[Senate Hearing 110-959]
[From the U.S. Government Publishing Office]




                                                        S. Hrg. 110-959

                   THE STATE OF THE BANKING INDUSTRY

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

                                HEARING

                               before the

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

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                                   ON

                   THE STATE OF THE BANKING INDUSTRY


                               ----------                              

                         TUESDAY, MARCH 4, 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







                                                        S. Hrg. 110-959


                   THE STATE OF THE BANKING INDUSTRY

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

                                HEARING

                               before the

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

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                                   ON

                   THE STATE OF THE BANKING INDUSTRY


                               __________

                         TUESDAY, MARCH 4, 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

                              ----------                              

                         TUESDAY, MARCH 4, 2008

                                                                   Page

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

Opening statements, comments, or prepared statements of:
    Senator Bennett..............................................     4
    Senator Reed.................................................     5
    Senator Dole.................................................     6
    Senator Bayh.................................................     7
    Senator Carper...............................................     7

                               WITNESSES

Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation..     8
    Prepared statement...........................................    65
    Response to written questions of:
        Chairman Dodd............................................   288
        Senator Reed.............................................   295
        Senator Crapo............................................   299
John C. Dugan, Comptroller of the Currency, U.S. Treasury........    10
    Prepared statement...........................................    87
    Response to written questions of:
        Chairman Dodd............................................   300
        Senator Crapo............................................   310
John M. Reich, Director, Office of Thrift Supervision............    12
    Prepared statement...........................................   141
    Response to written questions of:
        Chairman Dodd............................................   317
        Senator Crapo............................................   322
JoAnn M. Johnson, Chairman, National Credit Union Administration.    13
    Prepared statement...........................................   176
    Response to written questions of:
        Chairman Dodd............................................   323
        Senator Crapo............................................   330
Donald L. Kohn, Vice Chairman, Board of Governors, Federal 
  Reserve System.................................................    14
    Prepared statement...........................................   200
    Response to written questions of:
        Chairman Dodd............................................   330
        Senator Crapo............................................   351
Thomas B. Gronstal, Iowa Superintendent of Banking, State of Iowa    16
    Prepared statement...........................................   219
    Response to written questions of:
        Chairman Dodd............................................   352

              Additional Material Supplied for the Record

Financial Conditions of the Enterprises..........................   384

 
                   THE STATE OF THE BANKING INDUSTRY

                              ----------                              


                         TUESDAY, MARCH 4, 2008

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:08 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. The Committee will come to order. My 
apologies to our witnesses and my colleagues here for being a 
couple minutes late.
    I believe Senator Shelby will try and get by. There is a 
large Alabama meeting this morning, I think regarding the 
recent announcement of the fuel tanker issue, and Alabama has a 
strong interest in that. And for that reason, he will not be 
here, at least for a while this morning.
    What I will do here is I will begin with an opening 
statement. I will turn to any other members who would care to 
make a brief opening comment. I would like to, if we could, get 
to the questions and hear from our witnesses this morning. I 
want to thank all of them for participating.
    The Committee this morning examines the state of the 
banking industry in our Nation. Such an examination by this 
Committee could not be more important or timely, in my view. It 
is important because our first duty, obviously, as legislators 
on this Committee is to ensure that insured depository 
institutions operate in a safe and sound manner. These 
institutions currently hold over $4.3 trillion in deposits that 
are insured by the American taxpayer. Therefore, the taxpayer, 
of course, has a right to know that the appropriate agencies 
are ensuring that any risks to those deposits are being managed 
prudently and with taxpayers' ultimate liability in mind.
    I well remember sitting on this dais two decades ago--in 
fact, I think Senator Shelby was here, and others--cleaning up 
the mess caused by the reckless and wanton practices in the 
savings and loan industry. Those practices and the regulatory 
failures that allowed them to occur required a taxpayer bailout 
of some $150 billion. Those were very difficult days on this 
Committee. None of us, not a single person on this Committee, 
nor, I would suggest, any one of our colleagues, wants to go 
through that kind of exercise again, ever again. That is why 
this hearing is not only important but I think timely as well.
    Credit markets are experiencing unprecedented disruptions 
right now. The markets for mortgages, credit cards, student 
loans, auto loans, corporate debt, municipal debt--in short, 
for all of the economic activities that are indispensable to 
growth and prosperity--these markets have chilled and in some 
cases have frozen entirely. These markets have seized up mostly 
as a direct result of problems in the subprime market. Recent 
estimates indicate that insured depositories and other 
financial institutions could lose an additional $300 to $400 
billion due to exposure to mortgages, residential as well as 
commercial.
    It is no surprise, therefore, that many of these 
institutions have sought infusions of over $30 billion in 
capital from foreign sovereign wealth funds since November last 
year. The federally insured banks, thrifts, and credit unions 
of our Nation are not just another group of financial 
intermediaries. Their success or failure is not merely of 
concern to their employees and shareholders. It should be and 
must be a concern for all of us because these institutions in a 
very real sense form the cornerstone of our Nation's economic 
foundation. If these lenders do not or cannot lend, then our 
economy cannot and will not grow, obviously.
    President Kennedy is reported to have once said that if the 
economy is wrong, then nothing is right. If that is the case, 
then it is no less true that if the banking industry is wrong, 
then the economy is not right as well. The regulatory agencies 
that oversee this industry, therefore, play an indispensable 
role not only in the economic activities of the lenders they 
oversee, but in the economic life of our Nation. They do not 
merely apply and enforce the laws, as important as that job is; 
and they do not only ensure that the deposits which are insured 
by the American taxpayer are managed in a safe and sound 
manner, though they do that as well; fundamentally, you all 
serve as the gatekeepers of credit for the entire economy of 
our Nation. That is an awesome responsibility, and the men and 
women who work at our Nation's financial regulatory agencies 
understand that responsibility, and, by and large, they 
discharge those duties with diligence and with distinction, I 
would add.
    But their dedication is not tantamount to infallibility. 
That point was made a year and a half ago when Senators Allard 
and Bennett convened hearings on irregular practices in the 
mortgage lending industry. I have commended them before--and I 
do so again this morning--for those hearings, which were 
prescient in many ways. The point was made again a year ago 
when this Committee convened a hearing to examine the turmoil 
in our Nation's mortgage markets. At that time I detailed what 
I termed ``the chronology of neglect'' by Federal regulators, 
principally the Federal Reserve under previous leadership. We 
presented evidence that the Federal Reserve examiners knew as 
far back as late 2003 of the deterioration of lending standards 
and the origination of adjustable rate and nontraditional 
mortgages. Yet the Fed did nothing to intervene, in my view. On 
the contrary, its Chairman at the time actually encouraged such 
loans. But then he simultaneously embarked on a series of 
interest rate hikes that would make adjustable rate mortgages 
less affordable to homeowners.
    The impact of these policies is now felt, of course, by 
millions and millions of American consumers who face interest 
rate spikes that have led or will lead to foreclosure. It is 
felt by millions more who cannot obtain mortgage credit because 
the market for subprime and jumbo loans has seized up. It is 
felt by entrepreneurs who cannot obtain loans or other forms of 
financing because lending institutions are in a virtual credit 
lockdown. And it is felt by the lenders themselves, obviously, 
who are struggling in ways that they have not struggled in 
recent memory.
    It is no wonder that the Fed's own witnesses at a hearing 
before this Committee last year said that, in retrospect, his 
agency--and I quote--``could have done more sooner'' to address 
predatory mortgage lending practices.
    Again and again, the question has been asked over the past 
year, as our credit markets have grown increasingly impaired: 
Where were the regulators? Why didn't they do more? Were they 
asleep at the switch? And when the alarm went off, did they 
merely hit the snooze button?
    Four years ago, Senator Shelby convened an oversight 
hearing similar in purpose to today's hearing. At the time, the 
Federal agencies represented here this morning hailed 
innovations in risk management that enabled banks to better 
quantify risks and take other corrective measures to contain 
undue risks. They pointed to the second markets and newly 
developed structured finance products as tools that would help 
banks more effectively manage and diversify their risks. In the 
words of the then-Comptroller of the Currency, bank supervision 
would provide--and I am quoting--``a layer of protection 
against the challenges posed by our changing economy.''
    Four years later, we want to know what happened. What 
happened to the newfangled risk management innovations that 
were supposed to sound an early warning about reckless lending 
practices? What about the promise of securitization as a way to 
manage credit risk? Where was the layer of supervisory 
protection against excessive risk? Why didn't you more 
vigorously enforce good, old-fashioned, common-sense 
underwriting where a loan is made based on a borrower's ability 
to pay? And what are you doing now today to protect against new 
risks posed by instruments such as credit default swaps, 
trillions of which are held by the institutions you regulate?
    I have read your testimony, and you seem to suggest that 
you will study what went wrong here. You have all said that we 
need to get back to the fundamentals, that we need to return to 
core practices, that we need to revive the way banks manage 
risk, underwriting, and capital. But studying the problem is 
not enough, and I want to see some meaningful and substantial 
action from all of you as soon as possible.
    Specifically, I want to know what you intend to do to 
change what has been lax oversight of underwriting standards. I 
want to know what steps you intend to take to make sure that we 
rethink the assumptions underlying Basel II prior to its 
implementation. And I want to know what specific changes to the 
supervision of bank risk management you intend to implement 
moving forward.
    I intend to reconvene this panel within 60 days to hear 
your responses to these very important questions. These are 
legitimate questions, important questions, questions that 
American taxpayers have every right to ask and have answered 
for them.
    We appreciate the willingness of our witnesses, obviously, 
to appear today to help provide these answers. I am grateful to 
all of you.
    Let me turn to Senator Bennett if he has any opening 
comments he would want to make, and my other colleagues as 
well, and then we will hear the testimony.

             STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you very much, Mr. Chairman. I think 
you have outlined the problem extremely well. Let me make two 
very quick comments.
    First, in this morning's Wall Street Journal, in an article 
that references today's hearings, the authors of the article 
say, if I may quote, ``Today in Washington, D.C., the Senate 
Banking Committee is expected to grill Federal regulators on 
what went wrong. Did banks know how much risk they were taking? 
Did they know how much capital they needed to cushion them from 
sour loans? Did they prepare themselves adequately for the 
evaporation of liquidity or their ability to easily sell their 
securities or loans? The answer to all three questions appears 
to be no.''
    I think that is as good a summary of where we are and why 
we are here, and I add to that this personal anecdote, and I 
shall not disclose the individual because it was a one-on-one 
conversation between the two of us, and I do not suppose he 
would want me to violate the confidentiality of that 
conversation. But a very significant official from another 
country was in my office talking about the impact of all of 
this on the banking system in his country. And as he was 
describing the chain of events that led up to the crisis, he 
said, ``They bought the package''--speaking of the banks in his 
country, ``They bought the package on the basis of the rating 
that had been given it by nationally recognized rating 
agencies, and they did not know what was in it.'' And he kind 
of innocently did not realize what he was just saying, and now 
that they realize that in the package there were a bunch of 
subprime loans and they are going to have to change their 
capital structure to deal with this, and then with a sense of 
urgency and almost terror in his voice, he said, ``Senator, the 
bank in my hometown is going to go bankrupt over this. They 
bought a package based on AAA ratings, and now they are going 
to go bankrupt.''
    And, unfortunately, I did not have any consoling words for 
him or reassurances that it was, in fact, not going to happen.
    So the only additional comment I will make to your 
excellent opening statement, Mr. Chairman, is that this is not 
confined to the United States. This is spreading, and the three 
questions asked in the article very much applied to the foreign 
official that was in my office. The answer to the questions was 
clearly no, they did not know, and we are here to do whatever 
we can to try to help people in the future know what they are 
buying and what they are doing. It would be one thing to say to 
them, well, they bought a package without reading the fine 
print and they deserve what they got. But they did at least 
look at the overall risk, looked at the ratings that they got, 
and thought they had done some due diligence. Clearly, they did 
not do enough, and this hearing will help us deal with that 
problem.
    Chairman Dodd. Senator Reed.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Well, thank you, Mr. Chairman. I think this 
is a well-timed and very important hearing. You have made some 
excellent points, and just let me briefly say that there have 
been estimates recently by UBS that this whole financial crisis 
is on the order of $600 billion, and to date, banks, financial 
institutions, recognize roughly $160 billion. So we have a long 
way to go to work out this problem. And the difficulties and 
consequences that Senator Bennett alluded to, small banks 
across the world and across the United States, in communities 
and organizations and individuals will feel this pain 
dramatically.
    So I think we have two major challenges. One is to solve 
this liquidity crisis if we can, or at least prevent it from 
further exploding, and also make sure we do not repeat what 
seems to be, in hindsight at least, oversights and regulatory 
gaps that allowed the situation to develop.
    It would be great, as the Chairman suggested, if we were 
still in a world of good, old-fashioned underwriting standards 
where you knew your borrower and you kept the paper in your 
files and you had a vested interest in making sure the mortgage 
was paid and the terms were worked out. But in the world of 
securitization and globalization, that seems to be more 
nostalgic than anything else.
    But in this new world, we have to recognize that perhaps 
regulation is more important, and that is why I think when we 
talk about Basel II and others, where the framework would be 
self-evaluation by financial institutions and credit rating 
agencies, we have to take a pause, at least, to ensure we do 
that right.
    As we go forward, I think we have to look at this 
securitization process. It is a financial instrument that is 
not going to go away, or a financial technique that is not 
going to go away. But, again, it puts, I think, more pressure 
on regulators to get right, to look carefully at the off-
balance-sheet instruments that banks are holding, and vehicles. 
And then we have to, I think, have much more financial 
transparency. But the purpose of this hearing I think is 
necessary.
    I have not been here as long as the Chairman or my 
colleagues, but after Enron, I thought we had--and Sarbanes-
Oxley, I thought we had gone a long way in directing that steps 
be taken to account for off-balance-sheet transactions. That 
was one of the great problems with Enron. They had all these 
vehicles, Raptors, et cetera. It turns out that, I guess, we 
did not get it that time. We have got to get it this time. I 
think also 2 years ago, when Congress passed legislation giving 
the Federal Reserve the authority to pass rules with respect to 
what types of paper, what types of mortgage loans, what 
standards, et cetera, that was just recently enacted by 
regulations by the Fed--many, many years after it should have 
been put in place. So this is an opportunity, once again, to do 
what I think should be done.
    Thank you.
    Chairman Dodd. Senator Dole.

              STATEMENT OF SENATOR ELIZABETH DOLE

    Senator Dole. Thank you, Chairman Dodd, for holding this 
important hearing on the state of the banking industry, and I 
want to start off by saying a few words about Sheila Bair, the 
Chairman of the Federal Deposit Insurance Corporation.
    Sheila has a long history of public service that includes 
working as deputy counsel and counsel when my husband was 
Senate Majority Leader. And, Sheila, I want to thank you for 
your continued service to the public and the vital role that 
you are playing to assure competence and confidence in this 
volatile housing and financial market. It is a real pleasure to 
work with you in a professional way and always to see you.
    As we know oh so well, over the past 6 months our financial 
institutions have been shaken by the subprime lending markets. 
These institutions have been pressured by write-downs, and 
their fourth quarter earnings decreased significantly. The 
Office of Thrift Supervision reported that the thrift industry 
posted a record $5.2 billion fourth quarter loss. Additionally, 
the two biggest banks in North Carolina--Bank of America and 
Wachovia--reported that their earnings fell in the fourth 
quarter by 95 percent and 98 percent, respectively.
    Last week, the FDIC classified 76 banks as problem 
institutions for the fourth quarter of 2007. This is up from 65 
in the third quarter, which underscores the growing number of 
banks that are showing signs of strain. FDIC is taking steps to 
brace for a potential increase in failed financial 
institutions. I also applaud the FDIC for its prospective 
thinking and planning for future unforeseen circumstances that 
could adversely impact our banking infrastructure.
    Additionally, with respect to the current regulation of 
financial institutions, it has come to my attention that some 
smaller banks in particular are overburdened by compliance with 
Sections 404 and 302 of the Sarbanes-Oxley corporate 
accountability law. These financial institutions are already 
highly regulated, and it has become increasingly apparent that 
these additional regulations, while well intended, only 
increased the cost of doing business.
    Today, I will introduce, Mr. Chairman, the Regulatory 
Relief and Fairness Act, legislation that would allow qualified 
financial institutions to voluntarily opt out of Sections 302 
and 404 of Sarbanes-Oxley. There is companion legislation in 
the House of Representatives introduced by Congressman Walter 
Jones. I hope at a minimum the legislation serves as a catalyst 
for more debate in this Committee with respect to comprehensive 
regulatory relief reform.
    Again, I want to thank all of our witnesses for being here 
today, and I look forward to working with you on these and 
other important matters.
    Thank you.
    Chairman Dodd. Thank you very much.
    Senator Bayh.

                 STATEMENT OF SENATOR EVAN BAYH

    Senator Bayh. Thank you, Mr. Chairman, for holding this 
hearing on this important topic today, and I particularly want 
to thank you for your intention of having a follow-up hearing 
in 60 days. As you know, very often we have forums like this. 
We ask questions, we get promises and assurances, and then it 
kind of disappears into the void. So I think this is important 
enough that we stay focused on it, and I want to thank you for 
that.
    I also want to thank our panel for being here today. I know 
you are all busy. You have important responsibilities, so we 
are grateful for your time and for your insights.
    Mr. Chairman, I would particularly mention Mr. Dugan. His 
son, Jack, happens to be a classmate of my two boys, and so I 
assume he is a good Comptroller of the Currency, but I know he 
is a good father. And that is perhaps an even higher calling, 
so I just wanted to mention that today.
    Very briefly, Mr. Chairman, I will follow up on something 
that Senator Reed mentioned, and that is the recent UBS 
estimate of additional write-downs, which, if true, could very 
easily lead to a contraction of lending, which would then lead 
to an even more sluggish economy, which can then drive 
unemployment up. It sort of becomes a self-fulfilling problem 
that we have.
    So I agree with the comments that have been made that we 
have a short-term and a long-term challenge, and we need to try 
and reconcile these two to make sure that in solving today's 
problem we do not leave the bigger ones down the road. So we 
need to move aggressively to cauterize this wound, to stabilize 
the situation, but to do so in a way that does not lead to 
inflation down the road, does not lead to risks of moral 
hazard, weaker currency, these kinds of things.
    So I am eagerly awaiting your testimony and your advice 
about how to strike the right balance, and having said all 
that, Mr. Chairman, we are here to listen to them, not to me, 
and again, I thank you for having the hearing.
    Chairman Dodd. Thank you very much.
    Senator Hagel, any opening comments?
    Senator Hagel. No. Thank you, Mr. Chairman.
    Chairman Dodd. Senator Carper, any quick opening comments?

             STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. We welcome you. There has been an effort, 
as you probably know, to move a housing recovery package, and 
so far we have not been successful in doing that. But my hope 
is that under the leadership of Senator Dodd and Senator 
Shelby, we will have another bite at that apple in the next 
week or two or three. And when we do, our Republican friends 
will have an opportunity to offer amendments to that package, 
germane amendments, and we will have an opportunity on our side 
to offer some amendments as well.
    When it comes time to ask questions, one of the things I 
will be doing with the panel is really suggesting some of the 
amendments that we have heard that our Republican friends are 
interested in offering to that package, asking your comments 
for or against, if you have some suggestions how we might 
improve, and some amendments that our side is interested in 
offering as well. So that would be, I think, helpful to us, 
particularly if we have a chance to get back to the floor and 
take this package up in earnest.
    Thanks very much.
    Chairman Dodd. Thank you, Senator.
    Senator Corker.
    Senator Corker. Mr. Chairman, thank you for the hearing. I 
am looking forward to hearing the panel and, therefore, will 
not have any opening comments.
    Chairman Dodd. Very good. I thank all of my colleagues.
    Let me again welcome our witnesses here and thank all of 
you for taking the time to be with us.
    Sheila, I do not know of a better introduction that could 
be given of you than the one that Senator Dole gave you here, 
so we maybe just want to leave it there. We are delighted to 
have you before the Committee again.
    John Dugan is current Comptroller of the Currency and a 
welcome member anytime in this room, having sat in the chairs 
behind me here for some time. So we welcome you back to the 
Committee as the Comptroller of the Currency.
    John Reich is the current Director of the Office of Thrift 
Supervision, and we thank you very much, John, for being with 
us.
    JoAnn Johnson is the Chairman of the National Credit Union 
Administration, and we are pleased to have you with us.
    Donald Kohn is, of course, the Vice Chair of the Federal 
Reserve, and we thank you very much for being here this morning 
as well.
    And, last, Tom Gronstal, who is the Superintendent of the 
Iowa Division of Banking, is here on behalf of the Conference 
of State Bank Supervisors. You look like Mike. Are you related?
    Mr. Gronstal. All Gronstals are related, and we are first 
cousins.
    Chairman Dodd. Mike Gronstal is the leader of the State 
Senate in Iowa. Why would I know that? [Laughter.]
    Anyway, we are pleased to have all of you here with us this 
morning, and, Sheila, we will begin with you, and try and keep 
it to 5--you have all been here before. If you can try and keep 
it to 5 or 6 minutes--I do not wave a gavel around here, but--
and let me also say to all of my colleagues and to the 
witnesses, all of your statements, the full statements, 
supporting data, material, graphs, charts, whatever else you 
want to add, will be included in the record. So whatever else 
you need to give us will be a part of this hearing.
    Sheila.

             STATEMENT OF SHEILA C. BAIR, CHAIRMAN,
             FEDERAL DEPOSIT INSURANCE CORPORATION

    Ms. Bair. Good morning, Chairman Dodd and Members of the 
Committee. Thank you for the opportunity to testify.
    It is no surprise to anyone that the second half of 2007--
--
    Chairman Dodd. Would you check and make sure your button is 
on?
    Ms. Bair. It is no surprise to anyone that the second half 
of 2007 was a very tough period for the banking industry. 
Fourth quarter results were heavily influenced by a number of 
well-publicized write-downs by large banks. Weakness in the 
housing sector and a credit squeeze in financial markets made 
it a very challenging time for many institutions. We can expect 
these problems to continue throughout 2008.
    Last week, we released our ``Quarterly Banking Profile,'' 
which analyzes financial results for the entire industry. It 
was a weak report. Industry earnings were down 27 percent for 
last year, and while in the black, they were the lowest we have 
seen since 2002. Fourth quarter results alone were the lowest 
we have seen since the early 1990s. Higher loan loss 
provisions, big losses on trading activities, and write-downs 
of goodwill were the main factors that dragged down industry 
earnings during the quarter.
    A substantial part of the sharp decline in fourth quarter 
earnings was concentrated in a handful of institutions. Six 
large institutions accounted for more than half of the total 
decline. Fortunately, they all remain well capitalized. Many 
community banks are also having problems. They, too, are seeing 
their troubled loans increase and their earnings diminish, but 
less so than the large banks. Overall, slightly more than half 
of the 8,500 banks and thrifts that we insure reported lower 
fourth quarter earnings and have reported increases in troubled 
loans.
    Despite a tough economic environment, however, the vast 
majority of institutions so far are successfully coping with 
the challenges they face. The industry as a whole is coming off 
a golden period of record profits. Because of this financial 
strength, banks and thrifts of all sizes are overwhelmingly 
very safe and very sound. Ninety-nine percent of insured 
institutions were well capitalized at the end of 2007, 
representing 99.7 percent of all bank assets. Nearly 90 percent 
were profitable for the year, and insured institutions 
increased regulatory capital by more than $29 billion during 
the fourth quarter to bolster their ability to absorb losses.
    Nevertheless, we are well prepared should there be an 
uptick in bank failures. The Deposit Insurance Fund remains 
strong, with $52.4 billion, and we are beefing up the number of 
staff with experience in dealing with failed institutions. As 
for troubled banks, there are 76 on our problem list. This is a 
very small number by historical standards when you consider the 
nearly 1,500 troubled banks we had on the list in the early 
1990s. And these are small banks, with only $22 billion in 
assets compared with $13 trillion in total industry assets.
    As part of our efforts to stay ahead of the curve, our 
examiners are very focused on asset quality as write-offs and 
loss provisions are likely to remain high for the near future. 
We are focused not only on mortgages as the housing downturn 
continues, but also commercial real estate, credit card, and 
small business lending.
    We have been worried about commercial real estate lending 
for a number of months now. We warned industry, along with 
other regulators, about rising concentrations of these loans, 
especially for construction and development, and issued 
guidance in December 2006. Given the weakness in housing 
markets around the country, we are keeping a very close eye on 
trends in the construction and development sector, particularly 
at banks with high concentrations.
    We also remain concerned about the ongoing rise in 
foreclosures, especially for subprime borrowers. We continue to 
urge lenders to provide long-term, sustainable, and affordable 
mortgages. I am encouraged by the greater number of homeowners 
being helped, according to the Hope Now Alliance. I am also 
pleased that loan modifications as a percentage of total 
workouts rose in January. However, I do remain very concerned 
about the reliance on repayment plans. These may be 
unsustainable for borrowers and lead to delinquencies down the 
road and contribute to ongoing borrower distress. It is 
absolutely critical that borrowers have loans they can afford 
over the long term. I am hopeful that loan modifications will 
accelerate. But at the same time, I recognize that additional 
action might be needed to reduce foreclosures and prevent the 
housing market from overshooting as home prices adjust 
downward.
    Longer term, I firmly believe that by returning to more 
traditional lending practices, we can better protect consumers 
and help our regulated banking industry regain market share in 
mortgage lending in the process. In addition, there is now 
widespread recognition of the importance of strong capital to 
protect banks in times of stress as well as the need for 
transparency to maintain liquidity in the structured finance 
market. We need to recognize the limitations of this risk-based 
modeling, and we need a common-sense approach for using credit 
ratings. In short, we need to get back to basics in both the 
primary and secondary mortgage markets. In the long run that 
will serve us all.
    Thank you very much.
    Chairman Dodd. Thank you very much, Sheila.
    John, welcome.

                  STATEMENT OF JOHN C. DUGAN,
           COMPTROLLER OF THE CURRENCY, U.S. TREASURY

    Mr. Dugan. Chairman Dodd and Members of the Committee, 
thank you very much. I am pleased to be here today to testify 
on the condition of the banking system. And, Senator Bayh, 
thank you for those very kind words.
    In general, due to a long period of strong economic growth, 
exceptionally low credit losses, and strong capital ratios, the 
national banking system has been healthy and vibrant.
    Now, however, the system is being tested. Two powerful and 
related forces are exerting real stress on banks of all sizes 
and in many different parts of the country. One is the large 
and unprecedented series of credit market disruptions, still 
unfolding, that was precipitated by declining house prices and 
severe problems with subprime mortgages. The other is the 
slowdown in the economy, which has begun to generate a 
noticeable decline in credit quality in a number of asset 
classes. The combination of these forces has strained the 
resources of many of the national banks that we regulate.
    Despite these strains, the banking system remains 
fundamentally sound, in part because it entered this period of 
stress in such strong condition. Thus far national banks have 
been able to address a number of significant problems that have 
arisen while continuing to supply credit and other banking 
services to the U.S. economy--although there is no doubt that 
credit standards have tightened. For example, large banks 
provided liquidity support to asset-backed commercial paper 
conduits and structured investment vehicles, or SIVs, often 
involving the painful recognition of losses to restore more 
normal funding in these markets. Likewise, banks with 
concentrated positions in collateralized debt obligations 
backed by subprime asset-backed securities have recognized 
large losses, but have also raised large amounts of capital to 
offset these and other losses. And a large national bank 
holding company entered into an agreement to purchase the 
Nation's largest mortgage originator, which had been under 
severe funding stress, and that action had a calming effect on 
the market.
    Despite such efforts, however, significant market 
disruption issues remain to be addressed, such as the potential 
downgrades of monoline insurance companies; significant funding 
problems in the auction rate securities market; and severe 
constriction in the securitization markets for residential 
mortgage-backed securities, commercial mortgage-backed 
securities, and leveraged loans.
    Likewise, the economic slowdown and problems in the housing 
market have caused banks to increase loan loss reserves 
significantly for such assets as residential construction and 
development loans, home equity loans, and credit card loans. 
Indeed, smaller banks that have exceptionally large 
concentrations in commercial real estate loans--and there are 
many of them--face real challenges in those parts of the 
country where real estate markets have slowed significantly. 
Unlike the unprecedented market disruptions of the last 6 
months, however, these more traditional credit problems are 
familiar territory to bankers and regulators. The key to 
addressing them is for bankers to recognize problems early and 
manage through them, and that is exactly what our examiners are 
working with them to do.
    There is also a need to re-emphasize several fundamental 
banking principles: sound underwriting and robust credit 
administration practices; diversified funding sources and 
realistic contingency funding plans; strong internal controls 
and risk management systems, including stress-testing, 
valuations, and disclosures; and timely recognition of losses 
coupled with adequate loan loss reserves and strong capital 
cushions. In each of these four areas--asset quality, 
liquidity, risk management, and reserves and capital--we remain 
alert to emerging trends and to findings that may trigger 
additional supervisory action.
    Finally, you asked us to describe our current efforts to 
address foreclosure prevention and mitigation. This is very 
important for the OCC since the nine largest national banks act 
as servicers for about 40 percent of all U.S. mortgages, 
including a significant number of subprime mortgages. The OCC 
has taken a number of steps to encourage national bank lenders 
and servicers to work constructively with borrowers to avoid 
foreclosures except when absolutely necessary. We have joined 
the other banking agencies in issuing guidance to that effect. 
We have strongly supported the efforts of the Hope Now 
Alliance, and we have supported an amendment to the Community 
Reinvestment Act regulations that would provide CRA credit for 
foreclosure prevention activities in distressed middle-income 
neighborhoods.
    We also announced last week a significant new effort 
regarding the reporting of key data on mortgages, including 
mortgage modifications. We are requiring our largest national 
bank servicers to provide standardized reports on a range of 
mortgage metrics, not just for subprime adjustable rate 
mortgages but for all mortgages. These data, which are 
consistent with the Hope Now metrics, will provide an important 
way to track mortgage performance against a broad range of 
indicators.
    Thank you very much.
    Chairman Dodd. Thank you very much.
    Mr. Reich.

             STATEMENT OF JOHN M. REICH, DIRECTOR,
                  OFFICE OF THRIFT SUPERVISION

    Mr. Reich. Good morning, Chairman Dodd, Members of the 
Committee. Thank you for the opportunity to testify on behalf 
of the Office of Thrift Supervision. My written testimony 
contains fairly lengthy and detailed information, but in the 
few minutes I have here, I will highlight just a few points.
    First, the condition of the Nation's savings associations. 
My testimony today will be no surprise. Thrift institutions 
like the entire financial services industry are facing serious 
challenges from the mortgage market crisis affecting the 
broader economy, and I believe that these challenges will 
persist throughout 2008 and into 2009.
    During the fourth quarter of 2007, the thrift industry 
posted a record loss of $5.2 billion in the fourth quarter. 
Troubled assets continued to rise. For all of calendar year 
2007, the industry posted a profit of $2.9 billion.
    Although good news is scarce in the current landscape, I 
can tell you that the mortgage market's problems have created 
an earnings issue for thrift institutions, but not a capital 
issue, and I believe that is an important distinction. In 
addition to earnings, even reduced earnings, capital and loan 
loss reserves provide the foundation of support for financial 
institutions during times of challenge, and thrift institutions 
continue to maintain strong capital and continue to set aside 
significant loan loss reserves.
    I can also report that the OTS is in a strong position to 
continue to carry out our mission of ensuring the safety and 
soundness of thrift institutions and their holding companies 
and of ensuring compliance with consumer protection laws. These 
laws include prohibitions against unfair or deceptive acts and 
practices, an area where OTS recently issued a proposed 
rulemaking.
    Since I became OTS Director in 2005, we have increased our 
workforce by more than 15 percent, primarily among our 
examining force, and our budget is solid. Although the 
consolidation affecting the entire financial services industry 
has reduced the number of thrifts that we regulate to 
approximately 830, assets supervised by OTS have grown by 55 
percent over the past 5 years to more than $1.5 trillion, and 
in the last 3 years, more financial institutions have converted 
to the thrift charter than have converted from the thrift 
charter. This is a noteworthy trend, I believe, which speaks to 
the value that the financial services industry sees in the 
thrift charter.
    The last point I would like to make is that OTS understands 
the enormous impact that home foreclosures can have on 
Americans and the communities where they live. To contribute in 
a meaningful way to a solution to this growing problem, we 
recently suggested a foreclosure prevention proposal that we 
think merits discussion and debate to help financially stressed 
homeowners who owe more on their homes than they are currently 
worth. I have seen estimates that 30 percent of homeowners who 
have purchased their homes in the last 2 years are in this 
position of being upside down or underwater. Our plan would 
provide an incentive for homeowners in distress whose mortgages 
are underwater to stay in their homes instead of turning in 
their keys and walking away. It is a market-based proposal 
without the cost and potential moral hazard of a Federal 
bailout. It would also allow the lender or investor to share in 
the upside when the home again appreciates in value once this 
crisis subsides.
    Under this proposal, the distressed homeowner whose loan 
was previously sold into a securitization would obtain new FHA 
financing based on the current market value of the home. The 
servicer would receive a partial payoff and would record a 
negative equity certificate equal to the difference between the 
new FHA loan and the currently outstanding loan balance. When 
the home is sold, the certificate owner would recover an amount 
potentially reaching the full value of the certificate, 
depending on future home price appreciation. Beyond that 
amount, appreciation would revert to the homeowner.
    This proposal is certainly not the only idea to address the 
rising number of foreclosures, but we believe there is 
significant merit in considering this approach as a 
supplemental component to the efforts that are underway to deal 
with this crisis.
    With that, Mr. Chairman, I thank you, and I look forward to 
questions.
    Chairman Dodd. Thanks very much, and thank you for that 
testimony.
    Ms. Johnson.

            STATEMENT OF JOANN M. JOHNSON, CHAIRMAN,
              NATIONAL CREDIT UNION ADMINISTRATION

    Ms. Johnson. Thank you, Mr. Chairman and Members of the 
Committee, for this opportunity to testify regarding the state 
of the credit union industry in the context of your broader 
review of how financial institutions are performing during the 
recent turbulence. This is a timely and important subject that 
merits congressional oversight. NCUA provides oversight and 
supervision for 8,100 federally insured credit unions, serving 
approximately 87 million members.
    The financial state of the credit union industry remains 
strong and healthy with financial trends indicating a safe and 
sound industry. I will outline key data which supports this 
conclusion and also underscores NCUA's belief that the industry 
has implemented our regulatory guidance regarding the need for 
increased vigilance and more careful management of credit union 
balance sheets. federally insured credit unions are well 
capitalized. Net worth stands at 11.4 percent, and over 99 
percent were at least adequately capitalized. Total assets are 
at $753 billion, and aggregate net worth is $86 billion, the 
highest dollar amount in history.
    Lending continues to be a main focus of credit union 
service to members. As of the end of 2007, loans represented 
almost 70 percent of credit union assets. Within that figure, 
real estate loans comprised just over 51 percent of total 
loans.
    Credit union mortgage lending is primarily of the 
traditional variety: 58 percent of mortgages are fixed-rate, 
and only 2.3 percent are interest-only or optional payment 
loans that have garnered much of the recent attention on 
Capitol Hill and made this hearing, unfortunately, necessary.
    After several years of declines, delinquencies and losses 
have increased. Overall, loan delinquencies have increased from 
0.68 percent to 0.93 percent, and real estate delinquencies now 
stand at 0.68 percent. Net charge-offs are 0.08 percent.
    Those relatively low numbers indicate that credit unions 
have positioned themselves to withstand the current economic 
uncertainty and related mortgage problems. To make certain that 
continues, NCUA has played a proactive and aggressive role in 
issuing supervisory guidance regarding lending. Since 1995, 
NCUA has issued guidance on risk-based lending and specific 
mortgage lending guidance that has identified potential problem 
areas, particularly regarding subprime lending, credit risk 
management, due diligence, and stringent evaluation of third-
party relationships.
    Home equity lines of credit, or HELOCs, and so-called 
exotic mortgage products such as interest-only and payment-
optional, were also covered by this guidance. As in the past, 
and most recently in concert with my fellow regulators, joint 
guidance regarding workout arrangements, subprime lending, and 
loss mitigation was issued.
    All of this was aimed at increasing credit union awareness 
of the potential pitfalls inherent in a rapidly changing and 
complex lending landscape. It also served as a constant 
reminder to the industry of NCUA's vigilant posture when it 
comes to identifying and managing risk. While NCUA appreciates 
the desire of credit unions to serve their members as fully as 
possible, we recognize that there is no substitute for strong 
supervision that enhances safe and sound operations.
    Federally insured credit unions remain financially strong. 
They have implemented NCUA guidance related to real estate and 
other lending and, as a result, are positioned to weather the 
current economic turbulence. While data shows that the industry 
is not entirely insulated from the adverse impact of the 
mortgage situation, it also supports the conclusion that strong 
risk management and prudent standards, closely supervised by an 
engaged regulator, will ensure continued success.
    Thank you very much for the opportunity.
    Chairman Dodd. Thank you very much, Ms. Johnson.
    Mr. Kohn.

          STATEMENT OF DONALD L. KOHN, VICE CHAIRMAN,
           BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM

    Mr. Kohn. Thank you, Mr. Chairman. Chairman Dodd, Members 
of the Committee, I appreciate the opportunity to appear before 
you today.
    As you know the Federal Reserve has supervisory and 
regulatory authority over a wide range of financial 
institutions and activities, including supervision of bank 
holding companies and state-member banks, as well as 
responsibility to ensure fair and equitable treatment of 
consumers in their financial transactions. And all these are 
important components of our broader mandate to help maintain 
overall stability in financial markets.
    The U.S. banking system is facing some challenges, but 
remains in sound overall condition, having entered the period 
of recent financial turmoil with solid capital and strong 
earnings. The problems in the mortgage and housing markets have 
been highly unusual, and clearly some banking organizations 
have managed their exposures poorly, suffering losses as a 
result. But in general these losses should not threaten their 
viability. We, along with the other banking agencies, have been 
working with banking organizations to identify and rectify 
shortcomings in risk management that have led to losses and to 
ensure that the banking system continues to be safe and sound.
    Our efforts also include helping to minimize any excessive 
financial impact on those consumers affected by recent market 
disturbances. Bank holding companies have seen their 
profitability decline in recent months due to sizable write-
downs and substantially higher provisions for loan losses.
    Liquidity has also been under pressure at some of the 
largest bank holding companies, in some cases reflecting 
difficulties securitizing some assets and the need to bring on 
balance sheet some assets that had been previously securitized. 
In some cases, asset write-downs and unplanned increases in 
assets have placed pressure on capital ratios and caused some 
banking organizations to take a more cautious approach to 
extending credit.
    State-member banks are facing similar challenges, but also 
entered the recent period of financial disturbance in sound 
condition.
    In this environment, we have been focusing supervisory 
efforts on those institutions most exposed to residential and 
commercial real estate and other sectors that have come under 
pressure. We are also attentive to those institutions that 
would suffer most from a prolonged period of deterioration in 
economic conditions. Our attention remains on the financial 
condition of the banking organizations, including the adequacy 
of the liquidity capital loan loss reserves and their 
consequent ability to cope with additional losses.
    We are also evaluating risk management practices closely, 
including scrutinizing governance and controls, given some of 
the risk management lapses in those areas.
    Supervisors will be looking at the capacity of a firm as a 
whole to manage all its risks and to integrate risk assessments 
into the overall decisionmaking by senior management. 
Additional emphasis on enhancing stress-testing is also 
appropriate to focus more bank attention on risks that have a 
low probability of occurrence but severe potential costs.
    Particular areas of supervisory focus include residential 
mortgage lending, consumer protection, bank liquidity and 
capital positions, consumer non-mortgage lending, commercial 
real estate, and commercial lending. While residential mortgage 
lending has, unfortunately, presented substantial problems for 
many homeowners and communities, it has also created challenges 
for banking organizations. Accordingly, it is receiving much 
supervisory attention.
    For example, the Federal Reserve and other banking agencies 
have encouraged mortgage lenders and mortgage servicers to 
pursue prudent loan workouts to assist borrowers having 
difficulty meeting their payment obligations through such 
measures as modification of loans, deferral of payments, 
extension of loan maturities, capitalization of delinquent 
amounts, conversion of ARMs into fixed-rate mortgages or fully 
indexed, fully amortizing ARMs.
    Our reserve banks are working closely with local community 
groups to identify opportunities for workouts and to educate 
both borrowers and lenders. We are also carefully monitoring 
those areas that are most likely to be adversely affected by 
residential real estate, such as construction loans and non-
mortgage consumer lending, and taking appropriate action. We 
have implemented supervisory strategies to ensure that we have 
the proper examination staff assessing commercial real estate, 
ready to address banking problems.
    Finally, as part of a responsible and proactive supervisory 
approach, and as we have done in the past, we are conducting 
critical assessments of our own supervisory programs, policies, 
and practices. This is a prudent step and is consistent with 
longstanding Federal Reserve practice. Our intent is to 
identify opportunities for improving our own processes both 
within the current environment and as preparation for future 
supervisory challenges.
    It will take some time for the banking industry to work 
through this current set of challenges and for financial 
markets to recover from recent strains. The Federal Reserve 
will continue to work with other U.S. banking agencies and the 
Congress to help ensure that bank safety and soundness is 
maintained.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Mr. Kohn, for that 
testimony. It was very helpful.
    Mr. Gronstal, welcome.

                STATEMENT OF THOMAS B. GRONSTAL,
         IOWA SUPERINTENDENT OF BANKING, STATE OF IOWA

    Mr. Gronstal. Thank you. Good morning, Chairman Dodd and 
distinguished Members of the Committee. As Iowa Superintendent 
of Banking, I am pleased to testify today on behalf of CSBS on 
the condition of the Nation's banking industry, and 
specifically the challenges facing the State banking system.
    The collapse of the housing finance market has resulted in 
the collapse of investor confidence in bond ratings, bond 
insurers, collateral valuation of asset-backed securities, and 
the impact has spread to trust preferred securities issued by 
banks, auction rate certifications issued by student loan 
secondary markets, and a general depreciation of asset-backed 
securities held in banks' portfolios.
    A few lessons the State regulators would highlight from 
this experience are: one, that good underwriting is consumer 
protection; two, consumer protection is investor protection; 
and, three, transparency is in the interest of all parties. We 
believe these lessons should be applied to policies ranging 
from the preemption of State consumer protection laws all the 
way to Basel II. Also, as other witnesses have testified, the 
slowdown in the economy is beginning to reveal weaknesses in 
the commercial real estate sector. We will continue to work 
with our Federal counterparts to supervise the industry 
performance in this sector.
    As I highlight in my written testimony, State regulators 
are prepared to handle a greater number of bank failures than 
we have had to in the last several years. But based on current 
information and conditions, we do not expect widespread 
failures. Obviously, a significant change in the economy could 
change that outlook.
    I would note that while a manageable number of bank 
failures has a limited impact on the national economy, any bank 
failure is very disruptive to the local economy and the 
consumers in our communities and States.
    Two additional areas where we think problems could arise 
are reverse mortgages and agricultural lending. Reverse 
mortgages are ripe for consumer abuse and fraud and could 
present some long-term accounting and valuation issues. CSBS 
has developed a seminar to help State mortgage examiners learn 
about the fast developing reverse mortgage market. Currently, 
the ag sector is experiencing a combination of high oil and 
commodity prices, similar to the conditions of the 1970s. The 
value of farmland is directly correlated to the price of 
commodities. We could be witnessing the development of a bubble 
in agricultural real estate.
    The problems we are currently experiencing in the banking 
industry were triggered by the weakening of the housing market 
and the ensuing credit crunch.
    CSBS contends that an enhanced regulatory regime for the 
mortgage industry is absolutely necessary to ensure legitimate 
lending practices, provide adequate consumer protections, and 
to once again instill both consumer and investor confidence in 
the housing market.
    To that end, CSBS and ARMR launched the nationwide mortgage 
licensing system. The system is more than a database. It serves 
as the foundation of modern mortgage regulation by providing 
transparency for regulators, industry, investors, and 
consumers. While much has been done recently by Federal and 
State regulators to enhance supervision of the residential 
mortgage industry, State officials have also been very active 
in addressing the increasing foreclosures.
    In July 2007, the State Foreclosure Prevention Working 
Group, composed of Attorneys General and bank regulators from 
11 States and CSBS, was formed to work with participants in the 
subprime mortgage industry so borrowers could retain their 
homes with affordable mortgages. Beginning in November, the 
working group collaborated with the industry, the FDIC, and the 
Federal Reserve to develop a uniform data reporting format to 
measure the extent of the foreclosure problem and the 
servicers' efforts to respond. Last month, the working group 
issued the ``Analysis of Subprime Mortgage Servicing 
Performance'' report. It is my sense that many servicers are 
making positive efforts, but that we are still losing the 
larger battle to stem the tide of unnecessary foreclosures. 
More must be done to assist those Americans who are fighting to 
save their homes.
    CSBS looks forward to continuing to work with the Federal 
regulators and Congress to address the needs and the regulatory 
demands of an ever evolving financial system fostering the 
strongest economy possible while protecting consumers, 
minimizing regulatory burden, and ensuring access to the 
broadest range of financial opportunity.
    Thank you for the opportunity to testify today, and I look 
forward to any questions you may have.
    Chairman Dodd. Well, thank you very, very much, and let me 
thank all of our witnesses. I appreciate your brevity as well 
in allowing us to get to the questions here this morning.
    What I will do is I will turn the clocks on here for 
about--let me see, not too many of us here--7 or 8 minutes so 
we get a decent amount of time for the first round of 
questioning. There are a lot of issues to be raised.
    Obviously, as Senator Bennett pointed out, there is a 
fundamental question sort of raised this morning by the Wall 
Street Journal that will probably be a subject of all of our 
questions to one degree or another. But let me, if I can, begin 
by talking about Basel II, because this is a big issue. It is 
the center of a lot of attention in various articles here.
    The current problems in the market highlight, I think, the 
critical importance of adequate capital standards for banks. 
That is the core issue in many, many ways--although not the 
only one. I think the risk management as well, and there are 
other questions here, but obviously the core element of having 
adequate capital standards is fundamental. And with the 
upcoming implementation of Basel II--and I gather, and those of 
you deeply involved in this can correct me, but I gather just 
in terms of how fast this is moving that while I think there 
was some talk about spring, it is probably a greater likelihood 
it is probably more in the fall before they will begin to move. 
So we have got a little time here to look at this and respond 
to it, if we can.
    There is a potential for some major changes in the capital 
requirements that banks will face. There have been some 
concerns raised that the structure of Basel II would lead to 
some serious problems--I think you have all heard this--
especially in the current environment we are in. Specifically, 
there have been concerns raised about the reliance of Basel II 
on internal bank models of risk, models which failed during the 
recent crisis that we have experienced in the market. A recent 
piece written here by Harold Benink and George Kaufman in last 
week's Financial Times reveals--the headline, ``Turmoil reveals 
the inadequacy of Basel II.'' And let me quote from the 
article. It says, ``A more fundamental problem is that Basel II 
creates perverse incentives to underestimate credit risk 
because the banks are allowed to use their own models for 
assessing risk and determining the amount of regulatory 
capital. They may be tempted to be overoptimistic about their 
risk exposure in order to minimize required regulatory capital 
and to maximize return on equity.''
    I would like each of you to respond to that concern, if you 
would, and then a follow-up question with regard to it is 
whether Basel II, if it had been in effect--let's move the 
calendar in the opposite direction. Let's assume it had been in 
effect in the last couple of years. What impact would Basel II, 
as proposed, have been on the current situation in your views? 
Would we be looking at a better or a worse situation if Basel 
II were in place? And, again, as background here, we obviously 
know what happened at this recent financial institution in 
England here where you had it was able--this one bank said it 
was able--``enabled them to increase our 2007 interim dividend 
by 30 percent.'' You may have all read this report. ``And going 
forward, our dividend pay amount rate increases to 50 percent 
of underlying EPS from around 40 percent. Future capital 
planning, including reduction of capital assets, will allow us 
to return capital to shareholders through a share buyback 
program. The medium-term outlook for the company is very 
positive.'' That was Adam Applegarth, the Northern Rock Bank on 
June 30th of last year, and as all of you know, shortly 
afterwards they became insolvent, were nationalized, had the 
largest run since 1866.
    So despite the positive predictions here under Basel II, I 
am very interested in how each of you would respond to the 
question. What would our situation look like today had Basel II 
been in place? Then, of course, responding, if you can, to the 
concerns raised by Mr. Benink and Mr. Kaufman. Sheila, we will 
begin with you.
    Ms. Bair. The FDIC institutionally has had longstanding 
questions and concerns about the use of internal models to 
derive capital under Basel II, and my personal view is that we 
are taking a very go-slow approach in implementation so we will 
have plenty of time to make adjustments as we try to look 
through some of those issues.
    The problem with model-driven capital is that it relies on 
past performance, and when you have new higher-risk products 
that were developed and performed during a very favorable 
economic environment, your past performance is not going to 
tell you how they are truly going to perform when our economic 
circumstances change. And that is exactly what we saw with 
mortgages.
    Our QIS impact study, the QIS, the Quantitative Impact 
Study----
    Chairman Dodd. Shouldn't that be a part of it? I mean, if 
past performance has been sort of rosy, shouldn't you be 
anticipating these matters here if things do not go well, as 
well as if things are going well?
    Ms. Bair. You should absolutely stress test. But, again, 
models are only as good as the data you put into them, and 
these models rely on historical data. That is one of the issues 
we have had.
    The Quantitative Impact Study showed that there would have 
been a 73-percent median reduction risk-based capital for 
residential mortgage lending, and for home equity lending it 
would have been 79 percent. And, again, that was because there 
was benign historical data being fed into the models when the 
QIS studies were done.
    So I think it would have put us in worse shape, and I think 
not only would we have had lower capital going into this, but I 
think we would have had banks--banks already having to raise 
capital--that would have had to raise it a lot more. So you 
have a pro-cyclicality with these reduced capital levels using 
models for benign economic times that spike up sharply.
    So we think this has always been a crucial issue, a 
critical issue with the Basel II advanced approaches. I think 
there are many good elements of Basel II, also. I think it is 
important that there are other aspects of it that are positive. 
We will also go out for comment on the Basel II Standardized 
Approach, which does not use internal models but has more of a 
bucket system where for each asset category you have hard and 
fast floors under each bucket. And, of course, nobody is 
talking at this point about getting rid of the leverage ratio, 
which would be our fail-safe under all these new frameworks.
    Chairman Dodd. Well, I should have said--and I want to get 
to my question quickly. I do not want anyone here to walk out 
of this room with the assumption that the Chairman of this 
Committee is hostile to Basel II. I think there are some very, 
very positive elements of Basel II. The question is: Are we 
rushing ahead a little too fast without thinking about these 
other implications?
    So I have a positive attitude about Basel II. I am just 
concerned about how some of this may work.
    John.
    Mr. Dugan. Mr. Chairman, as I do on some of these issues 
with my colleague, I have a little different take on this. No. 
1, the losses that we have really seen happened in the Basel I 
world, not a Basel II world, which is not directly responsive 
to your question.
    I think on the Basel II question, there are some things 
that I think it clearly would have done better and will do 
better. I think it factors more risk management processes into 
the capital framework, and that is a good thing. I think it 
does a better job with not creating incentives between off-
balance-sheet and on-balance-sheet risk. They are treated more 
equally under that program.
    And with respect to the notion of dealing with historical 
data, while that is an issue with respect to Basel II, it was 
more of an issue when we only had benign data going into it 
because of all the benign credit issues that had gone on. We 
have taken care of that problem. There are a lot of losses now, 
that would be fed into the system. It is taken into account in 
how the data adjusts to those actual events and causes more 
capital to be raised. I think it is quite an open question, 
given the current events, whether capital in the system would 
go up, not down, as a result of what has happened.
    But having said all of that, I think there are some very 
specific things that happened that really need a look in the 
Basel II process, particularly with these ABS CDOs that were 
based by subprime-related securities. Senator Bennett referred 
earlier to the credit ratings. The irony of this whole 
situation is that the most highly rated securities, the ones 
that were thought to be least likely to default, are where a 
huge share of the losses have been concentrated. And the 
securities with the highest rating get the least attention from 
management, from regulators, and from our capital regime. The 
fact of the matter is the AAA in this context performed much 
differently, and much worse, than AAA in any other type of 
security we have ever witnessed before. There has to be a need 
to look at that, and one of the places we need to look at it is 
whether the Basel II capital risk weights for this particular 
kind of security need to be adjusted. I think that is extremely 
important going forward, along with some other measures.
    The last point I will make is, although the rule is final, 
it is quite a deliberate pace that is going on in the United 
States. Firms have 3 years to begin the first parallel year of 
running, which is not actually the year you get on it. There is 
another year, and then there is a 3-year transition period. No 
firm has actually even started that: the first firm may begin 
this summer. I think it will be staggered over time, and 
meanwhile we do have these systems of floors in place to fine-
tune things as we go along. But you are raising very good 
questions that need to be looked at and adjusted as we go 
forward.
    Chairman Dodd. John or JoAnn, do you have any comments on 
this? I want to hear the Fed's point of view on this, but I 
want to also hear if you have any thoughts on this. Yes, go 
ahead.
    Ms. Johnson. I would like to add just a point. While credit 
unions do not fall under Basel, we do have a risk-based capital 
proposal on the table for Congress to take a look at it, and I 
would ask your serious consideration because this would give us 
as a regulator a real tool to identify problems more quickly, 
and it would help the credit unions manage their risk more 
effectively. And it is our risk-based capital, prompt correct 
action proposal. We have been working for over 3\1/2\ years on 
it, but we need legislative action in order to get it done.
    So I would just please ask for your serious consideration. 
It would really give us a tool as a regulator.
    Chairman Dodd. John, do you want to comment?
    Mr. Reich. Mr. Chairman, I would like to make a comment. I 
began my banking career about 47 years ago, and I grew up in a 
generation of bankers who believed that you cannot have too 
much capital and you cannot have too much money in your loan 
loss reserves. I still believe that today.
    When I entered the Basel discussion as a banking regulator 
about 2\1/2\ years ago, I was a skeptic about Basel II. I am 
still sort of skeptical today, but I feel a lot more 
comfortable today about it than I did 2\1/2\ years ago, and one 
of the reasons is that I have been talking with my fellow 
regulators at this table about Basel II over the past 2\1/2\ 
years, and I know that there is one thing that we are all 
committed to, and I believe that every single individual is 
committed to making whatever changes need to be made between 
now and full implementation in 2012.
    We also have the authority, which is not discussed a great 
deal, in Pillar 2 of Basel II for the regulators to have the 
latitude and the flexibility to require whatever additional 
levels of capital we think are necessary over and above what 
the models predict. So we are not totally dependent on the 
models. Our examiners in the field and their supervisors in our 
regional offices will be reviewing capital, will be reviewing 
the risk profiles of these institutions. And if we feel they 
need more capital over and above what the models call for, we 
will call for that additional capital.
    Chairman Dodd. Let me just, Mr. Kohn, in asking you to 
respond to this, let me pick up on something that John Dugan 
said that I will just take a little issue with. John mentioned 
about how this was all operating under Basel I. Well, that is 
true in this country. It was not true in Europe. Europe was 
operating under Basel II. And the quote I had from that British 
bank here was under Basel II regulations.
    Again, I am a supporter of Basel--this thing moving 
forward, but it seems to me here that looking at what has 
occurred here under a regime that we are talking about adopting 
here raises some questions. And why shouldn't I be concerned 
about Basel II, having watched what happened in Europe and why 
that couldn't be here, and why it would be worse if, in fact, 
Basel II had been in place over the last several years?
    Mr. Kohn. Mr. Chairman, I think they are implementing Basel 
II this year in Europe, not last year, so----
    Chairman Dodd. Wasn't this effective--wasn't that British 
bank under those rules? Am I wrong about that?
    Mr. Dugan. It had the parallel running year, but the 
final----
    Chairman Dodd. The parallel year----
    Ms. Bair. They had approved the reductions that were 
referenced, and they were promising a dividend based on the 
reduction--the anticipated reduction risk-rated assets, which 
had been approved.
    Mr. Kohn. And I think to pick up on a point that John Dugan 
made, some of the issues in Europe and to some lesser extent in 
the United States involved capital arbitrage, moving things off 
of balance sheets because it was less capital-intensive to do 
that. And one of the things that Basel II does is it tries to 
even that out. It tries to reduce the capital incentive to move 
something off your balance sheet. And I think moving it off the 
balance sheet clearly gave banks a sense that they did not need 
to manage that risk as intensely as they would have if it was 
directly on their balance sheet, and a lot of that stuff ended 
up coming back onto their balance sheet.
    So I think from some very important perspectives, Basel II 
actually addresses some of the issues that have come to light 
in the most recent turmoil. That is not to say it is perfect. 
It is a huge step in the right direction, and I appreciate, Mr. 
Chairman, your support for this basic structure because I think 
it is an important step forward to make the capital 
requirements more risk sensitive so there is less of this 
arbitrage opportunities for banks.
    John pointed out one in the securitization area. It is 
heavy reliance on the credit rating agencies. I think we need 
to take a look at that and how close that reliance is. But 
there are a lot of safeguards here. There is the Pillar 2 
safeguard. The banks cannot implement these models before the 
supervisors have looked at them and given their OK that these 
are good models.
    There is the phase-ins that Sheila and John talked about. 
There will be a year of parallel running. Then there will be a 
3-year phase-in, and changes can be made at any time. And John 
Reich is absolutely right. The regulators are committed to make 
this work for a safe and sound U.S. banking system. We will 
have a period of years to watch how the implementation is 
occurring and to make adjustments if necessary.
    So I think it is important to move forward, recognizing the 
issues and keep a careful eye on how it is working out. But I 
think at the end, we will have a better capital system in 4 
years than we had last year.
    Chairman Dodd. And I hesitate to ask anyone at the Fed a 
simple yes or no question, knowing your resistance to those 
kind of answers. [Laughter.]
    But would we have been better off or worse off had Basel II 
been in place under the recent crisis?
    Mr. Kohn. The honest answer is I do not know. I think in 
many respects--in some respects we would have been better off, 
and I do not think we would have been worse off if the whole 
implementation process had been moved back 2 or 3 years, so we 
had the same safeguards in place, and if we started 
implementing in 2004 with the same safeguards that are in place 
in 2008 and 2009, I do think on balance we would have been 
better off.
    Chairman Dodd. Do you have any comments on this, Tom? I 
have taken a lot of time on this question.
    Mr. Gronstal. Thank you. I think the answer to your second 
question is that we probably would have had lower dollar 
amounts of capital per asset, and that makes it more 
challenging to deal with issues when times get rough. Being a 
banker in the 1980s out on the prairie in Iowa, there is no 
substitute for capital when things get rough.
    So I think we would agree that we do not want to see 
capital standards reduced, and we want to make sure that as 
Basel II is implemented that it provides an opportunity for 
regulators to make sure that we can require institutions to 
have adequate capital at all times.
    Chairman Dodd. Well, thank you very much. I took a long 
time--I apologize--going through that. I took a lot more than 8 
or 10 minutes. I should have realized with this many witnesses 
that was naive of me to assume I could do that.
    Richard, do you want to jump in here?
    Senator Shelby. I will, briefly. I know I have not--I have 
been gone. Thank you, and I welcome all of you. I will get 
right to a question.
    Comptroller Dugan, are you confident that banks have not 
outsourced their due diligence and risk analysis to credit 
rating agencies? And is that a problem? It seems to be a 
concern to a lot of people?
    Mr. Dugan. Senator, it did not take long for you to get 
right to the heart of the matter, as always. I do think there 
is an issue with credit rating agencies. I have spoken on this 
recently. I would not go so far as to say that banks have 
outsourced it lock, stock, and barrel. But I think that in the 
recent round we have seen the very high credit ratings for a 
certain class of securities, these collateralized debt 
obligations, based on subprime asset-backed securities which 
were not only rated AAA but were considered senior to AAA 
securities. I think there was an undue reliance generally on 
that rating, and even with some of the most sophisticated 
banks, as they packaged these, there was an undue reliance on 
the credit ratings. That should not happen, particularly with 
larger institutions that have the wherewithal and are in the 
business of making credit assessments. I think this is one of 
the fundamental lessons that has come out of this that we will 
be going back to our banks quite forcefully on.
    Senator Shelby. You are going to have to, aren't you?
    Mr. Dugan. Yes.
    Senator Shelby. Chairman Bair, it is my understanding that 
you currently have 76 institutions on the FDIC's problem list. 
In addition, there appear to be strong indications that further 
deterioration is occurring outside of mortgage lending, 
specifically in the construction lending, tied to new 
homebuilding and home equity lending.
    In your written testimony, you suggest several differences 
between this down cycle in the housing market and the period in 
the early 1990s. I believe you suggested the biggest 
differences between then and now is capital, which Senator 
Dodd, Chairman Dodd, was asking earlier. Even though banks are 
better capitalized, do you expect to see a gradual increase in 
the number of troubled financial institutions?
    Ms. Bair. Well, it is hard to predict the future, but 
certainly credit losses are going to continue to tick up, and 
so my guess is that we would see some increase in the troubled 
bank list. But I think we will still be easily within 
historical norms. I do not think it will be anything we cannot 
handle. Historically, banks fail. They used to fail a lot more 
than the numbers now.
    Senator Shelby. And this cycle will be no different, will 
it?
    Ms. Bair. No, it will not be. We went 2\1/2\ years without 
a bank failure. That was aberrational, frankly. It is common 
for a small number of banks to fail each year. The FDIC has a 
very good record. No insured depositors ever lost a penny of 
insured deposits. We almost always find another institution to 
acquire the insured deposits, so there is virtually no 
interruption in access to the money.
    So people should not worry. This is easily within 
historical norms.
    Senator Shelby. I know you cannot put a number on it, but 
would it be out of the question to say that it is possible 100 
banks would fail? You do not want to do that?
    Ms. Bair. I would think that would be surprising. We have 
76----
    Senator Shelby. There are 76 on the----
    Ms. Bair. Most of those will not fail. The historical 
average is----
    Senator Shelby. You will work around it.
    Ms. Bair [continuing]. 13 percent of those on the troubled 
bank list actually fail, which is a very small percentage. So 
it would be very, very surprising if we saw numbers at that 
level.
    Senator Shelby. How do you feel about the adequacy of the 
FDIC fund, and what size is it currently?
    Ms. Bair. We are at $52.4 billion. Our reserve ratio is 
1.22 percent. We have got an assessment of 5 to 7 basis points 
on insured deposits which will bring us to our target ratio of 
1.25 next year.
    So I am feeling we have a strong fund. It is a highly 
liquid fund. We have strong staff resources. We have strong 
contingency plans to be prepared for any eventuality. So I 
think that we have very good resources and are very in strong 
shape, and people really should not worry.
    Senator Shelby. Governor Kohn, do you believe that our 
money center banks, some of our largest banks that the Fed 
supervises through the bank holding company, will have to have 
a lot more capital than some have been getting additional 
capital?
    Mr. Kohn. Senator, I do not think that the level of capital 
that they currently have is inadequate to safeguard their 
fundamental safety and soundness. But I do think that there are 
a couple that----
    Senator Shelby. You say inadequate or adequate?
    Mr. Kohn. The level of capital that they have is adequate.
    Senator Shelby. Adequate, OK.
    Mr. Kohn. To be clear, to safeguard their fundamental 
safety and soundness. They are not threatened in that regard. I 
do think that raising capital will enable them to participate 
in the rebound, will enable them to be more active lenders as 
the economy recovers. So there are some whose activities would 
be constrained if they do not raise more capital. Their 
viability is not threatened, but they will be smaller 
institutions than if they raise capital.
    Senator Shelby. Do you have some of your larger holding 
companies on so-called watch lists? I know you watch them all. 
You have to say.
    Mr. Kohn. It is fair to say we do watch them all, and we 
are actively engaged in conversations with all of them about 
how they see their way forward.
    Senator Shelby. Are you deeply concerned about any or maybe 
concerned about a few?
    Mr. Kohn. We are talking to all of them, Senator.
    Senator Shelby. OK. Thank you, Senator Dodd.
    Chairman Dodd. Thank you very much.
    Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman, and 
thank you, ladies and gentlemen, for your stewardship and your 
dedication. I appreciate it very much.
    Let me selectively ask a common question, which--starting 
with Sheila Bair. Capital levels, liquidity, and dividend 
policy of your regulated institutions. Capital, is it adequate? 
Is there sufficient liquidity, or do you see a problem in that 
regard? And what about dividends policy in the sense that if 
there is a real push to ride out hard times, should banks be 
giving dividends at the rate they are? And then I will go to 
Mr. Dugan, then Mr. Kohn.
    Ms. Bair. Ninty-nine percent of our banks are well 
capitalized. That represents 99.7 percent of bank assets. So 
the overwhelming majority of banks, large and small, are well 
capitalized. We have about $270 billion in excess capital. That 
is an additional cushion that we can rely on. So, yes, I think 
banks are in a very, very strong capital position.
    Regarding liquidity, we are fortunate in the United States 
to have multiple funding sources. Deposits is one. The capital 
market is not as robust as it once was. But we have the Federal 
Home Loan Bank System that helps support mortgage lending 
through a variety of funding mechanisms that can be used. We 
require, as do the other primary regulators, to have 
contingency liquidity planning, and I think that works pretty 
well.
    We are in more challenging times, but I think we are taking 
the supervisory steps that we need to take, and the very strong 
capital levels I think will serve us well.
    I am sorry. What was the third----
    Senator Reed. The third one is dividend policy. Are you 
reviewing dividends, the dividends----
    Ms. Bair. Dividend policy, well, I think it is important--I 
was a little surprised at the level of dividends last year, but 
I think certainly that is one easy area to cut back on. So, 
again, if we get into a more challenging environment----
    Senator Reed. And let me inject one other factor. We are 
looking today at the climate, but the estimates that we are 
seeing--the UBS one I mentioned in my opening statement of a 
$600 billion write-down. I mean, capital is adequate today. Is 
it adequate in that sort of Category 5 hurricane effect?
    Ms. Bair. Yes. I think banks are raising additional 
capital. They will continue to do so. I think it is important 
to point out the UBS estimates relate to all financial 
institutions.
    Senator Reed. Across the world.
    Ms. Bair. A lot of these exposures are outside the insured 
depository institutions, so I think that is a much smaller 
exposure for assets actually held in the bank in terms of the 
structured finance products that they were talking about.
    Senator Reed. Mr. Dugan, same series of questions.
    Mr. Dugan. I agree with Sheila with respect to our national 
banks, which are some of the very largest banks, as well as 
some of the smallest banks, that capital is indeed adequate. We 
did have some issues that were more than earnings events that 
hit capital, but banks were able to successfully raise capital 
to more than offset those losses. There is a chart in my 
testimony that talks about that. That is a good thing because 
it means that the market is still prepared to invest in the 
basic business model of U.S. banks.
    Second, having said that, I will say you raise a very good 
question. As things change, there may be needs for more 
capital, and I think it is important that banks be ready to 
raise more, not just for today, but to prepare for additional 
things that are happening. As Governor Kohn mentioned, if banks 
want to be more forward leaning in participating in the 
rebound, they are going to have to have some extra capital.
    Senator Reed. And just that the alternative to raising 
capital--because there might be costs to doing that--is you 
shrink basically your lending activities and your----
    Mr. Dugan. Precisely. That is the part of the tradeoff that 
we worry about. I am going to take it a little out of order 
because I want to talk about dividends second because it is 
related to capital. You are right that there are a lot of 
dividends being paid out, and if you retained them, you would 
have more capital. But there is a tradeoff there. The fact is 
banks have been very good and very able to go and raise 
capital, in part because they pay dividends. And if you were to 
cut all the dividends, you would not so easily be able to raise 
capital in the markets. There is that tradeoff that goes on.
    I think several institutions, including some large ones, 
have made the judgment that it is prudent to cut dividend 
levels, not completely but some in order to husband more 
capital. We think that is perfectly appropriate and prudent 
given----
    Senator Reed. Do you engage in that dialog, Mr. Dugan?
    Mr. Dugan. Yes, we do engage in a dialog.
    Last, on liquidity, I would say the same thing as Sheila, 
that given all that happened and the tremendous stresses in 
market liquidity in particular, commercial banks fared actually 
pretty well because of their diversified funding sources and 
deposits. You mentioned the Northern Rock situation earlier. 
One of the reasons they had such problems is their whole 
business model was built on the securitization markets. I think 
banks had pretty good contingency liquidity plans. We spent a 
lot of time on that. Could they have used some more liquidity 
given the depth of this thing? Yes. Does that mean we need to 
look harder at this and update some of the liquidity things we 
are doing? Absolutely.
    Senator Reed. Let me jump to Governor Kohn now, the same 
series of questions, but you have a much more challenging 
responsibility because you have not just a bank in your 
portfolio, you have an investment desk and trading desk and the 
modern bank holding companies. So the same series of questions: 
capital, liquidity, and dividend policy.
    Mr. Kohn. OK. I agree with the comments of my colleagues. I 
think our institutions are well capitalized, but as I noted to 
Senator Shelby, I think they need to pay attention to the 
possibility of raising more capital to protect against downside 
risks and to take advantage of the opportunities that are 
there.
    I would say on dividend policy, looking at your dividend 
policy ought to be an essential component of looking at all the 
sources of capital and which sources you think will serve your 
bank holding company best over long periods of time. So I think 
dividend policies definitely should be on the table, as they 
have been for a number of institutions already.
    With regard to liquidity, liquidity was adequate, but it 
was strained from time to time. And it was not so much that the 
banks could not get liquidity, but the degree of stress on the 
banks was so great and so much greater than they anticipated 
that they started hoarding it and were unwilling to lend it in 
the market. So we saw pressures in term funding markets. Banks 
were holding onto the liquidity, unwilling to lend for a month, 
2 months, 3 months. And that was disruptive to the markets.
    So I think two points: one is the banks themselves need to 
do a better job of preparing for some of these worst-case 
outcomes in terms of stress tests and where liquidity is going 
to be so that they are better prepared for such a situation. 
But the other point is the Federal Reserve, seeing this strain 
and this stress, itself took actions to relieve it, to make the 
Federal Reserve a more open source of liquidity for banks. We 
reduced the penalty on our discount rate from a percentage 
point to 50 basis points in August, and we started a new 
auction facility where banks could borrow money from the 
Federal Reserve against a wide range of collateral. We started 
this in December, and that has been pretty successful. Banks 
have taken advantage of this, and I think it has helped to 
relieve some of the tensions in funding markets. But it 
required actions, I think, both on the part of the banks and on 
the part of the central banks to relieve the pressure on 
liquidity.
    Senator Reed. Thank you. My time has expired, Mr. Chairman. 
If you will indulge me for one other question, this goes back 
to the line of questioning that the Chairman raised about Basel 
II. Very briefly, since I am imposing on my colleagues, if 
there is not fundamental reform of the credit rating agencies, 
is it sensible to move forward to Basel II since the credit 
rating agencies--and I am simplifying this greatly--and self-
policing by the banks are the two elements, significant 
elements of Basel II? Unless we fix the credit rating agencies, 
are we inviting another problem? And I say that knowing that it 
is the SEC's responsibility, not your responsibility. Sheila.
    Ms. Bair. Well, I think we do rely far to much on external 
ratings, at least for structured finance products. And in the 
corporate debt market, there is enough transparency in the 
information about the underlying asset quality that it is OK.
    We have suggested--and we will have a question along these 
lines, I believe, when we go out for comment on the 
standardized approach as to whether use of a rating, at least 
for structured finance, should be conditioned on the 
availability of information about the underlying assets or 
whether we should affirmatively require banks to get that 
information to do their own independent analysis.
    So I think we are so heavily reliant on ratings that to 
just stop I think would be very difficult. But we have been 
thinking in terms of requiring additional transparency and 
analysis before you could use the rating, which I think would 
help provide some greater discipline on the rating process.
    Senator Reed. Anyone else? John.
    Mr. Dugan. I believe the rating agencies are doing some 
fundamental things to look at how they rate structured credit, 
particularly asset-based securities structured credit, and 
there are things that we can do as regulators, regardless of 
how they rate those things, to regulate how our institutions 
treat those rated securities as a matter of capital and so 
forth.
    I think it should not stop us from moving forward with 
Basel II, but there do need to be some changes made.
    Senator Reed. And Mr. Kohn.
    Mr. Kohn. I think the credit rating agencies do need to be 
more transparent about how they rate and the underlying assets 
that they are rating so that people who are using their ratings 
can look through the ratings to the underlying assets. And they 
are moving in that direction, but I think there is a lot of 
progress that needs to be made. And I think this issue of the 
structured finance is very important. A corporate bond with a 
AAA rating will behave very differently in the market than a 
piece of structured finance with a AAA rating. And people need 
to understand that. They cannot rely just on the AAA rating. 
And I think the credit rating agencies need to consider very 
carefully and probably move toward supplementing one rating 
that just is the probability of default, which is the AAA, with 
another rating, which says something about how the structured 
finance might behave under various market conditions, because 
it is a very different instrument than the ordinary corporate 
bond, and people need to understand that.
    Senator Reed. Thank you.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Jack, very much. There are some 
related issues, by the way, on the credit rating agencies. I 
appreciate Jack bringing it up again on this, the parallelism 
in terms of how various instruments are rated. There have been 
some articles written about that that are worthy, and I am 
going to take advantage, again, just to the issue that Jack has 
raised and your responses to it. But I said at the outset here 
about reconvening this group in 30 or 60 days. I know you are 
all studying these things, but what can the private 
institutions do? What do you need to do as regulators? And 
what, if anything, do we need to do up here to provide 
additional authority for regulators to implement regulations in 
these areas?
    So I am very interested in getting down to the nitty-gritty 
here. What specific steps need to be taken? I think we can 
study this stuff endlessly, but my sense of urgency about this 
I think is very strong, and so I would like to get back fairly 
quickly with you on some very specific ideas on how we move 
forward.
    With that, Senator Bennett.
    Senator Bennett. Thank you very much, Mr. Chairman. This 
has been a very interesting hearing, and I keep groping through 
my notes to try to come up with a worthwhile question that is 
responsive to your response, so if I might wander through some 
of my notes and then get your comments.
    Mr. Dugan, you talked about the models that were used. 
Models are stupid. They do not do nuance. And the question is: 
At what level should the judgment come in, human judgment that 
says, well, the model may say this--your point was well taken 
that all of the data fed into the model was optimistic because 
we had had a good time, so the model will naturally project 
optimistic results. Now we are going to feed a bunch of bad 
data into the model, and the model is going to tell us the 
future is going to be terrible. And at some point, we need to 
inject some judgment in this. And I do not know whether that is 
at your level or whether it is something that the banks should 
do and you folks just look at.
    My fundamental question as a policymaker dealing with this 
is: Where are we going? Are we going to work our way through 
this in the next 6 to 9 to 12 months? This was a bubble that 
burst. When the inventory overhang gets sold off, is it going 
to go away?
    Mr. Gronstal, you send chills down my back when you say ag 
land is on the edge of having the same kind of bubble, because 
there has been tremendous bidding up of the value of 
agricultural land. And are we focusing so much on, gee, the 
banking system that we are not seeing that there is a potential 
out there--and this, again, comes back to the question of 
judgment of what are we doing.
    A comment was made, I think by Governor Kohn, about it all 
froze up. Everybody was so anxious about getting capital into 
their institutions that they were unwilling to lend. And people 
who had absolutely nothing to do with subprime or housing 
suddenly could not get credit. And I certainly heard about 
that, and I am sure a number of Members of the Committee did.
    So as I try to find out where we are going here, what is 
going to happen in the future, in addition to all of the things 
we have talked about--we need to fix the rating agencies, we 
need to change this, that, and the other--what do you see in 
terms of the economy? The Chairman quoted President Kennedy 
about if the economy is not right, there isn't anything that is 
right. How invasive is this crisis in terms of other areas 
just--other areas besides the question of the safety and 
soundness of banks? This is a judgment call, but you are all 
very knowledgeable, more knowledgeable perhaps than we. And I 
am sure you have thought about this and just share with us your 
sense of where we are and how soon there is going to be a 
rebound and how vulnerable are we to other problems and how 
badly is the economy hurt by all of this. Respond, if you will.
    Mr. Kohn. Quite a set of questions, Senator.
    I think there is no----
    Senator Bennett. They have all been spawned by listening to 
you.
    Mr. Kohn. Right. There is no question that the turmoil in 
the markets has had effects beyond the mortgage market, as you 
say. Banks conserving liquidity and capital and concerned about 
the economic outlook, as you have enunciated, have become more 
cautious in their lending and not just in mortgage markets. But 
we survey the banks four times a year. Our last survey was at 
the end of January. And across the board, for every kind of 
lending, significant proportions of the banks said they were 
tightening terms and standards for making those loans.
    Now, to some extent, this is welcome because I think 
lenders and borrowers did not fully appreciate the risks out 
there. The risk was underpriced, as many of us said, for the 
last several years. The very benign economic environment of the 
mid-2000s led people to get too complacent about the risks, and 
particularly about the possibility of an adverse event like an 
unwind in the mortgage market spilling over to other markets.
    So I think to a certain extent the correction that is 
occurring in the markets is a necessary correction. But I do 
think that it is painful while we are going through it. It is 
not going to go away quickly. The economy has been hurt. That 
is why the Federal Reserve has been lowering interest rates, to 
cushion the effect on the economy of the tightening of credit 
that is going on throughout the economy as well as the decline 
in the housing market.
    So our effort has been to provide an offset to this general 
restriction of credit in order to keep the economy moving 
forward.
    Our outlook, as our Chairman testified before this 
Committee--last week, I guess--is that we will see a period of 
very slow growth, very sluggish economy. We have already had a 
fourth quarter which barely grew, according to the Bureau of 
Economic Analysis, and I think a lot of people anticipate that 
we are going to be in the neighborhood or just above zero for a 
quarter or two now. And in a sense, there is not much that we 
can do about that because policy acts with a lag.
    But I do think we have tried to position ourselves with the 
extra push from fiscal policy that you folks, the House, and 
the President put together for the second half of the year, 
that the economy is in a position to rebound later this year. I 
think that at the same time, as Chairman Bernanke pointed out, 
I think there are downside risks to this forecast, and a lot of 
it comes from the financial market dynamics that we are talking 
about today.
    If lenders become much, much more cautious because they are 
protecting themselves against very serious outcomes, not just a 
period of sluggish growth, that can have elements of a self-
fulfilling prophecy in it that will damp spending. As spending 
is damped, they become more cautious.
    We are very conscious of this, and that is part of the 
calculus in our monetary policy to try to think about whether 
we have adequate insurance against this downside risk to the 
economy.
    I think progress is being made in the financial market. It 
looks very shaky. Every day there is some more bad news. I do 
not know what has happened today--other than this set of 
testimonies, and I hope that is not bad news. But I think there 
are some signs out there that we are working through the 
problem. There is greater transparency by firms with problems 
on their books. There is capital coming into the system that 
several of my colleagues have mentioned here on the panel, so 
people are raising capital. They are being much more open about 
what the issues are. I think part of this problem is about 
uncertainty. So increased transparency by lenders, by others 
with problems on their books is going to be very helpful to 
letting people know what the downside risks are, how to price 
them in, and I do think the markets have gone to a point where 
they are anticipating some pretty adverse kinds of outcomes in 
the housing market and in the economy to a certain extent. So 
they are in the process of pricing in the downside risks.
    So my hope is that as they see the economy has stabilized, 
as they see the conditions are in place for a rebound next 
year, that confidence will return, trading return, and I think 
in the end, a year from now, we will have a safer financial 
market, one in which risk is priced better than it was a couple 
years ago, one in which there are fewer of these conduits and 
other kind of off-balance-sheet structures that have risks 
associated that people did not anticipate. So it will be a 
safer system. Banks will play probably a larger role in that 
system. Complex instruments will be less complex, more 
transparent. Credit rating agencies will do a better job. But 
it is not going to be easy getting from here to there.
    Senator Bennett. I am conscious of the time. I do not want 
to impose on----
    Mr. Dugan. I would just add a couple things because I think 
that was really an excellent answer. I think everybody is quite 
focused on this. I would say three things.
    One, as Don suggested, I think there is an awful lot of 
attention being paid to working through the particular problems 
that are being raised. And while it seems like we have an 
endless stream of them, some of them the banking system has 
made significant progress on including dealing with the SIV 
problem or the asset-backed commercial paper funding problem or 
the inter-bank funding problem. The Federal Reserve and central 
banks were quite aggressive with liquidity, and it made a real 
difference.
    There are other problems that are more in transit, and 
monoline insurance is one of those. We also have some more 
intractable problems about the residential securitization 
markets that are going to take more time and will lead to 
questions about house prices. I think there is an awful lot of 
attention being paid to what is going to happen to house 
prices.
    The last point I would make is it is true that underwriting 
standards, at least at our banks, have definitely gotten 
tighter. But they are still making loans, and credit has been 
expanding, not contracting. It has not expanded to the same 
degree. It has definitely cut back, but it has not been a 
wholesale scaling back and contraction. I just want to make 
sure we underline that point.
    Senator Bennett. Thank you.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much. Very good question 
here.
    Senator Casey.
    Senator Casey. Mr. Chairman, thank you very much, and I 
want to thank the witnesses who are here for your testimony and 
for your service.
    I wanted to direct your attention, first of all, to the 
subprime crisis, and I know we have talked about this in great 
detail. But I wanted to, first of all, ask Chairwoman Bair 
about parts of her testimony. In particular, I am looking at 
pages 16 through 18 where you address subprime borrowing, and I 
am just going to highlight part of your testimony and ask you 
to respond.
    When you talk on page 17 about strategies here to deal with 
this problem, you talk about servicers should do the following: 
No. 1, identify loans facing likely default; No. 2, develop 
broad templates for restructuring these loans into long-term 
sustainable loans with fixed rates for at least 5 years; three, 
proactively initiate that process. And then you go on from 
there, and you talk later about the concerns that servicers 
have about potentially legal liability, and you also mention 
pursuing other strategies.
    Give me your assessment as to where we are--when I say 
``we,'' I mean the Congress, the administration, the various 
strategies across the country, the Hope Now Alliance, the whole 
effort nationally. Where do you think we are? What are we not 
doing, and what do we have to do to make progress to dig people 
out of this hole that they are in?
    Ms. Bair. Well, I think voluntary loan modifications are 
helping--they are ticking up. I am encouraged by the numbers 
that came out yesterday. I think we need more granular 
reporting to be able to fully assess how much they are helping.
    We also need to focus beyond the reset problem. There is 
still a reset problem, notwithstanding lower interest rates. 
But we had very weak originations in 2006 and the first part of 
2007, so a lot of those loans started going delinquent before 
the resets. And, of course, with declining home prices, a lot 
of people are underwater now, and so they are dealing with 
unaffordable mortgages and they are owing a lot more than their 
property is worth.
    So you get into a situation where we were initially worried 
about forced foreclosures of people who have subprime hybrid 
ARMs. Now we need to worry about people just giving up and 
walking away.
    So I think we need multiple strategies, and they need to be 
systematic because of the volume of the problem. And we do 
believe that that is consistent with the servicers' 
responsibilities. Most of these loans obviously have been 
securitized, and are owned by securitization trusts. But we 
believe systematic approaches are allowed by the pooling and 
servicing agreements that govern the servicers' obligation, and 
in point of fact are required to the extent that a loan-by-loan 
process is not feasible and is just going to lead to more 
foreclosures, which will end up costing the pool more. But it 
needs to be systematic, and servicers need to staff up. I think 
some of them are, but they need to provide standard benchmarks 
whether a debt-to-income analysis or standard loan-to-value 
ratios, whatever they are going to use, to make that clear to 
the staff that are dealing with the borrowers who are coming 
and looking for modifications. And borrowers in turn need to 
proactively interact with servicers.
    Whether it will be enough, as the housing market goes down, 
I do not know. I think the jury is still out. We internally are 
thinking about other potential options that might be pursued. 
When I testified at this Committee in late January, I talked 
about the need to write down principal amounts of many of these 
loans to make them affordable and Congress made that a much 
more feasible option by passing the Debt Forgiveness Act in 
December so that a principal write-down would no longer lead to 
a tax liability on the part of the borrower.
    That is going to be increasingly a tool that servicers 
should use. I believe there are ways to structure those 
principal write-downs so that there can be some type of shared 
equity agreement with the borrowers so that if the property 
starts going back up, there would be a way for the investment 
pool to share in some of that subsequent appreciation.
    So I think we need to be looking at market-based solutions 
at this point, and keeping the pressure on for servicers to use 
systematic approaches, not loan-by-loan approaches, to deal 
with this, using the full panoply of tools available. Whether 
it will be enough, I do not know. I think we need a month or 
two more of data. I think, back to Senator Bennett's question, 
a lot of this is being driven by the housing market. How much 
home prices continue going down and how fast they go down I 
think will be a key indicator of whether we need to start being 
more proactive in terms of government intervention, but I do 
not think we are there yet.
    Senator Casey. Thank you, and I wanted to also ask a 
similar question to the Comptroller. I was happy that in your 
testimony, when you addressed the subprime mortgage crisis, 
what borrowers are facing, and the interplay between lenders 
and borrowers and servicers and borrowers, that you mentioned 
and highlighted counseling. I think the Congress moved with 
record speed in getting the $180 million approved, and that was 
done before the end of the year.
    The recent legislation which the Democratic side of the 
aisle was pushing very hard last week and will continue to push 
added another $200 million to that. I am happy that you talk 
about that, and I am happy that the Treasury has highlighted 
it. I would urge you, using your skills as an advocate, to urge 
other Members of the U.S. Senate to make this counseling 
priority much more urgent and much more important. But I wanted 
to give you the opportunity to weigh in on this question 
about--not just about counseling, of course, but just overall 
how we are approaching this crisis.
    Mr. Dugan. Well, I agree with much of what Chairman Bair 
said. I think we do have a situation where 97 or 98 percent of 
Americans who hold mortgages are still paying their mortgages 
on time. We still have a situation where we have relatively low 
levels of unemployment in the country. We do have more 
aggressive actions being taken by servicers, but we do not know 
how effective that is yet because we have not had enough time 
to look at it and the metrics have not been good enough yet. We 
do not know yet how deep the house price decline is going to 
be, so I think the jury is still out somewhat.
    As I mentioned in my testimony, we are requiring our 
largest banks, who service about 40 percent of the entire 
mortgage market, to do a much more detailed set of reporting of 
mortgage metrics on an apples-to-apples basis as a way to 
measure what kind of improvement is happening. That is not just 
with respect to subprime adjustable rate mortgages, but to all 
mortgages.
    The other factor is, because interest rates have come down, 
the reset problem, which has not gone away, has definitely 
improved, and that is a good thing.
    It is a mixed bag, and I think we are paying very close 
attention and monitoring our servicers. We will continue to do 
that. I know Congress will do the same, so I think the jury is 
still out.
    Senator Casey. Thank you very much.
    Chairman Dodd. Thank you very much, Senator. I am going to 
in the next go-round--those are very good questions Senator 
Casey has raised here, and I would note that this morning, 
apparently in a speech that the Chairman of the Federal Reserve 
has given to the community bankers this morning suggesting 
maybe something along the lines we have talked about earlier 
that the American Enterprise Institute and others have 
advocated, that I have been talking about, and that is this 
homeownership preservation idea, using existing platforms with 
very distressed mortgages.
    It is a complicated issue. The devil is in the details in 
those ideas. It sounds wonderful in the first couple of 
sentences, and then you start talking about how you actually do 
this, and it gets a little more complicated. But, nonetheless, 
I appreciate the Chairman's at least acknowledging--and I am 
going to come back at my round here and ask all of you maybe to 
comment on that concept and idea and whether or not we should 
not at least be thinking about rather than waiting for 
something to happen. But I will raise that.
    Senator Corker.
    Senator Corker. Mr. Chairman, I thank you, and being so 
low-ranking, I have the opportunity to hear a lot of great 
questions, and certainly some wonderful testimony by these 
panelists. I do think that this hearing has come at an 
excellent time. I really do. And I thank you for having it.
    I think that what we have seen is that the banking industry 
in general is very strong, and I think that is good for us to 
know. I think that we are all out seeing and hearing about a 
lot of problems. But the fact is that due to the great work of 
our panelists and just responsible bankers across our country, 
and lenders, we are actually in a really strong place. And I 
think that is a message that we all need to soak in and know as 
we think about what we might do in the future as it relates to 
housing and other issues.
    You know, the cheap and easy credit--and I do not mean to 
demean it, but, you know, today 10-year treasuries are at 354 
and, you know, real estate valuations are simply a measure of 
what interest rates are. I mean, when interest rates are low, 
commercial values increase tremendously. It is hard for me to 
believe that commercial real estate has been selling at 5 
percent caps, 6 percent caps, just ridiculously high prices. 
And there is no question there are going to be write-downs. 
People have made a lot of money over the last several years, 
and the chickens are going to come home to roost here in the 
near future. I think we all understand that.
    The same thing I think we have all seen happen with housing 
is that people buy housing based on what the mortgage payments 
are. Let's face it. And when rates are low, they will pay more 
for housing, and we have gone through an incredible time of 
rising home prices. As a matter of fact, a few years ago we 
were all concerned and reading daily in Wall Street about the 
overheated housing market. And even though the Chairman, doing 
a great job, pointed out that housing prices had dropped 10 
percent, we are still just back to some levels in 2006 that 
were at that time incredibly high. So I think your testimony 
today is very good to take into--is very good to help us with 
the perspective of where we are, and it is amazing that the 
banking system is so strong.
    I think it is also interesting to note that the folks who 
are involved in CDOs, as you have mentioned, they have already 
taken their hits. And in many cases, they took too aggressive 
of hits, and it is those folks that did lending the old-
fashioned way--they actually kept it on their balance sheet--
those are the ones you are going to be dealing with here in the 
near future. They have not yet taken their write-downs. They 
will be taking--those that actually loaned money the old-
fashioned way, the way we all used to borrow it.
    So I guess I have really two questions. One of the things 
that I see in these cycles is we get exuberant real estate, the 
best thing there is in the world, and everybody invests in it 
and everybody loans money toward it. And then when problems 
occur, some of the organizations that you actually represent--
and I think the Governor used the word I was going to use--
actually create a self-fulfilling prophecy. What happens is you 
begin to clamp down, bankers are afraid to make loans, 
especially with no offense to you, OCC in particular goes in 
and all of a sudden commercial lenders are not in the 
marketplace the way they were. They no longer are looking--you 
all fill out these forms that they have to fill out. Their 
credit is rated.
    I would like for each of you to respond to that, because I 
am concerned that you, in fact, could end up being the greatest 
problem that we have by helping create a self-fulfilling 
prophecy by causing these banks to tighten down more so than 
necessary.
    Mr. Dugan. Senator, that is certainly not our intent. As 
Chairman Dodd referred earlier, I sat behind this dais--not on 
the dais but behind it--and sat through all the hearings of a 
lot of bank failures in the 1980s and early 1990s from problems 
with commercial real estate.
    I also was in Government at that time when people were 
complaining about regulators acting too stringently, including 
the OCC. One of the issues that people have pointed to was 
that, in fact, the regulators--partly because they were 
overwhelmed--waited too long to move in on some of these 
problems until they got too big. When they had to act, they had 
to act strongly. And it was criticized as being too tight.
    We have tried to get out ahead of that. When we get into an 
economy and part of the credit cycle, we begin to experience 
losses, bankers cannot turn a blind eye to that. They are going 
to experience losses, and they have to be realistic about the 
problems of their assets on their books. But we want them to be 
realistic. We do not want to make those write-downs. We want 
them to make realistic judgments, and to have realistic 
appraisals about what is going on in the commercial real estate 
market. We want to work with them. We want to work through 
these issues when they are smaller so that we can work through 
them instead of waiting until they get too large, and then the 
actions we take have a more dramatic effect.
    That is an art, not a science. We have been quite forward 
leaning and proactive in trying to get bankers to understand 
that and to take good, strong measures about how they manage 
the risk in these times.
    The one thing that is different this time around--and it is 
a significant difference--is that community bankers in 
particular have much bigger concentrations of their entire 
balance sheet in commercial real estate assets, and that can 
make it more difficult. It does not take as big a problem to 
cause as big a problem. But we are very mindful of this 
balance, and, again, our consistent message is bankers need to 
be realistic about the actual value of the assets in their 
portfolio and take realistic write-downs and provisions as they 
occur. We do not want to overdo it, but there has to be a 
measure of realism, or else the problem will get worse.
    Senator Corker. And I think it is not so much the write-
downs as much as the future lending practices as a result of 
people having fears. And I would just say to you we are getting 
calls from board members, you know, who are concerned because 
the OCC is coming in and causing things to have to fit into a 
different and smaller box than in the past. And I would just 
urge you--it sounds like to me you are very sensitive to the 
issue, but I would just urge you not to exacerbate the problem 
by causing--and you have got a lot of folks who work with you 
throughout the country. Some are more exuberant than others, if 
you will. But I think that in itself could be a big factor as 
to whether we move through this period of slowed growth in 
better ways or not better ways.
    Mr. Dugan. Senator, we work very hard to have a measured, 
even way that we do things with our examiners. I do not think 
there is any issue in our community and mid-sized line of 
business that we spend more time on than having a consistent 
message about this.
    To the extent that there are problems that you hear about 
that you want to pass along to us, please do that, because, as 
problems occur, we want to hear about them. There is also a 
question of when there are problems, people are going to 
complain at times, and we understand that, too. We have to do 
our job.
    Senator Corker. And, again, my comments are really focused 
more on the past and the fact that I do think the OCC has in 
the past exacerbated problems instead of helping them. And it 
sounds like you are very sensitive, and I appreciate that.
    I wonder if--I guess I am out of time. I will wait until 
the----
    Chairman Dodd. No, no. You have got a couple more seconds.
    Senator Corker. Let me just on the transparency issue, the 
issue of transparency, these complex financial instruments--
which were great as long as nobody had to actually own them. 
You could make fees selling them to each other, and everybody 
was having a great time until somebody had to actually value 
those.
    I was up at the stock exchange--I have mentioned this once 
before--a couple weeks ago and noticed they are setting up a 
mechanism where you can actually in real time instantly value 
the debt instruments you have on your books. And I am just 
wondering if--you know, to have the same kind of transparency 
and valuation that we have in equity markets. I am wondering if 
any of you have comments about that or other things that might 
occur to keep these complex vehicles in the future from being--
the values made up, if you will, and fees really being 
generated to banks simply by trading them with each other, 
slicing and dicing and selling them back and forth to each 
other.
    Mr. Dugan. I will start. Valuation, of course, is a 
critical issue that we have seen. Part of the problem has been 
when all trading stops in an asset that is itself very 
complicated because it is based on a whole waterfall of 
different cash-flows from many different underlying mortgage-
backed securities, it is very difficult to get that instant 
value when you do not have market prices to look at. And part 
of the problem that we have seen is not that people relied on 
very complex models that were problematic. Quite the opposite, 
it is that they did not have very good, robust models that were 
complex enough and sophisticated enough to really accurately 
measure what these things were worth when there was not a 
market price for them. That is one of the things that we are 
spending a great deal of time looking at. The whole issue of 
valuation and transparency and how we deal with them has played 
a critical role in the disruptions.
    Senator Corker. Thank you.
    Mr. Kohn. I agree, Senator, and I think that to some extent 
the market is in the process of taking care of this. The 
participants in the market understand that part of the problem 
here was the complexity and opacity of the instruments. As I 
said before, it made it very difficult to look through the 
credit rating agencies' analysis to the underlying instrument.
    So I think going forward, at least for a while, we will 
have instruments that are easier to value and to market. But I 
think it is very important that, as regulators, we not impede 
and, if anything, encourage that movement by the credit rating 
agencies, by the banks, that they be able to have an 
independent assessment of what the value of the assets are and 
not rely on the credit rating agencies, for example. So I think 
that is an important part of what we need to do here.
    The valuation question is very hard, as the Comptroller 
said, when there is not a market or not even a closely related 
market. I think it is important, to go back to a previous 
comment he made, that these things be valued realistically and 
that people looking at the banks, the investment banks, have 
confidence that they are valuing them realistically and are not 
inflating those values. And it is really up to the banks, the 
investment banks, to be transparent enough about their 
valuation methodologies to convince people that is it, and that 
will begin to restore confidence in the markets.
    Ms. Bair. I would just add that I think some public pricing 
mechanism would have been very valuable. I think it is very 
difficult to mark-to-market when there is no market. And I 
think we should all give further thought to whether regulated 
exchange type mechanisms could lend themselves to some of these 
instruments that now are privately traded. But I do not think 
any public market would function given the lack of information 
about these instruments. The core of the problem is lack of 
transparency, getting information out of that underlying asset 
quality so investors can make an intelligent pricing decision, 
and then some type of public trading mechanism might work.
    Senator Corker. Thank you, Mr. Chairman.
    Chairman Dodd. Senator, thank you very, very much, and as 
the panel can see, your job now is to find that pathway between 
Senator Corker and Senator Dodd in how you respond to all these 
questions here. But I appreciate Bob's contribution to the 
Committee, very knowledgeable and a very great asset to the 
Committee.
    Senator Schumer.
    Senator Schumer. Thank you, and thank all of you for being 
here and for the difficult job you have to do.
    I have 3 different areas I would like to question. I would 
like to go back a little to the credit rating agencies. Senator 
Reed did a few questions on that.
    But I still scratch my head about how these credit rating 
agencies operated because many of us knew there were problems 
in the mortgage market and what was happening, particularly 
with subprimes. I mean, we knew them on an anecdotal basis. And 
the credit rating agencies just seemed to sort of rubber stamp 
them. And I guess their model was housing prices will increase, 
it does not--how could credit rating agencies just 
automatically give AAAs to no doc--you know, to a whole bunch 
of securities that contain no doc loans? You do not know if the 
person has the ability to pay. You do not know any of these 
things.
    And so, I would like to come back to this area of credit 
rating agencies. They just seem, to me, to have--from an 
outsider--to have just sort of gone through things in a 
mechanistic type way. And part of the reason, I think, or at 
least worth exploring, is conflicts of interest. I mean, you 
pay the credit rating agency--the issuer pays, and pays after 
they get the rating. Well, what does that say?
    And so my question to you is does this model of credit 
rating agencies not work? Are you recommending to your 
institutions that they rely less on the credit rating agencies?
    On the one hand you have simple mortgages where they messed 
it up. And on the other hand, as you just talked about, they 
have these very complicated financial instruments that I do not 
know if they understood.
    You know, when CEOs of banks tell me they do not understand 
these complicated documents, somebody in the middle of the bank 
does. Do the credit rating agencies understand them?
    Something is really wrong. And I think ultimately, when we 
look back on this, we are going to see that the banks relied, 
the credit rating agency, boom, they give the Good Housekeeping 
Seal of Approval, and everyone just goes ahead on their merry 
way.
    Don't we need a fundamental re-examination of A) how the 
credit agencies function, maybe going back to the old model, 
where the investor paid rather than the issuer paid. And 
second, aren't you telling your banks now that they are going 
to have to do much more of their own examination rather than 
just rely on the credit rating agencies?
    Sheila Bair.
    Ms. Bair. Well, I think a lot of those issues, we do not 
regulate the rating agencies----
    Senator Schumer. I know you do not.
    Ms. Bair. I think certainly we would be----
    Senator Schumer. The institutions you----
    Ms. Bair [continuing]. The banks have been having----
    Senator Schumer [continuing]. Regulate reliably----
    Ms. Bair. Yes, and we are certainly highly supportive of 
the steps that the rating agencies have taken on their own, as 
well as steps the SEC has been taking and may plan to take in 
the future.
    As a bank regulator and as an insurer of all banks, I am 
very uncomfortable with continuing to allow banks to set 
capital based on external ratings for structured finance when 
we do not know what the underlying asset quality is. The rating 
agencies use mathematical models. They never looked at 
underlying asset quality.
    Senator Schumer. Exactly.
    Ms. Bair. For some of these, it would take weeks and 
hundreds of thousands of pages to even find the underlying 
assets because they have been sliced and diced so many times.
    So we need to get back to basics. And again, the core is 
that you need to know what the underlying assets are ultimately 
backing those securities. And if you do not have that 
information, you cannot price.
    Senator Schumer. And they did not. And they did not have 
that information.
    Ms. Bair. They relied on mathematical models. So even if 
you were over-collateralized, basically the risk was that the 
higher tranches would not be covered--it was all done with the 
math.
    Senator Schumer. Governor Kohn, do you want to comment on 
this?
    Mr. Kohn. Yes, I do. I am sorry, do you want to go ahead?
    Senator Schumer. Go ahead, Mr. Gronstal.
    Mr. Gronstal. State regulators, as we evaluate bank 
management, we hold them accountable for understanding what 
investments they make. And when they make errors, we make them 
charge it off. And I think that is pretty much the same way the 
Federal regulators do with their banks.
    And these were very complex instruments and I think----
    Senator Schumer. The mortgages were not complex.
    Mr. Gronstal. No, the mortgages were not, but the 
securities, the way they got packaged up----
    Senator Schumer. With all due respect, when people walked 
into my office and told me the mortgage they were sold, I said 
you will never be able to pay that back. Your monthly payment 
exceeds your annual income.
    Mr. Gronstal. Unfortunately, a lot of people relied on the 
loan officer to tell them how much they could afford. And the 
loan officer was compensated on the size of the loan. So there 
was kind of a perverse incentive to make the loan too big.
    Senator Schumer. Right. Governor Kohn.
    Mr. Kohn. Yes, Senator, we are telling our banks to rely 
less on the credit rating agencies and to look at the 
underlying collateral, the underlying securities, and make 
their own judgments.
    And I think, as Comptroller Dugan said, there was just too 
much of that reliance before.
    I think, I am not sure that there is an alternative to the 
issuer pays model. What I was told was that the investor pays 
model was in effect until the Xerox machine was invented, and 
then it was really impossible to control.
    Senator Schumer. And they were private. The investor paid 
was not made public. And you do want some kind of public rating 
available.
    Mr. Kohn. That is right, and those ratings are used. So I 
think there is probably, in the end, no alternative to the 
issuer pays model. But I know that the SEC and other regulators 
are looking carefully at this conflict of interest question 
that you raised. The credit rating agencies have an interest in 
doing a good job. They have their reputation on the line. But 
obviously, that was not enough.
    Senator Schumer. No, they got very sloppy, obviously.
    Mr. Kohn. They got very sloppy and they were not really 
looking--they were taking other people's word for what was in 
those packages. And they were not drilling down and doing their 
own inspection.
    Senator Schumer. Exactly. You have sort of----
    Mr. Kohn. They need to find--they need either to take total 
responsibility themselves for looking at what is happening at 
the originator level, or they need to find another way of 
putting more pressure on the people who are packaging----
    Senator Schumer. It was almost a catch-22. The agencies 
relied on the banks for it, and the banks relied on the credit 
agencies. And look where we are now.
    OK, second area I would like to--my time is limited and I 
know you have fully opined on this, Comptroller.
    And that relates, Senator Dodd asked some questions on 
Basel II. And here is the dilemma we face: these markets are 
now international. All the problems in the U.S. have affected a 
lot of western banks outside. And yet the standards, even with 
the efforts of Basel II, are not international. You have still 
efforts by countries to have an easier system of regulation so 
that money will flow in that direction because it is cheaper if 
there is less regulation, fewer capital requirements.
    And you sort of get a race to the bottom and then that 
ultimately leads to the undoing of the financial system, which 
we have seen now.
    So how do you balance the need for some stringent 
regulation--admittedly some of you have stated that Basel II 
did not do the job or will not do the job. Obviously, it is not 
to blame because it has not happened yet in America, although 
it is in Europe.
    But how do you balance, how do you get sort of one 
international standard here, which is what we need, without 
individual countries sort of playing one-upmanship with one 
another? Isn't that the fundamental problem we face here? 
Because in good times, everyone is going to want to reduce the 
standard. And then in bad times, that reduced standard affects 
everybody, whether you have reduced the standard or not.
    Go ahead, Comptroller, and then Ms. Bair.
    Mr. Dugan. I think the whole point of Basel is to have some 
international minimum standards that everybody has that you 
cannot go below. Then there are questions about how much people 
add on in different areas.
    I actually think there has been progress to raise that 
across the board. Basel II is a step in the right direction, as 
we talked about earlier, because it is more related to risk, 
but it does have some issues that we have to address.
    I think it is fundamental to keep those efforts going. 
Personally, based on many discussions that I have had with 
international supervisors, it is not a race to the bottom. I 
think there really is an effort----
    Senator Schumer. So you think the framework can work?
    Mr. Dugan. Absolutely. And I would say the biggest single 
difference between my being in Government this time than 15 
years ago is there is much more cooperation and much more 
awareness that we have to have and work toward a common set of 
minimum standards because this is a global world.
    Senator Schumer. Exactly. We are one international economy. 
No one can build a wall. Ms. Bair.
    Ms. Bair. Well, I am concerned that the models serve an 
approach under the Basel II framework that actually is going to 
feed into more of this race to the bottom competition because 
it is much more subjective.
    First, under Pillar 1, you rely on each individual bank's 
own internal models to set capital. Those are validated by the 
individual supervisors of that country. We have been told that 
if the models are too low we can correct them under Pillar 2. 
Again, that gets back to supervisory discretion. So not only is 
it jurisdiction by jurisdiction, it is bank by bank.
    We have called for some international agreement on hard and 
fast supplemental capital standards, dare I say it--an 
international leverage ratio--or something like that. But 
something hard and fast that will set a minimum for all banks.
    The Financial Times ran an editorial a few weeks ago 
showing that a lot of major European banks are critically 
undercapitalized by our own PCA standards. This is something 
that everybody should be----
    Senator Schumer. Despite Basel II.
    Ms. Bair. Yes.
    Senator Schumer. Exactly, because they were seeking an 
advantage, I guess, each individual country or regulator.
    Ms. Bair. There is a tendency, which is why Chairman Dodd 
mentioned the inherent conflict of using internal models to set 
capital. Because sure, if you lower your capital, you are going 
to increase your return on equity. Absolutely.
    Chairman Dodd. I said it was like modeling weather reports. 
If you only use sunny days, you are going to set sunny day 
modeling. You have got to stress those models.
    Senator Schumer. But during the sunny days, the sunny day 
user has an advantage over the cloudy day people.
    Mr. Reich. Senator Schumer, I would like to add that as a 
member of the Basel Committee I have sensed, in the last year 
particularly, with the losses that some major foreign banks 
have taken in the past year, that there is much greater 
acceptance of the members of the Committee from our foreign 
regulatory counterparts to accept more stringent controls and 
additions to Basel II.
    Senator Schumer. I will just conclude here--my time is 
expired. But if there were ever a time to get everybody to sort 
of agree to have that minimum standard without, as Ms. Bair 
points out, the ability to go below it and get around it, now 
is the time because we have seen the--I agree with Ms. Bair 
here. There is something of a race to the bottom despite Basel 
II.
    And if we can now sort of tighten that up, now is the ideal 
time to do it because people have suffered from the lax 
standards I see.
    I am just going to have the record note that Governor Kohn 
was nodding his head in agreement.
    Mr. Kohn. Up and down.
    Senator Schumer. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much. Senator Carper.
    Senator Carper. Thanks, Mr. Chairman. And our thanks to all 
of you for being here today.
    I wonder if you are going to be testifying on Thursday. We 
have a hearing on GSE-regulatory reform? No? OK.
    I said earlier, when we were giving our opening statements, 
that our leadership brought forward a package that is designed 
to help with housing recovery. We had an opportunity to vote 
whether or not to proceed to that legislation last week. We 
could not get to 60 votes to proceed.
    And in the days that have followed, we have seen an effort 
on the part of our leadership in this Committee and others to 
try to find out how we can construct a package that has buy-in 
not just from Democrats but Republicans, as well. And also from 
the Administration.
    I just want to run through quickly maybe the 6 major 
elements of the proposals cobbled together by the Democratic 
leadership and just ask you to just tell me whether or not you 
think it is a good idea.
    And then I am going to do the same thing with some other 
ideas, some from our Republican friends, and just ask you to 
see whether or not you think--without getting into a lot of 
detail--whether or not that might be a good idea, as well.
    One of the proposals is to increase pre-foreclosure 
counseling funds by about $200 million nationwide. If you think 
that is a good idea or you do not, just tell me. Just start, 
Ms. Bair.
    Ms. Bair. Well, I think counseling is a very good idea. I 
know NeighborWorks has gotten a significant infusion already. 
So my only caveat would be how much they can use, how quickly, 
and how effectively. But certainly, the modification process is 
a highly complex one and we need intensive counseling and help.
    So I think to the extent you are increasing borrower 
leverage to be able to negotiate a loan modification, that the 
counseling process is helpful.
    We do not have a position on the dollar amount, though.
    Senator Carper. OK. Is there anybody at the table that has 
a different opinion than that that Ms. Bair has expressed?
    Mr. Reich. I do not have a different opinion, but I am on 
the board of NeighborWorks and I know that they have been 
working very hard in recent weeks to allocate the $180 million 
that was appropriated to a variety of counseling agencies 
around the country.
    It is a challenge to make certain that those funds go to 
the appropriate organizations who have the capacity to counsel 
many people. So the addition of another $200 million on top of 
the $180 million in a short period of time might be a bit 
problematic.
    Senator Carper. OK, thank you for that thought.
    The second ingredient is to allow housing finance agencies 
to issue bonds for refinancing. They can already issue bonds 
that are used for first-time home buyer programs, to use to 
develop multi-family rental housing.
    But this is a little different. First, I think this is one 
actually the Administration favors, too, in testimony before us 
by Secretary Paulson a couple of weeks ago. Your thoughts on 
whether or not that is a meritorious idea?
    Ms. Bair. Well, yes. This is not my area of expertise, tax 
policy, but I know I have certainly read the Administration's 
statement on this and know of the bipartisan support. So yes, 
intuitively it seems like a good idea.
    Senator Carper. OK. Does anybody have a different view?
    Mr. Dugan. Senator, I just have not looked at these 
particular policies and I must say I am quite uncomfortable 
passing judgment on how much----
    Senator Carper. I understand and you were fair to say that. 
You are fair to say that.
    My other proposal is to provide an additional $4 billion in 
CDBG funds to purchase foreclosed homes. We have actually 
allocated in our budget for this year, I want to say about $3.6 
billion. So this would actually be more than we have already 
allocated for the current fiscal year.
    Does anybody think that is a particularly good or bad idea? 
Anybody at all? Mr. Kohn? Do people call me Governor?
    Mr. Kohn. Fine.
    Senator Carper. They call me that, too. Do you like it?
    Mr. Kohn. Like John, we----
    Senator Carper. I still like it.
    Mr. Kohn. We have not looked at these issues so it is hard 
to have an opinion without----
    Senator Carper. All right. Fair enough. I understand.
    There is an issue on bankruptcy. Initially the proposal on 
bankruptcy or cram down was pretty broad and it was 
prospective, not retroactive. I did not just focus on subprime 
mortgages, but it was very broad.
    It has been modified so that the proposal would apply only 
to current subprime mortgages. The judge could reduce the 
interest rate to prime plus a reasonable premium for risk. The 
judge could extend the life of the mortgage, I am told, by some 
30 years.
    Does any of that make sense to you as part of what we are 
trying to get at here? We have had some concerns raised that if 
we provide for this kind of opportunity in bankruptcy that we 
run the risk of raising the cost of mortgages, that the 
interest rate might go up for primary residences. That is the 
caution that we have heard.
    Any thoughts?
    Mr. Reich. I would share that caution, and as well be 
concerned about the potential impact on investors returning to 
the market.
    Senator Carper. Senator Martinez and Senator----
    Chairman Dodd. Just to point out, if I can--and I 
appreciate John Reich talking about that--there is a history to 
that provision that goes back to the 1970s, where that was the 
negotiation that went on with the lending institutions, to 
provide money to otherwise risky borrowers in exchange for that 
was to provide some protection under the bankruptcy act.
    So the history--I am not necessarily endorsing a 
continuation of it, but sometimes we mention these things in a 
vacuum and do not appreciate there is a history and a rationale 
for that.
    Senator Carper. I understand. Thank you.
    I think Senator Martinez has a proposal that addresses 
appraisals. If you have any thoughts on this, we would 
appreciate it. His amendment would tighten the standards 
currently in place for appraisals. The amendment would require 
a written appraisal and physical visits before granting a 
mortgage, ending the current practice of drive-by appraisals.
    Does that make any sense in the context of a mortgage or 
housing recovery package?
    Mr. Reich. It makes sense in the context of what acceptable 
banking practice ought to be. I think most community banks try 
to do those things today.
    Senator Carper. Senator Feinstein has a proposal to license 
mortgage brokers. And that is just a thumbnail sketch. Does 
that strike any of you as part of the package of things that we 
should consider doing, to license mortgage brokers?
    Mr. Gronstal. From a CSBS standpoint, we think that is an 
appropriate thing to do. And that is why we have developed the 
national mortgage licensing system. So we think that is 
something that we need to support.
    Senator Carper. All right, thank you. Yes, Mr. Dugan.
    Mr. Dugan. Senator, we would agree that an effective 
licensing system for mortgage brokers is an important component 
of this, because I think one of the problems that we had 
underlying all of this is the ability to get even underwriting 
standards, not just for those loans underwritten by banks and 
banking organizations that are subject to our supervision or to 
State bank regulator supervision, but to get the same standards 
to apply to non-banks and to brokers that work in the 
origination process and are not subject to the same regulation 
and supervision.
    An effective licensing scheme could help that process. I am 
not sure it is a complete solution but it is something that 
could be helpful if implemented correctly.
    Senator Carper. All right, thanks. Ms. Bair.
    Ms. Bair. I would--yes, I think that would be extremely 
helpful. I used to work on the securities side, as you know. 
And when I contrast the extensive licensing and continuing 
education regime for securities brokers and their elaborate 
system of self-regulation and compare it to what we have on the 
mortgage brokers side, it is a very stark contrast.
    So if you want to have a $2,000 mutual fund investment, the 
protections there are much, much stronger than if you want to 
buy a $300,000 house. So I think that is absolutely an area of 
concern, and it goes beyond what the regulators could do.
    So I think I would absolutely urge action in that area.
    Senator Carper. I would just say to our leaders on this 
Committee, if we were in a position to go back and revisit this 
issue of a housing recovery package, the last provision there 
is actually a Feinstein and Martinez proposal that sounds like 
it might----
    Chairman Dodd. I will tell you, it is also one we have 
introduced in our own legislation we have drafted here as a 
comprehensive, addressing the question.
    What we are trying to do is something here, if at all 
possible, to raise--of course, to deal with some emergency 
steps that we might take. Some of these ideas are far more far-
reaching here. Very meritorious, but I think the goal of trying 
to get something done, a narrow idea, is what we are still 
working on. And hopefully maybe we can get something done 
before the Easter break.
    As the Senator knows, I have a deep interest in getting 
something up. But our ability to do that is going to depend on 
whether or not we get some comity and some agreement on these 
principles.
    Some of these ideas, while I am supportive of them, I 
realize they are going to be rather contentious and are 
included in a larger package. But I want to wait until we maybe 
do that under a way so we get it done, if we do not sacrifice 
getting something done.
    But let me, if I can, I appreciate----
    Senator Carper. Thank you.
    Chairman Dodd. I just want to raise a couple of questions. 
Senator Shelby has a couple of questions, as well for us.
    Let me step out of--you know, it seems to me here, as I am 
looking at all of this, there are 3 sets of issues we are 
dealing with. One, how do we avoid this from happening again, 
and the kind of steps we can take? How do we deal with the 
problems that people have, whatever they may be, that are 
suffering as a result of the problem? That is, dealing with 
foreclosures.
    What we are not seem to be addressing is the problem. We 
are dancing around this, trying to shut the door to make sure 
it does not happen again, and how do you address the issues 
that people are affected by this?
    I want to raise with you, Governor Kohn, if I can, an idea. 
This is just an idea, and something that you might have heard 
about yourself. And that is how do we--the freezing up of 
credit. How do we sort of unleash this credit freezing issue, 
which is at the heart of it in my view? More than anything 
else, that is the heart of this issue.
    And one idea that was suggested, trying to get people to 
think out of the box a little bit here, is to make available to 
the discount window private investment institutions, provided 
they be subject to Federal regulation, provide the necessary 
collateral and the like, so it just would not be the member 
banks that would access to it.
    This is a rather radical idea, to some extent. But to the 
extent you could send positive optimistic messages here about 
releasing the kind of--the rigidity that the credit markets 
face here. What is your reaction to something like this? Have 
you heard of this? Others may have raised this.
    And if not that, are there some other thoughts that we 
ought to be considering? That we all ought to be considering as 
a way of trying to deal with the problem, other than just, of 
course, making sure we shut the door so that it does not happen 
again and dealing with those who are affected by it, how do you 
deal with the central question that will bring us to some 
quicker conclusion to all of this?
    Mr. Kohn. I certainly have heard proposals to open the 
discount window to a broader array than just depository 
institutions. Technically, it is possible now----
    Chairman Dodd. You have the authority now to do that. It 
would not require legislation, would it?
    Mr. Kohn. Under Section 13.3 of the Federal Reserve Act, we 
can make loans to individuals, partnerships, and corporations 
under unusual and exigent circumstances by a vote of no fewer 
than 5 members of the Board of Governors.
    And we have not made any such loans since the 1930s. So 
Congress saw this as an emergency very, very unusual situation 
that they did not want us using.
    I would be very cautious about opening that window up more 
generally. I think the banks have access to the discount window 
but the quid pro quo, in some sense, or the control--there is a 
moral hazard issue here, having them have access. And the 
control on that is this panel, right? You have an extensive 
amount of bank examination supervision. You have constricted 
their activities in a number of ways relative to investment 
banks.
    I do not think that liquidity is the problem for the 
investment banks, or liquidity is the issue behind restarting 
these markets right now. I think it is about confidence. It is 
about the underlying economy. It is about the housing market. 
So I am not going to trade these securities until I can have 
some confidence that I can estimate the losses embodied in 
them, that I can price them in a way that will be sustainable.
    Chairman Dodd. I agree with that. It is kind of a chicken 
and an egg though, too, a little bit, isn't it? I mean, you get 
confidence, in a sense, if you also have access and liquidity.
    Mr. Kohn. Right. But I think it is also more of a capital 
problem, not so much capital in the banks, per se. But just the 
whole sense of losses and potential losses if the economy 
deteriorates further. So I do not think opening up credit to 
the investment banks will really be that helpful in the end and 
could carry some very major costs.
    Chairman Dodd. Well, I certainly agree with your cautionary 
note in all of this, and what is why I raised it and framed it 
the way I did. It is an idea that has been kicking around.
    Anyone else have any reaction to this at all? John, do you 
have any reaction to this?
    Mr. Dugan. As an old Treasury guy, too, I do have a 
reaction, which is you have to be very careful about giving out 
the Government's credit except to institutions that you really 
pay very close supervisory attention to. I would maybe even be 
more cautious than Don about this.
    And I think he is right. I think the issue has not been 
primarily about getting access to liquidity. It has been about 
what is going to happen to house prices. That is what everybody 
is looking at, before they go back into the housing market.
    I would just echo the very extreme note of caution.
    Chairman Dodd. Well, let me also just, if I can, I 
mentioned earlier this issue of jumping back to the issue of 
what do we do about those who are facing foreclosure. And as 
you all know, we have resets coming along here. I am hopeful 
that the Hope Now Alliance is going to work.
    There are some reports this morning that we may be getting 
more done than we had hoped. Certainly, the last year was not 
terribly encouraging. But obviously, if things are picking up a 
bit, that can be helpful.
    But the numbers could increase here. And now it looks as 
though a significant percentage of these foreclosures are not 
just in the subprime but prime and credit-worthy borrowers that 
are facing these problems, as well.
    And I want to raise the issue again of this idea--and 
again, I do not want to put words in the Chairman of the 
Federal Reserve--I did not read his speech yet. But I gather 
something along the lines of maybe being a bit more aggressive 
on this issue than just the Hope Now Alliance would indicate 
may have value here, including the idea that I have raised and 
others have raised.
    Chairman Barney Frank is talking about some ideas over 
there that are not dissimilar to the ones we are talking about.
    And again, you can wait for this to happen and try and do 
something. But again, the idea of putting something in place 
that requires some real work, because there are legitimate 
issues that get raised when you start talking about 
establishing--whether you are using a separate entity or 
utilizing one of the GSEs or using FHA. In any case, the 
details of this get very, very complicated.
    And my concern is that if we wait too long and we find this 
problem getting worse and try to deal with it on that level, 
that we may miss an opportunity to step up. And I just would 
like to get, those of you who are interested in commenting on 
this idea. As I pointed out earlier, the American Enterprise 
Institute and others have testified favorably about the idea.
    Sheila, do you want to comment on this? And just run down 
the table quickly.
    Ms. Bair. Well, yes, I think we should be looking at all 
options. I really do. I think the jury is still out on whether 
we will need to set up something quite major. But I think your 
thinking is right, whether it is a new agency or FHA or one of 
the current GSEs. If that greater level of Government 
intervention is necessary, this is something that we should all 
be thinking about now.
    But I do not think we are there yet in recognizing it.
    I would say, as another former Treasury person, that if we 
do set something up the moral hazard is significant. The risk 
of gaming is significant. And I would strongly recommend a 
mechanism to pay for it, hopefully paid by the people who would 
actually be using it and benefiting.
    Chairman Dodd. John, do you have any comment?
    Mr. Dugan. I agree with Sheila and I do not really have 
much to add to that, particularly since, as you said, I have 
not really looked at the particulars of it. We are not--
thankfully--yet anywhere near what we were in the 1930s when we 
had a much bigger proportion of people foreclosing their homes. 
We have still got a relatively small part of the overall 
population of mortgage holders. The jury is still out, before 
you engage in this.
    And also, it will take a long time to get it up and 
running, and that is part of your point I know. But I do think 
in the meantime we should not lose our focus on the other 
things that we are doing. But I share Sheila's thoughts.
    Chairman Dodd. Anybody else?
    Mr. Reich. At OTS, we have been----
    Chairman Dodd. You have been particularly good on that. I 
want to thank you, by the way, John. Your ideas, while I am not 
signing on to every dotted I and crossed t, I appreciate the 
effort of thinking about some ideas like this.
    Mr. Reich. Well, and it is not--to be honest, it is not 
fully developed yet.
    Chairman Dodd. I know.
    Mr. Reich. We put it out last week. We are talking with 
people at this table. We have a meeting tomorrow with 
securitizers and another meeting Thursday with regulators.
    But trying to find a way to use existing programs, existing 
delivery channels without creating a new entity that would deal 
with those people who are under water in their mortgages.
    Mr. Kohn. I think the message of the Chairman's speech--and 
I had only myself a chance to read it very quickly--is that, 
consistent with Sheila's first comment, all options should be 
on the table and we should continue to think about these 
things.
    But I agree with the cautions that the others noted. I 
think looking at existing programs and how to do it better, 
perhaps to expand them, the FHA for example, is probably more 
efficient, more effective.
    I think one of the issues we are dealing with here is--and 
people mentioned this earlier--on the borrower's side, getting 
the borrowers to contact their lenders has been very difficult. 
There are a lot of fears there, I am sure, about what you will 
find.
    And I do not have a quick fix for this, but the people I 
have talked to involved in this have said that one of the 
barriers to scaling up this process is having borrowers call 
in. The Federal Reserve Banks are very involved, working with 
community groups, lenders and borrowers, trying to get the word 
out. It is not a magic bullet to fix this.
    But I think we just need to work on all fronts to get these 
borrowers and lenders together.
    Chairman Dodd. Tom.
    Mr. Gronstal. I think it is obvious that until we can 
figure out what residential properties are worth in individual 
markets, it is going to be very difficult to decide how much 
can be loaned against them. And it is just going to take time 
to work through that.
    Chairman Dodd. Let me again, I do not want to get 
anecdotal, but just in Connecticut now, I think it was ranking 
like number 8 in the States with the foreclosure issue. We had 
almost 50,000 of them in Connecticut last year. I have 
mentioned before some 6,000 just in one city, potentially, in 
the city of Bridgeport, Connecticut.
    And we are getting calls in our office, and I use their 
words, it is anecdotal. But the run-around by the Hope 
Alliance.
    And I really use this forum here, even some of the 
consultants involved in this are raising some issues about how 
well this working, going to the very point you talk about. If 
that confidence is not there of that borrower to call and feel 
as though there is going to be some effort made here--I am not 
suggesting that every one of these callers deserve, 
necessarily, to get the help. But nonetheless, I have to raise 
the issue here that people need to make the calls. But when 
that call comes in, they need to have a person on the other end 
of that line that is going to be sitting there and very 
receptive to trying to help work things out. So I want to 
mention that to you.
    Senator Shelby.
    Senator Shelby. Thank you, Chairman Dodd.
    In a speech delivered last week, Comptroller Dugan 
discussed how banks, credit rating agencies, and regulators all 
failed to adequately assess the risk presented by 
collateralized debt obligations. Comptroller Dugan noted that 
regulators neglected to properly scrutinize super senior 
tranches of certain collateralized debt obligations which are 
now being drastically revalued and causing large losses for 
banks, as all of you know.
    He also indicated that bank underwriting standards were 
inadequate.
    Governor Kohn, would you explain--you are not only a member 
of the Board of Governors, the Vice Chairman of the Fed, but 
you are a big bank regulator. Would you explain why the Federal 
Reserve failed to take steps before the advent of the current 
market turmoil to make sure that banks under your supervision 
fully understood the risk presented by structured finance 
products, did not overly rely on credit ratings when making 
loans, or that banks simply followed sound underwriting 
practices?
    I know that where we are today, but a lot of people believe 
that the Fed was asleep at the switch in dealing with a lot of 
the big banks that you supervise.
    Mr. Kohn. Senator, I think we have been aware for some time 
that risk was not being appropriately priced, that people were 
taking risks that they were not adequately insuring against, 
and that risk management systems in these various institutions 
varied greatly across institution and we----
    Senator Shelby. What did you do about it, though?
    Mr. Kohn. We have been----
    Senator Shelby. If you were aware of it, as a supervisor of 
the banks?
    Mr. Kohn. We have been working with the other supervisors 
to evaluate those risk management systems. And we started 
before this turmoil broke out, and to try and draw some 
conclusions about how these systems needed to be improved.
    So I think we were not looking maybe at specific 
instruments and whether they were being value rated, but 
whether the systems were in place. And that is really--because 
that is what is going to protect us against the next issue. So 
just honing in on a particular instrument is not going to be 
helpful when there is another thing out there somewhere.
    So I think it is the systems we need to pay attention to.
    Senator Shelby. Well, what happened to the basic bank 
prudent lending in this area?
    Mr. Kohn. I think people got complacent.
    Senator Shelby. Got carried away?
    Mr. Kohn. Absolutely. Because of this period of good 
macroeconomic performance, low--I mean, as Chairman Bair was 
saying, we had no bank failures for several years. This is a 
highly unusual situation.
    Chairman Dodd. Would you apply that word complacent to the 
Fed, as well as to the bankers?
    Mr. Kohn. I think the Fed was less complacent, but I do not 
know that we fully appreciated all of these risks out there. I 
am not sure anybody did, to be perfectly honest.
    There were----
    Senator Shelby. Well, why didn't you, though?
    Mr. Kohn. I think we recognized that----
    Senator Shelby. Senator Dodd used the word complacent. You 
know, when good times are rolling along, people do become 
complacent.
    Mr. Kohn. And a number of us gave speeches warning against 
this. And our supervisors were aware of that. Certainly, there 
is a lot of conversation back and forth about that. And I think 
they were moving in the direction of trying to correct this, 
trying to make the banks aware.
    It is a very hard sell to the banks.
    Senator Shelby. It is a hard sell to the banks, yes. But 
you are the supervisor of all----
    Mr. Kohn. That is right.
    Senator Shelby [continuing]. The bank holding companies.
    Mr. Kohn. That is right.
    Senator Shelby And you are also the central bank. So you 
have not just a little bit of power, but a lot of power.
    Mr. Kohn. I agree
    Senator Shelby. Were you reluctant--not just you 
personally. Was the Fed reluctant to use their power? Were they 
afraid of the banks that they regulate?
    Mr. Kohn. No.
    Senator Shelby. Well, what were they? What happened?
    Mr. Kohn. I think some banks did not take adequate steps. 
Now we are doing a study, as I noted in my testimony, of 
lessons learned. We did not perform flawlessly. I absolutely 
agree with that.
    And I think perhaps when we get finished with this, one of 
the lessons that we will have learned is we need to be more 
forceful in these types of situations.
    Chairman Dodd. Can I pick up on Senator Shelby's question 
and add on to this thing? At the very time, just going back, 
you had promoting of the adjustable rate mortgages out of the 
Fed. You were raising interest rates at the time. Wasn't 
anybody--this is not a complicated set of questions.
    You are pushing ARMs and you are raising rates. It seems to 
me, you have got a perfect storm on the horizon here, that you 
had to be aware of the potential of that. Any answer to that, 
looking back and saying maybe that was not wise?
    Mr. Kohn. I am not sure that we were pushing ARMs. One 
person made a speech suggesting that.
    But I do think consumers, households, the structure of 
interest rates anticipated the rise in rates and people should 
have been able to see that if they were borrowing at a low rate 
now, when that reset after a year or 3 years or 5 years, it was 
going to be at a higher rate.
    So it is obvious that people did not see that. It is 
obvious that the lenders did not take appropriate account of 
the affordability of the loans when they were being made, as 
they reset.
    I think, as several of us have mentioned today, a problem 
was that people were counting on those house prices to rise 
forever. And therefore, especially in the mortgage market, the 
due diligence about whether these loans could be repaid under 
other circumstances just was not undertaken.
    Senator Shelby. Senator Dodd and I have both been on this 
Committee quite a while, and I chaired it for 2 terms of 
Congress. But we were here during the thrift debacle. And we 
worry about it. I have talked to Chairman Bair. I have talked 
to all of you at different times about this.
    We have a responsibility, here in the Senate, dealing with 
everything of the bank. But you have that responsibility at the 
Fed, and the others. But I believe the Fed was asleep.
    I want to pick up, and I am glad that my colleague from 
Rhode Island came in here because I was going to pick up on 
something that he brought up the other day that I think is very 
important. We were talking about Basel II.
    He asked--and I have the transcript here at the hearing 
where Chairman Bernanke was here. And I will quote, can I quote 
you?
    Senator Reed. Yes.
    Senator Shelby. In fact--and I will quote the record. This 
is Senator Reed, in addressing this to Chairman Bernanke: ``It 
has been reported that Northern Rock--'' which you are all 
familiar with ``--the British banking institution that failed, 
that has now been nationalized by the British government was 
able to lower their risk-weighted assets by 44 percent under 
Basel II. The CEO of Northern Rock, at that time, described it 
as the benefits of Basel.''
    This is, again, the words of Senator Reed, my colleague. 
And I suspect he is not describing it as that certainly--the 
Prime Minister is not describing it as the benefits of Basel 
now.
    You know, we were talking about models and liquidity and 
capital and everything. One of my concerns about Basel II, and 
I have talked to all of you about it, is that a lot of the 
banks wanted--including some of our banks--wanted to lower 
their capital.
    I know they want to create risk models to better use their 
capital. You want them to do this. We do, too.
    But I have said this many times up here in this Committee, 
I do not know of any financial institution that is well 
capitalized, and well regulated, and well managed that has ever 
gone under. You know, I appreciate my colleague from Rhode 
Island raising this issue.
    Is that a concern of all of you, dealing with Basel II, as 
you go through the regulations working together to make this 
work? It is of mine, sitting up here on the Banking Committee.
    Governor Kohn.
    Mr. Kohn. I think we have put a number of safeguards into 
place to avoid the kinds of outcomes that you are concerned 
about and that concern us, as well. We have a leverage ratio in 
place to put a minimum level of capital in there. We have 
oversight under Pillar 2 over the general capital levels of the 
institutions and can raise them if we think they are 
inadequate. There is a phase-in period of 3 years and we have 
agreed to take a hard look at the end of the third year and we 
will be looking at it constantly as we go through to see what 
the effects are.
    I completely agree with you, Senator, banks that are well 
capitalized, well managed do not fail. And it is our 
responsibility to make sure that what we put in place 
strengthens the capital and strengthens the management. And 
that is what we are determined to do.
    Senator Shelby. Chairman Bair, do you have any comment?
    Ms. Bair. Yes, I share your passion for capital.
    Senator Shelby. Since you have the funds to bail out 
anybody, I think you will guard those zealously. Go ahead.
    Ms. Bair. Yes, we share your passion for capital. It is our 
main line of defense against bank insolvencies, absolutely.
    And again, I think having clear transparent standards not 
only help assure that we have well-capitalized banks but also 
help address competitive disparities that might arise if you 
have more subjective standards.
    So I think we are taking a very slow, cautious approach to 
implementation of Basel II. We are also going to be proceeding 
with the standardized approach under Basel II, which is much 
more like the current risk-based framework but more granular.
    And so I think over this transition period we will work 
together to come up with the right result. But I could not 
agree with you more, this should not be about lowering capital.
    Senator Shelby. John.
    Mr. Dugan. I guess I would say 2 things. One, just to come 
back to the point that the losses that we have seen really have 
been in a Basel I world, even with respect to Europe because 
they really were not on the system until this year.
    I think Basel II has many things in it that will improve 
risk management and regulation and supervision. You are 
absolutely right, it is not perfect, and it has the safeguards 
that we have.
    Senator Shelby. But there is no substitute for capital, is 
there?
    Mr. Dugan. There absolutely is no substitute for capital. 
But you want to have enough of it and you want to have it 
reflect risk. And if you are taking a lot of risk, you want 
more capital in the system. And so I think that is absolutely 
critical.
    That is the point of Basel II. And if we get it wrong, then 
we will have not enough capital for the risk we are taking. But 
if we get it right, the more risk we have, the more capital it 
will have.
    That is what we should be striving to get to, in my 
opinion. And I think we are making strides to go down that 
path.
    The only other thing I will say about the Northern Rock 
situation, to be perfectly honest, is the big problem they had 
was a liquidity problem because they did not have a deposit 
insurance system in the U.K. like ours, and they had an old-
fashioned bank run. And as I said many times----
    Senator Shelby. First time in 100 years.
    Mr. Dugan. That is right. We have a lot of problems in our 
bank system, but one thing we know how to deal with----
    Senator Shelby. 150 years
    Mr. Dugan [continuing]. Is failing banks. We know a lot 
about how to deal with failing banks, sadly. And so we tend not 
to have bank runs, even though we have more failing banks, 
because we have a quite well-developed deposit insurance system 
that makes people confident that even if their bank fails their 
deposits will be safe. That is a bedrock of our system.
    Senator Shelby. John, you oversee a lot of our smaller 
banks. Capital is important, is it not? Management is 
important. Risks are important. We understand all of that.
    Do you have anything to add to this?
    Mr. Reich. Well, I said earlier, Senator Shelby, I think 
you were not in the room, that when I started my banking career 
46 years ago that I grew up in a generation of bankers who 
believe that you cannot have too much capital and you cannot 
have too much in your loan loss reserves. One of my concerns 
that I think today's environment is highlighting is the fact 
that some of our institutions may be challenged to raise their 
loan loss reserves as high as they should be because of SEC and 
accounting rules that do not give them as much flexibility as I 
think they need.
    Senator Shelby. Can I ask one last question, Mr. Chairman? 
I appreciate your indulgence.
    Getting back to the rating agencies--and Senator Schumer, I 
think, raised some important questions here.
    We are all troubled, as you are, by the faulty inadequate--
gosh, ratings. And now all the downgrades. You know all the 
other. What went up is coming down, as we all know it does.
    And some of the rating people have told me at times, well, 
they just give an opinion. You know, free speech, so to speak.
    My gosh, you know, that opinion--one, it is paid for, I 
believe by the wrong people. Second, it is relied upon not only 
by people who invest but a lot of our institutions that you 
regulate can hold investment grade securities.
    So we have got a circle here and I do not know how to break 
it. And I know you cannot legislate ethics. But you can put 
some things in place that will cut out a lot of obvious 
conflicts. That is a problem for us, I know, and also perhaps a 
problem for you, as regulators.
    Mr. Kohn. I think there is 2 things we can do to ameliorate 
the situation. One is to insist that our institutions place 
less reliance on the credit ratings and look at the underlying. 
But second is to push those credit rating agencies to reform as 
much as they possibly can and to do a better job and to push 
them to note that structured finance is different from other 
kinds of things. And to make sure that the purchasers of 
structured finance--not only banks, but pension funds, 
whatever. I think a lot of folks looked at the AAA and said it 
is as good as a AAA bond. And it was not.
    It is a very different instrument in which you are adding 
together a whole bunch of different loans. You get rid of the 
risk of individual loans to some extent, but you increase the 
risk that if the whole economy moves, the whole package of 
loans will move down together. And that is what happened there. 
And I think the purchasers did not recognize that risk, and the 
credit rating agencies did not do a good job of warning people.
    Senator Shelby. Thank you. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much.
    I just, on this point before turning to Senator Reed--and I 
know a couple of you have to get going. We have been here a 
long time.
    But Senator Shelby pointed out, when we were here in the 
S&L, we were talking about 1,000 banks in the S&L crisis. We 
are talking here, at least some numbers talk about--we are 
talking about foreclosure rates--but as many as 44 to 50 
million homes could be adversely affected.
    We are looking at prices dropping. When prices drop, values 
drop. When foreclosures occur, values drop of otherwise people 
who are very current in their obligations. Crime rates go up 
actually 2 percent in neighborhoods where that occurs.
    There is some significant and profound implications of all 
of this. And 1,000 banks is one thing. Talking about this issue 
makes that problem pale, in many ways. $150 billion bailout was 
not insignificant but the payer of last resort is the American 
taxpayer in all of this. And so while others may have been 
complacent and so forth and looking around, the American 
taxpayer pays an awful price for this if we do not get this 
right.
    And so I want to underscore the points that have been 
raised, and just to say--and I have got a couple of other 
questions and I will come back after Senator Reed. But that 
whole idea that you are the cops. You are the ones that are on 
the beat here, so to speak. When cops are not on the beat, they 
are not watching it and keeping an eye on it here, we end up 
where we are to a large extent.
    So I want to come back, as I say, in a few days we are all 
studying all of this. But I want some more specific answers on 
what we are going to do, what you are going to do, what the 
institutions have to do.
    Jack, let me turn to you.
    Senator Reed. Well, thank you, Mr. Chairman. And thank you 
again for your excellent today.
    Senator Shelby pointed out some concerns about Basel II 
that I expressed previously. But there is another concern, and 
that is sometimes I get the impression that we are not 
searching collectively with our global colleagues for the best 
regulatory system. We are responding to competitive pressures, 
perceptions within our banking community that there is much 
more flexibility overseas and if we do not move down that Basel 
road we are going to be left behind, we are going to see 
financial institutions redeploy to London, to elsewhere in the 
globe.
    And here again, the analogy of the regulator, the 
policeman, whatever, is that I think you have a special role to 
play to ensure that these competitive pressures, which are very 
powerful for financial institutions who are lobbying you 
prodigiously on these new rules, do not overwhelm sound 
regulatory practice in terms of capital ratios and all the 
other aspects.
    So that is another concern which I do not think is 
articulated enough, but it is a reality. People come in to see 
us and they can talk about ratios and capital levels and 
everything else. But they are afraid of being left behind in a 
global race, which I hope is not to the bottom. And your role 
is to prevent it from going in that direction.
    I was struck at your testimony, Governor Kohn. You talked 
about recent events indicate that bank management, in many 
cases, was not fully aware of the latent risk contained in 
various structures and financial instruments. Which raises a 
question which Senator Shelby raised--and I will raise it 
slightly different. To what extent did the Federal Reserve 
understand those latent risks? To what extent you should have 
done it earlier? To what extent--and this might be the 
perennial question of any regulator--you should have 
substituted your judgment for the judgment of very talented, 
very intelligent, and extremely well compensated individuals?
    Can you address that?
    Mr. Kohn. I think these are all questions we are asking 
ourselves, Senator, and I do not have definitive answers to 
them. I think we did recognize the risk, in a general way, 
somewhat better than the banks did. We tried to warn people in 
speeches and in conversations that we thought that they were 
taking risks and not being appropriately rewarded for them or 
controlling them. We tried to work with the banks.
    But I think it is quite possible that we could have been 
more forceful. We probably did not recognize it to the extent 
that it ended up existing. These are very unusual events. There 
are no excuses here. But I think it would have been hard to see 
a year ago where we are today. But that does not mean that both 
the Federal Reserve and the institutions that regulate should 
not have been taking steps to ensure against the remote 
possibility of a very adverse event. And it is obvious that we 
did not.
    Senator Reed. Well, I think that is a very candid and a 
very sincere response. In your reflection, which you are doing 
now--and I suspect you are--you have to ask some questions 
about the culture of regulation at the Fed. Because you pointed 
out how you communicate, through speeches, through sitting down 
and sort of having conversations with your regulated 
institutions. That might not be the most effective way to make 
a point when there is literally billions of dollars at stake if 
they pursue a policy that they judge might be prudent and you 
judge reckless and you are trying to discuss it. So I know you 
are going to reflect on that respect.
    Mr. Dugan, you had a comment?
    Mr. Dugan. Yes, if I could just add, I would say a couple 
of things. One, I do think that we were very much aware of the 
loosening of underwriting standards in the subprime market, and 
we spoke out about it. We had had some very bad experiences at 
the OCC with national banks and subprime loans, not so much in 
mortgages but in other places. And we were very reluctant to 
allow a lot of subprime lending, mortgage lending, to go on in 
the institutions we supervised. And as a result, there was not 
as much of it by a long shot being originated inside not just 
national banks but state and national banks.
    I think a lot more of the looser part of it was in entities 
completely outside the banking system, that went to Wall 
Street.
    Senator Reed. But were your banks buying this paper?
    Mr. Dugan. That is going to get to the second part.
    So then I think you look at where were we with respect to 
the things that have caused the biggest losses. And that is the 
speech that I was talking about that Senator Shelby referred 
to.
    This stuff got packaged into some very complex instruments 
and then got rated according to super senior tranches, that got 
very high ratings, and then lower ratings.
    The normal way any of us would look at that, is to look at 
the more risky tranches and pay more attention to them, and pay 
less attention to the least risky tranches.
    And I think it is fair to say that bank management, the 
most sophisticated people among the bank structurers and the 
bank regulators, were lulled into a sense of complacency by 
these very high ratings. In fact, the AAA rated asset-backed 
CDOs are the thing that really needs the focus because, as 
Governor Kohn said, they behaved differently. AAA ended up 
meaning something very different in that context than they 
meant elsewhere. And I think that is one of the places we need 
to focus.
    I also think that we ought to be careful about not throwing 
all credit ratings out. It is true that a lot of what we do 
focuses on credit ratings. But in a lot of ways, including the 
standardized approach that Chairman Bair was talking about, we 
are very focused on credit ratings.
    The part that really caused the big huge losses was the 
super senior tranches of ABS, of subprime related 
collateralized debt obligations. And that is what we really 
need to focus on, on how that is treated, how it is rated, what 
kind of capital applies to it.
    And the last point I will make is that we could have done a 
better job--and the banks certainly could have done a better 
job. Even though this was thought to be a relatively risk-free 
instrument, some institutions piled a ton of it up on their 
balance sheet and made a real concentration.
    Others just abided by the notion that they were not going 
to put as many of their eggs into that one basket. And that 
very simple principle about concentration risk is what caused 
the really big losses, not just at commercial banks but at 
investment banks and foreign banks. And that is a basic 
principle that we have to look at in the risk management when 
we come back to some of the things that you were talking about, 
Senator.
    Senator Reed. Thank you. Let me make, if I may, 2 brief 
points and then yield back. One is that last April, at the 
request of Senator Dodd, I chaired a hearing on the merging 
subprime crisis. I think some might have been here in 
attendance.
    But the problem then was $19 billion worldwide. It is now 
$160 billion, growing to $400 billion or $600 billion. One of 
the things that struck reading about Hope Now is that most of 
the relief that has been provided so far is to conventional 
mortgage holders, the best credit risk. The real problem that 
is facing us is when these alternates and subprimes start 
resetting, which is beginning. But we have not reached the 
middle of it yet.
    So we are looking at a wave that is coming toward us, not 
one that has passed by us. I think that has to strengthen or 
focus our options.
    The second point that Governor Kohn made is about one of 
the presumptions--it was not jut financial institutions, it was 
everybody in this country--housing prices are always going up. 
I ask you, we have evidence now that that assumption is 
invalid.
    But if that was the fundamental assumption that was 
motivating homeowners, lenders, everyone, we have to move I 
think much more aggressively to reinforce or reestablish that 
assumption; i.e., that housing prices will not decline 
precipitously.
    It goes back to what Senator Dodd is talking about. Until 
we really aggressively and quickly shore up the housing values 
in this country, the basic assumption that we have operated 
with, everybody, for the last decade or more, maybe 50 years, 
has formed all sorts of economic decisions from the sublime, 
the intricate securitizations, to whether your child is going 
to be able to afford college because you can borrow from your 
house.
    If we do not stop this decline quickly--and that is why I 
think Hope Now is not effective, it is just not face enough--we 
are going to see more pain and it is going to get worse and it 
is going to accelerate and will probably reach and maybe exceed 
that $600 billion mark, which would be unfortunate.
    Thank you.
    Chairman Dodd. Thank you, Jack, very, very much. You have 
said the point eloquently here. That is why there is a sense of 
urgency about this because, as you all point out here, the 
implications of this now, the domino effect of this is 
obviously going beyond just the housing issue here. It is 
affecting so much more.
    Senator Carper.
    Senator Carper. Thanks. You all have been very generous 
with your time and this has been, I think, an uncommonly good 
hearing, helpful for me and I suspect for my colleagues, as 
well.
    Chairman Dodd. All hearings in this Committee are all 
uncommonly good.
    Senator Carper. I can think of many one or 2 in the last 8 
years that did not quite rise to that standard, but this has 
been uncommonly good.
    I want to thank you for walking me through the housing 
recovery package and some of the proposed amendments to it. I 
realize you are operating with less than full knowledge about 
some of the provisions, so thank you for bearing with me. You 
provided some real constructive comments to us.
    Two or 3 weeks ago Secretary Paulson was before us. The 
question I asked of him on housing recovery package, what are 
the Administration's priorities. He said the first priority, 
GSE regulatory reform. Second priority, FHA modernization. The 
third priority is this piece where we allow housing finance 
agencies to issue bonds for refinancing. Those are his top 
three priorities.
    The Chairman and the Ranking Member have been working and 
their staffs have been working to try to get this to closure 
with the House of Representatives on FHA modernization. My hope 
is that we are almost there.
    The third element that I mentioned in the administration's 
priorities, there seems to be agreement, bipartisan agreement 
between the legislative and the executive branch.
    That leaves us with the third being GSE regulatory reform, 
and the last time--it has been a couple of years since we 
actually--and we have had a hearing on it this year, but we 
actually voted on this stuff about--what was it? Two years ago, 
I think. And we ended up taking pretty much a party line vote, 
as I recall. It is something that we do not oftentimes do here. 
But we were unable to come to a consensus, and if we do not 
have consensus on an issue like that, it is hard to get floor 
time, and we just do not legislate in the full Senate.
    There is going to be a hearing--the Chairman has set it as 
a priority, one of his early priorities for this year--to 
finish our work on GSE regulatory reform. And toward that end, 
we have another hearing that is scheduled for this Thursday. 
You all are not going to be there, but you are here today. And 
I am just going to ask you to give us some advice as we prepare 
hopefully to move to mark up legislation on providing 
regulatory reform for our GSEs.
    There is actually a fair amount that we agree on today that 
we did not a couple of years ago, and I will mention some of 
the elements of agreement we agree on: combining OFHEO and the 
Federal Finance Board; we agree on the need for the 
independence of the regulator from the appropriations process. 
We agree on independent litigation authority for the regulator. 
Currently, I think they have to go through the Department of 
Justice for that authority. We agree on right of receivership 
to place these entities in receivership if that is deemed 
appropriate. We agree on combining the mission oversight and 
the new product authority under one world-class regulator. We 
did not always agree on that. We agree on the need for 
flexibility for the regulator to set capital standards. And I 
believe we agree on some restrictions on the size of the GSE 
portfolios. Those are pretty much the areas I think on--some of 
the areas, major areas on which we have agreement now.
    Would you have any advice to us, as we hopefully prepare to 
move on to actually introduce legislation and begin marking up 
it, on GSE regulatory reform? The elements that I have 
mentioned I think are pretty much common knowledge. Are any of 
those that are especially important? Are there other things 
that we should be focused on as we take up our work?
    Ms. Bair. I used to work at Treasury when GSE reform 
started. I think the health, the safety, the stability of the 
GSEs is extremely important, especially in times like these 
when you have more and more mortgages becoming distressed, and 
they may be called upon increasingly to fulfill their 
guarantees. So I think it is very important, and I am 
encouraged by all the areas of agreement, and I would hope it 
could get done.
    I would also just add editorially that I would hope the 
GSEs, especially Fannie and Freddie, could take a more 
proactive role in supporting loan modifications as huge 
holders, portfolio holders, of mortgages, as well as those who 
hold substantial amounts of MBS. I think as major investors as 
well as their role as GSEs could play a very instrumental role 
in getting the market moving even more aggressively to modify 
loans. And I know there are aspects of the pooling and 
servicing agreements that impact conforming loans that may be 
an issue. But I would hope that that could be worked out, and 
that might also be something you would want to take a look at.
    Senator Carper. Great. Thanks very much.
    Mr. Dugan.
    Mr. Dugan. Generally, I think that the focus on the safety 
and soundness side is the part that we would stress--I think it 
is in the interests of the GSEs and of all parties to get 
comprehensive reform passed that provides a strong supervisory 
structure like what we have with the Federal bank regulators. 
Without going into all the details, I think that is really the 
kind of fundamental issue to get right, particularly, as we are 
in this period where all their assets are mortgages based on 
house prices. There are significant credit issues and other 
issues there, and you want to make sure you have a regulatory 
structure that is up for that task. I think it is important to 
get this right.
    Senator Carper. All right. Thank you.
    Mr. Reich.
    Mr. Reich. I do not know that I have anything substantive 
to add to that. You obviously have a number of areas that you 
agree on. I am supportive personally of all of the areas that 
the two parties are in agreement with, and I am hopeful that 
you will pass a bill.
    Senator Carper. All right. Thank you.
    Ms. Johnson, anything you would like to add?
    Ms. Johnson. Nothing additional to add. Just to say good 
luck.
    Senator Carper. Thanks. We might need it.
    Governor.
    Mr. Kohn. I think that it is very, very important that you 
reach agreement and get this done. I think the GSEs, as 
Chairman Bair was saying, could play an important role in 
helping the recovery of the housing market. But I would be very 
hesitant to see them greatly expand their role without 
appropriate and proper supervision, and of the nature, as 
Comptroller Dugan was saying, of the sort of oversight that the 
bank regulatory agencies have over commercial banks to protect 
the safety and soundness of those institutions if they were to 
expand. I think getting this done could build confidence in 
those institutions, and putting a structure in place in which 
they can expand, raise capital and expand, would be a very 
constructive step.
    Senator Carper. Thank you, sir.
    Mr. Gronstal. To the extent that debt issued by the 
Government-sponsored enterprises is part of the broader capital 
markets, it is important that we improve the transparency there 
so that we can improve the confidence of the investors in our 
entire capital market system, because that is a big piece of 
the problem.
    Senator Carper. All right. Thanks.
    Mr. Chairman, thanks for letting me get that question. I 
would just say, Mr. Chairman, in closing, I know an idea that 
you have been fleshing out focuses on these mortgages 
underwater or upside down, and the ideas that Mr. Reich has 
outlined and noodling with for, I think, to good effect in the 
last several weeks, I think there is a lot of promise----
    Chairman Dodd. I commended Mr. Reich about that. I did not 
agree with him on everything, but I commended him. And let me 
just say on the GSE issue, again, you know, there were those 
who had ideas on GSEs at Fannie and Freddie back a couple of 
years ago; had they been adopted, this problem would be a lot 
worse today. A strong regulator is absolutely essential. All of 
us agree on that here. I am determined to get a bill done, but 
I want to make sure we do it right as well. The idea there is a 
30-year or 40-year fixed-rate mortgage in this country, which 
is unique in the world, exists because of Fannie Mae and 
Freddie Mac. And the idea that some are brought to the table on 
the issue I think would do us some real damage. But I am 
interested in getting a bill done here. We will get that done, 
too.
    Senator Shelby. Mr. Chairman?
    Chairman Dodd. Yes.
    Senator Shelby. I have to add a few things.
    We are all, I hope, interested in GSE reform, but I believe 
that we have to take into consideration the thin capital 
structure of the GSEs, the systemic risk to the taxpayer, the 
product approval and so forth. I believe the GSEs have served a 
good purpose, but we want them to continue to serve a good 
purpose, and we do not want to, I believe, hopefully, to put 
the taxpayer at risk on all this. And I do believe they need a 
strong regulator, and they need somebody who is going to talk 
to them about capital, too.
    I think we had a strong bill several years ago. Obviously, 
they had a stronger lobby than our strong bill.
    Thank you, Mr. Chairman.
    Chairman Dodd. Let me raise one other question here, and, 
again, I am deeply appreciative of the time here. But this 
credit default swap issue is one that is lurking here that 
requires some comment, I think, before we complete.
    According to some recent reports, the potential exposure of 
our financial institutions to losses from credit default swaps 
on collateralized debt obligations backed by subprime 
collateral could be significant. The New York Times reported 
late last month that the top 25 commercial banks held credit 
default swaps, some including subprime collateral, worth $14 
trillion. American International Group, AIG, reported last week 
that it had lost $5.3 billion in the fourth quarter of last 
year doing par to a $15.5 billion write-down based on insurance 
the company had written for these CDOs. AIG's experience is 
only the latest example of some trends to downgrades and write-
downs related to these derivatives.
    I would just ask each of you here, in the course of 
examinations, how did the bank regulators review the valuation 
of significant assets such as CDOS in determining an 
institution's capital adequacy? And did the regulators perform 
an independent analysis of the value booked by the institution, 
or did it routinely accept the valuation of complex major 
assets? Governor Kohn.
    Mr. Kohn. The truth is I do not know the answer to whether 
we did our own independent evaluation of those things. I know 
that we valued the risk management systems and whether things 
were being marked to market and whether there was collateral 
behind the changing values, so that whether the banks were 
protecting themselves if the value of the CDS changed and they 
were collecting the margin for that. And I believe they are.
    So I think we looked at how the banks were protecting 
themselves and managing that risk. I do not know whether we did 
independent valuations--I question whether we would do 
independent valuations. As long as the risk management systems 
are in place, that is probably not necessary. But I do not know 
the----
    Chairman Dodd. Are you concerned, is the Fed watching this 
credit default swap issue?
    Mr. Kohn. Yes.
    Chairman Dodd. It is a very technical issue and one that--I 
have sat and listened to people at some length talk about it 
and how it works and how these things get sliced and diced down 
the line, and then at the end of that line, who actually owns 
the policy----
    Mr. Kohn. Right, and I think it----
    Chairman Dodd. Someone has got to know that, though. This 
is----
    Mr. Kohn. But in one sense, I believe the New York Times 
article was misleading because it implied that someone could 
trade--a counterparty could trade, and you would have a new 
counterparty, and the first person who may be purchased--if 
Person A purchased from Person B, Person B could transfer that 
to Person C without telling Person A. That is not true.
    Chairman Dodd. Well, I tell you, I am not going to talk 
about who, but I sat with a major figure at a major private 
investment house who said that is exactly how it works.
    Mr. Kohn. No, they cannot----
    Chairman Dodd. That is exactly what happens. I mean, I----
    Mr. Kohn. Well, that is not the way the market is supposed 
to work, and I do not believe that is the way the market works 
for the most part. There was a problem in that regard several 
years ago, and the Federal Reserve Bank of New York, working 
with the entities in the market, got together and said this 
business of assigning this liability without notifying the 
person was not acceptable, and the market agreed and that 
practice has been stopped.
    Chairman Dodd. John, do you want to comment on this?
    Mr. Dugan. Yes, I would say a couple of things. We also 
participated in that exercise, which really was about the 
mechanics of how these worked, because it is quite complicated, 
how they clear, how they settle. I think there are a couple 
things to bear in mind.
    No. 1 is that the notional values are huge, but they are a 
little misleading. Generally, banks tend to run, not perfectly, 
matched books that offset one position with another kind of 
position. They do not typically use it to offset their own 
credit risk positions. That is a very important point in how 
these things are structured.
    There are certain kinds of credit default swaps that 
involve so-called correlation and hybrid risk types of products 
where there are more risks involved in that, and we do pay a 
significant amount of attention to it.
    There are also still some mechanical issues about when you 
have more credit default swaps out than you have underlying 
bonds that you are using as a reference in how they are 
settled. This is an issue that has been raised by a number of 
people, both in the private and public sectors, as something 
that does need to be resolved over time. And the New York Fed 
and others have been paying a great deal of attention to it, 
but it is very much on the radar screen of the regulators as we 
look at this very important part of the market that has 
developed over the years. It is a very important part of our 
supervisory strategy.
    Chairman Dodd. Is it something we ought to be more 
concerned about than we are?
    Mr. Dugan. I think that you are appropriately asking 
questions about it and monitoring the situation, and we are 
doing the same. But I do not think it is something that we are 
suggesting in any way is setting off alarm bells.
    Chairman Dodd. OK. Sheila, do you want to comment on this?
    Ms. Bair. Well, a couple of things. The good news about 
this is that the exposure is concentrated mostly in the very 
large institutions, but the 5,200 banks that we regulate 
virtually have no exposure to this market at all.
    I think it is also an example of where the monolines, like 
the rating agencies, got into an area that they really did not 
understand and were being a counterparty to transactions that 
they did not really understand, and then people relied on their 
AAA credit rating. So I think it all intertwines and cascades 
back on us.
    So I think there may be further write-downs because of 
this. I do not really know. But I think based on the numbers we 
have been able to generate working with the primary regulators, 
this is something that the banks can absorb if it happens, and, 
again, it is concentrated in the very large institutions.
    Chairman Dodd. Yes, I am sorry. Go ahead.
    Ms. Johnson. I would just like to add that only 2 out of 28 
of our corporate credit unions invest in CDOs, and it is a very 
small part of their investment portfolio, less than 1 percent 
of the total investments. But we have stepped up our monitoring 
and stress-testing, and currently they are performing well.
    Chairman Dodd. I said the last question. Just if any one of 
you here could comment on this, we went through this issue back 
a few years ago with FASB during the Sarbanes-Oxley effort 
here, coming up with a different way. A lot of the same 
questions being raised about the credit rating agencies were 
raised about FASB, some of the inherent conflicts.
    Does the FASB model that we ended up adopting here have 
any--does that have any relevancy to this question of the 
credit rating agencies in terms of a resolution of that in your 
mind? Or is it just so different in terms of how FASB operates 
and how--I mean, obviously they are very different entities. 
But it occurred to me there we ended up with FASB. Originally, 
as you will recall, it was totally financed by the very people, 
obviously, that were helping their accounting, so the inherent 
conflict, we changed that. Obviously, it is a public entity in 
a sense, as opposed to a credit rating agency. But any value of 
examining that as a comparison? You are saying no.
    Mr. Kohn. I am saying I do not know, actually.
    Chairman Dodd. John.
    Mr. Dugan. I really do not know. I have never looked at it. 
It is an SEC type question as an oversight.
    Ms. Bair. I think it is probably working pretty well as 
compared to other things. There may be other priorities we need 
to look at.
    Chairman Dodd. Richard.
    Senator Shelby. I just have an observation. You know, in 
accounting when you are doing an audit, you are looking for the 
truth as you understand it, the truth of the financial system 
that this company has. And if you are looking at a bank, you 
are a regulator, you are looking at their assets and 
liabilities and their risk and how they manage risk. Do they 
have enough capital or have they really bitten off a lot more 
than they can chew and swallow?
    FASB has certain accounting rules, and I know they are 
different from what you have to deal with every day. But 
somebody has to understand these financial instruments. And if 
you do not understand them--I am not saying you do not, but, 
you know, they are very complicated--who does understand them? 
And how do you regulate institutions that hold a lot of these 
instruments that have been sliced, diced, you know, here and 
there, without really understanding them, without understanding 
the risk on those books, so to speak?
    I know it is a dicey proposition, but finance has moved 
down a road that very few people understand. But then it comes 
back to the fundamentals, and it is sitting in your lap now, 
and maybe the American people's lap, too. It is not nice.
    Thank you.
    Chairman Dodd. Well, thank you. We have kept you a long 
time, but, again, I think you saw by the participation of the 
Members here on both sides the interest in the subject matter.
    Tom, we appreciate very much the State perspective being 
here. It is a very valuable, added element in all of this, and 
I am grateful to you, Dr. Kohn, as well for coming, I know back 
and forth--we have had the Fed up here a lot over the last few 
weeks, and I am very sensitive to the idea that you have got a 
lot of other things to do other than just testify. But it means 
an awful lot to have all of you here.
    As I said at the outset, I want to get back now--a lot of 
these hearings, it can end up in the ether, but I am very 
interested. I did not press this, John, but you talked about 
some of the forward thinking that you have had going on in your 
shop, and I want to see some of that forward thinking, how we 
are addressing these questions. This is really the nub of it. 
The questions raised in the Wall Street Journal this morning 
that Senator Bennett talked about in his opening comments are 
really at the heart of this. From our perspective here, 
obviously we watch what happens very carefully with the private 
institutions, but it is the regulators, including the State 
regulators, here who play such a critical role. You are the 
backstop. These are subject matters that very few people 
understand, including, I would say this respectfully, our 
colleagues here. Despite their good intentions to really 
understand the totality of all of this, not to have a stovepipe 
mentality about it, sort of looking at these things in sort of 
separate funnels, failing to recognize the interrelationships 
that occur here and how all of this is critically important to 
our economic success. But we count on you. That is where really 
this has to be. And Jack Reed's point here, the culture of how 
you approach your public responsibilities, your regulatory 
responsibilities, are critically important.
    So I look forward to having you back here. We will work out 
schedules and times so it accommodates your busy schedules. But 
we are very grateful to you for your presence here today.
    The Committee stands adjourned.
    [Whereupon, at 1:31 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 CHAIRMAN DODD FROM SHEILA C. 
                              BAIR

                         ANTI-UNION REGULATION

Q.1. Last year, the Department of Labor issued a regulation 
drastically expanding the personal financial information union 
officers and employees must submit to the Department The new 
LM-30 rule will require more than 150,000 union volunteers, 
employees, and their families to report the terms of mortgages, 
car loans, and even student loans. To determine whether they 
must report such interests, these individuals must ascertain 
(1) whether the bank providing a loan does any business with 
the person's union, or (2) whether the bank does 10 percent of 
its business with firms whose employees are in the same union. 
The regulation requires individuals to write to banks asking 
for this info, and, then, if banks won't provide such 
information, to contact the Department of Labor for assistance. 
In the meantime, individuals are required to make good faith 
estimates of the bank's business with their unions and 
unionized firms.

      Given your agency's expertise in the regulation 
and practices of banks, do you believe that banks are able--and 
willing--to inform their customers whether they do business 
with particular unions and how much of their ``business'' and 
``business receipts'' are with particular unionized firms?

      Are banks obligated or prohibited by any federal 
or state law to disclose to their customers how much 
``business'' or ``business receipts'' they have with particular 
unionized firms? Can banks simply refuse to answer these 
written inquiries?

      What type of administrative burden will this LM-
30 rule, and the hundreds of thousands of resulting inquiries, 
place on banks and are banks currently prepared to respond to 
these inquiries?

      If banks don't provide this non-public 
information, is there any ``information reasonably available'' 
to the public that union officers, employees, and members could 
use to make good faith estimates?

A.1. The Labor-Management Reporting and Disclosure Act (LMRDA) 
requires public disclosures of certain financial transactions 
and financial interests of labor organization officers and 
employees (other than employees performing clerical or 
custodial services exclusively) and their spouses and minor 
children. It is our understanding that the purpose of this 
disclosure is, among other things, to make public any actual or 
potential conflict between the personal financial interests of 
a labor organization officer or employee and his or her 
obligations to the labor organization and its members.
    The U.S. Department of Labor's Office of Labor-Management 
Standards (OLMS) issued a final rule in 2007 implementing 
section 202 of LMRDA. See 72 FR 36106 (July 2, 2007). The final 
rule revised Form LM-30, Labor Organization Officer and 
Employee Report and its instructions. The final rule became 
effective for fiscal years beginning August 16, 2007, although 
no reporting is due under the rule until November 16, 2008. See 
72 FR. 38484 (July 13, 2007).
    The FDIC understands that financial institutions are 
expressly relieved of any reporting responsibilities of 
payments or loans under section 203 of the LMRDA (see 72 FR at 
36119 and 36136). Therefore, banks are not required to report 
customer information.
    The final rule deals with Form LM-30, which requires 
reporting by the union officers and employees covered under the 
LMRDA. The final rule, as revised, does not require union 
officers to report most bona fide loans, interest, or dividends 
from financial institutions. However, the final rule may 
require that union officers report these types of transactions 
if the bank does a specified level of business with a company 
that employs members of the same union. The OLMS is the agency 
responsible for implementation and interpretation of this 
regulation and the FDIC defers to its determination of the 
exact parameters of the categories where union employees are 
required to report bank loans.
    We know of no federal law that either requires or forbids a 
financial institution from informing its customers whether they 
deal with businesses that are unionized and what union 
represents the employees of those businesses, assuming that no 
customer information is disclosed. We see nothing in the 
Department of Labor rule that would require financial 
institutions to make those disclosures. We note, however, that 
banks typically build certain reporting codes into their 
information management systems to facilitate the creation of 
both regulatory related filings, such as call reports, as well 
as internal management reports. The basis for distinguishing 
and reporting based upon the type of union-related activity at 
issue here would not be a part of this reporting framework 
thereby creating issues regarding the practicality of 
disclosure.
    The FDIC will continue to analyze the impact of the final 
rule on our supervised banks as we approach the November 2008 
reporting deadline.

                         COMMERCIAL REAL ESTATE

Q.2. In December 2006, three agencies, the FRB, OCC, and FDIC, 
issued final guidance highlighting the risks to banks from 
concentrations in commercial real estate. In issuing the 
guidance, the regulators specifically emphasized that they were 
not setting any limits on banks' commercial real estate 
lending. Yet now we understand from the Comptroller of the 
Currency and the Chair of the FDIC that over a third of 
community banks have commercial real estate concentrations 
exceeding 300 percent of their capital.

      Are any community banks going to fail because of 
their overexposure to commercial real estate, including 
commercial real estate mortgage backed securities?

      Was it the correct policy not to set 
concentration limits in the guidance?

      What are examiners doing when they find these 
levels of concentrations?

      What off-balance sheet vehicles are banks using 
to invest in commercial real estate?

      Are the regulators approving these kinds of 
transactions?

A.2. As noted in the FDIC's testimony, weakness in the housing 
market will affect institutions with significant exposures to 
commercial real estate (CRE) loans--particularly construction 
and development loans. Given deteriorating conditions and 
excess supply in certain housing markets such as Florida, 
California, Arizona, and Nevada, construction and development 
lending could cause some community banks to fail in 2008 and 
2009. While we do not currently anticipate a sharp increase in 
failures, the protracted nature of real estate downturns may 
challenge the earnings capacity and capital levels of 
institutions with concentrated exposure to construction and 
development projects. At present, the various sectors of the 
commercial real estate market including apartments, office 
buildings, retail, and industrial have performed adequately and 
are not expected to cause bank failures in the near term. 
However, if we experience a significant economic downturn, 
commercial real estate mortgages could cause losses for insured 
institutions that may lead to failures.
    The December 2006 interagency commercial real estate 
guidance provided an appropriate, timely message to the 
industry regarding risk management standards, loan 
concentration reporting thresholds, and capital adequacy. 
Bankers are very aware of the monitoring thresholds stated in 
the guidance, and the document positively influenced commercial 
real estate credit risk management. The establishment of 
specific concentration limits would have been prescriptive and 
could have caused an unintentional aversion to commercial real 
estate lending. A limit on commercial real estate lending would 
have had negative consequences for the market and exacerbated 
the credit availability challenges in the current environment.
    In March 2008, the FDIC issued a Financial Institution 
Letter (FIL) to all banks under its supervision re-emphasizing 
the importance of strong capital and loan loss allowance 
levels, and robust credit risk-management practices for state 
nonmember institutions with significant concentrations of CRE 
loans, and construction and development loans. The FIL 
recommends that state nonmember banks with significant CRE loan 
concentrations increase or maintain strong capital levels, 
ensure that loan loss allowances are appropriately strong, 
manage portfolios closely, maintain updated financial and 
analytical information, and bolster loan workout 
infrastructures.
    FDIC examinations of institutions with significant 
commercial real estate loan concentrations, as defined by the 
2006 interagency guidance, focus on each bank's credit risk 
management program, internal measurement and reporting on 
concentrations, examiner review of individual credit 
relationships, and an assessment of capital and loan loss 
reserve adequacy. Examiners undertake a thorough review of 
commercial real estate lending policies and underwriting 
processes and gain an understanding of management's risk-taking 
philosophy. Departures from prudent policies, underwriting, 
risk selection, or concentration management may be subject to 
examiner criticism. Significant deficiencies related to 
commercial real estate loan concentrations sometimes result in 
formal or informal enforcement actions.
    From an investment standpoint, banks are generally limited 
in their acquisitions of commercial real estate to property 
that will only be used as bank premises. There are certain 
exceptions to this limitation that are permitted under the 
investment authorities for national banks. Otherwise, a bank 
must apply to the FDIC (under section 24 of the Federal Deposit 
Insurance Act (FDI Act)) for permission to invest in commercial 
real estate on the balance Sheet. An off-balance sheet 
investment in commercial real estate would be unusual.
    From a lending standpoint, commercial real estate loans or 
interests therein are typically originated and held directly by 
the bank, or a bank subsidiary, on the bank's balance sheet. 
Off-balance sheet holdings of interests in commercial real 
estate loans are generally rare and limited to the largest 
institutions: that securitize such loans. In a commercial 
mortgage backed security, a bank that securitizes commercial 
real estate loans sells the loans (on a non-recourse basis) to 
a trust that then distributes these credits on to third party 
investors. Depending on the governing securitization documents, 
the bank that originated a commercial real estate loan could be 
liable for the loan's performance under certain circumstances, 
as well as be required to prudently carry out the duties of 
special servicer if the bank retained servicing. It is 
theoretically possible that sold loans could be put-back to the 
originating bank if the governing documents or courts permitted 
such recourse. Such situations are relatively rare. The bank 
regulators do not approve securitization transactions, which 
are accounted for as loan sales. Large institutions that trade 
credit derivatives also could have a commercial real estate 
credit exposure off-balance sheet. However, most derivative 
positions are now booked on the balance sheet according to 
accounting rules.

                                BASEL II

    There was extensive conversation on what would have been 
the capital status of banks going into this crisis period had 
Basel II capital standards been in effect. Fed Vice-Chairman 
Kohn said that if, ``we had the same safeguards in place, and 
if we started implementing in 2004 with the same safeguards 
that are in place in 2008 and 2009, I do think on balance we 
would have been better off.'' Mr. Gronstal answered 
differently, stating: ``I think the answer to your second 
question is that we probably would have had lower dollar 
amounts of capital per asset, and that makes it more 
challenging to deal with issues when times get rough.''

Q.3.a. Can you explain in writing, whether you believe that 
banks would have had more or less capital in place for this 
current down turn had Basel II been implemented during the time 
frame that Vice-Chairman Kohn mentioned in his response? Can 
you also explain why you believe that to be the case, citing 
any empirical data on both the effects of Basel II on capital 
requirements and what we have experienced during this economic 
crisis, as it relates to assets?

A.3.a. I believe that banks would have had less capital in 
place for the current downturn had Basel II been implemented 
during 2004. The U.S. Quantitative Impact Study-4 (QIS-4) 
estimated the advanced approaches would reduce capital 
requirements for mortgages and home equity loans by 73 percent 
to 80 percent. In addition, for certain securitization 
exposures, the advanced approaches slash the capital 
requirements significantly compared to the current rules and 
would have encouraged banks to hold more highly rated 
collateralized debt obligations (CDOs) and other complex 
securities that have caused losses in the tens of billions of 
dollars for large financial institutions. For many of these 
exposures, the capital requirements are reduced by almost two 
thirds--from 1.6 percent to 0.56 percent of face value.
    There is every reason to assume that banking organizations 
would have reduced their actual regulatory capital holdings in 
an amount commensurate with this reduction in minimum capital 
requirements. A case in point is given by Northern Rock, the 
British bank with assets of about $200 billion that was 
recently nationalized. We understand that the British 
regulators provided banks that were interested, and deemed 
ready, the opportunity to implement certain aspects of the 
advanced approaches in 2007. In reference to the 44 percent 
reduction in risk-weighted assets Northern Rock reported using 
the advanced methodologies for its retail portfolio, its CEO 
wrote:

          We are pleased to have achieved approval for use of our Basle 
        II rating systems. This means that the benefits of Basle II 
        enable us to increase our 2007 interim dividend by 30 percent. 
        Going forward our dividend payout rate increases to 50 percent 
        of underlying EPS from around 40 percent. Future capital 
        planning, including the reduction of capital hungry assets, 
        will allow us to return capital to shareholders through a share 
        buyback programme. The medium term outlook for the Company is 
        very positive. --CEO Adam Applegarth, Northern Rock Interim 
        Results, June 30, 2007.

Q.3.b. During the discussion of Basel II, Comptroller Dugan 
told the Committee: ``The irony of this whole situation is that 
the very high--most highly rated best securities, the ones that 
were thought to be least likely to default was where all the--a 
huge share of the losses have been concentrated.'' Given Basel 
II's reliance on ratings of securities, does this observation 
give you reason for concern over the current Basel II 
structure? If so, what do you recommend be done; if not, why 
not?

A.3.b. The unprecedented downgrades and massive losses incurred 
by banks on AAA rated structured securities such as CDOs and 
asset backed securities (ABS) are a prime example why models 
cannot be relied upon to set capital requirements that are 
meant to protect and preserve the solvency of our nation's 
financial institutions. The models used to assign a AAA rating 
to these securities were no more than estimates that attempted 
to apply past performance to predict future events. However, 
the assumptions used to assign these ratings did not capture 
the true stresses that accompanied the current credit market 
crisis.
    In some cases, the models that failed the ratings agencies 
are similar to the models used by banks to set capital 
requirements on a wide range of exposures under Basel II. What 
is even more troubling is that these AAA rated structured 
securities that played a prominent role in contributing to the 
hundreds of billions of dollars in write-downs have been 
awarded sizable capital reductions under Basel II. Under the 
new rules, the capital requirement for these securities is a 
mere fraction of the losses incurred to date with banks only 
required to set aside 56 cents for every $100 in exposures. 
Under the existing U.S. rules that apply to all but the largest 
banks, the capital requirement for these same securities is 
$1.60 for every $100 in exposures.
    The Basel Committee has acknowledged some of the 
deficiencies with the Basel II framework, especially as it 
relates to the complex structured securities discussed above. 
However, the lesson to be learned from the credit market 
turmoil should be applied well beyond CDOs. The major issue is 
that the models did not perform adequately, and Basel II is 
heavily reliant upon models for determining capital 
requirements. Fixing the risk weights on complex securities is 
a good start but that alone will not address the larger scale 
problems with Basel II.
    In this respect, U.S. bank regulation benefits considerably 
from our statutory framework of Prompt Corrective Action (PCA), 
including regulatory constraints on bank balance sheet 
leverage. The PCA framework provides abase of capital to absorb 
losses in the event the risk-based models are overly optimistic 
and helps limit the exposure of governmental safety nets during 
difficult times. In addition, a leverage ratio, or similar 
clear-cut supplementary capital requirement to complement the 
risk-based approaches and constrain excessive leverage, would 
greatly benefit the effectiveness of global financial 
regulation.
    As you know, the regulation issued by U.S. banking, 
agencies does not allow any bank to exit its risk-based capital 
floors until the completion of an interagency study on the 
impact of the new advanced approaches. This interagency study 
will be extremely important in that it provides a structured 
process for the agencies to evaluate potential weaknesses of 
these new rules and decide how to address them.

                            TOO BIG TO FAIL

Q.4. I am concerned about the potential ramifications of the 
failure of a very large institution. Is your agency prepared 
today to handle the failure of a large systemically significant 
insured financial institution? What steps are you taking to 
prepare for this contingency?

A.4. The FDIC has been taking a number of steps to ensure our 
ability to handle the failure of a large financial institution. 
For example, several years ago we started a project to 
facilitate the claims process at the very largest and most 
complex banks. This includes a process to hold some fraction of 
large deposit accounts in the event of failure, to have the 
ability to produce depositor data for the FDIC in a standard 
format, and to be able to automatically debit uninsured deposit 
accounts to share losses with the FDIC. In January 2008 we 
issued a notice of proposed rulemaking to solicit comments in 
consideration of a final rule. We hope to issue a final rule as 
early as mid-year.
    In recent months, the FDIC also has begun hiring additional 
staff to ensure that we are prepared for any type of increased 
bank resolution activity: This hiring is a mix of temporary 
appointments that can lapse once any problems are addressed, 
retirees who can provide ``experience from past failures, and 
new skill sets (such as capital markets expertise) that are 
relevant to resolving troubled institutions in today's market.
    Finally, the FDIC has been working with other regulators to 
improve information sharing processes and procedures regarding 
troubled financial institutions to ensure that all of us have 
the information we need to fulfill our roles in the event-of 
bank failures. Our participation as part of the President's 
Working Group is a welcome improvement to this communication.

                       DATA ON LOAN MODIFICATION

Q.5. Please provide comprehensive data on mortgage 
delinquencies, foreclosures, repayment plans and modifications 
for the mortgages being serviced by the institutions you 
regulate for the past 12 months. Please provide this 
information by the following loan categories: subprime, Alt-A, 
and prime. Please describe the types of repayment plans and 
modifications that servicers are employing and the numbers of 
loans in each category.

A.5. Because most FDIC-supervised institutions do not service 
securitized loan pools, we do not collect data for the 
categories requested. Nevertheless, the available data so far 
seems to indicate that too many modifications involve repayment 
plans that only act to defer problems rather than create long-
term sustainable mortgages.
    Publicly available data from the HOPE NOW Alliance estimate 
that, on an industry-wide basis, mortgage servicers provided 
loan workout plans for over 2 million loans during 2007 and 
first quarter 2008. Subprime loans account for the majority of 
these workouts, at 60 percent of the total. Prime loans account 
for the remainder; there is no breakout for Alt-A loans. Loan 
workouts have numbered nearly three times more than foreclosure 
sales.\1\
---------------------------------------------------------------------------
    \1\ HOPE NOW mortgage servicers cover almost two-thirds of the 
mortgage industry for both prime and subprime loans. All data are from 
their release of quarterly 2007 and 2008 data at: http://www.csbs.org/
Content/NavigationMenu/Home/StateForeclosureApril2008.pdf.
---------------------------------------------------------------------------
    The following tables summarize borrower foreclosure sales 
and loan workout plans on an industry-wide basis from first 
quarter 2007 through first quarter 2008.

                                                FORECLOSURE SALES
                                        [Thousands of residential loans]
----------------------------------------------------------------------------------------------------------------
                                                       2007 Q1   2007 Q2   2007 Q3   2007 Q4   2008 Q1    Total
----------------------------------------------------------------------------------------------------------------
Foreclosure Sales:
    Total...........................................       110       117       135       151       205       718
    Prime...........................................        48        49        54        60        84       295
    Subprime........................................        62        89        82        92       121       426
----------------------------------------------------------------------------------------------------------------


                                           BORROWER LOAN WORKOUT PLANS
                                        [Thousands of residential loans]
----------------------------------------------------------------------------------------------------------------
                                                       2007 Q1   2007 Q2   2007 Q3   2007 Q4   2008 Q1    Total
----------------------------------------------------------------------------------------------------------------
Borrower Workout Plans: \*\
    Total...........................................       324       340       399       475       503     2,041
    Prime...........................................       135       132       150       173       206       796
    Subprime........................................       189       208       248       301       296     1,242
Formal Repayment Plans Initiated:
    Total...........................................       271       275       323       333       323     1,525
    Prime...........................................       111       102       120       136       159       628
    Subprime........................................       160       173       203       197       165       898
Loan Modifications Completed:
    Total...........................................        54        65        76       141       179       515
    Prime...........................................        24        30        30        37        48       169
    Subprime........................................        29        35        46       104       132       346
----------------------------------------------------------------------------------------------------------------
\*\ Workout plans are the sum of formal repayment plans initiated and loan modifications completed.
Note: Numbers may not add due to rounding.
Source: HOPE NOW Alliance.

    According to the Mortgage Bankers Association's National 
Delinquency Survey, the performance of prime mortgages 
deteriorated from the prior quarter. In fourth quarter 2007, 
5.82 percent of all mortgage loans were 30 days or more past 
due. The percentage of all mortgages that were seriously 
delinquent (loans that are 90 days or more past due or in the 
process of foreclosure) was 3.62 percent The survey reported 
that 3.24 percent of conventional prime mortgages were 30 days 
or more past due. The percentage of prime mortgages that were 
seriously delinquent was 1.67 percent.
    Delinquency and foreclosure rates for subprime mortgages 
continue to rise. In fourth quarter 2007, 17.31 percent of 
subprime mortgages were 30 days or more past due, while 14.44 
percent of these mortgages were seriously delinquent. Subprime 
ARMs continue to experience the. greatest stress. In fourth 
quarter 2007, 20.02 percent of subprime ARMs were 30 days or 
more past due, while 20.43 percent of these mortgages were 
seriously delinquent. The Mortgage Bankers Association does not 
provide a breakout for Alt-A loans.
    At FDIC-insured banks and thrifts, the ratio of noncurrent 
(90 days or more past due or on nonaccrual) 1-4 family 
residential mortgage loans increased to 2.06 percent in fourth 
quarter 2007. This level is double that of one year ago, when 
the ratio was 1.05 percent, and is the highest noncurrent level 
since at least 1991.
                                ------                                --
----


         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                      FROM SHEILA C. BAIR

Q.1. How accurate and predictive were the risk models used by 
banks and ratings agencies in identifying the risks now 
unfolding in the current market turmoil?

A.1. Banks, ratings agencies, and regulators vastly 
underestimated the risks in mortgage markets and in complex 
highly-rated securities. Even today, it is difficult to 
quantify these risks. Models did not forecast the significant 
deterioration in the credit markets, nor did they predict the 
fact that adverse events would be highly correlated, making a 
bad situation worse. The models failed to capture what is 
referred to as ``tail risk,'' the risk of loss associated with 
extreme events. Yet it is those same events that can threaten 
the solvency of our financial system. The models that will be 
used by banks in determining capital requirements under the 
advanced approaches are based largely on the same models that 
are used by the ratings agencies that failed to capture the 
massive losses in the credit markets.

Q.2.a. If the advanced approaches could have been put in effect 
immediately after they were published by the Basel Committee in 
June, 2004: Would banks using these approaches have been 
required to hold more capital against their mortgage 
portfolios?

A.2.a. No. The U.S. Quantitative Impact Study-4 (QIS-4) 
estimated the advanced approaches would reduce median capital 
requirements for mortgages and home equity loans by 73 percent 
and 80 percent respectively. If banks had been allowed to 
implement such reductions in capital requirements for their 
mortgages, they would have been much more vulnerable going into 
the current problems.
    The QIS-4 result likely reflects that the formula 
underlying the advanced approach mortgage capital requirements 
was developed during a period of benign credit conditions and 
historically robust house price appreciation. Banks calculate 
their mortgage capital requirements in the advanced approaches 
by inputting certain key parameters (probability of default 
(PD), loss given default (LGD) and exposure at default (EAD)) 
for the various pools of mortgages they hold, reflective of 
their own historical credit loss experience for similar 
mortgages, into a function prescribed in regulation.
    Some have argued that the advanced approaches would require 
more capital than QIS-4 estimated. No one has disputed, to our 
knowledge, that any reasonable approach to estimating 
historical mortgage credit losses over a long period of time 
prior to the current crisis would result in PI, LGD and EAD 
values that, if input into the advanced formula, would result 
in extremely large reductions in mortgage capital requirements 
compared to Basel I levels. The problem with this result, as we 
have seen in the current environment, is that perceptions of 
minimal risk based on historical statistics can induce lenders 
to change underwriting standards and develop new products that 
may sharply elevate losses compared to historical norms.

Q.2.b. Would the advanced approaches have generated sufficient 
capital requirements to account for the risks present in highly 
rated CDOs and other complex securities that have caused losses 
in the tens of billions for large financial institutions?

A.2.b. No. The advanced approaches reduce the capital 
requirements significantly compared to the current rules and 
could well have encouraged banks to hold more AAA-rated CDOs. 
For many of these exposures, the capital requirements are 
reduced by almost two thirds from 1.6 percent to 0.56 percent 
of face value, or equivalently from a 20 percent risk weight 
down to a 7 percent risk weight. This result is not unique to 
CDOs. Under the advanced approaches most AAA-rated securities 
are expected to receive this same reduction in capital 
requirements. The new framework thus risks giving banks an 
incentive to rely on ratings to an even greater extent than 
before.
    The Basel Committee recently announced that it will revisit 
the 7 percent risk weight for certain types of resecuritized 
assets such as CDOs. While worthwhile, it is noted that this 
effort should be considered a response to current events rather 
than an aspect of the advanced approaches that would have 
forestalled or mitigated the development of those events.

Q.2.c. Would the advanced approaches have provided a regulatory 
capital incentive for banks to avoid the use of off-balance 
sheet conduit financing arrangements such as SIVs?

A.2.c. No. The advanced approaches require no capital for bank 
SIV structures in which the bank has no legal commitment to 
support such entities. In recent months we have seen banks 
around the world take large volumes of assets back on their 
balance sheets--assets that were held in SIVs or other 
conduits. In many cases it appears there was no contractual 
legal obligation for banks to do this and, consequently, the 
banks were not required to hold capital against these 
exposures. There is nothing in Basel II that would require 
banks to hold capital before the fact against off-balance sheet 
entities in cases where the bank has no contractual legal 
obligation to provide support. After the bank has provided 
support, supervisors can determine the bank has de facto risk 
exposure and can require capital, yet even this is not a hard 
and fast requirement.
    The advanced approaches treatment of off-balance sheet 
entities where the bank does have a legal obligation to provide 
support also is of interest. Historically, Basel I provided a 
loophole where banks were required to hold capital against off-
balance sheet liquidity facilities with maturities of one year 
or more but were not' required to hold capital where the 
liquidity facilities had maturities of less than one year. Not 
surprisingly, many banks began using 364-day maturity renewable 
liquidity facilities to avoid the capital requirement. The U.S. 
banking agencies closed this loophole in 2004. Outside the 
U.S., however, the loophole remained open, and Basel II does 
have the advantage in those countries of closing that loophole.
    With respect to the amount of capital required for off-
balance sheet exposures, extreme caution is warranted in 
asserting Basel II is an improvement. FDIC calculations based 
on the QIS-4, for example, showed that the total amount of 
capital required for off-balance sheet exposures was 
considerably less under the advanced approaches than under the 
current rules. This reflects the greater flexibility banks have 
in the advanced approaches both to model the amount of their 
exposure and to use their own risk estimates to determine the 
appropriate risk weight for the exposure.

Q.2.d. Would the advanced approaches have provided a regulatory 
capital incentive for banks to avoid excessive dependence on 
bond insurers?

A.2.d. No. The advanced approaches give significant new capital 
relief for banks entering into credit default swaps with bond 
insurers. Under the advanced approaches, banks would be able to 
gain significant capital benefits under the assumption that 
they can transfer significant amounts of their credit risk to 
insurance companies and other parties through complex 
structures such as credit derivatives. The new rules also 
provide capital benefits that assume that there is very little 
correlation between the creditworthiness of the insurer and 
that of the banks' exposure. During the recent credit market 
turmoil, we have witnessed a significant deterioration in the 
creditworthiness of many of the financial guarantors that banks 
rely upon to cover losses. Further, the fortunes of both the 
banks' exposures and that of the insurer appear to be tied much 
more closely than we had anticipated. Under these conditions, 
the capital requirements might not fully be capturing that 
connection and might not fully reflect this risk.

Q.2.e. Would the advanced approaches have required banks to 
hold more capital against commercial real estate?

A.2.e. No. The QIS-4 estimated banks would have to hold about 
half the capital (median decline) against their commercial real 
estate (CRE) exposures. As described above for mortgages, banks 
calculate their CRE capital requirements by inputting their own 
estimates of the PDs, LGDs and EADs applicable to their CRE 
exposures into supervisory formulas. The capital requirements 
generated by such formulas depend upon these inputs, which in 
turn are heavily influenced by historical credit loss 
experience.
    The roughly 50 percent median reduction in capital 
requirements for CRE estimated by the QIS-4 was surprising to 
many observers because CRE is historically a relatively risky 
bank asset class. However, a large reduction in CRE capital 
requirements is exactly what the advanced approaches can be 
expected to deliver during a period of strong economic 
conditions. If such a reduction in CRE capital requirements had 
been put into effect in the years leading up to the current 
crisis, banks would be much less well positioned to deal with 
credit losses.

Q.2.f. Would the advanced approaches have required banks to 
hold more capital against leveraged commercial loans?

A.2.f. Capital for C&I loans, in general, declined (median) in 
the QIS-4 by about a third. In addition, please see our answers 
to questions 2a and 2e.

Q.2.g. Would the advanced approaches have required more capital 
overall, so that large banks would have been better capitalized 
going into the current market turmoil?

A.2.g. No. The median decline in risk-based capital 
requirements reported by the 26 U.S. banks in QIS-4 was 26 
percent, with a number of banks reporting declines of 30 
percent to 50 percent. Significant reductions in capital 
requirements were reported across all major loan categories 
with the exception of credit cards. Significant reductions in 
capital requirements also were reported for securitization 
exposures. The 26 percent median reduction in capital 
requirements includes the effect of Basel II's new capital 
charge for operational risk, indicating that the additional 
capital reported for the new charge was swamped by the large 
reductions in capital requirements for credit risk. The 26 
percent median reduction in capital requirements did not 
include the effect of a 1.06 ``scaling factor'' applied to the 
credit risk charge under the final rule that would dampen these 
reported capital reductions but not qualitatively change the 
overall result of large reductions in capital requirements.
    To reiterate points made in responses to earlier questions, 
had large U.S. banks been permitted during the years leading up 
to the current crisis to implement reductions in capital 
requirements of the magnitudes suggested by the advanced 
approaches, the banking system would be much more vulnerable 
today.

Q.3. Would banks reduce their actual capital in response to the 
advanced approaches?

A.3. Yes. We believe the evidence suggests banks would use the 
leeway available to them under the advanced approaches to 
reduce their capital.
    A comparison of the capital levels of large European banks 
versus large U.S. banks provides strong evidence that banks 
will reduce their capital levels when given a regulatory 
opportunity to do so. Ratios of tier 1 capital to balance sheet 
assets of large European banks typically are in the range of 
two percent to four percent, with the very largest institutions 
typically being closer to two percent. These banks have no 
direct regulatory constraint on financial leverage. U.S. banks, 
in contrast, do face leverage ratio requirements under the 
Prompt Corrective Action regulations, and the insured banks 
hold tier 1 capital well in excess of five percent of balance 
sheet assets as a direct result of these regulations.
    Capital regulation matters a great deal for the capital 
banks actually hold. Throughout the development of Basel II, 
most banks involved in the discussions understood Basel II and 
especially the advanced approaches to be an opportunity to 
lower their capital requirements. This accounts for the almost 
universal endorsement by large banks of the core elements of 
Basel II, which was tempered when constraints on capital 
reductions became part of the U.S. discussions.
    A case in point is given by Northern Rock, the British bank 
with assets of about $200 billion that was recently 
nationalized. We understand that the British regulators 
provided banks that were interested, and deemed ready, the 
opportunity to implement certain aspects of the advanced 
approaches in 2007. In reference to the 44 percent reduction in 
risk-weighted assets Northern Rock reported using the advanced 
methodologies for its retail portfolio, its CEO wrote:

          We are pleased to have achieved approval for use of our Basle 
        II rating systems. This means that the benefits of Basle II 
        enable us to increase our 2007 interim dividend by 30 percent. 
        Going forward our dividend payout rate increases to 50 percent 
        of underlying EPS from around 40 percent. Future capital 
        planning, including the reduction of capital hungry assets, 
        will allow us to return capital to shareholders through a share 
        buyback programme. The medium term outlook for the Company is 
        very positive.--CEO Adam Applegarth, Northern Rock Interim 
        Results, June 30, 2007.

Q.4. Would the advanced approach require banks to raise capital 
substantially during a downturn?

A.4. The advanced approaches capital requirements could rise 
sharply during a downturn compared to pre-downturn levels. This 
could cause banks to be either out of regulatory compliance or 
forced to raise substantial capital when they are least able to 
do so.
                                ------                                --
----


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM SHEILA C. 
                              BAIR

Q.1. Although not all the items that you suggested were 
included in this package and there might need to be a few 
tweaks, are there any items in this package that your agency 
cannot support or are these all items that would increase 
regulatory efficiency without. compromising safety and 
soundness and important consumer protections?

A.1. With one exception discussed below, the package of 
regulatory burden relief amendments generally does not raise 
significant safety and soundness or consumer protection 
concerns for the FDIC. In addition, our staff has identified a 
few technical issues that may merit further staff-to-staff 
discussion. FDIC staff will contact your staff to address 
issues regarding the bill's provisions that would eliminate the 
current statutory requirement for notice to the FDIC of certain 
public welfare investments by banks. We also would like to 
discuss some technical drafting suggestions to avoid unintended 
consequences from the bill's provisions regarding the 
applicability of section 404 of the Sarbanes-Oxley Act to small 
banks.
    The one provision the FDIC does not support is the proposal 
to raise the small institutions exception threshold for annual 
examinations from less than $500 million to less than $1 
billion in total assets. Current law requires the banking 
agencies to conduct a full-scale, on-site examination of the 
depository institutions under their jurisdiction at least every 
12 months. There is an exception for certain small institutions 
(i.e., institutions with total assets of less than $500 
million) that requires examinations of these qualifying smaller 
institutions at least every 18 months. At this time, the FDIC 
would not support raising the threshold and extending the 
examination cycle for institutions of $500 million or more. The 
threshold was only raised to $500 million in late 2006 and it 
would be useful to have more experience with this change, 
especially in the current challenging economic times, before 
considering expanding the exception.

Q.2. Since all of these items have been vetted and reviewed in 
past hearings before the Banking Committee, is there any reason 
to not move quickly forward with a package along these lines?

A.2. With the exception of the issues regarding increasing the 
exception threshold for annual exams for small institutions, it 
is likely that remaining issues regarding the regulatory relief 
proposal could be resolved fairly easily. In addition, we would 
recommend consideration of items from the legislative package 
provided to you by the FDIC in response to your previous 
request that should help reduce regulatory burden and improve 
regulatory efficiency.
                                ------                                --
----


  RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM JOHN C. 
                             DUGAN

                         ANTI-UNION REGULATION

Q.1. Last year, the Department of Labor issued a regulation 
drastically expanding the personal financial information union 
officers and employees must submit to the Department. The new 
LM-30 rule will require more than 150,000 union volunteers, 
employees, and their families to report the terms of mortgages, 
car loans, and even student loans. To determine whether they 
must report such interests, these individuals must ascertain 
(1) whether the bank providing a loan does any business with 
the person's union, or (2) whether the bank does 10 percent of 
its business with firms whose employees are in the same union. 
The regulation requires individuals to write to banks asking 
for this info, and, then, if banks won't provide such 
information, to contact the Department of Labor for assistance. 
In the meantime, individuals are required to make good faith 
estimates of the bank's business with their unions and 
unionized firms.

      Given your agency's expertise in the regulation 
and practices of banks, do you believe that banks are able--and 
willing--to inform their customers whether they do business 
with particular unions and how much of their ``business'' and 
``business receipts'' are with particular unionized firms?

      Are banks obligated or prohibited by any federal 
or state law to disclose to their customers how much 
``business'' or ``business receipts'' they have with particular 
unionized firms? Can banks simply refuse to answer these 
written inquiries?

      What type of administrative burden will this LM-
30 rule, and the hundreds of thousands of resulting inquiries, 
place on banks and are banks currently prepared to respond to 
these inquiries?

      If banks don't provide this non-public 
information, is there any ``information reasonably available'' 
to the public that union officers, employees, and members could 
use to make good faith estimates?

A.1. On July 2, 2007, the Department of Labor's Office of 
Labor-Management Standards (OLMS) published a final rule 
revising Form LM-30 Labor Organization Officer and Employee 
Report and its instructions (Final Rule).\2\ The Final Rule is 
effective for fiscal years beginning August 16, 2007, and the 
first reports on the revised LM-30 must be made 90 days after 
the end of the fiscal year. Thus, no reporting is due until 
November 2008.
---------------------------------------------------------------------------
    \2\ 72 Fed. Reg. 36106 (July 2, 2007).
---------------------------------------------------------------------------
    Form LM-30 is used by officers and employees of labor 
organizations subject to the Labor-Management Reporting and 
Disclosure Act of 1959 (LMRDA). The LMRDA requires public 
disclosure of certain financial interests held, income 
received, and transactions engaged in by labor organization 
officers and employees and their spouses and minor children. 
Financial institutions do not have to report payments or loans 
under section 203 of the LMRDA.\3\ Therefore, national banks 
are not required to report customer information under the 
LMRDA.
---------------------------------------------------------------------------
    \3\ Id. at 36119.
    \4\ A ``trust in which a labor organization is interested'' is a 
trust or other fund or organization (1) that was created or established 
by a labor organization, or one or more of the trustees or one or more 
members of the governing body is selected or appointed by a labor 
organization, and (2) a primary purpose of which is to provide benefits 
for the members of such labor organization or their beneficiaries.
---------------------------------------------------------------------------
    Under the final rule, union officers are not required to 
report most loans, interest, or dividends from financial 
institutions. However, the following loans must be reported:

      A loan to a union official from a financial 
institution that is an employer whose employees the official's 
labor organization represents or is actively seeking to 
represent.

      A loan to a union official from a financial 
institution that is a trust in which the official's labor 
organization is interested.\4\

      A loan to a union official from a financial 
institution that is: (1) a business that buys from, sells, or 
otherwise deals with the official's labor organization; (2) a 
business that buys from, sells, or otherwise deals with a trust 
in which the official's labor organization is interested; or 
(3) a business a substantial part of which (10% or more) 
consists of buying from, selling to, or otherwise dealing with 
an employer whose employees the official's labor organization 
represents or is actively seeking to represent.

    In January of this year, the AFL-CIO filed a lawsuit 
against the Labor Department challenging the Final Rule under 
the Administrative Procedure Act. The lawsuit is pending in the 
U.S. District Court for the District of Columbia (Case 1:08-cv-
00069). The lawsuit challenges five aspects of the Final Rule's 
modifications to the LM-30, one of which is the treatment of 
loans from financial institutions. The AFL-CIO claims that the 
LMRDA does not support the requirement that loans be reported 
on the LM-30 if the institution deals with the borrower's labor 
organization or a trust in which that organization is 
interested or does a substantial part of its business with 
employers whose employees the labor organization represents or 
seeks to represent. The AFL-CIO has filed a motion for summary 
judgment, and the parties have completed briefing on that 
motion.
    Given that these issues are in active litigation in which 
we are not involved, we are simply not in a position to comment 
on any of the requirements for reporting of bank loans on the 
LM-30.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 


          NEW COMPREHENSIVE OCC REPORT ON MORTGAGE PERFORMANCE


   Remarks by John C. Dugan, Comptroller of the Currency, Before the 
              American Securitization Forum, June 11, 2008

    It's a pleasure to be here with all of you this morning. 
The American Securitization Forum brings together key 
participants in securitization markets, which have financed an 
extraordinary amount of economic activity over the last several 
decades. Many of the roughly 1,700 national banks that the OCC 
supervises play outsized roles in these markets, as loan 
originators, servicers, structurers, trustees, dealers, 
distributors, and investors--and that's not an exhaustive list. 
They have been deeply involved in the growth of securitization, 
and nowhere has that been more apparent than in the phenomenal 
growth of residential mortgage securitization markets.
    For example, in 2007, national banks originated about 45 
percent of all home mortgages in the United States. They also 
act as servicers for about 44 percent of all U.S. mortgages. 
About 90 percent of the mortgages they service are held by 
third parties via securitization by Fannie Mae, Freddie Mac, 
and other financial institutions. National banks also hold a 
substantial amount of both mortgage securities and first 
mortgages on their balance sheets, which together total over 
$1.7 trillion. In short, over the last 20 years, national banks 
have become much more centrally involved in the mortgage 
business, and as a result, the OCC has become much more 
centrally involved in the supervision of these activities.
    Needless to say, against this backdrop, the mortgage market 
disruptions of the last year have been exceptionally 
challenging for both national banks and their supervisor. 
Fortunately, the banks we supervise were well capitalized going 
into this turmoil. In addition, their diversified businesses 
and strong deposit franchises have been real sources of 
strength, and they have benefited from the fact that they hold 
and service a disproportionately small share of subprime 
mortgages--only about 10 percent. Still, several national banks 
have sustained exceptionally large losses from mortgage-related 
assets--which they have offset by successfully raising 
capital--and mortgage exposure and mortgage involvement remain 
substantial across the national banking system.

                      THE NEED FOR BETTER METRICS

    As mortgage delinquencies and foreclosures have climbed, 
the OCC has intensified our already heavy focus on mortgage 
supervision. In this context, we began to realize that the 
substantial amount of mortgage data we had previously collected 
from our banks was not giving us a sufficiently granular look 
at declining mortgage performance. At the same time, given 
their leading role as mortgage servicers, national banks began 
to receive numerous and differing requests for data about 
mortgage performance and mortgage modifications from 
organizations around the country, including members of 
Congress, news organizations, and state and local governments.
    We also came to realize that there were some significant 
limitations with the mortgage performance data reported by 
other organizations and trade associations. These other sources 
often used differing definitions of ``prime,'' ``subprime,'' 
``Alt-A,'' and ``delinquency.'' This lack of standardized 
definitions made comparisons difficult across different 
studies. The same was true with respect to the different ways 
in which both institutions and data collectors described 
``mortgage mitigations,'' with some counting any contact with a 
borrower about payment reduction or relief as a mitigation in 
process, while others did not count mitigation efforts until a 
particular mitigation plan had been formally implemented. And 
virtually none of the data had been subjected to a rigorous 
process to check for consistency and completeness--they were 
typically responses to surveys that produced aggregate, 
unverified results from individual firms. That lack of loan-
level validation raised real questions about the precision of 
the data, at least for our supervisory purposes.
    In this context, the OCC realized we had a real opportunity 
to improve the way that mortgage performance could be measured, 
producing better information for our particular supervisory 
purposes, and better information for policymakers, other 
regulators, market participants, and the public at large. That 
is, we realized that a relatively small number of our largest 
national banks--nine, to be exact--conducted over 90 percent of 
servicing activities engaged in by our entire national banking 
population. These banks service about 40 percent of all U.S. 
home mortgages outstanding. They are large and have in place 
the kind of information systems that allow them to produce 
significant amounts of data that can be tailored to particular 
requests. And perhaps most important, we as their primary 
federal regulator could require them to take several important 
steps: report to us loan-level data on roughly 23 million loans 
for homes in every state in the country, totaling $3.8 
trillion; report such data in a common format, using 
standardized definitions; and validate the data submitted.
    So, we seized this opportunity. The participating banks 
immediately understood both our needs and the value of 
producing more precise information using common metrics and 
definitions. They have worked closely with us and the third-
party data aggregator we hired to begin reporting the 
extraordinary volume of information we have requested in the 
format we have established. And the aggregator has worked 
closely with us to translate key parts of that data into a 
report that can be issued to the public.

                  OCC'S FIRST MORTGAGE METRICS REPORT

    Today, I am pleased to unveil findings from the first OCC 
Mortgage Metrics Report, which covers loan-level mortgage 
information for the last two calendar quarters, from October 1, 
2007, to March 31, 2008. In the future, we plan to issue a 
Mortgage Metrics Report each quarter.
    Before I summarize key results from this first report, let 
me explain how it differs from other reports and data 
collection efforts, and how it addresses concerns that I 
previously identified.
    First, OCC Mortgage Metrics are comprehensive. They reflect 
activities of many of the industry's largest mortgage 
servicers--not just holders of the mortgages. In addition, the 
metrics capture information on all mortgages, not just 
subprime.
    Second, the report is based on ``loan-level'' data. In 
contrast with other reports that rely on surveys of lenders or 
interpretations of data, we collected 64 specific pieces of 
information on more than 23 million loans for each month of the 
reporting period. These include such data elements as credit 
score, interest rate, unpaid balance, property value, and 
payment history. This loan-level data can be analyzed more 
rigorously and in a wider variety of ways than information 
obtained through surveys.
    Third, our Mortgage Metrics use terms and definitions that 
are standardized. Today, if you simply ask lenders how many 
subprime loans they have, you'll get answers based on different 
definitions, because certain loans in one lender's subprime 
book may be another bank's Alt-A. Indeed, at the large national 
banks we supervise, the dividing line for prime, subprime, and 
Alt-A loans can vary widely across a range of credit scores and 
other characteristics of the loan and borrower. Our 
standardized Mortgage Metrics eliminate these disparities.
    For example, the three categories of creditworthiness in 
the report--prime, Alt-A, and subprime--are defined using FICO 
credit scores at the time of loan origination. We use the 
following breakpoints that have often, but not always, been 
used by industry analysts: prime--660 and above; Alt-A--620 to 
659; and subprime--below 620. Some may quibble with this 
particular segmentation, but the point is that they are the 
same quantifiable criteria used in every case, and as a result, 
``subprime'' will mean the same thing for each servicer and 
each loan.
    The metrics also establish a common--and conservative--
definition for ``newly initiated'' loss mitigation actions. A 
payment plan or loan modification won't count unless the 
servicer and borrower have entered into an agreement. This 
results in fewer loss mitigation actions reported, but a better 
picture, we believe, of the actual occurrence of such actions.
    Now, let me hasten to add that our new OCC metrics are not 
perfect. There has definitely been some ``noise,'' especially 
in this large initial data collection looking backward for six 
months. For example, 20 percent of the loans fell into an 
``other'' category, which meant that a credit score was 
unavailable. The inability to obtain such scores typically 
reflects problems with the flow of information through the 
systems that produce the data--purchased loan portfolios, for 
example, that came with databases that can't easily be read by 
the servicer's computer system. Now that the new data 
collection system has been established, we expect this problem 
to decline on a ``go forward'' basis as servicers realize that 
they will need this data whenever they acquire servicing 
portfolios in the future.
    In addition to the ``noise'' in the overall data set, we 
need to be cautious about identifying trends in a six-month 
sample. Month-to-month data may be quite volatile and subject 
to fairly strong seasonal effects that can only be discerned 
from a longer time series that permits year-to-year 
comparisons. So observed changes month to month should be taken 
with a grain of salt.
    Before turning to key results of the report, let me provide 
another important caveat: some of the conclusions we report 
here may seem different from conclusions that have been widely 
reported elsewhere--but there are good reasons for these 
differences. As I said previously, we believe the data is more 
precise than data reported in some other studies, and it 
reflects a huge proportion of the mortgages outstanding in the 
country. It obviously does not capture all mortgages, however, 
and it is not a statistically random sample.
    The particular population of mortgages held and serviced by 
these nine national banks has some different characteristics 
than the overall population of mortgages. This difference can 
cause different results. For example, the proportion of 
subprime loans in the pool is smaller than in the general 
population--national banks service only about 25 percent of all 
subprime mortgages, but they service 40 percent of all 
mortgages outstanding. Similarly, the prime mortgages serviced 
by national banks include a disproportionately high number of 
conforming loans sold to the GSEs--about 66 percent, compared 
to 43 percent for the industry overall.
    Finally, the standardized definitions produce different 
results. Other studies that don't break out Alt-A separately 
will lump these loans in either the prime category--thereby 
elevating delinquency and foreclosure ratios for those loans--
or the subprime category--where it will have the opposite 
effect.
    In short, while there are good reasons for the differences, 
the summary data from this first Mortgage Metrics report in 
some cases vary significantly from comparable categories 
recently reported in other surveys.

                          SIGNIFICANT FINDINGS

    So, with that quite long wind-up, what does this first 
report tell us? Here are six key findings.
    First, one somewhat surprising finding is that the overall 
mortgage servicing portfolio of the nine banks reflects credit 
quality that is relatively satisfactory and relatively stable. 
For example, the number of current and performing loans 
remained at about 94 percent over the entire six-month period. 
Serious delinquencies, which we define as bankrupt borrowers 
who are 30 days delinquent and all delinquencies greater than 
60 days, increased just one tenth of a percentage point during 
the period, from 2.1 percent to about 2.2 percent. This overall 
quality and stability likely reflects the differences in the 
national bank servicing portfolio that I described above.
    Second: Among the three segments of loans, we found, not 
surprisingly, that the majority of serious delinquencies was 
concentrated in the highest risk segment--subprime mortgages. 
Though these mortgages constituted less than 9 percent of the 
total portfolio, they sustained twice as many delinquencies as 
either prime or Alt-A mortgages.
    The third finding concerns loss mitigation actions, which 
for purposes of this report include only loan modifications and 
payment plans. Consistent with other reports, payment plans 
predominated, outnumbering loan modifications in March by more 
than four to one. But loan modifications increased at a much 
faster rate during the period.
    Servicers also indicated they are working with Fannie Mae, 
Freddie Mac, the Federal Housing Administration, and private 
investors to develop and offer new loss mitigation options. In 
fact, mortgage servicers reported several alternative loss 
mitigation actions not included in this analysis that we plan 
to include in future reports, including HomeSaver Advance, 
FHASecure, partial claims, new subsidy programs, and refinances 
with principal forgiveness. These actions provide banks 
additional alternatives to mitigate their risks and work with 
troubled borrowers.
    Fourth: Although subprime mortgages made up less than 9 
percent of the portfolio, they accounted for 43 percent of all 
loss mitigation actions at the end of March. Indeed, for these 
borrowers in that month, total loss mitigation actions exceeded 
newly initiated foreclosure proceedings by a margin of nearly 2 
to 1.
    Fifth: As in other studies, our report confirms that 
foreclosures in process are plainly on the rise, with the total 
number increasing steadily and significantly through the 
reporting period from 0.9 percent of the portfolio to 1.23 
percent. Interestingly, the number of new foreclosures has been 
quite variable. While one month does not make a trend, new 
foreclosures in March declined to 45,696, down 21 percent from 
January's high and down about 4.5 percent from the start of the 
reporting period last October. Similarly, the ratio of new 
foreclosures to serious delinquencies was lower in March than 
in either January or October.
    Sixth and finally, the data also show that seriously 
delinquent subprime loans had fewer new foreclosure starts than 
seriously delinquent prime or Alt-A mortgages. Why would 
troubled prime loans have more foreclosure starts than troubled 
subprime loans? One possible explanation is that the national 
emphasis on developing alternatives and assistance programs has 
been targeted to subprime borrowers, allowing a higher 
percentage of these borrowers to stave off foreclosure.

                       VALUE OF MORTGAGE METRICS

    These are just a few of the key findings from the first 
report, which will be available on our Web site. I urge you to 
review it yourselves for other information that you may find 
useful. That's exactly what we are doing, both with this and 
the other data we have collected, since we believe it will 
serve a variety of useful purposes.
    For example, the data will help us develop supervision 
policy and strategies. Examiners will be able to use the 
information to identify anomalies; compare national bank trends 
to the industry; evaluate asset quality and loan-loss reserve 
needs; and evaluate the effectiveness of loss mitigation 
actions. Over time, it will allow us to drill down to look at 
trends in performance based on origination channels or key 
credit characteristics. This in turn will help us more fully 
assess losses, loan modifications, payment plans, and recovery 
efforts.
    In the future, I hope that the standard definitions and 
methodology used in this report will be applied more broadly to 
an even larger proportion of the pool of outstanding mortgages. 
The more we can use standardized metrics across the board, the 
better we can measure, monitor, and manage mortgage risk.
    With this thought very much in mind, we have shared these 
standard definitions with the Office of Thrift Supervision, 
which has also begun requiring the thrifts it supervises to 
make similar monthly reports. If we could combine our results 
in future reports, the coverage would extend to 60 percent of 
all outstanding mortgages. We would also be interested in 
sharing the definitions and methodologies with other interested 
data collectors, like the state task force that is gathering 
data from a range of providers.
    Going forward, we think it makes sense to have a national 
standard for mortgage reporting. The American Securitization 
Forum is in a position to help advance this process, and I 
would encourage you to join us in working toward a common and 
uniform mortgage reporting regime in the U.S.
    While we think these metrics are useful, we know they are 
not perfect. We welcome input by other regulators and industry 
participants to refine and improve them going forward. In the 
end, we will all benefit from having more accurate and 
standardized mortgage metrics to make better business and 
policy decisions, and to avoid needless foreclosures.
    Thank you very much.
                                ------                                --
----


  RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM JOHN C. 
                             DUGAN

Q.1. Although not all the items that you suggested were 
included in this package and there might need to be a few 
tweaks, are there any items in this package that your agency 
cannot support or are these all items that would increase 
regulatory efficiency without compromising safety and soundness 
and important consumer protections?
    Since all of these items have been, vetted and reviewed in 
past hearings before the Banking Committee, is there any reason 
to not move quickly forward with a package along these lines?

A.1. We have reviewed the regulatory burden relief amendments 
proposed by Senator Crapo in the amendment to the ILC 
legislation that the Senator filed, but did not offer, at the 
markup of that legislation held on February 13, 2008. Our 
comments follow:

      Depository Institution Community Development 
Investments (Sec. 4) \1\
---------------------------------------------------------------------------
    \1\ Section numbers correspond with the section numbers in the 
Crapo amendment to the ILC legislation, which is the most recent 
version of the text of the provisions that we have seen.

    This amendment would restore the original scope of national 
banks' public welfare investment authority pursuant to 12 
U.S.C. Sec. 24(Eleventh). Although the Financial Services 
Regulatory Relief Act of 2006 (FSRRA) \2\ increased the 
permissible amount of national banks' public welfare 
investments, it also narrowed the applicable standard to 
require that such investments ``benefit primarily'' low- and 
moderate-income communities or families. As a result, national 
banks' ability to make public welfare investments, that would 
help economically distressed or underserved middle-income areas 
has been curtailed. The amendment would restore the original 
language of section 24(Eleventh) so that the applicable 
standard would once again be that investments must be 
``designed primarily to promote the public welfare.''
---------------------------------------------------------------------------
    \2\ Pub. L. No. 109-351, Sec. 305, 120 Stat. 1966, 1971-72 (Oct. 
13, 2006).
---------------------------------------------------------------------------
    The OCC strongly supports the amendment,\3\ and we.are 
grateful for Senator Crapo's inclusion of it in this package, 
as well as his support for its inclusion in other legislative 
vehicles in this Congress.
---------------------------------------------------------------------------
    \3\ See Letter from John C. Dugan, Comptroller of the Currency, to 
Senator Mike Crapo, January 25, 2008 (identifying 4 items for inclusion 
in regulatory relief legislation). See also Remarks by John C. Dugan 
Before the National Ass'n of Affordable Housing Lenders, Washington, 
D.C., February 12, 2008, available at www.occ.gov/ftp/release/2008-
14a.pdf.

---------------------------------------------------------------------------
     Gramm-Leach-Bliley Act Amendment (See. 6).

    This amendment would eliminate the annual privacy notice 
requirement for those financial institutions that do not 
disclose nonpublic personal information to any nonaffiliated 
third party in a manner that would be subject to a consumer's 
right to opt out under the Gramm-Leach-Bliley Act (GLBA) or the 
Fair Credit Reporting Act (FCRA) and that have not changed 
their disclosure policies since the most recent previous annual 
notice. The OCC supports this amendment. We note, as a 
technical matter, that the cross-reference to section 603 of 
the FCRA should read ``section 603(d)(2)(A)(iii)'' in order to 
capture precisely the non-transaction or experience information 
that is subject to customer opt-out.

      Sarbanes-Oxley Act Amendment Relating to 
Community Bank Exceptions (Sec. 7)

    This amendment would except from the requirements of 
section 404 of the Sarbanes-Oxley Act (pertaining to auditor 
attestation of management's assessment of internal controls) 
insured banks with consolidated assets of $1 billion or less. 
The OCC supports this Amendment.\4\
---------------------------------------------------------------------------
    \4 \ See Testimony of Julie L. Williams, First Senior Deputy 
Comptroller and Chief Counsel, Before the Committee on Banking, Housing 
and Urban Affairs, U.S. Senate, March 1, 2006, at pp. 9-10 (OCC 
Testimony) (noting high cost of compliance with section 404 for smaller 
banks).

      Examination Schedule for Certain Community Banks 
---------------------------------------------------------------------------
(Sec. 8)

    The OCC supports this amendment, which would raise from 
$500 million to $1 billion the asset-size threshold for banks 
to qualify for the expanded 18-month examination cycle 
authorized pursuant to the Federal Deposit Insurance Act.

      Repeal of Delay of Certain Authority of the Board 
of Governors of the Federal Reserve System (Sec. 16)

    The OCC supported the amendment authorizing the Federal 
Reserve Board to pay interest on reserves, which was enacted as 
section 201 of the FSRRA.\5\ We defer to the Board with respect 
to the elimination of the 5-year delayed effective date that 
was incorporated in section 201 and that would be repealed by 
this provision.
---------------------------------------------------------------------------
    \5\ Pub. L. No. 109-351, Sec. 201, 120 Stat. at 1968-69.

      Authority for Interest on Demand Deposits (Sec. 
---------------------------------------------------------------------------
17)

    The OCC supports this amendment, which would repeal the 
prohibition against banks' and Thrifts' offering interest on 
demand deposit accounts, effective 2 years after enactment.

      Interest-Bearing Transaction Accounts Authorized 
for All Businesses (Sec. 18)

    The OCC supports this amendment, which would expand from 6 
to 24 the number of permissible transfers made per month from 
money market deposit accounts. We note that the amendment would 
authorize the Federal Reserve Board to establish a greater 
number of transfers by rule or order and would permit ``the 
Board to determine that such an account is not a ``transaction 
account'' for purposes of section 19 of the Federal Reserve Act 
(subjecting ``transaction accounts'' to reserve requirements). 
We defer to the Board with respect to these grants of 
discretionary authority.

    We agree that all of the above-mentioned items would 
increase regulatory efficiency without compromising safety and 
soundness or consumer protections, and we see no reason to 
delay a legislative package that includes them.
    The OCC takes no position with respect to the provisions 
relating to the authorities of Federal savings associations 
(sections 5, 9, and 10), and we express no view with respect to 
the provisions relating to credit unions (sections 11, 12, 13, 
14, and 15).
    Finally, should the Committee wish to entertain additional 
amendments for inclusion in a regulatory burden relief 
legislative package, we have attached legislative language that 
would implement the two additional provisions that were 
recommended in Comptroller Dugan's letter to Senator Crapo of 
January 25, 2008. These provisions are: (1) the repeal of the 
state opt-in requirement for de novo branching and of the 5-
year state age requirement; and (2) the elimination of the 
``place of 5,000'' requirement from national banks'' general 
insurance agency sales authority. The attached legislative 
language is identical to the language provided with the January 
25 letter.

                                                      May 13, 2008.

        Additional OCC Regulatory Burden Relief Suggestions \1\

    1. Repeal the State Opt-In Requirement for De Novo 
Branching and Repeal the 5-Year State Age Requirement
---------------------------------------------------------------------------
    \1\ These two amendments are identical to those submitted to 
Senator Crapo earlier this year. See Letter from John C. Dugan, 
Comptroller of the Currency, to Senator Mike Crapo, January 25, 2008 
(identifying items for inclusion in regulatory relief legislation).

    2. Delete the ``place of 5,000'' requirement from national 
banks' general insurance agency sales authority

1. SEC __. EASING RESTRICTIONS ON INTERSTATE BRANCHING AND MERGERS.

    (a) De Novo Interstate Branches of National Banks.--
Section. 5155(g) of the Revised Statutes of the United States 
(12 U.S.C. 36(g)) is amended--
          (1) in paragraph (1), by striking ``paragraph (2)'' 
        each place that it appears and inserting ``paragraph 
        (3)''; and
          (2) by inserting after paragraph (1) the following 
        new paragraph and renumbering the remaining paragraphs. 
        accordingly:
          ``(2) Streamlined procedures for certain banks.--
                  ``(A) In general.--The requirements in 
                paragraph (1)(A) shall not apply to the 
                establishment and operation of a de novo branch 
                by a national bank if--
                          ``(i) the bank is a subsidiary of a 
                        bank holding company which is operating 
                        as a bank holding company subject to 
                        the supervision and regulation of the 
                        Board of Governors of the Federal 
                        Reserve System under the Bank Holding 
                        Company Act of 1956 (12 U.S.C. 1841, et 
                        seq.); or
                          ``(ii) the bank is not controlled by 
                        a company for purposes of the Bank 
                        Holding Company Act of 1956.
                  ``(B) Definitions.--For purposes of this 
                paragraph, the terms `subsidiary', `bank 
                holding company', and `company' have the same 
                meaning given to such terms in section 2 of the 
                Bank Holding Company Act of 1956 (12 U.S.C. 
                1841).''
    (b) De Novo Interstate Branches of State Nonmember Banks.--
Section 18(d)(4) of the Federal Deposit Insurance Act (12 
U.S.C. 1828(d)(4)) is amended--
          (1) in subparagraph (A), by striking ``subparagraph 
        (B)'' each place that it appears and inserting 
        ``subparagraph (C)''; and
          (2) by inserting after subparagraph (A) the following 
        new subparagraph and redesignating the following 
        subparagraphs accordingly:
                  ``(B) Streamlined procedures for certain 
                banks.--
                          ``(i) In general.--The requirements 
                        in subparagraph. (A)(i) shall not apply 
                        to the establishment and, operation of 
                        a de novo branch by an insured state 
                        nonmember bank if--
                                  ``(I) the bank is a 
                                subsidiary of a bank holding 
                                company which is operating as a 
                                bank holding company subject to 
                                the supervision and regulation 
                                of the Board of Governors of 
                                the Federal Reserve System 
                                under the Bank Holding Company 
                                Act of 1956 (12 U.S.C. 1841, et 
                                seq.); or
                                  ``(II) the bank is not 
                                controlled by a company for 
                                purposes of the Bank Holding 
                                Company Act of 1956.
                          ``(ii) Definitions.--For purposes of 
                        this paragraph, the terms `subsidiary', 
                        `bank holding company', and `company' 
                        have the same meaning given to such 
                        terms in section 2 of the Bank Holding 
                        Company Act of 1956 (12 U.S.C. 1841).''
    (c) De Novo Interstate Branches of State Member Banks.--The 
3rd undesignated paragraph of section 9 of the Federal Reserve 
Act (12 U.S.C. 321) is amended by adding at the end the 
following new sentences: ``A State member bank may establish 
and operate a de novo branch in a host State (as such terms are 
defined in section 18(d) of the Federal Deposit Insurance Act) 
on the same terms and conditions and subject to the same 
limitations and restrictions as are applicable to the 
establishment of a de novo branch of a national bank in a host 
State under section 5155(g) of the Revised Statutes of the 
United States, Section 5155(g) shall be applied for purposes of 
the preceding sentence by substituting `Board of Governors of 
the Federal Reserve System' for `Comptroller of the Currency' 
and `State member bank' for `national bank'.''.
    (d) Conforming Amendments.--
          (1) Federal deposit insurance act.--Section 44(a) of 
        the Federal Deposit Insurance Act (12 U.S.C. 1831u(a)) 
        is amended by striking paragraphs (5) and (6); and
          (2) Bank holding company act.--Section 3(d) of the 
        Bank Holding Company Act of 1956 (12 U.S.C. 1842(d)) is 
        amended--
                  (A) in paragraph (1)--
                          (i) by striking subparagraphs (B) and 
                        (C); and
                          (ii) by redesignating subparagraph 
                        (D) as subparagraph (B); and
                  (B) in paragraph (5), by striking 
                ``subparagraph (B) or (D)'' and inserting 
                ``subparagraph (B)''.

                              EXPLANATION

    This section would amend section 5155(g) of the Revised 
Statutes of the United States (12 U.S.C. Sec. 36(g)), section 
18(d)(4) of the Federal Deposit Insurance Act (FDIA) (12 U.S.C. 
Sec. 1828(d)(4)), section 9 of the Federal Reserve Act (12 
U.S.C. Sec. 321), and section 3(d)(1) of the Bank Holding 
Company Act (BHCA) (12 U.S.C. Sec. 1842(d)(1)) to ease certain 
restrictions on interstate banking and branching. Under the 
Riegle-Neal Interstate Banking and Branching Efficiency Act of 
1994 (Riegle-Neal Act), an out-of-state national or state bank 
may establish a de novo branch in a state only if that state 
has adopted legislation affirmatively ``opting in'' to de novo 
branching.
    This amendment would repeal the requirement for certain 
national and state banks that a state must opt-in to de novo 
branching to allow this form of interstate branching in the 
state. The language of this amendment is different from the 
version that was included in Sec. 401 of H.R. 3505 and may 
offer a solution to the issues concerning permitting state-
nonmember-bank industrial loan companies (ILCs) controlled by 
commercial companies to engage in unrestricted de novo 
branching that has impeded the enactment of this amendment in 
past Congresses. As explained below, ILCs controlled by 
commercial companies that are not supervised or regulated by 
the Federal Reserve Board (Fed) under the BHCA would not be 
allowed to engage in de novo branching without the state opt-in 
requirement under the amendment.
    This amendment would repeal the requirement that a state 
must adopt an ``opt-in'' statute to permit the de novo 
branching form of interstate expansion but it would repeal the 
requirement only for those national or state banks that are 
organized in one of two ways. First, the amendment would exempt 
a national or state bank from the state opt-in requirement if 
it is a subsidiary of a bank holding company which is operating 
as a bank holding company under the supervision and regulation 
of the Fed in accordance with the BHCA. Second, a national or 
state bank would be exempt from the state opt-in requirement if 
it is not controlled by a ``company'' for purposes of the BHCA. 
Thus, the amendment would repeal the state opt-in requirement 
for any national or state bank that is a subsidiary of a bank 
holding company or is not controlled by any company under the 
BHCA Banks that are subsidiaries of supervised bank holding 
companies or banks that are independent and are not controlled 
by a company would be able to engage in interstate de novo 
branching without being subject to the state opt-in 
requirement.
    Neither of the two exempt forms of organization, however, 
would apply to a bank, such as an ILC that' is controlled by a 
commercial company. While an ILC is a state nonmember bank, it 
is exempt from the definition of a ``bank'' under the BHCA if 
certain conditions are satisfied and, as a result, its parent 
company is not subject to the BHCA and may be a commercial 
firm. These commercial firms are companies for purposes of the 
BHCA but, because they do not control a ``bank'' under the 
BHCA's definition of ``bank'', they do not operate as bank 
holding companies under the Federal Reserve Board's (Fed) 
supervision and regulation and are not subject to the 
restrictions on commercial operations that apply to regulated 
and supervised bank holding companies. Neither of the 
exemptions in the amendment would apply to ILCs controlled by 
commercial firms and they would not be able to engage in 
unrestricted de novo branching under the amendment.
    The amendment also would repeal the state age requirement 
for interstate mergers. The Riegle-Neal Act permits a state to 
prohibit an out-of-state bank or bank holding company from 
acquiring an in-state bank unless the state bank has been in 
existence for a minimum period of time (which may be as long as 
five years). This additional limitation on bank acquisitions by 
out-of-state banking organizations is no longer necessary if 
interstate de novo branching generally is permitted for most 
banks under the amendment described above.
    Under the Riegle-Neal Act, interstate expansion through 
bank mergers generally is subject to a state ``opt-out'' that 
had to be in place by June 1, 1997. While two states ``opted 
out'' at the time, interstate bank mergers are now permissible 
in all 50 states. By contrast, de novo branching by banks 
requires states to pass legislation to affirmatively ``opt-in'' 
to permit out-of-state banks to establish new branches in the 
state and only approximately 23 states have opted in (17 of 
which require reciprocity). As a result, banks in many cases 
must structure artificial and unnecessarily expensive 
transactions in order to simply establish a new branch across a 
state border. However, Federal thrifts are not similarly 
restricted and generally may branch interstate without the 
state law ``opt-in'' requirements that are imposed on banks. 
Also, repeal of the state age requirement would remove a 
limitation on bank acquisitions by out-of-state banking 
organizations that is no longer necessary if interstate de novo 
branching generally is permitted.
    Enactment of this amendment would enhance competition in 
banking services with resulting benefits for bank customers. 
Moreover, it will ease burdens on banks that are planning 
interstate expansion through branches and would give banks 
greater flexibility in formulating their business plans and in 
making choices about the form of their interstate operations. 
Community banks that seek to serve customers across state lines 
would especially benefit since they lack the resource base 
available to larger banks that is required to structure the 
more complicated transactions now required to accomplish that 
result.

2. SEC.__. DELETING THE ``PLACE OF 5,000'' REQUIREMENT FROM NATIONAL 
                    BANKS' GENERAL INSURANCE AGENCY SALES AUTHORITY.

    The 11th undesignated paragraph of section 13 of the 
Federal Reserve Act (12 U.S.C. 92) is amended by striking 
``located and doing business in any place the population of 
which does not exceed five thousand inhabitants, as shown by 
the last preceding decennial census,''.

                              EXPLANATION

    Under current law, unlike state banks, national banks 
cannot engage in general insurance agency activities unless the 
bank is ``located and doing business in any place the 
population of which does not exceed five thousand inhabitants, 
as shown by the last preceding decennial census'' (``place of 
5,000 restriction''), or unless the national bank establishes a 
financial subsidiary. The Gramm-Leach-Bliley Act (GLBA) 
generally provides authority for financial subsidiaries of 
national banks to engage in general insurance agency activities 
subject to the capital, managerial, CRA requirements, and other 
safeguards in GLBA that, apply to the establishment and 
operation of financial subsidiaries under GLBA.\2\ These 
requirements do not apply to state banks engaged in insurance 
agency activities.\3\ The Conference of State Bank Supervisors 
reports that all states but one permit their banks to sell 
insurance as agent and only a very few impose the place of 
5,000 restriction that applies to all national banks.\4\ There 
is no safety and soundness reason to competitively disadvantage 
national banks and subject them to the place of 5,000 
restriction or require that these less risky agency activities 
must be conducted in a financial subsidiary subject to the 
capital deduction requirements and other safeguards while most 
state banks can engage in the same agency activity without 
these restrictions. This amendment would repeal the place of 
5,000 restriction and permit national, banks to sell insurance 
as agent in the same manner as state banks without the GLBA 
financial subsidiary requirements.\5\ Notably, nothing in this 
amendment would affect the functional regulation of insurance 
activities as provided by GLBA.
---------------------------------------------------------------------------
    \2\ To qualify to have a financial subsidiary to engage in general 
insurance agency activities without the place of 5,000 restriction, the 
national bank and each depository institution affiliate must be well 
capitalized and well managed, and the national bank's aggregate 
consolidated total assets of all of its financial subsidiaries is 
subject to a cap. In addition, certain other safeguards apply, 
including a requirement that, for purposes of determining regulatory 
capital, the national bank must deduct its outstanding equity 
investment in its financial subsidiaries from its total assets and 
tangible equity, must deduct the investment from its total risk-based 
capitals, and may not consolidate the assets and liabilities of a 
financial subsidiary with those of the bank. A national bank that 
ceases to continue to satisfy these requirements is subject to 
sanctions by the OCC, including divestiture. A national bank and its 
insured depository institution affiliates also are subject to CRA 
rating requirements when the bank acquires control of a financial 
subsidiary or engages in new activities in the subsidiary. 12 U.S.C. 
Sec. Sec. 24a; 1831w.
    \3\ The GLBA financial subsidiary requirements and safeguards apply 
only to insured state banks engaging as principal in national bank 
permissible financial activities in a subsidiary. If the state bank is 
engaged in agency activities in a subsidiary, such as selling insurance 
as agent, none of the requirements and safeguards apply under GLBA. Id 
at Sec. 1831w. Moreover, the requirement that a state bank must obtain 
the approval of the FDIC to engage directly or through a subsidiary in 
activities that are impermissible for a national bank or its subsidiary 
also applies only to activities conducted as principal and, thus, 
because of the less risky nature of agency activities, the FDIC is not 
required to approve state bank insurance agency activities. Id. at 
Sec. 1831a.
    \4\ See The Conference of State Bank Supervisors, A Profile of 
State Chartered Banking Twentieth Edition 2004/2005 Section III 9-12 
(2005).
    \5\ Item #137 in the Matrix of Financial Services Regulation Relief 
Proposals compiled by Sen. Crapo's staff in the 109th Congress would 
have given the Fed the authority to permit all bank holding companies, 
including those bank holding companies that do not elect or may not be 
eligible to become financial holding companies, to engage in general 
insurance agency activities through a nonbank affiliate. Both bank 
holding companies and national banks are subject to the place of 5,000 
restriction or must rely on the authority in GLBA to engage in broad, 
general insurance agency sales activities subject to the requirements 
and restrictions that apply to financial holding companies and 
financial subsidiaries, respectively. The OCC opposed Item #137 unless 
the amendment above is also adopted similarly permitting national banks 
to engage in general insurance agency activities.
---------------------------------------------------------------------------
                                ------                                --
----


  RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM JOHN M. 
                             REICH

Q.1. Last year, the Department of Labor issued a regulation 
drastically expanding the personal financial information union 
officers and employees must submit to the Department. The new 
LM-30 rule will require more than 150,000 union volunteers, 
employees, and their families to report the terms of mortgages, 
car loans, and even student loans. To determine whether they 
must report such interests, these individuals must ascertain 
(1) whether the bank providing a loan does any business with 
the person's union, or (2) whether the bank does 10 percent of 
its business with firms whose employees are in the same union. 
The regulation requires individuals to write to banks asking 
for this info, and, then, if banks won't provide such 
information, to contact the Department of Labor for assistance. 
In the meantime, individuals are required to make good faith 
estimates of the bank's business with their unions and 
unionized firms.
    Given your agency's expertise in the regulation and 
practices of banks, do you believe that banks are able--and 
willing--to inform their customers whether they do business 
with particular unions and how much of their ``business'' and 
``business receipts'' are with particular unionized firms?
    Are banks obligated or prohibited by any federal or state 
law to disclose to their customers how much ``business'' or 
``business receipts'' they have with particular unionized 
firms? Can banks simply refuse to answer these written 
inquiries?
    What type of administrative burden will this LM-30 rule, 
and the hundreds of thousands of resulting inquiries, place on 
banks and are banks currently prepared to respond to these 
inquiries?
    If banks don't provide this non-public information, is 
there any ``information reasonably available'' to the public 
that union officers, employees, and members could use to make 
good faith estimates?

A.1. The Labor-Management Reporting and Disclosure Act (LMRDA) 
requires public disclosures of certain financial transactions 
and financial interests of labor organization officers and 
employees (other than employees performing clerical or 
custodial services exclusively) and their spouses and minor 
children. It is our understanding that the purpose of this 
disclosure is, among other things, to make public any actual or 
potential conflict between the personal financial interests of 
a labor organization officer or employee and his or her 
obligations to the labor organization and its members.
    The U.S. Department of Labor's Office of Labor-Management 
Standards (OLMS) issued a final rule in 2007 implementing 
section 202 of LMRDA. See 72 FR 36106 (July 2, 2007). The final 
rule revised Form LM-30, Labor Organization Officer and 
Employee Report, and its instructions. The final rule became 
effective for fiscal years beginning August 16, 2007, although 
no reporting is due under the rule until November 16, 2008. See 
72 FR 38484 (July 13, 2007).
    OTS understands that financial institutions are expressly 
relieved of any reporting responsibilities of payments or loans 
under section 203 of the LMRDA (see 72 FR at 36119 and 36136). 
Therefore, savings associations are not required to report 
customer information.
    The final rule deals with Form LM-30, which requires 
reporting by the union officers and employees covered under the 
LMRDA. The final rule, as revised, does not require union 
officers to report most bona fide loans, interest, or dividends 
from financial institutions. However, the final rule may 
require that union officers report these types of transactions 
if the bank does a specified level of business with a company 
that employs members of the same union. The OLMS is the agency 
responsible for implementation and interpretation of this 
regulation, and OTS defers to OLMS's determination of the exact 
parameters of the categories where union employees are required 
to report bank loans.
    We know of no federal law that either requires or forbids a 
financial institution from informing its customers whether they 
deal with businesses that are unionized and what union 
represents the employees of those businesses, assuming that no 
customer information is disclosed. We see nothing in the 
Department of Labor rule that would require financial 
institutions to make those disclosures. We note that savings 
associations typically build certain reporting codes into their 
information management systems to facilitate the creation of 
both regulatory related filings, such as Thrift Financial 
Reports, as well as internal management reports. The basis for 
distinguishing and reporting based upon the type of union-
related activity at issue here may not be a part of this 
reporting framework, thereby creating issues regarding the 
practicality of disclosure.
    OTS will continue to analyze the impact of the final rule 
on our supervised savings associations as we approach the 
November 2008 reporting deadline.

Q.2. In December 2006, three agencies, the FRB, OCC, and FDIC, 
issued final guidance highlighting the risks to banks from 
concentrations in commercial real estate. In issuing the 
guidance, the regulators specifically emphasized that they were 
not setting any limits on banks' commercial real estate 
lending. Yet now we understand from the Comptroller of the 
Currency and the Chair of the FDIC that over a third of 
community banks have commercial real estate concentrations 
exceeding 300 percent of their capital.

      Are any community banks going to fail because of 
their overexposure to commercial real estate, including 
commercial real estate mortgage backed securities?

      Was it the correct policy not to set 
concentration limits in the guidance?

      Why did the OTS decline to join in issuing the 
final guidance, even after the OTS joined in the proposed 
guidance?

      What are examiners doing when they find these 
levels of concentrations?

      Are banks using off-balance sheet vehicles to 
invest in commercial real estate? If so, please describe. Are 
the regulators approving these kinds of transactions?

A.2. While OTS has observed an increase in the commercial real 
estate portfolios at some of our institutions, we have not seen 
any indication that there is an overexposure that would result 
in failure, particularly at community banks. In anticipation of 
the risk associated with this type of lending, our examiners 
utilize both on-site and offsite monitoring of these exposures 
at our institutions.
    On January 4, 2006, OTS joined the Office of the 
Comptroller of the Currency, the Federal Reserve Board and the 
Federal Deposit Insurance Corporation in publishing proposed 
CRE guidance in the Federal Register for notice and comment. 
When the comment period ended, OTS had received approximately 
1300 comment letters from savings associations, banks, trade 
associations, and individuals.
    Comments centered on three themes: the overly broad scope 
of the guidance, specifically that low risk multifamily and 
non-speculative construction loans be excluded from the CRE 
definition; the inappropriateness of rigid thresholds used to 
identify institutions with CRE concentrations because actual 
concentration risk varies so much with the type of CRE lending 
and an institution's risk management practices; and the 
potential chilling effect of the supervisory thresholds on 
community banks' lending practices.
    OTS significantly revised the Guidance to address concerns 
expressed through the comment process. The primary focus of the 
final Guidance issued by OTS is the expectation that savings 
associations actively engaged in CRE lending, especially those 
that are entering or rapidly expanding CRE lending, should:
    (1) Perform an internal self-assessment of exposure to 
concentration risk; continually monitor potential exposure to 
such risk; and report any such identified concentration risk to 
senior management and the board of directors; and
    (2) Implement risk management policies and procedures 
appropriate to the size of the portfolio, as well as the level 
and nature of concentrations and the associated risks, to 
monitor and manage those risks effectively.
    Although the guidance issued by the other Agencies contains 
numerical screens to be used for supervisory oversight, OTS 
decided not to include such screens in its guidance for several 
reasons. OTS's experience recognizes that concentration risks 
may be present at levels well below the other Agencies' 
thresholds. While savings associations are uniquely subject to 
a 400 percent of capital statutory investment limit on 
nonresidential real estate lending, through existing guidance 
and practice, OTS expects savings associations to continuously 
assess and manage concentration risk. OTS conducts quarterly 
monitoring of savings associations' portfolio composition to 
assess each association's exposure to concentration risk. 
Accordingly, OTS determined that inclusion of numerical 
thresholds in the guidance was unnecessary for savings 
associations and could result in unintended consequences and 
confusion in the industry. On December 14, 2006, OTS issued 
separate CRE guidance to the industry it supervises. Even in 
the current economic environment, we continue to believe that 
this was the correct policy to establish for the thrift 
industry.
    Finally, OTS has not observed any institutions using off-
balance sheet vehicles to invest in commercial real estate and 
have not received any applications to engage in this type 
transaction.

Q.3. There was extensive conversation on what would have been 
the capital status of banks going into this crisis period had 
Basel II capital standards been in effect. Fed Vice-Chairman 
Kohn said that if, ``we had the same safeguards in place, and 
if we started implementing in 2004 with the same safeguards 
that are in place in 2008 and 2009, I do think on balance we 
would have been better off.'' Mr. Gronstal answered 
differently, stating: ``I think the answer to your second 
question is that we probably would have had lower dollar 
amounts of capital per asset, and that makes it more 
challenging to deal with issues when times get rough.''
    Can you explain in writing, whether you believe that banks 
would have had more or less capital in place for this current 
down turn had Basel II been implemented during the time frame 
that Vice-Chairman Kohn mentioned in his response? Can you also 
explain why you believe that to be the case, citing any 
empirical data on both the effects of Basel II on capital 
requirements and what we have experienced during this economic 
crisis, as it relates to assets?
    During the discussion of Basel II, Comptroller Dugan told 
the Committee: ``The irony of this whole situation is that the 
very high--most highly rated best securities, the ones that 
were thought to be least likely to default was where all the--a 
huge share of the losses have been concentrated.'' Given Basel 
II's reliance on ratings of securities, does this observation 
give you reason for concern over the current Basel II 
structure? If so, what do you recommend be done; if not, why 
not?

A.3. It is OTS's view that applying the Basel II Advanced 
Approaches Final Rule as if it were in place going into the 
crisis period carries too many subjective empirical and 
supervisory assumptions for it to be a meaningful exercise. In 
fact, doing so discounts the critical safeguards the federal 
banking agencies included in the rule. Only in the U.S. did we 
include a 4-year implementation period. We include a first year 
parallel run, followed by 3 years with capital floors. At each 
step, a bank can only move on with supervisory approval.
    In addition, each of the agencies has committed to make 
necessary framework changes along the way to maintain capital 
levels commensurate with risk, to ensure safe and sound banking 
system. This is truly an evergreen rule. While developed during 
a benign economic period, the agencies have been adamant about 
making changes, as needed, to anticipate a stress period. Today 
banks are still building the framework by which they will 
estimate potential loss. We anticipate that the current 
experience with real stress, as opposed to theoretical 
assumptions, should yield even more rigorous loss estimates as 
we move through the years of implementation. Finally, the 
agencies have also committed to undertake a study of the 
Advanced Approach after we obtain sufficient data from the 
parallel run period. That study will provide the basis for any 
refinements to the framework or the regulation.
    In response to questions about ratings, the agencies, as 
part of the international effort of the Basel Committee on 
Banking Supervision, have already begun studying the causes of 
and potential responses to the limitations of bank reliance on 
ratings, especially within the securitization framework. We are 
also nearing the time when the agencies will bring forward a 
Notice of Proposed Rulemaking to introduce a Basel II 
Standardized Approach to the U.S. In that proposal, we will 
specifically seek comments on use of ratings for risk-based 
capital purposes.
    In sum, long before any new capital framework is in place 
and fully operational for any banks or thrifts, the agencies 
will be able to assess the current crisis in hindsight, and 
make whatever refinements are necessary to Basel II capital 
standards to ensure the continuation of a safe and sound U.S. 
banking system.

Q.4. I am concerned about the potential ramifications of the 
failure of a very large institution. Is your agency prepared 
today to handle the failure of a large systemically significant 
insured financial institution? What steps are you taking to 
prepare for this contingency?

A.4. OTS is continually monitoring the safety and soundness of 
our largest thrift institutions by maintaining a continuous 
examination presence at these institutions. This approach 
allows OTS to receive real time information regarding the 
health and risk exposures of these institutions. OTS actively 
works with the FDIC to address any risk of failure of the 
institutions we supervise. In addition to continuing 
communications with the FDIC, OTS shares Thrift Financial 
Report data, examination data and other institution data with 
the FDIC to insure that any information that could indicate an 
increased potential for failure is analyzed in a timely manner 
and would allow sufficient opportunity for the FDIC to take 
necessary steps in the event of a failure.

Q.5. Please provide comprehensive data on mortgage 
delinquencies, foreclosures, repayment plans and modifications 
for the mortgages being serviced by the institutions you 
regulate for the past 12 months. Please provide this 
information by the following loan categories: subprime, Alt-A, 
and prime. Please describe the types of repayment plans and 
modifications that servicers are employing and the numbers of 
loans in each category.

A.5. OTS, along with the other federal banking agencies, issued 
a Statement on Working with Borrowers on April 17, 2007, 
communicating our supervisory expectation that institutions we 
supervise work with borrowers having financial difficulty 
repaying their mortgages. Since that issuance, and as a part of 
our ongoing supervisory process, OTS contacted its six largest 
servicers in March of this year to establish and initiate a 
nationwide horizontal review of mortgage loan servicing data. 
We believe it is necessary to obtain this comprehensive 
mortgage data to assure that we have a detailed, current, and 
on-going picture of mortgage loan performance and loan 
modification efforts.
    OTS believes it is important to obtain key mortgage 
performance metrics across a broad spectrum of products, and 
therefore, our data collection request covers mortgages held on 
book by savings associations and their subsidiaries, in 
addition to loans serviced for others. In particular, the scope 
of the mortgage data we are requesting is not limited to 
subprime mortgages serviced for mortgages in securitization 
pools. The mortgage data we are seeking uses common definitions 
and data elements for asset quality metrics (delinquency 
measures, foreclosures, etc.), loss and foreclosure mitigation 
actions taken, and segmentation by credit quality risk 
indicators (such as FICO scores). With this approach, we will 
have data that are consistent, comparable, and reliable.
    We also believe it is important to build upon, and not 
conflict with, the mortgage data collection efforts of the HOPE 
NOW Alliance, whose members constitute a broad cross-section of 
industry and community organizations working to tackle the 
foreclosure crisis. In order to achieve that objective, we have 
retained the HOPE NOW Alliance data aggregator, McDash 
Analytics, LLC, to process the data submissions for us. The 
servicers submit the requested data to McDash Analytics. McDash 
compiles the information and provides reports directly to the 
OTS. We will receive our initial data reports from McDash in 
May.
    In advance of receiving the data from each of our 
servicers, OTS's preliminary discussions with several of our 
servicers indicate that loan workout activity at our 
institutions has increased dramatically over the past twelve 
months. The servicers indicate that the activity is inherently 
costly and does not always result in successful loan 
modifications. However, the public perception of the 
willingness of lenders to work with borrowers has grown, 
resulting in a much better response rate of borrowers to 
outreach efforts.
    Several of our servicers have indicated that early contact 
and open communications with borrowers is the most critical 
step in helping to prevent default. It allows the servicer to 
understand a borrower's specific needs and circumstances in 
order to prescribe a viable solution. There are several 
approaches that are being utilized to reach out to borrowers 
including personalized resource mailings, telephone calls to 
delinquent borrowers, and the use of automated commitments to 
pay.
                                ------                                


  RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM JOHN M. 
                             REICH

Q.1. Although not all the items that you suggested were 
included in this package and there might need to be a few 
tweaks, are there any items in this package that your agency 
cannot support or are these all items that would increase 
regulatory efficiency without compromising safety and soundness 
and important consumer protections?

A.1. Removing unnecessary regulatory obstacles that hinder 
customer service, innovation, competition, and performance in 
our financial services industry, and that also impede job 
creation and economic growth in the general economy, is an 
important and continuing objective of OTS. Although we have 
accomplished much in recent years to streamline and eliminate 
some of the burdens faced by the thrift industry, there remain 
many other areas for improvement. OTS is committed to reducing 
regulatory burden wherever it has the ability to do so, 
consistent with safety and soundness and compliance with law, 
and without undue impact on existing consumer protections. We 
support proposed legislation that advances this objective.

Q.2. Since all of these items have been vetted and reviewed in 
past hearings before the Banking Committee, is the reason to 
not move quickly forward with a package along these lines?

A.2. OTS encourages Congress to take swift action. These issues 
have been thoroughly vetted and there is no reason not to move 
forward in a timely fashion. It is incumbent on us to remain 
committed to reducing regulatory burden whenever we have the 
ability to do so, consistent with safety and soundness, and 
without undue impact on existing consumer protections. OTS 
would strongly support proposed legislation that advances this 
objective.
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM JOANN M. 
                            JOHNSON

Q.1. What is the extent of losses to the Share Insurance Fund 
in 2007, particularly in the 4th quarter of 2007? How does that 
compare to previous years? To what extent do those losses 
result from those failures?

A.1. In 2007 the National Credit Union Share Insurance Fund 
(NCUSIF) incurred charges of $40.8 million. To fund specific 
and non-specific reserves the NCUSIF expensed $186.4 million in 
2007, with $161 million occurring in the fourth quarter. Three 
credit unions conserved in 2007 accounted for $178.2 million of 
total expenses. Even with the higher level of actual charges 
and increased reserve expense in 2007, the NCUSIF finished the 
year with a 1.29 percent equity ratio, which closely 
approximates the targeted 1.30 percent level set by the NCUA 
Board.
    The Table below reflects the NCUSIF's expenses, charges, 
and reserve balance for the last 7 years.

----------------------------------------------------------------------------------------------------------------
            In millions                2001       2002       2003       2004        2005       2006       2007
----------------------------------------------------------------------------------------------------------------
Provision for Reserve Expense.....         $0      $12.5      $38.0      ($3.4)      $20.9       $2.5     $186.4
Actual Charges to the NCUSIF......       $4.7      $16.0       $8.8       $6.2       $15.6       $5.3      $40.8
Reserve Balance...................      $51.0      $47.5      $76.7      $67.1       $73.0      $70.2     $215.8
----------------------------------------------------------------------------------------------------------------

    As part of our continual analysis of the NCUSIF, NCUA 
stress tests the Fund under various catastrophic scenarios. The 
analysis completed in late 2007 shows the Fund performing 
favorably under the various scenarios, confirming the strength 
of the NCUSIF. The charges for 2007 are significantly below the 
stress levels we employ. The actual charges in 2007 are also 
significantly below the last period of significant economic 
downturn. The loss per thousand dollars of insured shares for 
2007 was $0.07 versus the actual range from 1991-1993 of $0.42 
to $0.60.

Q.2. With respect to Norlarco, how did such a significant and 
problematic situation develop so quickly? Was NCUA aware of the 
situation, or of any warning signs, before the failure 
occurred?

A.2. The problem did not develop rapidly, but instead over 
approximately a 20 month time horizon, from October 2004 
through June 2006. NCUA was aware of the situation at Norlarco 
Credit Union, a state chartered institution, and were using 
progressive enforcement steps to resolve the problems which 
included documents of resolution, state directives, a cease and 
desist order, and then ultimately conservatorship.
    The FAM Program. Norlarco Credit Union had experience 
dealing with First American Mortgage, (FAM) a residential 
construction loan broker and servicer, for loans made within 
Colorado. These activities were reviewed as part of a June 2004 
examination conducted jointly with the Colorado state 
regulator. When FAM began brokering and servicing loans in 
Florida, Norlarco Credit Union had already developed a 
relationship with and trust in the quality of services 
provided. With the establishment of the Florida program in 
October 2004 came a guarantee by both the homebuilder and FAM. 
The credit union had an understanding that the loans made were 
short term, fully guaranteed and carried a higher return than 
would be received through a similar short term investment. 
Actual delinquency did not begin to show in these loans until 
early 2007.
    NCUA Supervision. Annually, NCUA examines approximately 18 
percent of state chartered federally insured credit unions 
based on insurance risks. In the case of Norlarco, NCUA saw an 
increase in loan participations sold in late 2004 and that led 
the Agency to put this credit union on the 2005 examination 
list. In August 2005, as part of our work on another case, we 
determined that Norlarco had funded over 1,000 loans in 
Florida. During NCUA's joint examination conducted with the 
Colorado state regulator in October 2005, we discovered that 
the credit union had entered into a funding commitment with FAM 
for $30 million per month. NCUA's focused on improving the 
credit union's risk concentration and liquidity. Normal 
monitoring in March 2006 showed improvements in liquidity after 
the funding agreement was ceased. NCUA performed a supervision 
contact in May 2006 that revealed a prevalence of maturity 
extensions and led to questions surrounding the builder 
guarantees. At that contact, NCUA directed the credit union to 
cease funding any new residential construction loans. The 
growth in the portfolio after this contact was only through 
loans already in the pipeline after the credit union was 
required to cease and completion of loan commitments for homes 
already started.
    NCUA's February 2007 contact set in place more stringent 
required board actions based on the problems identified with 
the various contracts, FAM's inability to honor their 
guarantees, the decrease in housing values in Florida, and new 
management's lack of understanding of the program risks. NCUA 
also required the credit union to report all the loans as 
member business loans unless they could show affirmative proof 
that they were not investor owned properties. In April 2007, 
due to unsafe and unsound management practices being initiated 
to keep the loans artificially shown as non delinquent, the 
state issued a cease and desist order. A major component of 
that order was a full contract review of all participation, 
FAM, builder, and borrower contracts that had yet to be 
completed despite prior directives to do so. The preliminary 
review showed significant risk and led to the state regulator's 
conservatorship action in May 2007. As part of the 
conservatorship action, NCUA decided to continue funding loans 
till houses were complete. The rationale for doing so was the 
higher salability of finished homes versus incomplete 
construction loans.
    In summary, a combination of factors impacted the rapid 
development of the situation at Norlarco Credit Union. The 
credit union used a third party mortgage broker to originate 
residential construction loans (RCL) throughout the country, 
primarily to members in one of their two associational groups 
in their field of membership. By using a third party, the 
credit union was able to amass a significant portfolio in a 
relatively short period of time.
    The type of loan granted was often inaccurately captured in 
the RCL loan applications processed by the third party 
underwriter. Credit union management did not exercise 
sufficient oversight of the program to validate whether the 
loans were for an individual's principal or secondary 
residence, or for speculative investment purposes.
    It was not until near the end of this program that the real 
estate prices in Florida experienced a dramatic and rapid 
decline that resulted in speculative investors defaulting on 
their commitments.

Q.3. To what extent were the losses a result of member business 
lending?

A.3. Predominantly, the Florida loans made by Norlarco Credit 
Union were presented by the mortgage broker as owner-occupied 
properties. Following NCUA's January 2007 examination contact, 
NCUA required the credit union to report all the loans as 
member business loans proven otherwise. This resulted in 
approximately 80% of the portfolio being reclassified as member 
business loans for investor properties. The loans were all for 
residential construction and not for commercial construction 
properties.
    Irrespective of the classification, these loans were 
residential property loans, and the collapse of the Florida 
real estate market was the largest factor in the failure.

Q.4. In cases where the development of the concentration of 
high-risk assets occurs within relatively short periods--and in 
this situation it appears to have developed over a matter of 
months--how does NCUA respond before failures become likely?

A.4. NCUA's overall regulatory philosophy calls for effective 
not excessive regulation and supervision. Consequently, NCUA 
pursues a progressive approach to enforcement actions. NCUA 
balances aggressive supervision against the adverse effects on 
credit union innovation. Credit unions are in business to take 
reasonable and prudent risks in serving their members. NCUA is 
mindful of the need for vigilant supervision in the context of 
allowing credit unions to provide consumer-oriented financial 
services.
    During much of the Norlarco Credit Union situation, the 
high-risk nature of the assets was obscured by a guarantee 
contract, the short term nature of the loans, and the home 
value appreciation in the Florida market. Levels of delinquency 
and loan losses were masked by unilateral extensions made by 
the loan servicer, a practice that is not unusual in 
construction lending and were not in and of themselves unsafe 
and unsound practices. The fact that the loans were primarily 
investor properties, and therefore at higher risk than the 
owner-occupied properties (as reported) was not uncovered by 
NCUA until a more detailed loan was done as part of an 
examination.
    NCUA's initial source of information about an insured 
credit union is the quarterly call report. Review and analysis 
of trends contained in Norlarco's Call Report established the 
need for the credit union to be part of a more stringent joint 
examination program, in conjunction with the state regulator. 
Through off-site monitoring NCUA increased the level of 
supervision over Norlarco Credit Union as its balance sheet, 
income statement and off-balance sheet commitment deteriorated. 
Although the institution failed due to a ``perfect storm'' of 
circumstances, it is a case where our off-site supervision 
combined with on-site examination supported the increased 
enforcement actions taken by both the state regulator and NCUA.
    The credit unions associated with the Florida loans 
represented isolated instances of credit union failing to 
manage a third party loan program that grew very quickly, 
resulting in a high concentration of real estate loans at a 
time when real estate values suffered a precipitous decline. 
NCUA issued guidance in December 2007 and April 2008 to credit 
unions and field staff addressing third party due diligence and 
oversight.

Q.5. In light of Norlarco, what new efforts is NCUA making to 
identify such credit unions with such rapidly increasing levels 
of risk?

A.5. NCUA has intensified its review of emerging trends in 
credit union risk profiles. NCUA compiles quarterly risk 
reports and develops custom analysis based on aggregate trends 
in order to identify credit unions with increasing potential 
exposure. Field staff also regularly reviews risk reports in an 
effort to identify emerging risks in the credit unions they 
supervise. Changes to NCUA risk reports focus on growth in loan 
categories, share accounts, and borrowings in an effort to 
identify credit unions in the early stages of programs such as 
those involving the Florida loans.
    Additional emphasis is also being placed on reviewing third 
party arrangements and loan participation sales and purchases, 
as evidenced by recent examiner and industry guidance.

                         ANTI-UNION REGULATION

Q.6. Last year, the Department of Labor issued a regulation 
drastically expanding the personal financial information union 
officers and employees must submit to the Department. The new 
LM-30 rule will require more than 150,000 union volunteers, 
employees, and their families to report the terms of mortgages, 
car loans, and even student loans. To determine whether they 
must report such interests, these individuals must ascertain 
(1) whether the bank providing a loan does any business with 
the person's union, or (2) whether the bank does 10 percent of 
its business with firms whose employees are in the same union. 
The regulation requires individuals to write to banks asking 
for this info, and, then, if banks won't provide such 
information, to contact the Department of Labor for assistance. 
In the meantime, individuals are required to make good faith 
estimates of the bank's business with their unions and 
unionized firms.

A.6. With respect to credit unions, the new LM-30 rule requires 
a labor organization (``union'') officer or employee 
(``official'') to report bona fide loans, interest or dividends 
that he or she receives from a credit union in which his or her 
union ``is interested.'' General Instructions for ``Form LM-30 
Labor Organization Officer and Employee Report'' 
(``Instructions'') at 5. An official's union ``is interested'' 
in a credit union if it either ``created or established'' the 
credit union or ``selected or appointed'' one or more of its 
directors AND ``a primary purpose'' of the credit union is to 
benefit the union's members. Instructions at 13; 29 C.F.R. 
404.1(j) (2008); 72 FR 36106, 36118, 36158 (July 2, 2007).
    Our research indicates that sponsoring unions have a 
dominating ``interest'' in a minimal proportion of all insured 
credit unions. To date, there are 63 union-sponsored insured 
credit unions (according to their names), which are generally 
quite small in terms of asset size. Of those, the sponsoring 
union can arguably be credited with having ``created or 
established'' the credit union only when the union is its sole 
sponsor (i.e., has a single common bond of association among 
the sponsor's members). Similarly, the credit union can 
arguably be credited with having ``a primary purpose'' of 
benefiting the sponsoring union's members only when the union 
is the credit union's sole sponsor. In either case, credit 
union directors are never ``selected or appointed'' by a 
sponsor; they are elected by the membership. The small asset 
size of union-sponsored credit unions suggests that the 
majority of union-sponsored credit unions are each sponsored by 
a single union that may have a dominating ``interest'' in the 
credit union.
    The new LM-30 rule imposes a further reporting requirement 
when the source of loans, interest or dividends received by a 
union official is a ``business'' that transacts business with a 
union or a unionized firm. The LM-30 Instruction defines a 
``business'' entity as a ``vendor of goods or provider of 
services'' regardless whether it ``employs employees or 
otherwise meets the definition of `employer'.'' Assuming a 
credit union in which a union has an interest meets this 
definition of a ``business,'' a union official who is required 
to report credit union loans dividends and interest also must 
determine and report whether: (1) Ten percent or more of the 
credit union's business consists of buying or selling or 
otherwise dealing with an employer whose employees are 
represented by the official's union; or (2) Any part of the 
credit union's business consists of buying, selling or 
otherwise dealing with the official's union or a trust in which 
union has an interest.
    It is conceivable that a credit union would make loans, pay 
dividends on deposits or sell services to, or lease space from, 
an entity whose own employees are represented by the official's 
union, the sponsoring union itself, or to a pension trust 
controlled by the union. In these instances, a union official 
would be subject to the burden of collecting information from 
his or her credit union, and reporting, about the type and 
extent of these transactions. As our answers below suggest, it 
would be far more practical and efficient for the Department of 
Labor to assume responsibility for collecting information about 
a credit union's dealings with unions and unionized firms, 
instead of imposing that burden on union officials who 
generally are not privy to that information.

Q.7. Given your agency's expertise in the regulation and 
practices of banks, do you believe that banks are able--and 
willing--to inform their customers whether they do business 
with particular unions and how much of their ``business'' and 
``business receipts'' are with particular unionized firms?

(The questions were framed in reference to banks; our answers refer to 
                            credit unions.)

A.7. Credit unions may be willing to identify unions, and firms 
they know to be unionized, with whom they do business depending 
on the type of business. If the business between a credit union 
and a union or unionized firm consists of the union's or firm's 
member account activity (e.g., loans, deposits), a credit union 
would not be authorized to disclose that information to anyone 
but the union's or firm's authorized representative of record. 
If the business between a credit union and a union or unionized 
firm consists of the credit union's purchase of goods or 
services from such a firm or the leasing of space from such 
union, a credit union would be permitted to disclose that 
information to a member upon request, but may not be identified 
by vendor.

Q.8. Are banks obligated or prohibited by any federal or state 
law to disclose to their customers how much ``business'' or 
``business receipts'' they have with particular unionized' 
firms? Can banks simply refuse to answer written inquiries?

A.8. NCUA is not aware of any Federal law that prohibits 
insured credit unions from disclosing member account 
information. However, Article XVI, section 2, of the Federal 
Credit Union Standard By-Laws requires credit union officials 
to ``hold in confidence all transactions . . . with its members 
and all information respecting their personal affairs, except 
when permitted by state or federal law.'' No federal law 
authorizes credit unions to provide a union official who is a 
credit union member information about the type and extent of 
business between the credit union and its union sponsor or a 
unionized firm. A credit union that would disclose such 
information without authorization risks developing an unwanted 
reputation for not holding member financial information in 
confidence.

Q.9. What type of administrative burden will this LM-30 rule, 
and the hundreds of thousands of resulting inquiries, place on 
banks and banks currently prepared to respond to these 
inquiries?

A.9. The administrative burden on credit unions of retrieving 
responsive information and responding to inquiries will depend 
on a particular credit union's human and technological 
resources. A credit union that well-staffed and whose automated 
recordkeeping system is sophisticated will be equipped to 
respond in a timely fashion. The relatively small asset size of 
union-sponsored credit unions suggests that they would have 
minimal resources to devote to fielding members' inquiries 
about the type and extent of the credit union's business with 
unions and unionized firms.

Q.10. If banks don't provide this non-public information, is 
there any ``information reasonably available'' to the public 
that union officers, employees, and members could use to make 
good faith estimates?

A.10. Generalized financial data about the type and extent of 
credit union business dealings is available to a credit union's 
members from its financial statement, annual report and 
quarterly Call Reports. However, this data is unsuitable for 
making ``good faith estimates'' of credit union's business with 
unions and unionized firms (accounts, transactions, etc.) 
because it does not distinguish the type and extent of business 
transacted with such unions and firms.

                       DATA ON LOAN MODIFICATION

Q.11. Please provide comprehensive data on mortgage 
delinquencies, foreclosures, repayment plans and modifications 
for the mortgages being serviced by the institutions you 
regulate for the past 12 months. Please provide this 
information by the following loan categories: subprime, Alt-A, 
and prime. Please describe the types of repayment plans and 
modifications that servicers are employing and the numbers of 
loans in each category.

A.11. Credit union mortgage delinquency and foreclosures 
increased in 2007, but the results are consistently stronger 
than the overall mortgage industry performance. Below is the 
data on mortgage delinquencies for Federal Credit Unions.

------------------------------------------------------------------------
                                        12/31/2006         12/31/2007
------------------------------------------------------------------------
1st mortgage fixed rate                        0.25%              0.43%
 delinquency......................
1st mortgage adjustable rate                   0.23%              0.46%
 delinquency......................
Other real estate fixed rate                   0.29%              0.59%
 delinquency......................
Other real estate adjustable rate              0.34%              0.78%
 delinquency......................
1st mortgage loan net loss ratio..             0.02%              0.02%
Other real estate net loss ratio..             0.06%              0.17%
Foreclosed real estate outstanding       $75,008,594       $162,688,249
 on balance sheet and % of                     0.06%              0.11%
 outstanding RE Loans.............
------------------------------------------------------------------------

    Below is the data on mortgage delinquencies for all 
Federally Insured Credit Unions, including federally-insured 
state-chartered credit unions who NCUA insures, but where 
primary regulatory responsibility lies with the state 
regulator.

------------------------------------------------------------------------
                                        12/31/2006         12/31/2007
------------------------------------------------------------------------
1st mortgage fixed rate                        0.28%              0.48%
 delinquency......................
1st mortgage adjustable rate                   0.33%              0.69%
 delinquency......................
Other real estate fixed rate                   0.28%              0.67%
 delinquency......................
Other real estate adjustable rate              0.36%              0.80%
 delinquency......................
1st mortgage loan net loss ratio..             0.02%              0.02%
Other real estate net loss ratio..             0.06%              0.19%
Foreclosed real estate outstanding      $164,121,956       $331,862,670
 on balance sheet and % of                     0.07%              0.12%
 outstanding RE Loans.............
------------------------------------------------------------------------

    NCUA does not gather information regarding repayment plans 
or modifications for mortgages serviced by credit unions, or 
categorize mortgage loans by subprime, Alt-A, or Prime. NCUA is 
presently reviewing the mortgage and other lending data we 
gather and are considering making changes to gather additional 
information as appropriate.
                                ------                                --
----


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM JOANN M. 
                            JOHNSON

Q.1. Although not all the items that you suggested were 
included in this package and there might need to be a few 
tweaks, are there any items in this package that your agency 
cannot support or are these all items that would increase 
regulatory efficiency without compromising safety and soundness 
and important consumer protections?

A.1. The credit union-related items contained in the regulatory 
relief amendment referenced are appropriate and would be 
subject to NCUA regulatory and supervisory oversight if enacted 
into law.

Q.2. Since all of these items have been vetted and reviewed in 
past hearings before the banking committee, is there any reason 
to not move quickly forward with a package along these lines?

A.2. NCUA supports the prompt passage of the regulatory relief 
amendment contemplated by Senator Crapo.
                                ------                                --
----


 RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM DONALD L. 
                              KOHN

                         ANTI-UNION REGULATION

    Last year, the Department of Labor issued a regulation 
drastically expanding the personal financial information union 
officers and employees must submit to the Department. The new 
LM-30 rule will require more than 150,000 union volunteers, 
employees, and their families to report the terms of mortgages, 
car loans, and even student loans. To determine whether they 
must report such interests, these individuals must ascertain 
(1) whether the bank providing a loan does any business with 
the person's union, or (2) whether the bank does 10 percent of 
its business with firms whose employees are in the same union. 
The regulation requires individuals to write to banks asking 
for this info, and, then, if banks won't provide such 
information, to contact the Department of Labor for assistance. 
In the meantime, individuals are required to make good faith 
estimates of the bank's business with their unions and 
unionized firms.

Q.1. Given your agency's expertise in the regulation and 
practices of banks, do you believe that banks are able--and 
willing--to inform their customers whether they do business 
with particular unions and how much of their ``business'' and 
``business receipts'' are with particular unionized firms?

A.1. Pursuant to section 326 of the USA PATRIOT Act, all banks 
are required to have and maintain a written customer 
identification program (CIP) that is designed to allow the bank 
to form a reasonable belief as to the true identity of the 
bank's customers. See 31 U.S.C. 5318(1); 12 C.F.R. 
208.63(b)(2). In addition, banks often track the type and 
amount of business relationships they have with particular 
individuals or businesses for their own business or risk-
management purposes or for supervisory purposes (e.g., to 
monitor the amount of ``covered transactions'' with affiliates 
to ensure compliance with section 23A of the Federal Reserve 
Act, 12 U.S.C. 371c).
    Banks should be able to identify whether they have a 
customer relationship with a particular union, union member or 
business entity. It is unlikely, however, that a bank would 
have reason to know what (if any) labor organizations represent 
the employees of an unaffiliated business customer.
    Typically, banks consider both the identity of their 
customers and the amount of business they receive from 
particular customers as confidential and proprietary. The 
federal securities laws, however, require a publicly traded 
company to disclose in its annual report on Form 10-K the name 
of any customer if (i) sales to the customer represent 10 
percent or more of the public company's consolidated revenues, 
and (ii) the loss of the customer would have a material adverse 
effect on the public company and its subsidiaries taken as a 
whole. See SEC Form 10-K, Part I, Item 1; Regulation S-K, 17 
C.F.R. 229.101. Thus, if a bank is, or is part of, a publicly 
traded company and its relationships with a particular firm 
(whether unionized or not) met these thresholds, the bank or 
its parent company would have to disclose the name of the firm 
and its relationships with the bank or parent company in its 
annual filing with the Securities and Exchange Commission.

Q.2. Are banks obligated or prohibited by any federal or state 
law to disclose to their customers how much ``business'' or 
``business receipts'' they have with particular unionized 
firms?

A.2. Other than the provisions of the federal securities laws 
noted above, I am not aware of any federal law that would as a 
general matter obligate or prohibit a bank from disclosing to a 
union official the amount of business that the bank receives 
from a particular business entity. For example, the privacy 
provisions of the Gramm-Leach-Bliley Act would not apply in the 
situation you describe because a unionized firm likely would 
not be a ``consumer'' for purposes of these provisions. See 12 
C.F.R. 216.3(e)(1) (defining a ``consumer'' as an individual 
who has obtained a financial product or service for personal, 
household or family purposes). Similarly, the Right to 
Financial Privacy Act (12 U.S.C. 3401 et seq.) applies only to 
the provision of financial information to the U.S. government 
regarding individuals or partnerships comprised of five or few 
individuals. See 12 U.S.C. 3401(4) and (5). I understand that 
the Department of Labor's Form LM-30 and related rules also do 
not obligate a bank to disclose to a union official the amount 
of business the bank has with a unionized firm.
    The terms of a bank's agreement with a customer or 
applicable state law may restrict the ability of a bank to 
disclose information about a particular customer's business 
with the bank to another customer.

Q.3. What type of administrative burden will this LM-30 rule, 
and the hundreds of thousands of resulting inquiries, place on 
banks and are banks currently prepared to respond to these 
inquiries?

A.3. The revised Form LM-30 was adopted by the Department of 
Labor in August 2007, and a covered individual is required to 
file the revised Form LM-30 for any fiscal year of the 
individual that begins on or after August 16, 2007. Because 
many covered individuals use the calendar year as their fiscal 
year, many individuals will not have to file a revised Form LM-
30 until after December 31, 2008. Accordingly, it is too soon 
to tell how many inquiries banks may receive related to the 
revised form and the ability of banks to handle these 
inquiries.

Q.4. If banks don't provide this non-public information, is 
there any ``information reasonably available'' to the public 
that union officers, employees, and members could use to make 
good faith estimates?

A.4. As noted above, the federal securities laws require public 
companies to annually disclose the name of any customer if 
sales to the customer represent 10 percent or more of the 
public company's consolidated revenues and the loss of the 
customer would have a material adverse effect on the public 
company and its subsidiaries taken as a whole.

                         COMMERCIAL REAL ESTATE

    In December 2006, three agencies, the FRB, OCC and FDIC, 
issued final guidance highlighting the risks to banks from 
concentrations in commercial real estate. In issuing the 
guidance, the regulators specifically emphasized that they were 
not setting any limits on banks' commercial real estate 
lending. Yet now we understand from the Comptroller of the 
Currency and the Chair of the FDIC that over a third of 
community banks have commercial real estate concentrations 
exceeding 300 percent of their capital.

Q.5. Are any community banks going to fail because of their 
overexposure to commercial real estate, including commercial 
real estate mortgage backed securities?

A.5. On the whole, community banks entered the current period 
of financial stress with strong capital ratios. Moreover, most 
community banks maintain manageable exposures to commercial 
real estate and continue to perform well. However, some 
institutions have recently begun to face financial difficulties 
related to overexposure to commercial real estate. These 
difficulties could be exacerbated by weakening economic 
fundamentals and deterioration of the commercial real estate 
market and a very small number of these banks will likely fail. 
However, while it appears that we may be entering a period when 
we could experience a higher level of bank failures than we 
have seen in the recent past, it is important to note that an 
increase in the rate of failures from its historically low 
level would not call into question the fundamental safety and 
soundness of the overwhelming majority of community banks.

Q.6. Was it the correct policy not to set concentration limits 
in the guidance?

A.6. I believe it was correct. Numerical limits could deprive 
creditworthy borrowers of loans and banks of sound and 
profitable lending opportunities. Further, they can provide 
banks a false sense of security that inhibits appropriate risk 
management activities when their concentrations fall below the 
stated limits. For supervisors, the issue was whether banks' 
risk management practices were adequate to manage the CRE 
concentration risks. As past market cycles have shown, banks 
with high CRE concentrations that have strong risk management 
practices are better prepared to respond to deterioration in 
market conditions, minimizing their losses.
    The primary message of the CRE concentration guidance was a 
reminder to banks on the importance of sound risk management 
practices when a bank has a CRE concentration or is growing its 
CRE lending activity. While the guidance contained broad 
numeric screens to identify banks with potential CRE 
concentration risk, the criteria is not viewed as a safe 
harbor. There may be instances when a bank's risk management 
systems will be identified for further supervisory analysis 
when concentration levels are below the criteria, based on 
factors such as weaknesses in CRE loan underwriting, 
concentrations in specific CRE lending activity or geographic 
markets, or rapid growth. Indeed, the risk profile of banks 
identified with CRE concentrations can differ substantially 
depending on the bank's specific risk management practices. 
Therefore, the intent of the screens is to encourage a dialogue 
between the examiners and an institution's management about the 
level and nature of CRE concentration risk. The absence of a 
specific limit or limits on CRE lending does not present a 
barrier to our examiners in addressing CRE concentration risk 
at a particular bank.

Q.7. What are examiners doing when they find these levels of 
concentrations?

A.7. Examiners review a bank's CRE concentration from a risk-
focused perspective. In evaluating the presence of any CRE 
concentration risk, examiners review the bank's CRE portfolio, 
considering diversification across property types, geographic 
dispersion, underwriting standards, level of pre-sold or other 
types of take-out commitments on construction loans, and 
liquidity.
    An examiner will assess the effectiveness of a bank's risk 
management practices, including: strategic plans, board and 
management oversight, lending policies, credit administration, 
market analysis, management information systems and reports, 
and portfolio level analyses (e.g., stress testing and scenario 
analysis). To support the overall assessment of a bank's CRE 
lending activity and loan portfolio, examiners perform 
transaction level testing of individual credits and identify 
any specific weaknesses in underwriting practices. When 
weaknesses are identified, we expect the bank to improve its 
risk management practices as discussed in the CRE concentration 
guidance and we will monitor the bank's progress for addressing 
weaknesses.
    Board and Reserve Bank staff have identified and are 
closely monitoring state member banks at risk for deterioration 
due to CRE exposures and concentration levels. Based on this 
priority, examiners will be conducting targeted, on-site 
reviews of the bank's CRE loan portfolio, the adequacy of loan 
loss reserves, and an assessment of the bank's reliance on CRE 
lending for revenue and future earnings. Supervision staff is 
also enhancing the off-site monitoring of banks with high CRE 
concentrations, particularly those banks that experienced a 
recent supervisory rating downgrade. Finally, the Federal 
Reserve has been conducting specific examiner training on the 
CRE concentration guidance at each Reserve Bank, focusing on 
the key elements of sound risk management practices and prudent 
underwriting practices for CRE lending.

Q.8. What off-balance sheet vehicles are banks using to invest 
in commercial real estate? Are the regulators approving these 
kinds of transactions?

A.8. With reference to commercial real estate activity, large 
institutions are primarily using off-balance sheet vehicles to 
structure and distribute commercial mortgage backed securities 
(CMBS), not to make investments. Investments in CMBS and 
retained securitization exposures are typically held on balance 
sheet. CMBS issuance in the market grew substantially in the 
past several years as institutions made greater use of the 
``originate-to-distribute'' business model. The 2007 U.S. CMBS 
issuance of approximately $200 billion closely matched 2006 
activity, despite a substantial drop in volume in the second 
half of the year. This year, the volume of U.S. CMBS issuance 
has declined significantly as investors have become much more 
cautious.
    Examiners do not approve specific CMBS transactions, but 
they do closely monitor regulated institutions' CMBS risk 
management practices in order to assess their ability to manage 
the risks associated with both issuances and investments. The 
sophistication of an institution's CMBS risk management 
practices should be commensurate with the nature and volume of 
its activity. An institution with significant CMBS activity 
would be expected to have a comprehensive, formal strategy for 
managing risks, including contingency plans to respond to a 
reduced market demand that might make it difficult to 
securitize loans being warehoused on the bank's balance sheet. 
Currently, Federal Reserve examiners are reviewing the pricing 
and valuation processes of several large institutions to 
ascertain whether their processes are in line with our safety 
and soundness expectations. Given the current market 
turbulence, some of these assets have become more difficult to 
value precisely, but preliminary observations suggest that 
institutions have been diligent in fairly valuing these 
securities.

                            DISCOUNT WINDOW

    Governor Kohn at the hearing on March 4th, I asked you 
about your thoughts on opening the Fed's discount window 
lending to non-banks. You responded: ``So Congress saw this as 
an emergency very, very unusual situation that they did not 
want us using. I would be very cautious about opening that 
window up more generally. I think the banks have access to the 
discount window but the quid pro quo, in some sense, or the 
control--there is a moral hazard issue here, having them have 
access. And the control on that is this panel, right? You have 
an extensive amount of bank examination supervision. You have 
constricted their activities in a number of ways relative to 
investment banks. I do not think that liquidity is the problem 
for the investment banks, or liquidity is the issue behind 
restarting these markets right now.''
    In the subsequent weeks, one major investment bank failed 
due to liquidity problems and the Federal Reserve Board of 
Governors voted to authorize lending from the discount window 
to investment banks.

Q.9. Vice-Chairman Kohn, in light of the recent facts, can you 
explain your answer that liquidity was not the problem for 
investment banks? Further, can you please inform the Committee 
what, if any, supervisory measures the Board has implemented 
with respect to investment banks' ability to access the 
discount window? What additional measures would be appropriate, 
and does the Board need additional authority to implement such 
measures?

A.9. When I testified on March 4, financial markets were 
severely strained and liquidity pressures were clearly evident 
in uncollateralized wholesale funding markets. Nonetheless, 
investment banks had been able to manage reasonably well to 
that point, largely because they relied heavily on secured 
funding against high quality collateral in repo markets. 
Historically, borrowing against high quality collateral in the 
repo market has been a stable and reliable funding source for 
investment banks and other financial firms. In mid-March, 
however, these markets came under intense pressure as lenders 
came to question the value of collateral they were accepting in 
repo transactions and also became very concerned about 
counterparty credit risk. Many lenders applied higher haircuts 
on the collateral taken in repo transactions, and pulled back 
from lending to particular counterparties altogether. In 
response to these unusual and exigent circumstances, the 
Federal Reserve exercised the emergency authorities I discussed 
with you at the hearing to establish two facilities--the 
Primary Dealer Credit Facility (PDCF) and the Term Securities 
Lending Facility (TSLF)-aimed at supporting the liquidity of 
primary dealers and, indirectly, the liquidity of the broader 
financial markets. In addition, the Federal Reserve judged it 
appropriate to provide funding to Bear Stearns to prevent a 
disorderly failure that likely would have had significantly 
adverse consequences for our financial system and economy.
    All the primary dealers eligible to borrow from the Federal 
Reserve under the PDCF or to transact with the Federal Reserve 
under the TSLF are subject to supervision and regulation by the 
SEC. In addition, the parent companies of nearly all of these 
primary dealers are subject to consolidated supervision--either 
by the Federal Reserve in the case of dealers that are owned by 
a U.S. bank holding company, a foreign bank supervisory agency 
in the case of dealers that are owned by a foreign bank, or the 
SEC in the case of dealers that are not affiliated with banks. 
While the special lending facilities for primary dealers are in 
place, the Federal Reserve is working closely with the SEC to 
ensure that we have access to necessary supervisory 
information, and this coordination has been very effective.

Q.10. Vice-Chairman Kohn, you also said: ``I do not think 
opening up credit to the investment banks will really be that 
helpful in the end and could carry some very major costs.'' You 
subsequently voted to do just that. Can you please explain 
whether the Fed's action was helpful in the end? What costs 
came along with the action? And how is the Fed making sure that 
the taxpayer will not bear any costs associated with any of the 
Fed's recent actions?

A.10. The Federal Reserve's actions were essential to avert a 
financial crisis that likely would have had serious 
repercussions for the U.S. economy. Had Bear Stearns defaulted 
on its obligations, already disrupted financial markets would 
have been thrown into further turmoil, prices in key markets 
would have been affected as counterparties scrambled to lower 
risk, and the viability of other dealers would have been called 
into question. The actions we took do have the potential to 
exacerbate moral hazard; that is, that the incentives for 
primary dealers and their investors to effectively manage their 
liquidity risks could be weakened to the extent that they 
expect the Federal Reserve to establish emergency lending 
facilities in any future financial crisis. Although the 
potential for moral hazard should be carefully analyzed and 
considered by policymakers, it seems more likely that the 
example of Bear Stearns--in which shareholders and management 
suffered considerable losses--and the broader distress in 
financial markets will serve as a potent reminder to primary 
dealers and other leveraged market participants about the 
importance of prudent liquidity risk management. In particular, 
in developing their liquidity management plans, primary dealers 
and others must now attach considerable weight to scenarios in 
which their access to funding in the repo market is sharply 
curtailed. Of course, the Federal Reserve, the SEC, and other 
regulatory agencies will be working to reinforce that message.
    As to the potential for taxpayer losses associated with the 
Federal Reserve's recent actions, all credit extended to 
primary dealers under the PDCF and all transactions with 
primary dealers under the TSLF are fully secured by investment-
grade securities with ample haircuts applied to market 
valuations. In addition, the March 14 loan to Bear Stearns was 
repaid on March 17 without loss to the taxpayer. There are also 
substantial protections for taxpayers associated with the 
prospective $29 billion extension of credit by the Federal 
Reserve to be made in connection with the acquisition of Bear 
Stearns by JPMorgan Chase & Co. The collateral for the loan 
will be in the form of investment-grade securities and 
performing credit facilities, JPMorgan Chase will bear the 
first $1 billion of losses on the collateral pool, the Federal 
Reserve will be able to liquidate the collateral over a long-
term horizon, and we have hired a professional independent 
investment adviser to manage the collateral pool so as to 
maximize the returns to the Federal Reserve and the taxpayer.

                                BASEL II

    There was extensive conversation on what would have been 
the capital status of banks going into this crisis period had 
Basel II capital standards been in effect. Fed Vice-Chairman 
Kohn said that if, ``we had the same safeguards in place, and 
if we started implementing in 2004 with the same safeguards 
that are in place in 2008 and 2009, I do think on balance we 
would have been better off.'' Mr. Gronstal answered 
differently, stating: ``I think the answer to your second 
question is that we probably would have had lower dollar 
amounts of capital per asset, and that makes it more 
challenging to deal with issues when times get rough.''

Q.11. Can you explain in writing, whether you believe that 
banks would have had more or less capital in place for this 
current down turn had Basel II been implemented during the time 
frame that Vice-Chairman Kohn mentioned in his response? Can 
you also explain why you believe that to be the case, citing 
any empirical data on both the effects of Basel II on capital 
requirements and what we have experienced during this economic 
crisis, as it relates to assets?

A.11. The Basel II framework is designed to more closely align 
regulatory capital requirements with actual risks and to 
further strengthen banking organizations' risk-management 
practices. While it is difficult to quantify the level of 
capital banks would have had in place in 2007 if they had 
implemented Basel II in 2004, Basel II implementation would 
have placed banks in a stronger position by requiring them to 
institute more robust risk management practices that kept pace 
with changes in financial markets and business models. The 
system and infrastructure requirements under Basel II may have 
provided banks better and timelier access to important data as 
well as to validated measures of risk.
    The Basel II framework requires banks to develop robust 
data series on defaults, losses and recoveries that include an 
economic downturn. These data inputs are filtered through a 
prudential capital framework specified by supervisors, and 
which requires consideration of how exposures will perform 
during economic downturn conditions. This will induce a major 
upgrade in banks' risk management systems which, had these 
enhancements been achieved before the crisis, would have helped 
put banks on a more sound footing. Banks will only be able to 
use their internal measures of risk for regulatory capital 
requirements after rigorous supervisory review; the use of 
transitional safeguards during the first years of Basel II 
implementation will help ensure there are no sudden drops in 
capital levels and that bank inputs are robust.
    In addition, Basel II reduces incentives for regulatory 
capital arbitrage and includes enhanced public disclosure 
requirements. The greater transparency provided by the 
disclosure requirements creates more opportunities for market 
discipline to foster best practices in the banking industry. 
Banks also are required to assess the capital needed to support 
their overall risk profiles including liquidity and 
reputational risk which have been significant in the current 
turmoil. Taken together, the three pillars of Basel II (minimum 
capital, risk management and supervisory oversight, and market 
transparency) strengthen capital regulation by providing 
multiple perspectives on banks' risk and the adequacy of their 
capital cushions.

Q.12. During the discussion of Basel II, Comptroller Dugan told 
the Committee: ``The irony of this whole situation is that the 
very high--most highly rated best securities, the ones that 
were thought to be least likely to default was where all the--a 
huge share of the losses have been concentrated.'' Given Basel 
II's reliance on ratings of securities, does this observation 
give you reason for concern over the current Basel II 
structure? If so, what do you recommend be done; if not, why 
not?

A.12. The Basel Committee has committed to adjust the Basel II 
capital requirements in light of recent market events. 
Specifically, the Basel Committee is, among other things, 
revising the capital treatments for re-securitizations, 
liquidity facilities to ABCP conduits, CDO securities, and 
securitizations in the trading book, as well as for default and 
event risk. The Federal Reserve strongly supports and is 
actively participating in reassessment of the regulatory 
capital requirements for securitization exposures under the 
Basel II framework and making any adjustments that may be 
appropriate. Consistent with the recommendations of the 
President's Working Group on Financial Markets, U.S. 
authorities are also reviewing their use of credit ratings in 
regulations.

                            TOO BIG TO FAIL

Q.13. I am concerned about the potential ramifications of the 
failure of a very large institution. Is your agency prepared 
today to handle the failure of a large systemically significant 
insured financial institution? What steps are you taking to 
prepare for this contingency?

A.13. For several years, the Federal Reserve has been working 
closely with the FDIC and other relevant supervisors to examine 
and understand the issues that would be associated with the 
resolution of a large insured bank, and to explore options for 
resolving these issues to prepare for such a contingency. These 
efforts have involved, among other things, numerous meetings 
and exchanges of information with the FDIC as well as with the 
Department of the Treasury, including the OCC and OTS. These 
discussions have focused on how a least cost resolution could 
be implemented for a large insured bank, and how moral hazard 
could be minimized if a determination were made, in accordance 
with the requirements of the Federal Deposit Insurance Act, to 
invoke the so-called systemic risk exception to the least cost 
requirement. In addition, the Federal Reserve has worked with 
the FDIC and Department of the Treasury to develop a protocol 
describing the general types of information that would be 
useful to the agencies in considering whether to recommend that 
the systemic risk exception be invoked in a particular 
instance, and we have that protocol in place today. These 
efforts and others, such as simulation exercises, will continue 
to enhance the Federal Reserve's contingency planning for the 
resolution of a large, systemically significant insured bank.
    Moreover, the Federal Reserve worked cooperatively with the 
FDIC, OCC and OTS to develop a new memorandum of understanding 
describing the situations under which the FDIC would have 
access to information at an insured depository institution 
prior to failure to facilitate appropriate contingency planning 
and prepare for the possible processing of deposit insurance 
claims. To further improve the FDIC's ability to plan for and 
handle a large bank resolution, the Federal Reserve continues 
to support the FDIC's ongoing rulemaking efforts to address, in 
advance of a large bank failure, resolutions issues such as 
streamlining the claims process and clarifying how sweep 
accounts will be handled in a resolution.
    In addition to these domestic efforts, the Federal Reserve 
has participated on numerous international groups, sponsored by 
the Basel Committee on Banking Supervision (BCBS), the 
Financial Stability Forum (FSF), and the Governors of the G-10 
central banks, to explore issues related to the failure of a 
large, internationally active bank.

                       DATA ON LOAN MODIFICATION

Q.14. Please provide comprehensive data on mortgage 
delinquencies, foreclosures, repayment plans and modifications 
for the mortgages being serviced in the institutions you 
regulate for the past 12 months. Please provide this 
information by the following loan categories: subprime, Alt-A, 
and prime. Please describe the types of repayment plans and 
modifications that servicers are employing and the numbers of 
loans in each category.

A.14. The Federal Reserve Board (the Board) collects extensive 
data on mortgages, however, institutions' regulatory filings do 
not require a breakdown of mortgage exposure based on 
categories such as prime, subprime, or alt-A. These terms are 
not uniformly defined across banking organizations. To respond 
to the question, the Board has compiled information available 
from its supervisory activities and has surveyed a number of 
supervised institutions. These institutions are both state 
member banks and non-bank subsidiaries of bank holding 
companies, which are not supervised by the other agencies. The 
institutions were chosen based on the size of their mortgage 
servicing portfolios, with the nine largest servicers selected. 
Together, these institutions' servicing portfolios represent a 
significant portion of mortgage loans serviced by entities 
directly supervised by the Federal Reserve. The data have been 
provided directly from supervised institutions without examiner 
validation and should be used for informational purposes only.

Discussion of loss mitigation strategies

    The surveyed lenders employ a range of loss mitigation 
strategies including modifications, repayment plans, 
forbearance agreements, deed-in-lieu transactions, and short 
sales. Below is a brief discussion of each of these strategies, 
as described by the surveyed lenders.

      Modification plans change the terms of the note, 
including reducing the interest rate, conversion from an 
adjustable rate to a fixed rate, deferring payments, waiving a 
portion of the amount due, capitalization of past due amounts, 
or extension of the maturity date. Lenders provide both 
permanent and temporary modifications depending on specific 
borrower circumstances. A temporary modification can be made 
permanent at any time if the situation changes. Approval is 
usually subject to verification of income, assets and 
liabilities. Lenders report that the verification process is 
typically the most time consuming part of helping troubled 
borrowers. Upon receipt of the appropriate verifications, 
modifications are usually processed in about two weeks.

      Repayment plans are often employed when it is 
necessary for the customer to demonstrate the willingness and 
ability to pay a reduced amount after a period of sporadic 
payment history prior to completion of a more permanent 
modification. These types of repayment plans are generally less 
formal in nature in anticipation of a more formal written 
modification.

      Forbearance agreements are generally drafted 
after a foreclosure action has commenced and have specific 
terms and timeframes.

      Deed-in-lieu of foreclosures and short sales 
terminate the borrower's ownership of the property without the 
expense and time consumption of a formal foreclosure process 
and are negotiated transactions between the borrower and the 
lender. In a deed-in-lieu of foreclosure, the borrower turns 
over the deed to the lender. Settlement terms for any 
deficiency amount are negotiated on a case-by-case basis. In a 
short sale transaction, the borrower agrees to sell the 
property to a third party but the proceeds are not sufficient 
to fully repay the debt and settlement of any unpaid balance is 
negotiated on a case-by-case basis.

Discussion of the data

    The surveyed institutions were asked to provide information 
using defined credit score ranges. These ranges are believed to 
be consistent with those used by the other agencies in their 
response to this request and are consistent with the loan 
modification reporting standards used by the HOPE NOW alliance 
and other data collection services. The lenders who 
participated in the survey provided data for the six month 
period beginning October 2007 and ending March 2008. The 
lenders reported servicing more than $400 billion of loans to 
over 3.3 million borrowers. During the survey period, the 
dollar amount of loans originated with credit scores less than 
620, as well as loans originated with credit scores between 620 
and 660, each represented about 10 percent of the total dollar 
volume of surveyed loans. Loans originated with credit scores 
greater than 660 represented over two thirds of the portfolio, 
and the remaining amount was originated using a methodology 
other than a reported credit score. The attached tables present 
the data provided by the lenders and detail information by both 
dollar amount and by number of borrowers. As mentioned, the 
tables are further segmented by credit score and provide 
detailed information, by month, on current loans, delinquent 
loans, and foreclosure starts, as well as information on loss 
mitigation and loan modification activities.

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 RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM DONALD L. 
                              KOHN

Q.1. Although not all the items that you suggested were 
included in this package and there might need to be a few 
tweaks, are there any items in this package that your agency 
cannot support or are these all items that would increase 
regulatory efficiency without compromising safety and soundness 
and important consumer protections?

A.1. As you know, the Board has worked closely with your 
office, other members of Congress and supervisors, banking 
organizations and consumer organizations to develop numerous 
regulatory relief amendments. Many of the amendments supported 
by the Board were included in the Financial Services Regulatory 
Relief Act of 2006 (FSRRA), of which you were a chief sponsor. 
At your request, the Board in November 2007 also provided you 
with three new regulatory relief amendments as well as a 
technical amendment.
    One of the Board's priority regulatory relief items which 
was not enacted as part of FSRRA is included as section 17 of 
the package you introduced. This amendment would promote 
efficiency in our financial system by repealing the provisions 
in current law that prohibit depository institutions from 
paying interest on demand deposits. The Board continues to 
strongly support this amendment.
    The amendments included in your package also would remove 
the provisions in FSRRA that delay, until October 1, 2011, the 
effective date of the amendments in that act that provide the 
Federal Reserve both the ability to pay interest on balances 
held by depository institutions at a Reserve Bank and greater 
flexibility in setting reserve requirements. Having the ability 
to implement these authorities more promptly if appropriate 
would be beneficial.
    The Board continues to have concerns with the amendment 
included as section 5, which would raise, from $500 million to 
$1 billion, the asset threshold below which an insured 
depository institution may qualify for an extended 18-month 
examination cycle. The Board has not taken a position on the 
other amendments included in your package.

Q.2. Since all of these items have been vetted and reviewed in 
past hearings before the Banking Committee, is there any reason 
to not move quickly forward with a package along these lines?

A.2. The Board strongly supports efforts by Congress to 
identify those provisions of the federal banking laws that may 
be removed or modified without undermining the important public 
policy goals of financial regulation, including the safety and 
soundness of banking organizations, financial stability, and 
consumer protection. The Board and its staff would be pleased 
to work with you as you and your colleagues move forward in 
developing appropriate regulatory relief legislation.
                                ------                                --
----


 RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM THOMAS B. 
                            GRONSTAL

          BASEL II QUESTION FOR THE FDIC, FED, OCC, OTS, CSBS

Q.1. There was extensive conversation on what would have been 
the capital status of banks going into this crisis period had 
Basel II capital standards been in effect. Fed Vice-Chairman 
Kohn said that if, ``we had the same safeguards in place, and 
if we started implementing in 2004 with the same safeguards 
that are in place in 2008 and 2009, I do think on balance we 
would have been better off.'' Mr. Gronstal answered 
differently, stating: ``I think the answer to your second 
question is that we probably would have had lower dollar 
amounts of capital per asset, and that makes it more 
challenging to deal with issues when times get rough.''
    Can each of you explain in writing, whether you believe 
that banks would have had more or less capital in place for 
this current down turn, had Basel II been implemented during 
the time frame that Vice-Chairman Kohn mentioned in his 
response. Can you also explain why you believe that to be the 
case, citing any empirical data on both the effects of Basel II 
on capital requirements and what we have experienced during 
this economic crisis, as it relates to assets.
    During the discussion of Basel II, Comptroller Dugan told 
the Committee: ``The irony of this whole situation is that the 
very high--most highly rated best securities, the ones that 
were thought to be least likely to default was where all the--a 
huge share of the losses have been concentrated.'' Given Basel 
II's reliance on ratings of securities, does this observation 
give you reason for concern over the current Basel II 
structure? If so, what do you recommend be done; if not, why 
not?

A.1. The models and assumptions which drive the calculation of 
capital under Basel II were developed during a period of 
extraordinary economic growth and asset value appreciation. 
Given the historic low level of risk for residential mortgage 
loans, it is highly likely that most models would generate a 
lower level of required capital. The data from QIS-4 revealed 
significant declines in minimum required capital for 
residential mortgages and home equity lines of credit. 
Obviously, these asset categories have become a tremendous 
source of loss for the financial system. The only asset 
category to see an increase in capital allocation in QIS-4 was 
credit cards. Without the ability to detect and measure soft 
information impacting credit quality (i.e. changes in 
underwriting practices), it is likely that Basel II banks would 
be holding less capital heading into the current economic 
environment.
    Basel II must be re-evaluated in the context of the current 
market. The current crisis has challenged our long-held 
assumptions on the safety of residential mortgage loans and the 
reliance on the judgment of rating agencies. We can and should 
apply these lessons to other asset categories. One of the 
lessons learned from this crisis should be the importance and 
necessity of a minimum leverage ratio as part of our capital 
rules.

                       DATA ON LOAN MODIFICATION

Q.2. Please provide comprehensive data on mortgage 
delinquencies, foreclosures, repayment plans and modifications 
for the mortgages being serviced by the institutions you 
regulate for the past 12 months. Please provide this 
information by the following loan categories: subprime, Alt-A, 
and prime. Please describe the types of repayment plans and 
modifications that servicers are employing and the numbers of 
loans in each category.

A.2. As we discussed in testimony, working through a joint 
initiative with the state attorneys general, we are collecting 
loan modification data from 13 subprime servicers. The last 
report was issued in April. A copy is included as part of our 
response.

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