[Senate Hearing 110-958]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 110-958


      THE STATE OF THE UNITED STATES ECONOMY AND FINANCIAL MARKETS

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                                   ON

      THE STATE OF THE UNITED STATES ECONOMY AND FINANCIAL MARKETS


                               __________

                      THURSDAY, FEBRUARY 14, 2008

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate /
                            senate05sh.html



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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware           CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey          JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii              MIKE CRAPO, Idaho
SHERROD BROWN, Ohio                  ELIZABETH DOLE, North Carolina
ROBERT P. CASEY, Pennsylvania        MEL MARTINEZ, Florida
JON TESTER, Montana                  BOB CORKER, Tennessee

                      Shawn Maher, Staff Director
        William D. Duhnke, Republican Staff Director and Counsel
                       Dawn Ratliff, Chief Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor







                            C O N T E N T S

                              ----------                              

                      THURSDAY, FEBRUARY 14, 2008

                                                                   Page

Opening statement of Chairman Dodd...............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     5
    Senator Johnson
        Prepared statement.......................................    52
    Senator Dole
        Prepared statement.......................................    53

                               WITNESSES

Henry M. Paulson, Jr., Secretary, Department of the Treasury.....     6
    Prepared statement...........................................    55
    Response to written questions of:
        Senator Akaka............................................    68
        Senator Tester...........................................    70
        Senator Crapo............................................    71
        Senator Dole.............................................    72
Ben S. Bernanke, Chairman, Board of Governors of the Federal 
  Reserve System.................................................     8
    Prepared statement...........................................    57
    Response to written questions of:
        Senator Crapo............................................    72
        Senator Tester...........................................    73
Christopher Cox, Chairman, Securities and Exchange Commission....    10
    Prepared statement...........................................    62
    Response to written questions of:
        Chairman Dodd............................................    74
        Senator Akaka............................................    89
        Senator Crapo............................................    91

              Additional Material Supplied for the Record

``A Building Storm: The Housing Market and the Pennsylvania 
  Economy'', Mark Price and Stephen Herzenberg, The Keystone 
  Research Center................................................    94

 
      THE STATE OF THE UNITED STATES ECONOMY AND FINANCIAL MARKETS

                              ----------                              


                      THURSDAY, FEBRUARY 14, 2008

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:10 a.m., in room SR-325, Russell 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. Good morning. Let me first of all welcome 
everyone here this morning to this hearing on the state of the 
economy and capital markets. A couple of things, if I may.
    What I would like to do this morning, given the limited 
amount of time--we have got a couple of hours. The Secretary 
has, I know, an appointment at noon, or thereafter, and I am 
confident the other two witnesses probably do as well. Normally 
what we would do is allow everyone here to make opening 
statements. Needless to say, the simple math, it would probably 
eat up the 2 hours. I see smiles now appearing on the 
witnesses' faces at the prospect of listening here for 2 hours 
to all of us make statements about the state of the economy.
    What I would like to suggest--and it is merely a suggestion 
here--is that I make an opening statement, Senator Shelby make 
an opening statement, and then we will get right to the 
statements of our witnesses, and then go to questions and use 
the question period to make any comments you would like to, as 
well as engage in the questions you would like to ask of our 
witnesses. That may allow us to move along in that period, 
which I think is probably the most interest to most Members.
    Second, when we end up with a quorum here, I want to 
apologize to my colleagues, but we need to re-vote the ILC bill 
yesterday. Under the rules of this Committee, if there is not a 
majority of the majority present at the time the vote occurs, 
then the vote does not count in the sense. We had only 12 
people here. It was a 6-6 vote. And so we have to re-vote the 
issue under the rules, and I apologize to my colleagues. We did 
not have 13 Members, so we did not have a majority of the 
majority on that issue present at the time. As soon as a 
majority arrives, we will do that. All statements, by the way, 
will be included in the record. If people have any opening 
statements or information you want to include in the record, I 
will make sure that is all included.
    With that, let me proceed with some opening comments 
quickly, turn to my colleague Senator Shelby, and then we will 
get right to our witnesses this morning.
    This is a historic room, of course. We were talking 
outside; there have been many historic hearings that have been 
held in this room. I remember as a child being here watching my 
father actually chair hearings on violence in television back 
in the late 1950s, early 1960s. President Kennedy and Robert 
Kennedy announced their candidacies for the Presidency in this 
room. The Watergate hearings, Teapot Dome, the McCarthy 
hearings--this is a historic room, so maybe some historic 
suggestions this morning here from our witnesses might be an 
appropriate response.
    Anyway, today the Committee meets to discuss the state of 
our Nation's economy and capital markets. We are very pleased 
to welcome before the Committee three of the country's leading 
economic figures: Secretary of the Treasury Hank Paulson, 
Federal Reserve Chairman Ben Bernanke, and Securities and 
Exchange Commission Chairman Chris Cox. And we welcome all 
three of you.
    Gentlemen, thank you for coming before us today, and I want 
to note that the last time the heads of all three of these 
agencies appeared jointly before this Committee to discuss the 
state of our Nation's economy was in the immediate aftermath of 
the tragic attacks of September 11, 2001. And while the 
challenges that the Nation's economy faces today are very 
different from those we faced then, today's economic challenges 
are, unfortunately, no less serious. I think we would all agree 
on that.
    The current economic situation is more than merely a 
slowdown, in my view, or a downturn. It is more even than a 
mere recession--or near recession, I might add. Instead it is a 
crisis of confidence, I feel, among consumers and investors. 
Consumers are fearful of borrowing and spending. Investors are 
fearful of lending. Financial transactions which generate new 
businesses and new jobs are shrinking in number and in size.
    The incoming economic data shows how serious the problem 
is. The Nation's economy slowed to a near standstill in the 
fourth quarter of last year, with overall GDP growth by less 
than 1 percent, and private sector GDP growing only one-tenth 
of 1 percent. The country had a net loss of jobs in January, 
the first time we have had a loss of jobs of that nature in 
over 4 years. Incoming data on retail sales have been very 
weak, and most projections for economic growth this year have 
been revised down sharply. Credit card delinquencies are on the 
rise, as consumers find themselves increasingly unable to tap 
the equity in their homes to pay down credit card debt and 
other bills.
    Last, inflation increased by 4.1 percent last year, the 
largest increase in 17 years, driven mainly by the rise in 
costs of energy, food, and health care. Industrial production 
is falling, and we have been hemorrhaging jobs in the 
construction and manufacturing sector. This decline has been 
reflected in falling stock prices and increased volatility in 
the securities markets. Our economy is clearly in trouble, in 
my view, and the most important thing we can do right now is 
restore that consumer and investor confidence, which is 
absolutely critical if we are going to get back on our feet 
again.
    To that end, I want to commend Fed Chairman Bernanke for 
taking an active role in addressing the weakness in our 
economy, for injecting much needed liquidity, and cutting 
interest rates. I am also pleased that the administration and 
the Congress have been able to reach agreement on a stimulus 
package that provides some support for working families who are 
bearing the brunt of these difficult times. However, more needs 
to be done, in my view, to address the root cause of our 
economic problems, and I say respectfully that includes by the 
three agencies led by our witnesses here this morning.
    The catalyst of the current economic crisis in my view is 
the housing crisis. The housing starts are at their lowest 
levels in a quarter of a century. The inventory of existing 
home sales is nearly at 4 million units--almost double the 
number in January of 2005. This is equal to about 10 months of 
supply. And while many of us have experienced home price drops 
in our own States and regions, overall 2007 was the first year 
since data has been kept that the United States had an annual 
decline nationwide in home and housing prices. A recent Moody's 
report forecasts that home sales will drop in 2008 by as much 
as 10 to 15 percent--in fact, even in 2009 an additional drop. 
Others are predicting similar declines in 2009, as I just 
mentioned. This will be the first time since the Great 
Depression that national home prices will have dropped in 2 
consecutive years.
    If the catalyst of the current economic crisis is the 
housing crisis, then the catalyst of the housing crisis is the 
foreclosure crisis. This foreclosure crisis was triggered by 
what Secretary Paulson himself has called ``bad lending 
practices,'' and I commend him for making that statement. These 
are lending practices that no sensible banker would ever engage 
in. Reckless, careless, and sometimes unscrupulous actors in 
the mortgage lending industry essentially allowed loans to be 
made that they knew hard-working, law-abiding borrowers would 
not be able to repay. And they engaged in practices that the 
Federal Reserve in previous years under different leadership 
under the Bush administration had absolutely nothing--did 
nothing effectively to stop, in my view.
    The problems were compounded by inaccurate and misleading 
corporate disclosures and asset valuations, inflated credit 
ratings, and poor risk management, so investors could not act 
as a check on these problems. As a result of failures 
throughout the chain of mortgage finance from origination to 
securitization, foreclosures are at record levels. There are 
1.5 million homes that are seriously delinquent or in 
foreclosure right now. And what we have seen--and we have not 
seen the worst of it.
    Economist Mark Zandi estimates that 3 million homes will 
default between 2007 and mid-2009, and 2 million of those homes 
will end up in foreclosure. This crisis affects more than 
families who lose their homes. Property values for each home 
located within one-eighth of a square mile of a foreclosed home 
will drop by an average of $5,000. This will affect somewhere 
between 44 and 50 million homes.
    The foreclosure crisis could result or will result in an 
increased demand for social services, obviously, police and 
fire and further services to ameliorate the impact of increases 
in foreclosures and abandoned property. Yet State and local 
governments will have fewer resources with which to meet these 
demands as property values and tax collections drop. Localities 
could lose as much as $4.5 to $5 billion in property taxes and 
other revenues due to this wave of foreclosures.
    Any serious effort to address our economic woes must 
include, in my view, an effort to take on the foreclosure 
crisis. That is a crucial step toward restoring the confidence 
of consumers and investors in our economy.
    We on this Committee have already taken several steps to 
address these problems, and I want to thank Senator Shelby and 
Members of the Committee for their efforts. We worked to reform 
the FHA program and passed FHA modernization legislation 
through the U.S. Senate by a vote of 93-1. Now we need to make 
sure that this becomes law. We have appropriated close to $200 
million to facilitate foreclosure prevention efforts by 
borrowers and lenders. In addition, the recently enacted 
stimulus package includes a temporary increase in the 
conforming loan limits for GSEs to try and address the problems 
that have spread throughout the credit market into the jumbo 
mortgage market. While this is helpful, we still need to 
implement broad-based GSE reform, and I am committed to doing 
just that. As I have told the Secretary and others. Certainly 
Senator Shelby and Members of this Committee I have mentioned 
that to as well. And I have spoken about my belief in the need 
for additional steps to mitigate the foreclosure crisis in a 
reasonable manner. These steps include targeting community 
development block grants to communities struggling to counter 
the impact of foreclosed and abandoned properties within their 
communities, and they include establishing a temporary 
homeownership loan initiative, either using existing platforms 
or a new entity that can facilitate mortgage refinancing.
    But it is not just the Congress that needs to do more. The 
administration, including the agencies represented here this 
morning, I think need to do more as well--much more. Almost a 
year ago, I convened, with Senator Shelby, a summit of leading 
lenders and servicers. The attendees at that summit agreed to a 
set of principles that requires them to create a permanent, 
affordable solution, wherever possible, for at-risk borrowers. 
Unfortunately, the administration has been working, in my view, 
at cross purposes with us. Instead of helping us hold leaders 
and servicers to the commitments that they made back in the 
spring of 2007, they have, in essence, sanctioned backsliding 
from the kind of aggressive, broad-based effort that is more 
urgently required by the day. The latest administration effort, 
dubbed ``Lifeline,'' is a lifeline more to lenders than to 
borrowers, in my view, and the Treasury Department, HUD, and 
others in the administration need to do more.
    Similarly, the Federal Reserve as the lead financial 
regulator needs to break with its past and become more vigilant 
about policing indefensible lending practices. Now, I want to 
commend the Chairman of the Federal Reserve when last year the 
Fed finally accepted its duty under the Homeownership and 
Equity Protection Act to protect consumers from unfair and 
deceptive lending practices, and there were many steps taken 
and recommendations made in those regulations which I strongly 
agree with. The Chairman and I have talked about this. We have 
some disagreements about some of those suggestions, and I 
applaud the efforts, but my hope is that they will strengthen 
them in the coming days so that we can deal with some of these 
problems that have persisted and caused, as the Secretary of 
the Treasury has pointed out, bad lending practices that led us 
to this situation we are in today.
    As for the SEC, I want to commend Chairman Cox--Chris--for 
the oversight and credit rating agencies and for enforcement 
efforts related to subprime-related cases. But here, again, I 
think greater vigilance is urgently needed. The SEC needs to 
help restore investor confidence in the markets by more 
vigorous enforcement, by more comprehensive regulation of 
credit rating agencies, and increased accountability and 
transparency of publicly traded companies that are engaged in 
the mortgage finance system.
    Despite these unprecedented challenges, I remain confident 
in the future of the American economy. We may need to change 
some of our policies, regulations, and priorities. But the 
ingenuity, productivity, and capability of the American worker 
and entrepreneur ought to never be underestimated. I look 
forward, of course, to working with the Ranking Member, Senator 
Shelby, and other Members of this Committee so we can move 
forward on some of these critical issues, as well as working 
with the administration, the Department of the Treasury, 
obviously the Federal Reserve, and the SEC to restore that 
sense of confidence and optimism that is so critical to 
economic growth and prosperity in our country.
    With that, let me turn to Senator Shelby for some opening 
comments, and then we will turn to our witnesses.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you. Thank you, Chairman Dodd, for 
calling today's hearing on our financial system and economy. 
This is an opportune time to discuss the challenges that our 
economy faces in our housing and financial sectors. We have a 
distinguished panel here today to provide us with their 
perspectives regarding the current and future economic 
conditions.
    Mr. Chairman, one thing that is now clear to all of us is 
that the subprime problems are not contained. Sectors of the 
global financial system have lost confidence largely due to the 
subprime mortgage problem. Financial institutions in the U.S. 
and abroad have lost billions of dollars and have had to raise 
new capital as a result. Concerns about the valuation of assets 
have led financial institutions to become reluctant to borrow 
or lend money within the system.
    We are seeing signs of an economic slowdown. After several 
years of rapid expansion, the housing sector is now paying the 
price. Residential investments have declined for eight straight 
quarters. The most recent Blue Chip Economic Survey forecasts 
growth for this year at 1.7 percent when just a month ago they 
forecasted a 2.2-percent growth. The blue chip forecasters now 
see the recession's odds at almost 50 percent, although the 
majority of them continue to say a recession will be avoided.
    The administration and our financial regulators have taken 
a variety of actions intended to address the weakness in the 
housing sector and the slowdown in our overall economy. The 
Congress has already enacted and the President has signed an 
economic stimulus package. Even if every consumer spends their 
rebate check, I believe the impact to the overall economy will 
be negligible. I have equated it to pouring a glass of water in 
the ocean and expecting it to make a difference. I hope I am 
wrong.
    It will have one effect that is undeniable, however. It 
will put more debt on our children and grandchildren because we 
are borrowing the money to pay for it. And, yes, a year from 
now it is going to help balloon our deficits. Unfortunately, we 
may never know whether the benefit was worth the cost.
    Certainly, Mr. Chairman, the effects of these actions will 
take some time to work their way through the economy. I look 
forward to hearing from our witnesses this morning as to what 
factors they will be watching to judge the success of these 
efforts.
    Mr. Chairman, as we consider what action we may take, my 
hope is that we will take the time to examine thoroughly all 
facets of market conditions. Any Federal intervention I believe 
should be carefully considered and targeted to encourage and 
reward the right behavior. The market is already punishing 
certain risky behaviors at all levels, and it is not 
necessarily the American taxpayers' responsibility to mitigate 
those risks.
    I thank our witnesses for being here today, and I look 
forward to their views and other issues.
    Chairman Dodd. Thank you, Senator, very, very much.
    I will turn to you, Secretary Paulson. Thank you for being 
with us this morning.

 STATEMENT OF HENRY M. PAULSON, JR., SECRETARY, DEPARTMENT OF 
                          THE TREASURY

    Secretary Paulson. Thank you, Chairman Dodd, Senator 
Shelby, Members of the Committee. Thank you very much for the 
opportunity to be here today. I am pleased to appear with my 
colleagues Chairman Bernanke and Chairman Cox. I appreciate 
their leadership on the challenges confronting our economy and 
capital markets and look forward to continued close, productive 
working relationships.
    The U.S. economy is fundamentally strong, diverse, and 
resilient, yet after years of unsustainable home price 
appreciation, our economy is undergoing a significant and 
necessary housing correction. The housing correction, high 
energy prices, and capital market turmoil are weighing on 
current economic growth. I believe that our economy will 
continue to grow, although its pace in coming quarters will be 
slower than what we have seen in recent years.
    Four weeks ago, recognizing the downside risks to our 
economy and that the short-term cost of doing nothing was too 
high, President Bush called for an economic growth package to 
provide a temporary boost to our economy as we weather the 
housing correction.
    The Congress responded with bipartisanship, cooperation, 
and speed to pass an economic growth package that is temporary, 
broad-based, and will assist our economy quickly. We have 
demonstrated to the Nation and the world that we can come 
together to address the needs of the American people as we 
weather the housing downturn.
    Yesterday, the President signed the economic package into 
law, and Treasury is already working to send payments out to 
more than 130 million American households. The IRS will manage 
the current tax filing season and simultaneously prepare to 
issue these additional payments starting in early May. Payments 
will be largely completed this summer, putting cash in the 
hands of millions of Americans at a time when our economy is 
experiencing slower growth. Together, the payments to 
individuals and the investment incentives for businesses will 
help create more than half a million jobs by the end of this 
year.
    In addition to this growth plan, the Administration will 
continue to focus on aggressive action to try to provide 
alternative options to foreclosures. This includes encouraging 
the Hope Now Alliance, a coalition representing over 90 percent 
of the subprime servicing market, and nonprofit mortgage 
counseling organizations, trade associations, and investors.
    This industry-wide effort employs multiple tools to reach 
and help struggling homeowners, including streamlining able 
subprime borrowers into refinancings and loan modifications.
    The Hope Now effort is making progress. According to 
updated statistics, in the second half of 2007 the industry 
assisted 869,000 homeowners, including 545,000 subprime 
borrowers who received loan modifications and repayment plans. 
The progress rate is accelerating; the number of subprime 
modifications in the fourth quarter doubled over the rate in 
the third quarter. In Q4 alone, of the estimated 1.5 million 
homeowners of all types delinquent 60 or more days, over 
470,000 received help from their servicer, and almost 30 
percent of those received a loan modification.
    I expect that this progress will accelerate in 2008. In 
January, the industry began implementing a new framework to 
streamline mortgage modifications for able but struggling 
subprime borrowers. As announced by the American Securitization 
Forum, this framework will greatly speed the financial 
evaluation process. Borrowers who have made their initial 
payments but cannot afford the interest rate reset may be fast-
tracked for modification or refinance, allowing mortgage 
counselors and servicers to devote more time and resources to 
the more difficult cases.
    Currently, I am focusing on two aspects of this effort: 
first, on ensuring that the ASF framework is adopted throughout 
the industry so that the industry is better prepared to deal 
with the rising volume of subprime mortgage resets; and, 
second, on ensuring that the Hope Now Alliance produces timely 
metrics so that policymakers and industry participants can 
evaluate progress and make adjustments as needed.
    I appreciate this Committee's leadership and specific 
efforts to address issues that have arisen during the housing 
downturn. Finalizing the FHA modernization bill will provide 
additional tools to help homeowners, and I encourage you and 
the House to reach consensus as soon as possible. Enactment of 
GSE regulatory reform is also a very high priority for Treasury 
and the Administration, and I commend the Chairman and the 
Committee Members for your willingness to move forward 
promptly. While not under this Committee's jurisdiction, the 
Administration has also proposed legislation that will allow 
States to issue tax-exempt bonds for innovative refinancing 
programs. This tax proposal is in addition to that signed into 
law in December, which provides temporary tax relief for 
homeowners facing increased taxes due to forgiven mortgage 
debt. All of these initiatives may help mitigate the housing 
headwinds, and we remain open to other good ideas as we move 
forward.
    Treasury continues to monitor capital markets closely and 
to advocate strong market discipline and robust risk 
management. While we are in a difficult transition period as 
markets reassess and re-price risk, I have confidence in our 
markets. They have recovered from stressful periods in the 
past, and they will do so again.
    Working through the current stress is our first concern. 
Through the President's Working Group on Financial Markets, we 
are also reviewing underlying issues ranging from enhancing 
risk management to market infrastructure, to reporting and 
disclosure, to ratings and investor practices. We know a short-
term boost to our economy is needed. We also know that it is 
just as important to get the long-term policy response right.
    Thank you and I look forward to taking your questions 
later.
    Chairman Dodd. Thank you very much, Mr. Secretary.
    Chairman Bernanke, thank you for being with us.

 STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF 
                   THE FEDERAL RESERVE SYSTEM

    Mr. Bernanke. Thank you. Chairman Dodd, Senator Shelby, and 
other Members of the Committee, I am pleased to be here to 
offer my views on financial conditions, the near-term economic 
outlook, and related issues.
    As you know, financial markets in the United States and in 
a number of other industrialized countries have been under 
considerable strain since last summer. Heightened investor 
concerns about the credit quality of mortgages, especially 
subprime mortgages with adjustable interest rates, triggered 
the financial turmoil. However, other factors, including a 
broader retrenchment in the willingness of investors to bear 
risk, difficulties in valuing complex or illiquid financial 
products, uncertainties about the exposures of major financial 
institutions to credit losses, and concerns about the weaker 
outlook for the economy, have also roiled the financial markets 
in recent months.
    As the concerns of investors increased, money center banks 
and other large financial institutions have come under 
significant pressure to take onto their own balance sheets the 
assets of some of the off-balance-sheet investments that they 
had sponsored. Bank balance sheets have swollen further as a 
consequence of the sharp reduction in investor willingness to 
buy securitized credits, which has forced banks to retain a 
substantially higher share of previously committed and new 
loans in their own portfolios. Banks have also reported large 
losses, reflecting marked declines in the market prices of 
mortgages and other assets that they hold. Recently, 
deterioration in the financial condition of some bond insurers 
has led some commercial and investment banks to take further 
markdowns and has added to strains in the financial markets.
    The banking system has been highly profitable in recent 
years and entered this episode with strong capital positions. 
Some institutions have responded to their recent losses by 
raising additional capital. Notwithstanding these positive 
factors, the unexpected losses and the increased pressure on 
their balance sheets have prompted banks to become protctive of 
their liquidity and balance sheet capacity and, thus, to become 
less willing to provide funding to other market participants, 
including other banks.
    Banks have also become more restrictive in their lending to 
firms and households. For example, in the latest Senior Loan 
Officer Opinion Survey conducted by the Federal Reserve, banks 
reported having further tightened their lending standards and 
terms for a broad range of loan types over the past 3 months. 
More expensive and less available credit seems likely to 
continue to be a source of restraint on economic growth.
    In part as the result of the developments in financial 
markets, the outlook for the economy has worsened in recent 
months, and the downside risks to growth have increased. To 
date, the largest economic effects of the financial turmoil 
appear to have been on the housing market, which, as you know, 
has deteriorated significantly over the past 2 years or so. The 
virtual shutdown of the subprime mortgage market and a widening 
of spreads on jumbo mortgage loans have further reduced the 
demand for housing while foreclosures are adding to the already 
elevated inventory of unsold homes. Further cuts in home 
building and related activities are likely.
    Conditions in the labor market have also softened. Payroll 
employment, after increasing about 95,000 on average per month 
in the fourth quarter, declined by an estimated 17,000 jobs in 
January. Employment in the construction and manufacturing 
sectors has continued to fall while the pace of job gains in 
the service industries has slowed. The softer labor market 
together with factors including higher energy prices, lower 
equity prices, and declining home value seem likely to weigh on 
consumer spending in the near term.
    On the other hand, growth in U.S. exports should continue 
to provide some offset to softening in domestic demand, and the 
recently approved fiscal package should help to support 
household and business spending during the second half of this 
year and into the first part of next year.
    On the inflation front, a key development over the past 
year has been the steep run-up in the price of oil. Last year, 
food prices also increased exceptionally rapidly by recent 
standards, and the foreign exchange value of the dollar 
weakened. All told, over the four quarters of 2007, the price 
index for personal consumption expenditures, or PCE, increased 
by 3.4 percent, up from 1.9 percent during 2006. Excluding the 
prices of food and energy, PCE price inflation ran at a 2.1-
percent rate in 2007, down a bit from 2006.
    To date, inflation expectations appear to have remained 
reasonably well anchored, but any tendency of inflation 
expectations to become unmoored or for the Fed's inflation-
fighting credibility to be eroded could greatly complicate the 
task of sustaining price stability and reduce the central 
bank's policy flexibility to counter shortfalls in growth in 
the future. Accordingly, in the months ahead we will be closely 
monitoring inflation expectations and the inflation situation 
more generally.
    To address these developments, the Federal Reserve has 
moved in two main areas:
    To help relieve the pressures in the inter-bank markets, 
the Federal Reserve, among other actions, recently introduced a 
term auction facility through which pre-specified amounts of 
discount window credit can be auctioned to eligible borrowers. 
And we have been working closely and cooperatively with other 
central banks to address market strains that could hamper the 
achievement of our broader economic objectives.
    In the area of monetary policy, the Federal Open Market 
Committee, or FOMC, has moved aggressively, cutting its target 
for the Federal funds rate by a total of 225 basis points in 
September, including 125 basis points during January alone. As 
the FOMC noted in its most recent post-meeting statement, ``The 
intent of these actions is to help promote moderate growth over 
time and to mitigate the risks to economic activity.''
    A critical task for the Federal Reserve over the course of 
this year will be to assess whether the stance on monetary 
policy is properly calibrated to foster our mandated objectives 
of maximum employment and price stability, and in particular, 
whether the policy actions taken thus far are having their 
intended effects.
    Monetary policy works with a lag. Therefore, our policy 
stance must be determined in light of the medium-term forecast 
for real activity and inflation, as well as the risks to that 
forecast.
    At present, my baseline outlook involves a period of 
sluggish growth, followed by a somewhat stronger pace of growth 
starting later this year as the effects of monetary and fiscal 
stimulus begin to be felt. At the same time, overall consumer 
price inflation should moderate from its recent rates, and the 
public's longer-term inflation expectations should remain 
reasonably well anchored.
    Although the baseline outlook envisions an improving 
picture, it is important to recognize that downside risks to 
growth remain, including the possibilities that the housing 
market or the labor market may deteriorate to an extent beyond 
that currently anticipated or that credit conditions may 
tighten substantially further.
    The FOMC will be carefully evaluating incoming information 
bearing on the economic outlook and will act in a timely 
manner, as needed, to support growth and to provide adequate 
insurance against downside risks.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Mr. Chairman.
    Chris Cox, we welcome you to the Committee.

            STATEMENT OF CHRISTOPHER COX, CHAIRMAN,
               SECURITIES AND EXCHANGE COMMISSION

    Mr. Cox. Thank you, Mr. Chairman, Senator Shelby, and 
Members of the Committee. I appreciate the opportunity to be 
here today to update you on the work that the Securities and 
Exchange Commission is doing in this area.
    The deterioration of credit and liquidity conditions 
stemming from problems in the U.S. residential mortgage market 
has posed a number of challenges for our agency. We have been 
working closely with the other members of the President's 
Working Group on Financial Markets, including, of course, 
Secretary Paulson and Chairman Bernanke, with whom it is my 
privilege to appear today. We have also been working closely 
with our international regulatory counterparts, which is a 
reflection of the global impact that these U.S. market events 
have had.
    To coordinate the Commission's subprime efforts across each 
of our divisions and offices, Erik Sirri, who is the Director 
of the Division of Trading and Markets, is leading an agency-
wide task force. As you know, the Commission is not a front-
line regulator of the mortgage lending business, the 
derivatives industry, or the monoline insurance industry. But 
the securities markets and the market participants that the 
Commission does regulate--not to mention the investors whom it 
is our mission to protect--have been deeply affected by the 
problems with residential mortgage-backed securities and 
collateralized debt obligations.
    Among the questions that have been raised within our 
jurisdiction are the accounting treatment of the special 
purpose trusts and their assets; the adequacy of capital and 
liquidity at the Nation's major investment banks, and the 
strength of their risk management practices; the impact on 
money market funds from the devaluation of what had previously 
been presumptively safe assets; the quality of issuer 
disclosure by public companies involved in structured finance; 
the role of the credit rating agencies, over which the SEC 
gained regulatory jurisdiction 8 months ago; and the 
possibility of violations of the securities laws by subprime 
lenders, investment banks, broker-dealers, and other market 
participants.
    The accounting issues have centered around the questions of 
balance sheet consolidation and valuation. Twice in recent 
months--first in July of 2007 and again in January of this 
year--the SEC has provided guidance on the application of 
current accounting rules in the case of limited modifications 
for loans where default is reasonably foreseeable. In that 
circumstance, we have said, the limited modification would not 
invalidate off-balance-sheet treatment. This guidance has 
allowed refinancings and other work-out arrangements to 
proceed, with the advantage of keeping people in their homes 
and maximizing the value of the securitized assets. This is, 
however, a short-term response. For the longer term, the 
Commission's Chief Accountant has asked the Financial 
Accounting Standards Board to revisit the underlying accounting 
issues to determine whether or not the experience of the last 
several months points to the need not only for further 
clarifying guidance, but also for changes in the applicable 
rules.
    Another important aspect of our oversight responsibility is 
our Consolidated Supervised Entities program. Through this 
program the Commission supervises five of the systemically 
important U.S. securities firms on a consolidated, or group-
wide, basis. Those firms are Bear Stearns, Goldman Sachs, 
Lehman Brothers, Merrill Lynch, and Morgan Stanley. This 
prudential supervision of the Nation's largest investment banks 
is designed to be broadly consistent with Federal Reserve 
oversight of commercial bank holding companies, and its 
overarching purpose is to monitor for any weakness in any part 
of the firm that might place the regulated bank or broker-
dealer at risk. In particular, the Commission focuses on 
capital adequacy, liquidity, and liquidity risk management at 
the CSE firms.
    Subprime issues have also had an impact on the mutual fund 
industry, and, in particular, we have been active in working 
with the managers of money market funds as they cope with the 
downgrading of ratings and the declines in value of securities 
in which their funds have invested. We are also working in the 
area of public company disclosure to improve the quality of 
disclosure by banks and other financial institutions about 
subprime-related issues.
    In December 2007, the Commission wrote to 25 leading 
financial institutions, highlighting several disclosure areas 
that they should consider in relation to their exposure to off-
balance-sheet entities and structured finance products.
    Last summer, using the new statutory authority that the 
Congress gave the SEC effective in June of 2007, the Commission 
began examinations of the role of the credit rating agencies in 
the subprime market turmoil. These examinations are focused on 
whether the rating agencies diverged from their stated 
methodologies for determining credit ratings in order to 
publish higher ratings, and whether their role in bringing 
residential mortgage-backed securities and collateralized debt 
obligations to market impaired their ability to be impartial in 
their ratings.
    Beyond these ongoing examinations, we are also taking a 
fresh look at the wisdom of the legislative and regulatory 
provisions that grant a central role to the rating agencies in 
our markets.
    During the past 30 years, regulators, including the 
Commission, have increasingly used credit ratings as a proxy 
for objective standards in a variety of contexts. In addition, 
a number of Federal, State, and foreign laws and regulations 
today use credit ratings in this and analogous ways. The recent 
market disruptions have shown the limitations of this 
arrangement. As a result, I have directed the Commission staff 
to explore alternatives to the existing regulatory reliance on 
credit ratings where feasible. I have also directed the staff 
to develop proposals for new rules under the Credit Rating 
Agency Reform Act that respond directly to the shortcomings we 
have seen through the subprime experience.
    Finally, but perhaps most importantly, policing our markets 
to ensure compliance with the securities laws is also a 
critical aspect of borrower responsibility in connection with 
the subprime market turmoil. Our Division of Enforcement 
currently has over three dozen cases that are related to 
subprime activity. These investigations involve several areas 
of potential violations of the securities laws, but because 
they are still ongoing, the specific details remain 
confidential. Each of the actions we are taking and each of 
those that we are contemplating is designed to safeguard the 
health of our capital markets, to protect investors, and to 
promote capital formation.
    I appreciate the opportunity, Mr. Chairman, to describe the 
main aspects of the Commission's work in this area, and I would 
be happy to answer the Committee's questions.
    Chairman Dodd. We thank you very, very much, and we 
appreciate your testimony, all three of you, here this morning.
    First, let me announce that there has been an objection 
expressed, so we will have to take this vote on the ILC issue 
at another time, and I will schedule a time for that at the 
convenience of Members. I again apologize for the glitch 
yesterday on a technical matter in terms of how that vote 
occurred.
    What I would like to do now is I am going to have the clock 
on for about 8 minutes per Member. I counted up here. We have 
got a tremendous turnout here, almost the entire membership of 
the Committee, and that should make it possible for us to 
complete at least one round here before our witnesses have to 
leave at noon or a little after noon. So I will try and keep an 
eye on the clock myself as we go forward.
    Let me begin, if I can, with our witnesses. When this 
problem first began to emerge, I think it was expressed by some 
of you here at the witness table and I think many people 
certainly hoped that this problem would be contained within the 
housing sector, be limited to that. Obviously, we are learning 
as each week and month goes by that this problem is spreading, 
and your testimony this morning reflects the recognition of 
that.
    It has been deeply troubling--and I am sure my colleagues 
from New York and New Jersey are going to want to focus on this 
as well, but I could not help but note yesterday the lead story 
in the Wall Street Journal talking about how this credit crunch 
issue now could affect student loans, that some--I forget the 
number--colleges in the State of Michigan may be adversely 
affected as a result of the lack of availability of credit, 
forcing families to rethink how they are going to finance their 
children's education.
    The decline in home values, certainly we have seen, as I 
mentioned in my opening comments, the first time since the 
Great Depression we have had nationally a decline in values 
occurring, and the predictions of where those values may go. 
Literally, as people are watching, their values are declining. 
That equity they had built up over the years with the hopes of 
utilizing that equity for many different ideas, certainly not 
the least of which is possibly to finance their children's 
higher education, is certainly disappearing. So that pressure 
is mounting here, both the availability of credit and the lack 
of equity in homes.
    Then this morning's news about the headline, ``Train Pulls 
Out of New Corner of Debt Market,'' talking about the Port 
Authority of New Jersey and New York, that increase from 4.2 
percent to 20 percent, raise in the weekly interest rates to 
something around $300,000, this is one example--I presume there 
are many more around the country--to just once again highlight 
how this is expanding, this problem, beyond just a housing 
issue.
    And so my first basic question is: What are you going to do 
about it? I mean, this is a--what are we going to do about it? 
What are we going to do about it? This is not an issue that 
can--we can discuss it and the details of it, but this is 
growing. Should parents, for instance, be thinking about 
alternative means of financing their children's education as a 
result of this credit crunch and student loan availability? Is 
it that serious here? And I would be very interested in hearing 
some response as to what you think else can be done, what 
actions Congress should or should not be taking, what steps 
further the administration could be taking, and what 
admonitions or warnings should be given to the American public. 
As we try to rebuild that confidence, it is also important, I 
think, at hours like this that we express to them the steps 
they ought to be thinking about in light of some of these facts 
we are seeing.
    Mr. Bernanke. Mr. Chairman, the examples that----
    Chairman Dodd. You have to push that button, I think, Mr. 
Chairman.
    Mr. Bernanke. Sorry. Mr. Chairman, the examples that you 
are referring to illustrate the complex chains of causality 
that we are seeing promulgating throughout the financial 
markets at this point. The sequence in this event is that the 
losses in housing affected the value of CDOs, which in turn has 
hurt the bond insurance corporations, which in turn has reduced 
the value of their guarantees for these particular securities 
that make up municipal bonds and student loans and has 
disrupted that market, as you point out. So there is this very 
complex chain.
    I think with respect to municipal bonds and student loans, 
the good news is that the underlying quality of those credits 
is generally very good. No one is really doubting that the Port 
Authority's credit quality is any worse than it was before or 
thinking that it was worse than it was before. So I do not 
think that this is a long-term situation. I think it is going 
to require some adjustment, some rethinking in terms of how 
best to market these securities in ways that will be attractive 
to investors. It illustrates, though, the unexpected effects 
and consequences.
    I think the best thing we can do--there are a whole number 
of measures that we can do, but from the Federal Reserve's 
point of view, one of the best things we can do, of course, is 
to try and maintain a strong economy that will help cause, you 
know, eventually stabilization in the housing markets, 
stabilization in the credit markets, and that will allow these 
unexpected consequences to reverse themselves.
    Chairman Dodd. Mr. Secretary.
    Secretary Paulson. Yes, I very much agree with that and 
would just make a couple of additional points here.
    What we are seeing is, although it was subprime that maybe 
produced the spark that got this going, we had a dry forest out 
there, because for some time we had a lot of seemingly excess 
liquidity, low levels of inflation around the world, and 
investors reached for yield and mispriced risk in a number of 
markets. Now what we are seeing is a reaction, and the areas of 
the market that are under the most stress today are those that 
are the most complex products or auction products for 
municipals, preferreds, and so on.
    The example you have given is one that will solve itself 
pretty easily because the Port Authority will refinance, they 
will not pay 20-percent interest rates. But it is indicative of 
a broader problem. And to me, in addition to what the Chairman 
said, the other thing that needs to be done is to keep 
encouraging our financial institutions to recognize their 
losses, let the market work, and raise capital. And if there is 
any doubt they need capital, they need to go and raise capital, 
recapitalize so that they get the capital base they need. We do 
not want to see them shrink their balance sheets and pull back 
from doing the things they need to do in the economy.
    So, again, as risk is being re-priced, these things are not 
pretty while you are going through them, but these adjustments 
are necessary, and I believe the markets are going to work. But 
again, if we do anything, it is encouraging institutions to 
recognize the losses and raise capital.
    Chairman Dodd. What about the student loan issue here? The 
same answer? Would you have the same answer regarding the 
availability of student loans?
    Secretary Paulson. I would say, Mr. Chairman, I believe it 
is the same answer, but this is something we are looking at 
carefully. I think the underlying credits, I agree with the 
Chairman, are good. But there have been a number of changes, 
regulatory changes and others, that have impacted some of these 
companies. They have reduced profit margins. There are a number 
of things working here, and so this is something that we at 
Treasury are going to look at very carefully in the next couple 
of months. But I agree with the Chairman's general comment.
    Chairman Dodd. Is it a legitimate matter of concern, 
however, in light of what we----
    Secretary Paulson. Of course. Every one of these issues as 
we work our way through the markets impact real people. So we 
are talking about it in terms of the institutions and the 
markets, but they impact real people. And even when we are 
talking about things like some of these auction prefers and 
municipal auctions, if the auction fails and there is a 20-
percent interest rate, then there will be a refinancing. There 
will be some auctions that may fail where there is a lower 
interest rate and there will not be a refinancing, and 
individual investors will end up losing money.
    So, yes, they are all legitimate concerns, and student 
loans is something that we need to watch very carefully.
    Chairman Dodd. Let me jump quickly, if I can, in the time 
remaining here, to these projections regarding economic growth. 
And, again, I looked at yesterday--was it yesterday that the 
Philadelphia Federal Reserve Bank released an estimate of 
economists that revised their projections for economic growth 
to 1.8 percent in 2008. The Congressional Budget Office is 
projecting 1.7 percent as the growth rate for 2008 as what they 
call their blue chip economics report.
    I would like to ask both the Chairman of the Federal 
Reserve and the Secretary of the Treasury: One, is it fair to 
conclude--and I think you suggested this, maybe, in your 
testimony, but let me ask it again. Is it fair to conclude then 
that the Fed's economic projections that were made earlier--and 
correct me if I am wrong, Mr. Chairman. Somewhere between 1.8 
and 2.5 percent I think were the earlier projections, that 
range. Is it fair then to conclude today that the projections 
for 2008 need to be downgraded in your view? And, second--let 
me just ask the questions together to save time. The 
administration had a 2.7-percent growth rate. Again, I realize, 
look, predictions are exactly what they are. No one has an 
absolute crystal ball here. But that seems to be an excessively 
high projection in light of even the ones made earlier, Mr. 
Secretary. What was the purpose of that? It is not even close 
to being the reality of what you projected then.
    Secretary Paulson. That was made in November, and as you 
will recall, Mr. Chairman, as we watched--and we have been 
watching this economy very, very carefully--that consumer 
spending and business spending held up right into the fall. You 
will recall that the GDP growth was almost 5 percent in the 
third quarter, and then spending fell off very quickly. We 
would not have a similar forecast today.
    Chairman Dodd. What would be your forecast today? What do 
you----
    Secretary Paulson. I do not have a single-point forecast, 
but I will tell you it would be less, but I do believe we are 
going to keep growing here. I think that the risks are to the 
downside. We are watching it carefully. I think it is very 
important, this economic growth package. We are all focused on 
this, and there are no guarantees. But I continue to believe 
this economy is going to keep growing.
    Chairman Dodd. Will there be an adjusted number the 
Treasury will be coming out with shortly here that we can look 
to?
    Secretary Paulson. This was not a Treasury forecast. This 
was a forecast that was a joint forecast by CEA, the Treasury, 
OMB, and we come out with those periodically.
    Chairman Dodd. Mr. Chairman?
    Mr. Bernanke. Mr. Chairman, the Federal Reserve has 
recently changed to making quarterly projections, so you are 
referring to the October projection.
    Chairman Dodd. Right.
    Mr. Bernanke. In about a week, we will have a new set of 
projections, and it will show lower projections of growth, and 
they will be reasonably consistent with what we are seeing with 
private forecasters and so on. They do show, as I suggested in 
my testimony, that growth looks to be weak but still positive 
during the first half of the year, and with some expectation of 
strengthening later in the year. But, again, that is a 
baseline, and there are risks to that forecast.
    Chairman Dodd. Thank you very much.
    Senator Shelby.
    Senator Shelby. Thank you.
    Chairman Bernanke, Congress is facing a range of choices in 
addressing housing market conditions. Some of my colleagues 
seem to be suggesting that we should protect the entire home 
market from a decline in value, while others suggest allowing 
market forces to provide the solution.
    What do you think as Chairman of the Fed that our goal 
should be as we consider how or even if we should respond to 
current conditions?
    Mr. Bernanke. Well, Senator Shelby, first of all, I think 
we should all be open-minded and creative and keep thinking 
about different options. For the moment, we are working trying 
to support the Treasury in getting the private sector to be 
aggressive, to scale up its activities, to try to be more 
effective in meeting this large number of delinquencies that 
they are facing. The Federal Reserve is also working in 
communities, working with community groups and supporting 
counseling efforts and so on. So I think that is the first line 
of defense, is to make sure that the private sector is scaling 
up and is being aggressive and effective in dealing with these 
delinquencies.
    I think immediately what I would commend to the Congress in 
terms of making further progress would be to address the FHA 
and GSE bills. The FHA provides an opportunity to refinance 
troubled borrowers into more stable, long-term, Government-
supported mortgages. And an effective reform of supervision of 
the GSEs would allow the GSEs faithfully to expand their 
activities and to support the housing market, you know, more 
effectively.
    Senator Shelby. Are you still concerned about the long-term 
systemic risks that our GSEs have out there?
    Mr. Bernanke. I do think that is the concern. I would like 
to see a reform bill, a supervisory bill that addresses those 
concerns, that creates a strong, world-class regulator, that 
provides for adequate capital, receivership, and a public 
purpose for the portfolios. But I do believe that if that were 
all done, then the GSEs would be much better placed to raise 
capital, which they need to do, and with more capital to assist 
the housing market in particular by securitizing more 
mortgages.
    Senator Shelby. Chairman Bernanke, we appear to have swung 
from a cycle of credit being too freely available to the 
possibility that credit is now priced too highly or not 
available at all.
    You noted in your testimony, and I will quote, 
``considerable evidence that banks have become more restrictive 
in their lending to firms and households. The Fed has attempted 
to counter this problem in part through its term auction 
facility.''
    Do you believe that financial institutions are now in a 
position of overly stringent underwriting? And if so, what are 
your bank examiners doing to counter any overly stringent 
action by financial institutions in the current--due to the 
current situation?
    Mr. Bernanke. Senator, well, first you are correct, as 
Secretary Paulson mentioned, that we started out in a period 
probably where risks were underpriced and where credit was too 
freely available. We are going through a retrenchment, and it 
is a painful retrenchment. Some of that is certainly necessary 
to get back to a more normal level of underwriting and credit 
availability.
    We do have some concerns that the combination of losses by 
banks which reduced their capital and the expansion of their 
balance sheets as they took on off-balance-sheet vehicles or 
they are unable to securitize some of their loans have made 
some of these banks less able to extend credit than they would 
under normal circumstances. And we think that is going to be a 
drag on the economy. Our surveys show that terms and conditions 
have tightened.
    I agree very strongly with Secretary Paulson that the best 
remedy to that is for the banks to reveal their losses, to get 
them behind them, then to go out and raise more capital so that 
they can operate in a safe way and in a normal way.
    With respect to the supervisors, we need to achieve an 
appropriate balance. On the one hand, we certainly in no way 
want to sacrifice our important responsibility to maintain the 
safety and soundness of the banks. And to the extent that they 
have less capital and they are facing a more risky situation, 
then it is appropriate from that perspective for them to be 
more careful in their lending.
    On the other hand, we do not want to overreact so strongly 
to go far beyond what is reasonable and balanced to create an 
unnecessary credit crunch, and we are trying to make sure that 
we balance those important objectives, maintaining safety and 
soundness while not unnecessarily constricting credit to the 
American economy.
    Senator Shelby. Do you believe that there is a strong 
likelihood that there will be more charge-offs, you know, 
downgrading of a lot of our subprime securities, and even 
perhaps others, that will have an effect on some of our banks' 
capital?
    Mr. Bernanke. Well, it seems likely that there will be 
additional charge-offs. But an important consideration at this 
point is the evolution of the housing market and the economy. 
Many banks have already written down their mortgage holdings, 
for example, essentially under the assumption that the housing 
market will contract considerably further. Should the housing 
market do better than expected, some of those writedowns might 
be reversed, potentially. But I think it is a good guess, given 
recent trends, that we will see some additional writedowns in 
banks, in investment banks, in the coming quarters.
    Senator Shelby. As a bank regulator, do you see any 
possibility that some of our big banks might fail? You know, 
the U.K. has had the Northern Rock problem. Do you envision 
that here? Is that something that capital will keep from 
happening?
    Mr. Bernanke. Senator, our concern is primarily about the 
ability of the banks to make credit available. The banks came 
into this episode very well capitalized, with very strong 
earnings. They have been able to go out and raise new capital, 
and so all the banks--I will let Chairman Cox talk about the 
investment banks, but I believe it is the case there as well. 
But certainly all the banks that we supervise remain at strong 
capital positions, and at this point we do not see any imminent 
risk of any insolvencies.
    Senator Shelby. Secretary Paulson, given the importance of 
bond insurance to the national economy--the Chairman alluded to 
that earlier--what has been the Treasury Department's 
involvement with the New York Insurance Department's efforts to 
rescue the bond insurers that a lot of people believe we have 
got to bolster?
    Secretary Paulson. OK, well, we have obviously a strong 
interest in this because the bond insurers play an important 
role in the markets. And as you know, these institutions are 
regulated at the State level. So we, along with the Fed and 
others, have been actively monitoring what is going on there. 
We were supportive of the efforts, which are private sector 
efforts, to get all of the relevant people together--the 
parties: the rating agencies; the advisers, the financial 
advisers to these companies; investors are involved. And so we 
are watching this very closely.
    Senator Shelby. Can I ask one quick question?
    Chairman Dodd. Yes.
    Senator Shelby. Chairman Cox, could you update the 
Committee on the status of the SEC's examination of the rating 
agencies and whether the SEC has reached any conclusions about 
why the rating agencies appear to have grossly underestimated 
the riskiness of many securitized assets? I know you have 
talked to us about that before. Is that an ongoing thing?
    Mr. Cox. Yes, it is, and we are in the process of inferring 
lessons even now. As you know, our authority given to us by the 
Congress is months old, but we have aggressively used that 
authority. We have ongoing investigations--I should say 
``inspections''--of the credit rating agencies underway for the 
purpose of determining, among other things, whether or not, 
first, they followed their own procedures with respect to 
conflicts of interest, and then whether those procedures, if 
properly followed, were sufficiently sturdy in practice to 
prevent the conflicts which we know exist in the current model 
from interfering with the ability of the analysts to be 
independent.
    My estimation is that we will have ideas based on this 
experience for making that process more sturdy in plenty of 
time to inform our planned rule writing this year.
    Senator Shelby. Are you looking at the possibilities of 
ways to avoid the conflict of interest that looked so prevalent 
to so many people between the rating agencies, the advice they 
give them, the consulting they give them, and then rate the 
securities themselves?
    Mr. Cox. We are. The issuer-pays model, and the 
subscription model, all have potentials for conflicts of 
interest, and so what is most important is designing 
structures, procedures to deal with those conflicts. We cannot 
make them all go away. They are embedded in the market.
    One of the ways that the Congress, I think rightly, 
anticipated in the Credit Rating Agency Reform Act that we can 
deal with these conflicts is through competition. There are two 
kinds of competition--bad and good--in this area. The bad kind 
of competition, of course, would adhere in an issue where they 
are going first to one rating agency, then another, then 
another, until finally they get the high rating that they are 
willing to purchase. The good kind of competition is one in 
which the track records of these rating agencies are ruthlessly 
compared in the marketplace, and the SEC, I think, is going to 
be able to help facilitate that kind of head-to-head 
comparison. Comparability is difficult to achieve given the 
kinds of disclosure that currently are made.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much.
    After speaking with Senator Shelby, I realized we are not 
going to be able to get to everyone if I keep to 8 minutes. So 
we are going to restrict that time down to 5 minutes. I will 
not bang down the gavel, but so that everybody gets a chance 
here--and, obviously, if we can get through one round, we will 
go back for a second round with people. So I just did the math, 
and I realized we are not going to get to everybody. And I want 
everybody to have a chance to raise questions.
    Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman, and thank 
you, gentlemen, for your testimony today.
    We are all engaged in dealing with a host of very 
complicated, interrelated issues, but when you step back, one 
of the most sobering factors that has been alluded to by the 
Chairman is that if we just let things sort of work out over 
the next several months, there could be as much as a 20- to 30-
percent devaluation in the value of homes in the United States, 
which some people have estimated to be on the order for $4 to 
$6 trillion on household wealth. That is going to be a huge 
shock to the quality of life of most Americans. It is going to 
translate into whether children go to college or which college 
they go to. It is going to translate into whether they are 
prepared for retirement. It is going to translate into whether 
or not they can cope with a serious health crisis without 
insurance. And, frankly, that is a concern on the minds of my 
constituents right now, and the clock is ticking much faster, 
and I get the sense that the market is moving to these 
corrections, which puts, I think, huge pressure on not simply 
letting the market work out but to take much more deliberate, 
much more focused, much more concentrated action, because at 
some point the American people will demand it even more 
affirmatively than they are today.
    That said, I think there are two major challenges: one, 
timely, effective action to ease this liquidity crisis; but, 
second, a very sober, careful review of how we got here by the 
regulatory agencies so that we do not repeat these mistakes. 
And we have seen this happen before. Enron collapsed. We had 
FASB produce rules about special purpose entities. FASB got 
beaten back to move from a more specific rule to more 
principles based, and now, as Chairman Cox indicated, they are 
rethinking that. We have been there before, and I will ask just 
a question to Chairman Bernanke.
    First, you are not only the monetary policy leader in the 
country, but you also are the major regulator of financial 
institutions. You have on a daily basis, I would presume, 
hundreds of Federal Reserve examiners, agents in these 
institutions looking at everything they are doing. Have you 
looked back now and begun a searching review, an after-action 
report of the lapses that allowed these situations to develop?
    Mr. Bernanke. Senator, certainly we are looking at all 
those issues. I think I should say that this is very much an 
international issue, that other countries as well are very much 
involved in this, and there is, in fact, an elaborate process 
underway which is involving, first of all, each individual 
agency doing extensive analysis. We at the Federal Reserve have 
looked at our practices, have looked at a variety of other 
issues. Those are being combined together in a joint analysis 
of the President's Working Group, of which we all three are 
members. That in turn is feeding into international bodies, 
such as the Financial Stability Forum and the Basel Committee, 
which are trying to develop lessons learned not just for the 
Federal Reserve or for the United States, but for the entire 
world in terms of our regulatory processes and approaches.
    So we have thought about it very extensively both in terms 
of our own agency but there is, in fact, a very substantial 
international effort underway. And, in fact, the Financial 
Stability Forum at the G-7 meetings last weekend just released 
a preliminary report. We expect to see an extensive report at 
the next meetings in Washington, I think it is in April.
    Senator Reed. And these reports will be publicly 
distributed with very specific analysis of the steps that might 
have been taken previously by the Fed, SEC, and the Treasury 
Department?
    Mr. Bernanke. They will be very principles based. They will 
be talking about the kinds of approaches we need to take in 
order to make sure these problems do not happen again, but yes.
    Senator Reed. I appreciate that, Mr. Chairman, but I think 
at some point you have got to drill down to the specifics of 
adequacy of your procedures, adequacy of your staffing, 
cooperation from financial institutions. You know, we were 
aware of these SIVs and these SPEs for years and years and 
years. Suddenly, they are roaring and, you know, unstable--
destabilizing balance sheets.
    Let me switch to a slightly related question. Both you and 
the Treasury Secretary have said that the banks have to reveal 
very quickly their losses. Have they revealed their losses to 
you? You say in your statement there is still some uncertainty 
about what they have on their balance sheets. I would think 
that would be the first point of clarification. Do you feel 
that you are getting the kind of----
    Mr. Bernanke. We are getting very good information. The 
difficulty is that for many of these assets, a clear, succinct, 
sharp measure of the loss is not always easy because many of 
them are not traded frequently in markets, they are very 
idiosyncratic, and their valuations can change from day to day 
depending on, for example, how the market is valuing subprime 
mortgages. So it is not an easy problem.
    The FASB has set up a set of standards which divides 
measurements into three levels: those assets which have a 
market value; those which can only be addressed through 
modeling, which means using some market information but also 
some assumptions and models internally; and, third, those 
categories which are mostly judgment. And so inherently it is 
very difficult to get sharp answers, but--Chairman Cox can add 
to this, but we certainly are getting good cooperation, and we 
are urging our institutions to disclose as promptly and as 
effectively as possible.
    Senator Reed. My time has expired, Mr. Chairman. Thank you.
    Chairman Dodd. Thank you very much.
    Senator Allard.
    Senator Allard. Thank you, Mr. Chairman. I serve on the 
Budget Committee, and I am looking forward to getting our 
budget reported out around the 1st of March, the first week in 
March, at least. And we put out 5-year budgets, and in the next 
5 years here are some of the problems that I see facing our 
economy and facing the Congress as a challenge. I would like to 
have you comment on these, if you would.
    First of all, if the surge continues to work in Iraq, then 
that means that we will be pulling back troops to the United 
States homeland, and we will probably see a cranking down of 
the industrial-military complex. Historically, after a major 
conflict, you know, unemployment goes up because of them 
returning home. We also are looking at in the next 5 years, if 
Congress does nothing, a tax increase that will happen that 
will amount to about a $1.3 trillion increase in taxes over the 
next 10-year period, I am told by the Finance Committee. We are 
looking at growth in entitlements. We are looking at persistent 
deficits and high energy costs.
    Do you have any suggestions or any priorities that we 
should be looking at when we put this budget together and those 
problems that need to be addressed? I thought I would start 
with Dr. Bernanke and then perhaps Secretary Paulson and then 
hopefully Chairman of the SEC, Chris Cox, would comment.
    Mr. Bernanke. Well, I will be quick. You have, obviously, a 
number of difficult issues in the next 4 or 5 years. The 
alternative minimum tax remains an issue. If you are going to 
eliminate that permanently, how are you going to replace that 
revenue or reduce the spending?
    Domestic programs, the administration's budget requires a 
very tough lid on domestic spending. That is going to be very 
trying. It is very demanding for the Congress.
    Management of Iraq and Afghanistan spending, as that comes 
down.
    Those are some of the issues you will be facing in the near 
term, but as I said on a number of previous occasions, it is 
likely to see some--there is likely to be some near-term 
improvements in the deficit over the next 5 years or so. As we 
move into the next decade, the entitlement issues are really 
going to begin to be seen in the annual budgets, as, for 
example, Social Security stops producing a surplus each year 
and begins to be a net drain on the Federal budget.
    So from a longer-term fiscal perspective, I think the 
entitlement issues are the dominant question. The CBO estimates 
that in 2030 the entitlement spending plus interest payments 
will essentially take up the entire Government budget. And even 
so, the deficit might be as high as 9 percent of GDP.
    So the critical issue for the medium term and the long term 
is the entitlement question.
    Senator Allard. Secretary Paulson.
    Secretary Paulson. Yes, I will be brief because I agree 
with that. There are some short-term issues, but they all pale 
with the longer-term issues. When you look at our long-term 
competitiveness and financial flexibility and the big 
structural issues, No. 1 or right up there has got to be 
entitlements. And I am sure we as a country will come to some 
solution, but the longer we wait, the bigger burden we place on 
the next generation. And that is a huge problem staring us in 
the face, and it is one that is solvable.
    I would say energy security ranks right up there with that 
when you are looking at big structural economic issues, and 
then we are just going to have to continue to also look at 
other issues of competitiveness, and I think we know what they 
are. When we look at keeping our technology spending up, R&D 
spending, there are some issues that very much relate to 
immigration and making sure we have the talent here and that 
the people that are graduating from our top universities with 
degrees in engineering and other sciences, and we do not ship 
them out. Many of them are foreign nationals, and we are 
shipping them back overseas----
    Senator Allard. I want to cut you short here because I want 
to give Mr. Cox an opportunity to respond, too. When you were a 
Member of Congress, you always concerned yourself about high 
tax rates, and maybe you want to elaborate on what the other 
two said. And then also I would like to hear what you think 
about the $1.3 trillion tax increase that we could be facing in 
the next 5 years because the temporary taxes will be expiring.
    Mr. Cox. Well, Senator Allard, at the Securities and 
Exchange Commission, we look at things from the perspective of 
the investor, and so, as you and the Congress formulate fiscal 
policy, I hope that you will continue to be attentive to 
effects, both intended and sometimes unintended, on incentives 
for savings and for investment. It is vitally important to our 
mission that Americans make proper choices about how they spend 
their money. We, at your direction and with your funding, spend 
a good deal of money on investor education, all designed for 
these purposes. If Government policy in other ways provides 
disincentives for what we all consider to be wise and good 
behavior, then the country, the whole savings mechanism, 
intermediation, and ultimately our Nation's and global economic 
growth pay.
    Senator Allard. Mr. Chairman, I see my time has expired.
    Chairman Dodd. Thank you very much, Senator.
    Senator Menendez. Bob.
    Senator Menendez. Thank you, Mr. Chairman. Thank you all 
for your testimony.
    You know, nearly a year ago, when we had one of the first 
hearings on the foreclosure issue in this Committee, I said 
that we were looking at a tsunami of foreclosures, and the 
response then by members of the administration was--we had 
variations on the theme that the mounting waves of foreclosure, 
it was not a crisis; that it was contained; that it soon would 
be over. And instead of warning bells from those who are 
supposed to keep tabs on the pulse of the markets, we had timid 
responses. And instead of a clarion call to securitizers, 
lenders, brokers, and everyone who had a hand in the mortgage 
chain to take responsible action, we a let's-wait-and-see 
approach. And I think we have seen what the let's-wait-and-see 
approach has produced and where it has gotten us.
    Now, certainly when it comes to our markets, a knee-jerk 
reaction isn't in the Nation's interest, and that is certainly 
not what I am talking about. But when there is a real crisis at 
bay, when there is a storm brewing on the horizon, we count on 
those at the top--and certainly that is all of you--to sound 
the alarm. And to many of us, I think what we got was a snooze 
button. We have been behind the curve.
    And so I say that as a premise to two sets of questions 
that I hope to get some honest answers on. One is that I know 
the topic of this hearing is the economy. Mr. Secretary, are we 
headed toward or in danger of being in a recession?
    Secretary Paulson. Senator, I do not know how to answer it 
any more clearly than I did in my testimony, so I will say 
again I believe that we are going to continue to grow, albeit 
at a slower rate. The risks are to the downside. I do not have 
a crystal ball, but we did not sit back and wait. What we have 
done is move very quickly, I believe--you know, Congress and 
the Administration--with a stimulus package.
    Senator Menendez. Well, we appreciate the stimulus, but 
there are those of us who believe that that in and of itself is 
not sufficient. Let me just go through a few statistics. Last 
quarter, the economy grew at six-tenths of a percent, too slow 
to promote robust job growth. We lost 17,000 jobs last month. A 
number of Wall Street firms--including your former firm, Mr. 
Secretary, Goldman Sachs, Morgan Stanley, Merrill Lynch--
predict a recession this year. A survey of the Federal Reserve 
Bank of Philadelphia released just this Tuesday, on average 
forecasters said there was a 47-percent chance the economy 
would shrink in the first quarter of this year and a 43-percent 
chance that the economy would shrink in the following quarter, 
the second quarter of 2008. Every time it has risen above 40 
percent, the economy has gone into a recession. In a recent 
survey of economists by USA Today, more economists are 
increasingly predicting a recession compared to last October 
when only a third, now nearly half.
    So my point is for us to be able to move forward, we have 
to have some honest assessments and not be suggesting that--I 
do not want to talk down the economy, but at the same time we 
need to be able to work to build it up if we know we have 
challenges. And part of that challenge is the housing crisis, 
as the Chairman so aptly said at the beginning of his 
statement.
    You know, Mr. Secretary, you characterize the 
administration's efforts as ``aggressive action.'' I have to be 
honest with you. I remain unconvinced. I do not know that Hope 
Now is aggressive action when we are seeing foreclosures 
outpacing loan modifications 7 to 1. For subprime ARMs, which 
are at the root of the crisis, it is even worse--13 to 1. That 
does not even deal with the payment option ARMs that are 
looming on the horizon.
    And so are you telling the Committee that what the 
administration has proposed to date, particularly on the 
foreclosure crisis, which is at the root of our economic 
challenge where many of us feel that either we are in or headed 
toward a recession, that the voluntary actions are sufficient 
to stem the hemorrhaging and to ultimately--not only the 
hemorrhaging and the losses of homes for Americans, but at the 
same time the consequential effect it has on the economy?
    Secretary Paulson. I would say to begin with, if you are 
trying to talk the economy up, I would hate to see you try to 
talk it down.
    Senator Menendez. I am just not trying to hide my head in 
the sand either.
    Secretary Paulson. I am not either. But I would say that 
the Hope Now Alliance in my judgment has been an aggressive 
approach to stem avoidable foreclosures. To have 90 percent of 
the subprime market covered for adjustable rate mortgages--and, 
again, as I have said, I believe that what we are going to see 
as we go forward here. We are going to see that those mortgage 
holders that have their interest rates reset and, if they have 
been able to make the initial rates, they are going to be able 
to stay in their home if they want to stay in their home.
    Now, it took us until early January to get this group 
together. There were all sorts of technical hurdles. As 
Chairman Cox said, we obtained guidance from the SEC in early 
January. We are going to be very transparent. We are going to 
look at how it is working and if the industry is not 
performing, we will be all over them.
    Now, that deals with one part of this, and one part only. 
And the housing market is going through a correction. As you 
know, we have a number of other things. We would like to get 
the FHA modernization legislation signed. We have some 
proposals for tax-exempt financing. I am very open to looking 
at other ideas. I look at many ideas, look at them all the 
time, and it is a lot easier for people to say, ``Do 
something,'' than to say what it is we should do.
    So, again, we are going to keep looking at it and watching 
this quickly and watching it carefully.
    Senator Menendez. Well, Mr. Chairman, my time is up. I just 
want to say that there are several other initiatives. We look 
forward to having you consider them because we believe that 
just the voluntary aspect alone is not going to make us whole, 
either in stopping the American dream from being an American 
nightmare and too much debt that will result from that, too 
much loss in property values across the landscape of the 
country, and at the same time too much of a negative ripple 
effect in the economy.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator Menendez. And I raise 
this, as the Chairman knows and the Secretary knows, we started 
this process last March with the industry, the stakeholders, 
Senator Shelby and I did when we had those meetings. And I 
think other members may have shown up in those days, and we 
worked on a set of principles. And I am hoping it works as 
well. We all would like to see this work. You can understand 
Senator Menendez's skepticism and the skepticism we feel about 
it, just worried this is not going to be enough or is too timid 
and not catching up, Mr. Secretary.
    Secretary Paulson. Yes. I would just simply say it will 
certainly not be enough if the test we are using is going to 
somehow or other prevent all foreclosures.
    Chairman Dodd. No, no.
    Secretary Paulson. Or to prevent a necessary market 
correction. Our principle here has been: How do we prevent a 
market failure? How do we prevent those foreclosures that are 
avoidable? And so we are open--and I am open, I know the 
Chairman is--for other ideas. But, again, we are watching it 
carefully. I think we have been pretty active and pretty 
proactive on this. And, again, we are open to suggestions.
    Chairman Dodd. I hear that.
    Senator Hagel.
    Senator Hagel. Thank you, Mr. Chairman.
    Gentlemen, welcome. Just a note regarding the line of 
questioning that Senator Allard reviewed with the three of you. 
We are all aware that recently S&P and Moody's warned that if 
we do not deal with this entitlement issue, then our U.S. AAA 
bond ratings are in jeopardy, and we could see that as recently 
over the next few years. And I add that to the comments that 
you have made just to reconnect with not only the urgency of 
this issue but the reality of the consequences if we do not 
deal with these entitlement challenges that are ahead of us.
    I would like to talk for a moment about infrastructure. 
Senator Dodd and I have an infrastructure bill that we have 
introduced, and it would essentially leverage public and 
private capital--a little different approach than what we have 
seen in the past, and the reason for that is it is very clear 
to me that with the kind of deficits that we are running, will 
continue to run, with the obligations that you have noted here 
over the last few minutes, and most Americans are aware of, 
that the necessary capital for infrastructure is not going to 
be there. I do not know where we are going to get it.
    I noted, Secretary Paulson, that you did not think it 
should be included in the stimulus package--which I agree with, 
by the way. I think it is far larger than dropping rebate 
checks from an airplane. And I would be very interested in 
first understanding if the Treasury Department has looked at 
this infrastructure issue, will be making recommendations on 
what we should be doing. We clearly have an inadequate 
structure, and as we look down the road, again I do not know 
where we are going to find that capital, when the rest of the 
world is devoting an astounding amount of their resources to 
their infrastructure. And in a time when we are living at the 
most competitive time in the history of man, without an 
adequate infrastructure it will certainly have consequences on 
our ability to compete in the world. Secretary Paulson.
    Secretary Paulson. Yes, Senator, I agree that 
infrastructure is a significant issue in this country and 
others over the intermediate and longer term. This is not an 
issue that falls right within the Treasury's wheelhouse in the 
United States. We have other agencies that have responsibility 
for that.
    I would say to you, though, that, for instance, I was out 
late last year in California at an event, a trade event, where 
there was a good bit of discussion about infrastructure, 
because I think the infrastructure has a very important role to 
play. And, again, the focus there was on the private sector/
public sector partnerships and how to structure infrastructure 
projects so there could be more private capital involved. In 
this country and almost anywhere else around the world, I have 
looked at it and the needs are so large that it is going to be 
very difficult for the public sector to do it alone.
    So a big part of this is going to be structuring 
infrastructure projects so that they attract private capital.
    Senator Hagel. Thank you.
    I would also like to return to a line of questioning that, 
in particular, Senator Shelby has had regarding the GSEs. And 
we are all familiar with the fact that Fannie and Freddie are 
currently holding--either they own or are guaranteeing over $5 
trillion in mortgage-backed securities, which are not 
registered with the Securities and Exchange Commission.
    I asked a question at a hearing last week on this, and I 
quoted your response back to me, Chairman Cox, on whether it 
would be important to have the GSEs registering their debt as 
well with the SEC, and one of the Assistant Secretaries of 
Treasury noted it would be helpful.
    I would like to address that issue specifically with you, 
Chairman Cox, as well as you, Secretary Paulson, on the 
importance of registering that debt and understanding what the 
securities are that Fannie and Freddie own or guarantee, $5 
trillion worth. Do we really understand what they have? And 
would that registration with the SEC help us understand it? 
Chairman Cox.
    Mr. Cox. Well, I think you are absolutely right, Senator, 
that because GSEs sell securities to the public, they have 
public investors, they do not have the full faith and credit of 
the Government backing them, their disclosures should comply 
with the Federal securities laws. This has been done 
essentially on a voluntary basis heretofore. As you know, we 
had accounting problems at both Fannie and Freddie that have 
resulted in delays in getting them into compliance with respect 
to their 1934 Act compliance. Fannie is now there. Their 
periodic reports are being filed on time. Their 10K is expected 
on time this year. Freddie is not there yet.
    I think there is no question about the benefit to the 
markets and to investors from the maximum amount of 
transparency.
    Senator Hagel. Secretary Paulson, do you care to respond?
    Secretary Paulson. Yes. I do not have much to add to that. 
It makes sense. I think Fannie has registered under the 1934 
Act. Freddie is working to do that. That is, I think, very 
important, and I am also very focused on getting, as you all 
know, a GSE reform bill, which is, I think, at least as 
important.
    Senator Hagel. Thank you.
    Mr. Chairman, thank you.
    Chairman Dodd. Thank you very much, Senator Hagel, and I 
appreciate your raising the issue of the infrastructure bill 
that you and I are working on.
    In fact, we might ask the Treasury and others to take a 
look at this proposal, Mr. Secretary. We have not asked, I do 
not think, for comments on it. But this is one we worked on 
over the last 2\1/2\ years, putting together this idea of 
exactly what you are talking about as a way to attract private/
public capital, because you are not going to do it on the 
Appropriations Committee.
    Secretary Paulson. Right.
    Chairman Dodd. The needs are in the trillions of dollars.
    Secretary Paulson. Yes.
    Chairman Dodd. And it is going to take much more creative 
financing than what we have been accustomed to if we are going 
to do something about it. So I would be interested in your 
comments.
    Senator Brown.
    Senator Brown. Thank you, Mr. Chairman.
    I remain a bit surprised and troubled, Secretary Paulson, 
that your comments tend to gloss over some structural problems 
in our economy. Every day 200 families in Ohio, for instance, 
lose their homes to foreclosure, and none of that surprises 
you. And the troubles--I mean, to be sure, the troubles are 
worse in my State than perhaps the, quote-unquote, national 
average. But they are also not much different--if different in 
magnitude, not much different from the rest of the country's. 
Wages have been stagnant. Chairman Bernanke as long ago as 14 
months talked about income equality and how the industry has 
repeated that message and some ideas about what to do about it. 
Job growth has been anemic in the last 7 years. You know about 
gas prices, home heating costs. The food bank pantries around 
my State tell me it is worse than at any time in the last 
quarter century. And for the first time, as we know, in our 
lifetimes, families' housing wealth across the country is 
evaporating, as Senator Reed had pointed out.
    The stimulus package that the President signed into law 
should help somewhat, but even there we need to do much more. 
And I want to ask you a specific question.
    If I understand correctly, rebates will be issued only to 
people who file tax returns, but millions of eligible Americans 
who receive railroad retirement or Social Security retirement 
or disability benefits are not required to file tax returns. If 
they do somehow get word and do go to the IRS free-file 
program, they will be kicked out because the software is 
programmed to prevent them from filing.
    I am sure you aware of this. I would just like to know, Mr. 
Secretary, what steps you plan to take to ensure that everyone 
receives what Congress believes they are due.
    Secretary Paulson. That is the question we are really 
focused on right now. There is going to be a huge effort 
getting those people who normally do not file to file, and file 
as soon as possible. So in addition to the IRS website, there 
is going to be a big outreach effort, and we are going to go to 
a number of agencies, and to Members of Congress, because we 
have some experience in the past with the telephone excise tax 
and doing things on a smaller scale. But you have pointed your 
finger at an issue, because we have got to get to 130 million 
people and a good number of those are not normal filers.
    Senator Brown. And your job is both to find them and to 
make sure the software does not kick them out when you do find 
them. You can assure us of that?
    Secretary Paulson. Our idea is to find them, get to them, 
and encourage them to file and make it easy for them to file, 
because there should be a very easy basis for doing this.
    Senator Brown. OK. Thank you.
    Chairman Cox, nice to see you again. I appreciate the 
attention you are giving to sovereign wealth funds. I am 
curious why there is not much concern attached to this issue as 
many think there should be. As you will recall, President 
Clinton in, I believe, 1999 proposed to invest a quarter of the 
Social Security surplus, about $50 billion a year, in equity 
index funds. The reaction to that proposal in some quarters was 
pretty energetic. The esteemed Chairman of the House Republican 
Policy Committee called it ``the largest nationalization in 
history, threatening the very soundness of the economy.'' A 
Presidential candidate at the time called it a blatant Big 
Government power grab.
    I do not want to relitigate the Social Security question, 
but when we are looking at much greater amounts of money being 
invested selectively by foreign governments, and often 
governments very hostile, if not hostile to us certainly very 
different in their makeup in terms of being democratic and 
sharing the values that we have, we are looking at much greater 
amounts of money being invested selectively by foreign 
governments. Shouldn't there be a little more concern about 
their investment in U.S. private concerns--banks, other 
financial institutions, manufacturing companies, service 
companies--in this country?
    Mr. Cox. Well, these are important questions for the 
Congress, for the markets, certainly for all of us in the 
President's Working Group, and in some special ways for the 
Securities and Exchange Commission, because sovereign wealth 
funds, as any other large investors, come directly into contact 
with our regulatory system.
    As you know, sovereign wealth funds have recently made 
investments in Citigroup, in Merrill Lynch, Morgan Stanley, 
UBS. These investments from the standpoint of the Securities 
and Exchange Commission have been treated in the same fashion 
as would any investments by any large investor. And I think the 
reason for that cannot be said often enough in this context. It 
is because the United States welcomes and will continue to 
welcome with open arms both foreign investment in U.S. capital 
markets and the opportunity for Americans to invest beyond our 
borders. But in this context it is certainly worth paying 
attention to the unique features of sovereign wealth funds. 
They are not, first of all, all the same, as you know. But, 
because they are fundamentally arms of governments, they raise 
all the familiar questions about government ownership of 
industry, to which you alluded in your statement. They are 
growing in size, but they have been around for a long time.
    And so, in one sense, there is certainly no cause for 
alarm. Kuwait started its first sovereign wealth fund, which 
was not called that, over a half-century ago. Today one 
estimate from the Federal Reserve of New York puts the size of 
all of these funds combined at about $2.5 trillion. That is a 
lot of money. To be sure, it is more, for example, than all the 
world's hedge funds combined. On the other hand, as a 
percentage of assets that are managed by SEC-registered 
investment advisers, it is about 6.5 percent of that $38 
trillion. And as a percentage of all of the world's investable 
assets--equities, bonds, and bank holdings--it is about 1.2 
percent, although the Federal Reserve of New York estimates it 
is going to grow to about 4 percent.
    So I think that we have the opportunity to watch this 
phenomenon and to understand it. It is not something that we 
have to deal with definitively this week. On the other hand, if 
the trends that are being identified are correct, if they 
really do grow, as is expected, to some 4 percent of global 
financial markets in 7 years, that could at some point have a 
qualitative impact on our markets. And I think you are right to 
focus on it, but I would also caution that if what we do first 
is regulate and restrict, then we may have the kinds of impacts 
on our own capital markets that we are concerned about 
governments of other countries imposing upon us. So the remedy 
can also be a problem. We have to be very thoughtful about what 
we do in response. And, as you know, this question is being 
looked at by a lot of people in a lot of ways, including a 
focus on transparency I know that Secretary Paulson is leading 
as Chairman of the President's Working Group, because we have 
all agreed that both the sovereign wealth funds and the 
countries in which they invest will all be better off if they 
behave like any other commercial actors and if they are 
completely transparent.
    Thank you.
    Senator Brown. I appreciate the work----
    Chairman Dodd. Your microphone, please.
    Senator Brown. I appreciate the work of Senator Biden. I am 
just still a little bit confused that there was such anger and 
outrage that the U.S. Government would consider investing, but 
there is sort of tepid acceptance or indifference to investment 
by a Chinese or Dubai fund. I just remain a bit confused by 
that. But thank you.
    Chairman Dodd. All right. Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    I have got 5 minutes and lots of questions, so if you would 
keep your answers short, I would appreciate it.
    Chairman Bernanke and Secretary Paulson, how much of the 
stimulus in the bill signed by the President yesterday needs to 
get into the economy and how quickly does it need to get there 
to have an impact in the second half of the year?
    Mr. Bernanke. Senator, I think that the provisions made for 
the very quick action by Congress, the fact that the Treasury 
is working hard to get the IRS to send the money out very 
quickly, I think it will have an impact as early as the third 
quarter, maybe even a little bit in the second quarter. So it 
is a very timely bill in that respect, and I think it will be 
helpful.
    Senator Bunning. But how much of the stimulus package--we 
have got $160 billion. How much of that has to get in?
    Mr. Bernanke. Secretary Paulson could help me, but I 
believe that the money is going to be disbursed--over about 10 
weeks or so?
    Secretary Paulson. Yes, it will get out quickly, Senator. 
We are going to get the first payments out in the very 
beginning of May, and I think the vast majority of the payments 
going out to individuals will be out by mid-summer.
    Senator Bunning. So it can have a significant impact.
    Secretary Paulson. Yes, it will--we are going to get this 
out quickly.
    Senator Bunning. There are a lot of us who worried that it 
was not going to. OK.
    Chairman Bernanke and Secretary Paulson, with Fed fund 
rates at 3 percent and the President having just signed the 
economic stimulus package, do you have the proper tools today 
to react to an external energy shock or a disruption or a 
terrorist attack?
    Mr. Bernanke. Well, certainly, as I said, the monetary and 
fiscal stimulus we have should give us a better second half 
than otherwise would have been the case, and that should make 
the economy more resilient in the face of some kind of external 
shock. It would depend on the size of the shock, the nature of 
the shock, but it certainly makes us more resilient.
    Secretary Paulson. I would agree with that. We could all 
envision shocks that would be more severe than others. We are a 
bit more fragile than we were before we went into this period 
because the economy is slowing down and our institutions are 
not as well capitalized. They are adequately capitalized, but 
they are a bit more fragile. But I believe we are doing what we 
need to do, and if there is a shock, we will figure out how to 
react to it.
    Senator Bunning. All right. Well, thank you.
    Chairman Bernanke, our unemployment rate last month was 4.9 
percent. The average rate has been from 4.5 percent to 5.5 
percent. How close do you consider that to full employment? 
What is the natural rate of unemployment for our economy today?
    Mr. Bernanke. Senator, that is very contentious, and we are 
not very sure. People differ considerably. But recently the 
U.S. economy has shown an ability to maintain an unemployment 
rate somewhat a little bit below 5 percent. So we are not far 
from what many economists would call ``the natural rate.'' But 
I would really emphasize that there is an enormous amount of 
uncertainty about exactly where that is.
    Senator Bunning. Well, 10 years ago, 6 percent was 
considered full employment.
    Mr. Bernanke. Well, the economy has changed. I mean, the--
--
    Senator Bunning. That is why I am asking.
    Mr. Bernanke. Yes, and I think it is not a question of 
changing estimates. I think it is the fact that the economy, 
the demographics have changed, the ability to find jobs has 
improved, for example, using the Internet. A number of other 
factors have gone in to bring down that rate, and I think that 
is consistent with evolution of the economy.
    Senator Bunning. You have, I believe, answered this before, 
Secretary Paulson, but do you believe the banks and other 
financial institutions are adequately stating their exposure 
relating to the mortgage mess, including risks to prime in all 
types of other loans?
    Secretary Paulson. I believe that there is a big effort 
being made to do that, and as Chairman Bernanke said, some of 
the securities they are holding, there is not a----
    Senator Bunning. A free market or open market.
    Secretary Paulson. A market, and so what they are doing is 
they are marking these securities based upon ratings and based 
upon changes in the economy. And so this is difficult, but I 
think a lot of progress has been made, and I think that I am 
doing everything I can--and I know the Chairman is and Chairman 
Cox is--to encourage banks to take the losses and raise 
capital.
    Senator Bunning. Chairman Bernanke, I just want to give you 
a heads up. When you see something coming, don't put it off as 
the Chairman of the Fed. Take action immediately, because this 
housing market has been coming to us for a year, a year and a 
half, and we did not react properly to it.
    Thank you.
    Chairman Dodd. Let me inquire--I appreciate it, Senator 
Casey. Thanks very much.
    Senator Schumer.
    Senator Schumer. Well, thank you, Mr. Chairman, and I want 
to thank my colleagues and my colleague from Pennsylvania as 
well. I have a few questions.
    First, you know, being from New York, I talk to a lot of 
people who are involved in the credit markets, and more and 
more it seems there is a disconnect. They are in a state of 
severe worry, even some I talk to panic about the brittleness, 
the frozenness of the credit markets, which affects everything. 
And the statements that both Secretary Paulson and Chairman 
Bernanke have made have said, well, this is a problem, but it 
will not even take us into recession.
    My question is: When we are now seeing credit really 
damaged in corporate lending, lower-grade corporate lending, 
this 20 percent that the Port Authority paid shows a 
brittleness and an inflexibility. That is a good, safe 
investment, the Port Authority. I do not know how many people 
think the Port Authority is going broke, and you have got to 
pay 20 percent when the previous rate was 4.2 percent?
    Aren't we reaching a point where the lack of confidence 
overall in credit in this country--not just in housing, not 
just in student loans, but throughout, with the combination of 
the complex credit tools that have been used and the fact that 
people seem to have a sort of rather happy attitude about all 
of this until the housing crisis hit, aren't you 
underestimating not paying enough attention to the severity of 
the problem in the credit markets, which could become a much 
greater problem to the economy than the lack of--you know, the 
slowdown in consumer spending?
    Secretary Paulson. Yes, I would just say one thing, 
Senator. Yesterday and today, I talked with six or seven CEOs 
of the major firms in New York and continually get updates. I 
understand what happened in the auction and looking at other 
auctions that are coming up. It is one thing to identify a 
problem; it is another to know exactly what to do about it.
    I do believe, though, that what you are seeing here is the 
market pulling back from complexity, from any kind of 
instrument that is going to finance longer-term assets on a 
shorter-term basis.
    Senator Schumer. Aren't they more worried than your 
testimony or Chairman Bernanke's----
    Secretary Paulson. Well, I----
    Senator Schumer. I talked to them, too, and they seem much 
more worried than you guys are.
    Secretary Paulson. Well, let me say some seem more worried 
than others. I will tell you this: I have watched these things 
before, and it will take a while to get through this, and it is 
something we are watching carefully. But, again, the situations 
you talked about, like, for instance, the 20-percent rate. That 
is an overreaction. It is more of a reaction against the 
structure than the credit. It will be very quickly refinanced. 
And, again, I do not mean to be overly complacent, but I do say 
that one of the things we are going to have to do is re-price 
risk, mark securities to market, and raise capital.
    Senator Schumer. Right, OK. I am going to--since you and I 
talked on the phone about this yesterday, Mr. Chairman, I will 
go to my next question because I want to stay--the problem that 
we have had with the mortgage insurance is a problem, of 
course, not with mortgage insurance itself where the State 
regulators have done a good job, but when these companies then 
went over and did CDOs in--I am sorry, with bond insurance, 
with the Government bond insurance. When these companies like 
MBIA stepped into some new territory, CDOs, mortgage bonds, et 
cetera, led to their problems, not necessarily the insuring of 
State and local risk. And this brings in a problem of systemic 
risk. So I am considering introducing legislation that would 
regulate them when they do get involved in other types of 
activities, at least have some kind of Federal oversight 
greater than we have now. I am not sure if it should be by the 
Fed or by some other agency.
    I would like, Chairman Bernanke, your opinion of that and, 
Secretary Paulson, your opinion of whether there should be some 
greater oversight, Federal, on the systemic risk side, not 
necessarily on the insuring government side, of these bond 
agencies--these bond insurers.
    Mr. Bernanke. Senator, I am not quite sure what you have in 
mind. From a microeconomic point of view, the State insurance 
department regulates them, and we have no complaints about 
their regulation. But from a macroeconomic or from a market 
stability point of view, we are obviously watching that 
situation very carefully.
    I am not quite sure what additional powers you would have 
in mind, but, you know, I think that it is important to note 
the monoline problem is in some sense a reflection of the 
deeper underlying problem, which is the problems in the CDOs, 
the problems in the underlying assets.
    Senator Schumer. Yes.
    Mr. Bernanke. The best way to address this issue is to 
strengthen the underlying economy, the housing market and so 
on.
    Senator Schumer. Maybe they should not be able to buy such 
a high percentage of these types of things in terms of systemic 
risk without any regulation.
    Secretary Paulson.
    Secretary Paulson. Yes, I would say something, Senator 
Schumer, that addresses this, at least in part. One of the 
things we are working on very diligently right now at Treasury 
is developing a blueprint, a regulatory blueprint, for today's 
world and today's markets, because if someone came down from 
Mars and you were trying to explain the regulatory structure 
and how this works the way, it does. The regulatory structure 
has not evolved with the markets, and it is a patchwork quilt 
in many ways.
    And so hopefully when we are ready to unveil this, we can 
have some good discussion.
    Senator Schumer. I think it is a good idea for you to look 
at that, and I am, too.
    Thank you, Mr. Chairman, and I thank my colleague from 
Pennsylvania.
    Chairman Dodd. Thank you very much, Senator. I appreciate 
it.
    Senator Dole.
    Senator Dole. Yes, thank you, Mr. Chairman.
    First, I certainly want to echo the favorable comments that 
we have heard this morning regarding GSE reform. I have been a 
sponsor of that legislation, a cosponsor with Senator Hagel, 
and am very pleased to hear the strong support,and I hope we 
can move on that expeditiously.
    Chairman Cox, since the passage of Sarbanes-Oxley, there 
have been a number of complaints from smaller companies, from 
financial institutions, with regard to Section 404 and the 
burdensome nature of compliance, especially from the financial 
institutions because they are heavily regulated.
    Has there been any thought of easing the Section 404 
requirements for these institutions?
    Mr. Cox. Most definitely, Senator. In fact, both at the 
Securities and Exchange Commission and at the Public Company 
Accounting Oversight Board, which implements the audit rules 
for SOX 404, we have taken it upon ourselves to slay the 404 
beast. It has been, more than any part of Sarbanes-Oxley, the 
subject of criticism both here in the United States and abroad, 
not so much because of what Congress intended this provision to 
do, but because of the way that it was implemented.
    And so, to begin with, the SEC issued guidance for 
companies that had not existed before. The companies were 
having to use the guidance that was intended for auditors so 
that they could do their own internal assessment without the 
auditors under 404(a). And, second, we repealed entirely the 
long and cumbersome and very expensive auditing standard that 
had been adopted under very urgent conditions right after the 
passage of Sarbanes-Oxley, Audit Standard No. 2, and replaced 
it with something that is shorter, simpler, more principles 
based, top down, risk focused, guided by materiality and scaled 
to companies of all sizes. That is now going to kick in for 
this year, and we have a cost-benefit study underway at the SEC 
to make sure that it is working as we intended.
    Finally, with respect to the smaller public companies, we 
have on multiple occasions extended their time for compliance, 
and we have just done so one more time into 2009.
    Senator Dole. Thank you.
    Secretary Paulson, on January 24th, Business Week reported 
that sovereign wealth funds were the main topic of the Davos 
World Economic Forum talks. This has been mentioned already 
this morning, but I wanted to get you to reflect on this a 
moment because I know that some countries, like Norway, have a 
more transparent investment process while other countries, like 
China and Russia, have less so.
    What is the current status of the Treasury's work in this 
area with appropriate international entities to come up with a 
way that these funds can be at least more transparent or better 
understood?
    Secretary Paulson. Senator Dole, thank you very much. We 
are quite focused on this topic, and as Chairman Cox says, 
although they are a growing part of the capital markets in 
terms of their size, on a relative basis they are still fairly 
modest. But we are quite focused, and what we are focused on is 
to make sure that what they are driven by is commercial and 
economic purposes. We have had a history for many years with 
sovereign wealth funds, and for the most part, they are driven 
by getting a higher risk-adjusted return. They are driven by 
economic purposes.
    We at Treasury have spent a lot of time meeting with the 
sovereign wealth funds. We had a breakfast at Treasury where we 
had 25 or 30 of them there, and they all assure us that they 
are driven by economic intent. But our purpose there is to come 
up, and we are encouraging the IMF to work with them and 
others, with a set of business practices, best practices, 
principles that have to do with governance and transparency, 
and that will help them convince so many of the countries that 
are going to be the recipients of their investment that their 
intent is for economic purposes.
    Again, I want to reiterate what Chairman Cox says. In this 
country, we welcome foreign investment. That is the highest 
vote of confidence anyone can pay, is to make a direct 
investment in our economy. We want to be welcoming to that 
investment, but we also want to be vigilant.
    Senator Dole. Thank you very much.
    Chairman Dodd. Thank you very much, Senator.
    Senator Casey. And thank you, Senator Casey, for yielding 
to Senator Schumer. I appreciate it.
    Thank you, Mr. Chairman. Thanks for calling this hearing, 
and it is great to have these three individuals here--Secretary 
Paulson, Chairman Bernanke, and Chairman Cox. We appreciate 
your testimony and your service to the country.
    I want to speak first with regard to the subprime prices. 
Secretary Paulson, I wanted to just lay some Pennsylvania facts 
on the table. Two overall facts for the State--three, really. 
When you look at the third quarters of 2005 versus 2007, the 
number of delinquencies in our State has increased by some 
40,000. Then if you go forward and talk about foreclosures, 
full-blown foreclosures, the projection is third quarter 2007 
versus third quarter 2009, that is supposed to go up by some 
45,000. They are statewide numbers.
    One number which I do not think many of us talk about is a 
number that I just came across recently that was in a report by 
the Keystone Research Center. I would ask, Mr. Chairman, 
consent that this report be made part of the record.
    Chairman Dodd. It will be made a part of the record.
    Senator Casey. It is entitled, ``A Building Storm: The 
Housing Market and the Pennsylvania Economy.'' It is by the 
Keystone Research Center, Mark Price and Stephen Herzenberg.
    An interesting fact in here, which I put on the table as a 
foundation for my first question, is that we all know that 
subprime mortgages affect principally, in many cases, in many 
communities almost exclusively, low-income families. However, 
we sometimes think about that as an urban issue.
    This report found that the highest subprime mortgage rates 
are at least in Pennsylvania, in addition to the city of 
Philadelphia, the other eight in the top nine were rural 
counties. Overwhelming numbers, almost half the mortgages 
subprime. I say that in the context of my question in terms of 
the people we are worried about here and that I know you are 
worried about, and to ask you how you respond to some of the 
recent criticism that we have seen in the press.
    I know that, for example, the Wall Street Journal--not what 
I would call a left-leaning newspaper--from yesterday, 
``Earlier subprime rescue falters.'' I know you have seen that 
story. That is a national story that says in part in the first 
paragraph, ``Earlier efforts have done little to help the most 
troubled borrowers.'' It goes on to talk about criticisms of 
what has been happening so far.
    And then just yesterday, as well, the Pittsburgh Tribune 
Review newspaper--again, not a left-leaning newspaper--the 
headline is ``Mortgage lifeline falls short,'' and it talks 
about the Allegheny County Sheriff's Department, a big county 
in Pennsylvania, second largest county, saying that they are 
doing what the new initiative sets forth to do. And I would ask 
you to respond to that because I think people are worried that 
there is not the sense of urgency and we are not getting the 
results that we should have in the last couple of months.
    Secretary Paulson. Well, Senator, I understand that, and I 
spent time myself going around visiting communities where there 
are the most foreclosures. So I spent time on the ground. I 
have spent I would say a third of my time on this issue. And it 
is a difficult issue. It is not an easy issue.
    Take the case of the initiative that was announced earlier 
this week, Project Lifeline. There was a lot of criticism that 
it is not enough, et cetera, et cetera. That effort is aimed at 
anyone in the U.S. that has a mortgage and that is delinquent 
90 days. So they are right on the verge of losing their home. 
And one very sad fact is that over 50 percent of the 
foreclosures take place where the homeowner never talks to 
anyone.
    Now, it is very difficult to help someone if they will not 
try to help themselves or talk to anyone. So we have a hotline, 
888-995-HOPE, and we are urging people to call. This effort, 
again, is a last-ditch effort to get to people and get to them 
with a mailing and say here are some simple, pre-set procedures 
you can go through, and if you go through them, there may be an 
opportunity to have a modification in your loan agreement.
    Now, some people criticize that, and I frankly do not 
understand where their criticism comes from, because it is 
something we all should be doing. Now, is that going to help 
all those people stay in their homes? No. But it will help some 
people stay in their homes.
    The other effort that we have been working very, very hard 
on is the number of adjustable rate mortgages. And you are 
right, the next 2 years are going to be the toughest 2 years. 
The poorest quality mortgages in terms of underwriting 
procedures were made in 2006, so there are almost 2 million 
adjustable rate mortgages where the rates are going to be reset 
and move up. So we have 90 percent of the industry working very 
hard overcoming many technical issues and accounting issues. We 
have the industry telling us--and I believe they are very 
sincere in doing this--that they are going to move very quickly 
to deal with those homeowners that are able to make their 
initial payments and aren't able to afford the others, and help 
them avoid foreclosure. There are going to be fast-track 
modifications which are interest rate freezes. There are going 
to be refinancings. They are going to give us the information.
    So I did not create this problem. I am working to try to do 
something about it. If this effort does not work, then we will 
make adjustments to it. I do not mean to sound heartless 
because, I will tell you, when you are there and you look at 
the predatory lending abuses it is heart-rending. But what we 
are doing is trying to deal with it.
    All I can say to you is if you have other ideas for me for 
Pennsylvania, send them on in, because I think the tax-exempt 
financing can be helpful if that gets passed. We are going to 
try to make all of these programs work to the extent they can. 
And I agree with you, it is not just an urban problem. It is a 
serious problem, and we are doing everything we can to deal 
with it.
    Senator Casey. Well, and we are working on it here, too, as 
you know, but I am out of time.
    Chairman Dodd. Thank you, Senator, very, very much.
    Let me turn to Senator Corker.
    Senator Corker. Mr. Chairman, thank you. And to our panel, 
I want to say that I followed your careers and have tremendous 
respect for you being in the positions that you are in, and I 
am glad that you are.
    I will also say that I think the most discouraging moment 
of my 13-month career here has been this so-called economic 
stimulus package. We spent most of our morning talking about 
credit, and sprinkling $160 billion around the country and 
asking people to spend it as quickly as possible to solve this 
problem to me was not a solution worth debating or passing. But 
we have done that, and I just--obviously, these entities that 
are losing billions of dollars in the mortgage business, that 
is not a good thing for them either. And we have seen that when 
you can make a little money doing some conduit and securitized 
lending, you make a whole lot doing more, and so excesses 
occur.
    What do we see happening, Secretary Paulson, in the private 
sector to--obviously, the borrower and the lender are now 
separated. In some cases, the files may be in a warehouse in 
Kansas or Europe someplace, and so it is very difficult to 
solve these individual problems. What do we see the private 
sector--not today but over time--doing adjustment-wise to keep 
this kind of thing from occurring in the future?
    Secretary Paulson. Well, clearly there will be an aversion 
for some period of time to complexity, because one of the real 
problems we have here is complexity and an over reliance on 
credit ratings. So that will be one reaction.
    You pointed to the conduits and SIVs, which are very 
interesting. There was a great deal of focus on private pools 
of capital, hedge funds, and a lot of other issues. I think the 
regulators overall had to be surprised to see that some of the 
biggest issues were in the big regulated entities and the lack 
of transparency. And there is a lot of work being done to 
address this.
    I do not come from the school that says that the private 
sector itself will deal with it. I believe there needs to be a 
regulatory response, a policy response. The first thing we need 
to do is get through this period with minimizing the impact on 
the real economy. But as both Chairman Bernanke and Chairman 
Cox have mentioned, we are working and thinking about what the 
right response is.
    The last thing I would just say very quickly, which, 
without being overly defensive on the stimulus, when you look 
at housing overall, and you see estimates of the degree to 
which housing prices in some areas of the country are 
overvalued, there are two ways you can have a correction: 
housing prices going down or the economy continuing to grow and 
growing into that.
    So one way of minimizing the extent of the correction is to 
keep our economy healthy and growing. The focus of this 
Administration has been let us get in and do things 
aggressively to avoid those foreclosures that are preventable, 
to prevent a market failure with the kinds of things we have 
been doing, and let us do what we can to keep the overall 
economy growing, recognizing that this correction is necessary.
    So that is the response there.
    Senator Corker. Well, I did notice you said the focus of 
this Administration. I still have to believe that at night you 
are receiving cell phone calls from some of your former 
colleagues wondering what in the world we were doing. And I am 
sure that explanation----
    Secretary Paulson. Well, I will tell you: they have not.
    Senator Corker [continuing]. Has been developed.
    Secretary Paulson. The interesting thing is every colleague 
that I have talked to or CEO of the financial services industry 
wanted a response like the stimulus plan and believe it will be 
helpful, but believe it is not sufficient.
    When they say not sufficient, they all recognize that as 
helpful as monetary policy is and as helpful as the stimulus is 
that those programs alone will not be sufficient; that the 
industry is going to need to re-price risk, recognize losses, 
raise capital, and that given the degree of integration of our 
capital markets into the global capital markets and the degree 
of complexity means, it is going to take time and some pain 
before we work through this.
    Senator Corker. Just--I know my time is up, just a quick 
one word response from you and Chairman Bernanke, if we could.
    But there have been a lot of descriptions about where we 
are in the housing sector, whether it is a crisis or whether 
this is a correction. And I am wondering if each of you might 
chose a word to describe where we are today.
    Secretary Paulson. I do not use loaded words. And so I have 
been using a correction, because it is a correction. And I 
would say this: that 93 percent of the mortgage holders in this 
country are making their mortgage payment on time. But what we 
have and why we have different voices is again this is a 
nationwide issue.
    There is a different degree of a problem in different areas 
of the country. And at the end of December, I went around and I 
visited a number of communities that had the highest rates of 
foreclosure. And they fit into two categories.
    They fit into--either those communities that may have a 
strong underlying economy, but where there had been very, very 
rapid appreciation of home prices, to the point that when you 
look back on it, it is hard to even imagine home prices going 
up 15 percent, 18 percent a year and not sustainable.
    When you look at parts of--I was in Orlando, Florida; I was 
in Stockton, California, where you had home prices going up 
very quickly. And then, you would go to a place like Kansas 
City, Missouri, or you look at parts of Pennsylvania or Ohio or 
Michigan, where you maybe did not have the same appreciation, 
lower appreciation, but where we have a tough economy.
    Where the economy is weaker and that, coupled with some of 
the very bad lending practices, have put us where we are.
    Mr. Bernanke. I think the mortgage payment rate is probably 
closer to 98 percent, but in any case it is--most people--
obviously, the great majority of Americans are paying their 
mortgages on time.
    I agree with what the Secretary said, in particular there 
is two phenomena--on the one hand, in parts of the country 
where there was enormous price appreciation, that has been 
vulnerable to correction. So that is really in some sense an 
offsetting of what happened over the last 5 to 10 years in 
those markets.
    There are, however, other places in the upper Midwest, for 
example, where they never got that much appreciation. Now, 
prices are falling because of general weakness in the economy, 
and that is one of the reasons why there is a direct connection 
between broad economic health and job creation and prices of 
housing, and there is a link there.
    Senator Corker. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator, very much. I was--I 
could not help resist when you are asking whether it is a 
correction or crisis. Where you stand on that issue depends on 
where you sit.
    Senator Corker. That is right.
    Chairman Dodd. And if you are sitting there watching your 
house get foreclosed, believe me, it is a crisis. And we can 
move around with these numbers all we want. The fact is this is 
a big problem. And I agree I do not want to see the--it would 
be inappropriate for the Secretary or the Chairman to start 
putting a label of a word on there. That could have its own 
self-fulfilling prophecy here, so we ought to be careful about 
language. Language has significance and implications.
    But needless to say, I think we all agree here. We would 
not be sitting here if this were not a major issue we need to 
grapple with here, and I do not want to--I am not trying to 
engage in hyperbole, but I do not think we ought to underplay 
it either. I think you have got to be honest with people about 
this is serious and requires a lot of work. And I think that is 
the point worth making.
    Secretary Paulson. We have both said for some time by far 
the biggest risk to the economy is the housing downturn.
    Chairman Dodd. Thanks very much.
    Senator Carper.
    Senator Carper. Thanks, Mr. Chairman. Gentlemen, welcome. 
Thanks very much for joining us and for your testimony today.
    I want to especially thank you, Mr. Secretary, for the good 
work, for the leadership that you demonstrated in working with 
the House and Senate to craft a stimulus package, which I think 
does no harm and hopefully will do some good as we get into the 
summer and the latter part of this year.
    I want to commend Chairman Bernanke. I want to commend you 
and those with whom you work on the work that you have done--
lowering the Fed Funds rate I thought in an unprecedented way, 
not once but twice last month.
    But thank you for being there. And I think what you have 
done is actually more important than what we have done in terms 
of the stimulus side. And we--I am anxious to know when do you 
think these--when will we know whether or not these steps are 
working? And how will we know. Let us just start with that.
    When will we know whether these steps are working and how 
will we know?
    Mr. Bernanke. Well, Senator, we will be looking over the 
next few quarters obviously at the general performance of the 
economy, but as I mentioned in my testimony, I think there are 
a few areas of particular sensitivity we need to watch. First 
is the housing market. We need to begin to see some 
stabilization in starts and sales. That would be very 
productive in terms of both of the economy and the credit 
markets.
    Second is the labor market. We would like--we do not expect 
a rip-roaring labor market by any means, but it would be nice 
if the labor market would begin to stabilize close to current 
levels.
    And third, the credit markets. Senator Schumer was correct 
that there is a lot of concern among participants in the 
financial markets about the state of the credit markets. Much 
of that is connected with uncertainty about the broad economy. 
A significant worsening in financial conditions or in credit 
availability would certainly be a warning bell that we need to 
take further action.
    Senator Carper. OK. Good.
    Treasurer Paulson, any--Secretary Paulson, anything you 
want to add or take away to what the Chairman has said?
    Secretary Paulson. I would just simply say looking at the 
Housing Initiative, the HOPE Now Alliance, we are going to be 
getting numbers every month. And so in terms of that 
initiative, we are going to look at it and we are all going to 
see that they are doing what they say they are going to do and 
how it is working.
    Senator Carper. All right. Thank you.
    Mr. Bernanke. Senator, if I could just add a word on that?
    Senator Carper. Please.
    Mr. Bernanke. I mean, one of the big problems with the 
foreclosure issue is we have not had good numbers. We have had 
numerous studies that are not comparable. We do not know 
exactly what they refer to. It is hard to know how much 
progress is being made.
    So I think getting consistent numbers over time will be 
extremely helpful.
    Senator Carper. Good. There is an interest on both sides 
here, Democrat and Republican, in doing more on the housing 
side and trying to address one, the properties for which--which 
have been foreclosed, the properties that are sitting vacant, 
then trying to make sure that there--we somehow encourage 
homeowners to come in, new owners to come in, purchase those 
properties, and bring--and live in them.
    And there is an interest in doing some other things to 
restore liquidity in this area of our economy. Among the steps 
that have been suggested that would be helpful--one, 
reauthorize FHA. Do so in a way that we bring the FHA into the 
21st century and make it relevant. There are a number of 
aspects of that that would be helpful.
    So our proposal to work with our State housing authorities 
to give them greater flexibility to refinance troubled 
mortgages, because Senator Isakson has an idea that we provide 
a $5,000 tax credit to anybody that would move into a home that 
has been foreclosed and to live in that home.
    Or there has been a suggestion that we enlarge, appropriate 
a little more money to CDBG, Community Development Block Grant 
funds, with a stipulation that those monies be used to help in 
this regard.
    There has been talk about us passing a strong GSC bill, 
strong regulator, and somehow include in there the--make 
permanent or more permanent the increase in the mortgage that 
can be financed through GSEs. And also we have this idea about 
government-era--or actually Depression-era government 
corporation, sort of a quasi-government corporation, to kind of 
revisit that and try to bring that into the 21st century and 
see if it could be made relevant.
    That is sort of a menu that has been suggested to us, and 
there are other ideas, good and bad.
    Of that list, which one or two seems to make the most sense 
to you for us to take as a next step?
    Secretary Paulson. Well, first of all, I am familiar with 
all of the ideas, and we review every idea and continually 
review them.
    And clearly, among the things that we believe should be 
done now is GSE reform. So put that at the top of the list 
right there with the FHA modernization, and, of course, you 
have all said that. So we just now need to get them into the 
law. We have a Senate bill. We have a House bill. We need to 
get legislation passed that can be signed.
    So I put those at the top of the list, along with the tax 
exempt financing authority for the State and municipal 
governments to let them come up with their own programs to 
assist with mortgage financing and help as the situation may 
warrant at the State and local level.
    I have been very interested and talked with Senator Isakson 
about his bill. We continue to study it, think about it, think 
about other alternatives, but the issues--the initiatives that 
we are for right now are the ones that I mentioned.
    Senator Carper. Thank you. Last question for Chairman 
Bernanke. Just give us a quick update on Regulation Z. Where we 
are going? Where you are going? And when we can likely see that 
so we will have better disclosure with respect to credit cards 
and other items.
    Mr. Bernanke. Thank you. Senator, as you know, we did a 
very extensive review of disclosures for credit cards. We have 
a new Schumer box. Senator Schumer is not here.
    Senator Carper. Cannot we come up with a better name for it 
than the Schumer box?
    Mr. Bernanke. Do you have a suggestion, Senator?
    Senator Carper. Carper box.
    Mr. Bernanke. Among the benefits are a much clearer 
disclosure of penalties and other issues.
    We have--the comment period has closed. We received lots of 
comments. We are working through them now. So we expect to have 
a final rule soon. And we are hopeful that it will be a major 
help to making people better understand their credit cards and 
what their responsibilities are.
    Senator Carper. When you say soon, today is the day that 
the pitchers and catchers report for spring training. You think 
soon might be opening day of baseball season?
    Mr. Bernanke. I am sorry?
    Senator Carper. I am trying to understand what soon might 
be. I am in a baseball mode today.
    Mr. Bernanke. Yes. I--we will shoot for opening day.
    Senator Carper. Good. Thank you very much. That would be a 
good way to start the season. Thank you.
    Chairman Dodd. Thank you. Senator Bennett.
    Senator Bennett. Thank you much, Mr. Chairman.
    Chairman Cox, you and I have had a number of discussions 
about naked short selling. I have a lot of opinions about the 
mortgage thing. We have beaten that horse to death. And I will 
move on to another subject without sending the signal that I am 
not interested in the other issues, the economy and so on. It 
is just that it has all been plowed before.
    Let me give--I have done some investigating on my own, and 
let me give you some of the benefit of that and then ask you to 
comment, and I have a suggestion for you.
    Three months prior to the SHO Regulation, which you issued 
to try to deal with naked short selling, the volume in Fails to 
Deliver on NASDAQ was 150 million shares a day, and 3 months 
after, it was 20 million shares, which would show great 
progress.
    Unfortunately, there is an indication that all it shows is 
that the people who are involved in naked short selling have 
hidden their activities a little more carefully than they did 
before.
    Let me give you some examples. First, for those listening 
in that do not understand exactly what we are talking about, 
when a broker dealer purchases the sale of a short share, he 
has 3 days to deliver a borrowed share to the purchaser and the 
purchaser has 3 days to deliver his money.
    And in the old days, when I was short selling and losing 
money doing it, the buyer did not--if the buyer did not receive 
his shares by settlement day, 3 days after the trade, he took 
his money back and undid he transaction.
    So he got a crinkly piece of paper that said I really do 
have these shares. Well, we have done away with that now with 
the DTCC. Everything is electronic, and what he gets in his 
account is an electronic blip that says you own that share, and 
he does not know whether it is a real share or a counterfeit 
share.
    And increasingly, it is easier in this electronic world to 
give you a counterfeit share.
    Now, many of the people who engage in short selling have 
multiple entities, many of them offshore, and they sell large 
naked short positions from entity to entity. Position rolls is 
what they call it, and they are frequently done broker to 
broker or hedge fund to hedge fund in block trades that do not 
appear on any exchange. And each movement resets the time clock 
for the naked position so that the Fail to Deliver, which you 
monitor, never shows up.
    And it is a way of keeping the company off the SHO 
threshold list. And the stock lend of these kinds of 
counterfeit shares is enormously profitable for the broker 
dealers who do it, because they charge short sellers fees for 
the ``borrowed'' shares. They are really manufactured shares, 
whether they are real or counterfeit.
    And when the shares are loaned to a short, they are 
supposed to remain with the short until he covers his position 
by purchasing real shares.
    Well, the broker dealers do 1 day lends, which enables the 
short to identify to the SEC the account that the shares were 
borrowed from and as soon as the report is sent in, the shares 
are returned to the broker dealer to be loaned to the next 
short.
    This allows eight to 10 shorts to borrow the same shares, 
resetting the SHO Failed to Deliver clock each time, which 
makes the counterfeit shares look like legitimate shares and 
the broker dealer charges each short for it.
    We have the situation, which we have talked about before, 
that illustrates this. Robert Simpson, an investor, in 2005 
bought every single issued and outstanding share of a company 
called Global Links Corporation, every single one, and then 
filed with the SEC his report that he now owned 100 percent of 
the shares and then he watched that share--that stock trade 37 
million shares the next day and 22 million shares the day after 
that. They were obviously trading counterfeit shares.
    All right. My concern is with the DTCC, which is the 
clearinghouse that handles all of these electronic shares and 
through whom the creation of counterfeit shares becomes 
possible. They are totally opaque. It becomes impossible to 
find out what is going on.
    I have had a number of conversations with you personally 
and with your staff and I salute publicly the work that the SEC 
is doing to try to curb this.
    But I have seen companies in my own State see their share 
prices driven down virtually to nothing when there are more 
shares trading than there are shares outstanding. They have 
tried to solve it by getting the DTCC to give them physical 
control of their shares. The DTCC will not. One of the 
investment bankers involved in this helping a new company that 
said we want to go public said all right, I will help you go 
public on the condition that you never allow physical control 
of your shares to disappear. You cannot allow a single share to 
go to the DTCC because as soon as you do, you expose yourself 
to the creation of counterfeit shares.
    So my question to you is what can we do to get more 
transparency over the DTCC? And do you have any authority to 
deal with them to try to create transparency so that the 
creation of counterfeit shares begins to stop?
    Mr. Cox. Well, Senator, thank you for describing some of 
the pathologies that surround this phenomenon of naked short 
selling and also for your compliments to the Agency for the 
work that we have been doing on this.
    We take, as you know, illegal naked short selling very, 
very seriously, and we are pursuing wrongdoing very seriously.
    What you have described, in part, with the daisy chaining 
of share lending and with resetting the Reg SHO clock and so on 
could amount to market manipulation in violation of Rule 
10(b)(5) so that what we might have on our hands is not just 
insufficient regulation, but outright fraud. And certainly, in 
those cases, the Commission----
    Senator Bennett. I am convinced you do.
    Mr. Cox [continuing]. Is equipped with tools to deal with 
this.
    The net settlement aspect of the way that DTCC operates has 
other consequences that we are trying to deal with in related 
contexts as well, as you know, such as over voting in elections 
and the related question of broker voting. All of this relates, 
in turn, to the way our proxy system works.
    And so we have an abiding interest not only in the clearing 
and settlement system, which is a fundamental piece of the 
infrastructure of the financial markets of the United States, 
but also we want to make sure that our proxy voting system 
works and that people have confidence that the markets work as 
they are intended.
    So we will continue to work with you on this.
    I just want to update you on further amendments that we are 
making to Reg SHO to make it work better, because each time we 
have taken an aggressive step, we have solved part of the 
problem, but we have seen it manifest in other ways.
    We had a grandfather provision, as you know. It was 
thought, once that went into effect, that the grandfathering 
was itself contributing to the problem, so we have now repealed 
the grandfather provision. The phase-in period for putting this 
new rule into effect, which gets everything down to 13 
consecutive days, was just 6 weeks ago.
    And so, we are going to monitor very closely whether that 
has been useful.
    The other thing that we were doing is disclosing aggregate 
fail to deliver data on our own Web site for the first time. 
And we hope that that contributes to people getting at this 
problem.
    So we look forward, Senator, to working with you and your 
staff and being as public and open as we can about our fight to 
stop abusive naked short selling.
    Senator Bennett. Thank you.
    Chairman Dodd. Thank you very much, Senator, and I--just to 
take before I turn to Senator Bayh, I just want to reiterate 
the concern Senator Shelby has, I have as well, Chairman Cox, 
on the rating agency issues. We have had one hearing on it 
already. We may want to do it again, but we are very interested 
in hearing--I know you responded to Senator Shelby's questions 
regarding this, but we are very interested in following up with 
you; obviously, Secretary Paulson as well, having almost a 
lifelong experience in this area; and the publicly traded 
company issue, looking at these companies to determine whether 
or not any wrongdoing occurred is something I want to make a 
request of you to maybe report back informally, at least 
initially to Senator Shelby and I in this area, and then 
possibly make it the subject for another hearing to focus on 
that specifically, the publicly traded companies and the rating 
agency ideas, if any.
    As you said in your testimony here, there are a number of 
ideas out there. We want to make sure we do the right thing, 
understanding what is going on, what percentage; obviously a 
relatively small percentage of the market, but nonetheless, a 
very important and critical area.
    So we will invite that comment from the SEC.
    Mr. Cox. We will look forward to reporting back to you, Mr. 
Chairman.
    Chairman Dodd. Thanks very much. Senator Bayh.
    Senator Bayh. Thank you, Mr. Chairman. In fact, my first 
comment was going to be about the rating agencies. But before I 
get to that, I would like to thank all three of you for your 
public service.
    I have a high regard for each of you and you take your fair 
share of criticism, but I think you also deserve a fair amount 
of praise for what you do on behalf of all of us.
    Chairman Cox, I listened with interest to--and I am going 
to look with interest for the recommendations that you have 
actually come up with about how do we prevent these conflicts 
of interest that were apparent.
    And I think it is good that you are thinking about 
requiring greater disclosure so that the discipline of the 
marketplace can function.
    But the losses here have been so staggering and the adverse 
consequences to our economy have been so great, this may have--
and the damage to our global brand as a safe and secure place 
from which investments originate that this may be one area 
where some minimum standards for conduct mandated by regulation 
or law may be in order.
    So I encourage you to take a very rigorous look at this. 
Human nature being what it is, abuses can tend to reoccur, and 
so more information is great. The discipline of the market is 
great, but some minimum standards for conduct may be in order 
here, and I would just encourage you along those lines and 
along with the Chairman and Senator Shelby await with interest 
your report because so many people bought what they thought was 
AAA rated stuff, and it was infected with anything but. And we 
have got to make sure that that kind of thing does not reoccur.
    That said, I would like to turn to Chairman Bernanke and 
Secretary Paulson.
    I am--in follow up on something that both Senator Dole and 
Senator Brown raised, and that is the whole issue of the 
sovereign wealth fund, and both of you encourage--you said one 
of the most important things our financial institutions can do 
is to raise capital. They have been busy doing that. A good 
chunk of it has come from the sovereign wealth fund area.
    And, Secretary Paulson, I want to follow up on something 
that you said and the President said, I think it is very 
important that our country remain a safe and secure place for 
capital investment from abroad, including from sovereign wealth 
funds.
    As you had pointed out to date, and I think maybe the 
Chairman mentioned this--oh, no the--Commissioner Cox mentioned 
this, to date the experience has been a very positive one. The 
investments have been passive. But a recent behavior by the 
Russian government, China's relentless pursuit of economic 
advantage, using any number of levers to obtain that, does give 
some pause.
    And I want to follow up on something that Senator Brown was 
asking, and I am being somewhat of a devil's advocate here, but 
let me just put it to you this way: I am fascinated by the 
prospect that this Administration could be standing for the 
proposition that U.S. Government ownership of U.S. businesses 
is an acceptable thing.
    Chairman Bernanke, your predecessor came before the 
Congress and stated very clearly that in his view, it was not 
an acceptable thing because of unavoidable risk of political 
interference with economic decisionmaking.
    And, Mr. Secretary, one of your predecessors, Secretary 
O'Neill, said the same thing. I think his direct quote was the 
U.S. Government has no business owning U.S. businesses.
    And so my question to both of you is would you agree with 
those statements? And, if not, the left wing of my party will 
be delighted.
    And so I am kind of curious. If our own government, the 
Federal Government, of our country let us say to solve the 
Social Security problem, or any number of other things were 
proposing taking major equity stakes in U.S. companies, would 
that be OK? If not, what should we do to safeguard against the 
risk of political interference?
    Secretary Paulson. Well, Senator Bayh, clearly, I do not 
believe that the U.S. Government should be owning our companies 
or parts of the private sector. We are an economy that has been 
open for a long time. We have privatized. But we are in a 
situation where in various parts of the world, their economies 
are still privatizing or they have huge pools of money.
    And even in our economy, you know, we have State pension 
funds. We have CALPERS. Alaska has its fund. There are 
different forms of funds, and the overriding question is do we 
want our capital markets to be open and competitive. We do not 
want them after having privatized, to be not open to market 
forces.
    So I think the real question we are getting at is, are the 
investments coming into our country driven by market forces or 
are they being driven by political forces? And that is where 
the focus is, and being vigilant there. That is why the focus 
on best practices, transparency, and so on.
    Senator Bayh. If I could be indulged to just follow up, Mr. 
Chairman. Mr. Secretary, thank you for your response. I would 
observe a couple of things.
    First, our State pension funds, which are sometimes raised 
as an analogy, as you know, are subjected to all sorts of 
transparency requirements, governance restrictions, which I 
think the sovereign wealth funds would probably bridle at.
    So that is No. 1. It is sort of an imperfect analogy.
    Second, some of the shareholder activism that our State 
pension funds engage in proves the point that they are 
susceptible to sometimes having political agendas, which--and I 
think you would agree that just as our own government would be 
susceptible to that, foreign governments would be no less 
susceptible. So how do we attract the capital and yet protect 
against the potential, not yet the reality, but the potential 
as these become bigger and bigger players for something other 
than economic motivations to be driving decisionmaking?
    Secretary Paulson. I think we are saying the same thing. 
And what we are doing because we are approaching this at 
Treasury from two angles, two ends.
    First, we have been very actively engaging with sovereign 
wealth funds, the newer ones and some of the established ones 
that have some very good procedures, processes, transparencies, 
and we have been talking with them about their motives, about 
their governance, about their processes and procedures, and we 
have been encouraging them and saying you want to make 
investments around the world. There are these very natural and 
understandable concerns. You can assuage these concerns by 
developing best practices and by living by those best 
practices.
    And so there has been a lot of work done at Treasury and at 
the G-7 and to do this right now. The IMF is helping lead an 
effort to get more transparency.
    Then, on the other side, we are working with the countries 
that are going to be the recipients of a lot of this 
investment--the OECD countries coming up with also best 
practices so countries will not dress up protectionist 
sentiments as being, you know, using the sovereign wealth funds 
as an excuse--to close their markets from investment.
    There has been in this country for some time and in many 
countries in the world a concern about foreign investment.
    I can remember back in the 1970s and 1980s, when Japanese 
companies were buying the Rockefeller Center or golf courses or 
investing, and there was just this huge concern.
    So there is a concern in our country that I think has been 
for a long time somewhat unfounded, and there is a concern in 
many other countries that would try to hold back foreign 
investment.
    I think it is a two-pronged approach. We need to be 
vigilant, as Chairman Cox says, although the amount of money 
has increased, as a percentage of global wealth, it has not 
really increased that much.
    The trend lines say it is going to increase. Sovereign 
wealth funds are going to increase. I never am quite sure I 
believe all the trends, because the past is very seldom a great 
predictor of the future, but we are watching it carefully, and 
we are very vigilant here.
    Senator Bayh. My time has expired, Mr. Chairman. Chairman 
Bernanke, you get off the hook here today, because we have 
exhausted our time.
    I would only observe, Secretary, that we are talking about 
government investment, not private. We would not even be having 
this discussion if it was about private foreign investment.
    And with regard to best practices and the IMF and all that 
sort of thing, perhaps with some of the more traditional 
investors with a long-term track record that might work well. 
Some of the newer actors--let us take China, for example. I 
know you have worked very diligently to try and convince them 
about the best practices of allowing the marketplace to set 
exchange rates.
    Their progress has been, let us say, halting to date. As a 
matter of fact, it is that practice that has led to some of the 
reserves they have accumulated which now lead us to the 
sovereign wealth fund issue.
    So some of us are a bit skeptical that moral suasion and 
best practices alone will be enough to convince some of the new 
actors on the stage to behave in a way that the American people 
would view as good for our economy and yet insulating us from 
the potential for political abuse.
    Secretary Paulson. Can I make one other point that is 
related to all of this? And, as Chairman of the CFIUS process, 
I work very hard to look at national security and other issues 
and enforce the law.
    I would say the other thing that we have got going for us 
is once any investment comes into this country, we have the 
full force of the SEC, the Justice Department, all of the laws, 
all of the regulations we have to protect us, protect us 
against abuses and so on. So, again, I think we need to be 
vigilant. I do not think we need to be fearful, and I know you 
are not suggesting that. You are I think in a very careful way 
raising the issues, and these are issues we are all focused on.
    Senator Bayh. Thank you.
    Chairman Dodd. Thank you very much. Let me just--you know, 
since you have raised CFIUS and I thought this was important. I 
want to thank Senator Bayh and others who raised this. We had a 
very good hearing Senator Bayh chaired earlier in the year. 
This is a very important subject matter for the very reason. 
The last thing we want to be is xenophobic about this subject 
matter. It has been a--there has been a great source of wealth 
creation in the country to attract capital to come here.
    On the CFIUS, I am having--we did a good job I think here 
working with the Administration and writing that legislation. 
And there is some, I think, maybe a little confusion about the 
question of these bright lines, and you sort of alluded to it 
right there, which provokes this point.
    And that is we set a line on a certain amount of investment 
in the country that would trigger CFIUS and the kind of 
examination--national security issues.
    As I recall having written this, along with other members 
here, that line is not that bright. I mean there are ways in 
which actually, as you point out, I think we need to be clear 
on this that we are--the CFIUS process can actually be engaged 
far short of a minimum amount of investment in the country, 
where there are some controlling interests, board members, 
other matters here that would allow the Treasury and others to 
take a good hard look at this.
    And it might be helpful, Mr. Secretary, to clarify that a 
bit. In light of Senator Bayh's question, I think we might 
reduce some of the concerns about the ability of us to actually 
make the very examination you just suggested in your last 
point.
    Secretary Paulson. Well, right. Well, first of all, CFIUS 
is----
    Chairman Dodd. National security motivated.
    Secretary Paulson. National security----
    Chairman Dodd. I agree. And it is----
    Secretary Paulson [continuing]. It is focused on national 
security, so that is paramount.
    Chairman Dodd. But Senator Bayh's point here when you are 
talking about some of these issues, that line gets blurred a 
bit between national security and economic investment.
    Secretary Paulson. It is so. It is focused on national 
security, and then, as you said, when you look at control, what 
is control and there we do not have bright lines. It can be 
different in different situations. So I think it is very 
important that we have the flexibility when we look at this, 
because, as someone who has worked in the capital markets for a 
long time, I can just tell you depending on the size of the 
company, the composition of the shareholder base, the 
composition of the board, control can take place at different 
shareholding levels.
    So, again, we have flexibility, and we are vigilant there.
    Chairman Dodd. I do not want to dwell on the point, but I 
think, in fact, Senator Bayh talking the other day, we made the 
point that it was recent major investment in a major bank in 
New York, and then the--and then there was an investor that had 
less than 10 percent, but before they decided on the new CEO, 
they went out and checked with that latest investor, which 
raises the issue.
    Anyway, we are going to run out of time here. The last 
questioner is Senator Akaka, and then we are going to be 
through. Thanks.
    Senator Akaka. Thank you very much, Mr. Chairman. I want to 
add my welcome to Secretary Paulson, Chairman Bernanke, and 
Chairman Cox to this Committee's hearing on our economy and 
financial markets.
    I want you to know that the years I have been here, I have 
been very interested in financial literacy and raising the 
level of information to our people in this country so they may 
work with the financial industry.
    Mr. Secretary, the Fair and Accurate Credit Transactions 
Act created the Financial Literacy and Education Commission, of 
which you are the designated chairman. And because of my 
feelings, I feel this is very, very important to our country.
    Without a sufficient understanding of economics and 
personal finances, individuals would not be able manage their 
finances appropriately or evaluate credit opportunities 
successfully, invest in long-term financial goals in an 
increasingly complex marketplace; or to be able to cope with 
difficult financial situations.
    It is essential that we work toward improving education, 
consumer protections as well, and empowering individuals and 
families through economic and financial literacy in order to 
build stronger families and businesses and communities.
    So I want to see the Commission improve the financial 
literacy of all Americans.
    The GAO has recommended that the Financial Literacy and 
Education Commission incorporate additional elements into the 
national strategy to help, and these are the two: to help 
measure results and ensure accountability.
    So my question to you is what has the Financial Literacy 
and Education Commission done to address the issue of measuring 
results and ensuring accountability?
    Secretary Paulson. Senator, first of all, thank you very 
much for the question, and thank you for your leadership in 
this area, which is absolutely critical.
    As you have said, I chair the Commission, and the President 
had asked me to put together a plan, which we have put 
together, which we have rolled out, and it is one that is aimed 
not just at educational institutions, but it is aimed at the 
workplace. It is aimed at communities, and it is really quite a 
comprehensive plan.
    And I would very much welcome the opportunity to come up 
and spend some time with you on this and really to talk to you 
about this in some detail.
    Senator Akaka. Thank you.
    Secretary Paulson. Thank you.
    Senator Akaka. Thank you for that. I appreciate it.
    Chairman Bernanke, in my home State of Hawaii, remittances 
are extremely important to many of my constituents, and a 
portion of their hard-earned wages are sent to relatives 
abroad.
    I am concerned that the fees that are often paid are too 
high. And our banks and our credit unions often provide lower-
cost remittances.
    So my question to you is what do you think must be done to 
encourage more people to utilize mainstream financial 
institutions for remittances services?
    Mr. Bernanke. Senator, you are correct. That is a very 
important question, one the Federal Reserve has been very much 
involved in. I think there is, in some cases, a tendency for 
new arrivals to be distrustful of the banks or less willing to 
be involved in the banking system. And it is incumbent on the 
banks and the credit unions to reach out to a new group of 
customers who not only will be remittance customers, but once 
they become acquainted with the bank could become depositors or 
savers or borrowers as well.
    So we have encouraged banks and other financial 
institutions to reach out, to get people, staff, who speak the 
relevant language, to have community outreach, to try to bring 
people into their organizations. As you point out, frequently 
they can offer remittance services at reasonable prices.
    The Federal Reserve has also been trying to support these 
efforts by establishing relationships with, for example, banks 
in Mexico that will help transmit remittances at the lowest 
possible cost.
    So I think by, you know, through all these efforts, we will 
accomplish several goals. One is to increase competition and 
improve service and reduce costs for remittances in 
particularly immigrant neighborhoods; at the same time, bring 
more people into the mainstream of our financial system and it 
relates, of course, to financial literacy so they can be full 
participants in our economy.
    Senator Akaka. Thank you very much, Mr. Chairman. My time 
has expired. I will submit a question for the record.
    Chairman Dodd. Thank you very much, Senator. I appreciate 
it very much.
    And I am going to--this has been very patient. We have kept 
you a long time today, but very, very important and very 
valuable.
    Chairman Cox, Senator Shelby has a question for you, but I 
am going to excuse our two other witnesses. I know they have 
other appointments to make. I want to thank both of you. This 
is an ongoing obviously conversation. I think this is a very 
serious problem. Obviously, language is important, but I think 
we need to emphasize how important it is we work together to do 
everything we can to get this moving in the right direction.
    Let me just also suggest to you here--I am going to leave 
the record open for written questions. I would ask that because 
we have had some problem in getting answers back within 2 
weeks, and I would ask the respective offices of the Treasury 
and the Fed if you could have the answers back within 2 weeks, 
it would be very, very helpful. Thank you very much.
    Senator Shelby.
    Senator Shelby. Chairman Cox, I will be brief. One of the 
factors that has not helped the current crisis in our credit 
markets is our lack of transparency. There is no price 
reporting mechanism for collateralized debt obligations in 
credit default swaps, for example.
    One of the biggest shocks to our financial system was the 
rapid loss of confidence in complex instruments like these that 
were sold by banks to a handful of investors.
    Do you believe it would be beneficial to our markets to 
allow the investors to see the actual prices for these complex 
instruments? And what steps could you take as a regulator, as 
the Chairman of the SEC, to make that happen?
    Mr. Cox. Senator, transparency is helpful in any market, 
and certainly that is the case here.
    Senator Shelby. It helps set the market, does it not?
    Mr. Cox. In particular, when one combines the lack of 
transparency with complexity of the instruments----
    Senator Shelby. Yes.
    Mr. Cox [continuing]. Part of the reason that the ubiquity 
of these products has resulted in consequences that one might 
not have predicted on the face of it all is that there was a 
whole lot of reliance on other parties, on other guarantors of 
quality, and what the market now insists on doing is finding 
out for itself whether or not investments are of sufficient 
investment grade that funds and firms will make these 
investments themselves.
    So all that we can do to help to provide transparency in 
this market, the SEC will do.
    Senator Shelby. That is good. Thank you.
    Chairman Dodd. Very good. Chairman Cox, we thank you very 
much as well. Thanks for staying around a few extra minutes for 
Senator Shelby's question.
    Mr. Cox. Thank you.
    Chairman Dodd. It was a very good hearing. We had--I think 
virtually every--almost member attend, indicating obviously the 
interest in the broad subject matter here.
    I want to thank my colleague, Senator Shelby, and other 
members of the Committee, and the Committee will stand 
adjourned.
    [Whereupon, at 1:02 p.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


         RESPONSE TO WRITTEN QUESTIONS OF SENATOR AKAKA
                     FROM HENRY M. PAULSON

                    A. RESOURCES FOR FLEC ACTIVITIES

    In its review of the Financial Literacy and Education 
Commission (FLEC), the GAO indicated that effective national 
strategies should include discussions of cost, the sources and 
types of resources needed, and where those resources should be 
targeted.

Q.1. What resources will be needed to ensure that FLEC can 
adequately fulfill its mandates?

A.1. The Commission is presently fulfilling its mandates 
through the existing resources of the 20 agencies that comprise 
the Commission.

Q.2. What additional resources will be required to support the 
President's Financial Literacy Council?

A.2. Additional resources to support the President's Advisory 
Council on Financial Literacy are not required. It is expected 
that the Council will work closely with the private sector to 
accomplish its objectives.

Q.3. Will you commit that this new council will not take 
resources away from the Commission?

A.3. The President's Advisory Council on Financial Literacy 
will not divert resources away from the Financial Literacy and 
Education Commission.

                            B. THE UNBANKED

    Secretary Paulson, approximately 10 million households in 
the United States do not have accounts at mainstream financial 
institutions. Unfortunately, too many of these households 
depend on high-cost fringe financial services. The unbanked 
lose too many resources to check cashers and refund 
anticipation loan providers. They also miss out on 
opportunities to save and borrow at credit unions and banks.

Q.4. In addition to efforts to increase financial literacy, 
what is the Department of the Treasury doing to help bring the 
unbanked into mainstream financial institutions?

A.4. On behalf of the Financial Literacy and Education 
Commission, Treasury held four regional conferences entitled 
``How to Bank the Unbanked'' in 2006 and 2007. The conferences 
were held in Chicago, New York, Seattle, and Edinburg, Texas. 
Treasury is using findings from these conferences to implement 
its Community Financial Access Pilot. This new initiative will 
provide assistance to eight demonstration sites throughout 2008 
and 2009. In each pilot location, Community Consultants 
(Treasury staff) will provide technical assistance to implement 
community initiatives. At the conclusion of the pilot Treasury 
will release to the public information on effective practices. 
As of February 2008, the Community Consultants have begun the 
process of assessing community needs, facilitating 
partnerships, working with local organizations to develop 
financial products to bring the unbanked into mainstream 
financial institutions, and implementing financial education 
services.

               C. CFA RECOMMENDATIONS FOR THE COMMISSION

    During a financial literacy oversight hearing held in 
April, Mr. Steve Brobeck from the Consumer Federation of 
America outlined several strategies to achieve significant and 
measurable improvements in specific financial decisions made by 
most Americans. Examples of these include encouraging self-
measurement of net personal wealth, use of automatic savings 
opportunities, periodic checking of credit records, and on-time 
repayment of loans. He also recommended that the Commission 
develop an online tool that could be widely promoted as an 
annual financial checkup instrument. This was a very 
interesting recommendation that could lead to the development 
of concrete proposals that would result in positive behavioral 
change.

Q.5. Will the Commission be developing similar strategies to 
achieve significant and measurable improvement in the decision 
making of consumers?

A.5. The Commission tracks its progress in two ways: Completion 
of tasks listed in Taking Ownership of the Future: The National 
Strategy for Financial Literacy (``National Strategy''), and 
the level of distribution of financial education information.
    The Commission's National Strategy includes enumerated 
``Calls to Action'' to improve the nation's financial literacy. 
The primary method used by the Commission to measure its 
progress is the completion of the Calls to Action. Of the 32 
Calls to Action, 22 of them require implementation by the 
Federal government. Of the 22 Calls to Action for the Federal 
government, 12 have been completed.
    The Commission also records the volume of its material 
distribution. Since April 2006, more than 2,140,000 English-
language publications and 41,700 Spanish-language publications 
have been ordered through the My Money Web site and 1-888-My 
Money hotline. In addition, approximately 106,500 combined 
English- and Spanish-language versions of the Commission's 
National Strategy have been distributed.
    The Commission has also measured approximately 35,000 
monthly visits to the My Money Web site (or 1,150 per day), 
with a total of nearly 1.5 million visits since the site 
launched in October 2004.
    Additionally, during the first meeting of the newly created 
President's Advisory Council on Financial Literacy (Council), 
the Council advised the Treasury Department to consult with the 
Financial Industry Regulatory Authority Investor Education 
Foundation (Foundation) on an upcoming baseline survey the 
Foundation will be conducting on the financial knowledge, 
attitudes and behaviors of the adult population in the United 
States. Treasury and the Council will use the results of the 
survey to assess the nation's current level of financial 
literacy and to measure future changes in financial literacy. 
The survey will be helpful in targeting and monitoring the 
effectiveness of both the Council's and the Commission's 
financial literacy initiatives.

                     D. STIMULUS ANTICIPATION LOANS

    I am concerned that working families will have their 
stimulus checks unnecessarily diminished by payday lenders. 
With a completed 2007 tax form, payday lenders will be able to 
provide a stimulus anticipation loan to taxpayers. The interest 
rates on payday loans are outrageously high.

Q.6. What will the Department of the Treasury do to prevent 
predatory lenders from exploiting working families?

A.6. 
    Weblink: On behalf of the Financial Literacy and Education 
Commission, the Department of the Treasury has provided a link 
on the front page of MyMoney.gov leading to a fact sheet on the 
economic stimulus package on the IRS website. This information 
contains stimulus payment scenarios, answers to frequently 
asked questions, and a rebate scam alert.
    Mailing: Also, for 20.5 million recipients of Social 
Security or Veterans Affairs benefits the Internal Revenue 
Service has mailed informational packages on the stimulus 
payment to help them get their payment. Many of these 
recipients receiving the informational package are unlikely to 
have filed a tax return for 2006 but must file for 2007 to 
receive the stimulus payment. The tax package contains 
everything the recipients will need to file a 2007 tax form 
immediately. The package is specially designed for people who 
may qualify for a stimulus payment but who normally aren't 
required to file a tax return. The mailing is separate from the 
more than 130 million other economic stimulus letters that were 
sent to taxpayers who filed tax returns in 2006. Both of these 
mailings list the IRS website as a resource to visit with any 
questions or concerns regarding the stimulus payment.
    Pilot Outreach Campaign: In the second half of 2008, the 
Department of the Treasury will develop messages to educate 
adults on how to determine actual lending needs, consider total 
lending costs, and comparison shop for the best alternatives. 
These materials will be delivered in selected markets through a 
number of channels such as targeted radio announcements, 
printed materials, and Internet advertisements. Adults will be 
directed to educational materials available at MyMoney.gov. 
These materials will focus on how to avoid predatory loans and 
obtain low-cost financial services.
                                ------                                --
----


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR TESTER FROM HENRY M. 
                            PAULSON

Q.1. As many have noted, the strength of a country's economy 
dictates the strength of its currency. As the dollar has 
rapidly declined in currency markets--down almost 30% over the 
last five years--what will continued stagnation in growth mean 
for the dollar? And will the recent interest rate cuts 
strengthen or lessen the dollar's position? What will it mean 
for American consumers?

A.1. As I have stated before, a strong dollar is in our 
nation's interest. Economies have their ups and downs, but I am 
confident that the long-term strength and vitality of the U.S. 
economy will eventually be reflected in currency markets.

Q.2. In the course of previous critical economic situations--
recessions--we have witnessed a wave of bank failures due to a 
variety of factors. Do you have any concern that banks will be 
in similar situations in the coming months? Or will the failure 
of non-bank mortgage lenders (finance companies) that operate 
outside the banking reserve system be the only casualties from 
the housing and credit crunch that we are currently facing?

A.2. Our financial institutions entered this period of turmoil 
well-capitalized. A number of financial institutions have 
experienced problems associated with the current dislocation in 
mortgage and other credit markets. To date, most of the 
failures have been concentrated in non-bank mortgage lenders, 
although there have been a few failures of federally-insured 
depository institutions. I have encouraged financial 
institutions broadly to continue raising capital should they 
think it necessary, so they can continue to lend and support 
our economy.
                                ------                                --
----


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM HENRY M. 
                            PAULSON

Q.1. Considerable work has already been done establishing that 
our capital markets are at risk of falling behind and providing 
specific regulatory, tax, and liability reforms to revive the 
leadership position of the U.S. capital markets. Do you agree 
that it is past time for all of us to resolve these outstanding 
issues and action is required now?

A.1. A strong financial system is vitally important--not for 
Wall Street, not for bankers, but for working Americans. When 
our markets work, people throughout our economy benefit--
Americans seeking to buy a car or buy a home, families 
borrowing to pay for college, innovators borrowing on the 
strength of a good idea for a new product or technology, and 
businesses financing investments that create new jobs.
    The current regulatory framework for financial institutions 
is based on a structure that has been largely knit together 
over the past 75 years. It has evolved in an accretive way in 
response to problems without any real focus on overall mission: 
Congress established the national bank charter in 1863 during 
the Civil War, the Federal Reserve System in 1913 in response 
to various episodes of financial instability, and the federal 
deposit insurance system during the Great Depression. Changes 
were made to the regulatory structure in the intervening years 
in response to other financial crises (e.g., the thrift crises 
of the 1980s) or as enhancements (e.g., the Gramm-Leach-Bliley 
Act of 1999 (``GLB Act'')), but for the most part the 
underlying structure resembles what existed in the 1930s.

Q.2. What are the top initiatives that your agency is pursuing 
to meet this need, when will you propose them, and have you set 
deadlines for implementation?

A.2. Last March, Treasury convened a blue-ribbon panel to 
discuss U.S. capital markets competitiveness. Industry leaders 
and policymakers alike agreed that the competitiveness of our 
financial services sector and its ability to support U.S. 
economic growth--is constrained by an outdated financial 
regulatory framework. As the conclusion to a process that began 
in June 2007, on March 31, 2008, Treasury released its 
``Blueprint for a Modernized Financial Regulatory Structure.''
    In this report, Treasury presents a series of short, 
intermediate and long-term recommendations for reform of the 
U.S. regulatory structure. The short-term recommendations 
present actionable changes to improve regulatory coordination 
and oversight immediately. The intermediate recommendations 
focus on eliminating some of the duplication of a functional 
regulatory system, but more importantly try to modernize the 
regulatory structure for certain financial services sectors 
within the current framework. Finally, we also include a long 
term model for discussion. This model holistically addresses 
the inadequacies of the current functional regulatory system.
                                ------                                


         RESPONSE TO WRITTEN QUESTIONS OF SENATOR DOLE
                     FROM HENRY M. PAULSON

Q.1. Secretary Paulson, I want to commend you for this 
Administration's efforts to assist distressed borrowers--
Treasury's collaboration with the HOPE NOW coalition, Project 
Lifeline, the cooperation with the private sector on the 30-day 
foreclosure freeze--these are all important initiatives. But I 
would like to ask you if there is even more we could be doing 
to provide distressed borrowers with refinancing options, too, 
so we can get them back into mortgages that are appropriate for 
them?

A.1. Treasury recognizes the critical importance of refinancing 
as an option to help distressed borrowers avoid foreclosure; 
several key actions have been taken in this area.
    In September, HUD announced FHA Secure, a program targeted 
at helping borrowers with adjustable-rate mortgages refinance 
into a lower-rate loan. Since the announcement of the program, 
FHA has closed more than 140,000 refinancing loans, and expects 
to close 300,000 loans by the end of 2008. FHA Modernization is 
essential to allow FHA to achieve even further progress, and 
Treasury urges Congress to enact this legislation.
    In December, the American Securitization Forum announced 
the ASF fast-track framework for streamlining the refinancing 
and modifying of subprime loans facing rate resets. The ability 
to identify loans that qualify for refinancing is a key element 
of the framework, and Treasury has encouraged Hope Now Alliance 
members to make refinancing an even more central part of their 
toolkit in addressing the needs of distressed borrowers.
    We have also called on Congress to complete GSE reform and 
pass legislation to encourage states to encourage refinancing 
by issuing tax exempt bonds.
                                ------                                


  RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM BEN S. 
                            BERNANKE

Q.1. Considerable work has already been done establishing that 
our capital markets are at risk of falling behind and providing 
specific regulatory, tax, and liability reforms to revive the 
leadership position of the U.S. capital markets. Do you agree 
that it is past time for all of us to resolve these outstanding 
issues and action is required now?

Q.2. What are the top initiatives that your agency is pursuing 
to meet this need, when will you propose them, and have you set 
deadlines for implementation?

A.1. and A.2. The Federal Reserve currently is engaged in 
diagnosing the causes of financial market turmoil and 
developing regulatory responses to address the problems that 
have been identified. Efforts to put markets and market 
participants on a sound footing are our top priorities, and 
they will remain so for some time. That said, however, these 
efforts also are consistent with the long-term goal of ensuring 
that U.S. markets deliver financial services in a competitive 
and efficient manner. Regulatory policies are being evaluated 
carefully to ensure that they do not exacerbate strains on 
markets or market participants. In addition, responses are 
being coordinated with authorities in other jurisdictions to 
maintain a level playing field for global market participants 
going forward.
                                ------                                


  RESPONSE TO WRITTEN QUESTIONS OF SENATOR TESTER FROM BEN S. 
                            BERNANKE

Q.1. As many have noted, the strength of a country's economy 
dictates the strength of its currency. As the dollar has 
rapidly declined in currency markets--down almost 30% over the 
last five years--what will continued stagnation in growth mean 
for the dollar? And will the recent interest rate cuts 
strengthen or lessen the dollar's position? What will it mean 
for American consumers?

A.1. In the long run, exchange rates tend to be set by markets 
on the basis of an economy's fundamental strengths. Over 
shorter horizons, however, a wide array of factors may 
influence the exchange rate, including movements in interest 
rates here and abroad, expectations of future economic 
policies, and the evolution of the nation's trade and current 
account balances. For much of the period since 2002, the U.S. 
economy has expanded solidly, even as the value of the dollar 
has declined in foreign exchange markets. Most recently, the 
dollar has weakened alongside indicators of U.S. economic 
growth.
    Recent cuts in U.S. interest rates have reduced the rate of 
return on liquid, dollar-denominated debt instruments, and 
thus, all else equal, may have had some effect on the near-term 
trajectory of the dollar. However, we believe that responding 
to slowing economic activity through monetary policy actions 
helps to safeguard the economy's essential dynamism and thus, 
in the medium and long run, should be reflected in the exchange 
value of the dollar. Such a development, in turn, would 
restrain increases in the cost of living that owe, in part, to 
rising import prices.

Q.2. In the course of previous critical economic situations--
recessions--we have witnessed a wave of bank failures due to a 
variety of factors. Do you have any concern that banks will be 
in similar situations in the coming months? Or will. the 
failure of non-bank mortgage lenders (finance companies) that 
operate outside the banking reserve system be the only 
casualties from the housing and credit crunch that we are 
currently facing?

A.2. While most banking institutions continue to perform well 
amidst the ongoing financial turmoil, a few institutions--some 
larger, some smaller--are facing difficulties. These 
difficulties could be exacerbated by weakening economic 
fundamentals. As in past periods of financial distress, some 
banks will fail should challenges presented by the current 
environment continue.
    One must put any discussion of possible bank failures in 
perspective and recognize that even in good times, banks can 
fail. For more than a decade we have experienced few bank 
failures--no more than ten in any given year since 1995 and 
none in 2005 and 2006.
    In general, U.S. banks entered the current period of 
financial distress with strong capital ratios, which should 
reduce any potential threats to their solvency. Through our 
examination, monitoring and surveillance programs we will work 
diligently to identify problem institutions and take the 
appropriate supervisory response. When bank failures do occur 
we will strive to minimize the risk to the deposit insurance 
fund.
                                ------                                


         RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD
                      FROM CHRISTOPHER COX

Q.1. Concerns have arisen that some NRSROs use the same letters 
for credit ratings for municipal debt, corporate debt and 
structured debt instruments which have different default rates. 
For example, one NRSRO's cumulative five-year default rate for 
CDOs rated at its minimum investment grade was between eight 
and ten times higher than its default rate for corporate bonds 
that it similarly rated.
    Do you feel that this is a subject of concern? Do you think 
that investors would benefit from requiring clearer or 
different credit ratings scales or designations for municipal 
debt, corporate debt and structured debt instruments?

A.1. Yes. Because a number of commenters have indicated that 
there should be greater differentiation of ratings of 
securitized products from corporate ratings, the Commission 
recently proposed new rules that would require credit rating 
agencies either to use distinct ratings symbols for structured 
products, or to make special disclosure of the differences 
between ratings for structured products and other securities, 
such as corporate bonds.

Q.2. The full Committee held a hearing on ``The Role and Impact 
of Credit Rating Agencies on the Subprime Credit Markets'' on 
September 26, 2007, only a few days after the SEC's new 
authority took effect under Public Law 109-291, the Credit 
Rating Agency Reform Act of 2006. At the Committee's September 
hearing, Columbia University Professor Jack Coffee recommended 
that ``the SEC . . . calculate the five year cumulative default 
rates on different classes of financial products and disclose 
this data on one centralized web site.''
    What is your view of this recommendation?

A.2. I believe that credit ratings performance measurement 
statistics are vital to users' ability to understand how well a 
credit rating agency has assessed the creditworthiness of 
issuers and obligors. The rules that we proposed on June 11, 
2008, include new disclosure requirements to facilitate 
reliable comparisons of performance between NRSROs. The 
disclosure of performance statistics for NRSROs would provide 
better comparability of ratings performance across the NRSROs. 
This could include specifying the time periods to be covered by 
the statistics (e.g., 1, 3, and 10 years) and requiring 
statistics for different ratings classes. As with Professor 
Coffee's recommendation, the goal is to make the NRSROs' 
performance statistics more useful and transparent. I have also 
asked the Commission staff to carefully review the 
recommendations suggested by Professor Coffee in considering 
possible future rulemaking. The staff is also reviewing what 
additional performance measurement statistics, including 
historical downgrade and default rates within each rating 
grade, would be useful to users of ratings.

Q.3. Since the time of the hearing, what has the SEC learned 
about the NRSROs, including their ability to manage conflicts 
of interest and their role in the subprime crisis? Do you feel 
NRSROs should be subject to additional regulatory requirements, 
such as due diligence requirements or an obligation to update 
past ratings when rating model assumptions are changed? Does 
the SEC need more statutory authority to perform its mission in 
this area?

A.3. Beginning last fall, using the new statutory authority 
that took effect in September 2007, the Commission began 
examinations of the role of the rating agencies in the subprime 
market turmoil. We have just released the findings from these 
exams and the Commission staff has provided a detailed briefing 
on our findings to your staff. A copy of the report has been 
separately provided to you. Given the recent enactment of the 
Rating Agency Reform Act, I believe the Commission has 
sufficient authority to address any problems that are 
identified through our examinations, including those relating 
to conflicts of interest and whether firms followed their 
stated procedures with respect to keeping ratings up to date. 
As I have indicated, the Commission staff is also preparing 
additional rulemakings using that new authority. If we should 
find that we lack needed authority, we would, of course, work 
with you to address any deficiency.

Q.4. A key factor in restoring and maintaining investor 
confidence is having a Federal securities regulator that is 
fully funded and has sufficient authority to protect large and 
small investors while facilitating fair and efficient capital 
markets.
    The President's proposed Budget would fund the SEC for FY 
2009 at $913 million, an increase of less than 1% over FY 2008 
($906 million). The Enforcement Division's proposed budget for 
FY 2009 ($318 million) is about 1% more than the budget for FY 
2008 ($315 million). This year, the SEC will ramp up the 
examination and regulation of the NRSROs, investigate conduct 
related to the subprime crisis, review late filings for options 
backdating, review corporate disclosures, oversee rules for new 
markets and engage in other important activities. Will this 
budget be sufficient to effectively perform your duties?

A.4. As you know, the SEC has an enormous task, overseeing the 
nearly $44 trillion traded on U.S. equity markets; the 
disclosures of almost 13,000 public companies; and the 
activities of about 11,000 investment advisers, nearly 1,000 
fund complexes, and 5,700 broker-dealers, among others. Given 
the size and complexity of the markets we regulate, even if the 
SEC's budget were to double or triple, the agency still would 
need to carefully set priorities. The SEC must continue to 
think strategically about which areas of the market pose the 
greatest risk, and which areas of potential improvement hold 
the greatest benefit for investors. And given the fast pace of 
today's capital markets, we must remain agile and flexible 
enough to redirect our resources with little notice.

      The FY 2009 request would result in 4% overall 
increase over two years, which is sufficient for the SEC to 
fulfill its mission, continue its major initiatives, and deploy 
resources as needed to emerging issues. Nonetheless, any 
additional money that the Congress saw fit to provide would be 
put to good use.

Q.5. Would you recommend that Congress make any statutory 
changes to allow the Commission to resolve the current subprime 
crisis or face the next crisis more effectively?

A.5. Yes. As I testified to the Committee, the Consolidated 
Supervised Entities program should be authorized in statute and 
made mandatory for investment banks, as opposed to today's 
voluntary program. In addition, last year, the Commission 
proposed numerous authorization proposals that would improve 
the functioning of the SEC, including by enhancing our 
enforcement authority. Finally, in July 2007 I wrote to the 
Committee's leadership calling for improvements in the 
statutory regime governing municipal securities in order to 
improve the functioning of that important market, where we can 
expect further subprime and derivatives-related problems.

Q.6. Public companies, including banks and securities firms, 
are required to make full and fair disclosures in their 
securities filings about collateralized debt obligation 
holdings and their valuation. As the subprime crisis has 
progressed, some investors have complained that corporations 
filed inadequate disclosures and inaccurate valuations about 
their holdings in certain mortgage-backed securities. In 
December 2007, the SEC staff asked public companies with 
investments in structured investment vehicles and other 
collateralized debt obligations to make specific types of 
disclosures in their filings.
    Will the SEC staff increase the frequency and thoroughness 
of its reviews of corporate filings, or take other appropriate 
steps, to make certain that investors are given appropriate 
information about such investments?

A.6. Yes. Through its regular and systematic review of public 
company disclosure, the Division of Corporation Finance 
reviews, at a minimum, the financial statements of each public 
company at least once every three years. Also, consistent with 
the requirements of Sections 408 of the Sarbanes-Oxley Act of 
2002, the Division of Corporation Finance reviews the 
disclosure of the largest companies more frequently. Over the 
past eight months, Division of Corporation Finance staff noted 
that a number of large financial institutions could improve 
their disclosure regarding off-balance sheet arrangements by 
providing additional information to their investors. As a 
result, and in recognition of changing economic circumstances, 
the staff sent letters to certain large financial institutions 
in early December highlighting disclosure points that the staff 
recommended the institutions consider when responding to the 
Commission's disclosure requirements relating to exposure to 
off-balance sheet arrangements. The staff posted a sample of 
the December 2007 letter on the Commission's website so that 
all companies with material off-balance sheet arrangements 
could consider the disclosure suggestions. A similar effort is 
contemplated with respect to firms' disclosure of how they are 
valuing complex and illiquid securities.
    The staff will continue to monitor the disclosure these 
financial institutions provide and will, as appropriate, make 
suggestions on how they can continue to improve their 
disclosure. The Division of Corporation Finance will also 
continue its regular and systematic review of public company 
disclosure and consider whether additional action is warranted.

Q.7. Some large U.S. financial firms that took major write-
downs resulting from their subprime holdings have raised 
capital by selling securities to sovereign wealth funds, which 
are owned by foreign governments. The partial ownership of U.S. 
companies by foreign governments offers additional sources of 
capital but also has raised questions involving conflicts of 
interest, transparency, market efficiency and the enforcement 
of securities laws abroad. These funds could invest for purely 
economic reasons or could attempt to influence a corporation's 
policies and practices--such as location of business 
operations, allocation of credit or capital, hiring decisions 
or lobbying agenda.
    Chairman Cox, in a recent speech you raised two good 
questions: ``What are the logical and likely outcomes of growth 
in this kind of activity? Could the rise of sovereign business 
ultimately change the character of U.S. markets? How should we 
go about answering these questions? What are your views on 
these matters?

A.7. Our market economy is not premised on government ownership 
of commercial enterprises. Governments have other important 
roles to play in the economy, including as regulators, and an 
arms-length relationship to commercial and competitive concerns 
is healthy to the functioning of a genuine market. Nonetheless, 
in other nations government ownership of business, including 
increasingly through equity investments, is the norm. When such 
governments make portfolio investments in the U.S. capital 
market, there are--as with cross-border investment generally--
potential benefits. Through their competition for investments 
in the United States, sovereign wealth funds can help offer 
U.S. companies a lower cost of capital and a more liquid market 
for their securities than might otherwise be available. But 
those same benefits would likely accrue to U.S. companies and 
markets if the foreign investment were privately directed, 
rather than government directed. A sovereign investor in a 
number of potential concerns for regulators and other market 
participants:

      Because investor is a government, the incentives 
that normally drive private sector marketplace participants to 
make decisions may be absent, or at least very different. 
Sovereign wealth funds, and sovereign businesses, may therefore 
have a distorting effect on markets, the pricing of assets, and 
the allocation of resources.

      In addition, neither sovereign wealth funds nor 
sovereign businesses are typically transparent in their motives 
or operations. Generally, the level of transparency is related 
to the degree to which the government itself is transparent to 
its citizens and to the public. Overall, disclosure by 
sovereign wealth funds leaves much to be desired, while public 
disclosure surrounding sovereign business tends to stop at the 
level of the company's interaction with the government itself.

      Another concern about sovereign wealth funds and 
sovereign businesses is not that they are foreign, but that 
their managers are sovereign. Conflicts of interest necessarily 
arise when government is both the regulator and the regulated. 
Rules that might be rigorously applied to private sector 
competitors will not necessarily be applied in the same way to 
the sovereign who makes the rules.

      Governments that control sovereign wealth funds 
and sovereign businesses, because they are governments, can in 
some cases control certain economic events, and they may have 
information advantages over private market participants. 
Governments routinely are privy to certain types of information 
that most private investors are not.

      In addition, there is the increased opportunity 
for political corruption. Graft, bribery, and other forms of 
financial corruption by governments and political figures is an 
unfortunate fact of life throughout the world--as the 
Commission's enforcement responsibilities under the Foreign 
Corrupt Practices Act remind us on a daily basis. When 
individuals with government power also possess enormous 
commercial power and exercise control over large amounts of 
investable assets, the risk of misuse of those assets, and of 
their conversion for personal gain, rises markedly.

Q.8. Congress approved our CFIUS reform law last year to 
address national security threats that might arise from a 
foreign agents' access to sensitive U.S. technology, critical 
infrastructure, or important defense supplies. It is not 
necessarily meant to address some critics' concerns over 
foreign companies' potential use of passive investment as 
economic leverage on U.S. capital markets.
    In a speech at Harvard University's Kennedy School of 
Government on October 24, 2007, you stated ``the rise of 
sovereign wealth funds challenge our regulatory model in a 
number of ways...if government-owned investments lack 
transparency, they could contribute to market volatility 
stemming from uncertainty about the allocation of their 
assets.'' What tools and enforcement authority are currently 
available to the SEC to protect investors from such market 
volatility and to ensure fair and orderly markets?

A.8. The SEC currently has rules that impose disclosure 
obligations on all large investment funds, including sovereign 
wealth funds. The primary disclosure requirements applicable to 
unregistered funds arise under Sections 13 and 16 of the 
Exchange Act. These provisions require the reporting of 
beneficial ownership of securities if the owner acquires more 
than a certain threshold percentages of the stock of an issuer. 
These provisions apply to fund advisers as the beneficial 
owners of the securities in the funds they manage. For example, 
if a fund adviser has acquired more than 5% of the stock of an 
issuer, Section 13 applies and the adviser must file a Form 13D 
or 13G. If a fund adviser has acquired more than 10% of the 
stock of an issuer, Section 16 applies and the adviser must 
file a Form 3 or 4. The forms require the fund adviser to state 
whether the fund has any intent to change control of the 
company, or whether the acquisition is instead a passive 
investment.
    Investment advisers having investment discretion over $100 
million or more in Section 130 securities (generally any 
equities registered pursuant to Section 12 of the Exchange Act) 
also must also file a Form 13F, which is a quarterly report of 
all the Section 13(f) securities positions held by the adviser. 
In filing Form 13F, an adviser to multiple clients may 
aggregate all of his clients' positions in a particular 
security. The required filings provide the SEC and the public 
with a quarterly ``snapshot'' of the fund's Section 13(f) 
securities holdings.
    The SEC has brought enforcement actions for violation of 
these disclosure requirements. See, e.g., In re Quattro Global 
Capital, LLC, Adv. Act Rel. No. 2634 (Aug. 15, 2007) (action 
against registered investment adviser having investment 
discretion over at least $100 million in relevant assets for 
failure to file quarterly Form 13F disclosing its Section 13(f) 
securities for a period of over three years); SEC v. Scott R. 
Sacane, et al., Lit. Rel. No. 20258 (Aug. 29, 2007) (SEC 
settled action for disclosure violations under Sections 13 and 
16 of the Exchange Act as part of a market manipulation 
scheme). If a fund were not complying with its reporting 
obligations, the Division of Investment Management would likely 
bring the filing requirements to the funds' attention. If 
further steps are necessary to obtain the necessary 
disclosures, the Enforcement Division may file an injunctive 
action in federal court, or an administrative proceeding within 
the SEC, to compel compliance with the disclosure requirements. 
The difficulty with opaque investors such as sovereign wealth 
funds, of course, is that the SEC has no way of knowing whether 
they have failed to comply in the first place.

Q.9. The press reports that there is growing uncertainty 
regarding the ability of bond insurers to meet their financial 
obligations in the event of downgrades to collateralized debt 
obligations, asset-backed securities, and other structured 
finance products containing subprime loans. In recent weeks, 
several bond insurers have seen their credit ratings lowered 
and analysts have speculated that bond insurers may face future 
ratings downgrades. These events could have serious 
implications for banks and other financial institutions which 
hold insured bonds or credit default swaps.
    What is your assessment of this situation and the efforts 
of State regulators and the private sector to address this?

A.9. As a threshold matter, the Commission does not regulate 
these financial guarantors, known colloquially as monoline 
insurers; rather this is the domain of state insurance 
regulators. There are, however, various ways that the 
securities markets and their participants, which the Commission 
does regulate, may be impacted by ratings downgrades of 
monoline insurers.
    These bond insurers began by insuring against defaults on 
bonds issued by municipalities--a market that has not 
historically experienced many or sizable defaults. During the 
1990s, some bond insurers migrated to insuring complex 
securities backed by home mortgages, including subprime 
instruments. In insuring such structured products, many of 
these bond insurers assumed that losses on mortgage-backed 
securities would stay within historical ranges. As the housing 
boom continued for many years, defaults were indeed low and 
housing-related assets were considered relatively safe. During 
2006, however, there was increasing evidence of the 
deterioration in home prices and a related rise in mortgage 
default rates. As the deterioration has continued, market 
participants are questioning whether such bond insurers will in 
fact be able to pay on their bond guarantees and credit 
protection that they underwrote.
    Fortunately, the underlying credit of many insured 
municipal bonds is quite strong. Indeed, the municipal issuers 
are beginning to question the desirability of obtaining 
municipal bond insurance at all. Demand for municipal bond 
insurance is reportedly shrinking at the fastest pace in the 
industry's 36-year history. State and local governments bought 
protection on only 26 percent of the $40.8 billion in bonds 
they sold in January and February 2008, down from 53 percent a 
year earlier, according to data compiled by Bloomberg.\1\
---------------------------------------------------------------------------
    \1\ Michael McDonald and Christine Richard, ``Insurance Drops for 
Municipal Debt, Undermines MBIA,'' Bloomberg News, March 13, 2008.
---------------------------------------------------------------------------
    The Commission staff recognizes that a significant 
downgrade in a monoline insurer's rating could result in the 
securities becoming ineligible under rule 2a-7 for investment 
by money market funds. Also, in the long term, the inability of 
bond insurers to maintain high credit ratings may restrict the 
supply of high-quality paper for tax-exempt money market funds.
    There are other possible effects that a significant 
downgrade in a monoline insurer's rating could have on money 
market funds. The municipal securities they hold include 
variable rate demand notes (``VRDNs'') and tender option bonds 
(``TOBs'') that typically have liquidity backstops, or 
``puts,'' that are provided by a financial institution. These 
liquidity features serve to provide a source of cash to satisfy 
redemptions by fund shareholders, and also to shorten the 
municipal bonds' maturities and make them eligible investments 
for a money market fund. A significant downgrade could 
terminate the put, and thus result in money market funds 
holding long-term securities that would be inappropriate for 
funds maintaining a stable net asset value. The Commission 
staff has been in regular contact with fund management 
companies, which are aware of these risks and have taken steps 
intended to protect funds and thus fund investors from the loss 
of these puts.
    Monoline insurer downgrades also potentially affect 
systemically important securities firms. SEC staff have 
discussed frequently the various exposures to monolines with 
risk managers, treasurers, and business unit personnel at these 
firms. While the monolines are important market participants, 
the systemically important securities firms are highly aware of 
and actively manage their exposures to the monoline sector. The 
Commission staff is also in regular communication with other 
financial services supervisors, particularly the Federal 
Reserve Board, which directly oversees the holding companies of 
the most of the systemically important commercial banks, the 
OCC, which oversees nationally charted commercial banks, and 
the UK's Financial Services Authority. Through a variety of 
formal and informal channels, the staff has worked with these 
other supervisors to understand the possible impact of 
downgrade or financial distress on individual institutions and 
on the broader financial system.

Q.10. Does it appear to you that there will result potentially 
significant problems involving the securitization of credit 
card debt?

A.10. The SEC does not regulate credit card debt markets and 
these securities are generally offered in private placements 
outside the Commission's purview. Through the SEC's supervision 
of systemically important securities firms the Commission does 
monitor the investment firms' risk exposure to and risk 
management of securitized products supported by a range of 
assets, including credit card receivables. In our ongoing and 
frequent discussions with senior risk officers and market 
participants, the firms have represented that they are aware of 
their risk exposures to such products and have risk controls 
for managing such exposures.

Q.11. What lessons has the Commission learned from the current 
subprime crisis?

A.11. While the Commission is not a front-line regulator of the 
mortgage lending business, the derivatives industry, or the 
monoline insurance industry, the securities markets and the 
market participants that the Commission does regulate--not to 
mention the investors whom it is our mission to protect--have 
been deeply affected by the problems stemming from the 
widespread packaging and selling of residential mortgages as 
securities. Among the problems that have surfaced are the 
deterioration in lending standards that led to the creation of 
so much low-quality mortgage debt; the abuses stemming from the 
prevalence of the originate-to-distribute model that diminished 
incentives to control risk, the accounting treatment of the 
trusts created to hold this risky debt in securitized form; the 
adequacy of commercial banking measures of capital and 
liquidity for determining the proper levels of assets at the 
nation's major investment banks; the impact on money market 
funds from the devaluation of presumptively safe assets; the 
quality of issuer disclosure by public companies involved in 
structured finance; and the adequacy of the standards for 
evaluating structured products employed by the credit rating 
agencies, over which the SEC gained regulatory authority last 
summer.
    The deterioration of lending standards that led to the 
creation of so much risky paper, as well as the role of 
commercial banks in originating and securitizing mortgage 
credit, falls outside the SEC's jurisdiction. The accounting 
issues have centered around the questions of balance sheet 
consolidation. Current accounting rules limit the discretion of 
firms to manage special purpose trusts (and the underlying 
loans they hold) once a loan has been sold, if they wish to 
continue to maintain off-balance sheet treatment. Twice in 
recent months, first in July 2007 and again in January 2008, 
the SEC has provided interpretive guidance on the application 
of these rules in the case of limited modifications for loans 
where default is reasonably foreseeable. In that circumstance, 
we have said, the limited modification would not invalidate 
off-balance sheet treatment. As a result, these financial 
institutions were not required to consolidate these trusts--
which would have had negative ramifications on the bank's 
regulatory capital requirements. As a result, refinancings and 
other work-out arrangements have proceeded, with the advantage 
of keeping people in their homes and maximizing the value of 
the securitized assets. This is, however, a short-term 
response. The Commission's Chief Accountant has also asked the 
Financial Accounting Standards Board to revisit the underlying 
accounting guidance to determine whether recent experience 
points to the need not only for further clarifying guidance, 
but also for changes in the applicable rules.
    The members of the President's Working Group on Financial 
Markets play an active role in overseeing the stability of the 
financial system. One important aspect of that oversight is our 
Consolidated Supervised Entities (CSE) program, through which 
the Commission supervises the systemically important U.S. 
securities firms on a consolidated, or group-wide, basis. In my 
testimony to the Senate Banking Committee on April 3, 2008, I 
described in significant detail the CSE program as it related 
to the events leading up to the merger between Bear Stearns and 
JP Morgan Chase. We have learned from the Bear Stearns 
experience that investment banks can be subject to a ``run'' 
similar to the way deposit-taking institutions have been, and 
we have learned that the 2004 decision to apply commercial bank 
metrics for capital and liquidity to investment banks was 
inadequate to prevent such a run.
    Another aspect of our oversight is the mutual fund 
industry. Here, the Commission staff has been active in working 
with the managers of money market funds as they cope with the 
downgrading of ratings and the declines in value of securities 
in which their funds have invested. Commission rules limit 
money market funds to investing in high-quality, short-term 
investments in an effort to ensure that these bedrocks of the 
financial system are reliable in all market conditions. Losses 
by a money market fund would be reflected by the fund re-
pricing its securities below $1.00 (known as ``breaking the 
buck''). The Commission is closely monitoring the fund industry 
and while we have seen some instances of funds requiring 
infusions of capital from the corporate parents of fund 
advisers, no money market fund has repriced its shares below 
$1.00.
    In light of recent events, we are also working to increase 
the transparency of the key publicly-traded financial 
institutions in their disclosures to markets and investors. In 
December 2007, Commission staff wrote to 25 leading financial 
institutions that are publicly owned companies, highlighting 
specific disclosure issues that the firms should consider in 
relation to their exposure to off-balance-sheet entities and 
certain structured finance products. Better illuminating the 
facts concerning these exposures should give counterparties 
increased confidence in the fundamental soundness of the 
financial system. We are planning a similar initiative to 
increase the transparency with respect to how firms are valuing 
their assets.
    Using the new statutory authority that took effect in 
September 2007, the Commission recently concluded examination 
of the role of the rating agencies in the subprime market 
turmoil. A copy of our examination report has been separately 
provided to you. This examination is important, because more 
than just providing the markets one view of the likelihood of 
default, the past several months have demonstrated the power of 
credit ratings to move markets, and their potential to create 
cascading effects in those markets. Beyond these ongoing 
examinations, we have recently proposed rules aimed at reducing 
the extent to which our regulatory system grants a central role 
to the rating agencies.
    We have also proposed detailed rules under the new Credit 
Rating Agency Reform Act that respond directly to the 
shortcomings we have seen through the subprime experience. Our 
proposals would require credit rating agencies to make 
disclosures regarding past ratings, in a format that would 
improve the comparability of track records and promote 
competitive assessments of the accuracy of the agencies' past 
ratings. In addition, the rules would enhance investor 
understanding of important differences between ratings for 
municipal and corporate debt and for structured debt 
instruments.
    Each of the regulatory actions we are taking and each of 
those that we are contemplating, both here and abroad, is 
designed to promote the health of our capital markets, to 
protect investors, and to promote capital formation.

Q.12. The public expresses concern when they perceive that 
corporate executives receive excessive compensation, 
particularly when the corporation is losing money or its stock 
is falling value. For example, there was public concern last 
October, when the CEO of a large securities firm left with 
reportedly over $160 million in stock, options and retirement 
benefits a week after the firm reported its largest-ever 
quarterly loss, which included write-downs of $7.9 billion 
across CDOs and U.S. subprime mortgages, and the firm's stock 
price fell significantly.
    In 2006, the SEC required public companies to disclose more 
information about executives' compensation in annual filings, 
but that does not seem to have controlled the problem. 
Shareholders have offered proposals regarding executive 
compensation at the annual meetings of public companies. 
Recently, the SEC developed an Internet tool for investors to 
compare executives' compensation online.
    What are the Commission's views and plans on how to address 
the executive compensation issue in the future?

A.12. Shareholder proposals asking boards to implement advisory 
shareholder votes on executive compensation--commonly called 
``say on pay'' proposals--are one way that investors can use 
the enhanced information provided under the SEC's new executive 
compensation rules. The Commission's rules concerning such 
shareholder proposals allow ordinary shareholders meeting 
modest eligibility requirements to submit proposals that may be 
considered at the company's annual meeting through the 
company's proxy materials. The staff received 28 no-action 
requests to exclude ``say on pay'' proposals during the 2006-
2007 proxy season and received 19 during the 2007-2008 proxy 
season. Generally, the ``say on pay'' proposals request that 
shareholders be allowed to cast non-binding votes on executive 
compensation at the companies' annual meetings. In most cases, 
the staff has found that companies must include these proposals 
in their proxy materials.
    The Commission staff is also working to ensure that the 
executive compensation rules are being applied in company proxy 
statements as intended. In an effort to both evaluate 
compliance with the new rules and provide guidance on how 
companies could improve their first-time disclosures in this 
area, the Division of Corporation Finance reviewed the 2007 
proxy statements of 350 companies and published its ``Staff 
Observations in the Review of Executive Compensation 
Disclosure.'' This report provides an overview of the 
significant areas of comment on the first-year disclosures. 
Subsequently, the Division of Corporation Finance issued second 
comment letters to approximately 70% of the companies. 
Following its normal procedures, the Division of Corporation 
Finance is posting the correspondence relating to its completed 
reviews on the SEC website. This should provide greater 
information on the actual comments and how companies responded 
to them, and assist companies in enhancing future executive 
compensation disclosure.
    The Executive Compensation Reader on the SEC website was 
designed to alleviate the power of XBRL data tagging for making 
the compensation paid to top executives understandable to 
investors. It was a demonstration based on one year's data for 
500 of the largest American companies. We are currently working 
to develop XBRL data tags for general use by all public 
companies so that investors can do industry comparisons or 
perform analyses of particular forms of compensation, such as 
stock options, on a permanent basis.
    This will provide quicker and more efficient analysis of 
executive compensation and will enable all shareholders to be 
better-informed.

Q.13. The SEC recently reported a significant decrease in the 
total dollar amount of penalties and disgorgements it ordered 
against violators in fiscal year 2007 when compared to fiscal 
year 2006, declining to $1.6 billion from $3.3 billion--a 
decline of about 50 percent. In 2007, the Division of 
Enforcement initiated only slightly fewer total investigations, 
civil proceedings, and administrative proceedings in fiscal 
year 2007 than in fiscal year 2006.
    What are the reasons for this decrease?

A.13. Last year the Commission filed the second highest number 
of enforcement cases in the agency's history (655), resolving 
92% of these cases successfully. The majority of the cited 
decline in monetary remedies is due to differences in the 
levels of disgorgement, a remedy requiring the securities law 
violator to forfeit all ill-gotten gains. Thus, the amount of 
disgorgement obtained depends on the circumstances of the 
specific case, not the discretion of the Commission. While 
legal, factual, and mathematical analyses are required to 
determine the appropriate amount of disgorgement in some cases, 
the amount of disgorgement is generally not subject to change 
by the Commission. When further sanctions are appropriate, the 
Enforcement Division and the Commission normally consider the 
amount of the disgorgement in determining the correlative size 
of a civil money penalty. It should be noted that in Fiscal 
2007, the Commission imposed more corporate penalties (15) than 
in any prior year in the agency's history. The ratio of penalty 
to disgorgement was essentially the same in fiscal years 2006 
and 2007.
    In the years after the Enron scandal, the country witnessed 
a series of massive accounting frauds involving enormous 
amounts of disgorgement and penalties. These cases, including 
WorldCom, Qwest, AOL, Healthsouth, AIG, Fannie Mae, and Tyco, 
were brought in SEC fiscal years 2003 through 2006. Since these 
cases have made their way through the enforcement process, the 
level of penalties is still much higher than it had been 
previously, including throughout the 1990s, and as noted, 
corporate penalties are now much more frequent.

Q.14. Proxy Access was the subject of a November 1, 2007 letter 
from several colleagues on this Committee and me and of a 
hearing held by this Committee on November 14, 2007.
    On November 28, 2007, the SEC in a split vote deprived 
shareholders of the right to offer proposals on proxy access. 
At the time, you stated ``I believe we can move forward and re-
open this discussion in 2008 to consider how to strengthen the 
proxy rules to better vindicate the fundamental state law 
rights of shareholders to elect directors.''
    Please describe your plans and timetable for reconsidering 
the shareholder proxy access issue at the Commission this year.

A.14. The Commission's careful and extensive review of the 
proxy process, which has included three Roundtables in 2007 
that focused on the relationship between the federal proxy 
rules and state corporation law, proxy voting mechanics, and 
shareholder proposals, is ongoing. The November 2007 Commission 
action codified the staff's longstanding interpretation of the 
``election exclusion'' in Rule 14a-8(i)(8), but as I have 
stated then and subsequently, I will ask the full Commission to 
further consider these questions this year. It is my firm 
belief that we can better align the federally-regulated proxy 
system with the state-authorized rights of shareholders to 
determine the directors of the companies they own.

Q.15. The SEC is budgeted nearly one billion dollars per year 
with which to protect investors, maintain fair, orderly, and 
efficient markets, and facilitate capital formation. The 
Commission is considering the concept of ``mutual recognition'' 
in which U.S. citizens could purchase or trade securities 
directly with foreign broker-dealers or on foreign exchanges 
and be regulated not by the SEC but by the foreign regulator. 
When considering a mutual recognition framework that would 
allow U.S. citizens to directly invest in foreign markets and 
be solicited by foreign brokers, will the SEC consider not only 
the comparability of a foreign regulator's regulations, but 
also the foreign regime's enforcement and inspection resources, 
independence from the government, respect for the rule of law, 
culture of fair dealing, tradition of investor protection, 
impartial regulation over market participants, and related 
factors?

A.15. Yes. Any mutual recognition arrangement must begin with 
comprehensive assessment of the foreign regulatory regime, 
including its enforcement and inspection resources, 
independence from the government, respect for the rule of law, 
culture of fair dealing, tradition of investor protection, and 
impartiality. Given the Commission's investor protection 
mandate, the assessment would, of course, focus on the key 
regulatory principles underlying the U.S.'s own regulatory 
regime, and would entail a consideration of the results 
achieved by the foreign securities regulatory system in 
addressing these core securities regulatory principles. In 
addition, the assessment of the foreign regulatory regime would 
consider the principles and the regulatory system of a foreign 
regime overall. Comprehensive arrangements for both enhanced 
enforcement and supervisory cooperation would also be an 
important component of an approach to mutual recognition. Such 
arrangements would facilitate robust enforcement in the event 
of a cross-border violation of securities laws.

Q.16. In response to a question about Section 404 of the 
Sarbanes-Oxley Act, you stated that ``we do have a cost study 
underway at the SEC to make sure that it's working as we 
intended.''
    A careful assessment of the benefits can provide a useful 
perspective from which to view the costs. Will this study also 
include an assessment of the benefits to public companies that 
have resulted from Congressional passage of the Sarbanes-Oxley 
Act, such as consideration of: improved access to capital, 
lower cost of capital, increased stock market valuation of 
public companies listed in the U.S., improved internal 
controls, improved accounting, reduction or prevention of 
certain types of frauds, increased investor confidence in the 
information published by public companies, increased investor 
trust of the securities markets, more effective boards of 
directors, enhanced corporate governance and improved executive 
responsibility?

A.16. Yes. The study will consider both the benefits and costs 
associated with Section 404 of the Sarbanes-Oxley Act. In 
reviewing the sources of benefit, the study will take into 
account such considerations as you have listed.

Q.17. The Commission has pursued a number of investigations and 
enforcement actions to address the improper backdating of stock 
options issued to corporate executives.
    On September 6, 2006, you testified to the Committee: ``Not 
only must option grants be reported now within two business 
days, but this information was among the first that's now 
required to be reported to the SEC using interactive data. 
Thanks to this new data-tagging approach, economists, 
researchers, law enforcement and the investing public now have 
almost instant access to information about stock option grants 
in a form that they can immediately download into spreadsheets, 
analyze and compare.''
    During Fiscal Year 2007, over 2,900 Forms 4 reporting 
executive stock options grants were filed late with the 
Commission, including over 1,500 Forms 4 that were filed more 
than 21 business days late. Of these, over 1,100 Forms 4 were 
filed more than 100 business days late, and over four hundred 
Forms 4 were filed more than 300 business days late.
    Please confirm that the Commission staff on an ongoing 
basis reviews late filings reporting options grants to assess 
whether there has been improper options backdating. Please 
describe the Commission's actions to deter improper options 
backdating.

A.17. The Division of Enforcement currently has approximately 
80 open investigations regarding possible fraudulent reporting 
of stock option grants, including options backdating. The 
companies involved in the investigations are located throughout 
the country, are of various sizes, and span multiple industry 
sectors. The investigations arose from several sources, 
including staff investigations (with the assistance of the 
Office of Economic Analysis) in conjunction with late-filed 
Forms 4. Other sources of enforcement investigations are 
companies that self-report following internal investigations; 
companies that announce potential restatements; staff reviews 
and assessments of suspicious grants identified in analyses 
that were performed by independent research organizations, 
institutional investors, or analysts; and tips from the public. 
Although the staff cannot review all late-filed Forms 4 due to 
volume, the staff does review these forms in the context of 
specific investigations and does routinely review egregious and 
non-trivial cases. Also, the staff continues to review and 
evaluate other sources of information for indications of 
improper backdating.
    The SEC has taken many steps to stamp out backdating of 
employee stock options. The revised executive compensation 
disclosure rules the Commission adopted in 2006 include a 
number of provisions that address backdating of options. For 
example:

      A company must now disclose how it determines 
when it will make equity awards. This requires a company to 
disclose how, and why, it backdates for its executives.

      A company must disclose the grant date of equity 
awards. If the grant date is different than the date on which 
the board took action, the company must disclose the date of 
the board's action.

      A company must disclose the exercise or base 
price of an option if it is less than the market price of the 
underlying security on the grant date. If it is less than the 
market price on the grant date, the company must disclose the 
market price on the grant date. This disclosure is intended to 
provide an investor with a complete picture of the true terms 
of each option award by allowing the investor to compare the 
grant date market price to the in-the-money exercise price.

      Further, if the exercise or base price of an 
option grant is not the closing market price per share on the 
grant date, a company must describe its methodology for 
determining the exercise or base price.

Q.18. At the Banking Committee hearing on September 6, 2006, 
Professor Erik Lie testified ased on his then-unpublished 
research, conducted with Professor Randy Heron, in which they 
examined a sample of 39,888 stock option grants to top 
executives across 7,774 companies between 1996 and 2005. They 
estimated that ``14% of all grants to top executives dated 
between 1996 and 2005 were backdated or otherwise 
manipulated.''
    How many cases involving improper backdating of stock 
options granted to executives has the Commission staff reviewed 
or investigated?

A.18. The Commission's Division of Enforcement currently has 
approximately 80 open investigations involving possible 
fraudulent reporting of stock option grants, including options 
backdating. The companies are located throughout the country, 
and include Fortune 500 companies as well as small cap issuers. 
The companies span multiple industry sectors.

Q.19. How many such cases have been the subject of enforcement 
proceedings or criminal referrals?

A.19. As of March 19, 2008, the Commission has filed 
enforcement actions against eight public companies and 31 
former executives (associated with 17 different companies) 
alleging securities law violations in connection with 
backdating stock options. Parallel criminal charges have been 
brought against 15 former executives, three of whom have been 
sentenced to serve, or have agreed to a plea involving, time in 
prison. The executives charged include former CEOs, general 
counsels, chief financial officers and other accounting 
personnel, human resources personnel, and a former compensation 
committee member.

Q.20. What is your evaluation of this research of Professor 
Lie?

A.20. The research of Professors Lie and Heron draws 
information from publicly available data concerning stock 
option awards to top executives from 1996 through 2005 and 
suggests that a large number of companies had an uncanny 
ability to choose grant dates that coincided with low stock 
prices. The research suggests that patterns of potential 
backdating significantly decreased after 2002, when the 
Sarbanes-Oxley Act shortened the time period for reporting 
option grants to two business days.
    Before the Sarbanes-Oxley Act, officers and directors were 
not required to contemporaneously disclose their receipt of 
stock option grants or exercise of their stock options. In many 
cases, the disclosure of this information--via a Form 5 filed 
by the company--was not required until after the end of the 
fiscal year in which the transaction took place, which, in some 
cases, meant an individual had more than a year to disclose a 
grant.
    This delay in reporting provided the opportunity for 
companies to misrepresent the date of an option award to make 
it appear that the option was granted at an earlier date, and 
at a lower price, than when the award was actually made. The 
intent of backdating option grants is to allow the option 
recipient potentially to realize larger eventual gains, but 
still characterize the options as having been granted ``at-the-
money''--disguising the fact that the company actually granted 
the options ``in-the-money.'' In this way, companies were able 
to give the option recipient a larger ``upside'' benefit while 
at the same time minimizing the compensation expense of the 
award to the company.
    Sarbanes-Oxley made these kinds of abusive practices much 
harder to conceal. Section 403 of the Sarbanes-Oxley Act, and 
the Commission's rules governing ownership reports by company 
insiders, now require that officers and directors disclose any 
transactions in their companies' equity securities within two 
business days. Not only must option grants now be reported 
within two business days, but this information is required to 
be filed electronically through the Commission's EDGAR filing 
system. This allows the public almost instant access to 
information about stock option grants. The need to report 
option grants no later than two business days after the event, 
combined with the enhanced transparency of electronic filing, 
now make it exceptionally harder for companies to manipulate 
the grant date of option awards.
    The empirical evidence we have seen indicates that in 
combination, these steps have dramatically reduced if not 
eliminated backdating abuse, and they have effectively 
eliminated any easy opportunities for companies to secretively 
grant options.

Q.21. If there is a significant difference between the number 
of cases estimated by Professor Lie's research and the number 
of cases investigated by the Commission, please explain your 
understanding of the reasons for the difference.

A.21. The estimates in the Lie/Heron research are based on 
statistical analysis. However, the determination of whether a 
particular company engaged in illegal backdating or other stock 
grant manipulations depends on the facts and circumstances of 
each case. For the government to make a successful case in a 
court of law, far more is required. The Commission has made an 
extraordinary commitment of resources to address the problem of 
stock option grant manipulation and to determine whether 
illegal backdating has actually occurred in specific cases. The 
Commission has focused its efforts on identifying intentional 
misconduct and alleged misconduct that postdates the executive 
compensation and option grant reforms enacted by Sarbanes-Oxley 
and the Commission's executive compensation rules.
                                ------                                


RESPONSE TO WRITTEN QUESTIONS OF SENATOR AKAKA FROM CHRISTOPHER 
                              COX

                            A. MUTUAL FUNDS

    A. Mutual Funds are so important because they are the 
investment vehicle utilized by millions of middle-income 
Americans to prepare for retirement investment or other long-
term financial goals and dreams.

Q.1. When do you expect the Commission to move forward on its 
proposals to improve mutual fund disclosures?

A.1. The Commission will consider final rulemaking on these 
proposals this summer. The Commission voted unanimously in 
November 2007 to propose rule amendments that would require 
every mutual fund to provide investors with a concise, plain 
English summary of key facts about the fund. The proposals 
would permit funds to harness the power of the Internet in 
order to provide investors with information that is easier to 
use and more readily accessible, while retaining the 
comprehensive quality of the information that is available 
today.

                         B. FINANCIAL LITERACY

    Chairman Cox, I have been impressed by your commitment to 
protecting senior investors from fraud. I also appreciate the 
Commission's willingness to work with the North American 
Securities Administrators Association and the Financial 
Industry Regulatory Authority on this important issue.

Q.2. In addition to senior fraud related initiatives, what else 
is the SEC doing to ensure that average investors can make 
informed financial decisions?

A.2. On June 25, 2008, the Commission voted to propose a new 
rule that would define most equity-indexed annuities as 
securities. This would permit ordinary investors to have the 
protections of the securities laws governing the sales 
practices and suitability requirements for these products that 
are so often the subject of investor complaints.
    The Commission's Office of Investor Education and Advocacy 
(OIEA) provides investors with the foundational information 
they need to make informed investment decisions. In addition to 
specialized information geared towards seniors, the military, 
and online investors, OIEA's webpages provide answers to 
Frequently Asked Questions on popular investor inquiries, 
including how to change the name on a stock certificate, how to 
check on the credentials of investment professionals, and how 
to file a complaint with the SEC. There's also a mutual fund 
cost calculator, links to viewers that makes it easier for 
investors to analyze public companies' and mutual funds' 
financial results, and links to other financial education 
websites.
    OIEA's advocacy function has contact with nearly 100,000 
investors and other constituents annually. Our investor 
advocates research, resolve, or redirect common complaints, 
including complaints involving allegations of fraud or 
unsuitable sales practices and complaints about specific types 
of securities products. To expand the communication into more 
preventative and educational messages, OIEA is implementing 
technology to enable more direct communication with investors, 
including ``mass customized'' messages of interest to 
investors, interactive webpages, and opt-in email/phone alerts. 
OIEA is also developing an audio library targeted to those 
without internet access that will give investors telephone 
access to a range of recorded messages on investing topics.
    OIEA also plays a role in the Commission's regulatory 
policy and disclosure agenda. OIEA is conducting focus groups 
on the proposed mutual fund summary prospectus that highlights 
key information in a concise, user-friendly format. This 
spring, OIEA is conducting a survey of 1,000 investors to gain 
insights into how understandable and how useful they find other 
SEC-mandated disclosures, such as proxy materials and annual 
reports. These are first steps in OIEA's increasingly robust 
effort to test ``usability''--encompassing disclosures and 
interactive media--to ensure that what is delivered to 
investors is as effective as possible.
    As noted above, the Commission voted unanimously in 
November 2007 to propose rules to authorize a ``summary 
prospectus'' for mutual funds--a short, investor friendly 
document that discloses a mutual fund's investment objectives, 
as well as all of the information about fees, risks, 
performance, and other vital subjects that customers need to 
understand to make a sound investment decision. Using the 
Internet, investors could drill down from the summary 
prospectus to more detailed information, depending on their 
interests and needs.
                                ------                                


RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM CHRISTOPHER 
                              COX

Q.1. Considerable work has already been done establishing that 
our capital markets are at risk of falling behind and providing 
specific regulatory, tax, and liability reforms to revive the 
leadership position of the U.S. capital markets. Do you agree 
that it is past time for all of us to resolve these outstanding 
issues and action is required now?

A.1. Yes. The Commission's statutory missions are to protect 
investors, keep our markets healthy and vibrant, and promote 
capital formation. Each of the policy areas you cite can and 
does impact the accomplishment of these missions, and there are 
opportunities for improvement in each of them. Our regulatory 
system needs to be consistently reexamined with a view to the 
rapidly changing conditions of the global marketplace. As the 
SEC works to improve its rules and the implementation of our 
rules to better achieve these goals, we welcome any assistance 
other policymakers can offer.

Q.2. What are the top initiatives that your agency is pursuing 
to meet this need, when will you propose them, and have you set 
deadlines for implementation?

A.2. Rationalizing the implementation of section 404 of the 
Sarbanes-Oxley Act remains the most important action the SEC 
can take to help American businesses remain competitive in the 
global marketplace. To make sure that the U.S. capital markets 
remain robust and competitive, the SEC repealed the costly 
Auditing Standard No. 2, which had made Sarbanes-Oxley 
compliance so difficult, and replaced it with a completely new 
standard that is top-down, risk-based, materiality-focused, and 
scalable for companies of all sizes. The new standard was used 
for the first time with annual reports filed this spring. We 
are now monitoring implementation of the new standard to ensure 
that the desired cost efficiencies are being achieved. The SEC 
has also delayed application of the section 404 audit 
requirement for smaller public companies while we conduct a 
benefit-cost study to ensure that the expected efficiencies 
from the new auditing standard and guidance for management are 
being realized. The study will be completed by the fourth 
quarter of 2008.
    Additionally, in November of 2007, we adopted new rules 
designed to make it much simpler and easier for smaller 
companies to raise capital. We expanded the number of companies 
who can use the Commission's scaled disclosure and reporting 
requirements for smaller companies. Now, companies with a 
public float of up to $75 million can use these simpler rules, 
compared to the $25 million cap that was in place under the old 
rule. That means another 1,500 public companies will be 
eligible to use our simplified disclosure and reporting 
requirements. We also further simplified the rules themselves. 
We eliminated five forms, and 36 separate items that used to 
make up Regulation S-B. We made it more economical for smaller 
companies to sell restricted securities under Rule 144 of the 
Securities Act. We reduced the holding period from one year to 
six months, and eliminated many of the other restrictions on 
using Rule 144. And non-affiliates won't have to file forms any 
more--a change we expect will reduce the number of Form 144s 
filed with the Commission by nearly 60%. This is a way to cut 
the cost of capital for smaller companies without sacrificing 
investor protection. In taking these steps, we were responding 
to several key recommendations of the SEC's Advisory Committee 
on Smaller Public Companies, which issued its final report in 
April 2006.
    We have also undertaken an initiative to reduce complexity 
in financial reporting. I appointed an Advisory Committee on 
Improvements to Financial Reporting which will recommend 
improvements that will keep America's financial reporting 
system as the gold standard for the world. They have already 
issued interim recommendations, and their final recommendations 
are expected this August.
    Last year, the Commission voted unanimously to take the 
next step on the SEC's International Financial Reporting 
Standards ``Roadmap'' first announced three years ago. As a 
result, foreign issuers can now file their financial statements 
with the SEC using IFRS, without need of keeping a second set 
of books under U.S. GAAP. The Commission is also examining 
whether U.S. companies should be able to file with the SEC 
using International Financial Reporting Standards as published 
by the International Accounting Standards Board. Having a set 
of globally accepted accounting standards will be critical to 
the rapidly accelerating global integration of the world's 
capital markets. We will consider proposed rules on IFRS this 
summer.

Q.3. It is my understanding that the Commission is working on a 
rule proposal that would expedite the SEC's processing of rules 
submitted by exchanges and is engaged in efforts to update the 
current regulatory structure including initiatives to foster a 
number of new approaches to cross-border regulation. Please 
describe the Commission's efforts to update mutual recognition 
and expedite the processing of rules submitted by exchanges.

A.3. On June 25, 2008, the Commission adopted a new rule of 
internal procedure to speed up the handling of SRO rules. Now, 
rules will be published and take effect within 15 days of 
filing and in non-controversial cases, rules can take effect 
immediately. This will make the rule approval process vastly 
more efficient. As to mutual recognition, the SEC is currently 
in various stages of discussions with Australia, Canada, and 
the European Union concerning how cross-border activities of 
broker-dealers and markets are regulated in that country. On 
March 29, I met with Kevin Rudd, the Prime Minister of 
Australia, to announce that the SEC and the Australian 
government had begun initial discussions as a prelude to a 
possible formal mutual recognition arrangement for the two 
countries' securities markets. Those discussions are 
continuing. We are also engaged in similar discussions with 
Canada. With the European Union we are discussing the 
establishment of a framework that would permit the U.S. and 
individual EU members to engage in bilateral talks. While 
countries vary widely in their approaches to securities 
regulation, we are exploring the extent to which the 
protections that particular foreign jurisdictions offer 
investors produce similar outcomes to our own regulatory 
system.

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