutes.
    Under the rules that apply when we have cabinet and 
cabinet-level officials, there are two opening statements on 
each side, the chairs and ranking members of the appropriate 
subcommittees. In this case, it seems clear to me that it is 
the Financial Institutions Subcommittee that is the developing 
subcommittee so that is how we will proceed. The official part 
of the hearing will now begin and I will recognize myself for a 
fairly strict 5 minutes.
    When I was about to become chairman of this committee in 
2006, I was told by a wide range of people that our agenda 
should be that of further deregulating. I was told that the 
excess regulation in America from Sarbanes-Oxley and other acts 
was putting American investment companies and financial 
institutions at a competitive disadvantage and that people much 
prefer the softer touch of the financial services authority to 
the harshness of the American regulatory structure. Things have 
    Where there was a strong argument as recently as November 
of 2006 that we had been over-regulating the financial system, 
I believe the evidence is now clear that we are in one of the 
most serious economic troubles that we have seen recently, in 
part because of an inadequacy of regulation.
    Clearly, that has been the case with regard to subprime 
mortgages, but what has been striking is not simply that we had 
the problems with subprime mortgages, but that those problems 
infected so much of the financial system, including, I must 
say, many in Europe. One of the things though that I do take 
away from that set of conversations, and then it's a fairly 
clear one is that what we do, and I believe there is a 
consensus now among people in the Administration, among many of 
us in Congress, and among people in the financial industry, 
that an increase in regulation is required. It must be done 
sensibly. It must be market sensitive.
    But I believe we have seen a significant shift from the 
notion that the most important issue was to deregulate further 
to one recognizing the need for more sensible regulation, but 
more regulation. It is clear that this needs to be done in the 
context of international cooperation, and I am encouraged to 
believe, and the first trip this committee took when I became 
chairman was to Belgium and London to meet with people from the 
European Union and Great Britain in terms of their financial 
regulation. This needs to be done with international 
cooperation and I think the prospects of that are very good. I 
think there was a broad international recognition that some 
form of increased regulation was necessary. And the form we are 
talking about is regulation of risk-taking outside the very 
narrowly defined commercial banking. Innovation is very 
important, and an innovation that has brought a great deal of 
benefit during the last few decades is securitization.
    Securitization replaces the lender-borrower relationship 
and the discipline that you have in the lender-borrower 
relationship. A very large part of our problem is that we have 
not yet found sufficient replacement for the discipline of a 
lender not lending to a borrower unless the lender is sure that 
the borrower will be able to repay. Something that simple 
causes problems in subprime, and it has caused problems 
    We have had too many loans made without sufficient 
attention to whether or not the loans could be repaid. And, 
what we now have is a contagion, because people who bought 
loans in various forms that they shouldn't have bought are now 
resistant to buying things that they should buy.
    That is why I believe regulation properly done, regulation 
of risk that is too unconstrained today, because the various 
risk management techniques that were supposed to replace the 
lender-borrower relationship have not been successful. 
Diversification and quantitative models and the rating 
agencies, we have not yet replaced them. Some form of 
regulatory authority is necessary. If properly done, a market 
sensitive regulatory authority not only prevents some of the 
problems, but is pro-market, because we have investors now who 
are unwilling to invest even in things they should.
    Many of our nonprofit institutions and our State and local 
governments have been the victims of this. So our job, I 
believe--and I congratulate the officials of this 
Administration for having done a good job in the current legal 
context of dealing with these problems--is to look at what 
happened, to look at what is now going on, and to decide what 
should be done to provide a better statutory framework for the 
increase in regulation that I believe people agree should 
    The gentleman from Alabama.
    Mr. Bachus. I thank the chairman for holding this hearing 
on systemic risk and the appropriate regulatory responses to 
managing that risk and I know there will be short-term 
responses, and at some time in the future maybe a new 
regulatory structure which will take time.
    The two public servants before us today I think are 
eminently qualified to speak to these issues and we welcome 
Secretary Paulson and Chairman Bernanke. They had agencies 
whose mandates and responsibilities are broad and are deep, but 
the issue of systemic risk also requires the involvement of 
other significant and capable regulators, including 
particularly the SEC and the Federal banking regulators.
    It is my expectation that the leaders of these agencies 
will appear at a subsequent hearing with their comments and 
that will supplement our understanding and the testimony we 
gather today on this difficult issue, and I trust that 
Secretary Paulson and Chairman Bernanke agree that a 
collaborative effort that includes these agencies is going to 
be needed if we are to have a successful outcome.
    To say we are living through interesting times in our 
financial markets is to state the painfully obvious. We have 
seen a run on what was then the Nation's 5th largest investment 
bank, Bear Stearns. We have seen the Federal Reserve intervene 
in order to avoid a cascading effect from Bear Stearns's 
collapse that could have spread throughout the financial system 
with what I believe would have been decidedly negative 
implications for the larger economy.
    And we have seen the Federal Reserve take steps or a series 
of steps that in the short term at least have brought a measure 
of confidence and stability to the financial markets. But now 
that the immediate crisis created by the run on Bear Stearns 
has passed, we face some difficult, long-term policy questions.
    Perhaps the most critical question is, have we arrived at 
the place where virtually every primary dealer is considered 
too big or too interconnected to fail? The logical extension of 
this too big to fail perception is that markets no longer work 
and that the government must not only exercise greater control 
of our capital markets, but also be the ultimate guarantor of 
financial solvency; that would be a conclusion I could not 
    And in reading over the remarks of Secretary Paulson in 
London, I see that you did not endorse it, either. A far better 
alternative is to restore market discipline within appropriate 
regulatory bounds. I believe we have reached a consensus that 
we must establish a modern, regulatory structure to strengthen 
the safety and soundness of our institutions and discourage 
unsound practices and conduct. However, these regulations 
should not and cannot ensure that institutions will never fail. 
And if one does fail, we must ensure that taxpayers are not 
left holding the bag.
    Thanks to the fast action of the Federal Reserve in 
cooperation with the SEC and the Treasury, we dodged a bullet 
when Bear Stearns collapsed. We may not be so lucky next time. 
For that reason, I look forward to hearing from today's 
witnesses about what we can do to provide for an orderly 
resolution in the event a large financial institution fails.
    The regulatory regime we establish and follow must 
accomplish three things: ensure market discipline; provide a 
shock absorber against systemic risk; and, first and foremost, 
protect the taxpayer. To preserve market discipline and 
discourage moral hazard, we must see to it that no firm should 
be considered too big or interconnected to fail. To protect 
against systemic risk, we must ensure that when a firm fails, 
it does not bring down the entire financial system with it, 
i.e., an orderly liquidation. And to protect the taxpayer, we 
have to make sure that the cost of that failure is borne by the 
firm's shareholders and creditors, and not passed on to the 
taxpaying public.
    In conclusion, of necessity we have to plan for how to 
handle the failure of a major institution. It is important, 
however, that we create a system focused not on failure, but on 
success. In doing so, we must also resist the temptation to 
over-regulate in our zeal to discourage practices such as 
overleveraging an excessive risk-taking that put institutions 
at risk of failure. This is a tall order.
    Thank you, Mr. Chairman, for holding this hearing, and 
thank you to our witnesses.
    The Chairman. The gentleman from Pennsylvania is now 
recognized and will temporarily preside.
    Mr. Kanjorski. Mr. Chairman, this hearing comes at a 
critical juncture. As the economy reels from a widespread, far-
reaching financial crisis that continues to wreak havoc on 
everything from the housing market to student loans, while we 
remain focused on many current economic difficulties average 
Americans face, we must simultaneously look to the future to 
determine how to prevent or at least mitigate future crises.
    Financial innovation and the proliferation of complex and 
exotic financial instruments are probably inevitably going to 
occur under our capitalist system. But we must develop 
innovative, regulatory and oversight responses to keep pace as 
these market transactions evolve. One such proposal worth 
considering is the Systemic Risk Reduction Act of 2008 put 
forth by the Financial Services Roundtable.
    This bill seeks to make regulation more efficient by 
closing gaps in our regulatory structure and by promoting 
consolidation and cooperation among regulatory agencies. Their 
proposal includes a provision of particular interest to me; 
namely, it proposes establishing a bureau similar in concept to 
the Office of Insurance Information which passed the Capital 
Markets Subcommittee yesterday.
    Without a Federal repository to collect and analyze 
information on insurance issues, we cannot fully understand and 
control systemic risk. The Roundtable proposal would also 
expand the authority of the Federal Reserve so that investment 
banks who borrow from the Fed's discount window in various 
facilities do not get a free pass.
    No one else can borrow money without conditions, and the 
American people do not expect that the investment bank be 
allowed to do so.
    Chairman Bernanke spoke 2 days ago and raised many of these 
issues and offered ideas for consideration, noting that the 
financial turmoil since August underscores the need to find 
ways to make the financial system more resilient and more 
stable. I whole-heartedly agree. He further stated that the 
Fed's powers and responsibilities should be commensurate.
    It is the job of Congress to strike that proper balance. 
While many concur that the Federal Reserve's move to bail out 
Bear Stearns in March of this year was necessary to prevent a 
financial meltdown, most also agree that we should be concerned 
about setting precedents with broad ramifications down the 
road. Taxpayers cannot be asked to bail out financial 
institutions, and we should look for ways to prevent such dire 
situations from arising in the future.
    Another area germane to today's discussion is speculation. 
Specifically, we must determine to what extent speculation in 
commodities futures has hurt American consumers by artificially 
inflating the price of oil, energy, and other goods. I 
appreciate the ongoing debate on speculation with economists, 
traders, pundits, and politicians staking out various positions 
on the issue. To the extent that we can glean further insight 
from our panelists today, that would be of tremendous help, for 
it is true that speculators bear blame. Then congressional 
action in the form of increased oversight in authority is 
    on a related note, I am very interested in consolidating 
the regulation of our securities and commodities markets. While 
the CFTC currently has jurisdiction of this market, the 
Treasury's recommendation to merge SEC and FCTC seems a 
sensible course of action for Congress.
    We need to take this action now and I look forward to 
working with the Administration.
    The Chairman. The gentlewoman from Illinois.
    Mrs. Biggert. Thank you, Mr. Chairman, and thank you for 
holding today's hearing on systemic risk.
    Your responsiveness to the letter submitted in April by Mr. 
Garrett, Ranking Member Bachus, and more than a dozen of us on 
this side of the aisle is very much appreciated, and I would 
also like to thank Congressman Garrett for his leadership on 
this issue.
    I welcome our distinguished witnesses today: Federal 
Reserve Chairman Bernanke; and Treasury Secretary Paulson. Your 
steady leadership is helping us weather the storm that our 
markets and our economy are experiencing. As a side, Secretary 
Paulson, I would like to specifically thank you and your staff, 
as well as the public and private sector partners for 
organizing the HOPE NOW Alliance, which has helped to keep 
hundreds of thousands of families in their homes.
    And Chairman Bernanke, the Federal Reserve's actions 
continue to help preserve confidence and bring stability to our 
financial markets and institutions. Infusing liquidity into the 
marketplace has prevented the credit crunch from seizing the 
system, and facilitating the sale of Bear Stearns to J.P. 
Morgan is viewed by many as having been the lynchpin that 
prevented a run-on-the-bank type crises which could have spread 
throughout our financial system and caused irreparable harm.
    What brought us here today are these specifically and the 
latter actions on the part of the Fed, actions that begged the 
question, what can the Federal Government do to prevent future, 
similar bailouts that can put taxpayer dollars at risk? Is the 
Federal Government prepared for another Bear Stearns? Can a 
Federal regulator or regulators monitor specific indicators 
that will flag weaknesses within individual, financial 
institutions and prevent another Bear Stearns? And can they do 
so without unnecessarily increasing regulatory burdens that 
would diminish the competitiveness of the U.S. financial 
institutions in the global marketplace?
    It is vital that we closely examine the capacity of the 
Federal Government to monitor the large financial institutions 
like Bear Stearns, which represent not only American innovation 
and financial strength, but also our great vulnerability with 
respect to systematic risk in the financial system.
    I think without delay, we need to strike the right balance 
and create a simpler, stronger, regulatory system that 
preserves the resilience of our economy, protects taxpayers, 
and maintains the position of our financial system as the envy 
of the world.
    I look forward to the testimony and I yield back.
    The Chairman. I think the gentlewoman.
    We will now go to the opening statements, and a subject to 
which I sometimes pay insufficient attention is protocol. We 
don't usually have two such distinguished witnesses. The 
question is, who goes first?
    I think the order, certainly, of succession to the 
Presidency is which Department was established first. And, I 
think, Mr. Paulson, that you have about 125 years on Mr. 
Bernanke, so we will begin with you.


    Secretary Paulson. Mr. Chairman, Ranking Member Bachus, 
thank you very much for holding this hearing and for your 
leadership on these very important issues.
    As you know, our financial markets have been experiencing 
turmoil since last August. It will take additional time to work 
through these challenges. Progress has not come in a straight 
line, but much has been accomplished. Our financial 
institutions are repricing risk, de-leveraging, recognizing 
losses, raising capital, and improving their financial 
position. Their ability to raise capital even during times of 
stress is a testament to our financial institutions and to our 
financial system.
    Fannie Mae and Freddie Mac are also working through this 
challenging period. They play an important and vital role in 
our economy and housing markets today, and they need to 
continue to play an important role in the future. Their 
regulator has made clear that they are adequately capitalized.
    Market practices and discipline on the part of financial 
institutions and investors are also improving. Our regulators 
are shining a light on our challenges. Through the President's 
Working Group on Financial Markets, we have issued a report 
analyzing the causes of the turmoil and recommending a 
comprehensive policy response, implementation of which is well 
    Regulators are enhancing guidance, issuing new rules, and 
communicating more effectively across agencies domestically and 
    Although our regulatory architecture and authorities are 
outdated and less than optimal, we have been working together; 
while respecting our different authorities or responsibilities, 
we have been working together to ensure the stability of the 
financial system, because it is in the interest of the American 
people that we do so.
    Today this is by far our most important priority. And our 
seamless cooperation to achieve it is made possible by the 
leadership and support provided by this committee and by other 
leaders in Congress. I have confidence in our regulators and 
markets. We need to remain focused and continue to address 
challenges with your support and with your help. But we will 
ultimately emerge with strong capital markets, which will in 
turn enable our economy to continue to grow.
    Now looking beyond this period of market stress, which will 
eventually pass as these situations always do, I have presented 
my ideas for improving our regulatory structure and expanding 
our emergency powers. I look forward to discussing these ideas 
with you today, even as we continue our primary focus on 
confronting current challenges and maintaining stable, orderly 
financial markets.
    In March, I laid out a Blueprint for a Modernized Financial 
Regulatory Structure in which we recommended a U.S. regulatory 
model based on objectives that more closely link the regulatory 
structure to the reasons why we regulate. Our model proposes 
three primary regulators: One focused on market stability 
across the entire financial sector; another focused on safety 
and soundness at institutions supported by a Federal guarantee; 
and the third focused on protecting consumers and investors.
    A major advantage of this structure is its timelessness and 
its flexibility, and that because it is organized by a 
regulatory objective rather than by financial institution 
category, it can more easily respond and adapt to the ever-
changing marketplace.
    If implemented, these recommendations eliminate regulatory 
competition that creates inefficiencies and can engender a race 
to the bottom. The Blueprint also recommends a number of near-
term steps. These include formalizing the current informal 
coordination among U.S. financial regulators by amending and 
enhancing the Executive Order which created the President's 
Working Group on Financial Markets, and while retaining State 
level regulation of mortgage origination practices, creating a 
new Federal level commission, the Mortgage Origination 
Commission, to establish minimum standards for among other 
things personal conduct and disciplinary history, minimum 
educational requirements, testing criteria and procedures, and 
appropriate licensing revocation standards.
    The Blueprint includes recommendations on a number of 
intermediate steps as well, focusing on payment and settlement 
systems in areas such as futures and securities, where our 
regulatory structure severely inhibits our competitiveness.
    We recommended the creation of an optional Federal charter 
for insurance companies similar to the current dual charter 
system for banking, and that the thrift charter has run its 
course and should be phased out. We also recommend the creation 
of a Federal charter for systemically important payment and 
settlement systems, and that these systems should be overseen 
by the Federal Reserve in order to guarantee the integrity of 
this vital--
    The Chairman. Mr. Secretary, I don't want you to feel 
constrained. Both you and the Chairman should ignore the time 
limits. We will be constrained by them, but this is too 
important for you to be, so please, both of you can ignore the 
red lights.
    Secretary Paulson. Okay. I am just about finished.
    The Chairman. No, I didn't mean to--
    Secretary Paulson. Okay.
    The Chairman. Just the opposite. We have enough time to 
listen to this, so please don't be constrained.
    Secretary Paulson. When we released the Blueprint, I said 
that we were laying out a long-term vision that would not be 
implemented soon. Since then, the Bear Stearns episode and 
market turmoil more generally have placed in stark relief the 
outdated nature of our regulatory system and has convinced me 
that we must move much more quickly to update our regulatory 
structure and improve both market oversight and market 
    Over the last several weeks, I have recommended important 
steps that the United States should take in the near term, all 
of which move us toward the optimal regulatory structure 
outlined in the Blueprint. I will summarize these briefly.
    First, Americans have come to expect the Federal Reserve to 
step in to avert events that pose unacceptable systemic risk. 
But the Fed does not have the clear statutory authority, nor 
the mandate to do this. Therefore, we should consider how to 
most appropriately give the Federal Reserve the authority to 
access necessary information from complex financial 
institutions, whether it is a commercial bank, an investment 
bank, a hedge fund, or another type of financial institution, 
and the tools to intervene to mitigate systemic risk in advance 
of a crisis.
    The MOU recently finalized between the SEC and the Federal 
Reserve is consistent with this long-term vision of the 
Blueprint, and should help inform future decisions, as our 
Congress considers how to modernize and improve our regulatory 
    Market discipline is also critical to the health of our 
financial system, and must be reinforced, because regulation 
alone cannot eliminate all future bouts of market instability. 
For market discipline to be effective, market participants must 
not expect that lending from the Fed or any other government 
support is readily available. I know from firsthand experience 
that normal or even presumed access to a government backstop 
has the potential to change behavior within financial 
institutions with their creditors. It compromises market 
discipline and lowers risk premiums, ultimately putting the 
system at greater risk.
    For market discipline to effectively constrain risk, 
financial institutions must be allowed to fail. Today, two 
concerns underpin expectations of regulatory intervention to 
prevent a failure. They are that an institution may be too 
interconnected to fail or too big to fail.
    Steps are being taken to improve market infrastructure, 
especially where our financial firms are highly intertwined. 
The OTC Derivatives market and the triparty repurchase 
agreement market, which is the marketplace through which our 
financial institutions obtain large amounts of secured 
financing, must be improved. It is clear that some 
institutions, if they fail, can have a systemic impact.
    Looking beyond immediate market challenges, last week I 
laid out my proposals for creating a resolution process that 
ensures the financial system can withstand the failure of a 
large, complex financial firm. To do this, we will need to give 
our regulators additional emergency authority to limit 
temporary disruptions. These authorities should be flexible, 
and to reinforce market discipline, the trigger for invoking 
such authority should be very high, such as a bankruptcy 
    Any potential commitment of government support should be an 
extraordinary event that requires the engagement of the 
Treasury Department and contains sufficient criteria to prevent 
cost to the taxpayer to the greatest extent possible.
    This work will not be done easily. It must begin now and 
begin in earnest. Again, thank you for your leadership.
    [The prepared statement of Secretary Paulson can be found 
on page 67 of the appendix.]


    Mr. Bernanke. Thank you. Chairman Frank, Ranking Member 
Bachus, and other members of the committee, I am pleased to be 
here today to discuss financial regulation and financial 
    The financial turmoil that began last summer has impeded 
the ability of the financial system to perform its normal 
functions and has adversely affected the broader economy. This 
experience indicates a clear need for careful attention to 
financial regulation and financial stability by the Congress 
and other policymakers.
    Regulatory authorities have been actively considering the 
implications of the turmoil for regulatory policy and for 
private sector practices. In March, the President's Working 
Group on Financial Markets issued a report and recommendations 
for addressing the weaknesses revealed by recent events.
    At the international level, the Financial Stability Forum 
has also issued a report and recommendations. Between them, the 
two reports focused on a number of specific problem areas, 
including mortgage lending practices and their oversight, risk 
measurement and management at large financial institutions, the 
performance of credit rating agencies, accounting and 
evaluation issues, and issues relating to the clearing and 
settlement of financial transactions.
    Many of the recommendations of these reports were directed 
at regulators in the private sector and are already being 
implemented. These reports complement the Blueprint for 
regulatory reform issued by the Treasury in March, which 
focused on broader questions of regulatory architecture.
    Work is also ongoing to strengthen the framework for 
prudential oversight of financial institutions. Notably, recent 
events have led the Basel Committee on Banking Supervision to 
consider higher capital charges for such items as certain 
complex structured credit products, assets and banks trading 
books, and liquidity guarantees provided to off-balance sheet 
vehicles. New guidelines for banks liquidity management are 
also being issued.
    Regarding implementation, the recent reports have stressed 
the need for supervisors to insist on strong risk measurement 
and risk management practices that allow managers to assess the 
risk that they face on a firm-wide basis.
    In the remainder of my remarks, I will comment briefly on 
three issues. The supervisory oversight of primary dealers, 
including the major investment banks, the need to strengthen 
the financial infrastructure, and the possible need for new 
tools for facilitating the orderly liquidation of a 
systemically important securities firm.
    Since the near collapse of the Bear Stearns companies in 
March, the Federal Reserve has been working closely with the 
Securities and Exchange Commission, which is the functional 
supervisor of each of the primary dealers and the consolidated 
supervisor of the four large investment banks, to help ensure 
that those firms have the financial strength needed to 
withstand conditions of extreme market stress.
    To formalize our effective working relationship, the SEC 
and the Federal Reserve this week agreed to a memorandum of 
understanding. Cooperation between the Fed and SEC is taking 
place within the existing statutory framework, with the 
objective of addressing the near-term situation.
    In the longer term, however, legislation may be needed to 
provide a more robust framework for prudential supervision of 
investment banks and other securities dealers. In particular, 
under current arrangements, the SEC's oversight of the holding 
companies of the major investment banks is based on a voluntary 
agreement between the SEC and those firms. Strong holding 
company oversight is essential, and thus in my view the 
Congress should consider requiring consolidated supervision of 
those firms and providing the regulator the authority to set 
standards for capital liquidity holdings and risk management.
    At the same time, reforms in the oversight of these firms 
must recognize the distinctive features of investment banking 
and take care neither to unduly inhibit innovation, nor to 
induce a migration of risk-taking activities to less-regulated 
or offshore institutions.
    The potential vulnerability of the financial system to the 
collapse of Bear Stearns was exacerbated by weaknesses in the 
infrastructure of financial markets, notably in the markets for 
over-the-counter derivatives and in short-term funding markets.
    The Federal Reserve together with other regulators in the 
private sector is engaged in a broad effort to strengthen the 
financial infrastructure. For example, since September 2005, 
the Federal Reserve Bank of New York has been leading a major 
joint initiative by both the public and private sectors to 
improve arrangements for clearing and settling credit default 
swaps and other OTC derivatives.
    The Federal Reserve and other authorities are also focusing 
on enhancing the resilience of the markets for triparty 
repurchase agreements, in which the primary dealers and other 
large banks and broker-dealers obtain very large amounts of 
secured financing from money funds and other short-term risk-
averse investors.
    In these efforts we aim not only to make the financial 
system better able to withstand future shocks, but also to 
mitigate moral hazard and the problem of too big to fail by 
reducing the range of circumstances in which systemic stability 
concerns might prompt a government intervention.
    More generally, the stability of the broader financial 
system requires key payment and settlement systems to operate 
smoothly under stress and to effectively manage counterparty 
risk. Currently the Federal Reserve relies on a patchwork of 
authorities, largely derived from our role as a banking 
supervisor as well as on moral suasion to help ensure that the 
various payment and settlement systems have the necessary 
procedures and controls in place to manage the risks that they 
    By contrast, many major central banks around the world have 
an explicit statutory basis for their oversight of payment and 
settlement systems. Because robust payment and settlement 
systems are vital for financial stability, the Congress should 
consider granting the Federal Reserve explicit oversight 
authority for systemically important payment and settlement 
    The financial turmoil is ongoing and our efforts today are 
concentrated on helping the financial system to return to more 
normal functioning. It is not too soon, however, to think about 
steps that might be taken to reduce the incidence and severity 
of future financial crises.
    In particular, in light of the Bear Stearns episode, the 
Congress may wish to consider whether new tools are needed for 
ensuring an orderly liquidation of a systemically important 
securities firm that is on the verge of bankruptcy together 
with a more formal process for deciding when to use those 
    Because the resolution of a failing securities firm might 
have fiscal implications, it would be appropriate for the 
Treasury to take a leading role in any such process, in 
consultation with the firm's regulator and other authorities.
    The details of any such tools and the associated decision-
making process require more study. One possible model is the 
process currently in place under the Federal Deposit Insurance 
Corporation Improvement Act, or FDICIA, for dealing with 
insolvent commercial banks. The fiducial procedures give the 
FDIC the authority to act as a receiver for an insolvent bank 
and to set up a bridge bank to facilitate an orderly 
liquidation of that firm. The fiducial law also requires that 
failing banks be resolved in a way that imposes the least cost 
to the government, except when the authorities through a well-
defined procedure determine that following the least cost route 
would entail significant systemic risk.
    To be sure, securities firms differ significantly from 
commercial banks in their financing, business models, and in 
other ways, so the fiducial rules are not directly applicable 
to these firms.
    Although designing a resolution regime appropriate for 
securities firms would be a complex undertaking, I believe it 
would be worth the effort. In particular, by setting a high bar 
for such actions, the adverse effects on market discipline 
could be minimized.
    Thank you. I would be pleased to take your questions.
    [The prepared statement of Chairman Bernanke can be found 
on page 61 of the appendix.]
    The Chairman. Thank you. Let me begin with the Secretary, 
because I was pleased to note in your statement that you 
understand that the regulator at OFHEO, of Fannie Mae and 
Freddie Mac, believe that they are now adequately capitalized. 
They were important institutions and I think that was--I'm 
pleased that you made that statement. I think that is important 
for people to understand.
    I said before that we are talking about more regulation 
done sensibly. Obviously there are still areas that the 
Secretary indicated where we could improve by simplifying 
regulation. That doesn't mean that it means more regulation 
everywhere. But there does seem to me to be emerging a 
consensus that we need a regulator concerned with threats to 
the systemic stability of the economy, that come from 
unconstrained risk-taking in a group of financial institutions 
outside the commercial banking system. And I was pleased, Mr. 
Secretary, that you mentioned hedge funds and investment banks. 
I think it would be a great mistake to talk about type of 
institution. That would give people an incentive to change 
their hats.
    We are talking about the impact of the activity, and we are 
talking I think, and a consensus appears to be emerging that it 
is going to be the Federal Reserve. I have to say that there 
are people who say, well, either you create a brand new 
regulator, it seems to me, which would be I think a mistake, or 
you give it to the Federal Reserve. And I agree with both of 
you, that in order to do that, the Federal Reserve needs more 
power. A situation in which the Federal Reserve is available 
and is under pressure to provide funding, but does not have the 
ability to act well before that time to diminish the need for 
that and to oppose conditions, that is unacceptable.
    We are talking, but we should be clear, about an increase 
in regulatory power. And let me say, you know, there was a time 
when the notion of requiring hedge funds to register was very 
controversial. It does seem to me that we have clearly gone 
beyond that. We are talking about giving the Federal Reserve 
the power to not just get information but to deal with various 
things which could include capital requirements and other 
    Now those are very important issues, and I think, as I 
said, there was a consensus emerging that it should be the 
Federal Reserve. And I have to say when people say, ``Well,'' 
they'll have this or that question about whether the Federal 
Reserve should do it, I invoke, as people have heard me do, the 
wisdom of a great 20th Century philosopher, Henny Youngman. The 
maxim was, ``How's your wife? Compared to what?'' And the 
Federal Reserve compared to what? I don't see any alternative 
to the Federal Reserve.
    But my question is this. I think this is an important task, 
and there's a great deal of agreement, that we should be moving 
to empower the Federal Reserve to have regulatory authority 
over a wide range of financial institutions in recognition in 
part of the fact that they have a systemic impact and that the 
current situation puts the Fed in an untenable position of 
being given a set of expectations to respond when it doesn't 
have the full panoply of tools to respond.
    But here is the question: How soon? Now we are where we 
are. It is July of an election year. This is a very complex 
subject. We don't want to do anything that would interfere with 
our wonderful financial system. And I mean our wonderful 
financial system, which has been so productive. We want to curb 
abuses without interfering with the productive function.
    Mr. Secretary, you said that they don't now have that 
authority, and we all agree with that. Is it essential that we 
move now? My sense is this--and I applaud the signing of the 
memorandum of understanding between the SEC and the Fed. That 
kind of cooperation has been useful. The cooperation between 
your two entities has been useful.
    I guess there are two options. One is that we have to try 
and legislate something now. And let me say we should 
distinguish. Mr. Secretary, you had a broader set of 
recommendations involving thrift institutions and credit 
unions, and a whole lot of things that no one in this 
institution is eager to deal with. So nobody is in any hurry on 
those. But we have I think taken out of that--and you have 
elaborated with the resolution issue--the question of macro-
stability regulator, of the Federal Reserve being given powers 
to deal with the problems that could come to a system from 
someone too big or too unconnected to fail.
    Here is the question: Working together as we have within 
existing authorities, with yourselves, with I hope 
cooperation--that you understand cooperation with us--can we 
get by until the end of the year? We obviously will start 
working on this. Is it your view that immediate legislation is 
necessary? Or are we able to get by, given the cooperation we 
have had, given the kind of support we try to give you as much 
as possible, and begin working immediately together, so that 
early next year, one of the first items on the congressional 
agenda will be the legislation you talked about? Let me ask 
each of you to respond.
    Secretary Paulson. Mr. Chairman, let me respond by saying 
first of all, the role of the Fed as a macro stability 
regulator will take time to think through. It's a complex 
question. It's an important question. The authorities that will 
go with that, how that will work. That will clearly take some 
time to consider and to get the legislation through.
    Even more pressing is--which is again a complex issue which 
will take time--is the issue of the resolution process and 
procedures for complex financial institutions that aren't 
federally insured. We both talked about that. And so in terms 
of priorities, that should be even the higher priority in terms 
of time. But that will take some time.
    I think what you are getting at is even though our system 
may not optimal, the authorities may not be optimal, we have 
been able to work together to protect the system by 
communicating with Congress, and that's our plan and our 
expectation that we are going to need to keep doing that, and 
we are going to work in that way, recognizing that the requests 
we have made are not things that can be implemented 
    The Chairman. Mr. Chairman?
    Mr. Bernanke. I would associate myself with Secretary 
Paulson's remarks. We are working together extremely 
cooperatively, the Secretary and I, and the other agencies. 
Obviously, we'd like to have additional tools, but these are 
very complex matters, as the Secretary has indicated. So my 
hope would be that the Congress would begin soon to think hard 
about these issues, and we are happy of course to provide 
whatever support we can. But I think for the time being that 
the most likely outcome and the expectation is that we will 
continue to work in a creative way together to try to manage 
these ongoing situations.
    The Chairman. I'm going to break my own rule just to make 
one statement, because I gather what you're saying is, it is 
better in this very complex and very important set of issues 
that we do it right and that we do it very quickly.
    Mr. Bernanke. I would agree with that.
    The Chairman. The gentleman from Alabama.
    Mr. Bachus. Thank you. I think there is a consensus that 
there needs to be a single regulator for market stability, and 
I think that is in the Treasury's Blueprint. But short term, 
what are your present powers that you could bring to bear near 
term on risk management on containing risk, containing systemic 
risk, what are some things that you can do right now?
    Mr. Bernanke. There were a number of recommendations in 
those reports I referred to. There are many steps that could be 
taken at the regulatory and supervisory level to strengthen the 
oversight of banks and other financial institutions. For 
example, I mentioned the Basel Accords which are strengthening 
liquidity requirements, changing capital charges for different 
kinds of activities, making recommendations to the regulators 
about how to go about strengthening the risk management systems 
of these firms.
    We are paying very close attention to the system as a 
whole. We are looking at the payment systems and other parts. 
The Federal Reserve has after all acted as a de facto--along 
with the Treasury--crisis manager for many decades. So there 
are a number of things we can do to strengthen the oversight 
under existing statutes and to make sure that the 
infrastructure is working as well as possible. For example, I 
mentioned also the private-public cooperation that we are now 
having to strengthen the OTC derivatives infrastructure and the 
    So there's a lot that we can do, but we are doing--I just 
want to make very, very clear that what we are doing is, you 
know, working within the current statutory framework. The 
broader reforms that I believe are necessary are obviously the 
purview of Congress. And, you know, we hope that you'll be 
addressing those issues in a timely way.
    Mr. Bachus. Secretary Paulson?
    Secretary Paulson. I agree very much with what Chairman 
Bernanke has said, and I would just simply say that even if the 
structure isn't optimal and all of the authorities aren't 
optimal, regulators are working together seamlessly to address 
some of the issues that have arisen, and I think progress has 
been made.
    Mr. Bachus. You know, one thing I have noticed, I know the 
President's Working Group, you know, as far back as say a year 
ago or I think as late as March, talked about the risk 
management practices of the investment banks as being faulty 
and that resulted in a lot of what we are seeing, market 
    I think the response I have seen from the Fed particularly 
has been that, you know, establishing risk management 
standards, which I certainly understand. You have also 
mentioned I think long term it's necessary to establish capital 
standards and liquidity standards. But short term, I do worry 
about new capital requirements and liquidity standards as sort 
of precipitating and sort of a tension between that and the 
need for these institutions to raise more capital. So how do 
you balance that?
    And I know one thing that you have talked about, I think 
the Treasury has talked about, is giving these--a lot of the 
banks the right to increase borrowing from or raising capital 
from private equity. Would you like to address that?
    Secretary Paulson. Yes, Congressman. We have encouraged, 
both of our organizations have encouraged financial 
institutions to recognize losses and to raise capital, because 
capital is available, and that is a much better alternative 
than shrinking their balance sheets and pulling back from the 
activities that are so necessary.
    And as it relates to raising capital, private equity is one 
source, and we very much endorse the Fed's posture, which is 
being open to private equity investors and encouraging private 
equity investors.
    Mr. Bernanke. Congressman, our first objective is to make 
sure that these firms are safe and able to withstand the 
current stresses. And so, for example, in our work with the SEC 
at the investment banks, we have urged them, and they have 
complied, in raising capital and especially in raising 
liquidity, which was one of the key issues with Bear Stearns. 
So we want them to be safe and we want to do that immediately.
    In the longer term, there is this issue of 
``procyclicality,'' the possibility that capital rules and 
reserving rules and so on, accounting rules, will tend to 
exacerbate the credit cycle. It is a very important issue. We 
have some elements of the Basel II Accords that address that. 
But I think it's something that as we go forward, we will want 
to look at much harder to try to limit the regulatory impact on 
the procyclicality of credit.
    On private equity, I agree absolutely with the Secretary 
that we are looking for banks and other financial institutions 
to raise capital. Private equity is a very good source of 
capital. There are the issues relating to effective control as 
established by the Bank Holding Company Act, which has a 
statutory limit of 25 percent ownership. Below that, the 
Federal Reserve has to address what constitutes effective 
control. We are currently looking at that in the hope that we 
will make a clearer statement about when private equity can 
come in and add capital to the banking system.
    Mr. Bachus. Thank you.
    The Chairman. The gentleman from Pennsylvania.
    Mr. Kanjorski. Thank you, Mr. Chairman. Secretary Paulson, 
Chairman Bernanke, listening to your response to the chairman 
about timing, since last August of course all of us have 
examined and watched market failure occurring in various and 
sundry areas growing from subprime failure in August to what we 
call now a credit crisis. And the information that I am 
receiving from some entities is that the end is not here; there 
are other shoes to fall.
    And what occurs to me is that this gap we are talking about 
between now and when the new Congress convenes it could pass 
the emergency powers or extraordinary powers or change powers 
that are necessary to meet this crisis. It is probably for all 
intents and purposes 9 months at least.
    In the meantime, between now and March or April of next 
year, what type of anticipated problems could we be dealing 
with or could you be dealing with and the American economy be 
dealing with that we should take cognizance of now? And is 
there perhaps a need for extraordinary emergency legislation to 
empower either the Federal Reserve or Treasury to take certain 
actions to prevent systemic risk if over the next 9-month 
period the Congress is not able to act and you discern that the 
powers you have are not adequate to meet the challenges? That 
hiatus seems to me to be one that we have to address now.
    Mr. Secretary?
    Secretary Paulson. Let me say that I have grown up in a 
world where you don't always have all the tools you'd like to 
have, and I have very seldom seen a perfect hand that someone 
has to play. We are dealing in a financial market that has 
evolved greatly since the time that many of our rules were put 
in place, that many of the--that the regulatory structure was 
set. And so, realistically, I agree with the Chairman, that it 
will be difficult to get it done as quickly as we would like.
    The resolution powers for a large financial institution 
that is not a bank, it would be nice to be able to have that. 
But I will again say to you, even though this is a difficult 
period we are going through, and we both said that it's going 
to take some time to get through it, there will be some more 
bumps on the road, I really want to emphasize that you have 
seen the Federal Reserve, by opening up the discount window to 
the investment banks, through the Bear Stearns actions, to make 
a very strong statement about the importance of the stability 
of our financial system. And I have seen those investment banks 
working with the Fed and the SEC to strengthen their liquidity, 
strengthen their capital positions, and re-price risk. So we 
are making progress here.
    And, you know, I get reports all the time. Our regulators 
are very vigilant. I received a report about the banking 
industry and get it regularly. As of the end of March, even 
though the banks are going through some difficult problems, and 
their situation is evolving, the reports I got indicated that 
99 percent of those institutions holding 99 percent of the 
assets fell into the highest capital category, well 
capitalized. So we are making progress. We don't have 
everything we would like to have, but I think the right answer 
to our question, Congressman, which is a good question, is we 
have to--we always have to have contingency plans, be prepared 
for various eventualities. We plan, we work together. We have 
been doing that from before the turmoil started, from the day I 
set foot in Washington. And we are just going to have to work 
together, be creative and work with you.
    Mr. Kanjorski. Mr. Secretary, my time is running out. This 
morning I spoke to a student loan group, and we worked for the 
last 4 or 5 months to try and resolve that pressing problem, 
the failure of the auction market. And even what I received 
from them is that sometimes the activities or willingness of 
our Departments, like the Department of Education and even your 
Department, are unwilling to take the risk of implying the 
authority to do things.
    I am just urging, either you recognize that now, and if you 
need emergency powers on some of these things you mentioned to 
us before we get to catastrophe.
    Secretary Paulson. Well, let me mention the student loans, 
because here is a case where I think you have seen our 
department work creatively with the Department of Education to 
deal with a problem that's here and now, and so we have a 
program in place which I think is going to be acceptable to 
most fellow lenders. I think it's going to work. To the extent 
that we need something else, the Department of Education is 
ready with their direct lending, their lending of last resort. 
Meanwhile, we are working creatively at Treasury to come up 
with other market-based solutions to help this market.
    So we are working through this. We have a program that's 
going to get us through this period, and we are working to do 
things to help that securitization market become more vital.
    The Chairman. The gentleman from Delaware.
    Mr. Castle. Thank you very much, Mr. Chairman. To the 
Chairman of the Federal Reserve and to Secretary Paulson, I 
would just like to thank them I think for what has been 
excellent work in very difficult circumstances, as well as the 
chairman and the ranking member of the committee.
    My questions, I guess, are going to be more about timing 
than anything. We see the expressions ``short term,'' 
``intermediate term,'' ``long term,'' expressions like that. I 
guess when you're--we all look at our calendars differently. 
When you're in Congress, you sort of think in terms of the next 
election or whatever it may be. We have a couple of more weeks 
in July. We have September, and then we have the election 
season coming up. And, Secretary Paulson, you mentioned that 
the financial institutions need to recognize their losses and 
raise capital, those kinds of things.
    But my question to you regarding the fluctuations in the 
various equity markets around the world, plus the housing 
market in the United States is this: Is the short term 
measurable, in a matter of months or whatever it may be, not 
years at this point?
    Furthermore, is there anything that we in Congress should 
be doing in the short time we have left that would be helpful 
with respect to the problems that exist right now in America? 
Is there anything--and you probably have identified this in 
your testimony, but I must admit it's complicated enough for me 
to have trouble following. Are there things that you all should 
be doing on a short-term basis that would be helpful that we 
should know about?
    Secretary Paulson. Well, let me mention a couple of things 
right away. First of all, your committee has been out in front 
on this, but let's get the GSE reform legislation done, to have 
a strong, independent regulator that will inject confidence 
into those institutions and into the markets, and that's a very 
positive thing.
    And then secondly, we both haven't said don't work on this. 
I mean, work should begin immediately and urgently on these 
resolution authorities and these steps we have suggested. We 
are just telling you that realistically, because we have heard 
from you, and we know it to be the case, realistically, it's 
going to be difficult to get things done this year. But this is 
going to take some time, so begin work urgently on that. But 
those are the two things that I would suggest.
    Mr. Castle. Chairman Bernanke?
    Mr. Bernanke. Like Secretary Paulson, I have no objection 
whatsoever to early action and will continue to work with you 
closely in all directions. It's just our sense, and of course 
you're in a better place than we are to make the judgment, that 
the more complex issues like resolution or even financial 
regulatory restructuring are simply not likely to happen in a 
short term, and we need to take the time to make sure it's done 
right and thoroughly worked through.
    So we will continue to think about what steps might be 
taken on a shorter-term basis and be in close touch with 
Congress. But, again, we are--I just want to be clear that, you 
know, it's not that we don't have any tools. We have plenty of 
tools, and we are working together very well I think to address 
a difficult situation.
    Mr. Castle. Well, I would agree with you. I think probably 
everyone in this room would agree with you on GSE reform. I 
hope you will carry that same message to the Senate, too. We 
think that is vitally important. And I would agree with you 
that we do need to work on some of these regulatory systems. 
But can you give me some sense of what you think the timing may 
be? I don't see that happening this year, either in Congress or 
by outside regulatory procedures. But do you have some sense of 
what the timing may be on the centralizing of regulation as 
encapsulated in what you have been stating? Is this something 
you would expect to happen next year, or would it take 3 to 5 
years to do this?
    Secretary Paulson. Well, yes. I think maybe I should have 
even been clearer on this. In terms of--when we started 
thinking about regulatory structure, we began the thinking 
before this period of market turmoil, well before this. And we 
started off saying, if we were beginning from scratch, which we 
obviously aren't, how would you design a system? And that was 
more of a vision to start a discussion. And to me, to get to 
there, as the Chairman said, would take a good while. We are 
talking about multiple years. But if you don't know which way 
you would like to head, you know, you have no chance of getting 
    So we started with that vision, and then we came up with 
some immediate priorities and some other things that could be 
done in the intermediate term. And as I look at what can be 
done in terms of the timing the one thing we are not talking 
about a lot here, but I do believe we don't want to forget, is 
the fact that a lot of this problem came about as a result of 
sloppy and lax mortgage origination procedures. These mortgages 
were originated, most--many cases at the State level with State 
regulation and supervision. We weren't proposing doing away 
with this, but a mortgage origination commission to set 
standards at the Federal level and evaluate what's going on, 
you know, at the States, I think is something you shouldn't 
lose sight of.
    And then the things we have talked about here that can be 
done quickly are the resolution authorities for complex 
financial institutions that aren't federally insured, giving 
the Federal Reserve authority and responsibility over the 
payment systems, which can be done very quickly; moving to have 
the Fed while retaining their responsibilities as a 
consolidated regulator, to give them the authorities they need 
to do the macro stability job, can be done.
    And then, looking out a little bit further, there is no 
doubt that we should have a merger, in my mind, with the SEC 
and the CFTC. And so that again is something that can be done 
in the intermediate term, as could an optional Federal charter 
for insurance.
    The Chairman. The gentlewoman from California.
    Ms. Waters. Thank you very much, Mr. Chairman. I would like 
to thank you first for holding this very important hearing 
today, and I would like to thank both Secretary Paulson and 
Chairman Bernanke for being here today.
    Let me start by saying that which you have probably heard 
too often, how disappointed I am with all of us, Members of 
Congress, for what appears to have been weak oversight of our 
regulatory agencies, and our regulatory agencies for what 
appears to have been weak oversight of our financial 
    I have to tell you, I have been holding hearings throughout 
the country on the subprime meltdown, and I'm absolutely 
stunned by the extent of the devastation to some of our 
families and communities caused by this subprime meltdown. I'm 
stunned when I hear about these exotic products and how they 
could ever have come into being without any oversight.
    I'm really stunned about some of the ARMs and the way that 
they reset, and the fact that there's something called a margin 
that I never knew about before, and that margin can be whatever 
the financial institution decides it should be, above and 
beyond the going interest rate.
    I came on this committee right after the S&L scandal, and I 
heard a lot about reform. And so while I suppose I should be 
impressed with the fact that there's a President's Working 
Group on Financial Markets and the reports that have been 
issued, I'm skeptical about what is being proposed. As it said 
in March, the President's Working Group on Financial Markets 
issued a report and recommendations for addressing the 
weaknesses revealed by recent events, both at the international 
level--between the two reports--and at the domestic level, 
between the two reports, focused on a number of specific 
problems, including mortgage lending practices and their 
oversight, risk management and management at large financial 
    And then there was, Mr. Bernanke, the Blueprint that you 
talked about for a modernized financial regulatory structure, 
and you proposed a new regulatory architecture, and the third 
regulatory agency would be focused on protecting consumers and 
investors. I have to tell you, I'm surprised, because I thought 
that our regulatory agencies, no matter how they were 
organized, whether it was by financial institution category or 
not, had as its prime objective, all of those things that you 
talk about doing now.
    So what I really want to know is not so much what you plan 
that may not be instituted for some time, because it takes some 
time to get this into practice, I want to know what you're 
doing now. I want to know what you know about servicers. We 
have found that there's little if any regulation of mortgage 
    And I want to know if you have anything in your plans to 
deal with them, because after we get finished with all of the 
President's HOPE NOW program and the money that we are giving 
to NeighborWorks and other organizations to do counseling, they 
can't do very much good, because the servicers are the ones who 
make the decisions.
    They're the ones that are in charge of these accounts. They 
decide to collect--well, they have to collect the fees, they 
have to collect the mortgage payment. They increase fees. They 
agree to extend or modify arrangement, but they can do 
practically whatever they want. I want to know what you know 
about them, what you're doing about them.
    And secondly, I want to know and understand Mr. Bernanke, 
what you know about the sale of Countrywide to Bank of America. 
I understand that Bank of America bought these mortgages at 
quite a reduced rate. And I want to know what that rate was and 
whether or not these properties could go back on the market 
appraised at a higher rate than the bank purchased them for, 
and who gets the profit and the difference, and why can't that 
go back to the homeowners who are losing their homes through 
foreclosure. First, I would like to hear from Secretary 
    Secretary Paulson. Well, first of all, I understand your 
frustration, and I understand what's going on right now in the 
marketplace, how it's affecting homeowners, and I feel your 
frustration and I understand it.
    Ms. Waters. Mortgage servicers.
    Secretary Paulson. In terms of market servicers, the HOPE 
NOW Alliance is, I believe, making a big difference and making 
a difference every single month. It is helping 200,000 people a 
month. And it is getting to those people, and as far as I can 
see, Congresswoman Waters, and I look at this data all the 
time, and the standard I use is this: Are there people who can 
afford to stay in their homes, who want to stay in their homes 
but are being forced into foreclosure?
    Very sadly, there have been people who have been put in 
homes who didn't have the ability to stay in the homes and to 
afford to stay in the homes, and there are others who were 
speculators and walked away from mortgages. So what we have 
done, this HOPE NOW Alliance is again focused on getting to 
people and making a difference. And I think the servicers are 
making a difference.
    Ms. Waters. I'm sorry. I really do need to ask a question 
about mortgage servicers.
    The Chairman. We can't ask another question. We are over 
time. We have a time problem. Mr. Chairman, do you want to 
    Mr. Bernanke. I would like to briefly answer, yes. I said a 
few things. On consumer protection, about a year ago I 
testified before this committee and said that the Federal 
Reserve was going to take significant action on protection for 
high-cost loans. On Monday we will announce the final rules, 
and I think they will be very effective in addressing some of 
these issues.
    Admittedly, it would be better if it had been earlier, but 
we have responded and you'll soon see the proposal or the rules 
that we are going to be issuing with respect to consumer 
protection. We are also of course working on rules with respect 
to credit cards as well.
    On foreclosure avoidance, again, HOPE NOW has been taking a 
leadership role. The Federal Reserve has been supporting that 
in various ways, including urging banks to work with customers 
in trouble and through a variety of neighborhood activities 
through our reserve banks around the country, which I would be 
happy to provide more information about.
    And finally, on Countrywide, of course that was a market 
transaction. The Fed had nothing to do with it, and the 
discounts related to the probability that some of those loans 
would go into default. I do think that in a sense some of those 
savings ought to pass through to the ultimate borrowers. And in 
a sense, when there's a principal writedown or other loan 
modification that is essentially what is happening, that you're 
giving a break to the borrower so the borrower can stay in the 
home, and I think that's a good thing to do.
    The Chairman. Let me ask, Mr. Secretary, that you respond 
in writing, particularly because of our time constraints, on 
the servicer issue.
    Secretary Paulson. Yes, I look forward to doing that.
    The Chairman. So I would ask that you respond in writing to 
the servicer part of the question. The gentleman from 
    Mr. Royce. Thank you, Mr. Chairman. I want to thank you, 
Secretary Paulson and Chairman Bernanke, for being with us, and 
I want to begin with a question to Secretary Paulson. And 
Chairman Bernanke, you might want to comment on this, too.
    There was a speech delivered by the Federal Reserve 
Chairman, former Fed Chairman Alan Greenspan, to the Federal 
Reserve Bank of Chicago in May of 2005. And he said, ``Market 
participants usually have strong incentives to monitor and 
control the risks they assume in choosing to deal with 
particular counterparties. In essence, prudential regulation is 
supplied by the market through counterparty evaluation and 
monitoring rather than by the authorities. Such private 
prudential regulation can be impaired, indeed even displaced,'' 
said Greenspan, ``if some counterparties assume that government 
regulators obviate private prudence. We regulators are often 
perceived as constraining excessive risk-taking more 
effectively than is demonstrably possible in practice, except 
where market discipline is undermined by moral hazard, for 
example, because of federal guarantees of private debt, private 
regulation generally has proved far better at constraining 
excessive risk taking than has government regulation.''
    And more recently, Jeffrey Lacker, the president of the 
Federal Reserve Bank of Richmond, and he said--he got into 
details about the need for regulators to distinguish between 
fundamental and nonfundamental runs on financial institutions 
when considering intervention by the regulators. And he said, 
``There are models in which runs are self-fulfilling 
prophesies, are costly, and could be avoided perhaps through 
central bank intervention. Other runs arise from fundamental 
developments, and for these, central bank intervention 
interference with market discipline distorts market prices.''
    And so I would ask you both if it is possible to establish 
a regulatory model that can provide a sense of security to 
prevent self-fulfilling prophesies, to use, you know, Jeffrey 
Lacker's words, with respect to runs on our financial 
institutions, and at the same time avoid interfering with the 
type of market discipline that Mr. Greenspan believes is so 
critical to the health of our capital markets.
    And if I could start with you, Secretary Paulson.
    Secretary Paulson. I believe that is really the trick. 
That's what needs to be done, to have the right balance between 
market stability, you know, the regulatory piece, and market 
discipline. That is critical. And a well-balanced, healthy 
system over time is going to need that.
    And what I have said, and what I tried to say today is that 
right now we are going through a period of unusual turmoil. The 
focus on all of our parts is on market stability. That's what 
the focus is. But our system will never be what it should be 
unless we can get to the point where market discipline plays 
its necessary role. And in order to get there, I want to 
emphasize what Ben Bernanke said.
    We need to do some things to strengthen the infrastructure 
we have, the over-the-counter derivative market, the tri-party 
repossession market, and that which is secured financing 
between institutions, and we need to do that so that the 
appearance and the reality that institutions are too 
interconnected to fail no longer exists, and we are going to 
need broader emergency authorities for the resolution or wind-
down of complex financial institutions that don't have Federal 
deposit insurance.
    But that's where we need to get. That is what we have to 
drive toward, but let's not forget today our institutions have 
been doing the things they need to do, shoring up their 
liquidity, their capital, and our emphasis is on stability 
    Mr. Royce. Thank you, Secretary Paulson. Chairman Bernanke, 
if you could respond.
    Mr. Bernanke. I would like to. Thank you. First of all, I 
agree absolutely that market discipline is the heart of our 
system. Avoiding the moral hazard, having strong market 
discipline makes the system work better, and an example would 
be the counterparty discipline between the banks, investment 
banks, and the hedge funds, has protected the banks and the 
banks and the investment banks from any losses from hedge 
funds. There have been no material losses to banks or 
investment banks because of failing hedge funds, and because 
the banks have been doing due diligence, and that's what we 
want to see.
    Now in my view, our action to address the Bear Stearns 
situation was necessary, given the financial conditions at the 
time, but it's absolutely correct, as President Lacker has 
pointed out, it does raise moral hazard concerns going forward, 
and then the question is how do you address those.
    In my remarks today, I listed three possible approaches or 
complementary approaches. The first is supervisory oversight of 
those institutions to make sure that they are in fact doing 
what they need to do to be safe and sound, are not taking 
advantage of the implicit backstop. So since we have gone into 
the investment banks, they have all raised their liquidity, not 
reduced it. So that is one way to ensure that the moral hazard 
is minimized.
    Second, as Secretary Paulson mentioned, if we can 
strengthen our infrastructure sufficiently so that it could 
absorb the failure of a large firm--we felt it wasn't able to 
do so in March. But if it were clearer that the system could 
withstand the failure of a firm of Bear Stearns' size, then we 
would be much more comfortable letting it happen, because we 
would think the system would be preserved.
    And finally, I think that, as has happened in the 
commercial banking world, we do have stronger resolution 
procedures that would allow us to intervene in an early stage 
perhaps and to try to create an orderly process that doesn't 
create the market externalities at the same time it would avoid 
moral hazard because the equity holders, the management and 
subordinate debt holders would all be subjected to losses in 
that process.
    The Chairman. The gentleman from Alabama had a unanimous 
consent request.
    Mr. Bachus. Thank you. Mr. Chairman, I would like to ask 
for unanimous consent to submit for the record Secretary 
Paulson's speech in London on July 2nd on market discipline.
    The Chairman. Without objection, the speech will be made a 
part of the record, and the gentlewoman from New York is 
recognized for 5 minutes.
    Mrs. Maloney. Welcome, and thank you for your service. I 
want to give a very special welcome to Secretary Paulson who 
previously was a business and civic leader in the great City of 
New York, and it is reassuring to me and many Americans that 
someone who has deep experience in the day-to-day operation of 
financial markets is at the helm of Treasury and really 
initiating this conversation and discussion today.
    I also want to welcome Chairman Bernanke, who has brought 
the Fed to fully realize its role, not only managing monetary 
policy and guarding the safety and soundness of our financial 
institutions, but also focusing on curbing unfair and deceptive 
practices that have hurt working Americans and our overall 
economy. Next week we look forward and congratulate you on your 
new regulations to shore up mortgage lending, and I 
enthusiastically support your proposed role to eliminate 
abusive practices in credit cards.
    I would like to follow up on my colleague's questioning on 
market discipline and ask Secretary Paulson, who has a great 
deal of experience in this area. It's clear from recent events 
that many expected synergies of financial service activities, 
whatever benefits that they gave during times of economic 
prosperity, gave rise to conflicts and excessive risk taking. 
It appears that many firms are in so many lines of businesses 
that conflicts and excessive risk arise.
    Huge trading operations have also put more mundane 
activities of financial institutions at risk. For example, some 
have said Bear Stearns' trading operation may have caused risk 
to its clearing operations. And in view of these recent events 
and challenges, some have said that the repeal and deregulation 
of Glass-Steagal may have gone too far.
    And I would like to ask, would a financial service industry 
where banks, hedge funds, investment banks, and other entities 
were more limited to the array of business they are in help the 
situation by providing competitive and arm's-length checks and 
balances on financial activities through the marketplace? And 
would a more diversified financial service industry that had 
more specialization and less concentration offer any benefits 
in reducing risk and the need for regulation?
    Secretary Paulson. Congresswoman Maloney, that's an 
important question. There is no doubt that our financial system 
has grown. It has become much more complex. We have seen a 
complexity of financial instruments, and a lot has taken place 
between the last stress we had in the market in 1998 and this 
current period. And so we are seeing how a number of these 
institutions and securities are performing under stress for the 
first time.
    I do agree with you that large, complex financial 
institutions are difficult to manage. So I agree with you 
there. I would also say, though, that a lot of the diversity in 
our financial system, and Chairman Bernanke commented about it, 
you know, the so-called hedge funds where people were saying is 
that going to be a major problem? And yet those risks, so far 
we have managed through those pretty well.
    I believe that the biggest problems we are dealing with is 
not the diversification of these organizations but it is the 
amount of risk that was taken on, and the amount of leverage, 
much greater than was understood, because a lot of it was taken 
on through complex products that were difficult to understand. 
And that's why it's taking so long to work through this.
    So I believe the big part of the answer here is going to be 
the de-leveraging and going forward enhancing liquidity 
practices, risk management practices, and getting our arms 
around some of these complex products.
    Mrs. Maloney. Thank you. My time has expired. Unless you 
would like to--
    The Chairman. You cut yourself off, but did you want a 
response from the Chairman?
    Mrs. Maloney. Absolutely, if time permits. If time permits, 
Mr. Chairman.
    The Chairman. Well, the rule is that no member can ask 
questions after their 5 minutes is up, but if there is a 
question pending, we will take it.
    Mr. Bernanke. Just very quickly, Congresswoman. I think 
Gramm-Leach-Bliley has some definite positives in terms of 
diversification, complementary services and the like has 
created very, very big firms. One of the things that the 
various reports from the PWG and the FSF have highlighted is 
that firms did not do a good enough job of firmwide risk 
management. They looked at individual business lines and not 
the firm as a whole. That's a critical step for them to be 
doing. We are encouraging that. And we are also trying to do a 
better job of our consolidated supervision whereby we focus not 
just on the holding company but we make sure that we interact 
more intensively with the functional regulators of the 
subsidiaries or the affiliates.
    So I don't think the system is broken, but it does need 
some improvement in execution.
    Mrs. Maloney. Thank you very much.
    The Chairman. The gentleman from Texas.
    Dr. Paul. Thank you, Mr. Chairman. And welcome, Secretary 
Paulson and Chairman Bernanke. I'm delighted the two of you are 
here today because I might just get to the bottom of the 
question I have been asking for many years, which is, who is in 
charge of the dollar? Because sometimes when I ask the Fed, I 
get referred to the Treasury and vice versa, but maybe I can 
get a better answer today.
    I do want to acknowledge the gentleman from New Jersey, Mr. 
Garrett, for playing a part in bringing these hearings about, 
and also Chairman Frank for having these hearings because I 
deeply appreciate it.
    But I would like to take a minute to just challenge 
something he said during his questioning, because he made the 
flat statement that there was no alternative to the Federal 
Reserve system. I don't want to take my time to explain the 
alternative, but maybe later on, Chairman Frank and I can talk 
and I can explain to him what an alternative might be.
    The Chairman. That's not very likely.
    Dr. Paul. But anyway, I would like to pursue the theme of 
the day, and that has to do with systemic risk. And there's a 
lot of talk about systemic risk and also taken in the context 
of market discipline. But, you know--and we are talking so much 
about more regulations. And quite frankly, I think we should 
have a lot more regulations, but I think we should have market 
    I would like to see a lot more regulations on the 
government and on the Federal Reserve, because I think it's the 
ability of the government, through regulatory agencies as well 
as the Federal Reserve, to disrupt markets and destroy market 
discipline. That is where I think our problem lies.
    When Enron failed, we immediately said, well, it must have 
happened because we didn't have enough regulation, so Congress 
immediately responded by passing Sarbanes-Oxley. It hasn't 
exactly helped our markets. You know, our markets today, almost 
every index of the market today is where it was 8 to 9 years 
ago, and that's not taking into consideration inflation, the 
devaluation of the dollar. So the markets are in severe 
trouble. They are very dysfunctional.
    But the real question is, why are they in such disarray? 
And of course I maintain that they're in disarray because our 
monetary policy disrupts the markets because we create interest 
rates below market rates. Right now the money is free to the 
banks. They can borrow money at 2 percent. Real inflation is 10 
or 12 percent.
    And we wonder why there are disruptions when you have 
artificially low interest rates, you cause the malinvestment, 
you cause excessive debt to accumulate, and you cause the 
bubbles to burst. And then when they burst, the only thing we 
can come back for is more regulations and more inflation, we 
need lower interest rates, we need to print more money.
    But it is back to this basic fundamental problem that we 
think that we can compensate for lack of savings by creating 
money out of thin air, and it doesn't work. It has never worked 
throughout history, it's not going to work this time, and we 
can't bail ourselves out by more regulations and more monetary 
inflation. And that is where we are today.
    I think the IMF is correct in this circumstance. They say 
we are in worse shape than since the Depression. And yet our 
government tells us there's not even a recession. This is 
utterly amazing. Ask the American people. Our government tells 
us inflation is 4 percent. Nobody believes that. I mean, just 
look at the cost of energy. So we have to someday get back to 
the fundamentals of what is a dollar, where do they come from, 
and who's in charge of the dollar.
    So my question is directed to Secretary Paulson dealing 
with the dollar, because evidently he is the spokesman and he 
is the champion of the dollar, and all public statements are 
that the dollar is to be strong. Well, the dollar lost 20 
percent in the last 2 years. In the last 3 years, we have 
created $4 trillion of new dollars. But when we go to China, we 
tell the Chinese we want a weak dollar.
    I would like to see if I can get the Secretary of the 
Treasury to explain this to me. Do we want a weak dollar or a 
strong dollar, and why don't we worry about the value of our 
    Secretary Paulson. Congressman, we want a strong dollar. 
And what I have said is, a strong dollar is in our Nation's 
interest, and I think you and I agree on that, at least I think 
we do. And I have had a career in the financial markets, and 
that has taught me that a strong dollar is in our Nation's 
    Now as I look at what's going on in our economy, and we are 
going to have some ups and downs. Every economy does. We are 
going through a tough period right now. But I travel around the 
world, and I don't see a major industrial nation that has 
better long-term fundamentals than we do. I don't see a major 
industrial nation that I believe is going to perform better 
over the long term in their economy than ours will.
    And so what I say is, I believe these long-term 
fundamentals are going to be reflected in the value of our 
currency. And what we need to do is to have policies that are 
going to enhance confidence in our economy. And to me, those 
polices are pro-growth policies, they are continuing to 
advocate for trade, for open investment.
    Now in terms of China and the renminbi, what I believe in, 
Congressman, are markets, and I think it is a--there are many 
countries around the world that don't have market-determined 
currencies. There's no country as big as China and as 
integrated as they are into the global economy in terms of 
goods and services. And so in some ways, it's an unnatural act.
    And they are not ready yet to have a market-determined 
currency, but we are encouraging them to move in that direction 
and move more quickly in that direction, because that will be a 
key also to their continued development and economic progress, 
which is important to all of us. Because contrary to what some 
people may believe, we will benefit if China continues to grow 
and has a healthy economy.
    The Chairman. Mr. Secretary, I'm going to cut you off 
because I received a letter, let me just say, from the ranking 
member of the full committee and the ranking member of the 
Domestic and International Monetary Policy Subcommittee asking 
for a hearing on what is being done by you two gentleman--the 
letter suggested not enough--to protect our currency, and 
particularly to focus on its relationship to oil prices. I have 
instructed the staff to schedule such a hearing.
    So the request that the minority has made for that hearing 
is going to go forward. We hope to have it--you know, we will 
have it before we break in August, and we can get further 
conversations on that.
    Dr. Paul. I appreciate that very much.
    The Chairman. The gentleman from North Carolina.
    Mr. Watt. I want to get back to the framework, the model 
that Secretary Paulson--I'm over here, I know you are looking 
for me--has outlined, the three primary regulators. And you--I 
don't understand it, or I have some concerns about it.
    Maybe you can help me understand it. And maybe that will 
address my concerns. But three areas you outlined: A regulator 
focused on market stability across the entire financial sector; 
another focused on safety and soundness of institutions 
supported by Federal guarantee; and a third focused on 
protecting consumers and investors.
    The first concern I have is that the third one, the one 
focused on consumers and investors, will be the redheaded 
stepchild. And the discussions, all of the discussions we have 
had this morning suggest that because there had been very 
little discussion of the consumer and investor side.
    But I want to set that one aside, because I don't want to 
spend my 5 minutes talking about my concern about it. I do have 
that concern and I want you to know it.
    If we had a regulator that is solely focusing on consumers 
and investors, I think it will be so marginalized that it 
will--it will in effect, be a third powerful regulator rather 
than a one or two, or equivalent--equal player in the process. 
But let me make sure I understand the other two, because I 
don't understand what falls into the second category for 
example, the one focused on safety and soundness of 
institutions supported by a Federal guarantee.
    Either you are acknowledging the implicit guarantee that we 
apply to Fannie and Freddie, or you are talking about something 
else. What are the institutions that would fall, in your model, 
under that second regulator, the current institutions that you 
are talking about?
    Secretary Paulson. Yes, Congressman, those are institutions 
that have Federal insurance or guaranteed insurance.
    Mr. Watt. Okay. You are talking about--are you talking 
about flood insurance, for example?
    Secretary Paulson. Well, it could be. You could have an 
    Mr. Watt. Okay. Just give me a couple of examples of who 
you are talking about.
    Secretary Paulson. The banks. The depository insurance.
    Mr. Watt. Okay.
    Secretary Paulson. But again, I want to say something--
    Mr. Watt. So that--would that take the portfolio of the 
    Secretary Paulson. Yes, exactly.
    Mr. Watt. The credit union regulator.
    Secretary Paulson. Right.
    Mr. Watt. So that would be a conglomerate of the existing 
    Secretary Paulson. Right.
    Mr. Watt. --but we don't provide a guarantee to credit 
unions, do we?
    Secretary Paulson. Well, whether there is--what this would 
do--this would be a charter that would go for every banking 
institution where there is any kind of Federal deposit 
insurance, where the depositors have insurance.
    Mr. Watt. Okay. But you still have a bunch of entities, 
financial entities that are left out of that category. And I 
didn't see them pick up in the first category, because when you 
all started talking about market stability across the entire 
financial sector, I assumed that is an expansion of the Federal 
Reserve's authority now.
    But there are some institutions here that are still left 
out of this equation. And I don't know where they go in these 
three tranches that you are giving us in this model.
    Secretary Paulson. Are you--let me begin by saying this 
model is sort of an optimum long-term model to start the 
discussion. Now I am going to start for the life of me--
    Mr. Watt. But you have to get all of your--
    Secretary Paulson. I will--
    Mr. Watt. --institutions into the model.
    Secretary Paulson. You are right.
    Mr. Watt. Okay.
    Secretary Paulson. Here is what we will do. And let me 
begin by saying in terms of regulation by objectives, it 
escapes my imagination how anyone could believe if you--if you 
had an institution just focused, not divided--just focused on 
protecting investors and investor protection how somehow 
whether that would be a weaker institution--one misguided, 
divided focus.
    So again, I believe if you have to have a focus, that would 
be very strong. Secondly, what we do is in the optimum model--
what we do is we say we are not going to have regulatory 
competition. We will have one charter.
    So there will be a charter for every institution, whether 
it's--I think you are driving at credit unions, whatever it is. 
And we say specifically, we would not get into business model.
    So if there is a cooperative that would be fine. I very 
much appreciate what credit unions do. If they are community-
based, they would have a tax-exempt status.
    So again, in the optimum model, and that would be a long 
time before you get there, we wouldn't do anything in the 
immediate term. But in the optimum model, you would have one 
charter for institutions that do the same thing.
    You wouldn't have regulatory competition. There would be a 
level playing field in terms of that. But we wouldn't pre-judge 
ownership. You could still have cooperative, community-based.
    And you could still have tax exemptions that went along 
with that ownership model. So again, this was--and in the 
intermediate term, there would be a number of things we would 
do. But again, it wouldn't impact their credit unions.
    The Chairman. The gentlewoman from Illinois.
    Mrs. Biggert. Thank you, Mr. Chairman. Chairman Bernanke, I 
think that you announced on July 8th, this past Tuesday, that 
you were considering extending the term of the primary dealer 
credit facility.
    I think that Federal Reserve Governor Kevin Warsh has said 
that the Federal supplied liquidity is a poor substitute for a 
private sector supplied liquidity. And that the Fed-provided 
liquidity should not be mistaken for capital.
    Do you think that extending the term of the PDCF would make 
the credit markets even more dependent on continued support 
from the Federal Reserve?
    Mr. Bernanke. Congresswoman, you are correct. We are 
considering extending the PDCF. If we extend it, it will be 
based on the judgement that unusual and exigent circumstances 
still prevail in financial markets.
    And that by withdrawing that facility, we might evoke a 
severe reaction in the markets. It's true that--I mean two 
comments about dependency: One is, of course, that barring any 
change in rules, that this is a self-limiting facility, because 
it's only legally allowed so long as there is a set of unusual 
and exigent circumstances.
    So at some point we would have to phase it out when we felt 
that the system had sufficiently recovered. The other point I 
would make is that even as we take steps like this to support 
the financial markets and help improve their functioning, we 
are simultaneously on a track to try to strengthen the 
financial system and reduce the need for these kinds of 
    So I mentioned again in my testimony, the necessary 
supervision, the strength in the infrastructure, the resolution 
regime. Those are the kinds of things--improved oversight. 
Those are the kinds of things that would make the PDCF less 
necessary over time.
    And therefore I think those two things should go together 
to support the improved function of financial markets and to 
make such facilities less and less necessary.
    Mrs. Biggert. I guess I was concerned because you said that 
if current unusual circumstances continue to prevail. So did 
you think that if it were right now that you would want to 
extend that--condition such?
    Mr. Bernanke. Well, we have already--in March, when we 
instituted this, we set a target essentially of 6 months into 
September. And I don't think there is justification at this 
point for removing it.
    The markets remain quite strained, particularly the dealer 
funding markets and other markets where this was particularly 
focused. So I don't think that moving at this point would be a 
good idea.
    What we are considering in this issue is--at this juncture 
is whether the circumstances warrant an extension. And how to 
structure that.
    Mrs. Biggert. Thank you. Secretary Paulson, we have been 
talking about all the things that need to be done. What is the 
most pressing priority that needs to be addressed to ensure 
that our markets remain stable?
    Secretary Paulson. I wish I could tell you one thing, but 
there isn't a silver bullet. If there was, and we knew how to 
address it right now, we would. And what is going on now as I 
said earlier, is it's just taking us a good while because there 
is much more leverage than was--what was once healthier--much 
more leverage than was perceived to be the case.
    And it was in the form of financial products. And then many 
of which were complex. There has been recorded progress made. 
It hasn't been in a straight line, but the progress I would 
site has been the risk reduction, the de-leveraging, the things 
that the Chairman has cited, in terms of increased liquidity 
and management, funding management by the investment banks, the 
capital that has been raised, being raised.
    But I believe part of this of course, is confidence. And 
having been through periods like this, they always are the 
worst until they are resolved. And before they are resolved, 
you wonder how they ever are going to be resolved.
    But confidence has a way of returning to the markets. And 
over time there have been many investors, wise investors, that 
have come in during times of great risk, adversity, and made 
investments and have made money on those investments.
    I think one of the key things is going to be when you start 
to see, and we are seeing some, more of these hard-to-sell 
assets changing hands and private money coming into the 
markets. But meanwhile, we have, all of us, some real work to 
    The Chairman. The gentleman from Kansas.
    Mr. Moore of Kansas. Thank you Mr. Chairman, for having 
this meeting. My questions are for both Secretary Paulson and 
Chairman Bernanke.
    For the past several years, the Treasury and the Federal 
Reserve have argued that the housing GSE's pose systemic risk 
to the financial system, and that they were a likely source of 
the next financial crisis. I agree that we should pass 
legislation that will give the GSE's a strong, new independent 
    Do you agree that the GSE's have played a constructive role 
in trying to stabilize the markets?
    Secretary Paulson. As I said, I believe that GSE's have 
played a constructive role, and that they are playing a very 
important and vital role right now. They touch 70 percent of 
the mortgages that are made in this country.
    And so they are a very important part of our economy, a 
very important part of our housing market. And they are an 
important part now, and they are going to be an important part 
in the future.
    Mr. Moore of Kansas. Thank you, Mr. Chairman.
    Mr. Bernanke. I agree that the GSE's are playing a critical 
role there at this point, a very big part of the existing 
mortgage market.
    I think they could do an even better job if they were 
better supervised and better capitalized. With respect to 
supervision, I support the call for a GSE reform that has been 
    With respect to capitalization, I believe that they are 
well capitalized now in the sense of--in an inventory sense. 
But I think as we have called upon all financial institutions 
to expand their capital bases so that they can be even more 
proactive in providing credit and support for the economy.
    So I would include the GSE's in that broad call for 
increased capital.
    Mr. Moore of Kansas. Thank you, and one follow-up question: 
Do you still believe the GSE's pose a systemic risk to the 
economy? And if so, how does that risk compare with the risks 
that have come to light with our current gaps in regulatory 
oversight that have in part led to the current crisis?
    Secretary Paulson. I would say Congressman, in today's 
world I don't think it is helpful to speculate about any 
financial institution and systemic risk. I am dealing with the 
here and now, and the important role that they are playing, and 
other financial institutions are playing.
    Mr. Moore of Kansas. Thank you, sir. Mr. Chairman, do you 
have anything to add to that?
    Mr. Bernanke. No.
    Mr. Moore of Kansas. Thank you.
    The Chairman. The gentleman from Connecticut.
    Mr. Shays. Thank you both for being here and for your 
service. And I want to say before I ask a question that I am 
very proud of being on this committee and I appreciate the work 
that our chairman does and our ranking member.
    This is the one area in Congress, where I think 
surprisingly we see less politics and a real interest in trying 
to do what is right for our country. I am deeply concerned 
obviously, as everyone else is, about energy and the incredibly 
high cost of oil.
    I am surprised that it has only resulted in a 4-percent 
increase in inflation. And I want to know if there is just a 
lag, and if next we are going to see inflation at 5, 6, or 7 
    It is hard for me to imagine that we won't. I also have 
found myself altering what I say. I say we need to be energy 
independent, and we are. And I was rightfully correct in we are 
energy independent as it relates to natural gases, it relates 
to hydropower and coal in a sense.
    These are homegrown. And Europe doesn't have these 
resources. We have a competitive advantage as it relates to 
energy, ironically in spite of our big gap in oil. And I am 
being told that because energy is becoming such a high price--
in other words, our electric power is much less--our production 
costs are much less as it relates to energy.
    That energy is now beginning to trump labor costs. And that 
we have reason to believe that we might see a renewal in 
manufacturing, because of the advantage that we have over many 
countries over energy.
    So one, I would like to know about the impact of energy on 
inflation, not just this year but the next. And I would like 
you to comment on do we have a comparative advantage on the 
energy sector that we could start to see benefiting this 
    Also related to obviously, the value of the dollar and what 
exports advantage--the advantage we have on exporting. I would 
like both of you to answer.
    Mr. Bernanke. Let me start, Congressman. First of all, it 
does take a bit of time for the oil price increases to feed 
through to the consumer. So when oil prices go up, it takes a 
bit of time before it shows up at the pump.
    And so over the next couple of months, we would expect to 
see the headline inflation rate rising, reflecting that. Once 
that impulse has passed through, if oil prices stabilize, even 
at the current level, then you would expect to see inflation 
come back down.
    But of course, that is an uncertainty at this juncture. I 
don't think we have a strong comparative advantage. We have 
been--in energy--we do produce certain kinds of energy. But we 
are less energy efficient than some countries.
    We have less alternatives than some countries. So I think 
it's very important--one of the benefits of a high price of 
oil--the--cost of course, but there is at least one benefit, 
which is it generates incentives for development of alternative 
forms of energy for conservation, and even for exploration and 
development of oil.
    So we need to allow that process to work. I think it will 
help us develop the energy, not necessarily independence, but 
less vulnerability to energy prices than we currently have.
    Secretary Paulson. I don't, Congressman, have much to add 
to that. There are some parts of our economy where we are maybe 
more efficient than some others when it comes to using oil, 
like for instance--
    Mr. Shays. We are not talking about oil, that is the 
difference. Our electric generation is coal, hydro--
    Secretary Paulson. Right.
    Mr. Shays. --it's nuclear. And it's homegrown. And it's 
less expensive than in almost any other part of the world. And 
there are people coming to me now saying that we have this 
competitive advantage, now that you see energy costs continue 
to climb.
    So the bottom line is this is not something you all have 
thought about, I am gathering.
    Secretary Paulson. Well, I would say this, I have thought 
about it. And as I look at energy and power around the world, 
there are obviously some countries that aren't nearly as 
efficient as we are, in some of the developing countries aren't 
nearly as efficient.
    Although I can tell you--in our automotive sector, you know 
that's oil, we rank up there with the inefficient. But the--we 
are--I again believe that the challenge here for us is going to 
be continued investment in new technologies and alternative 
sources of--
    Mr. Shays. Before the red right light goes on, let me just 
say I believe absolutely that there are going to be alternative 
sources of energy that are going to move us along in the long 
term. But we have short-term needs. Thank you.
    Secretary Paulson. Yes, I agree with that.
    The Chairman. The gentleman from Texas.
    Mr. Hinojosa. Thank you, Mr. Chairman. I also want to thank 
both of you for coming to our committee, and giving us an 
opportunity to better understand the problems that we are 
facing in financial markets.
    My first question is directed to Secretary Paulson. And I 
want to say that there are people coming to my office, as the 
chairman of the Higher Education Subcommittee, and expressing 
their problems about accessibility and affordability of higher 
education. And they go directly into asking for relief to 
college student loan providers.
    They talked to us about 3 or 4 months ago about lacking 
liquidity. And so the Committee on Education went on and passed 
some legislation that would give them some relief, as you 
mentioned earlier in your comments about your Department being 
a lender of last resort.
    Secretary Paulson. The Department of Education is a lender 
of last resort.
    Mr. Hinojosa. We talked about both the Treasury being 
    Secretary Paulson. Right.
    Mr. Hinojosa. --and that the--as secretary--
    Secretary Paulson. Right.
    Mr. Hinojosa. --be that lender of last resort. But it's not 
working. And this week, we have had representatives of 
companies, entities that are not-for-profit, including COSTEP 
of South Texas and the Panhandle Plains Higher Education 
Authority. The third one was the Razos Higher Education Service 
Corporation, all saying that they need for us to be aware that 
some of their lenders are no longer wanting to participate.
    And an example is this COSTEP memorandum that says, ``It is 
with the deepest regret that I have to announce that effective 
July 1, 2008, Texas State Bank Trustees for COSTEP will suspend 
making new Federal Family Education Loan Program loans.'' And 
they go on to explain why.
    Secretary Paulson. Let me first of all say that this is a 
very important area. It is critically important that students 
receive loans. And that the Treasury Department is doing 
everything we can to work with the Department of Education to 
address the need. That's the first thing.
    The second thing I will say is let's make a distinction 
between certain lenders that don't participate and whether or 
not students are getting loans, because I think the key 
question for all of us is are the students going to get the 
loans they need to attend college?
    And what the program, and we very much appreciate in that 
Congress gave to the Department of Education and the programs 
that have been put in place to get us through this period. The 
first part of the program was government buying loans you know, 
that originated by these--by these financial services firms.
    And most of the failed lenders are participating in that 
program. Some aren't, but most are. And most are participating 
at a level where they will be able to make money and students 
will have loans. And as I have said, if to the extent that just 
to be sure the Department of Education has greatly expanded 
it's resources, ready to do--get involved with direct loans, 
lender of last resort.
    And the other thing we are doing at Treasury is working to 
develop market-based solutions to help further make this market 
more robust, because it's not ideal but I think the thing that 
will really get my attention is if you come to me and say, 
``Here is a student who qualifies and can't get a loan.''
    I think that is our first priority, to make sure students 
get loans, and do what we can to get this market up and going 
    Mr. Hinojosa. All I can tell you is that when you get--the 
university is also coming in to see me and talking about the 
barriers such as the one that is explained in this note here. 
In order to participate in the Loan Participation Purchase 
Program, the eligible lender must certify they--participation 
interest in front loans to the Department of Education with an 
aggregate balance of not less than $50 million.
    And so that eliminates companies like these three that I 
have mentioned, which by the way Mr. Chairman, I ask unanimous 
consent that they be included in today's--
    The Chairman. Without objection, and the witnesses will 
    Secretary Paulson. Yes. And I will--I am sure that 
Secretary Spellings will be very happy to get back to you with 
the details with that. But again, and it's regrettable when any 
of these lenders don't participate.
    The program that was designed--hopefully they all would 
have participated, but some didn't. But again, the key thing 
is, are students getting the loans? I believe students are 
going to get loans and attend college, and we are going to meet 
that need and we are going to keep working on strengthening the 
    The Chairman. The gentleman from Texas, Mr. Hensarling.
    Mr. Hensarling. Thank you, Mr. Chairman. I appreciate you 
calling this hearing and I appreciate the gentleman from New 
Jersey for his leadership in calling for this hearing as well.
    Chairman Bernanke, I believe the central question really 
before the committee is should the Federal Government really 
become the guarantor of last resort, or the lender of last 
resort to investment banks, not unlike they are commercial 
banks for the purpose of creating financial stability within 
our markets, obviously doing this with taxpayer dollars, given 
the recent intervention of the Fed by facilitating the Bear 
Stearns sale, which I am led to believe is the first time in 70 
years that the Fed has opened up a discount window to a non-
depository institution.
    My question is, have investment banks become so big and so 
interconnected that their bigness and interconnectedness alone 
now defines systemic risk?
    Mr. Bernanke. There were really three reasons why we took 
the action we did. One was the actual size of the firm and its 
implications for the broad financial markets. The second one 
was the fact that the infrastructure was not strong enough to 
deal with the implications of the failures in the derivatives 
markets in triparty repo markets and other areas. And the third 
was that the existing financial conditions were extremely 
fragile at the time that we made that decision.
    So I think we made the right choice in the sense that it 
was necessary at that time and in those circumstances to 
prevent much wider prices in financial markets and I was 
reminded of the gentleman from Texas asking about student 
loans. The problem with student loans came directly from the 
option rate securities market which fell apart because of the 
financial stresses.
    These things directly impact Americans. It is not just a 
question of Wall Street, it really affects broad based welfare 
and the economy. So I believe we did the right thing. I would 
do it again. I think it was necessary to protect the financial 
    I don't want to do it again, and so to avoid doing it 
again, we want to have things in place that will make it 
unnecessary, and that includes good supervision and includes 
strengthening the infrastructure, and it includes other 
measures to make the financial markets more stable. If we do 
those things, I hope that such events will be extraordinarily 
rare, as they have been historically.
    Mr. Hensarling. Mr. Chairman, in another speech, you were 
quoted as saying, ``Under more robust conditions we might have 
come to a different decision about Bear Stearns.'' Again, you 
haven't been at the Fed for 70 years, but this is the most 
extraordinary remedy.
    Looking in the rear view mirror, were there other 
circumstances that you believe that the Fed should have opened 
the discount window to non-depository institutions in the past, 
and by what criteria, what extraordinary criteria will be used 
under your current authority to do it in the future?
    Mr. Bernanke. Well, there have been many financial crises 
going back to the 1930's, which was of course was probably the 
worst of the 20th Century. Each one is different--
    Involves, in some way or another, with most of these 
financial crises, either through, as oversight, as moral 
exhortation, it is convening power, and we have a wide variety 
of episodes where the Fed has been involved in trying to 
mitigate a potential financial crisis.
    The Fed always has to make the choice whether or not it 
needs to intervene to protect the system or whether the system 
is strong enough to accept a failure, and in some cases the 
failure shows in the latter. For example, Drexel was allowed to 
fail because it was viewed at the time that it would not bring 
down the whole system and that was the correct assessment.
    So I think it is a very rare thing to do. This particular 
confluence of circumstances has not occurred in the past and 
these were the powers that we had available to try and address 
this problem.
    Again, I share your concerns. This is not something I want 
to do again, it is not something I really wanted to do in the 
first place, and I hope that the Congress can work with us to 
develop a set of regulations and rules that will make this 
unnecessary in the future.
    Mr. Hensarling. Mr. Chairman, you alluded to the 1930's and 
obviously the Great Depression. Now those who seem to have an 
abiding faith in regulators and regulation, I know you have 
studied the Great Depression, can not a case be made that 
frankly we had very bad regulation that helped turn a garden 
variety recession into the Great Depression, including the Fed 
allowing the money supply to contract dramatically, 
protectionism in a trade war brought about by Taft/Hartley and 
the prohibition of nationwide branch banking?
    Mr. Bernanke. All those things were relevant but another 
thing that was quite relevant was that the Federal Reserve did 
not follow through on its responsibility to try to stem the 
bank failures, and the continuation of bank failures over a 
number of years contributed to the decline in the money supply 
and to the contraction of credit and was a major source of the 
Depression. So it was exactly the failure of the Fed to act in 
the early 1930's that made the situation as bad as it was.
    Mr. Hensarling. Thank you, Mr. Chairman.
    The Chairman. The gentleman from Massachusetts.
    Mr. Lynch. Thank you Mr. Chairman. Mr. Chairman I 
appreciate you holding this hearing and I want to thank the 
ranking member as well. I want to thank the Secretary and the 
Chairman for appearing before us and helping the committee with 
its work.
    I want to go back to a point that was raised earlier, Mr. 
Secretary, in your response to Ms. Maloney and also I think, 
Mr. Chairman, you address it at page three of your remarks.
    And basically my question is this. A lot of the lack of 
confidence, I think, in some aspects of our market come from 
the complexity and the opaqueness of some of these derivatives 
that we have actually gone back and tried to drill down into 
the models on which some of these derivatives are actually 
based. And in some cases they probably stretch from myself to 
Mr. Hensarling down there.
    I am just wondering, is there anything in your proposed 
reforms that might get at this issue? I mean, some of these 
derivatives I have to admit, it is just very, very tough to 
value them or mark them to book as some of my friends in the 
industry have described it. The credit default swaps that are a 
huge, huge part of the market out there, these collateral debt 
obligations, the failure of these risk and recovery models to 
really predict or to ascertain the value of these things, they 
are so complex, I honestly believe if we adopted a simple rule 
that said an investor had to understand these things before 
they bought them, that this whole market would come to a 
screeching halt. I honestly believe that, and I am only half 
    But is there anything that you have proposed that would get 
at that opaqueness and lack of transparency and complexity? 
Something that would allow investors to have more confidence? I 
mean, in some of these cases, and synthetic CDOs, we don't even 
know where the actual ownership lies. So it is just very, very 
tough for an investor, especially in difficult times to have 
confidence in their investment when they can't really determine 
that on their own.
    Secretary Paulson. I think Congressman, both the Chairman 
and I spoke about how important it was to make enhancements in 
the infrastructure and the transparency around credit default 
swaps and other over the counter derivatives. And I think you 
heard him say that the New York Fed is driving an effort, or we 
need to have a clearinghouse, we need more transparency, we 
need better protocols, I think more standardization. So there 
is a lot of work being done.
    Now I want to also say to you that there is--these 
contracts have done a lot to make the markets more efficient, 
and we have gone through periods of time where we have had some 
major failures, at the time of Enron and so on, and the markets 
were able to weather it because of the efficiency of these 
markets. But they clearly need more discipline and stronger 
    Now there were other things that have been suggested and 
are being pursued really quite aggressively to deal with this. 
One is, as you have made the point, investors need to do their 
work and make sure they understand, and if they don't, then 
they shouldn't be investing.
    And there is a lot of work being done on the part of the 
rating agencies and Chairman Cox has spoken to that and he has 
done a lot of good work there in terms of reforming those 
practices. We at the President's Working Group have suggested 
that when the rating agencies make their ratings, that they 
make a differentiation between a rating that goes to a standard 
corporation or a municipality and one that is a structured, 
highly structured financial product, maybe they should get a 
different designation.
    So there have been a number of suggestions that have been 
made, and they are all being pursued. Now it is going to take 
some time to work through this, but progress is being made 
    Mr. Lynch. Okay. Mr. Chairman?
    The Chairman. Quickly, Mr. Chairman.
    Mr. Bernanke. I would just say that the Federal Reserve is 
very much involved in this process to make the post-trade 
clearing and settlement process, the management of the risks 
associated with this, the transparency, the standardization, 
these are all things we are working on, and I elaborated a bit 
on that in the speech I gave earlier this week, and this is a 
very high priority for us.
    Mr. Lynch. I look for it. Thank you.
    The Chairman. The gentleman from New Jersey.
    Mr. Garrett. Thank you, Mr. Chairman, and thank you, 
Chairman Bernanke and Secretary Paulson for your service to the 
    Secretary Paulson, I was very pleased to see your comments 
on Tuesday regarding covered bonds and how there can be maybe 
another way to increase the availability and lower the cost of 
mortgage financing to hopefully get us back to normal home 
buying in this country. I agree that covered bonds both in the 
commercial area and in residential area present a great way to 
provide more liquidity to the U.S. housing market during this 
credit crunch.
    I have spoken to Chairwoman Baer directly about cover bonds 
and I know my staff has been in touch over the weeks with your 
colleagues at the Treasury. And over the last 3 months, I have 
been working with outside interested parties to see whether we 
can work together on coming up with legislation to help 
facilitate covered bonds.
    Chairman Bernanke, on this topic I have not heard, maybe 
you have made a statement, but I have not heard it, do you have 
position, are you generally in favor or support of Secretary 
Paulson with regard to helping address the mortgage situation?
    Mr. Bernanke. I do. Like you Congressman, I think it is 
very important for us to be--here we mean both the regulatory 
community but also the private sector--looking for new ways to 
get financing.
    Covered bonds are a very successful financing vehicle in 
Europe, and therefore it is an attractive thing for us to look 
at here. The FDIC has a rule that is about worked out that will 
clarify some of the issues associated with the priority of 
covered bond collateral versus deposit insurance fund. I'm in 
favor of working in this direction.
    I wonder, I think it is not yet known, whether this can be 
successful without legislation. I think that is a question we 
want to look into.
    Mr. Hensarling. I look forward to working on this 
legislation. Turning now to the issue that most of us have 
talked about so far, the Bear Stearns situation. I had a chart, 
but I know the numbers are pretty small, but you should be 
familiar with it because it comes from your own folks on your 
Web site, it is the Federal Reserve balance sheet as of June 
25, 2008.
    As I read and others explain, it indicates that there is 
only roughly $22 billion, generally speaking, of Treasury bills 
remaining, and the Fed has already exchanged $255 billion, 
roughly, for a variety of types of private debt, some of which 
you could question the quality.
    Now today the Secretary has made remarks to the need for a 
new statutory framework and the deal with the unwinding of the 
situation. I am sure you have seen a number of the articles 
that talk about this, and the press indicate there are several 
other brokers out there that might be facing significant 
problems as well going forward, and you have already indicated 
you would hate to have to deal with this situation as you had 
with Bear Stearns in the past.
    So, Mr. Chairman, it appears to me that if one of these 
highly interconnected investment banks were to fail in the near 
future, the Fed's balance sheet then has limited or no room 
left on it coupled with there being no legislative framework in 
place going into this, would the Fed, in essence, have to 
monetize the situation to bail them out? Would the Fed have to 
deal with new Treasury paper to bail out the bondholders, which 
is what really occurred with the Bear Stearns situation, if 
another situation came?
    I have three questions. First, can you assure, and I think 
I know the answer to this question, but can you assure us that 
you will not conduct any similar Bear Stearns transaction if 
another investment bank or a GSE gets in trouble without the 
prior explicit authorization of Congress via some sort of 
enabling legislation?
    Second, if you decide that there is no alternative than to 
conduct another bail out or support, however you want to call 
it, to one of these troubled organizations, will you be willing 
to monetize the debt to finance such a transaction due to the 
current limitations on your balance sheet?
    And third, your claim that your actions with the Bear 
Stearns transactions are granted to you under section 13 of the 
Federal Reserve Act, are there any limitations within that 
section or elsewhere as to your abilities going forward to deal 
with these situations?
    Mr. Bernanke. Well, to try to address that range of 
questions, over the weekend where we were working on the Bear 
Stearns issue, I was in touch with congressional leaders, kept 
them informed, and the sense I got was that there was not an 
objection to pursuing it. I also of course worked very closely 
with the Treasury and with the SEC and other authorities to 
develop a consensus for the actions we took, and as I have 
argued before, they were necessary.
    So I don't want to make any commitments. I don't think a 
situation like this is at all likely, but unless I hear from 
Congress that I should not be responding to a crisis situation, 
I think that it is a longstanding role of the central bank to 
use its lender of last resort facilities to address--
    Mr. Hensarling. The first answer is ``yes.'' The second 
question then is would you essentially monetize the situation 
at the--
    Mr. Bernanke. There is not monetization. This is a 
sterilized operation; there is no effect on the money supply.
    And in addition, I would add that our lending, not only to 
Bear Stearns but more generally to the banks and so on, is not 
only collateralized with good hair cuts, it is also a recourse 
to the banks themselves. We have not lost a penny on any of 
this lending, and it is just lending, we are not purchasing any 
of it, it goes back to the bank when the term of the loan is 
    Mr. Hensarling. So there is no limit to the amount.
    The Chairman. No, I'm sorry, no further questions. We were 
over the 5 minute--
    Mr. Hensarling. Can I get an answer to my last question?
    The Chairman. He can answer, but no further questions from 
    Mr. Bernanke. It does not affect the money supply. We have 
plenty of balance sheet room left, so I don't visualize that as 
a constraint in the near term.
    The Chairman. The gentleman from North Carolina.
    Mr. Miller. Thank you. I have served on this committee for 
almost 6 years, and I remember the testimony pretty well on 
mortgage lending, but I have recently gone back and reviewed 
some of it to see what the lending industry was saying at the 
time about the kind of mortgage practices that have led to the 
    And what they have always said was that the provisions of 
the mortgages that may seem to be a problem, they seem 
unfavorable to consumers, actually were risk based, they were 
responding to a greater risk by certain borrowers, and that 
without those provisions they would not be able to lend to 
those borrowers, and those borrowers would be denied credit, 
would be unable to buy a home, and be unable to borrow against 
their homes to provide for life's rainy days.
    Looking back on the practices that actually led to the 
problem, the subprime mortgages made in 2005 and 2006, it is 
pretty clear that those provisions had nothing to do with risk 
and nothing to do with benefiting consumers or making credit 
available to them that would otherwise not have been available. 
It was a fundamental change in consumer lending from making an 
honest living off the spread to trying to trap consumers, 
homeowners into a cycle of having to borrow repeatedly and 
paying penalties and fees when they did, and that the loans 
were intended to become unpayable for the borrowers, so the 
borrower would have to borrow again.
    Insurance regulation at the State level generally requires 
that policy forms provisions and policies and premiums be 
approved in advance by the State regulator, and that the 
insurer has to justify those provisions. So the kinds of 
arguments that we heard in this committee that we were not 
really in a position to judge on a provision by provision 
basis, a reasonably competent regulator could judge and 
determine whether that really was related to the risk, whether 
it really was to the advantage of the consumer, and whether it 
also presented a solvency issue for an insurer.
    Secretary Paulson, the proposed regulator to protect 
consumers, will that regulator have the authority, should it 
have the authority, to review consumer lending products in 
advance to see if the practices can be justified both for what 
it might do to the solvency of the institution and also what it 
does to the consumer?
    Secretary Paulson. Well, I would say this, whether it 
reviews in advance or not, I believe that if we had a regulator 
that was focused solely, completely on consumer protection and 
investor protection, it is difficult to imagine we would have 
had some of the abuses that we have had today.
    In terms of, we did not intend when we set out this 
Blueprint to get involved in exactly what this regulator would 
do and how it would do it, but if that was the pure focus, 
there is no doubt that it would be involved there.
    I think in the meantime, because that is a long-term 
vision, the things that we are seeing done by the Fed right now 
in terms of the HOPE NOW Alliance and in terms of looking at 
unfair lending practices, it is very, very essential.
    And again, in the meantime, I do hope, because I think it 
is unlikely that anytime soon we are going to supplant the 
State regulation of mortgage origination, I do encourage you, 
even if it is in the next Congress, to pick up the idea of this 
mortgage origination commission which will be able to work with 
States and evaluate the State programs and do it in a very 
transparent way, and I think that may help.
    Mr. Miller. Chairman Bernanke, do you think there should be 
some way to review in advance before they go into widespread 
use, consumer financial products, to make sure that they are 
not rapacious to the consumer?
    Mr. Bernanke. Well, to some extent that is happening, in 
the following sense that first, as Secretary Paulson mentioned, 
the Federal Reserve is releasing on Monday a new set of rules 
which will limit the parameters, essentially, of how the 
mortgage can be constructed, and will eliminate certain kinds 
of confusing and other practices from the possible contracts.
    Second, we are continuing--as we have recently done in 
credit cards--a very sensitive set of disclosure reviews so 
that the lender will be required to explain and provide 
essential information to the borrower. I think we are going to 
go a long way towards reducing both the predatory aspects of 
the lending that you were referring to and also what I would 
just call the bad lending which ended up being losses for the 
lenders themselves because they had insufficient oversight and 
care when they made the loans.
    In terms of creating a standardized project in advance, I 
think it is an interesting idea. It would simplify things in 
some ways, but on the other hand, there are some benefits to 
having flexibility and innovation in the mortgage market to 
have different types of mortgages available like shared 
appreciation mortgages or variable maturity mortgages and so 
on, so I wouldn't want to take government action to eliminate 
the possibility of innovation in that market.
    The Chairman. The gentleman from California.
    Mr. Campbell. Thank you, Mr. Chairman.
    There seems to be general agreement--with which I concur--
that we need regulatory restructuring, regulatory reform, and 
that we want to do it right rather than quickly. However, 
markets don't wait. If we are waiting until next year, which is 
I think the implication here in the next Congress, the next 
President, three-quarters are going to pass at least before we 
have something in place.
    So my question to both of you is, if there were a financial 
institution that, to use your terms, Secretary Paulson, is 
either too big or too connected, that we are approaching some 
failure, some major difficulty, do you currently have the 
transparency to know in time and the tools to deal with that 
and/or is there anything we can give you quickly to help with 
    Secretary Paulson. Let me say what history shows us is that 
it is very difficulty to predict in advance, and I don't think 
you're going to be able to reasonably give us any tool right 
now. So I'm going to just tell you that there is an urgent 
need. We are not saying take your time, wait. There is an 
urgent need to get more tools. But I also will tell you that I 
believe that the focus on market stability and the actions that 
the Fed has taken, not just in the Bear Stearns episode, but in 
the follow-up in opening the PDCF to the opening of the 
diskette window to the investment banks has sent a very strong 
signal. And the work that the Fed and the SEC has done with 
these good institutions is a strength in their liquidity 
management, is, I think, very important. So neither of us are 
predicting another incident and we are looking at the progress 
that has been made.
    We both would like additional tools. We are not saying take 
forever, but we recognize the fact that the regulatory 
structure hasn't been changed in a long time and the fact that 
we don't have these tools mean that it's not going to be easy. 
It's going to need to be thought through and the sooner the 
better, but we are prepared to work together, work with you to 
deal with the situation on the interim.
    Mr. Campbell. You do believe, and then a question for you 
Chairman, you do believe you could deal with a too big or too 
connected failure to prevent the systemic damage?
    Mr. Bernanke. What distinguishes the situation today from 
where it was before Bear Stearns is we have taken additional 
steps to try to prevent such a contingency in the first place. 
So, in particular, in conjunction with the SEC, we have pushed 
the investment banks to increase their capital and particularly 
liquidity, which they have been doing. We have opened up the 
window to provide a backstop source of liquidity so that 
reduces the chance of a run. So those things, I hope and 
expect, will make this contingency much less likely, and should 
it arise, we would have to deal with it in real time with what 
tools we have.
    With respect to timeframe, you know, again, it's really 
Congress's judgment about what is possible and in what period 
of time, if there is an appetite in Congress to work in some of 
the things for example that we have outlined in our various 
proposals. I'm sure we will be more than happy to facilitate 
that in any way possible, but it has just been our sense that 
given the complexity of these issues, it's probably going to 
take longer rather than what could be done in this year.
    Mr. Campbell. Okay, and my final as we expire question is 
relative to this, but also to the GSEs, to Fannie and Freddie. 
If there were issues and so forth there, you have the tools you 
need there.
    Secretary Paulson. Well, I don't think we should be 
speculating or talking about what-ifs with any particular 
institutions. And so with Fannie or Freddie, what I'm 
emphasizing is the tool that I want is the reform, and the 
reform legislation that will inject a confidence into the 
marketplace. And we have a situation here where the independent 
regulator said as adequate capital and where we both know this 
is a very important institutions that have an important role to 
play in their economy.
    Mr. Campbell. Thank you.
    The Chairman. The gentleman from Texas.
    Mr. Green. Thank you, Mr. Chairman.
    I think this is a most important hearing and I am greatly 
appreciative that you decided to have it.
    Chairman Bernanke, I want to thank you. I think it took 
great courage to do some of what you have done. You are in a 
tough position and you have made some very difficult choices. 
And, you have done it, I think, with the notion that you were 
doing it in the best interest of the country.
    I thank you, Secretary Paulson, for some of the things that 
you have done. I have read some of your messages at home and 
abroad and I think that the two of you understand that it is 
time for us to act, and I greatly appreciate it.
    Mr. Chairman, you indicated that because you did not have 
and I'm paraphrasing, ``restraints,'' imposed upon you, you 
felt it appropriate to move forward with the Bear Stearns, for 
want of better terminology, ``deal.'' Given that these things 
are always going to be different, there probably will not be a 
cookie cutter approach to dealing with a Bear Stearns scenario.
    Given this and given that you have to act sometimes 
expeditiously because you have exigent circumstances, systemic 
problems, systemic failures that may erupt, do we need to 
clarify this area of law, if you will, such that there won't be 
any question as to whether you can act. And you indicated that 
unless Congress said no, you would move forward. But is there a 
need for some clarity in this area so that you can act without 
reservation or hesitation?
    Mr. Bernanke. Well, the two that we used was our 13(3) 
authority, which allows us to lend to individuals, 
partnerships, and corporations, so long as there are not other 
credit accommodations available. That was set up by Congress 
with the intention of creating a very flexible instrument that 
could be used in a variety of situations, and it allowed us to 
address a situation in which we did not anticipate and which 
had not been seen before. And so in that respect, having that 
flexibility, I think, was very valuable.
    That being said, both in the short term, I think it would 
be entirely appropriate for us to have discussions. And as I 
have discussed personally with congressional leadership about 
what the will of the Congress is and how we should be 
approaching these types of situations; and, in the longer term, 
as Secretary Paulson has proposed, it would be better if we had 
a more formal mechanism that created some hurdles from 
decisionmaking that set a high bar in terms of when these kinds 
of power would be invoked and provided more than this lending 
tool, which was really not well-suited in some cases to address 
systemically important failures.
    So I think the IPC authority is an important authority and 
it has important flexibility, but I certainly agree that 
ultimately it is the decision of Congress about, you know, in 
terms of advice and in terms of legislation about how they want 
the authorities addressing these kinds of situations.
    Mr. Green. For the short term, you are comfortable with the 
13(3) authority?
    Mr. Bernanke. Well, we have needed it. We have used it in 
several contexts, and it does give us a lot of flexibility. I 
think prior to putting any constraints on that it would be 
important to provide some substitutes, some alternative methods 
or approaches for dealing with systemically relevant failures.
    Mr. Green. Thank you.
    I appreciate the way you have approached dealing with some 
of these large, financial institutions in terms of commenting 
on their strength or lack thereof, because perception has a lot 
to do with reality and we don't want to create perceptions that 
can infringe upon reality.
    With this understanding, as we approach trying to draft and 
craft the regulations that can have the positive impact we 
desire, we, I think, have to be very careful that we don't 
create the perception with the institutions that there is 
something imminent about to occur, and I quite frankly don't 
know all of what we can do to prevent that perception from 
developing. Just know how important it is to prevent it.
    Your comments, please?
    Mr. Bernanke. Well, that is one advantage of having a 
deliberate process. If you take time to do it right and then 
take some time to get this done it will be evident to the 
market that you're not addressing some immediate crisis, but 
rather, thinking about the next set of issues.
    Mr. Green. Thank you, Mr. Chairman. I will yield back the 
balance of my time.
    The Chairman. The gentleman from Illinois.
    Mr. Roskam. Thank you, Mr. Chairman.
    Mr. Chairman, I was involved in a meeting with you and 
other members a couple of weeks ago where you kind of walked 
through the decisionmaking that you and your leadership went 
through in the Bear Stearns situation and kind of in a 
nutshell, I don't want to over-characterize this, but you're 
the umpire. You're calling balls and strikes. You called it a 
strike, did what you felt like you had to do. Others called it 
a ball.
    But you made it very clear that you weren't happy about 
that situation and you made it clear that there's a plan moving 
forward. In your testimony today, you outlined three points. I 
just would like you to focus in, and I don't think this will 
take all 5 minutes, and I'll give you all the time.
    Could you focus in particularly on the supervision piece as 
it relates to investment banks, and could you comment on the 
interplay between statutory change that you might think 
necessary, the regulatory piece that are rules that you can 
promulgate in relationship with the Securities and Exchange 
    But also, could you please comment on the attitude of the 
investment banks and kind of what is the backdrop of the 
conversation? Because basically dad came home, right? I mean, 
at the party, and looked around, and what is the look in their 
eye as they're interacting with you and the demeanor going 
    Mr. Bernanke. Well, on the last point, our presence in the 
investment banks is based on agreement and coordination with 
both the SEC and with the firms. We have had a good working 
relationship with the firms. They have not resisted our 
interest. Your broader question, I think, where the statutory 
authority is needed in clarifying that the investment banks 
require consolidated supervision, and what the powers of that 
consolidated supervisor should be.
    Currently, the SEC's authority is based on essentially a 
voluntary agreement between the companies and the SEC. I think 
it ought to be made more explicit and required. In terms of the 
actual, regulatory practice I started off my testimony by 
referring to some reports and activities by the committee and 
others. There really is a remarkably globally-integrated 
response to this set of issues, and many of them bear on 
supervisory practice and supervisory expectations.
    The triumvirate, which is always critical, is capital 
liquidity and risk management, and in all those areas, the 
regulators around the world are talking about ways in which we 
need to strengthen financial institutions on those three 
dimensions. I think one concern the investment banks might 
have, and I'm putting words in their mouths, they would say our 
business model and our financing is not the same as a 
commercial bank. Therefore, we wouldn't be comfortable having 
the exact rules used in a commercial bank context applied 
without modification to us. And I think that's a legitimate 
    Again, as long as we stick to the basic principles of 
capital liquidity risk management the details could be 
different from a regulatory perspective for investment banks 
because of the differences in their business models and their 
financing. So I am very much in favor of differentiating 
between different types of firms in our regulatory approach.
    The Chairman. The gentleman from California.
    Mr. Sherman. Thank you, Mr. Chairman.
    Mr. Bernanke, we see what happens when there's a lot of 
risk to financial institutions. We would all want to reduce 
that risk.
    Would allowing financial institutions, including commercial 
banks, go into real estate brokerage or other lines of 
commerce, increase the financial risks they bear?
    Mr. Bernanke. Well, the issue you're referring to is of 
course under Gramm-Leach-Bliley. The Treasury and the Fed are 
in power to allow banks or bank holding companies to enter 
activities that are incidental to financial activities. The law 
will require us to make a determination as to whether that's 
incidental or not. But the Congress, obviously, had some 
concerns about this; and, therefore, Congress has essentially 
prevented us from even making that determination. We have not 
attempted to determine whether it meets the statutory test, nor 
have we done extensive analysis of the systemic implications of 
such a move, so, for the time being, it seems to be pretty much 
a moot question.
    Mr. Sherman. So with Congress taking the stance, you 
haven't even investigated whether you have the legal right to 
let that happen and then having not determined the legal right, 
you haven't done the economic analysis to see whether it would 
be a wise move. But, in general, I would think that the greater 
you expand the rights of banks to engage in all kinds of non-
financial commerce, the greater the risks that they face, my 
other question is Black Rock gets the contract to administer 
this portfolio. It was a no-bid contract.
    Will you provide us with a copy of that contract? And, now 
that the immediate crisis has passed, will you put asset 
management out to bid, or will Black Rock receive a long-term, 
no-bid contract that would last until the portfolio is disposed 
    Mr. Bernanke. We will certainly provide you with all the 
important information, the relevant information, associated 
with our contract with Black Rock. They are one of our 
relatively few number of firms that could address the needs 
that we have; and, given the exigencies of the weekend, it was 
obviously beneficial that we could get their services in a very 
short-term notice.
    We will be reviewing these conditions and terms and try to 
ascertain whether any additional steps are necessary. I can't 
at this point, I guess at this point, it's not an immediate 
plan to change the company as they have been working very 
effectively for us. We think that it has been a good 
arrangement with them at this point.
    Mr. Sherman. Well, now that there's not a crisis situation, 
wouldn't you want competitive bidding on such an important 
    Mr. Bernanke. We will look into it.
    Mr. Sherman. Okay. I now have quite a number of questions 
for the record, because I realize my time is limited and I look 
forward to getting responses. The first is whether off-balance 
sheet financially engineered instruments oppose a risk to the 
major corporations of this country. The second is whether we 
have moved to a system of capitalism for the poor and socialism 
for the rich. The pizzeria in my district that goes out of 
business, they're not going to get any kind of bailout from the 
Fed. And, the subordinated debt-holder, namely the guy's uncle 
who lent him money to start the place, he isn't going to get 
anything either.
    I understand why the Fed acted in an emergency situation, 
but now we are no longer in an emergency situation, and the 
question is what are we doing to make sure that those who 
should have borne the risk, the shareholders, the subordinated 
creditors, who are going to come out of this thing whole, even 
though they bought subordinated debt, and the regular debtors 
of Bear Stearns are not contributing and paying for this $30 
billion worth of risk that the taxpayers have borne.
    Should we, and I would like both Treasury and the Fed to 
respond to this, be looking to impose a tax on the subordinated 
creditors, on the shareholders, to recapture for the Federal 
Government a fair fee for the incredible risk that the Federal 
Government is assuming, or should we just make this huge gift 
that no private sector company would ever engage in to those 
who are thought on Wall Street to be so important, something we 
would never consider doing for a pizzeria in my district.
    The Chairman. The gentleman's time has expired.
    Mr. Sherman. Thank you.
    The Chairman. We will get, as the gentleman requested, 
responses in writing.
    The gentleman from Missouri.
    Mr. Cleaver. There are those who suggest that had Congress 
not approved the stimulus package when it did, the current 
crisis would probably be worse. There's no way to tell for sure 
whether they are accurate or not.
    But I'm curious about your position on the talk now about 
stimulus package no. 2, which might include an extension of 
employment insurance and perhaps even deal with some of the 
issues that we failed to deal with in the first stimulus 
package, like infrastructure construction, where the Federal 
Government funds infrastructure projects and the local 
communities are able to go out and hire.
    And in addition to that, also predicting that the 4th 
quarter will look very, very bleak, and that the positive 
benefits from stimulus no. 1 are fading. So they would suggest 
that there is a need for stimulus no. 2. Do you agree with 
those who are encouraging stimulus no. 2?
    Mr. Bernanke. Well, it's a preliminary matter of fact. I 
think UI extension was in fact--is that passed, or is that--
    The Chairman. It has been signed; it is part of the 
    Mr. Bernanke. Yes. So that part has been--
    The Chairman. That was signed, not cheerfully, but it was 
    Mr. Bernanke. That has been done. I think it's just a bit 
early. The stimulus package no. 1, as you call it, is only now 
really beginning to feed into consumer incomes. Our sense is 
that it is being helpful. We have seen consumer spending hold 
up, despite a lot of other concerns. But I guess my inclination 
would be to wait a bit longer to see: (a) if the economy begins 
to strengthen on its own; and (b) to assess the effects of the 
stimulus that has already been put into the system.
    Mr. Cleaver. Well, as we talk about systemic action, I mean 
do we wait until we get into the 4th quarter and realize--
    The Chairman. Could I say again that we are going to have 
the Chairman back next week on Humphrey-Hawkins, when this will 
be very much the center of the discussion.
    Mr. Cleaver. Yes. This will be more appropriate at that 
time. Thank you, Mr. Chairman.
    The Chairman. Mr. Ellison, I'm going to miss the previous 
question on the Washington Rochambeau myself. I think my 
constituents will forgive me. We are going to end soon. You 
know, members, that the vote is about to end. It is the 
previous question on the rule for the Washington Rochambeau or 
whatever it is. I'm going to stay here, so anyone who wants to 
stay and ask questions can do that.
    The gentleman from Minnesota?
    Mr. Ellison. Mr. Chairman, a lot of my questions do have to 
do with Humphrey-Hawkins--
    The Chairman. Well, then we will take it back. The 
gentleman from Indiana?
    Mr. Donnelly. Thank you very much, and thank you both for 
being here.
    I'll ask a question real quick, because I do have to vote. 
Do you think that the immense amount of monies being sent 
overseas for energy purchases weakens the dollar? And that it 
almost becomes a vicious cycle that we are defunding ourselves, 
the dollar weakens, oil increases even more because the dollar 
weakens, and then it just keeps going around?
    Secretary Paulson. You know, that's interesting. I have 
heard a number of people say that one of the reasons the price 
of oil has gone up so much is the dollar has depreciated. And 
yet when you look at the statistics, look at what has really 
happened, if you go back to February of 2002, the dollar has 
declined in value 24 percent, the price of oil gone up over 500 
percent. And so again, I really think the price of oil is being 
driven by supply-and-demand factors, and the real solution here 
is to address both. There is not an easy, short-term solution, 
but there is a lot that has to be done.
    Mr. Donnelly. And if I could just ask you real quick, do 
you think it's dangerous that there has been such a transfer of 
wealth for energy purchases to our country?
    Secretary Paulson. Well, I would say this: If you're asking 
me whether we should have greater energy security in this 
country, the answer is, you betcha. And we have a lot to do. 
And there are things, this is subject to self-help. There are 
things we can do ourselves right now in this country in terms 
of development of oil resources and things we can on the 
conservation and efficiency side and alternative sources of 
    Mr. Donnelly. Okay. Thank you.
    The Chairman. The gentlewoman from California?
    Ms. Speier. Thank you, Mr. Chairman. Thank you, Secretary 
Paulson and Chairman Bernanke, for your service during this 
particularly difficult time in our country's financial history. 
I'm one of the newer members, as you can tell by my seating 
here, so maybe I have a little license to ask some dumb 
    I guess to you, Mr. Chairman, the investment banks are now 
eligible to access money through the discount window. Unlike 
the commercial banks that are subject to much regulation, they 
are not. And I want to know if you intend to put any 
regulations on the investment banks that the commercial banks 
presently have.
    Mr. Bernanke. Congresswoman, we are already doing that. The 
SEC has been their oversight regulator for some time, and they 
have tried to apply rules very similar to the ones that are 
applied to commercial banks, in particular the Basel II Capital 
Rules. Since we began lending to the investment banks, the 
Federal Reserve has also had people onsite, collaborating with 
the firms and with the SEC to make sure that those firms do 
meet safety and soundness standards.
    So in fact we are doing that now, and in my statement I do 
think, though, that it is something of an ad hoc arrangement, 
and I do think that the Congress ought at some point to clarify 
what the supervisory regulatory responsibilities are with 
respect to the investment banks.
    But we are already doing most of what you're suggesting in 
that we are onsite in those firms, working with the SEC to make 
sure that the investment banks meet the appropriate standards 
of safety and soundness.
    Ms. Speier. Well, the Washington Post editorial today would 
suggest that is not the case. And in fact, it was entitled 
``Bail Out Ben,'' which I guess is attributed to you. But the 
point being made in the editorial was that there is money being 
made available without strings attached to investment banks. 
And you're saying that is not the case.
    Mr. Bernanke. No, it's not the case. We are there and we 
have expectations for their capital liquidity and risk 
management. I think the way I would have interpreted some of 
the concerns is that, as I said, this is sort of an ad hoc 
arrangement. You know, we have joined the SEC in looking at 
these firms because we made the loans. No one intends us to be 
the long-term, permanent arrangement. And I think what the 
thrust of that editorial was that Congress needs to begin to 
clarify its views on how they would like to see these firms 
supervised, going forward.
    Ms. Speier. So how do we make sure that investment banks 
don't continue to take undue risk, because we now have a 
history where the U.S. Government has bailed them out?
    Mr. Bernanke. Well, again, there are several ways of doing 
    The first is prudential supervision, a consolidated 
supervision, where you're there and you make sure that they 
meet the appropriate standards. If the capital regulations tie 
the amount of capital they hold to the risk that they take, so 
if they want to take bigger risk, they have to hold more 
capital. So by ensuring through prudential supervision on 
capital and liquidity and risk management, we can ensure--well 
not ensure, but at least make much more likely that those firms 
won't get into trouble or take excessive risks in the future.
    Secondly, I suggested in my testimony a few other steps we 
can take to make the system as a whole stronger, so that should 
the time come, if a Bear Stearns were to ever happen again, 
unlike in March, when we just felt that the system was not 
strong enough, resilient enough to suffer the consequences of 
that, we might be able to make a different decision in the 
future, because we would say this is something that the system 
can absorb.
    So, as I have noted earlier, along with our lending 
decisions, we have also been looking at ways in which we and 
the Congress can move forward to make sure that there's a 
commensurate supervision that balances out whatever lending 
privileges the investment banks get.
    Ms. Speier. Mr. Chairman, I would like to just point out 
that there probably is some action that we should take as the 
committee sooner than later, as it relates to the authority of 
the Fed over investment banking institutions, because another 
Bear Stearns can happen, it could happen in the course of 6 
months while we are campaigning for re-election. And if it's as 
important as you say it is to get some authority in place, so 
it's very clear, I would think that would be one priority--
    The Chairman. Well, if the gentlewoman would yield, I would 
disagree with her. And I think frankly it's a disservice to 
suggest that they don't have the authority. They had it under 
Bear Stearns, and I don't think we should be suggesting--in 
fact I think there is an agreement here that they do have the 
authority--it's not as perfect in many ways as they want it to 
be, but they did for Bear Stearns. I have talked to the 
agencies, and people have talked about this, but I haven't seen 
anybody draft anything. There are a whole lot of people ready 
to write, but they are in favor apparently of somebody else 
drafting this legislation.
    Anybody is free, of course, to introduce a bill or do 
whatever they want. But I do think it's a disservice to suggest 
that there's a shortfall in authority now. I believe that with 
the memorandum and with the work we have done together, and 
with the support that they would get from us, so that no one 
would think they could end run things, that we are capable of 
getting through this. And if someone things he or she can write 
a bill that we can pass that quickly, obviously, everybody has 
that right.
    I am very skeptical, and I think beginning a process and 
getting it bogged down in the Senate or elsewhere is more 
likely to cause uncertainty than saying, ``Look, we have gotten 
this far, we will continue to work this way together.''
    Other members are free, if they want to write up something 
and try to offer it. The Departments are free to do it. The Fed 
is free to do it. I think the fact that no one has done it is a 
recognition of reality.
    Ms. Speier. Mr. Chairman, I recognize that I have very 
little expertise in this area at this point. But I do sense 
from our two speakers that there is a sense of urgency that we 
need to act. And I just want to make sure that we are not in a 
situation in a few months where there is a need to act--
    The Chairman. Well, I want to respond. I very much disagree 
with gentlewoman's statement. As we made clear at the 
beginning--I don't know if the gentlewoman was here for the 
whole hearing.
    Ms. Speier. I was--
    The Chairman. We addressed that early on, and they said--
and I don't think that should be undercut--that the authority 
that we have had so far is still there. I think it is a mistake 
to suggest that there is a lack of authority, and yes, we all 
agree that there is an urgency. The Treasury has not and the 
Federal Reserve has not asked us specifically to do something. 
And I think that is in recognition that it is best for 
everybody out there to understand that we are going to continue 
as we have been, pending this situation until we can do new 
    And the likelihood of being able to do this very 
complicated subject--and I would say this: Doing it and then 
redoing it would be, I think, a very bad idea. I think the 
instability that would be there would be a mistake.
    So as I listen to our two witnesses, their view is that in 
an ideal world, we would have more authority, but that we are 
able to continue working together as we have been, with the 
SEC, with them and with us. And as I said, I think it's a great 
mistake to suggest that there is going to be some crisis we 
can't handle. We did handle Bear Stearns, and I think we will 
be able to deal with others.
    Ms. Speier. I yield back.
    The Chairman. The gentleman from Massachusetts?
    Mr. Capuano. Thank you, Mr. Chairman.
    Mr. Secretary and Mr. Chairman, first of all, thank you for 
coming. And I apologize. My plan today was to be here for the 
entire hearing. Unfortunately, I had to go to the--
    The Chairman. No. It was at my request. The gentleman from 
Massachusetts was accommodating my request to handle bills on 
the Floor. It was not his fault.
    Mr. Capuano. I don't mind, and it has nothing to do with 
the chairman. It got embroiled in some political chicanery and 
I got stuck. So I apologize.
    But I do want to ask--first of all I want to make it very, 
very clear that I support almost everything you have done and 
are discussing doing. Both of you I think are doing a great 
job. I think both of you are talking about the things you need 
to talk about. I think both of you are on the right path to 
where we need to go. I know how difficult it's going to be to 
get there. I know now controversial it is to some. I'm not so 
sure we are all going to agree on every detail, but that's not 
    The concepts you are talking about, in my opinion, are 
exactly the right concepts that we should be talking about. I 
personally think we should have been talking about them years 
ago, but we will let that dog lie for a while, and we will just 
move forward.
    So I'm looking forward to getting us from where we are now 
to where we need to be.
    I do want to talk about a couple of specific items, though, 
that have been concerning me--especially relative to the Fed. I 
believe--I agree with the chairman--I believe that you have the 
authority to have done what you have done thus far. Under the 
unusual and exigent circumstances language, I believe that. I 
agree with what you have done; I think it's fine.
    However, it does raise serious questions. I think you know 
that. And I believe that moving forward, we will try to address 
those on a more permanent basis.
    My concern is in the meantime--you have seen this today, 
and I haven't seen the debate here today, but I have heard it a 
thousand times--there are a lot of people here that every time 
you hint at this much more oversight or regulation, they go 
absolutely berserk and somehow that's anti-American, and it's 
going kill the entire capitalist system, and the world will go 
to hell in a hand basket. I'm not like that; I believe that 
reasonable, fair, clear regulation actually helps the 
capitalistic society, and I think it's a good thing
    Between now and there, I'm deeply concerned of what we are 
going to do and what we have, and I am particularly concerned 
with the--it's not the amount, but the amount combined with 
what I see is the lack of requirements that the Fed is putting 
on those people who are coming to all the different windows 
that you have created. They are huge amounts of money.
    In the last 6 months, by my figures, the Fed has, all 
totalled, loaned out, give or take, over $3 trillion, which is 
more than 100 times more than you loaned out the previous 6 
months. I'm not complaining about it. I think it's necessary. I 
think it's fine. I don't think it's unstable. I think it's the 
right way to go. But it's a huge amount of money. And almost 
all of that money has gone out with virtually, in my opinion, 
minimal at best, if any, requirements.
    I would argue--and I would ask your opinion--I would 
suggest that since you have the power to loan the money--you do 
not have the power, and I agree, to impose regulations on 
people before they get to the window--but I do believe that as 
a condition of the loan, you do have the ability to impose, not 
regulation but conditions of the loan that may look like 
regulations to some, that simply allows those people who come 
to the window to say, ``Hey, if I want the money, I will meet 
these requirements,'' whatever they might be. Capital 
requirements--and I trust your judgment as to what they might 
be; I know you would do it in conjunction with the Secretary 
and others--and I'm just curious, do you believe, do you agree 
or disagree that you currently have the authority, if you chose 
to use it, to put very clear, very concise conditions--not 
regulations, but conditions--on the loan that hopefully would 
lead us and my colleagues to know where you might want to go, 
if we gave you the authority--which I would be happy to do--if 
we gave you the authority to have those regulations before they 
got to the window?
    Mr. Bernanke. Well, Congressman, there are two classes of 
firms that are borrowing from us. There are the commercial 
    Mr. Capuano. Right.
    Mr. Bernanke. --which already have a well-established 
regulatory structure and a set of regulators. And we are, of 
course, along with our fellow regulators, working hard to make 
sure that they have adequate capital and that they are taking 
all the steps necessary.
    Mr. Capuano. Right.
    Mr. Bernanke. The investment banks have had a more ad hoc 
relationship because we have been working with the SEC, as you 
know. But as I have mentioned, between us we have made strong 
demands on the firms. We have insisted that they raise their 
liquidity holding in particular, because that turned out to the 
major point of vulnerability for Bear Stearns. And we have also 
asked them to raise their capital, to improve the practices of 
risk management, and so on.
    So we are doing very much the same kind of thing between 
the Fed and the SEC in the investment banks that we and other 
regulators already do in the commercial banks. So there is a 
quid pro quo that if we are going to lend to you, you have to 
take steps to--
    The Chairman. The gentleman from Massachusetts earned a 
waiver of the 5-minute rule. So if he has any further 
    Mr. Capuano. Thank you, Mr. Chairman.
    I'm glad to hear that. I agree with it. I would personally 
like to see it in a more organized fashion as opposed to--and I 
understand that you're still running quickly to get where you 
want to go.
    And Mr. Secretary, I would ask you--I mean I know you're 
very familiar with what the Fed is doing--do you agree with 
what the Chairman has said, and do you agree with the general 
format that they're operating under?
    Secretary Paulson. I couldn't agree more. I agree totally. 
This is an example of regulators coming together to transcend 
some of the issues in the regulatory system. And again, the 
emphasis that the Fed and the SEC are placing on the investment 
banks is one that is different from commercial banks, because 
the issues here are different and the focus has been more on 
funding and liquidity. I strongly agree with that, and I have 
been gratified to see some of the improvements that are 
    Mr. Capuano. One of the reasons I ask--actually the main 
reason--I believe that if these requirements were put in a more 
formalized fashion, there would be more uniform, as opposed to 
each time you come to the window--I actually--maybe I'm wrong--
but I think it would actually help the market, it would help 
some of my friends who might have some concerns about the 
concept of regulation. And I think it would actually help some 
of the stabilization.
    I know you have addressed some of the issues, some of the 
so-called rumors about Fannie and Freddie today, and as I 
understand it, you have addressed those issues that, you know, 
some people are concerned that capital requirements are going 
to go through the roof, and they're going to get shaky. It's my 
understanding that has been addressed and clarified.
    At the same time I think that if there were formalized 
regulations across the board--not regulations, I shouldn't use 
the word--formalized requirements for a loan, then I would 
argue that they would help stabilize the market.
    And the other question I want to ask--and again I 
apologize--but just a few days ago there was a story in the 
paper that concerned me deeply. I raised it yesterday, and I'm 
going to raise it again today with you. I read--again, it's 
only on the basis of news reports, I have not yet had an 
opportunity to get beyond the news reports, so forgive me if 
anything I say is wrong--but I read that the SEC is considering 
basically for all intents and purposes adopting international 
accounting standards--a little overstatement, maybe a little 
overreaching for that--but going much further along that way, 
doing it relatively quickly, hopefully I guess theoretically 
before the term ends or the current chairman.
    My concern with that is, I'm not opposed to moving 
thoughtfully and steadily towards international accounting 
standards, but I am deeply concerned that to simply say 
American regulators no longer have authority here, and the 
American regulations, just in yesterday's news, were going to 
international regulations like this, that it would undermine 
many of things you are currently doing to try to stabilize the 
    It raises questions on how do we make the transition. It 
raises questions on transparency. It raises questions on 
investor protections. And I think it raises questions on 
whether we have the ability or the authority to somehow 
regulate our own financial markets.
    I know it's not directly what you're doing, but I ask: Are 
you familiar with what the SEC is doing on this issue? And if 
you are familiar, I would like to know what your initial 
opinion is of the matter.
    Secretary Paulson. Yes. I would say I'm familiar and I'm 
supportive of it. And I thought that statement was--I read the 
same press report, and I didn't agree with the way it was 
slanted--that what the SEC is doing is moving toward greater 
convergence in accounting and acceptance, and they're 
concentrating on those accounting regimes where the standards 
and the qualities are very similar to what we see in the United 
States and in the principals. So I'm supportive.
    Mr. Capuano. Mr. Chairman?
    Mr. Bernanke. Well, there are two elements. One is that 
FASB and the International Regulatory Accounting Board are on a 
convergence path already. They've set goals to essentially be 
the same or very similar within a couple of years. And so that 
process is useful and taking place.
    As I understand it, the SEC's action is to give 
internationally active companies a choice--this doesn't apply 
to all U.S. firms but to companies that already have to do the 
international standards, can they avoid having a duplicate set 
of books, essentially, using the FASB standards? And that seems 
to make sense in terms of giving, you know, more incentive for 
foreign companies to operate in the United States, for example.
    So long as the system that we are looking at is one that we 
are comfortable with and is very similar to FASB, I don't think 
it creates necessarily any major problems with either 
accounting system or our regulatory system.
    The Chairman. Can I--let me just speak. The Secretary 
referred to some, I thought, questionable things in the 
article. Nothing in that, as you have described it, Mr. 
Chairman, to allow either set to be done would, for instance, 
waive any part of the Sarbanes-Oxley or non-account or any 
other regulation. I don't think that was clear from the 
article. So is that correct?
    Secretary Paulson. I didn't mean to cast aspersions on the 
article. I'm just saying I read the article quickly--
    The Chairman. It's okay to cast aspersions on articles. 
Free speech works both ways.
    Secretary Paulson. And again, as I look at accounting, we 
have by industry different accounting standards. We have 
different accounting standards for different financial 
institutions. It's hard to say there is one--
    The Chairman. But it does not--that decision about mutual 
recognition would not relax any other regulatory standards.
    Secretary Paulson. No.
    Mr. Capuano. Let me just say--Mr. Chairman, if I might.
    The Chairman. Yes.
    Mr. Capuano. I actually have the article. And I would 
suggest it didn't imply anything. Again it's an article, but 
it's an article from a reputable source. It says very clearly--
and again, it's an article, and that's why I caveat it right up 
front and I haven't had a chance to talk to the SEC about it--
but it says it would ``permit American companies to shift the 
international rules which are set by foreign organizations and 
give companies greater latitude in reporting earnings.''
    Now that alone right there--greater latitude in reporting 
earnings after our Enron mess and all the mess that we have 
right now--if that doesn't raise hackles on the back of your 
neck, I don't know what does. After all the work that you have 
done to try to stabilize the books and stabilize--and again I'm 
not saying the article is right, I'm simply saying if that is 
    And it goes on to say that it enabled companies, for 
example, to provide fewer details about mortgage-backed 
securities. Now if that's correct--I don't know yet--I hope 
that raises concerns, if it's correct. If it's not correct, so 
be it. Again, I agree with the Chairman. I don't necessarily 
accept anything wholehearted, no matter how good the source.
    But those lines just in and of themselves in a relatively 
short article raised major questions in my mind that with all 
the problems we have in mortgage-backed securities right now, 
to then go into a regime now--I'm not saying that we shouldn't 
do it over time, thoughtfully one step at a time--as you 
stabilize things, we can head towards convergence, I'm all for 
it--but if this is correct, and they do it like this, I will 
tell you that I for one will have some major concerns, because 
I want you two to be able to finish what you're doing to get us 
to a more stable ground, so that we can then look to continue 
to progress in our economic status.
    Secretary Paulson. Yes. I totally--you should definitely 
talk to Chairman Cox about this.
    But the only thing I will say is that there are different 
accounting regimes that have different standards and different 
requirements that doesn't make them worse than ours. We have 
had plenty of issues in our markets, in our system, with our 
accounting regime. And so again, I think that the Chairman's 
approach is to take other countries where they have accounting 
systems and regimes, which he thinks have standards that are 
very similar to ours, the highest standards, and then allowing 
for this--
    The Chairman. Let me say--and I have to wind this up. I am 
very appreciative of the witnesses' time; they have stayed over 
time and it has been helpful. We have a hearing in 2 weeks with 
Chairman Cox and the President of the New York Federal Reserve, 
Mr. Geithner, to go over many of these same issues, and that 
obviously will be something that we will expect Mr. Cox to be 
    I would just say for the purposes of the members on the 
Democratic side of the aisle, or others listening, we will 
begin the questioning there with those who didn't get to ask a 
question today, as we will next week on Humphrey-Hawkins begin 
the questioning with those who didn't have a chance.
    Some other substantive points I wanted to make: One, I 
disagree with the gentleman from California, Mr. Sherman. 
Obviously we have a different view here. I do not think that 
competitive bidding would have made any sense in the crisis 
atmosphere regarding Bear Stearns with Black Rock. Two, I don't 
think that people thought this was the most desirable 
assignment ever set up. And three, to now disrupt what Black 
Rock is doing and put it out to bid, I think, would be very 
disruptive. So I think--I would also add that the Government 
Operations Committee had requested some information about this, 
and the Chairman of the Federal Reserve did respond very 
appropriately to their inquiries.
    I understand that there are questions about urgency. I 
guess a lot of people believe in urgency in principle, but not 
on paper. And you can't be urgent in theory. You have to be 
urgent with very specific legislation. I do not believe that it 
is either necessary or possible to deal with this complex set 
of issues with the appropriate degree of certainty or at least 
assuredness, and to do it and then have to re-do it or amend it 
a few months later, I think would be a terrible idea.
    But this is what I want to make very clear. No one should 
think that we here in the Congress are available for end-runs. 
We have a situation where the SEC and the Federal Reserve and 
the Treasury and other regulators will be putting together 
their various powers, so that if crises arise they can be met. 
I believe we have sufficient power now to get through the 
crisis. We don't have sufficient power, frankly, to avoid some 
of the crises. And that, I think, is a distinction.
    We have the power to respond if there are crises. What we 
are looking for are rules that will make the crises less 
likely. And I think that is a very high priority. We will begin 
working on this. Work we begin now--frankly if we were to 
decide to do it now, I don't think we could get it finished 
just in terms of the complexity of the issues and the hearings 
and the bills in both Houses.
    But we are going to start now, and I hope that early next 
year we will able to complete it. But I don't want anyone to 
think that there are somehow loopholes that they can run 
through, and that they might get some cooperation here. I think 
we have all worked together very cooperatively when it comes to 
the crisis situation, and I believe that we will be able to 
continue to do that.
    I thank the Chairman and the Secretary, and the hearing is 
now adjourned.
    [Whereupon, at 1:17 p.m., the hearing was adjourned.]

                            A P P E N D I X

                             July 10, 2008