[Senate Hearing 110-1008]
[From the U.S. Government Publishing Office]



                                                       S. Hrg. 110-1008


RECENT DEVELOPMENTS IN U.S. FINANCIAL MARKETS AND REGULATORY RESPONSES 
                                TO THEM

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

                                HEARING

                               before the

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

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                                   ON

RECENT DEVELOPMENTS IN U.S. FINANCIAL MARKETS AND REGULATORY RESPONSES 
                                TO THEM


                               __________

                         TUESDAY, JULY 15, 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

                      Amy S. Friend, Chief Counsel

                    Mark Osterle, Republican Counsel

                       Dawn Ratliff, Chief Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor














                            C O N T E N T S

                              ----------                              

                         TUESDAY, JULY 15, 2008

                                                                   Page

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

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     3

                               WITNESSES

Henry M. Paulson, Jr., Secretary, Department of the Treasury.....     4
    Prepared statement...........................................    42
Christopher Cox, Chairman, Securities and Exchange Commission....     6
    Prepared statement...........................................    44
    Response to written questions of:
        Senator Shelby...........................................    49
        Senator Testor...........................................    51

 
RECENT DEVELOPMENTS IN U.S. FINANCIAL MARKETS AND REGULATORY RESPONSES 
                                TO THEM

                              ----------                              


                         TUESDAY, JULY 15, 2008

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 12:23 p.m., in room SR-325, Russell 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. The Committee will come to order. Let me 
once again thank Secretary Paulson and Chairman Cox for 
agreeing to come before the Committee in such an expeditious 
manner and way. As you know, for the last hour and a half or 
so, we have had a good hearing with the Chairman of the Federal 
Reserve. We thank Chairman Bernanke for his involvement, and I 
am deeply grateful to Senator Shelby and others for allowing us 
to have this hearing in an expedited fashion, waiving some of 
the rules that would otherwise be necessary.
    Let me just suggest a couple of things. One is, obviously, 
as we look at these proposals, Mr. Secretary, that have been 
raised over the weekend, I want to thank you and I want commend 
you for putting forth some ideas here and how we can deal with 
this present situation. And so I begin by suggesting that we 
are all trying to find some common ground and some common 
answers here that make sense, both in the near term and in the 
longer term, for economic stability and for restoring 
confidence and optimism in our country.
    Chairman Cox and I had a good chance to talk over the 
weekend as well, and some of the ideas have become the subject 
of public debate and discussion over the last 24 ours or so.
    It is also important--and I think all of you understand 
this--that as Members of this Committee, we have been charged 
with the responsibility of oversight and jurisdiction on these 
policy matters. And so it is important that we be probative as 
well of these issues as to how they would work, what the impact 
could be, what are the implications of what we are suggesting 
in these various ideas. And so as a part of this hearing, which 
is unprecedented in many ways because of the circumstances, I 
want the tone of it to reflect both a welcoming tone in light 
of the ideas that have been suggested, but also one that is 
probative, that we examine thoroughly these ideas and what the 
implications are. Inaction is not an option, in my view. That 
may be an option for some. It is not for this Chairman. I do 
not believe we can do anything and just watch events unfold. I 
think we have a responsibility to respond.
    I think the notion of fresh capital is critically important 
and we need to act expeditiously, in my view, in how we do 
that. And so I begin the process by suggesting to you that we 
have a good discussion here over the next hour or so if we can, 
with my Members who are here, to engage in this debate and 
discussion. In a sense, I must say at the outset here that the 
plan, Mr. Secretary, that has been proposed is somewhat ironic 
in a way in that for much of the last year or so, those of us 
who have offered some ideas on how to prevent foreclosures have 
been labeled as ``costly bailouts'' for our ideas. And I know 
that is not the view of everyone, but certainly there were 
those who suggested that was the case.
    We have also gone through the period over the last year or 
so when this problem became most poignant of going from 
basically this will correct itself, it is not that big a deal--
those were the comments almost a year ago--to the point where 
obviously we are talking about some unprecedented ideas and 
suggestions as to how we might move in all of this.
    Let me just identify, if I can, as part of the plan and 
idea that raised some questions. There are those who suggest 
that what we are looking for here or what the proposal would be 
amounts to a blank check to buy GSE debt and stock and that 
could spend an unlimited amount of public dollars to buy such 
debt and stock. The only limitation seems to be the duration of 
the plan, at least as some have raised. The purchases would be 
exempt from the debt ceiling, off budget, concerns about that. 
The Fed would be consulted. We have been talking around some 
questions to the Chairman of the role of the Fed in all of 
this. The bill that is pending now and resolution between the 
House and the Senate--and I am grateful, again, to those of you 
here who have been supportive of what we have tried to 
accomplish here--establishes a very strong regulator for the 
GSEs.
    There are those--I am included here--that would be 
concerned about, in a sense, substituting that very strong 
regulator--and I say this respectfully--to the Chairman of the 
Federal Reserve, given the authority that is being suggested 
over that strong regulator, making the regulator far weaker in 
many ways than I think what many of us would like to achieve 
and see. There are concerns about that as well. And then, of 
course, there is the proposal that is, as I said, basically 
dealing with the Fed and giving it that power, a strong role 
than would otherwise be necessary.
    So those are some of the concerns that have been raised. 
Obviously, this is an important moment, an unprecedented 
moment, as I said a moment ago, that we need to grapple with 
and deal with. And we are, again, deeply appreciative of your 
presence here to be probative, to be supportive of good ideas 
that will move us in the right direction. I think it is very 
important that we not contribute to the fear--unwarranted fear, 
I might add--that exists in too many places. This is a time for 
calm, for stability, for solid ideas that can get us back on 
the right track.
    And with that, I thank you for your presence here. Let me 
turn to Senator Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman. I will try to be 
brief, but I think this is a very, perhaps one of the most, 
important hearings we have had in the Banking Committee, and we 
have had others.
    We will now, as you mentioned, focus on a very important 
topic: preserving the viability of our Nation's Government-
sponsored enterprises. These entities must be financially 
strong if we are to work through the housing market correction. 
Their vitality is also crucial for the future of our capital 
markets and the economy as a whole. This Committee right here 
has worked for a number of years to strengthen the regulatory 
system governing Fannie Mae, Freddie Mac, and the Federal Home 
Loan Bank System.
    Some years ago, as Chairman of this Committee, I presided 
over a Banking hearing, a markup of GSE legislation that would 
have created a strong regulator with the authority to assess 
the risk posed by the enterprises to our financial system. At 
that meeting I noted that, should one of these institutions 
encounter significant financial difficulty, the consequences 
could be grave for the entire economy as well, perhaps, as the 
American taxpayer.
    Regretfully, that legislation was opposed by those who 
argued that a strong regulator would endanger the GSEs by 
undermining their financial fundamentals. Goodness. I hope it 
is now clear that quite the opposite is true.
    In recent days, market volatility, as everyone here knows, 
has affected both the debt and equity holdings for Fannie Mae 
and Freddie Mac. In response, various public officials have 
made statements regarding the financial conditions of the GSEs. 
In particular, an OFHEO statement noted that both Fannie Mae 
and Freddie Mac hold adequate capital in excess of the 
statutory minimums, which is probably true. The GSEs have large 
liquidity portfolios, access to the debt markets, and over $1.5 
trillion in unpledged assets. Many would thereby conclude--and 
many have stated publicly -that each GSE is safe and sound. 
Goodness again. If the enterprises are operating in a safe and 
sound manner, it begs the question: What are we doing here 
today? Well, we all know why we are here.
    Over the years, the debate over GSE reform included a great 
deal of controversy regarding the topic of systemic risk raised 
by the Federal Reserve Chairman and others before him. In other 
words, could a GSE judged to be operating in a safe and sound 
manner pose a broader systemic risk? For some time, a lot of us 
have argued strongly that it could. I hope recent events have 
resolved the debate on this question. The GSEs, even when they 
are deemed safe and sound, can pose systemic risk. We would not 
be here today discussing taking unprecedented action to shore 
up their financial condition for the broader purpose of 
protecting the overall economy if that were not the case.
    The administration is now proposing--and we will hear in a 
few minutes from Secretary Paulson--additional statutory 
changes in response to developing market conditions. The 
proposal we will hear about this morning should raise a number 
of serious questions for the Members of the Banking Committee 
and the U.S. Senate. If Congress intends to reaffirm Wall 
Street's view that the American taxpayer stands behind the 
GSE's debt, we will undoubtedly harden the so-called implicit 
guarantee. If that is the case, I think this Committee needs to 
fully understand why this step must be taken. What exactly 
would we be getting in taking an ownership stake, or something 
like it, in the GSEs? What rights would the Government possess 
as an owner or a guarantor? What impact would such actions have 
on the dollar and the broader economy, both now and in the 
future?
    Mr. Chairman, I hope that our hearing today provides the 
Committee with answers to some of these and other important 
questions. I hope we can take what we will learn today and make 
whatever changes to any legislation bill that we deem 
necessary. I fear that we are sitting on a financial powder 
keg.
    Thank you.
    Chairman Dodd. Thank you very much, Senator Shelby.
    Again, let me turn to you, Secretary Paulson and Chairman 
Cox. We thank you both for being with us. Secretary Paulson.

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

    Secretary Paulson. Good afternoon, everyone. Thank you very 
much, Chairman Dodd and Senator Shelby and Committee Members, 
for your leadership and for the opportunity to discuss these 
very important issues on short notice.
    As you know, our financial markets have been experiencing 
turmoil since last August. It will take additional time to work 
through these challenges, and progress has not come in a 
straight line. However, our financial institutions are 
repricing risk, deleveraging, recognizing losses, raising 
capital, and seeking to improve their financial positions. And 
policymakers and regulators are vigilant in their efforts to 
address the current challenges.
    Fannie Mae and Freddie Mac, two of the Government-sponsored 
enterprises--the so-called GSEs--are also working through this 
challenging period. Fannie and Freddie play a central role in 
our housing finance system and must continue to do so in their 
current form as shareholder-owned companies. Their role in the 
housing market is particularly important as we work through the 
current housing correction. The GSEs now touch 70 percent of 
new mortgages and represent the only functioning secondary 
mortgage market. The GSEs are central to the availability of 
housing finance, which will determine the pace at which we 
emerge from this housing correction.
    In addition, debt and other securities issued by the GSEs 
are held by financial institutions around the world. Continued 
confidence in the GSEs is important to maintaining financial 
system and market stability.
    Market stability and support for housing finance are among 
my highest priorities--and they have been for some time--during 
this period of stress in our markets. Therefore, after 
consultations with the Federal Reserve, OFHEO, the SEC, and 
congressional leaders, we are asking Congress, as it completes 
its work on a stronger GSE regulatory structure, to also enact 
a three-part plan to address the current situation. Our plan is 
aimed at supporting the stability of financial markets, not 
just these two enterprises. This is consistent with Treasury's 
mission to promote the market stability, orderliness, and 
liquidity necessary to support our economy.
    Our proposal was not prompted by any sudden deterioration 
in conditions at Fannie Mae or Freddie Mac. OFHEO has 
reaffirmed that both GSEs remain adequately capitalized. At the 
same time, recent developments convinced policymakers and the 
GSEs that steps are needed to respond to market concerns and 
increase confidence by providing assurances of access to 
liquidity and capital on a temporary basis if necessary. The 
plan we announced will strengthen our financial system as we 
weather this housing correction and establish a new world-class 
regulator for the GSEs. It has three parts.
    First, as a liquidity backstop, the plan includes an 18-
month temporary increase in Treasury's existing authority to 
make credit available for the GSEs. Given the difficulty in 
determining the appropriate size of the credit line, we are not 
proposing a particular dollar amount. Flexibility is the best 
means of increasing market confidence in the GSEs and also the 
best means of minimizing taxpayer risk.
    Second, to ensure the GSEs have access to sufficient 
capital to continue to fulfill their mission, the plan gives 
Treasury an 18-month temporary authority to purchase--only if 
necessary--equity in either of these two GSEs. Let me stress 
that there are no immediate plans to access either the proposed 
liquidity or the proposed capital backstop. If either of these 
authorities is used, it would be done so only at Treasury's 
discretion, under terms and conditions that protect the U.S. 
taxpayer and are agreed to by both Treasury and the GSE. I have 
for some time urged a broad range of financial institutions to 
raise capital, and at Treasury we have constantly encouraged 
the GSEs to do just that. In March, at my request, both the 
Chairman and Ranking Member of this Committee hosted a meeting 
with me and the CEOs of the two GSEs where they agreed to raise 
capital, and you began the effort to move your GSE reform bill, 
which is now hopefully about to be enacted with the 
modifications we are recommending today.
    Third, to help protect the financial system from future 
systemic risk, the plan strengthens the GSE regulatory reform 
legislation currently moving through Congress by providing the 
Federal Reserve authority to access information and perform a 
consultative role in the new GSE regulator's process for 
setting capital requirements and other prudential standards.
    Let me be clear. The Federal Reserve would not be the 
primary regulator. As I have said for some time, the Fed 
already plays the role of de facto market stability regulator, 
and we must give it the authorities to carry out that role. 
This role for the Federal Reserve with respect to the GSEs is 
consistent with the recommendation made in Treasury's Blueprint 
for a Modernized Financial Regulatory Structure. Clearly, given 
the scope of the GSEs' operations in world financial markets, a 
market stability regulator must have some line of sight into 
their operations.
    We have long maintained that the GSEs have the potential to 
pose a systemic risk and worked with Congress on legislation to 
create a GSE regulator with authorities appropriate to the task 
and on a par with other financial regulators. We must complete 
this work. The Senate passed GSE reform legislation last 
Friday, and we urge the House to act quickly to advance this 
process.
    As I have said, we support the current shareholder-owned 
structure of these enterprises. Our plan addresses current 
market challenges by ensuring, on a temporary basis, access to 
both liquidity and capital, while also ensuring that the GSEs 
can fulfill their mission--a mission that remains critical to 
homeowners and homebuyers across the country, especially during 
this housing correction.
    I look forward to working closely with you, your colleagues 
in the House, and congressional leadership in both chambers to 
enact this plan as part of a complete legislative package as 
soon as possible.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Mr. Secretary.
    Chairman Bernanke has already indicated he made his 
statement earlier and does not have a statement to make at this 
point. Is that correct, Mr. Chairman?
    Chairman Cox.

STATEMENT OF CHRISTOPHER COX, CHAIRMAN, SECURITIES AND EXCHANGE 
                           COMMISSION

    Mr. Cox. Thank you very much, Mr. Chairman, Senator Shelby, 
and Members of the Committee, for this opportunity to describe 
the SEC's actions to deal with the recent developments in our 
financial markets.
    Since the credit market crisis began with the deterioration 
of mortgage underwriting standards and a contagion of abusive 
lending practices, and then spread to the capital markets 
through securitization, the SEC has used its law enforcement 
and regulatory powers to contribute to orderly and liquid 
markets. We have acted in three main areas: the investigation 
and prosecution of violations of the securities laws; the 
regulation of problem areas in the markets, including credit 
rating agencies under recent authority granted to us by the 
Congress; and accounting and disclosure standards in order to 
bring hidden risk into the light. Our work in these areas has 
been both national and international.
    First and foremost, the SEC is a law enforcement agency. 
Our enforcement actions to address the capital markets turmoil 
have involved not only our Division of Enforcement and each of 
the agency's 11 regional offices, but also nearly every major 
SEC division and office, and every area of professional 
emphasis, through our agency-wide Subprime Task Force. We are 
also working closely with other Federal and State regulators.
    The SEC has over four dozen pending law enforcement 
investigations in the subprime area. They are focused on the 
activities of subprime lenders, on the roles of credit rating 
agencies, insurers, investment banks, and others involved in 
the securitization process; and on the banks and broker-dealers 
who sold mortgage-backed investments to the public.
    As one example of these initiatives, just a few weeks ago 
the Commission brought enforcement actions against two 
portfolio managers of Bear Stearns Asset Management, whose 
hedge funds collapsed in June of last year and caused investor 
losses of over $1.8 billion. These cases, and others like them 
in the subprime area, are making it clear that vigorous 
investor protection extends to hedge funds, which are by no 
means unregulated when it comes to fraud.
    The same vigorous commitment to investors extends to our 
jealous protection of the integrity of public disclosure. 
Because the reliability of information about public companies 
is so important to market confidence, there have long been 
clear rules that prohibit market manipulation by knowingly 
spreading false rumors. But for the entirety of its 74-year 
history until 2008, the Commission had never brought an 
enforcement action of this kind. It is probably because of the 
difficulty in tracing where a false rumor starts, and proving 
that it was knowingly false, that these cases haven't been 
brought in the past. But now the same technology that instantly 
spreads rumors around the globe is also helping law enforcement 
track down the culprits. As a result, just a few weeks after 
the demise of Bear Stearns, we successfully sued a trader who 
used instant messages to other brokerage firms and hedge funds 
to spread fake information about a pending acquisition. The 
false rumors that he started caused the stock to drop by 17 
percent and caused a wipeout of market capitalization of $1 
billion in 30 minutes and led to a halt in trading in those 
securities on the New York Stock Exchange.
    Following our enforcement action, the Commission not only 
hit the trader with penalties and other sanctions, but also 
banned him for life from the industry. This was a landmark 
case, and it will not be unique. If we are successful in 
bringing future cases like this, I believe the penalties should 
be commensurate with the enormous amount of shareholder value 
that is destroyed by this kind of wantonness toward other 
people's money.
    For several months, we have had other active investigations 
underway concerning the possible manipulation of securities 
prices through various combinations of manufacturing false 
rumors and short selling. In addition, the Commission has 
joined with other securities regulators in undertaking 
industry-wide sweep examinations that will include hedge fund 
advisors, aimed at preventing the spread of intentionally false 
rumors to manipulate securities prices.
    In addition to enforcing our existing regulations, the 
Commission is also using our authority to promulgate new rules. 
Today, the Commission will issue an order designed to enhance 
protections against ``naked'' short selling in the securities 
of primary dealers, Fannie Mae, and Freddie Mac. The emergency 
order will provide that all short sales in the securities of 
primary dealers, Fannie, and Freddie will be subject to a pre-
borrow requirement. In addition to this emergency measure, we 
will undertake a rulemaking to address these same issues across 
the entire market.
    We are also using our new authority under the Credit Rating 
Agency Reform Act to write sweeping new regulations that will 
apply to the rating of structured investments. Until the 
passage of this landmark legislation, the credit rating 
industry has been largely unregulated. Now, in the 10 months 
since the first firms became registered under the new law, they 
are subject to thorough and ongoing regulation of everything 
from their public disclosures, to their management of conflicts 
of interest, to their ability to prevent unfair, abusive, or 
coercive behavior in the ratings process. The new law also gave 
us the authority to examine these firms, and we are using it 
aggressively. As you know, we recently provided to the 
Committee a complete report of our staff's findings in these 
examinations.
    The subprime crisis was also deepened by problems with 
disclosure and accounting, and so in recent months, we have has 
asked financial institutions to provide additional disclosure 
regarding both off-balance-sheet arrangements and the 
application of fair value to financial instruments.
    Last Wednesday, the Commission held a roundtable to hear 
from market participants and regulators about the challenges of 
current fair value accounting and auditing requirements, which 
will provide the basis for potential new guidance from the SEC, 
the FASB, and the PCAOB.
    Since the events of mid-March that culminated in the Bear 
Stearns acquisition, the SEC has broadly engaged with other 
regulators on issues related to capital and liquidity. We have 
broadly strengthened liquidity requirements, and we are closely 
scrutinizing the secured funding activities of each CSE firm. 
Working together with the Federal Reserve, we have developed 
additional stress scenarios in light of the Bear experience. 
These scenarios entail a substantial loss of secured funding 
and assume no access to the Fed's liquidity facilities. Our 
recently concluded Memorandum of Understanding with the Federal 
Reserve Board is facilitating this cooperation as well as our 
joint work in a number of other important areas.
    Finally, I note that the subprime crisis has affected 
markets not only here in the United States but all over the 
world, and so we have been working closely with our 
international regulatory counterparts to ensure that our 
solutions to these problems work across national borders and in 
other markets.
    Thank you, again, Mr. Chairman, for this opportunity to 
discuss these important issues, and I will be happy to take 
your questions.
    Chairman Dodd. Thank you very much, Mr. Chairman, and we 
appreciate your presence again here today.
    I will put 6 minutes on the clock here, and we will move 
along. Because everyone has shown up here, we will move in a 
normal seniority system here, as everyone has been for the last 
2 or 3 hours.
    Let me address, if I can, the very points, Mr. Secretary, 
that you have raised. Again, this is our responsibility here to 
be probative and examine these ideas, particularly if we are 
going to try and act in some expeditious fashion here. 
Normally, there would be a period of time to really go over 
these issues in far greater detail, but the sense of urgency is 
something I think all of us, or at least most of us here 
appreciate.
    Let me begin by, first of all, asking a quick series of 
questions regarding the issue of the lines of credit, and then 
I will get to the issue of stock and then the issue of the 
regulator, if I could quickly.
    One, you are seeking an unprecedented grant of authority to 
purchase GSE debt and stocks. What kind of assurances can we 
offer taxpayers--because we do not have a number here, this is 
an unlimited amount we are looking at potentially. What has 
happened with the $2.25 billion, the present authority that 
exists from the Federal Reserve? Why aren't we going and just 
opening the discount window? Institutions that have access to 
the discount window--and Chairman Bernanke can respond to this 
as well--use GSE debt as collateral, as a basis of qualifying 
for borrowing at that discount window. If we do that, why not 
allow these GSEs to have direct access? That way we do not need 
legislative authority and would provide that kind of fresh 
capital we are looking at. Why not just go that route if we are 
looking for some quick action here that would reassure the 
markets that there will be adequate capital?
    Secretary Paulson. Thank you, Mr. Chairman. Let me answer 
that question. First of all, in terms of the size, as you know, 
when the GSEs were--legislation was set up in 1971 there was a 
direct line of a back-up credit provided by Treasury of $2.25 
billion for each agency. At that time, Freddie Mac had 
capitalization of $1 billion.
    Why are we asking for an unspecified amount? And the reason 
we are is I have the same objective that you have. What I would 
like to do is provide stability in the market and do so at the 
least cost to the taxpayer. And I see it very clearly that the 
way to minimize the chance that this facility will ever be 
called upon will be to take any questions off the table and to 
provide as much flexibility as possible.
    Now, to your question relative to the----
    Chairman Dodd. Can I just interrupt? The big question we 
are going to be faced with our constituents is how much is this 
going to potentially cost us.
    Secretary Paulson. Yes, and as I have said, since we 
believe that the right thing to do is to keep these 
institutions in their current form, the question which I am 
answering is that this is a back-up facility, hopefully would 
never be used; and if you want to maximize the chances it will 
ever be used, you would have maximum authority for a temporary 
period of time. We are asking for it for a temporary period of 
time. All I can do is tell you which in my judgment, what I 
believe is the best for providing stability, providing 
confidence, and minimizing the chance it will be used and 
minimizing the chance that people will lose confidence and draw 
down the back-up facility.
    Now, in terms of the----
    Chairman Dodd. Why not just the discount?
    Secretary Paulson. In terms of the Fed, the Fed has a 
number of other very important priorities, and what the Fed did 
here, which was--and I am very grateful to the Chairman and for 
the Federal Board, because what they said to me was they said, 
Hank, if you can, you know, through your consultations with 
Congress, develop a plan and you believe based upon your 
conversation with the leaders--and as you know, I talked with 
many leaders of Congress--and you can get some buy-in in 
advance that something like this might be acceptable, then we 
would be willing to provide a back-up while we are waiting.
    But I guess the question I would--the way I would throw it 
back at you, the Fed has their lender-of-last-resort 
responsibilities. That is unspecified. Why is it unspecified? 
It is unspecified because it increases the confidence. Congress 
in their wisdom set up the Treasury as providing the back-up 
facilities here. That is what the authority is. They just have 
not been updated in a long time. So that is why we--that is why 
we proposed--I consulted with Congress. We proposed this. We 
think this is the best way to limit the cost to the taxpayer. 
And, again, I am very grateful that the Fed agreed to be there 
providing the back-up while we are waiting for Congress to act.
    Chairman Dodd. Let me ask Chairman Bernanke this. As I 
understand it, in the past there has been some willingness to 
allow access to the discount window if the $2.25 billion 
authority lines of credit has been exhausted. Once that is 
exhausted, then the possibility of having access to that 
discount window becomes available. Am I understanding that 
correctly?
    Secretary Paulson. I would say that is--look at that as 
sort of a normal working of Government. I provided that, we 
provided that to the Chairman in the interim. But it was done 
with the understanding--and the way I worked with the Chairman 
over the weekend was we worked through the weekend, we 
consulted. I told him I made the various calls that I had made, 
that I was optimistic that we would persuade Congress that the 
back-up facility should be increased. And then on that basis, 
he went and agreed to fill it in in this period.
    Chairman Dodd. Well, let me ask Chairman Bernanke the 
question. In fact, if the GSE debt can be used as collateral 
for other institutions that come and have access to the window, 
why not allow the GSEs to have access directly to that?
    Mr. Bernanke. I think the reason has to do with who sets 
the criteria and makes the decision. The Federal Reserve's 
lender-of-last-resort function is a very flexible tool. It is 
very important because we can use it quickly in unanticipated 
circumstances and provide liquidity in situations where it is 
needed.
    When a policy has potential fiscal implications, it is far 
better if time and circumstances permit to have the fiscal 
authorities make that decision.
    So I think it is really appropriate for the Treasury 
Secretary, in consultation with the Congress, and not the 
Federal Reserve Chairman, to make those decisions, and that is 
why it would, I believe, make more sense to be the 
responsibility of the Treasury Secretary.
    Chairman Dodd. Is there any question in your mind that you 
have the authority to make that window available to the GSEs if 
you so decided to do so?
    Mr. Bernanke. We do have the authority, although we have a 
regulation we would have to address which says only under 
economic circumstances that are stressed. But, again, I do 
think that the lending and the decisionmaking ought to be 
lodged with the fiscal authorities.
    I would point out that what the Secretary is proposing is 
not a simple expenditure. Either a liquidity provision or an 
equity purchase is a loan or an investment that has an asset on 
the other side. So it is not quite the same thing as a simple 
fiscal expenditure. It is a loan as the Government makes in 
many contexts, or an investment.
    Chairman Dodd. My time has expired. Senator Shelby.
    Senator Shelby. I want to pick up on what Senator Dodd was 
talking about. Secretary Paulson, just take us through slowly, 
step by step, what is the proposal that you have set forth to 
deal with the GSEs? And what is the potential cost to that? 
Because this is not an empty gesture. I think you mentioned a 
minute ago, used the phrase ``they might not need this, they 
might not use this, this would be the best of all worlds.'' But 
what if they did? Let's go through the steps of what you are 
proposing so we can understand this fully. I think it is very 
important.
    Secretary Paulson. Senator, I want to start off with 
something you said, which was essentially we did not design 
this, we are playing the hand we are dealt. Right? And as I see 
this, that what we have asked for--and I will go through them 
again--is, first of all, the authority for a temporary period 
of time, authority for 18 months?
    Senator Shelby. What do you mean by temporary? How long?
    Secretary Paulson. Eighteen months, and I would like to 
talk about that for a minute, because we asked what is the 
right period here. And it seemed to me that we did not want 
to--I could have asked for it for the end of the year. It did 
not seem like--we do not know what the markets will be like at 
the end of the year. It did not seem like a great gift to give 
to my successor, whoever he or she may be, to have something 
like this expiring right away. And so as we thought about it, 
we said 18 months or through the end--I guess we said through 
the end of 2009, that should give time to get the new regulator 
established, to work through this current, you know, period of 
turmoil, to have the new administration--give them some time to 
assess the situation, give them some time to work with 
Congress, give you all time. And so that was where we came up 
with asking for it until the end of 2009.
    Senator Shelby. How much money are you contemplating here?
    Secretary Paulson. Well, again, I would say with that there 
is no current plan, and it would be the expectation, with a 
facility like this, that, again, a back-up facility is about 
confidence. And if you want to make sure it is used, make it 
small enough, and it will be a self-fulfilling prophecy.
    And so, again, all I can do is say to you that while I am 
here, I would--it would be--I would ask for it to be 
unspecified, and I would plan on doing what you found I have 
done in everything else, which would be consult extensively.
    The next authority we asked for was the authority at 
Treasury's discretion, but also given, you know, the engagement 
and mutual support of the GSEs, that Treasury would have----
    Senator Shelby. Is that open-ended? Is that----
    Secretary Paulson. Again, that would be for 18--Senator, 
that is also for 18 months, because I again think that as I 
look at this proposal, I believe what we have got here today is 
something to address the short term and the long term. I am 
going to get to that in a minute. So I think we have got a 
proposal that is going to address the short-term issue and the 
longer term.
    So with regard to, again, the temporary authority--and 
while I am here, again, I would plan on consulting--you know, 
consulting with you and the other leaders here before 
exercising that authority. But I would----
    Senator Shelby. The word ``consulting'' you are using here, 
is there any ambiguity to that?
    Secretary Paulson. Well, yes, I would not like it to be a 
legislative requirement, and the reason I would not is, again, 
I think to the extent you limit it or take away the 
flexibility, it then makes it worth less in the marketplace. 
But, again, the authority to make an equity investment if it is 
deemed necessary. And, again, if that were done, it would be 
done with the appropriate protections for the taxpayer.
    And then, of course, the third--let me just----
    Senator Shelby. You go ahead.
    Secretary Paulson. Then I will just say the third thing, 
because you asked for all three, and I think this is important 
here, because we have all been working--and you, Senator, have 
been a champion in this area. We have been working to get 
reform with a world-class regulator. And I think that when that 
regulator is in place and that regulator is up and going, I 
think there will be a real opportunity to have the discussion 
for what is the right size, what are the risk characteristics, 
capital requirements, business activities. And so I think you 
are going to be able to address the longer term. and this also 
addresses the short term.
    Senator Shelby. Secretary, what is the trigger, at what 
point, in other words, would Treasury exercise this new 
authority? And what if, for example, the equity price falls 
below a dollar? We know the consequences of that, I think. Or 
if debt cannot be issued, or is it at the--is it too wide a 
spread over the Treasurys? In other words, a lot of these 
events--you just want to reserve that----
    Secretary Paulson. I think just for that, Senator, you have 
laid out the reasons why we would be--it would be self-
defeating to start putting limitations on that. So I think the 
way I would see that and the way I would like it to work is 
temporary and the understanding you would have with me, 
although we would not have, you know, legislative requirements, 
the understanding you would have with me, this would be 
something that I would talk about with the leadership of this 
Committee and committees in the House before, and it would be 
if needed. And just remember, as you said in your opening 
statements, the regulator who we have confidence in has said 
they are adequately capitalized. The market is saying that 
there are concerns. And so we--one way of reassuring the market 
and being ready to respond is to say that--and, again, with the 
objective of market confidence and having the GSEs play that 
role which is so important in our housing market right now.
    Senator Shelby. Are you basically saying that this is a 
temporary involvement by Treasury, it is not open-ended, but it 
is an involvement to reassure the markets and protect the 
downside?
    Secretary Paulson. Right. I am saying the first two are 
exactly right. You said it very well. Temporary, protect the 
downside, and to make sure that these entities continue to play 
that role we are going to need to play to get through this 
housing downturn. And the third part of this, which is, you 
know, the strong independent regulator, that is permanent. And 
that will be--and so as I said, this addresses the short term 
and the long term.
    Senator Shelby. Thank you.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much.
    Let me turn to Senator Carper.
    Senator Carper. Thank you, Mr. Chairman.
    I want to go back about 28 years, and we were concerned 
here--I was State Treasurer of Delaware at the time, but we 
were concerned about the failure not of GSEs but the failure of 
one of the Big Three--Chrysler Corporation. And I remember Lee 
Iacocca calling on the Congress, calling on the President to 
provide assistance. And what we did in my State and in a number 
of States, we negotiated a loan to Chrysler, collateralized 
loans, which we made and ultimately earned interest on. We 
actually made money on those loans.
    Here in Washington, there was an agreement negotiated with 
Chrysler, which involved, I think, warrants which could 
ultimately be exercised. And at the end of the day, Chrysler 
survived, and I believe the Federal Government actually made a 
dollar or two on the deal.
    I do not believe there was a great anticipation 28 years 
ago that that would happen. We were hopeful that Chrysler would 
survive. The fact that the money was made on the warrants and 
also on the loans that we made from our States was, if you 
will, the icing on the cake.
    There is a lot of concern here, rightfully so, of the 
exposure that we put the taxpayers to and the Treasury to by 
virtue of going down this path. Is there any upside, aside from 
the fact that we want the GSEs to survive, we want them to be 
there when the economy--when the market bottoms out, when all 
those renters across the country say this is the time that they 
want to start buying a house. And I think that will happen, 
hopefully sooner rather than later. But there is another upside 
other than making sure that our mortgage markets are prepared 
and our housing market is prepared for that recovery.
    Secretary Paulson. Senator, let me mention two things. 
First of all, the big upside is every homeowner in this country 
or everyone who wants to buy a home or wants to refinance a 
home, refinance a mortgage is benefiting. But now let me also 
explain that unlike the Chrysler situation--and I am old enough 
to have been around to remember it--this is not what we are 
recommending. These organizations are very viable. They are 
playing a very important role. And what we are doing is--I am 
not here recommending putting taxpayer money in these 
institutions at this time. I am here recommending that we 
increase on a temporary basis the back-up facility to provide 
the confidence to the markets and to minimize the chance, 
greatly minimize the chance, that the taxpayer would be 
involved there, and here also to reassure and say that we have 
the capacity again for a temporary period of time to make an 
investment if it is needed and if it is in our discretion and 
the GSEs' agreement, then if that--and only then if that 
investment is made will it be made on terms where hopefully we 
will protect the taxpayer along the lines that you talked 
about.
    But the overriding issue here is the confidence in our 
capital markets more broadly, our financial system more 
broadly, the stability of our financial system more broadly, 
and the fact that the GSEs--really right now this market is the 
only really working secondary market in housing finance in our 
country today.
    Senator Carper. One of the proposals that you have 
suggested is an increase in the Treasury line of credit for 
Fannie and Freddie. I have some concerns--and I suspect my 
colleagues do, too--about having no cap, no limit at all. For 
some of us, it sounds a little bit like a blank check. And I 
know that is not the intent.
    The second recommendation that you have is that the 
Treasury be authorized to purchase the stock of Fannie and 
Freddie. If you ultimately do that, and if the value of the 
stock does go up, is there some potential for Treasury actually 
making money on this deal?
    Secretary Paulson. Well, let me say two things. First of 
all, your comment about the blank check, I think I have 
answered that before.
    Senator Carper. I know you----
    Secretary Paulson. I hope you understand what I said.
    Senator Carper. I did.
    Secretary Paulson. And I know it is--if people have not 
thought about these issues for a long time, it is 
counterintuitive. But, really, the greater the confidence, the 
less likelihood that the taxpayer is actually going to end up 
paying.
    Senator Carper. And I agree with that.
    Secretary Paulson. And, second, I can assure you that if we 
decide to make an equity investment in these institutions, we 
will do so to protect the taxpayer, and, you know, I would 
believe there would be--but we would have to talk about that at 
the time. But obviously----
    Senator Carper. Let me interrupt because my time is 
limited. Let me just interrupt. So you don't think several 
years down the line when the shares that the Treasury has 
bought in Fannie and Freddie turn out to be a windfall and we 
are able to balance the budget, there will not be, like--you 
will not be heralded and saluted for the role that you played 
in that?
    Secretary Paulson. No. Again----
    Senator Carper. I say that with tongue in cheek. I say that 
with tongue in cheek.
    Secretary Paulson. Well, again, what I am saying is--
because I really do need to be clear. There is not a plan to do 
that at this time. I would sure hope, like you, that if there 
is one, that as our markets recover and if the shareholders put 
money in, they end up making a lot of money, as was the case in 
Chrysler. But, remember, this is not Chrysler, and there is not 
a plan to put equity in these institutions at this time.
    Senator Carper. And if I could, one last quick question. I 
think you are proposing a more formal role for the Federal 
Reserve, working in conjunction with the new GSE regulator. How 
would that work?
    Secretary Paulson. OK. Let me--because I think this is 
important, and it is something that we have thought about for a 
long time, and we suggested it that other countries--the U.K. 
has taken this up with their central bank. I need to step back 
and say if you really look at what the market has come to 
expect, they have come to look at the Federal Reserve and 
saying if there is an issue that threatens market stability, we 
expect them to play a role.
    And so one of the things we have asked is not that they 
supplant other regulators. Not at all. That they have other--
but have asked that they have some line of sight, they have a 
visibility and they are able to play a consultative role. So 
they--and it is only fair when you look at what--and fair to 
our country, what might happen.
    And so what this--to be very specific for you, this is not 
designed in any way to undercut the authority of the new 
regulator. This regulator has got to be world class, got to be 
a strong regulator. You will be working with a new regulator. 
You will be working with a new regulator to address the issues 
that so many people have talked about. But I would warrant that 
you and other Americans and people around the world will feel 
more confident--I sure will--knowing that the Fed is there to 
play a consultative role and be able to give their comments 
also. And that is the purpose.
    Senator Carper. All right. Thanks so much.
    Chairman Dodd. Thank you very much.
    Senator Bennett.
    Senator Bennett. Thank you very much, Mr. Chairman.
    Mr. Secretary, going to your testimony on the second page, 
you say, ``Let me stress that there are no immediate plans to 
access either the proposed liquidity or the proposed capital 
backstop.'' And you have made that very clear, and I think 
appropriately so. Then this sentence: ``If either of these 
authorities is used, it would be done so only at Treasury's 
discretion, under terms and conditions that protect the U.S. 
taxpayer and are agreed to by both Treasury and the GSE.''
    Can you help us understand a little bit more the specifics 
of the terms you have agreed to with the GSE? Or are there 
any----
    Secretary Paulson. There are no terms because we have not--
as I said, there are no plans to use it as yet. I said ``if 
needed.'' And so if needed--and we would obviously be 
consulting, and we would look to work something out that was 
mutually agreeable. But it would have to be, you know, on terms 
that would protect the U.S. taxpayer.
    And so I cannot--it is a little bit like Senator Shelby 
said, that you could think of so many contingencies or what-
ifs, it would be pretty hard to design those terms, you and I 
sitting here today.
    Senator Bennett. Well, I am assuming if the GSEs felt, OK, 
we are in trouble, and then they came to you, that would be the 
triggering event that would cause you to look at it?
    Secretary Paulson. That could be one triggering event, 
absolutely. It could be another triggering event that--we or 
the marketplace, you know, could be a triggering event. So I 
would not want to say to you the only basis on which we would 
talk to the GSEs about capital is if they came to us.
    Now, my own belief--and let me say----
    Senator Bennett. I assume you will be in conversation 
with----
    Secretary Paulson. Yes, let me say we have been--and I just 
would compliment--I just want to say something about both of 
these organizations. I agree with Senator Shelby that there are 
systemic risks, and no one today who has looked at this could 
argue that there isn't. But I would also say that when you look 
at the way they have run their operations, the reason we have 
these issues is they have got one line of business, there has 
been a housing correction. I would say that their standards and 
underwriting standards as we have gone through this period have 
been good relative to what we have seen many other places. And 
I would also say that they have worked with me, you know, not 
only over the weekend but leading up to the weekend, in a very 
constructive way. And so I would have every belief that, you 
know, the question you asked would play out that we would be in 
dialog, we would be in consultation. I think it will be very 
unusual if we suddenly say we think you need equity and no one 
else does, OK? I think this is something that we would work on 
together.
    But, again, to protect the Government, I cannot say that 
the only trigger is the GSEs come to us and ask for it and we 
give it to them. You would not want me to do that.
    Senator Bennett. I understand that. And your discretion 
means they come to you and ask for it, you may say no. That 
could also be----
    Secretary Paulson. My discretion, that is right, we may say 
no or we may say these are the terms we think. But I think what 
you are going to find is it has got to be at our discretion. I 
was very clear with them when we talked over the weekend that 
this was not going to be something that we were going to be 
forcing on them. This would be something we would have to work 
on together, and it would be done mutually.
    Senator Bennett. That is what I wanted to get clarified, 
and I think you are in exactly the right place.
    Chairman Cox, I was interested in your comments--you will 
not be surprised when I raise this, given our past history on 
the issue. I was interested in your comments about naked short 
selling and the steps that you are taking. I want to commend 
you. Your staff has been to see me with a list of all of the 
steps they are taking with respect to naked short selling. I 
want to stress again I am not opposed to short selling. Short 
selling is an essential part of maintaining an orderly market. 
But I am satisfied that there are circumstances where people 
sell short without, in fact, having located the stock that they 
are selling short, and then hope that the confusion in the 
marketplace covers up that fact and that they never get--the 
failure to identify the shares that they are selling short 
never catches up with them. And I congratulate you on the work 
that you have done there.
    May I make a suggestion, and this comes out of a completely 
separate kind of experience, but as I watched the Winter 
Olympics in Salt Lake City, I discovered something that I had 
never understood before. At the end of a luge run or a bobsled 
run, or whatever it might be, before the athlete gets out of 
the luge, he reached into a basket that is filled with colored 
balls, and he pulls out a ball. And it is orange or red or 
whatever it might be. If it is black, the athlete is instantly 
taken to a place where there is a drug test so that the 
athletes know that there is always the possibility, even if it 
is completely random, that he or she will be subjected to a 
drug test.
    Might I suggest that you set up a SWAT team of some sort 
that can drop into a brokerage house completely unannounced, 
completely at random, on no particular tip, to simply say we 
want to pick out a couple stocks and look to see if within your 
brokerage house somebody has been in engaged in naked short 
selling. And it is completely random. You walk away with an 
orange-colored ball or a red ball and whatever. You are 
completely clean. There is no stigma attached to it. But I 
think the people who are engaged in naked short selling might 
be a little nervous if they thought there are a dozen people in 
the SEC that just might show up at our doorstep and start 
looking at this kind of thing.
    So I use the opportunity of your being here to make that 
suggestion to you, even as I commend you and your staff for the 
great strides you have made in this area in the past.
    Mr. Cox. Well, I thank you, Senator. As I mentioned, in 
addition to the emergency action that we are taking today, 
which will have a 30-day life, we are also contemporaneously 
going to be starting a rulemaking focused not only on the 
primary dealers and on Fannie and on Freddie, but on the 
broader market. And in that connection, the kind of sweep 
examination that you were talking about, which is part and 
parcel of what the SEC routinely does, will help inform our 
decisions. And so I very much appreciate your suggestion.
    Senator Bennett. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Dodd. Let me underscore that point as well. We had 
a conversation over the weekend, and just the mere announcement 
of where you are moving may have the desired effects that we 
are talking about. Just announcing things can have certain 
implications. I think this is very smart and very wise. I 
remember very distinctly in our hearing on Bear Stearns/
JPMorgan Chase. I think I am quoting you exactly when you were 
asked a question--I think by Jon Tester it may have been--on 
this matter, you said certain matters are too big to miss, and 
we appreciate the fact that the agency seems to be responding 
to that.
    Mr. Cox. We have been very busy on this for many months, 
Senator.
    Chairman Dodd. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman. Thank you all 
for your testimony. I hope we have been listening to the Three 
Wise Men of the Economy here and that what you are telling us 
is going to steer us in a different direction. But I have some 
concerns. You know, I have in the past at some of these 
hearings suggested that we seem to be behind the curve instead 
of ahead of it; that we seem to be constantly reactive instead 
of proactive. And I am just wondering, you know, we seem to be 
in a pattern that is developing where our regulators suddenly 
realize an emergency on a Friday, and then hastily formulate a 
rescue plan at the 11th hour during the weekend. We saw this 
happen with Bear Stearns, and now we are talking about this as 
it relates to Freddie and Fannie. And we saw what happened at 
IndyMac. And I am just concerned that what we have here is the 
equivalent of last-minute cramming regulatory action. And that 
puts us in a process of expediency over well-thought-out 
policy.
    You know, I wonder, Mr. Secretary, how is it that knowing 
what has happened with reference to companies that have been 
shaken dramatically, that have securitized loans over the past 
year, why we thought that Fannie and Freddie would be insulated 
from the very same market conditions that have crippled other 
companies that specialize in loan securitization. That is one 
question.
    The second question is: I hear you when you say that it is 
your intention or desire and hope not to use the very power 
that you are asking for, but I am concerned, you know, all of 
us here play a fiduciary role to the taxpayers not only of our 
States, in the country. And as you just mentioned a moment ago, 
it is counterintuitive to say give us a blank check or a blank 
authority as the best way to ensure that taxpayers are not on 
the hook. That is certainly counterintuitive.
    And the difficulty is, having just seen the Bear Stearns 
process that we went through, where it has now had about $1 
billion of asset loss since March, which now puts us into the 
area where, in fact, the Federal Government--i.e., the 
taxpayers--begin to come into play in terms of responsibility 
for picking up the tab if this decreases further, I know it is 
not your intention to use it, but by the same token, you know, 
there is no safeguard under your proposal for us to create some 
limits of those liabilities should you have to use it.
    And, finally, I am concerned about that while I know it is 
not your intention to use it and you think that this is the 
best way to avoid taxpayer liability, just look at what Wall 
Street basically did in terms of when the plan was announced. 
You know, it pushed Fannie's stock up by 20 percent, Freddie by 
more than 15 percent in early trading. And then it closed down 
8, and Fannie was off 5 product at the end of the day. So it 
almost seems to be saying--they seem to be saying it is just 
not enough. So did they want some guarantees here? And if you 
want guarantees, that means more than just the possibility for 
18 months. It may mean more.
    So I hope you can address those issues. Why did we not see 
this possibility coming? How is it that, in fact, we go back 
and tell the taxpayers there is absolutely no way you are going 
to be put on the hook here, and, third, when we have lost $1 
billion already in the Bear Stearns process?
    And then, finally, let me put the last question out there 
and let you answer it. It would be to Chairman Cox. I 
appreciate that you said, first and foremost, the SEC is a law 
enforcement agency. And I appreciate a good part of your 
written testimony talking about going after market manipulation 
where in one case the false rumors in Bear Stearns caused the 
stock to drop by 17 percent and wiped out $1 billion of market 
capital in the first 30 minutes and had the stock exchange halt 
the trading in the company's securities. Can we expect you to 
vigorously pursue more enforcement activities of that type 
going in the days ahead?
    Those are the questions I would like to hear answered.
    Secretary Paulson. Yes, Senator, let me respond.
    First of all, on not foreseeing this. I would say to you, 
from the day I set foot in Washington, I started work to get 
GSE reform. I was told you got no chance of getting it. There 
are people on each side. It is a holy war. And the best you are 
going to have is what we currently have.
    Every time I testified, when I testified before this 
Committee before, and I got asked about various housing 
proposals, I said they are important but this is by far the 
most important. I did everything I knew humanly possible to 
move this through Congress.
    In terms of raising capital, again with the authorities we 
had, which was just really talking, pushing, even having 
meetings with the Chairman and the Ranking Member and the GSEs 
to raise capital.
    In terms of the plan, it could just as easily have come 
together during the week as over the weekend. We have been 
working on this. This was not a Bear Stearns situation. This is 
something that will be helpful at calming the markets.
    In terms of the unspecified line of credit, what I meant to 
say was not that it was counterintuitive to sophisticated 
people who are in markets all the time and used to thinking 
about it. What I said is if you are not used to thinking about 
these issues it seems counterintuitive. But if you are used to 
thinking about the issues, it is very intuitive, that if you 
have got a squirt gun in your pocket, you may have to take it 
out. If you have got a bazooka and people know you have got it, 
you may not have to take it out. You are not likely to take it 
out.
    I just say that by having something that is unspecified, it 
will increase confidence. And by increasing confidence it will 
greatly reduce the likelihood it will ever be used.
    And then I think that answers the questions. Chris?
    Mr. Cox. Senator, I think you are absolutely right that 
more of these cases need to be brought. As I mentioned, they 
have not been brought in the history of the Agency largely 
because it has been, in the past, so difficult to parse where 
rumors start and where they are just being spread about in our 
increasingly efficient information society. But the tools that 
we now have with technology are permitting us to trace back in 
many cases, through e-mails, through instant messages and so 
on, to the very individuals that have manufactured 
intentionally false information that is designed to manipulate 
securities prices. And that goes to the bread and butter of 
what SEC law enforcement has always been about.
    Just for the record, I want to make clear that the example 
that I gave in my testimony of the first ever case that we 
brought came right in the wake of, just weeks after, Bear 
Stearns. But it was not Bear Stearns securities. It was 
Alliance Data Systems securities where that $1 billion drop in 
market cap occurred in 30 minutes as a result of the rumor.
    Senator Menendez. Just one, Mr. Chairman. So do you expect 
to pursue more enforcements of this type?
    Mr. Cox. Yes, we do. This will not be unique. And we have 
other investigations of this type underway.
    Senator Menendez. Thank you.
    Chairman Dodd. Thank you. Senator Hagel.
    Senator Hagel. Thank you, Mr. Chairman.
    For the record, as the distinguished SEC Chairman noted, I 
want to just briefly respond to a comment that Secretary 
Paulson made in response to the distinguished Senator from New 
Jersey about what happened.
    I recall 6 years ago, Mr. Chairman, that I worked with 
then-Congressman Baker from Louisiana in the House on GSE 
regulation. And I introduced legislation based on Congressman 
Baker's bill. And I could not get one cosponsor from my party 
or the other party on this issue. And I was informed by a 
number of people that this was so far beyond the realm of 
possibility, as we talked then and now are dealing with that 
reality today, systemic risk, what would happened? Would the 
taxpayers be saddled with this possibility.
    So Secretary Paulson's answer is correct. In fact, when 
Secretary Paulson and I first became acquainted, I think the 
first conversation we had was about this issue.
    Now on to other issues more current in dealing with this 
reality.
    Let me ask the three of you, I am going to read a list of 
companies that you are all quite familiar with: Citigroup, AIG, 
Merrill Lynch, Wachovia, UBS, Bear Stearns, Morgan Stanley, 
MBIA, and there are others. What do they all have in common? 
Well, one thing they have in common is that their senior 
management has taken responsibility for what has happened to 
each of their company's stock as it has gone down. And we know 
the rest of the story.
    Now here is the question: the current management of Freddie 
Mac and Fannie Mae, as far as I know, are well compensated. 
Their board is actually well compensated. And my question to 
each of you is how much responsibility should be placed on the 
management, on the management of Fannie Mae and Freddie Mac?
    We have been gliding over this issue for some time. I have 
not heard anyone address that today. Maybe someone has. I have 
not been here for every minute of the hearing.
    But should the management be held accountable? Let us start 
with you, Secretary Paulson.
    Secretary Paulson. Yes. I would say, as a general 
proposition, I believe management should be held accountable 
and compensation should match performance. But I would say in 
these instances, again, these are companies that have a single 
line of business. It is housing. We have quite a significant--
you would have to go back a long period of time to see a 
correction like we have had in the housing market.
    I believe that their lending standards have not been lax, 
certainly not compared with many others in the marketplace. The 
issues that you and I are concerned with have to do with 
systemic risk and reform and all of the things that will be 
debated with a new regulator.
    So my--and again, there is no proposal today to inject 
Federal funds in these companies at this time.
    So my experience with management has been a construction 
experience and a constructive experience as we are working 
through this. And my experience with the boards, I would say 
that I talked directly with the Freddie Mac board, did not talk 
with the Fannie Mae board but had very good discussions with 
Dan Mudd. And they all were very constructive.
    So I am not looking for scapegoats here. I am looking to 
get this done and I am grateful for the service that board 
members are providing and that management is providing.
    Senator Hagel. Well, I am going to ask each of you as well, 
I am not looking for scapegoats, either. I am looking for 
accountability. And if the American taxpayer----
    Secretary Paulson. I know you are, sir.
    Senator Hagel. Mr. Secretary, if the American taxpayer is 
going to fulfill the plan that you have laid out, if we need to 
do that, then I consider them investors. Somebody has got to 
pay the bill. It seems to me accountability somewhere along the 
line here has to be brought forward. And I understand what you 
are saying.
    But this is not a new issue, Mr. Secretary, just as you 
presented that issue to me when you came to see me when we 
talked about your confirmation.
    Mr. Chairman, how do you respond?
    Secretary Paulson. I would just say one additional thing, 
because you are right. If and when--and again, there is no 
plans to do it. But if Government funds go in, then I think we 
need to look carefully at the ways to protect the taxpayer, the 
appropriate terms and conditions, and think all of that 
through.
    Senator Hagel. Well, the only comment I would make about 
that, then it is too late.
    Mr. Chairman.
    Mr. Bernanke. Well, I was going to just say that if the 
investment is made, just like any investor there would be terms 
and conditions. And if management changes or part of what the 
assessment was at that point in time, then that would certainly 
be something that the Treasury Secretary would be able to bring 
to the table as a possible condition.
    Senator Hagel. Mr. Chairman.
    Mr. Cox. Senator, I am going to interpret your question as 
not a difficult one. Management in the private sector needs to 
be accountable to the board of directors and to the 
shareholders. And to the extent that both Fannie and Freddie 
are going to be private companies, the degree to which that 
accountability exists will be a measure of the degree to which 
they are successful in that respect.
    Senator Hagel. Well, I have got 30 seconds here over and I 
would just add this as I end, Mr. Chairman. The real issue is 
going to be, should be, and it will be the next hearing, I 
suspect. I was reflected in a Washington Post editorial today, 
which I suspect you all read, The Perils of Paulson.
    The real issue is do GSEs work? I mean, what we are dealing 
with here just did not come out of the night, a bolt of 
lightening. We have been dealing with this issue for the last 
few years as far as not what Moody's did today in cutting the 
preferred and say they may cut it more for these so-called 
whatever they are, agencies.
    So the question we are really going to be dealing with, the 
next president, the next set of Government managers and 
regulators, is this a model that works anymore? Because we are 
not going to be able to keep coming back and back and back to 
the taxpayer and no confidence in all that now is integrated 
into this system.
    Now that if for another hearing another day, I understand. 
But I do not think we can walk away from the larger picture 
here.
    Secretary Paulson. Can I just say, Senator, because you and 
I agree. I think, as I said, there is two parts to this. One is 
addressing the current situation and the other is the long-
term. And I believe this plan has got both parts. And you get 
the strong regulator in place, you will have the opportunity. 
With that regulator there will be a time and a place, with that 
regulator in place, to address all of the issues that you want 
to address. Time, in terms of size, risk, business activity.
    But my comments were--had to do with the GSEs in the 
current model, the current form. And I am certainly not looking 
to be an apologist for management. But I just wanted to say 
that it would have been surprising to me if there were not some 
of these issues, given the size and given what is happening in 
the housing market, when they are in the housing market.
    Chairman Dodd. Thank you.
    This will be a subject of longer discussion, but let's 
remind ourselves, this began with predatory lenders out there 
marketing products that borrowers could not afford. GSEs, 
Fannie and Freddie, were never bottom feeders. They had some 
Alt-A, they had some subprime, but nothing to the extent these 
other institutions had. That is where the problem lay, the 
failure to actually oversee, to regulate, to monitor that 
effectively, is where the problems began.
    We had legislation adopted 14 years ago for which a 
regulation was never promulgated to protect against deceptive 
and fraudulent practices. Had that been done, had cops been on 
the beat, going after these people who are marketing these 
products as they were as aggressively, we would not be here 
today.
    This was not a natural disaster. This was malfeasance and 
misfeasance, in my view, that created this mess that we are in 
today.
    Senator Reed.
    Senator Reed. Thank you, Mr. Chairman.
    Mr. Secretary, recently the Federal Reserve and the 
Securities and Exchange Commission entered into a memorandum to 
coordinate their supervision of the consolidated supervised 
entities. I do not believe there was a specific legislative 
requirement that they do that, they consult, or anything else. 
So why is it necessary to have a legislative requirement that 
this new super regulator consult with the Federal Reserve?
    I would think it would happen or could happen in the course 
of the common interest of both regulators. And the downside I 
think has been expressed by some of my colleagues, is if we 
have the super regulator, if he is looking over his shoulder 
every moment, even for--as your language requires--even for 
guidelines or directives concerning prudential management 
operations, that would involve the Federal Reserve I think in 
the routine decisions on a daily basis.
    Secretary Paulson. Let me just say first thing is I think 
that is something confused there because it would certainly not 
be what the role of the Fed we would be suggesting.
    But let me get back to the specific question. The way the 
Fed and the SEC have come together underscores a very important 
point. We have a regulatory structure, in my view, that is 
outmoded in this country. It is not just that we do not have a 
world class regulator with all the necessary powers for the 
GSEs. We have a regulatory structure that does not work the way 
we would like it to work for our financial system today.
    So while we are waiting for Congress--and it is going to 
take some time because these are going to take time to work 
through these issues and to deliberate. What you have seen is 
regulators have been able to come together and work 
cooperatively for the good of the system. And that is what you 
saw happening with the Fed and the SEC. In consultation with 
Congress, working together, using the SEC, working with the 
FED.
    There is now, while we are putting something in place, 
which is hopefully going to be a permanent long-term solution 
in terms of a strong independent regulator, we have made the 
case and I think it makes sense, and for the reasons I have 
articulated, not to be the primary regulator, not to look at 
appointment of directors, but to consult when you look at 
capital and issues of risk, and to formalize that.
    And that is, as I said, what we have suggested more 
broadly. And I think it is a good model.
    Senator Reed. Well, Mr. Secretary, this is, I think, your 
language that coordination with the Board of Governors of the 
Federal Reserve prior to issuing any proposal or final 
regulations, guidelines or directives concerning the prudential 
management and operations standard and safe and sound operation 
of end capital requirements.
    That seems to be a rather expansive consultative process.
    Secretary Paulson. Well, the idea is when you are going to 
consult, again, when you are consulting on prudential issues 
and capital issues, that is what we would like. And I would 
like to understand how that could be a negative, to have the 
Federal Reserve, which our country has come to look at on a de 
facto basis--and let me say, when the powers were put in place 
many years ago, we did not have GSEs. Our regulatory structure 
was set up when this country was primarily about banks.
    When you look at the importance that other financial 
institutions play, the thought is strong independent 
regulators. But to have one entity that we are looking to 
anyway for systemic risk, to be able to have a line of sight 
and to consult on matters of prudential regulation of capital. 
So that is just----
    Senator Reed. Thank you, sir.
    Mr. Chairman, do you have the capacity to consult on a 
daily basis about directives that this new super regulator will 
be giving? Or the willingness?
    Mr. Bernanke. Well, our understanding, as the Secretary 
said, is that there would be a strong independent regulator, 
which would----
    Senator Reed. Who would turn to you----
    Mr. Bernanke [continuing]. Not be the Federal Reserve.
    Senator Reed [continuing]. For guidance on directives.
    Mr. Bernanke. The Federal Reserve already has a good 
working relationship with OFHEO, as do many other regulators. 
And we are prepared to cooperate, assist in any way that the 
Congress thinks is helpful.
    Senator Reed. Well, it seems to me that one of the problems 
we have seen over the last several months, the regulatory 
response to many of these issues, was that the Federal Reserve 
was making statements and giving speeches about subprime, there 
were different actors. But there was a lot of consulting going 
on, but there was not a lot of regulating going on.
    I think one of the purposes that we have been striving for 
these many months is a regulator that--in the military 
parlance--unity of responsibility and command. They are the 
where the buck stops.
    I think we have to just consider this very carefully. I am 
not dismissing the merit of having an overarching regulator but 
I think we have to look carefully at capacity and also about 
making sure that the underlying regulator is not constantly 
looking over the shoulder on operational details, but is 
consulting where it counts, at the top in terms of risk, in 
terms of systemic risk.
    Secretary Paulson. That is the intent here. And again, I 
would just say to you, and I just feel so strongly about this, 
that we have a fragmented system and with multiple regulators. 
And the regulators need to be strong. And we have fought to 
have this regulator be as strong and powerful as possible.
    But again, to have an overarching regulator with 
overarching responsibility for systemic risk being able to have 
a line of sight information, to be able to consult on these 
very important matters is something that we have recommended, 
and I believe something that would give the market great 
confidence.
    Senator Reed. Thank you.
    Chairman Dodd. Thank you very much.
    Senator Bunning.
    Senator Bunning. Well thank you, Mr. Chairman.
    First of all, let me tell you, Secretary Paulson, and my 
good friend Chris Cox, the Honorable Chris Cox, that I am going 
to be here after you leave. You are going to be gone. And we 
are going to be responsible to the taxpayers.
    The taxpayers have reacted and the market has reacted to 
your plan, Secretary Paulson, by driving down Fannie Mae shares 
26 percent today, right now. And Freddie Mac's are down 29 
percent as of this moment, just in case you are interested on 
how the market is reacting to your wonderful plan on bailing 
out Freddie and Fannie.
    Oh, but you may not do it because it is only as a backstop. 
Well, do you know in the same bill that you would like to 
attach this to there is a tax on Fannie and Freddie from $500 
million to $800 million per year for a housing trust fund? Do 
you know that? You do not. Well, it is in the bill----
    Secretary Paulson. Senator, would you like me to respond to 
both your points? First of all----
    Senator Bunning. Well, I have got--go ahead, respond.
    Secretary Paulson. Well, first of all, I would say I assume 
you would like to see a strong regulator for the GSEs?
    Senator Bunning. Yes, I sure would. And we passed that 2 
years ago and it got dumped between the Committee and the 
floor.
    Secretary Paulson. And I assume you would want to get this 
GSE reform bill done.
    Senator Bunning. The other part is the part I do not like, 
the $300 billion other.
    Secretary Paulson. Well, I have got to tell you, in terms 
of the housing trust fund, it certainly was not my idea. It is 
certainly not something I am pushing for.
    Senator Bunning. But it is in the bill.
    Secretary Paulson. It is. It is in your bill. But I would 
say to you that I would like to get a bill done. The housing 
trust fund is not the priority. And in terms of the stability 
for the stock price, it is not something I do not think any of 
us can do is stabilize the stock price. We are focused on the 
underlying credit and----
    Senator Bunning. Are you trying to stabilize Freddie and 
Fannie?
    Secretary Paulson. We are.
    Senator Bunning. Well, your plan is not being accepted.
    Secretary Paulson. Well, I would say this, with all due 
respect Senator, the credit spreads are very strong and holding 
in there. I think there is confidence in the market. It is 
going to take time for shareholders to figure out what the 
value of those equities are.
    I do not think government can----
    Senator Bunning. Well, that is exactly what your proposal 
is, that Government be the backstop.
    Secretary Paulson. Our proposal, again Senator, is that--
well, you have heard me answer. If you have got a better idea, 
I would like to hear it.
    I think our idea is that by having the Government provide 
an unspecified backstop, the odds are very low that it will be 
used and the cost to the taxpayers will be minimized.
    Senator Bunning. Well, there are a lot of us who would like 
to believe what you are saying. But we are a little skeptical. 
Because every time we propose and do something, it always gets 
used. And you want an unlimited amount used. And none of us at 
this table like that idea. Or some of us at this table do not 
like that idea of an unlimited sum of Federal dollars being 
backstopping two GSEs which are already assumed to be 
backstopped by the Federal Government to start with. They are 
price stock and they are equity.
    Do you really think, do you think that we can believe 
exactly what you are saying, Secretary Paulson?
    Secretary Paulson. Well, I can tell you what you can 
believe. You can believe I believe everything I say and that I 
have been around markets for a long time and that I----
    Senator Bunning. So have I.
    Secretary Paulson [continuing]. Share your frustration at 
not getting GSE reform legislation done. I share your 
frustration with certain parts of it. Again, all I can say to 
you is what I have said earlier, that----
    Senator Bunning. Where will the money come from if, in 
fact--where will the money come from if, in fact, we have to 
use the backstop?
    Secretary Paulson. As I said to you, that it is my very 
strong belief that the way we can minimize the cost to the 
taxpayer, the way to minimize that cost----
    Senator Bunning. Is not to do it.
    Secretary Paulson [continuing]. And likelihood is to be 
unspecified and enhance the confidence in the market. So that 
is my answer, it continues to be my answer.
    Senator Bunning. But it does not answer the question. Where 
is the money going to come from if you have to put it up?
    Secretary Paulson. Well, obviously, it will come from the 
Government. But I would say----
    Senator Bunning. And who is the Government?
    Secretary Paulson. The taxpayer. And what I am looking to 
do is the same thing you are, Senator, to minimize the cost to 
that taxpayer. And I think the surest way to do that is----
    Senator Bunning. Secretary Paulson, I know you are very 
sincere in your proposal.
    Secretary Paulson. Yes.
    Senator Bunning. But come January, you will be gone.
    Secretary Paulson. Right.
    Senator Bunning. And the rest of us will be sitting at this 
table, or at least most of us. And we have to be responsible to 
the taxpayer for what we have done. And I do not think this is 
a responsible----
    Secretary Paulson. Then Senator, you will vote against it 
in all your wisdom.
    Senator Bunning. I will do everything I can to stop it.
    Secretary Paulson. And maybe you will have a better plan, 
but----
    Senator Bunning. Yes, I had one about 2 years ago.
    Secretary Paulson. But I am about getting something done 
that can get done that will make a difference, and in my 
judgment is in the best interest of the taxpayer and will 
minimize the cost to the taxpayer.
    Senator Bunning. Thank you, Mr. Chairman.
    Secretary Paulson. You and I, respectfully, disagree.
    Chairman Dodd. Thank you.
    Senator Tester.
    Senator Tester. Thank you, Mr. Chairman.
    Secretary Paulson, for a number of decades you were a 
banker. You probably wish you were back in that realm once 
more. But I just want to lay out a scenario for you and put on 
your old banker hat for a minute.
    If I were to come into you and ask you for an 18-month line 
of credit, unlimited, to be able to use any time I chose to use 
it within that 18 months with little or no assets backing it 
up, what would you say?
    Secretary Paulson. Senator, what I am asking for is 
unspecified 18 months. I have said I will consult with you. And 
if I was sitting where you are and you were asking me for what 
I am asking for, I would say yes because given my experience in 
the markets, I understand what market confidence is all about.
    As I said, you all have had more experience than I have had 
in Government. You have had more experience watching these 
GSEs, playing your Congressional role as it relates to them.
    I can just tell you, given where we are now, that if I were 
sitting where you were, I would say yes.
    Senator Tester. I appreciate the fact you brought forth a 
solution. I will go back to what the Chairman said. There has 
been a total--from my perspective--lack of oversight in the 
industry and it has gotten away. But let us just lay out the 
scenario. Let's say you have to use that. Let's say we do not 
do anything. In which case we hit a point where reserves versus 
loans in the GSEs hit a critical point and then the Federal 
Government steps in anyway. Isn't that correct? Isn't that the 
way the current law is? I believe it is.
    Secretary Paulson. I would say that the current law we have 
a backstop credit facility which is $2.25 billion. Like so many 
other things that I found in Government, the architecture was 
set a long time ago, the market changed, the architecture did 
not change. That was put in place in 1971 when Freddie Mac had 
$1 billion of capital.
    Senator Tester. So it is $2 billion period?
    Secretary Paulson. Yes.
    Senator Tester. And once that money is gone things tend to 
fold up pretty quickly; correct? What impact is that going to 
have on our credit rating, on the Treasury's credit rating?
    Secretary Paulson. What is it you were asking?
    Senator Tester. What happens if we do nothing and the 
reserves to loans becomes improper proportion? What happens to 
our Treasury credit rating when that happens?
    Secretary Paulson. As I said, we have no intent to 
nationalize----
    Senator Tester. No, I am talking if we do nothing and you 
spend the $2 billion, what I am asking is what happens? What is 
the downside?
    Secretary Paulson. Well, the downside, the least of the 
downside if you spend that and nothing happens, the least of 
the downside is the $2.25 billion. We are talking about, 
Senator, two huge organizations.
    Senator Tester. But it has got to be bigger than that. You 
are talking about potentially spending $1 trillion here. I 
mean, whoever you, or whoever the next Secretary of the 
Treasury is, if we pass this you are giving temporary authority 
to spend any amount of money that you want or whoever sits in 
your chair wants. It could be $1 trillion.
    And the question is if we are not--I am trying to give you 
a chance to explain what happens if we do nothing. If we do 
nothing, if this body does nothing, what is on the law right 
now you said is there will be a $2 billion expenditure. And 
then what happens? What happens to our credit rating in the 
Treasury? What happens to the housing market, people's 
availability to get money, interest rates? What happens?
    Secretary Paulson. Rather than speculating about a lot of 
things, what I will say to you is this: first of all, these 
entities are essential right now to the housing markets. I 
tried to explain that earlier. They are essential to 
homeowners. They have got securities all over the world. The 
confidence in their securities are essential to confidence in 
our capital markets.
    Senator Tester. I am going to put that question in writing 
for you, because truthfully, if I am going to vote to allow you 
or whoever sits in your chair the ability to spend an unlimited 
amount of money, I want to know what happens if I do not allow 
you that ability. I want to know. I do not want to know what 
projected interest rates are going to be and how long--you are 
in the business--how long you project them to be hi or low or 
no money available in the credit market, and the list goes on 
and on and on. Or what happens to our credit rating in the 
Treasury notes. All those things.
    I mean, I think they are really important. I mean, you 
might not want to speculate. But the truth is that you guys are 
the professionals. You guys deal with this issue every day. And 
if you had not been confirmed and were not in this position, it 
is a position of leadership. And we need to know what you 
think.
    That is all. I am not being critical.
    I do want to go back to what Senator Hagel said, though, 
about accountability, and accountability of the people who run 
the GSEs. Because right now what we saw, what we have seen from 
my perspective is a housing downturn, the banks start doing all 
sorts of funky stuff, going belly up and that kind of thing.
    And then you have got the GSEs who are supposed to be a 
backstop to them, if I see the picture correctly. And they are 
in as bad a shape or worse than some of the banks that they are 
supposed to be the backstop for. How did this happen?
    Secretary Paulson. Again, first of all, I do not buy into 
the proposition that these institutions are not viable, that 
these institutions are playing a very major role right now in 
the economy.
    Now in terms of what has happened, I tried to address that 
earlier in a couple of other questions. In many ways, you would 
be better off asking the CEOs directly. But from my 
perspective, you have large entities, a single line of 
business, home finance. You have an event where a major 
downturn in home prices. So it should not be surprising to 
anybody that they would have some issues to work through.
    And they have been working through those issues. They have 
been playing a very important role in our housing market.
    Senator Tester. OK, my time is done. I am sorry, Mr. 
Chairman, for using more time than I should have.
    I will have some more questions for the record. I 
appreciate all three of you being here today. I am sorry I 
could not ask questions to you, Chairman Cox. I do have some 
questions about how the investigation is going. We need to 
visit again. You talked about a previous person who is--on a 
different issue--who was nailed. I would like to know how this 
is proceeding because the longer it goes the more people tend 
to forget. But that is all.
    Thank you very much, Mr. Chairman.
    Chairman Dodd. Thank you, Senator, very much.
    Senator Dole.
    Senator Dole. Thank you, Mr. Chairman.
    Chairman Bernanke, like Senator Hagel, I have been 
concerned about the health of these entities long, long before 
we got here today. In fact, I am sponsoring with Senator Hagel 
legislation to reform the GSEs since my first year in the 
Senate.
    Now let me try to look down a little different path to 
shift to another future focus. Last week, in a speech that you 
delivered at an FDIC forum, you stated that since 2005 the 
Federal Reserve Bank of New York has been providing leadership 
for a major joint initiative by the public and private sectors 
to improve arrangements for clearing and settling credit 
default swaps and other over-the-counter trade derivative 
contracts. Furthermore, I believe that the offices at the 
Department of the Treasury and at the SEC have been looking at 
ways to improve the clearing of CDS.
    Could each of you tell us more about how regulators are 
attempting to make the CDS and other OTC derivatives markets 
more transparent?
    Mr. Bernanke. Let me start. This is a very important part. 
It is an unglamorous part but it is an important part of the 
financial system to make sure that contracts are honored, that 
there is good record keeping and so on.
    The Federal Reserve Bank of New York has convened a group 
of public and private regulators and private industry 
participants to try to improve the speed and accuracy with 
which these contracts are recorded and they have made 
substantial progress in that respect.
    They have also extended this to some other instruments like 
equity derivatives, as well. It is very important, in times 
like these when the situation can change quickly, that everyone 
understand exactly what their positions are, who their 
counterparties are, and so on. And that is what this effort is 
all about.
    The New York Fed is also working with the private market to 
work toward a central counterparty who could take both sides of 
these trades and create the certainty that both sides were--
that the contract would be honored, so it would not have to be 
bilateral and over-the-counter.
    Other changes are being made, for example providing for 
cash settlement in case the bond in question is not available. 
And as you indicated, improving transparency to provide more 
information to the public and to the market about the 
transactions that are taking place, and so on.
    The objective is to move our infrastructure in a direction 
where there is more standardization, more central counterparty 
activity, cleaner resolution in case of a problem, and better 
transparency. We think, by taking those steps, that the 
fragility of the system will be reduced and will make it much 
better to deal with stressful situations like the ones we have 
experienced recently.
    Senator Dole. Mr. Secretary?
    Secretary Paulson. The Chairman did such a great job, I am 
only going to underscore what he said and say, to really 
emphasize that I think of all of the recommendations that came 
out of the President's Working Group on Financial Markets after 
this turmoil, this was the most important one. That it is 
strengthening that infrastructure. We have too much complexity, 
not enough standardization. And getting the protocols right, 
getting these contracts so they know that they will perform 
under stress is just critical to having our financial system 
work the way we need it to work.
    Senator Dole. Mr. Chairman.
    Mr. Cox. I am sorry, Mr. Secretary, are you still----
    Secretary Paulson. I was just going to say one other thing 
that I had not said, Mr. Chairman, at the start which is I do 
believe--and just to underscore what you said--given what is 
going on in the world, people all around the world are watching 
us. And I think this is something that should be done quickly 
in terms of the GSEs. And I think this is something that will 
be a great confidence builder throughout the world, to see 
Republicans and Democrats, both houses, come together and do 
something quickly here.
    Chairman Dodd. I agree with that.
    Senator Dole. Earlier this month, the Financial Times 
published an editorial suggesting the need for regulators to 
begin to explore implications of the rise of equities trading. 
This is in an off-exchange trading environment, what is called 
dark pools.
    As we have seen across the derivatives market during this 
current credit crisis, the collapse of confidence in pricing 
these structured products has led to serious issues that the 
financial markets are still grappling with as we sit here 
today.
    I am concerned that down the road the equities market could 
inadvertently suffer a similar lack of price transparency by 
way of these dark pools. Could I ask each of you to comment on 
whether you have been tracking these entities and what your 
reaction is to transparency concerns in this area?
    Mr. Cox. Senator, the dark pools, of course, can only 
function to the extent that they have a reference price in an 
open and transparent market. So at least, so long as they are 
operating at the margin, there can be efficiencies with 
internal matching of trades.
    But I think your point is a very, very important one. As 
our markets continue to become more global and we are exposed 
to more and more, different participants in the markets that 
are lacking in transparency, we have to worry as regulators 
that the basic function of our markets, price discovery, will 
not occur in the most efficient fashion unless all of the 
information that is necessary for that to occur is transparent.
    And so we have a very, very weather eye to these 
developments and we want to make sure that in every corner of 
the market, including equities, that transparency will be 
maintained for the benefit not only of the efficiency in the 
markets and pricing, but also investor confidence and the 
investors' willingness to participate in these markets.
    Chairman Dodd. Thank you, Mr. Chairman.
    Thank you very much, Senator.
    Senator Casey.
    Senator Casey. Mr. Chairman, thank you very much. I think I 
might be the last questioner. I know those that have been 
waiting a long time will be happy to hear that.
    I want to thank all three of you for your testimony today 
as witnesses. But my questions will be directed at Secretary 
Paulson. I had a chance earlier to ask some questions of 
Chairman Bernanke. And Chairman Cox, I hope I can get to you on 
another day, if not today.
    I wanted to pick up on something the Chairman said earlier, 
that all of this began with predatory lending. I think all of 
us would agree on some of the origins of our problems here. In 
the State that I represent, Pennsylvania, when you are just 
looking at it from the perspective of the subprime market in 
terms of our housing challenges, it is really remarkable. A 
report done in the early part of 2008, when you look at the 
rate of subprime mortgages, just the existence of those 
mortgages at a very high rate, it was not just a big city like 
Philadelphia. The other 8 counties cited in the top 9, really, 
were all rural or relatively rural counties. I mentioned this, 
I think, to Secretary Paulson before.
    In light of that, though, I just wanted to let the 
Secretary know, I have sent a letter today to HUD Chairman 
Preston and I have copied you on this letter. You can react to 
it or not, because you have not seen the letter. But I want to 
highlight what the letter is about.
    It is an attempt to provide some answer, some one solution 
to part of our subprime crisis.
    In Philadelphia, a new program called the Philadelphia 
Residential Mortgage Foreclosure Diversion Pilot Program--a 
long name for a program which does two or three things 
basically. No. 1, it requires face-to-face meetings between 
borrowers and lenders and no owner-occupied home can be sold at 
a sheriff's sale without the owner first getting an opportunity 
to take part in a ``conciliation session'' with lenders. That 
is part one.
    Part two is the homeowner must participate in a free 
counseling session to develop a proposed payment schedule to 
present to their mortgage company.
    And finally, the third point, the Philadelphia Inquirer 
reported that approximately 200 Philadelphia lawyers--you do 
not hear too much about lawyers in this context--200 
Philadelphia lawyers have donated their time to the program. 
And out of 600 homeowners who are in danger of losing their 
homes, approximately 325 were able to avoid foreclosure and 
eviction.
    I say that really to all three of you, but in particular to 
Secretary Paulson because I know you have worked a lot of 
months now on this problem and you have been determined and 
dogged and creative and resolute about it. And I would ask you 
to take a look at that letter and see if there is anything 
Treasury could do to--if you can endorse it and highlight it.
    Basically, what we are asking is to take a share of the 
counseling money and use it for a program like that. I do not 
know if you have any reaction to that.
    Secretary Paulson. Senator, it sounds like a good idea and 
we will be on it. You have been particularly constructive in 
working with us and helpful and appreciate the ideas. And this 
is one we will very much look at carefully and follow up on.
    Mr. Chairman, could I just say one other thing? That when 
we were talking about----
    Chairman Dodd. I am not sure Senator Casey is through. Are 
you through?
    Senator Casey. I just have about two more minutes.
    Secretary Paulson. I am sorry, Senator.
    Senator Casey. I wanted to ask you about--you had a couple 
of questions that were posed to you today regarding the GSE 
reform. And in particular in your testimony the second part of 
your proposal talks about 18 month temporary authority to 
purchase only if necessary equity in either of the two GSEs.
    Am I correct in understanding that that authority, the 
dollar amount would be unlimited?
    Secretary Paulson. Yes, Senator. On that, again, we were 
not sure how to size that, what would be necessary. Again, the 
reason we did not want to put a specific number on it, we 
thought if we were unspecific it would be more confidence 
inspiring and it would put the Government in a stronger 
position and minimize, again, the cost to the taxpayer.
    Senator Casey. So the reason for the unlimited nature of it 
is to send a signal to inspire confidence?
    Secretary Paulson. It was to send a signal, inspire 
confidence, no specific plans.
    But again, to get back the other topic we talked about with 
the backup facility. As I said before, in 1971 Freddie Mac, 
Treasury was given a $2.25 million line of credit for a backup 
facility. And then Freddie had $1 billion of assets. Today, at 
the end of 2007 they had $794 billion.
    Again, we are asking for this for the whole system. There 
was a $4 billion line of credit for the Federal Home Loan Bank 
System. And today it is, in 1980 they had $54 billion of 
assets. Today they have got $1.3 trillion.
    With Fannie Mae in 1971, again $2.25 billion Treasury 
facility. Today they have got $883 billion. Then it was $19 
billion.
    So again, I just think this is another example of what I 
have found throughout Government, a regulatory structure, a 
system, architecture that was set up to deal with a world that 
existed at one time not being updated to deal with the world we 
have today.
    Senator Casey. One more point. I am just about out of time. 
This is not in the form of a question. But I was struck by 
something you had in your testimony. I am looking at the second 
page under the second part of your proposal. This just jumped 
off the page at me, where you conclude that section--and I do 
not say this to be argumentative. I say it to ask you to 
deliver a message to the person that you report to.
    You conclude by saying, you conclude this section by saying 
when you are talking about GSE reform bill, ``hopefully about 
to be enacted with the modifications we are recommending 
today.'' The word enacted jumped off the page.
    Because look, if we are going to meet the goal that you 
have set forth of enactment, and we all want something enacted, 
the President of the United States, President Bush, has to show 
some leadership on this. And what we have gotten so far on this 
particular legislation are veto threats. And in particular, he 
is talking about vetoing this legislation probably for several 
reasons. But the one reason that he keeps identifying is CDBG 
money, Community Development Block Grant money, not the 
modifications that you are recommending.
    So I would ask you to tell the President that if this is to 
be enacted as you want, and I want, and a lot of other people, 
he has got to help us here. He cannot just be a partisan 
fighter on this. He has got to help us get this passed.
    Secretary Paulson. Senator, let me say the President is 
very committed to getting this passed. The focus has been on 
GSE reform modernization. We, in the Administration, have taken 
the view which is a strong view that the CDBG block grant is 
not called for. And it has been my expectation all the way 
along that when the bill got to the President's desk it would 
not have that as part of it.
    And I think that continues to be my expectation. And again, 
I just hope we can get this done quickly, that we do not take 
hostages. It just would be a great signal for the whole world 
to move this through quickly.
    Senator Casey. Thanks very much.
    Secretary Paulson. Thank you.
    Chairman Dodd. Senator Schumer.
    Senator Schumer. Well, thank you. And I apologize to the 
witnesses. As I am sure people have mentioned, we have our 
Democratic and Republican Caucus lunches, and so I had to be 
there.
    First I just, not my main point of questions, but I wanted 
to underscore what Senator Casey said. We are going to need 
broad bipartisan support to get this done. There is already 
word that one Republican senator said he would do everything he 
could to block it, which then means we need 60 votes. So we 
have to do this in a bipartisan way. And we just need your 
commitment and the President's, that they are going to do 
everything they can to get this done and done quickly.
    I, for one, think that you have put together a good plan. 
And you are sort of in a funny situation here. I mean, markets 
always get overconfident. That is the history of them. That is 
why we have booms and busts. But in this world of universal 
knowledge, everyone gets overconfident at once. And it is not 
one corner of a State or then one corner of a country or even 
one country in the world, but everybody.
    And so when the problem occurs and everyone thinks OK, we 
can all do no doc mortgages because housing values will always 
get up, everybody gets in trouble. And that means you need 
broad solutions.
    And so I, for one, think that the irony here is the more 
limits we put on this, the more worried the markets be. And if 
the real issue here is not the fundamental strength of Fannie 
and Freddie, low as their stock price is, but rather the 
psychology, in a certain sense the more open-ended the power, 
the ability--not the use but the ability, as I think you said, 
it is a bazooka in your pocket that you hope you do not have to 
use--the better.
    So I hope we can move this quickly and I think we ought to 
be careful before imposing various limitations in terms of 
giving the markets confidence that if, God forbid, something 
bad happens--and I do not think it will--the Government will be 
there. So I salute you on that.
    The two kinds of limitations that I think are appropriate 
are one, in time. You have had 18 months. Maybe it should just 
be a year and we will renew it if, God forbid, it is still bad.
    The second, and you have done some of this, is to make sure 
the Government comes first over the shareholders, that the 
Government is fully repaid before the stockholders and other 
financial interests get repaid. Can you assure us that the plan 
we put together will keep that limitation, which I think is a 
reasonable limitation that will not spook the markets in any 
way, is there?
    Secretary Paulson. Yes, Senator. As we had a discussion and 
Senator Shelby raised some issues there and said that, as we 
went through it, it is very difficult out how to structure 
something when we have not even made a decision. And there is 
no decision, no intent, at this time to put money in.
    I would say if we do, we will be very mindful of 
structuring something in a way in which it protects the 
taxpayer.
    Senator Schumer. And you know, Freddie's debt offering 
yesterday, as I understand it, was oversubscribed and they were 
able to borrow at low rates?
    Secretary Paulson. Yes.
    Senator Schumer. I do not think that would have happened 
without this plan being there in the back of people's minds. 
And that, I think, attests to the need for it, the need to do 
it quickly, and the need not to spend too much time just 
arguing about limitations and delaying it for a couple of 
weeks. Because even if there is a 5 percent chance, if you are 
at the precipice, you do not want to even risk falling over. Do 
you agree with that?
    Secretary Paulson. Thank you for your support. Thank you.
    Senator Schumer. Yes, OK.
    The second question I have to Chris Cox. This is on short 
selling. I asked Chairman Bernanke at the first half. I am 
hearing from more and more responsible people that some kinds 
of limitation should be placed on short selling. Not to 
eliminate it. It is a fundamental part of the market. We need 
it. And it does a lot of good things. A lot of short sellers 
prove companies are overstating or being too optimistic.
    In the old days we had the uptick rule, which seemed to 
work pretty well. And then we went from selling stocks in 
eighths, and an eighth of a point uptick was significant, to 
selling it in hundredths and a one-hundredth of a point is not 
very significant.
    But what would be wrong with reimplementing the uptick 
rule, not for one uptick but for say 12 upticks, so you are 
back to where you were before? Particularly, and I think I 
talked about this with Chairman Bernanke, for financial stocks, 
which seem to be under particular assault, and also are more 
subject to the psychology we talked about than those who make 
tangible goods?
    Mr. Cox. Well, Senator, I think you are right on several 
respects. First, our rule 10a-1, which goes back to 1938, had 
much more of a real life meaning when stocks were trading in 
eighths than after decimalization.
    The effect or lack of effect of this rule was studied more 
carefully by economists within and without the SEC than I think 
anything that the Commission has done in recent years. And it 
was just very clear that that rule no longer mattered, that 
everybody was trading around it, it did not have any point.
    What we do know, however--and this is a second point on 
which I agree with you. What we do know is that the combination 
of short selling and other manipulation in the market can be a 
very, very volatile mix. Indeed, it is a witch's brew of very 
dangerous activities. So we want to make sure that the 
combination of short selling and the intentional spread of 
false information can't occur in our markets. We are doing a 
lot of enforcement around that.
    The emergency action that we announced today is going to 
have a lot more effect than the price test which economists 
have told us did not do anything.
    Senator Schumer. No one believes you will be able to track 
down purveyors of false information very often. So it is not 
very--it is true, we should do it. But it is not very 
effective.
    Mr. Cox. No, the emergency action I am talking about is--
although the enforcement piece----
    Senator Schumer. No, I know that.
    Mr. Cox [continuing]. I think we will get better at. But 
what I am talking about is a hard locate requirement, a pre-
borrow requirement for----
    Senator Schumer. Just tell me for a minute, why would that 
be more effective than a modified uptick rule, which seemed to 
work pretty well for the decades before we went to 
decimalization?
    Mr. Cox. One of these is aimed at preventing naked short 
selling. If you are really trying to drive a stock down and you 
want to do it in a manipulative fashion, combining false 
information or rumors or what have you with the ability to put 
so much pressure on the stock that you are using shares that 
might not even exist, is the sort of thing that I think 
investors have a right to have the Federal Government guard 
against.
    But another thing that the Commission is going to be 
looking at, in addition to broader rulemaking on the naked 
short selling side, is the question of whether some other kind 
of a price test that is not in pennies, that is not related to 
a tick, might be useful for circumstances such as we find 
ourselves in now. We are very open to that and, in fact, we are 
going to be doing it.
    Senator Schumer. Secretary Paulson, do you have any 
comments on that, given your broad experience in the markets?
    Secretary Paulson. I would have the following comment: you 
are very right that the regulatory architecture did not keep up 
with the change in markets. When you went to decimalization the 
uptick rule became meaningless. A stock is at 100, someone can 
bid it up to 100.01 and then short it. I would say that is No. 
1.
    No. 2, I can tell you that Chairman Cox has been focused on 
many things that are making a big difference. And he has been 
focused very hard on this area and I am very supportive of the 
steps he has taken.
    Chairman Dodd. Thank you very much.
    Senator Shelby.
    Senator Shelby. Thank you, Senator Dodd, Mr. Chairman.
    I just want to recapitulate here, just for the record and 
for our knowledge base, that you are proposing, Secretary 
Paulson. These are your words.
    First, as a liquidity backstop--that is No. 1--the plan 
includes an 18-month temporary increase in Treasury's existing 
authority to make credit available for the GSEs. You also do 
not want to put a dollar amount on it.
    Now I understand sometime the reason for ambiguity, not 
stating things. But I think you could be risking the taxpayer's 
dollar here. I think we had better look at this. We will 
consult with you on this. But to give you, and we have a 
respect for you as Treasury, a blank check I am not sure. But I 
understand why you do not want to put a dollar amount on it. I 
think I do.
    Second, your other set of your proposal is to ensure that 
the GSEs have access to sufficient capital to continue to 
fulfill their mission. I think that is very important. And this 
gives Treasury an 18-month temporary authority to purchase, if 
necessary, equity--in other words stock--in the two GSEs. And 
there is no dollar amount on that, either, and so forth.
    Third is something we have been working at a long time, 
dealing with the GSE reform, and that is to bring about a 
strong regulatory reform and so forth. And a strong regulator 
of GSEs.
    Now, are you basically proposing a stand-alone, as Senator 
Dodd and I have, regulator over the GSE with a lot more power 
than they have had in the past, which you have indicated. And 
then a role for Treasury and the Federal Reserve here. But you 
are not making yourself and recommending to yourself, I hope, 
and for the Fed, you would be kind of co-regulators. Am I 
correct?
    Secretary Paulson. I was not even--I do not believe that--I 
do not see a role for Treasury in the consultative regulatory 
process.
    Senator Shelby. OK.
    Secretary Paulson. That would not be my proposal. But for 
the Fed it would be. And so again, as you have stated, it would 
not be co-regulator. Not at all. It would be, we would have a 
strong independent regulator. And then the Fed would have a 
consultative role, as we are suggesting more broadly across the 
whole economy but for the reasons that I have stated before.
    But again, I am not suggesting that role for Treasury.
    Senator Shelby. Well, I think the Fed will obviously play--
since they are the central bank here--they will play a role in 
any kind of a rescue package or whatever you want to call it.
    On the other hand, we have not reached the point of 
legislation to fulfill some of your recommendations on what 
role the Fed will play in the future in our financial 
regulator, what role the SEC will play, or what role Treasury 
will play, and so forth. So I think these three things, Senator 
Dodd and I would recommend, Senator Dodd as just a member of 
the Committee, that we try to work with you on this. And that 
we also try to protect the taxpayer and see where we are going, 
Mr. Chairman.
    Secretary Paulson. And I would just very respectfully say I 
think if you institutionalized a consultative role for the Fed 
on something this important, it would inspire market confidence 
and it would help protect the taxpayer.
    Senator Shelby. Thank you.
    Chairman Dodd. Let me wrap up here. First of all, let me 
thank the three of you very, very much, particularly Chairman 
Bernanke, who has been tremendously patient here for a long 
time before this Committee this morning. But I do not think 
anyone would argue--I cannot think of another moment in time, 
certainly in my tenure, when there is as much at stake as the 
decisions we have to make in the coming days.
    And let me end where I sort of began, Secretary Paulson, by 
commending you and others who worked over the last number of 
days in proposing some ideas here. Inaction is not an option. 
And clearly, we need to consider some steps that need to be 
taken.
    Having said that, I also want to emphasize to you and I 
understand the need for moving expeditiously. But I want to 
make very sure to the extent possible we have thought about 
this to the extent we have to here, going through this.
    There are a couple of issues that come to mind and Senator 
Shelby and I are going to sit down. I will be talking with my 
members of the Committee to go through these steps and think it 
through carefully.
    For instance, just as a suggestion I say to you here--and I 
realize a statement is not a legislative proposal. So I 
understand the distinction between the remarks you have made 
here and what has to be drafted if, in fact, we are going to 
include some things. But on this issue involving the equity 
interest here, at least the language in your proposal talks 
about consulting with the GSEs. But I think you are going to 
have to spell out specifically, if the GSEs are going to be 
directly involved, that needs to be covered.
    It cannot be the sole discretion of Treasury, in my view, 
or you are going to have the private markets react negatively. 
I happen to agree with Senator Schumer that probably the 
Federal Government ought to be protected. I suspect that that 
is going to have an undesirable reaction by the private market 
if they feel as though they are going to come in second at a 
time we are trying to get private capital into this.
    So we have got to think this through. This is not a 
contradiction to get what needs to be done. But I want to sit 
down and talk with people to make sure that before we draft 
stuff here we are not going to do something that we are going 
to regret.
    Now you do not intend that, and I know that.
    I want to ask you, Chris, we have not asked you about this. 
And you have got, your job is to protect investors. What are 
your reactions to this? You are a talented individual. You 
served with us up here in the Congress. You know these issues 
pretty well. What is your reaction to this? This is important, 
to get some views that you would have on this.
    Mr. Cox. As you know, the SEC has had its own involvement 
with Fannie and Freddie, with enforcement actions. In fact, 
very recently, in the last year, bringing actions that have 
nearly broken records for penalty size and so on because of 
accounting.
    We want to make sure that as Freddie now becomes a 
reporting company, so both Fannie and Freddie will be reporting 
companies. As you consider whether or not to maintain an 
exemption under the 1933 Act for their debt and their mortgage-
backed securities or whether they should be treated like other 
private companies, that they do in fact start to look like 
other private companies.
    My recommendation to this Committee before and again today 
is that that exemption be discontinued and that they become 
reporting companies essentially like any other private entity.
    I would hope that in addition to what we are doing right 
now, which is in extremis, that we keep in mind the end state 
that we are trying to achieve and that we quickly learn the 
lessons of the moment, which include the fact that the systemic 
risk that has been able to be located in here, in part because 
of the Government embrace or the perception of a Government 
embrace of them, that that no longer be the case in the future.
    I think the combination of socialized risk and private 
profit is a very suspect model. And so I hope that the Congress 
takes as much advantage of this opportunity as you possibly can 
to treat those problems, as well as the immediate problems. And 
I think given the fact that Fannie and Freddie together 
comprise about $5.3 trillion out of the $12 trillion U.S. 
mortgage market suggest that we have not any choice but to deal 
with them in the near term as we are doing because of that 
implicit Government guarantee that has always been there.
    Chairman Dodd. So this idea that you have heard the 
Secretary talk about is one that you think makes some sense?
    Mr. Cox. Well, obviously, there is a big distance between 
this proposal of making clear to the market that the Government 
is going to stand behind Fannie and Freddie and how you in 
Congress choose to execute it. And I think it is important 
simply for the SEC, as the investors' advocate, as the 
administrator of our rules and regulations for disclosure and 
so on, to observe that to the extent that you can make Fannie 
and Freddie fit in with the rest of that system, as they have 
been moving toward in any case, and accomplish that in the 
bargain, so much the better.
    Chairman Dodd. Well, we may want to call upon you or your 
staff in the next matter of hours and so forth as we look at 
all of this to get some thoughts on this.
    I tried to think, if I could, of another example in my 27 
years where we had one regulator have to consult--at least in 
the language you have used here, Hank, and the way we describe 
the Fed's role here. I could not think of another example of 
where we had one regulatory statutorily--as Jack Reed was 
asking the question. We sort of expect that, as the Chairman 
pointed out he consults all the time with the SEC, I presume 
with the Treasury, on matters. That goes on every day.
    But statutorily requiring it takes this to another level. 
And I am just uneasy about what we are trying to achieve here. 
You know, I want to hold some hearings at some point here on 
the architecture for financial services and the regulatory 
needs of the 21st century. And that needs to be done.
    I am not sure I want to get to a financial services 
administration model yet that Great Britain has. And I respect 
that model. I think it works well for them. But I want to, as 
the Chairman of this Committee, listen to a lot of different 
ideas as to how we ought to create that architecture.
    I wonder if we are back-dooring this a little bit here, in 
trying to get to that point in a moment like this, and whether 
or not we ought to be----
    Secretary Paulson. This is obviously your decision, and 
this is a major decision. And again, in terms of the U.K., we 
suggested it. I believe they are moving to adopt it. OK. I do 
not say they have this now.
    I think the thing you need to ask yourself, and you need to 
ask yourself long and hard, is when we have a system that was 
developed when commercial banks were not only the dominant, the 
predominant financial institution. And now we have a system 
where we have got the GSEs. We have got hedge funds. We have 
got investment banks. And it is going to be a long time, no 
matter how many hearings you hold, before the regulatory 
structure of this country is changed in a way in which it meets 
up with the world in which we live in.
    And so, as we have noted, that if people look increasingly 
to the Fed to play a clean up role, to me we need to put 
ourselves in a responsibility where we minimize the likelihood 
that we get into situations like this. And one way to do that 
is to have one regulator across the whole economy--not to 
supplant the other regulators. But to be able to look at risks 
to the system. And when they see risks to the system, be able 
to get the information, see the risks, and play a role.
    But as you rightfully point out, which is very fair, we 
have presented this idea and presented the idea. And what we 
are doing is bootstrapping it onto something which we felt 
would be the right move and would inspire market confidence and 
is an obvious step. But you may choose not to do that now, but 
that is----
    Chairman Dodd. Listen, I am more in agreement with your 
overall needs, in fact, and how we ought to look at the 
architecture down the road. That is a very legitimate question. 
I know there are a lot of different ideas as to what that ought 
to look like.
    Let me ask you, Mr. Chairman. I know your answer is look, 
whatever Congress decides to do, you accept those conclusions. 
But I need to ask you whether or not you would want this role 
that has been described over the GSEs. In your view of the role 
of the Federal reserve bank, is this--put aside whether or not 
we decide to give it to you or not, I want to know whether or 
not you think you ought to have it?
    Mr. Bernanke. Well, it bears, to some extent, on this 
overall architecture. We need to think about the whole system 
and whether you want to have this kind of centerfield, safety 
or whatever position. And if so, what appropriate authorities 
would be to go along with that responsibility.
    So as the Secretary points out, this is just a portion of 
the overall structure that the blueprint recommends. If we do 
only that piece, then it really is not doing the whole 
approach. And so in that context, it would really be ratifying, 
to some extent, what we already do which is talk to other 
regulators and we talk to OFHEO.
    I do think that we could be helpful to them. They could 
provide information to us. And we are willing, if it is deemed 
valuable to do it.
    But I think doing that is not the same thing as accepting 
this overall model that Secretary Paulson's blueprint puts 
forward. As I have said, I think that is a very interesting 
direction worth discussing. But being risk-averse, I would want 
to make sure that if the Federal Reserve were given such 
overarching authority or responsibility that the authorities 
that it received would be commensurate and allow it to fulfill 
that responsibility.
    Chairman Dodd. I understand that.
    In other words, if I am understanding you correctly, 
obviously the consultative role as I understand it--we all 
understand the word consultative role. But I also, I think I 
hear you saying you do not want veto power over OFHEO?
    Mr. Bernanke. No, I do not think so. But I think--again, we 
can discuss it in the context of a broad reform. In this 
context, again we will do whatever Congress wants.
    Chairman Dodd. I understand.
    Mr. Bernanke. But I think the most valuable thing would be 
for us to be in a consulting/discussion/information exchange 
type of relationship.
    Chairman Dodd. But not a veto role?
    Mr. Bernanke. No.
    Chairman Dodd. Not the super regulator?
    Mr. Bernanke. That is not my thought at this moment, but we 
would want to think about the whole system.
    Secretary Paulson. Mr. Chairman, let me just add one thing 
to what Ben said, which is something we have talked about 
extensively obviously.
    As part of the overall regulatory architecture if you 
decide to do that in the months ahead, to make this work for 
the Fed they would have to have--with the overarching 
responsibility--they would have to have certain authorities. 
They would have to have--they would not become the regulator 
for any of these entities, but they would have the power to get 
information, to disseminate information, to consult on the 
capital rules. And then, if they find a real deficiency, they 
would need to have the powers to deal with that, corrective 
powers.
    So what the Chairman is saying is the idea that has been 
proposed, which would be part of something that would be much 
broader that you would do if you decide to do it, which would 
be--because we have no one today that looks across entire 
financial architecture and to be able to have responsibility 
for saying OTC derivatives, as the Senator pointed out are a 
problem, or to be able to look at one thing or another.
    So what we have done here was just proposed a portion of 
that.
    Chairman Dodd. You are asking us to act expeditiously on 
something that clearly needs some urgent attention. This is an 
issue that deserves a lot of thought and consideration. There 
is a broader question. And I just do not want to have us graft 
on to a problem we need to address in the next few days with 
something that is far more far-reaching, that deserves a lot 
more thought and consultation before we move in that direction.
    And I am, as I say, relatively sympathetic to the direction 
you want to move in. I do not think we want to do exactly the 
models we look at in some other places, but clearly some 
additional thought on the overall architecture. That is my 
concern.
    Yes, Chuck?
    Senator Schumer. Yes, thanks. I think this is a great 
discussion and I appreciate your leading it.
    But the big conundrum we have in our financial system is it 
has evolved, as the Chairman has said, away from just 
commercial banks. Systemic risk is far more interrelated to the 
relationships between these hundreds and thousands of entities. 
And the responsibility for systemic risk is chopped up in 
different pieces. I mean, Bear Stearns is a classic. The 
authority involved for systemic risk was the Fed. But the 
authority that looked at Bear Stearns was the SEC. And it sort 
of did not add up.
    And so I, for one, have been pretty strongly of the view a 
single regulator, particularly in regards to systemic risk, but 
in general makes sense. Or at least more unified regulation. 
And at least to my way of thinking, and I could not agree with 
you more, Mr. Chairman, to take this aspect, which is looking 
at the GSEs and then bootstrap it and say we should do it for 
everybody would be a mistake.
    On the other hand, when the GSEs present such systemic risk 
problems, you need somebody to do this. And you know, I do not 
think OFHEO, for instance, has the ability to look at the 
systemic problems that the GSEs would cause given their--so I 
do not--I think if we took your admonition in mind, be careful 
that this does not bootstrap it to everybody, but did not shy 
away from doing it--because I think we do have to do it with 
the problems the GSEs had--I think that may be a way to cut 
this knot as opposed to just not doing it at all.
    Chairman Dodd. Because the point we have made in the strong 
regulator is because today we have not rationalized this. We 
have HUD involved. We have had obviously OFHEO involved. We 
have others. So to try to get some consolidation with that 
strong regulator that is in the bill that passed the Senate 
last week was specifically designed to do this.
    What I am leery of a little bit is having done that with 
this legislation we now begin to bifurcate it once again at a 
critical moment when we need exactly what you have said over 
and over again today, that very strong regulator here.
    So that is the point I wanted to make. But this has been 
worthwhile.
    Senator Shelby. Mr. Chairman.
    Chairman Dodd. We will end on this note.
    Senator Shelby. I do not know who will be the answer. Will 
the Fed be the answer here? But it is obvious just from our 
discussion here that more taxpayer exposure, I think, brings 
about and necessitates more taxpayer protection. We are 
potentially layering taxpayer resources on top of massive 
systemic risk. And how do we balance that? How do we go? I 
think the Chairman will, I am sure, hold a lot of hearings on 
this.
    Chairman Dodd. We will do that, as well.
    This has been very worthwhile. Again, my compliments to all 
of you for your involvement and your sharing some thoughts.
    We are going to be in very close touch with you now the 
next couple of days here. We have got to make some decisions 
that will be very, very important.
    So I say to my Committee members as well, and your staffs 
here, we need a lot of work on this over the next few days.
    Thank you all very much.
    [Whereupon, at 2:46 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]
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     RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM 
                        CHRISTOPHER COX

        PROTECTING ANY FEDERAL GOVERNMENT INVESTMENT IN THE GSES

    Chairman Cox, presently Fannie Mae and Freddie Mac are 
exempt from the registration and disclosure provisions of the 
Federal Securities Laws.

Q.1. If the Federal government purchases GSE debt or stock as 
set forth under Secretary Paulson's proposal, should the 
exemptions for the GSEs be removed so that U.S. taxpayers have 
the full protection of the Securities Laws?

A.1. Whether or not the Federal government purchases GSE debt 
or stock, it is my longstanding recommendation to the Congress 
that both Fannie Mae and Freddie Mac should be required to 
become public companies essentially like any other private 
entity. I believe this will benefit the strength and liquidity 
of the market by ensuring the timely availability of 
information for investors and other market participants and 
help to restore overall market confidence in these entities.

                          CORPORATE GOVERNANCE

    Chairman Cox, you have testified previously to this 
Committee about the corporate governance issues raised by 
sovereign wealth fund investments in U.S. companies. By an 
unfortunate turnof-events, today we are talking about 
investments in U.S. companies by the U.S. government.

Q.2. Would you please discuss the problems raised by government 
investments in private corporations?

A.2. Neither our market economy nor the authorities given to 
government agencies to regulate it are premised on government 
ownership of commercial enterprises. Government's role as 
regulator necessitates an arms-length relationship to 
commercial entities and their competitive concerns. Conflicts 
of interest necessarily arise when government is both the 
regulator and the regulated. Rules that might be rigorously 
applied to private sector competitors may not necessarily be 
applied in the same way to the sovereign who makes the rules 
and whose interest becomes, in part, protecting its own 
investment. Use of taxpayer funds also heightens demands for 
political scrutiny, which further weakens the independence of 
regulation that is normally a strength of our system.

Q.3. What protections should be considered to address these 
problems in connection with any investments by the Treasury 
Department in Freddie and Fannie?
A.3. Any government investment should be designed to minimize 
the duration of that investment. To encourage rather than 
discourage private sector investment in these entities, the 
government's investments should be on the same terms as private 
investors, so that the goal of government intervention is not 
seen as threatening the interests of private investors.

                  FED-SEC MEMORANDUM OF UNDERSTANDING

    Chairman Cox, the Fed and the SEC recently signed a 
memorandum of understanding regarding information sharing and 
coordinating oversight of primary dealers. In the agreement, 
the SEC and Fed agreed to cooperate with each other in setting 
capital requirements for primary dealers. The Federal 
Securities Laws, however, confer on the SEC alone the authority 
to regulate the capital requirements of all broker-dealers.

Q.4. Chairman Cox, would you please explain why the SEC 
considered it necessary to relinquish its authority over the 
regulation of broker-dealers?

A.4. The SEC has not relinquished any authority over the 
regulation of broker-dealers. The SEC-Federal Reserve Board 
Memorandum of Understanding (MOU) which was signed on July 7, 
2008, explicitly states that nothing in the MOU modifies in any 
way the ability and responsibility of the Commission to enforce 
its statutes and regulations. (Article II, Paragraph 4) The 
Federal Reserve likewise retains all of its authority. The MOU 
clearly states that the SEC is the supervisor of the 
Consolidated Supervised Entities. The MOU is aimed, rather, at 
cooperation among regulators.

Q.5. Does conferring authority on both the Fed and the SEC for 
the regulation of primary dealers risk increasing the costs of 
regulation and make it difficult to hold regulators accountable 
for their oversight of primary dealers?

A.5. Primary dealers are banks and broker-dealers that trade in 
U.S. Government securities with the Federal Reserve Bank of New 
York These banks and broker-dealers are regulated under the 
same regulatory regime as other similarly constituted financial 
institutions (some as CSEs, and some as ANCHCs). There is no 
regulatory regime applicable solely to primary dealers since 
the disbandment in 1992 of the Federal Reserve's dealer 
surveillance unit. For these reasons, there is no increased 
regulatory cost or particular accountability issues raised by 
these firms' primary dealer status.
                                ------                                

     RESPONSE TO WRITTEN QUESTIONS OF SENATOR TESTOR FROM 
                        CHRISTOPHER COX

    At an April 3, 2008 hearing, you told me that if market 
manipulation or insider trading played a role in the rapid 
demise of Bear Stearns, ``The rumors surrounding the activity 
you described are too big to miss, and our Enforcement Division 
is very active for a number of reasons.'' While I understand 
that this is a law enforcement issue, I hope this matter will 
be resolved promptly.

Q.1. Would you care to update the Committee on any proceedings 
the SEC is undertaking in this situation?
A.1. On July 13, the Commission announced that the SEC and 
other securities regulators are conducting sweep examinations 
aimed at the prevention of the intentional spreading of false 
information intended to manipulate securities prices. The 
examinations are being conducted by the SEC's Office of 
Compliance Inspections and Examinations, as well as the 
Financial Industry Regulatory Authority, Inc. and New York 
Stock Exchange Regulation, Inc. The sweeps include both broker-
dealers and hedge fund advisers. And on April 24, the 
Commission brought its first-ever case of securities fraud and 
market manipulation for intentionally spreading false rumors.

Q.2. With your recent actions to limit certain types of short 
selling on major financial firms, do you believe that types of 
short selling may have played a role in distorting the market 
over the past few weeks? Did it possibly play a role in the 
demise of Bear Stearns leading up to its March 2008 merger with 
JP Morgan Chase?

A.2. The Commission's staff is currently preparing a detailed 
analysis of the events surrounding the distressed sale of Bear 
Stearns to JPMorgan Chase. That analysis is looking at the full 
range offactors including the role played by market rumors, 
novations in the over-the-counter derivatives markets, short 
sales, and general conditions in the credit markets. That study 
has not yet reached any conclusions.


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