[Senate Hearing 110-1012]
[From the U.S. Government Publishing Office]
S. Hrg. 110-1012
TURMOIL IN U.S. CREDIT MARKETS:
RECENT ACTIONS REGARDING GOVERNMENT-SPONSORED ENTITIES, INVESTMENT
BANKS, AND OTHER FINANCIAL INSTITUTIONS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
ON
THE RECENT ACTIONS TAKEN BY THE FEDERAL REGULATORY AGENCIES TO CONTAIN
THE FINANCIAL CRISIS, THE CURRENT STATE OF THE FINANCIAL MARKETS, AND
PROPOSALS TO ADDRESS THE CRISIS
__________
TUESDAY, SEPTEMBER 23, 2008
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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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
Devin Hartley, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
C O N T E N T S
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TUESDAY, SEPTEMBER 23, 2008
Page
Opening statement of Chairman Dodd............................... 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 4
Senator Johnson.............................................. 7
Senator Bennett.............................................. 8
Senator Reed................................................. 8
Senator Enzi................................................. 9
Senator Schumer.............................................. 10
Senator Hagel................................................ 11
Senator Carper............................................... 12
Senator Bunning.............................................. 13
Senator Menendez............................................. 13
Senator Crapo................................................ 15
Senator Brown................................................ 16
Senator Dole................................................. 17
Senator Casey................................................ 18
Senator Martinez............................................. 20
Senator Bayh................................................. 21
Senator Corker............................................... 22
Senator Akaka................................................ 23
Senator Allard............................................... 24
Senator Tester............................................... 34
WITNESSES
Henry M. Paulson, Jr., Secretary, Department of the Treasury..... 25
Prepared statement........................................... 87
Ben S. Bernanke, Chairman, Board of Governors of the Federal
Reserve System................................................. 28
Prepared statement........................................... 89
Christopher Cox, Chairman, Securities and Exchange Commission.... 30
Prepared statement........................................... 94
James B. Lockhart III, Director, Federal Housing Finance Agency.. 32
Prepared statement........................................... 102
Response to written questions of:
Senator Reed............................................. 130
TURMOIL IN U.S. CREDIT MARKETS: RECENT ACTIONS REGARDING GOVERNMENT-
SPONSORED ENTITIES, INVESTMENT BANKS, AND OTHER FINANCIAL INSTITUTIONS
----------
TUESDAY, SEPTEMBER 23, 2008
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 9:35 a.m., in room SD-G50, Dirksen
Senate Office Building, Senator Christopher J. Dodd (Chairman
of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman Dodd. Good morning. I want to thank our
colleagues, thank our witnesses, those who are in attendance.
The Committee will come to order, and this morning we meet for
a hearing on the ``Turmoil of U.S. Credit Markets: Recent
Actions Regarding Government-Sponsored Entities, Investment
Banks, and Other Financial Institutions. We want to welcome our
distinguished witnesses here this morning. We thank the
Secretary of the Treasury, Hank Paulson, who is here; the
Honorable Ben Bernanke, of course, the Chairman of the Federal
Reserve; Christopher Cox, Chairman of the Securities and
Exchange Commission; and Jim Lockhart, the Director of the
Federal Housing Finance Agency.
The way we are going to proceed this morning is I will make
a brief opening statement; turn to my colleague from Alabama,
Senator Shelby, former Chairman of the Committee, to make his
opening remarks; and given the magnitude of this issue and the
seriousness of it, I am going to ask if my colleagues would
like to make any brief opening comments quickly; and then we
will get to our witnesses.
My goal would be that we terminate the hearing sometime
around noon, if we can. We all recognize the gravity of the
situation and the importance of these witnesses to be able to
get back and do the work they are doing. So my hope would be
that we try and move along here. But, again, I want to give
each of my colleagues a chance to at least say something at the
outset of these remarks. But I beseech you to try and keep them
brief. All of your full statements will be included in the
record, and any supporting documents you care to include in the
record will be there as well.
So, with that admonition in mind, we will try and make the
opening rounds here about 8 minutes apiece. That way we can at
least get decent responses and properly ask questions. And I am
not going to gavel down tightly, but try to keep it within that
framework, if we can.
With that, let me share some opening thoughts this morning,
and then I will be turning to Senator Shelby.
The Committee gathers this morning at an extraordinarily
and perilous moment in our Nation's history. The landscape of
our Nation's economy has been radically reshaped by the U.S.
Government over the course of just a few days in a totally ad
hoc manner, it would seem. Companies that have formed the
foundation of our financial markets are shrinking and
disappearing practically overnight. Their insatiable appetite
for risk in many cases has permeated all sectors of the
financial services industry and has spread beyond our shores.
It has felled giants like Bear Stearns and Lehman Brothers;
brought others to their knees like Merrill Lynch, AIG, Fannie
Mae, and Freddie Mac; prompted the largest, I might point out,
thrift failure in our Nation's history, the Indy Mac Bank; and
eliminated the final two independent investment banks, Morgan
Stanley and Goldman Sachs.
These drastic changes have reverberated far beyond the
trading floors and boardrooms of corporate America. Across our
great Nation, families are gathering around their kitchen
tables each night asking how they will weather this storm and
how it will affect them very directly. Hundreds of billions of
dollars that Americans invested in retirement accounts and
mutual funds have evaporated. Homeowners are watching the value
of their homes plummet. Foreclosures are forcing 9,800 families
from their homes each and every day in our country. Families
worry about how they will afford groceries and gasoline. Six
hundred thousand Americans have lost their jobs while millions
more have watched their paychecks shrink and their benefits
wither away.
Perhaps the most dangerous consequence, the one that we do
not speak enough about, in my view, of this economic maelstrom
is that our collective confidence in our Nation's future has
been badly shaken, and that needs to be restored.
Less than 6 months ago, our Banking Committee gathered in
this very room to listen to the financial leaders of the Bush
administration describe what at the time seemed an
inconceivable event: the Government's $30 billion intervention
in the sale of Bear Stearns to JP Morgan. Now after spending
hundreds of billions of dollars more to prop up, bail out, and
wind down a multitude of institutions, the U.S. Government
effectively runs, supports, or outright owns vast swaths of the
financial sector.
American taxpayers are angry, and they demand to know how
we arrived at this moment and, more importantly right now, how
the architects of this economic landscape will put us back on a
sound financial footing and restore American confidence and
optimism.
As I and many Members of this Committee have argued for the
past 17 months since I became Chairman of this Committee, the
root cause of our economic crisis has been the collapse of our
housing market, triggered by what Secretary Paulson himself has
called ``bad lending practices.'' These are practices that no
sensible banker should have engaged in--and many did not, I
might add--reckless, careless, and sometimes unscrupulous
actors in the mortgage lending industry that allowed loans to
be made that they knew hard-working, law-abiding borrowers
would not be able to repay. Financial regulators acted much too
late and much too timidly. They failed to enforce the laws that
Congress passed requiring them to prohibit these bad lending
practices.
What is tragic and lamentable is that the ensuring calamity
was entirely foreseeable and preventable. This was no act of
God. It was not like Hurricane Ike. It was created by a
combustible combination of private greed and public regulatory
neglect. And now we must confront the present crisis.
Barely 72 hours ago, Secretary Paulson presented a proposal
that he believes--and others do as well--is urgently needed to
protect our economy. This proposal is stunning and
unprecedented in its scope--and lack of detail, I might add. It
would allow the Secretary of the Treasury to intervene in our
economy by purchasing at least $700 billion of toxic assets. It
would allow the Secretary to hold onto those assets for years
and to pay millions of dollars to hand-picked firms to manage
those assets. It would do nothing, in my view, to help a single
family save a home, at least not up front. It would do nothing
to stop even a single CEO from dumping billions of toxic assets
on the backs of American taxpayers, while at the same time do
nothing to stop the very authors of this calamity to walk away
with bonuses and golden parachutes worth millions of dollars.
And it would allow this Secretary and his successors to act
with utter and absolute impunity without review by any agency
or a court of law.
After reading this proposal, I can only conclude that it is
not just our economy that is at risk but our Constitution as
well. Nevertheless, in our efforts to restore financial
security to American families and stability to our markets,
this Banking Committee has a responsibility to examine this
proposal carefully and in a timely manner. In my view, any plan
to address this crisis must embody three principles:
First, American taxpayers must have some assurance that
their hard-earned money is being used correctly and
responsibly;
Second, we must put in place proper oversight so that the
executors of this plan are accountable and their actions are
transparent;
And, finally, we must address the root cause of this crisis
by putting an end to the rising number of foreclosures sweeping
across our Nation.
In the longer term, it is clear that our current economic
circumstances demand that we rethink, reform, and modernize
supervision of the financial services industry. Certain basic
principles should form the foundation for reform. We need a
leader in the White House who will ensure that regulators are
strong cops on the beat and do not turn a blind eye to reckless
lending practices. We need to remove incentives for regulators
to compete against each other for bank and thrift clients by
weakening regulation. We need to ensure that all institutions
that pose a risk to our financial system and taxpayers are
carefully and sensibly supervised. And we need to accept the
premise that consumer protection and economic growth are not in
conflict with one another but inextricably linked.
If we learn nothing else from this crisis, it is that the
failure to protect consumers can cause the collapse of our
largest financial institutions, the loss of hundreds of
thousands of jobs, and the draining of hundreds of billions of
dollars of wealth from hard-working Americans.
Today, we are very fortunate to be joined, as I said at the
outset, by Treasury Secretary Henry Paulson, Federal Reserve
Chairman Ben Bernanke, SEC Chairman Chris Cox, and the Director
of the Federal Housing Finance Agency James Lockhart.
Regardless of how so many feel about the decisions these
leaders have made and the impact they have had, we all ought to
be able to agree that these four individuals are good,
talented, knowledgeable, and experienced individuals who, I
think, want to do the very best for our country. And I agree as
well that we need to move, and move quickly if we can, but I
feel even more strongly that we need to move carefully and
prudently and to make sure that what we do is right. I
understand speed is important, but I am far more interested in
whether or not we get this right. There is no second act to
this. There is no alternative idea out there with the resources
available if this does not work. So it is critically important
that we get it right. And the purpose of this hearing is to
discuss whether or not this is the right approach and how we
can prove it if we need to.
Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Chairman Dodd.
This may be the most important hearing that this Committee
has conducted, at least in the 22 years I have been a Member
here. Over the last 10 years, trillions of dollars were poured
into our mortgage finance markets, often with the encouragement
of well-intended Government programs. At first, the money
backed conventional mortgages with standard downpayments and
properly verified incomes.
Over time, however, the number of homebuyers that met
conventional loan requirements dwindled rapidly. In order to
fuel the upward spiral, mortgage products became more exotic,
requiring less of borrowers and involving more risk. Without
regard for fiscal prudence and simple economics, bankers,
investment bankers, mortgage brokers, realtors, home builders,
mortgage bankers, and homebuyers created the conditions that
helped inflate the housing bubble. At the same time, Wall
Street was developing ever more sophisticated financing
vehicles to ensure that money continued to flow into the
mortgage markets to meet the demand.
Mortgages were pooled, packaged, and rated so-called
investment grade by the credit rating agencies. They were then
sold into a market eager to purchase securities with a wide
range of risks and yields.
Many purchasers employed massive amounts of leverage,
layering risk upon risk in an effort to maximize return. To
cover their risks, many of the buyers also bought credit
protection from one another, entered into derivatives contracts
with nominal values in the hundreds of trillions of dollars.
All the while, our financial regulators appeared to be unaware
as they sat on the sidelines.
As early as July of 2003 here at the Banking Committee, I
asked Chairman Greenspan, then Chairman of the Federal Reserve,
whether he was concerned about the growing number of loans to
borrowers with weak credit histories and the number of
homeowners who spent more than 50 percent of their income on
housing. I also asked him if he was concerned whether an
economic downturn could lead to increasing delinquencies and
foreclosures. Chairman Greenspan at this very Committee assured
us that increasing home prices provided an equity cushion for
mortgagors and that lending to such borrowers would pose ``a
rather small risk to the mortgage market and the economy as a
whole.''
As recently as March of this year, Vice Chairman of the
Federal Reserve Cohn, testifying before this very Committee,
assured us that the banking system was in, and I will quote his
words, ``sound overall condition'' and that losses ``should not
threaten their viability.''
Now, we now know that was not the case. Eventually,
economic reality caught up with our housing market, and housing
prices stalled and then began falling. Many who bought homes
with unconventional loans found that they were unable to afford
their rising payments. Because home values were dropping, they
were unable to refinance, and delinquency rates skyrocketed, as
we all know.
Once homeowners began defaulting, the value of mortgage-
backed securities plummeted. Collateralized debt obligations--
we call them ``CDOs''--that were comprised of the riskiest
mortgage-backed securities became worthless. As a result,
financial institutions holding securitized assets have suffered
enormous losses and have been desperately trying to raise new
capital.
Of the five investment banks regulated at the beginning of
the year by the Securities and Exchange Commission under its
Consolidated Supervised Entities Program, two have failed, one
was forced to merge with a bank, and the remaining two have now
left the program to become bank holding companies. The recent
demise of our investment banks lies in stark contrast to the
vote of confidence we received in the Banking Committee from
Chairman Cox in February of this year, when he assured us that
the CSE program was up to the task, and I will now quote
Chairman Cox. According to Chairman Cox's words, ``The purpose
of the CSE program is to monitor far and to act quickly in
response to financial or operational weakness in a CSE holding
company that might place regulated entities or the broader
financial system at risk. The Commission''--that is the SEC he
is speaking of--``seeks to ensure that the holding company has
sufficient stand-alone liquidity and financial resources to
meet its expected cash outflows in a stressed liquidity
environment for a period of at least 1 year.''
That was earlier this year. In late 2007, Mr. Erik Sirri,
head of Market Regulation for the Securities and Exchange
Commission, described a consolidated supervision program that
had ``demonstrated its effectiveness during the current credit
market difficulties.'' Nothing can be further from the truth.
He likewise assured us that the SEC's consolidated
supervision had achieved ``the goal of reducing the likelihood
that weakness within the holding company or an unregulated
affiliate will place a regulated entity or the broader
financial system at risk. Notwithstanding assurances to the
contrary, uncertainty about housing prices and the value of
mortgage-backed securities have brought our markets to a halt.
We are now facing the most serious economic crisis, as
Chairman Dodd said, in a generation. So far, the Treasury
Department and the Fed's response to the crisis has been a
series of ad hoc measures.
First came the bailout of Bear Stearns, which we were told
was unavoidable. Then came Lehman Brothers, which was allowed
to fail. And then, just last week, the Fed and Treasury
organized a bailout of AIG.
I believe the absence of a clear and comprehensive plan for
addressing this crisis has injected additional uncertainty into
our markets and has undermined the ability of our markets to
tackle this crisis on their own.
Unfortunately, the Treasury Department's latest proposal
continues, I believe, its ad hoc approach, but on a much
grander scale. The plan contemplates the purchase, as we know,
of up to $700 billion in troubled, toxic, mortgage-related
assets from financial institutions that nobody would buy.
Treasury expects, but is not required, to purchase most assets
through a type of reverse auction process.
There are very few details in this legislation. In fact,
Treasury officials admit that they will have to figure out the
mechanics as they go along. Rather than establishing a
comprehensive, workable plan for resolving this crisis, I
believe this legislation merely codifies Treasury's ad hoc
approach.
My hope is that this hearing will give us an opportunity to
explore the parameters of the plan and why Secretary Paulson
believed it will work. I also hope to hear why the plan does
nothing to address the root cause of the crisis: the rise in
default rates on mortgages. While Wall Street banks get to sell
their bad investments to the Treasury Department, homeowners
will still be saddled with mortgages that they cannot afford.
My record is very clear on taxpayer-funded bailouts. I have
long opposed Government bailouts for individuals and corporate
America alike. As a young Congressman, I voted against the loan
guarantees for Chrysler, I believe in 1979 or 1980. However, if
the Government is going to get into the bailout business,
shouldn't we also be focusing our resources on average
Americans, the taxpayers, rather than sophisticated and well-
compensated Wall Street bankers?
The Treasury's plan has little for those outside of the
financial industry. It is aimed at rescuing the same financial
institutions that created this crisis with the sloppy
underwriting and reckless disregard for the risk they were
creating, taking, or passing onto others. Wall Street bet that
the Government would rescue them if they got into trouble. It
appears that bet may be the one that pays off.
Once again, what troubles me most is that we have been
given no credible assurances that this plan will work. We could
very well spend $700 billion or $1 trillion and not resolve the
crisis. Before I sign off on something of this magnitude, I
would want to know that we have exhausted all reasonable
alternatives. But I do not believe we can do that in a weekend.
Unfortunately, the incredibly accelerated process for
considering this bill means that Congress does not have time to
determine if there are better alternatives or any alternatives
to the Treasury's plan.
I am very concerned that the express need to pass something
now may prevent us from devising a plan that would actually
work. Without question, our markets and financial institutions
need serious attention. I do not believe, however, that we can
solve this crisis by spending a massive amount of money on bad
securities. It is time for this administration and the Congress
to do the work of devising as quickly as possible a
comprehensive and workable plan for resolving this crisis
before we waste $700 billion to $1 trillion of taxpayer money.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator Shelby.
Senator Johnson.
STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. Thank you, Senator Dodd.
This administration has asked Congress for the authority to
buy up to $700 billion worth of residential and commercial
mortgage--related assets from troubled Wall Street financial
institutions. They are asking that this package have no
strings. In South Dakota, we believe strongly in personal
responsibility. When you make mistakes, as many of these
companies have, you should be held accountable for those
decisions. This package may be a necessary evil, but we cannot
allow it to become a gift.
It should have teeth, with real oversight from Congress. We
should not use this package or American tax dollars to benefit
foreign banks. And this package should contain limits on
executive compensation. People in South Dakota work hard for
the taxes they send to Washington, and their earnings should
not be wasted on the bloated compensation of a CEO.
Today we need answers from the regulators as to how we got
to this point and specifics about how our regulatory system
failed us. We also need to begin the dialog between the
regulators and this Committee as to how to best change the
regulatory structure so that this type of crisis does not
happen again. Our system needs good, effective regulation that
balances consumer protection and allows for sustainable
economic growth.
For years many Members of this Committee, and myself
included, have been calling for just this sort of regulation.
There should be no mistake that change is coming. I look
forward to working with the Members of this Committee to
institute the changes needed to regulate and to guarantee a
responsible, modern regulatory system.
Please submit my full statement for the record.
Chairman Dodd. Thank you, Senator. Let me urge again, as I
said at the outset, to try and keep these comments as brief as
we can so we can get to the testimony. I am very grateful, by
the way--we have been working as a Committee, by the way, many
of us over the weekend, a lot of us, and Senator Bennett and I
have talked at length, and I thank him for his participation.
Senator Bennett.
STATEMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you, Mr. Chairman.
We have had a housing bubble, and the bubble has burst. And
every time we have a bubble, whether it is housing or dotcom
stocks or anything else, when the bubble bursts there is
disaster. And we will have bubbles in the future because the
human propensity to believe that the market will always go up
is still there. Let us understand that.
The economy runs on credit, credit is granted on
confidence, and confidence is based on one of two assumptions:
the collateral is worth it or the cash-flow will be sufficient.
One way or the other, the loan will be repaid. What we are
faced with now is finding a way to restore the confidence in
the system so that credit can start to flow again. That is what
we are here to try to do.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you.
Senator Reed.
STATEMENT OF SENATOR JACK REED
Senator Reed. Thank you very much, Mr. Chairman.
The essence of the proposition that the administration is
presenting to us today is that the taxpayers will assume the
risk of disastrous investment decisions made by very highly
compensated individuals and institutions on Wall Street. I
think the custom on Wall Street is that when you assume the
risk, you get paid to do that. I believe it is essential that
the taxpayers of this country are compensated for their
assistance. I think the only effective way to do that is a
mandatory program of warrants as a prerequisite to
participating in this assistance for non-voting equity in
companies. And as these companies improve, which is the hope
and expectation of this program, the American taxpayers could
also benefit from that improvement.
I think this also goes to the very difficult issue of
pricing these securities, that if the Treasury or its agents
misprice the securities and they overpay, presumably the
benefits of that will flow to the companies and, frankly, with
the appreciated stock, again, I think taxpayers should benefit
from that.
I think also, too, there is some discussion that if we do
this, there will be some limitation in participation, but I
would suggest that might not be altogether a bad thing; that if
this system can be gamed by people who are not desperately in
need of Government assistance, that will be done. I think to
present a company with the choice between surrendering warrants
and participating or simply getting through on their own is not
an unfair choice for sophisticated business managers who, we
presume or we hope, are dedicated to preserving their company
and benefiting the shareholders.
And, finally, I want to associate myself with the comments
of the Chairman and others who say that we cannot simply assist
Wall Street. We have to assist hundreds of thousands of
homeowners who are facing foreclosure. If we do not do that,
that will be, I think, unfair and it will not result in a
program that is legitimate in the eyes of the American people.
Thank you very much.
Chairman Dodd. Very good. Thank you.
Senator Enzi.
STATEMENT OF SENATOR MICHAEL B. ENZI
Senator Enzi. Thank you, Mr. Chairman.
In the past 6 months, our Federal Government has devised a
dozen strategies to save America's financial markets. Each plan
has been more costly, more risky, and less aligned with the
principles of our country's free market economy than the last.
I am disappointed to say that this latest plan puts all the
rest of them to shame. This proposal means a full-scale
intervention into our country's free markets with the Treasury
buying every bad asset in sight with taxpayer money.
To make this point clear, if approved in this current form
of $700 billion, this plan will cost every man, woman, and
child in this country approximately $2,300. This plan will come
with an enormous cost and enormous risk. Unfortunately, the
only plan more costly would be doing nothing at all.
Last week, I was given the legislative language for this
proposal, and it was only three pages long--$700 billion, three
pages. I know that it has grown to six pages and perhaps to 42
pages. When I questioned Secretary Paulson and Chairman
Bernanke about this plan on Sunday, they explained that
flexible and broad authority was the only way the plan would
work. I was immediately reminded of the last time the Chairman
and the Secretary appeared before this Committee and asked for
such broad authority; that was to save Fannie Mae and Freddie
Mac from insolvency this past summer. I hope this time the plan
is more successful.
I have no illusions about the urgency of the problem our
economy faces today, but Congress cannot be expected to approve
this bill without a guarantee of proper oversight and
accountability for the taxpayers. As I said before, we are
talking about the equivalent of $2,300 from every U.S. citizen.
This Committee would not be doing its job if that were allowed
to happen.
Where is the accountability for these banks and their
management? The Treasury and the Federal Reserve have asked us
to cut them the biggest bailout check in history, and that
money will be handed out to the same banks that put us in the
mess to begin with. Nowhere in the text of this bill do I see
any equity sharing or loss mitigation that will protect
taxpayers from unknown costs. It did make a difference to AIG
stockholders who are trying to pay off their loan already. A
Treasury buy from our banks will be priced by the seller, not
buy the buyer. The Federal Government could end up owning
mortgages that cost multiples of the resale value, and yet
there is no recourse for our taxpayers. It does not make any
sense. It will reward the banks first who got us in the
financial mess and the taxpayers second, many of whom were
completely unaware that this kind of financial----
Chairman Dodd. I am going to ask the audience--we will have
to clear this room. I do not want to do that. It is a public
hearing. Let's have respect for the speakers, and there will be
no outbreaks, applause or other comments. This is a serious
hearing.
Senator.
Senator Enzi. I have heard the argument that punitive or
prescriptive measures could cause sellers to leave the market.
I think that offends common sense. If banks can get a better
price for their paper from someone other than Treasury, they
should not be bailed out in the first place. If they choose to
fail rather than sell their debt at its real market value and
record their loss on the books, they should be free to take
that option.
This legislation must be passed to help Main Street, not
because the Federal Government is being held hostage by Wall
Street.
I have some ideas. This Committee must find a way to make
financial regulation more efficient, effective, and
accountable. I have some ideas, including a reevaluation of the
marked-to-market accounting. It is clear that such a method is
not sustainable in a volatile market. Providing some relief
today could prevent firms from needing this expensive Federal
bailout. Reforms in the long term could prevent capitalization
issues down the road.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator.
Senator Schumer.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Thank you, Mr. Chairman, and thank you for
holding this hearing.
My colleagues and fellow Americans, we live in amazing and
dangerous times. Who would have thought that the lowly
mortgage, long regarded as the safest of investments, could
bring our financial system to its knees? But that is where we
are. And while we must look back and see what went so
dramatically wrong, our immediate task is to look forward and
to try and avoid a meltdown of the financial system. And as we
look forward in the week ahead, we face both a Scylla and a
Charybdis--dangers on both sides.
On the one hand, as we are reminded, there are real dangers
if we do not act. The description Chairman Bernanke gave us
when the leadership of the Democratic and Republican House and
Senate met in Speaker Pelosi's conference room, the description
Chairman Bernanke gave, in quiet terms, without hyperbole, was
astounding. Chairman Bernanke told us that our American
economy's arteries, our financial system is clogged, and if we
do not act, the patient will surely suffer a heart attack,
maybe next week, maybe in 6 months, but it will happen. So we
must act, and we must act soon.
And make no mistake about it, while Wall Street caused the
problems we face, unfortunately if we do nothing, Main Street
will also pay a severe price. Pension funds, money market
mutual funds, 401(k) plans will be negatively impacted. The
lockdown in lending has widespread consequences. I have heard
from car companies that it is virtually impossible to get an
auto loan right now unless you have a credit score over 720.
And if that continues, the auto industry will sell 6 million
fewer cars this year than it did in years past. Even though the
workers in Buffalo and Detroit and St. Louis are blameless,
they will suffer. It is not fair. It is not right. But that is
the world we live in.
So I want to assure the markets--and I think I speak for
all of us--that we will not be dilatory, we will not
``Christmas tree'' this bill with extraneous amendments, and we
will work in a bipartisan way to act, and to act soon.
But there is also the Charybdis, the other danger of acting
so quickly that we choose a bad solution. The markets want
action, and we understand that. But if we act so quickly that
we create an ineffective solution without adequate safeguards,
then we risk the plan failing, which would be an even worse
outcome for the markets, for the economy, for our country. Even
on Wall Street, $700 billion is a lot of money, and none of the
thousands of money managers would invest that sum without
appropriate due diligence.
This hearing today and the discussions that will follow are
our congressional due diligence, and we take that
responsibility seriously, and we will make intelligent and
relevant improvements. Secretary Paulson has proposed his plan,
the Troubled Asset Relief Program, or TARP, to Congress. And
while I certainly recognize the need for action and want to
move quickly, I think some changes are necessary.
To Secretary Paulson's TARP program I believe we need to
add THOR: T for taxpayer protections; H for housing; O for
oversight; and, down the road, R for regulation.
I can talk about each of these at some length, but we do
not have time, Mr. Chairman. But on taxpayers, we must put
taxpayers first, should this program work. They must come ahead
of bondholders, shareholders, and executives, and we need to
add to this legislation those types of protections, such as my
colleague Senator Reed has spoken about in terms of warrants.
That would be more of a mandatory than an optional nature.
Homeowners. Secretary Paulson has labored mightily to try
to improve the homeowner problem, and Chairman Bernanke has
said repeatedly until we find a floor to the housing markets--
and foreclosures are directly related to the housing markets--
we will not solve this problem. And that affects not just those
who made bad mortgages or not just those who will lose their
home through not fault of their own, but every homeowner. The
number of foreclosures and the price of the average American's
home is related and cannot be separated.
Oversight. There have been lots of discussions of oversight
led by Chairman Dodd, and there are excellent suggestions, and
we must do them.
And R, regulation. We must have a much better system of
regulation, and many of us have begun thinking about this. It
will probably have to wait until after we act here, but we must
do it.
The bottom line, Mr. Chairman, is this: We do have to act,
but we have to act smartly, wisely, and relevantly. And I
believe that is what this Committee will do over the next few
days.
Chairman Dodd. Thank you very much, Senator.
Senator Hagel.
STATEMENT OF SENATOR CHUCK HAGEL
Senator Hagel. Thank you, Mr. Chairman.
The essence of our efforts and final product is
accountability, transparency, and timeliness. We must define a
rescue agreement based on the common interests of our country.
We have a responsibility to construct a program based on the
general principles of agreement, not held hostages to the
details of the differences.
We are in uncharted waters. We are living in a 21st Century
global marketplace. We are behind in not only understanding
that, but regulating that. This is going to require a new 21st
Century regulatory regime.
But our current effort--we must stay focused on our current
effort--is a short-term rescue effort, clearly in the interests
of our country and the world. And it must be done. And it must
be done with responsibility but also with timeliness.
Mr. Chairman, thank you.
Chairman Dodd. Thank you, very much.
Senator Carper.
STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. Mr. Chairman, thank you.
Gentlemen, thank you very much for joining us again here
today.
What I would like to just mention, I am going to mention
four things that I hope to take away from this hearing today.
The first of those is to better understand how we got into this
mess. Chairman Cox and I were talking about short selling
yesterday and I want to understand better the role that that
played in getting us where we are today. I want to better
understand how changing leverage ratios has gotten us to where
we are today. But I want to know when we walk out of here
today, I want just a better understanding of how did we end up
in this mess.
The second thing I hope to get out of this is after
understanding how we got into this mess, how do we get out of
this mess? And how do we do so in a way that does not reward
bad behavior from people who should not be rewarded for the bad
behavior?
The third thing I would like to take away with me today is
to have some assurance myself in the plan that we are
discussing here or that eventually evolves, so that we can make
sure this kind of tragedy does not occur again in our lifetime
and beyond.
And finally, I want to better understand how we maximize
the chances that the Treasury will be made whole or maybe even
make a buck or two for the taxpayers at the end of the day. I
mentioned at another meeting here on Capitol Hill this morning,
I went back and recalled the bailout at the time of Chrysler
where the Federal Government did not provide loans to Chrysler,
they provided loan guarantees issued in conjunction with
warrants which were exercised--we never had to backup the loans
but we did have the opportunity to exercise the warrants. We
made money for the taxpayers on that deal.
When the S&L debacle occurred, we ended up creating the
Resolution Trust Corporation. The Resolution Trust Corporation,
you all will recall, came in and bought not the savings and
loans, but what were deemed to be the bad assets of the savings
and loans. And as it turned out, a lot of them were not bad
assets. They were assets whose value had diminished during that
crisis but assets that over time appreciated in value. We were
able to sell them and recover most of the taxpayers' money.
My hope is as we go forward here, that we look to those two
examples as maybe a bit of a road map to enable us, while we
find out how we got into this mess, how we get out of it, how
we make sure it does not happen again, how we do all of that
without rewarding bad behavior, at the end of the day--putting
this much taxpayer money at the risk--at the end of the day I
would feel a lot better if we had a pretty good assurance that
when all is said and done that we have actually recovered this
money for our taxpayers.
And if we can make a buck or two at the end of the day, so
be it.
Thank you.
Chairman Dodd. Thank you, Senator, very much.
I want to point out, I turn to Senator Bunning, it was 2
years ago that Senator Bunning and Senator Allard held a joint
hearing on subprime mortgages, at the conclusion of which
Senator Schumer, Senator Reed, Senator Sarbanes, and myself,
joined them in a letter to the regulators asking what actions
and steps they were going to take in the subprime mortgage
problem.
Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman.
So much has happened since the last time we had our
witnesses before us that we could probably hold this hearing
for a week and still have more to talk about. It is hard to
even know where to begin.
What is pressing is the $700 billion Treasury proposal that
is being negotiated with the Chairman of the House Financial
Services Committee. The Paulson proposal is an attempt to do
what we so often do in Washington, D.C., throw money at a
problem.
We cannot make bad mortgages go away. We cannot make the
losses that our financial institutions are facing go away.
Someone must take those losses. We can either let the people
who made the bad decisions bear the consequences of their
actions or we can spread that pain to others. And that is
exactly what the Secretary's proposal is to do, take Wall
Street's pain and spread it to the taxpayers.
The plan has not even passed and already Americans are
paying for it because of the fall in the dollar as a result of
all of the new debt that we will be taking on.
I know there are problems in the financial markets and I
share a lot of the same concerns that other members and
witnesses do. However, the Paulson plan will not fix those
problems. The Paulson plan will not help struggling homeowners
pay their mortgages. The Paulson plan will not bring a stop to
the slide in home prices. But the Paulson plan will spend $700
billion worth of taxpayers' money to prop up and clean up the
balance sheets of Wall Street.
This massive bailout is not a solution. It is financial
socialism and it is un-American.
Thank you.
Chairman Dodd. Senator Menendez.
STATEMENT OF SENATOR ROBERT MENENDEZ
Senator Menendez. Thank you, Mr. Chairman.
Certainly in my 16 years in Congress, there has not been a
more critical time for our economy and a more important Banking
Committee hearing than this one. The Administration's economic
and regulatory policy over the last 7 years has led us to
today. Now we have been told that we have less than 7 days to
make our choices and 8 minutes to ask questions, so you will
forgive me if I am not signing right away on the bottom line.
Unfortunately, the Administration comes to the Congress at
the final hour instead of before, and in doing so leaves us
with undesirable choices. The credit crunch and the failing
investment banks did not occur in a vacuum. At their core they
are about the housing foreclosure crisis. And that weakness was
created by lax regulation, regulators asleep at the switch, and
an unwillingness by many to acknowledge the direness of the
situation early on.
In March of 2007, Mr. Chairman, at this Committee I raised
the prospect of a tsunami of foreclosures in the Banking
Committee, but the Administration dismissed it. A few months
later, as foreclosures mounted, they assured us that the
problems would be contained to the housing market. And in July,
we asked them about the prospect of a bailout of Fannie and
Freddie, but they could not foresee it.
So how many times can the Administration be wrong and still
instill confidence?
This is why, while I need to know--and I think we need to
act, and I agree we need to act--I am not going to be stampeded
into rubber-stamping this proposal. There are serious questions
that we need answers to before you have at least my vote.
Illiquid assets are illiquid either because they are non-
performing, they are over valued, or even worse, we do not even
know what their true values are. Questions range from are you
intending to buy these bad loans at a significant discount or
will we be overpaying? If they are at a deep discount, how does
that create the much-needed capital for their cash future, and
therefore solve the problem? If Treasury is overpaying and
working to create capital for the institutions, why aren't we
getting equity just as shareholders do so that the taxpayers
can recoup their money? And as Treasury has amended their
proposal for foreign entities to also be subject to this
bailout, what are the central banks of those countries doing to
establish and prop up their own institutions?
Why are we asked to put $700 billion to keep CEOs in their
office while families get kicked out of their homes and the
public gets the bill while this Administration says it is all
about Main Street?
We cannot say that homeowners should bear all of the
consequences of bad decisions but that financial institutions
get to share the pain of their bad decisions through public
debt.
So Mr. Chairman, last week the President said ``The risk of
doing nothing far outweighs the risk of the package.'' As his
statement inherently implies, there is a risk involved. And
with risk comes responsibility. We need to quantify that risk.
We need to limit taxpayer exposure. We need to work to keep
families in their home as part of their effort.
Therefore, I look forward to some honest answers here
today. The Secretary's testimony, as it has been presented to
the Committee, just reiterates the need. But I hope we will get
to the answers of how do they intend to have this work and work
in a way that limits the taxpayers' exposure, puts homeowners
back in their home, and creates responsibilities by those who
have believed that private risk can now become public debt.
Chairman Dodd. Thank you, Senator.
Senator Crapo.
STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you very much, Mr. Chairman.
I share many of the concerns and observations that have
been made by my colleagues, so I will not restate all of them.
I do want to indicate, however, that I agree that this is
probably the most critical threat to our economic circumstances
in our country that we have faced since I have served in
Congress. And one which has the type of urgency that requires
us to take prompt action.
But I also share the sentiments that we must take the time
to get it right. And I have a lot of the same concerns that
others have shared about whether we have the right proposal or
whether we need to continue to work through a refinement of it.
I have a number of questions. For example, as have been
raised by some already today, how will these assets be priced?
If there is a market value that the holder or seller simply
does not want to sell at, will the taxpayer be asked to buy
them at a premium simply to help recapitalize those who are
facing capital problems?
And if so, how will the taxpayer ever regain its investment
in this circumstance if more than the assets are worth are paid
for them?
In fact, that raises another very interesting question. And
that is if it does require a significant infusion of capital,
should the plan be having the taxpayers purchase distressed
assets? Or should the plan involve the taxpayers gaining some
type of ownership interest or some type of ability to come
ahead of the shareholders in terms of the losses that are taken
in the operations of the firms?
The question as to what type of investment or what type of
capitalization should take place is critical and I think that
the basic bottom line here is that we must protect the
taxpayers. So that as losses must be taken, those losses are
taken not by the American taxpayer but they are taken by those
who have the ownership interests in the firms involved.
I have many, many other questions. But again, the bottom
line to me is how do we make sure that the connection between
Main Street and Wall Street is understood not only by America
but by the policymakers here in this Committee and in this
Congress so that we address the issue in such a way that we
make sure that the taxpayer is protected and that the markets
are strengthened and reassured?
I think that Senator Schumer's comment about assuring the
markets that we are going to be diligent and careful and
prudent as we move forward is very helpful. I think the markets
need to know that. We also need to make sure that the markets
know that we will be efficient and careful and prudent to
making sure that the solution that we get is the right
solution.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator, very much.
Senator Brown.
STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Senator Dodd, for calling today's
hearing. Thanks to the witnesses for joining us. They have had
many long nights lately and this may be a long morning. I make
no apologies for that. I doubt they seek any.
Like my colleagues, my phones have been ringing off the
hook. The sentiment from Ohioans about this proposal is
universally negative. I count myself among the Ohioans who are
angry. Had the Federal Government acted to contain the epidemic
in subprime lending, I do not think we would be sitting here
today. The time we spend this morning will be time well spent,
not just for our own benefit but for the benefit of the people
we represent. I am not sure they will be convinced, but they
sure deserve a better explanation than they have received to
date.
A man from Westerville, Ohio was so concerned he took a day
off work and drove to Washington this week--a 7 hour drive--to
share his views with me. He quite rightly asked why we are
rushing to bail out companies whose leaders got rich by
gambling with other people's money?
Here is another communication, and I quote, ``The Federal
Government must not prolong necessary corrections in the
housing market, bail out lenders, or subsidize irresponsible
borrowing and lending at the expense of hard-working people who
have played by the rules.'' Except that statement did not come
from Ohio. It came from the Office of Management and Budget
three short months ago.
Throughout this sorry chapter in our Nation's financial
history, the Administration has shown extraordinary attention
to the problems of Wall Street while at times showing hostility
to rebuilding Main Streets across the country. The statement I
quoted above was from the Administration's veto threat of the
housing bill. Congress had the audacity to include $4 billion
to rebuild neighborhoods devastated by the foreclosure crisis
but the Administration did not want to reward irresponsible
borrowing and lending.
Now it does. But before we agree, there are many, many
unanswered questions that Congress and the American people have
a right to ask that the Administration needs to answer.
As Chairman Bernanke knows, the bank panic of 1933 started
in Detroit and in 2 weeks spread to Cleveland. Two of the
city's largest banks were shuttered and never reopened. One had
ties to my predecessor in this seat, Republican Marcus Hanna.
Rumors flew that the bank's closure was a political decision.
If we do not know the rules now, these types of rumors will be
reborn.
Secretary Paulson, as much as I respect your judgment, you
will not be making the hundreds of individual decisions that
this effort will require. And as your colleague, Secretary
Kempthorne has found, a lack of close supervision and adherence
to rules can lead to disastrous results.
Many of the people who will be making these decisions as to
the purchase of these troubled assets have come from Wall
Street, and they may be returning to Wall Street. The notion
that they can operate without clear guidelines is not just
unfair to taxpayers, I think it is unfair to them.
So I hope this morning we go into considerably greater
detail. I hope we can give Main Street a good bit more help and
attention than we have to date. I think the taxpayers need to
be protected. And I think the leadership of these companies
have to be held accountable.
If any CEO hesitates to participate because of his or her
narrow self-interest, his or her compensation, I would say it
is time to get a new CEO. It is fine to say that people's
401(k) accounts may be affected. They will be if we do not act.
But for most people, their home is their 401(k). We need to
help them, as well.
Mr. Chairman, gas is expensive. I want that man from
Westerville, Ohio to know that his time and his money were well
spent.
Chairman Dodd. Thank you very much, Senator.
Senator Dole.
STATEMENT OF SENATOR ELIZABETH DOLE
Senator Dole. Mr. Chairman, I have very strong concerns
that this rescue proposal will unfairly hold taxpayers
responsible for the costly and reckless decisions of investment
bankers on Wall Street.
I, like the North Carolinians I am hearing from, am very
skeptical of this proposal. And frankly, I am extremely
frustrated that we find ourselves in this position.
So much of what is happening with regard to the credit
crisis, the housing slump, the bankruptcy and dissolving of
major financial institutions can be linked to the mismanagement
of Fannie Mae and Freddie Mac, which was made possible by weak
oversight and little accountability.
Since arriving in the Senate, I have been one of a handful
of members pushing for stronger oversight of Fannie Mae and
Freddie Mac. I have helped introduce--as have Senators Chuck
Hagel, John Sununu, Mel Martinez, and Richard Shelby--
legislation to strengthen oversight. And I have raised the
issue in the Banking Committee hearings time and time again.
Unfortunately, Fannie and Freddie dispatched an army of
lobbyists, reportedly spending more than $100 million, to gain
protection in Congress and this Committee to oppose our
legislation.
As we know, one of my Committee colleagues proclaimed in
April 2005 that Fannie and Freddie have done, and I quote, ``A
very, very good job.'' It was only 2 months ago that our bill
was finally included in the housing stimulus package. So it
took 5 years to finally get appropriate action.
This problem could have been resolved years ago. It is
astounding that despite the years of widely publicized
mismanagement at Fannie and Freddie, despite our group of
United States Senators sounding the alarm about the lack of
oversight, despite Alan Greenspan in 2005 urging Congress to
act, warning that we are placing the total financial system of
the future at a substantial risk, despite the preponderance of
red flags, it took--of all things--the Investment Banking
Division of Morgan Stanley, hired by the Treasury Department,
to uncover that Fannie and Freddie were still using overly
aggressive accounting techniques to inflate their capital
adequacy positions.
Now my constituents, and indeed taxpayers across the
Nation, are asking how we arrived at this crisis. It is
infuriating. We need to end the existing structure of an
implied Government guarantee. We need to end the practice of
private rewards at public risk. I fully support the mission of
affordable housing and believe the Government will continue to
play an important role in this area.
That said, it is abundantly clear that Fannie and Freddie
have utterly failed to deliver on their intended purpose. In
fact, because of their Congressional apologists, Fannie and
Freddie have effectively done just the opposite. They have put
us on the brink of a situation in which almost no one can
obtain financing for a home.
One of the big casualties in all this mess is AIG. As we
know, Treasury had to swoop in with an $85 billion loan to
prevent the largest company failure in history. The AIG
downfall was caused, in large part, by the hemorrhaging credit
default swaps on mortgage-backed securities.
Consistently throughout the year, I have been one of the
few members who called for more oversight and tougher reporting
requirements for the $60 trillion credit default swaps market,
which we now know also played a significant role in the
collapse of Lehman Brothers. I reference this as yet another
example of what is now painfully obvious, the Federal
Government's oversight structure for the financial sector is
fatally flawed. And I am not at all convinced that this bailout
plan, which appears incredibly expensive and hastily concocted,
is the answer.
I welcome today's hearing, not only for us lawmakers to get
answers but for the taxpayers who need to understand in no
uncertain terms why they are being asked to foot this bill.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator.
Senator Casey.
STATEMENT OF SENATOR ROBERT P. CASEY
Senator Casey. Mr. Chairman, thank you very much.
I want to thank Secretary Paulson, Chairman Bernanke,
Chairman Cox, and Director Lockhart for your presence here
today.
I think my reaction to the proposal that was sent by the
Administration this weekend was similar to not just members of
this Committee and others, but I think the American people, in
a couple of ways. One was I thought it was far too broad a
grant of authority to the Treasury Department, and I will talk
more about that. But I think in terms of what was missing from
it were a couple of basic features. First of all, I think it
missed completely the idea of addressing directly the root
cause of this problem, which you know started with
foreclosures. And I know there has been work done this weekend
to try to fill in that hole, fill in that blank.
On Friday, I sent a letter both to you, Secretary Paulson
and Chairman Bernanke, outlining a couple of things on housing.
First of all, HOPE for Homeowners is a way to further amplify
or expand our efforts in that area. The moratorium issue that
Senator Brown, Senator Menendez, and Senator Schumer and I
proposed.
And also, an innovative way in the city of Philadelphia,
where literally the city government, the court system
intervened, to try to prevent foreclosures. And it is a very
successful model.
And I think there are other ideas that we will hear. I know
that Chairman Dodd has made a series of proposals just in the
last couple of days that I think are very instructive here and
very helpful on transparency and accountability, the idea of
oversight, certainly in the area of assistance for homeowners.
So we are going to have a chance to review those today and
in the next couple of days.
I think overall, people are looking for--taxpayers and
families are looking for a couple of things. They are looking
for more oversight. They want to know that if a department of
their Federal Government is given the opportunity to exercise
power which involves the expenditure of maybe $700 billion,
that there is some oversight by the elected officials and
others who are charged with that responsibility.
I think taxpayers have a real concern, obviously, a deep
abiding concern about their own savings. What will this mean to
their own livelihood, any kind of short-term livelihood, but
especially long-term, in terms of their own personal savings. I
think they know that we need more performing loans, not loans
that are headed to foreclosure. And I think the bankruptcy
strategy here, in terms of that enhancing our ability to modify
loans, is central to achieving that kind of result where you
have more performing loans instead of loans headed to
foreclosure.
But I think in the end what people are most concerned about
is staying in their homes. We have got to do everything
possible with limited time, I realize, and under duress and
urgency, to do everything possible to keep people in their
homes. And I think that is, in the end, what most Americans are
concerned about. They are concerned about not just their own
family, but their own neighborhoods. And it really comes down
to peace of mind in so many ways.
I would hope that in your efforts, and I know that you are
trying to do this, but in your efforts to explain what has to
happen to support financial institutions and other entities
which will, in turn, strengthen our economy and help on Main
Street, that you keep in mind what individual families are up
against.
In my home State of Pennsylvania, which has been spared
somewhat, in a relative sense, what other States have gone
through, the foreclosure crisis got a lot worse in August of
2008 compared to August of 2007, up 60 percent, a much higher
rate than the rest of the country.
And then if you add the foreclosure problem in a State like
Pennsylvania and add the other challenges that people have,
with gas prices, health care costs, the costs of education. One
that stood out for me is child care. If you are a family in
Pennsylvania and you have got two kids, your monthly cost for
child care is $1,311. That is weighing on people as they worry
about making the house payment this month and next month and
all these months ahead of us.
So I would urge you, as we finalize a proposal, I know we
are trying to work together to make this happen, that we keep
in mind those families and their peace of mind and their
economic security.
Thank you very much.
Chairman Dodd. Thank you, Senator.
Senator Martinez.
STATEMENT OF SENATOR MEL MARTINEZ
Senator Martinez. Thank you, Mr. Chairman.
I look forward to hearing from the witnesses, and I will be
very, very brief. But I do think it merits for us to look for a
moment to how we got here because a lot can be said about the
lack of regulation. And I want to associate myself with the
excellent comments from Senator Dole.
I cannot help but have a sense that a lot of what has
transpired here, a lot of what we are dealing with today, has
its origins in Fannie Mae and Freddie Mac. And as we look at
that, and we try to deal with the current problem, we cannot
help but also look back. We have not looked back enough to know
how Fannie Mae and Freddie Mac got the entire financial world
in the mess that we are in today.
One of the problems is that it did not have a world class
regulator. And I know it is real popular today and easy to do
to just beat up on the Administration and blame everything from
tsunamis to hurricanes on them. But having been a part of this
Administration and having come to this Congress, and before
this very Committee, to testify in 2003, along with then-
Secretary of Treasury Snow, to ask for stronger regulation over
Fannie and Freddie, to have a world class regulator, I find it
just a little troubling to just exactly overlook and not pay
some attention to how we got here.
And I do want to recall also Chairman Greenspan's comments
in 2005 before this Committee where he said that if Fannie and
Freddie continue to grow, continue to have the low capital that
they have, continue to engage in the dynamic hedging of their
portfolio--which they need to do for interest rate aversion--
they potentially create ever growing potential systemic risk
down the road. And that is where we are today, systemic risk.
So that is just a little bit on how we got here, where I
think we need to, Director Lockhart, I hope we are going to
drill down and find out a lot more about how Fannie and Freddie
got us here. But beyond that, we need to do what we need to do
now. We need, in the long term, to also deal with a complete
revamping of our regulatory scheme of our financial
institutions.
But that will come in the future. For now, I believe we are
saddled with a problem that needs and requires action, that
action needs to be thoughtful but timely. We need to talk about
oversight. We need to talk about the size of this fund, and
whether it will work or not. But it does appear to me that
there are also some questions that we need to have answered,
which is if the underlying problem regarding this entire matter
has to do with the ever declining home values, what are we
doing here that will help to stem that decline in home values?
It seems to me, when we look at the State of Florida, that
it is about a tremendous inventory of unsold properties, as
well as the availability of credit. Hopefully, what we are
doing here may help with the availability of credit. But
certainly the tremendous inventory is something that I think we
also need to address.
So I look forward to hearing the testimony from the
witnesses, having many questions answered. But at the end of
the day, I do believe that it is our responsibility to act, to
act timely, and to act responsibly but yet to act.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator. Senator Bayh.
STATEMENT OF SENATOR EVAN BAYH
Senator Bayh. Thank you, Mr. Chairman and thank you,
gentlemen, for your public service. We may not agree on
everything but we are all grateful for your efforts to try and
deal with this important moment for our Nation.
Mr. Chairman, we gather here today at a time of the most
palpable sense of national crisis since we gathered here in
this building immediately following the 9/11 attacks. It has
been less than 72 hours since we listened to the Chairman of
the Federal Reserve tell us that we were only a matter of
perhaps days from the beginning of a major economic collapse,
the free fall of our financial markets, and the beginnings of a
severe and protracted recession that could cost businesses
going out of business, many jobs being lost, savings being
wiped out, people losing their homes, real distress for our
country. And coming from a man who I think, Mr. Chairman, it is
safe to say is not known for engaging in hyperbole, this tended
to focus the mind.
So the sense of urgency is palpable. And yet, we also have
to focus on getting it right.
I am going to focus my questions on what alternatives have
been considered? Why are we convinced that this is the right
path? Were there no private sector solutions available that
would perhaps lead to better outcomes than the ones that have
been proposed?
If it takes us a couple of extra days to increase the
likelihood that this will work and work well, well it is worth
working through the weekend. It may be worth postponing going
home to campaign for. I mean, this is important enough that we
take the time to get it right.
And so I am going to focus my questions first on what other
alternatives were considered? And why do we think this is the
optimal solution to the problem?
Several of my colleagues, including Senator Menendez, have
mentioned is our purpose here to protect the taxpayers by
buying these instruments at market prices? If that is the case,
how does it help solve the problem by recapitalizing these
institutions? If we are paying above market prices, what do the
taxpayers receive in return? If equity is the answer, that is
one thing. If it is not equity, then we have to ask why not?
And if it is not equity, we have to ask why do we encourage, or
at least permit, sovereign wealth funds to invest in our
companies and markets but perhaps not allow the American
taxpayers to take a similar interest in our own companies and
markets? So I will be asking about that, as well.
Finally, and perhaps my greatest concern, Mr. Chairman, and
you and I have discussed this. We have to act. But we also have
to be willing to take the steps to make sure that this
situation does not reoccur. As my colleagues have indicated,
there is a sense of outrage on the part of ordinary taxpayers.
I hear from my citizens all the time, people who behaved
prudently, who did not take inordinate risks, who saved their
money, who did not get in over their heads, who did not
participate in highly leveraged instruments that have not come
back to haunt them.
What about them? Who speaks for them? Who will protect
them? We owe it to them to make sure that we learn the lessons
from this so that it does not happen again.
And the way Washington works--I must say, I am not a cynic
but I am a skeptic. We will act in this moment of crisis. But
once the crisis has abated, the sense of urgency will
dissipate. The forces of reform will not have the energy they
have today. All of the interests will circle this place like
hungry birds looking at carrion to prevent us from taking the
steps that are necessary. And we must not let that happen.
So I understand we cannot make the long-term reforms in
this vehicle. It is not possible in the time frame that is at
our disposal. But I am going to be looking for some incentive,
Mr. Chairman, some mechanism that will force us to revisit this
issue. Because if we do not revisit the issue of long-term
reform to keep this from happening again, it will happen again.
And history will judge us poorly and our children and
grandchildren will not forgive us, nor should they.
Chairman Dodd. Thank you, Senator.
Senator Corker.
STATEMENT OF SENATOR BOB CORKER
Senator Corker. Senator Bayh made some good comments.
I want to say to all of you that I thank you for coming. I
think it is absolutely reprehensible that in the biggest
financial crisis in modern history, our timeline is to get out
of here on Friday so we can adjourn for the year in September.
And I agree with those who think we ought to get this right. I
will focus these comments to Secretary Paulson and Chairman
Bernanke.
I cannot imagine two people that have a better background
to deal with this, nor people that I respect more from the
standpoint of that and their perspective. I did not support the
rebate stimulus, and I did not support the ``bazooka in the
pocket'' theory. And history will judge whether that was a good
decision or not. But in both cases, you came to us with
strength of commitment and telling us that that absolutely was
the right thing to do. I disagreed.
In this case, what bothers me is that each of you--and I
realize you are trying to solve a problem, and I truly believe
you are trying to do it in a way that you think is best for the
country. I believe that with all of my heart. But I get a sense
that it is with more of a deer-in-the-headlights mentality.
This is a much bigger undertaking, this bailout, and I do
not, by the way, criticize you for not knowing exactly what to
do. But this is being done on the fly. If this $700 billion
were to be extended per Bloomberg data today, it would add up
to $1.8 trillion that we have extended to the markets, not
counting the rebate checks that went away at $168 billion or
somewhere thereof.
So I just have to tell you that I hope today that what you
will do in questions and answering is talk about some of the
options that you have thought about that Senator Bayh brought
forth, and I hope you will be able to convince us that this
solves the problems that we are dealing with.
I am getting letters from bankers throughout the State of
Tennessee that were not involved in this, and yet they have
severe issues that are caused by some of the things that have
happened on Wall Street.
So I hope this meeting will be full, Mr. Chairman. I did
the math for you. I hope you do not object. But 21 times 8 is
168 minutes. I know no one will stay within that 8 minutes, and
I do hope that this hearing will last long enough so that we
leave here fully understanding what it is we are talking about.
Chairman Dodd. I appreciate that very much, and, again, I
thank my colleagues. And there are a couple more members who
want to be heard from, but this is, as many have pointed out,
probably the single most important hearing this Committee has
held, certainly in my tenure. Therefore, having the opportunity
for Members to be heard on this I think is particularly
important. And it is important, I think, that our witnesses
have the opportunity as well. They are reflecting the views of
their constituents about these matters, and it is clearly
important that we be working together on this.
So I apologize for the length of it, and I will try and
make sure we move along here, recognizing our witnesses have
work to do as well. But it is a critical moment in our system
that we hear from Members. So I thank my colleagues for their
comments as well.
Let me turn to Senator Akaka and then Senator Allard, and
then we will then go to our witnesses. Senator Akaka.
STATEMENT OF SENATOR DANIEL AKAKA
Senator Akaka. Thank you very much, Mr. Chairman. I
appreciate your conducting this hearing today, and I want to
add my welcome and thanks to the witnesses who are here today.
Mr. Chairman, I understand the need to act to stabilize the
markets. However, we must not give the Secretary of Treasury a
blank check with no accountability or oversight. We must
deliberate and provide a solution that protects taxpayers as
much as possible and limits the potential for this new
authority to be abused. Seven hundred billion dollars is a huge
sum of money.
I know the President has said that the whole world is
watching Congress now. I remind all of you that the Members of
this Committee and the rest of the taxpayers will be closely
watching the development of the Troubled Assets Program. The
purchase and sale of assets has great potential to be abused
and lead to corruption. Members of Congress, the GAO, the
Treasury Inspector General, and the public must review the
activities of Treasury authorized by this proposed act. We must
make sure that this situation, which has been caused partially
be greed, will not be exploited to enrich individuals and
corporations.
In addition to stabilizing the markets, we must do more to
help working families. We need to help those who have already
suffered the consequences of the current economic downturn. We
must do more to try and keep people in their homes. Consumer
protections must be improved to better protect families from
being exploited by predatory lenders.
Mr. Chairman, we are here today due to a massive market
failure. In addition to this emergency legislation, we need a
complete reexamination of our financial services oversight
system in order to strengthen regulation and prevent the need
for future bailouts. While most of those issues will be
considered in the next session of Congress, I look forward to
working with all of you to bring together a fair proposal to
stabilize the markets, improve the lives of working families,
and overhaul the financial services regulatory system.
Thank you very much, Mr. Chairman.
Chairman Dodd. Thank you, Senator.
Senator Allard.
STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. Thank you, Mr. Chairman.
I want to thank the panel for being here with us today.
This is a critical time in our Nation and our economy, and we
must move forward from here. I hope to get more details on how
we do that.
We need to act on solid facts so that we can act in the
interests of the taxpayers of this country. I urge the
administration to be more forthcoming with facts on their plan,
their cost estimates and implementation. Telling Congress to
give full discretion in implementing the bailout program is not
the way to go. Congress needs to be involved, and I urge more
cooperation and sharing with the Congress in the hope that we
can act in a limited way and avoid going beyond what is
necessary to stabilize the markets. This Committee, this
Congress, must act to preserve our free market tradition. We
have tried to avoid propping up failed businesses on Main
Street. We should not prop up failure, malfeasance, and avarice
on Wall Street.
Second, we cannot do so successfully, even if we wanted to.
The history of Government's ineptitude at running business is
known now the world over.
And, third, we must prevent panic both in the market and in
the Government. Overreaction will in the long run be worse for
our freedom and our economy. We must remember the long run.
Mr. Chairman, thank you.
Chairman Dodd. I thank the Senator very much.
Before turning to Secretary Paulson, let me just say for
the benefit of my colleagues and others, our intention had
been, quite frankly, barring events of the last few days, to
actually use this month and next month to have some hearings
and informal conversations on exactly the issue of long-term
restructuring of our financial service regulatory system. My
intention is as some point to do this. In fact, Chairman
Bernanke and I ever chatted about this yesterday as well, and
we hope to get to that to be able to start that process before
the inauguration of the new President in January to be able to
present some ideas. It is impossible this week to do that, but
I want my colleagues to know it is our intention. I know
certainly Members--Senator Allard and others--have worked on
regulatory reform for a long time, and so I am going to be
calling upon us as a Committee, informally or formally, to
actually have those conversations in the coming weeks even
before we commence our work in January to actually consider
ideas that would allow for the restructuring of that. So I want
the witnesses as well as our colleagues to know that.
With that, Secretary Paulson, let me underscore what has
been said by others here. We admire immensely your willingness
to serve our country, and that goes for all of you there at the
table. There are obviously concerns that are being expressed
here strongly this morning. I hope it has been valuable for you
to hear from across the country how our colleagues are hearing
from their constituents and their own concerns about these
issues.
In no way should this be an interpretation of our lack of
respect and admiration for those willing to serve our country,
and we appreciate immensely your willingness to do it. We
admire as well your background and experience you bring to this
issue.
So, with that, we thank you for being here this morning and
are anxious to receive your testimony and ask some questions.
STATEMENT OF HENRY M. PAULSON, JR., SECRETARY, DEPARTMENT OF
THE TREASURY
Secretary Paulson. Thank you very much, Chairman Dodd,
Senator Shelby, Members of the Committee. Thank you very much
for the opportunity to appear before you today. I very
appreciate the comments you made, and I understand them and I
appreciate them.
Chairman Dodd. Could you pull that microphone a little
closer?
Secretary Paulson. I also share the comments that you all
made about the importance of the situation and the importance
of this hearing.
This is a difficult period for the American people. I very
much appreciate the fact that congressional leaders and the
administration are working closely together so that we can help
the American people by quickly enacting a program to stabilize
our financial system.
We must do so in order to avoid a continuing series of
financial institution failures and frozen credit markets that
threaten American families' financial well-being, the viability
of businesses both small and large, and the very health of our
economy.
The events leading us here begin many years ago, starting
with band lending practices by banks and financial institutions
and by borrowers taking out mortgages they could not afford. We
have seen the results on homeowners--higher foreclosure rates
affecting individuals and neighborhoods. And now we are seeing
the impact on financial institutions. These loans have created
a chain reaction, and last week our credit markets froze. Even
some Main Street non-financial institutions--or, excuse me,
some non-financial companies had trouble financing their normal
business operations. If that situation were to persist, it
would threaten all parts of our economy.
Every American business depends on money flowing through
our system every day, not only to expand their business and
create jobs, but to maintain normal business operations and to
sustain jobs.
As we have worked through this period of market turmoil, we
have acted on a case-by-case basis, addressing problems at
Fannie Mae and Freddie Mac, working with market participants to
prepare for the failure of Lehman Brothers, and lending to AIG
so it can sell some of its assets in an orderly manner.
And here I would make the comment, you know, I have heard
your comments on executive compensation. I share your
frustrations. I feel those frustrations. Practices throughout
America also upset me. Let me just say that, with regard to
Freddie and Fannie and AIG, in case you or your constituents do
not know, in those cases CEOs were replaced, the Government got
warrants for 79.9 percent of the equity, golden parachutes were
eliminated, strong action was taken.
I will also say to the comments made about Freddie and
Fannie and the bazooka, you all can be darn glad you gave us
the bazooka, because we needed it.
Let me tell you something. The root of that problem was in
congressional charters started many, many years ago. We were
living up to our obligations here. There are ambiguities. There
are obligations around those charters. And what we did was we
came in, we stabilized the market, mortgage rates went down so
that capital could flow through our system. And I can just say
I for one--and I know that the other witnesses feel very glad
about this--thank goodness that was done and they were
stabilized before we had some investment banks report their
earnings, or let me tell you, this would be a much more serious
situation than it is today. So there is an example of broad
authorities working the way they were supposed to work to
stabilize our system.
Sorry for that ad hoc response, but we have also taken a
number of powerful tactical steps to increase confidence in the
system, including a temporary guaranty program for the U.S.
money market mutual fund industry. These steps have been
necessary but not sufficient.
More is needed. We saw market turmoil reach a new level
last week and spill over into the rest of the economy. We must
now take further, decisive action to fundamentally and
comprehensively address the root cause of this turmoil.
And that root cause is the housing correction, as you have
all pointed out, which has resulted in illiquid mortgage assets
that are choking off the flow of credit which is so vitally
important to our economy. We must address this underlying
problem and restore confidence in our financial markets and
financial institutions so they can perform their mission of
supporting future prosperity and growth.
We have proposed a program to remove troubled assets from
the system. We would do this through market mechanisms
available to thousands of financial institutions throughout
America--big banks, small banks, savings and loans, credit
unions--to help set values of complex, illiquid mortgage and
mortgage-related securities to unclog our credit and capital
markets and make it easier for private investors to purchase
these securities and for the financial institutions to raise
more capital after the market learns more about the underlying
value of these hard-to-value, complicated mortgage-related
securities on their balance sheets.
This Troubled Asset Relief Program has to be properly
designed for immediate implementation and be sufficiently large
to have maximum impact and restore market confidence. It must
also protect the taxpayer to the maximum extent possible and
include provisions that ensure transparency and oversight while
also ensuring the program can be implemented quickly and
effectively.
And let me give you another ad hoc comment there. When we
all met Thursday night, as you will recall, Chairman, with the
leaders of Congress, you all said to us, ``Don't give us a fait
accompli. Come in and work with us.'' We gave you a simple
three-page legislative outline, and I thought it would have
been presumptuous for us on that outline to come up with an
oversight mechanism. That is the role of Congress. That is
something we are going to work on together. So if any of you
felt that I did not believe that we needed oversight, I believe
we need oversight. We need oversight. We need protection. We
need transparency. I want it, we all want it. And we need to do
that in a way that lets this system, lets this program work
effectively, quickly, because it needs to work effectively and
quickly, and it needs to get the job done.
Now, the market turmoil we are experiencing today poses
great risk to U.S. taxpayers. When the financial system does
not work as it should, Americans' personal savings and the
ability of consumers and businesses to finance spending,
investment, and job creation are threatened.
The ultimate taxpayer protection will be the market
stability provided as we remove the troubled assets from our
financial system. Don't forget that. This system has to work,
and has to work right, and that will be the ultimate market
protection. I am convinced that this bold approach will cost
American families far less than the alternative--a continuing
series of financial institution failures and frozen credit
markets unable to fund everyday needs and economic expansion.
Again, I am frustrated. The taxpayer is on the hook. The
taxpayer is already on the hook. The taxpayer is going to
suffer the consequences if things do not work the way they
should work. And so the best protection for the taxpayer and
the first protection for the taxpayer is to have this work.
Over these past days, it has become clear that there is a
bipartisan consensus for an urgent legislative solution. We
need to build upon this spirit to enact this bill quickly and
cleanly, and avoid slowing it down with provisions that are
unrelated or do not have broad support. This troubled asset
purchase program on its own is the single most effective thing
we can do to help homeowners, the American people, and to
stimulate our economy.
Earlier this year, Congress and the administration came
together quickly and effectively to enact a stimulus package
that has helped hard-working Americans and boosted our economy.
We acted cooperatively and faster than anyone thought possible.
Today we face a much more challenging situation that requires
bipartisan discipline and urgency.
When we get through this difficult period, which we will,
our next task must be to address the problems in our financial
system through something you have all talked about. We need
reform that fixes this outdated financial regulatory structure.
You have all heard me talk about that a lot. And we need other
strong measures to address other flaws and excesses in the
system. And there are plenty, and we have all talked about
them, and they cannot be addressed this week. We need to take
time to address these. I have already put forward my
recommendations on this subject. Many of you have strong views
based on your expertise. We must have that critical debate, but
we must get through this period first.
Right now, all of us are focused on the immediate need to
stabilize our financial system, and I believe we share the
conviction that this is in the best interest of all Americans.
Now let's work together to get it done.
Thank you.
Chairman Dodd. Thank you very much, Mr. Secretary. I would
be remiss if I did not just point out--and thank you, by the
way--that but for the cooperation that Senator Shelby and the
overwhelming majority of Members of this Committee, we were
able to enact that legislation in July that you have
referenced. It does not mean that everybody was supportive of
every detail of it, but it was an example of coming together
and getting a job done. It took some time, but we got it done,
and I thank you for your comments about it, and I thank Senator
Shelby and Members of this Committee, Democrats and
Republicans, who worked with us to get that done.
Chairman Bernanke.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF
THE FEDERAL RESERVE SYSTEM
Mr. Bernanke. Mr. Chairman, Senator Shelby, I have
submitted formal written testimony for the record. With your
permission, I would like to speak just a few minutes about the
Treasury proposal.
The Fed supports the Treasury initiative. We believe that
strong and timely action is urgently needed to stabilize our
markets and our economy. But I believe some clarification is
needed about why this proposal could make a positive
difference, and I would like to offer a few thoughts on that
subject.
Let me start with a question. Why are financial markets not
working? Financial institutions and others hold billions in
complex securities, including many that are mortgage related. I
would like to ask you for a moment to think of these securities
as having two different prices. The first of these is the fire-
sale price. That is the price a security would fetch today if
sold quickly into an illiquid market. The second price is the
hold-to-maturity price. That is what the security would be
worth eventually when the income from the security was received
over time.
Because of the complexity of these securities and the
serious uncertainties about the economy and the housing market,
there is no active market for many of these securities. And,
thus, today the fire-sale price may be much less than the hold-
to-maturity price.
This creates something of a vicious circle. Accounting
rules require banks to value many assets at something close to
a very low fire-sale price rather than the hold-to-maturity
price, which is not unreasonable in itself given their
illiquidity. However, this leads to big writedowns and
reductions in capital, which in turn forces additional sales
that send the fire-sale price down further, adding to pressure.
Meanwhile, private capital is unwilling to come in because of
uncertainty about the value of institutions and because of the
prospect of more writedowns.
One suggestion that has been made is to suspend mark-to-
market accounting and use banks' estimates of hold-to-maturity
prices. Many banks support this. But doing this would only hurt
investor confidence because nobody knows what the true hold-to-
maturity price is. Without a market to determine that price,
investors would have to trust the internal estimates of banks.
So let me come to the critical point.
I believe that under the Treasury program auctions and
other mechanisms could be designed that will give the market
good information on what the hold-to-maturity price is for a
large class of mortgage-related assets. If the Treasury bids
for and then buys assets at a price close to the hold-to-
maturity price, there will be substantial benefits.
First, banks will have a basis for valuing those assets and
will not have to use fire-sale prices. Their capital will not
be unreasonably marked down.
Second, liquidity should begin to come back to these
markets.
Third, removal of these assets from balance sheets and
better information on value should reduce uncertainty and allow
the banks to attract new private capital.
Fourth, credit markets should start to unfreeze; new credit
will become available to support our economy.
And, fifth, taxpayers should own assets at prices close to
hold-to-maturity values which minimizes their risk.
Now, how to make this work. To make this work, we do need
flexibility in design of mechanisms for buying assets and from
whom to buy. We do not know exactly what the best design is.
That will require consultation with experts and experience with
alternative approaches.
Second, understanding the concerns and the worries of the
Committee, we cannot impose punitive measures on the
institutions that choose to sell assets. That would eliminate
or strongly reduce participation and cause the program to fail.
Remember, the beneficiaries of this program are not just those
who sell the asset, but all market participants and the economy
as a whole.
But, finally, and very importantly, this is not to say that
the financial industry should not be reformed. It should be. It
is critical. I agree with the Treasury Secretary. The Federal
Reserve will give full support to fundamental reform of the
financial industry. But whatever reforms the Congress makes
should apply to the whole industry, whether they participate in
this program or not.
So, in summary, I believe that under the Treasury authority
being requested, a program could be undertaken that will help
establish reasonable hold-to-maturity prices for these assets.
Doing that will restore confidence and liquidity to the
financial markets and help the economy recover without an
unreasonable fiscal burden on taxpayers. So I urge you to act
as soon as possible.
Thank you.
Chairman Dodd. Thank you, Mr. Chairman, for that testimony.
Christopher Cox.
STATEMENT OF CHRISTOPHER COX, CHAIRMAN,
SECURITIES AND EXCHANGE COMMISSION
Mr. Cox. Thank you, Chairman Dodd, Ranking Member Shelby,
and Members of the Committee, for inviting me here to today to
discuss the current turmoil in our markets and our policy
responses to it. The extraordinary nature of recent events has
required an extraordinary response from both policymakers and
regulators.
Last week, by unanimous decision of the Commission and with
the support of the Secretary of the Treasury and the Federal
Reserve, as well as in close coordination with regulators
around the world, the SEC took emergency action to ban short
selling in financial securities to stabilize markets as you
consider this legislation. At the same time, the Commission
unanimously approved two additional measures to ease the crisis
of confidence in the markets. One makes it easier for issuers
to repurchase their own shares on the open market, thus
providing additional liquidity. The second requires weekly
reporting to the Securities and Exchange Commission by large
investment managers of their daily short positions.
In addition, the SEC recently issued new rules that more
strictly enforce the ban on abusive naked short selling under
our Regulation SHO. Beyond these immediate steps, the SEC is
vigorously investigating how illegal activities may have
contributed to the subprime crisis and the recent instability
in our markets.
First and foremost, the SEC is a law enforcement agency,
and we already have over 50 ongoing investigations in the
subprime area alone. The Division of Enforcement has undertaken
a sweeping investigation into market manipulation of financial
institutions, including through the use of credit default
swaps, a multi-trillion-dollar market is completely lacking in
transparency and is completely unregulated.
Last month, the Enforcement Division, working with State
regulators, entered into agreements that will be the largest
settlements in SEC history, in behalf of investors who bought
auction rate securities from Merrill Lynch, Wachovia, UBS, and
Citigroup. Happily, the terms of these agreements would provide
complete recovery for individual investors.
The Commission also recently brought enforcement actions
against portfolio managers at Bear Stearns Asset Management for
deceiving investors about the hedge funds' overexposure to
subprime mortgages.
The Commission is using its regulatory authority
simultaneously to ensure that the market continues to function.
Last week, the Commission's Office of Chief Accountant provided
guidance to clarify the accounting treatment of banks' efforts
to support their money market mutual funds. This will help
protect investors in those funds. And our examinations of the
major credit rating agencies for mortgage-backed securities
exposed weaknesses in their ratings processes and led to our
sweeping new rules to regulate this industry under the new
authority that this Committee and the Congress have given us.
We are also moving quickly to mitigate the impact of recent
events. In the past week, the SEC oversaw the sale of
substantially all of the assets of Lehman Brothers, Inc., to
Barclays Capital. Hundreds of thousands of Lehman's customer
accounts with over $1 billion in assets can now be transferred
in a matter of days, instead of going through a lengthy
brokerage liquidation process.
With all that has happened, it is important to keep in mind
how we got here. The problems that each of these actions has
addressed have their roots in the subprime mortgage crisis,
which itself was caused by a failure of lending standards. The
complete and total mortgage market meltdown that led to the
taxpayer rescue of Fannie Mae and Freddie Mac was not built
into the stress scenarios and the capital and liquidity
standards of any financial institution. Bank risk models in
every regulated sector, for better or for worse, failed to
incorporate this scenario that has caused so much damage in
financial services firms of all kinds.
The SEC's own program of voluntary supervision for
investment bank holding companies, the Consolidated Supervised
Entity program, put in place in 2004, was fundamentally flawed
because it adopted these same bank capital liquidity standards
and because it was purely voluntary. It became abundantly clear
with the near collapse of Bear Stearns that this sort of
voluntary regulation does not work. Working with the Federal
Reserve, the Division of Trading and Markets moved quickly last
spring to strengthen capital and liquidity at investment bank
holding companies far beyond what the banking standards
require, and we immediately entered into a formal Memorandum of
Understanding with the Fed to share both information and
expertise. But the fact remains that no law authorizes the SEC
to supervise investment bank holding companies let alone to
monitor the broader financial system for risk.
For the moment, this regulatory hole in the statutory
scheme is being addressed in the market by the conversion of
investment banks to bank holding companies. But the basic
problem must still be addressed in statute by filling that
regulatory hole, as I have reported to Congress on previous
occasions.
I will conclude, Mr. Chairman, by warning of another
similar regulatory hole in statute that must be immediately
addressed or we will have similar consequences. The $58
trillion notional market in credit default swaps, to which
several of you have referred in your opening comments--that is
double the amount that was outstanding in 2006--is regulated by
absolutely no one. Neither the SEC nor any regulator has
authority over the CDS market, even to require minimal
disclosure to the market. This market is ripe for fraud and
manipulation, and indeed we are using the full extent of our
antifraud authority, our law enforcement authority, right now
to investigate this market. Because CDS buyers do not have to
own the bond or the debt instrument upon which the contract is
based, they can effectively ``naked short'' the debt of
companies without any restriction, potentially causing market
disruption and destabilizing the companies themselves.
As the Congress considers reform of the financial system in
the current crisis, I urge you to provide in statute for
regulatory authority over the CDS market. This is vitally
important to enhance investor protection and to ensure the
continued operation of fair and orderly markets.
Mr. Chairman, I appreciate the opportunity to discuss the
current market turmoil, and I look forward to answering your
questions.
Chairman Dodd. Thank you, Mr. Chairman. Just very briefly,
we received your testimony about 20 minutes before the hearing
began today. Other Chairmen over the years have talked about
it, and again, I would just raise it briefly here with you. We
need to get the testimony--and I appreciate the fact we did
from other witnesses last evening. We need to get it from the
SEC earlier than 20 minutes before a hearing.
Mr. Lockhart.
STATEMENT OF JAMES B. LOCKHART III, DIRECTOR,
FEDERAL HOUSING FINANCE AGENCY
Mr. Lockhart. Chairman Dodd, Senator Shelby, and Members of
the Committee, thank you for the opportunity to testify on the
Federal Housing Finance Agency's decision to place Fannie Mae
and Freddie Mac into conservatorship.
Fannie Mae and Freddie Mac share the critical mission of
providing stability, liquidity, and affordability to the
Nation's housing market. Between them, these enterprises have
$5.3 trillion of guaranteed mortgage-backed securities and debt
outstanding, which is equal to the total publicly held debt of
the United States. Their market share earlier this year reached
80 percent of all new mortgages made.
During the turmoil that started last year, they had played
a very important role in providing liquidity to the conforming
mortgage market. They required capital to support a very
careful and delicate balance between safety and soundness and
mission. That balance was upset as house prices, earnings, and
capital have continued to deteriorate. In particular, the
capacity to raise capital without Treasury Department support
vanished. That left both enterprises unable to fill their
mission. Worse, it threatened to further damage the mortgage
and housing markets if they had to sell their assets.
Rather than letting those conditions worsen and put the
financial markets in further jeopardy, FHFA decided to take
action. The goal of these dual conservatorships is to help
restore confidence in Fannie Mae and Freddie Mac, enhance their
capacity to fulfill their mission, reduce systemic risk, and
make mortgages--and this is the most important--make mortgages
available at lower cost for the American people.
FHFA based its determination on five key areas, each of
which worsened significantly over the last several months:
First, there were accelerating safety and soundness weaknesses.
Second, there was a continued and substantial deterioration in
equity, debt, and MBS market conditions. Third, the current and
projected financial performance and condition of each company,
as reflected in the second quarter financial reports and our
ongoing examination. Fourth, the inability of the companies to
raise capital or to issue debt according to normal practices
and prices. And, last, the critical importance of each company
in supporting the country's residential mortgage market.
I shared our growing concerns with Federal Reserve Chairman
Bernanke, who was made our consultant in the law you passed in
July, and with Secretary Paulson. They agreed that a
conservatorship was necessary, as did the boards of both firms.
A detailed list of events leading to our conclusion to appoint
a conservator is provided in my written statement. I will just
highlight a few.
It became apparent during this intense supervisory review
that began in July that market conditions were deteriorating
much more rapidly than anybody expected. We supplemented our
examination team with senior examiners from the Fed and the
OCC. All three sets of examiners corroborated that there was a
significant deterioration in the credit environment and it was
a threat to the capital of these two companies. We also
finished our semi-annual examination ratings of the companies
and, across the board, there were significant and critical
weaknesses.
The companies themselves disclosed in their second quarter
filings how rapidly the environment had deteriorated and was
negatively affecting their outlook and their ability to raise
capital. Freddie Mac reported losses of $4.7 billion over the
last year. Fannie Mae reported losses of $9.7 billion.
Now, let me turn to the conservatorships. The first signs
are that the conservatorships are positive. The enterprise
funding costs and the spreads on MBS have declined. This lower
cost has been passed on to homebuyers, with 30-year mortgage
rates well below 6 percent for the first time since January. On
the first day, business opened as normal but with stronger
backing for the holders of their mortgage-backed securities,
their debt, and their subordinated debt.
Over the next 15 months, they are allowed to increase their
portfolios to provide support to the housing market. They will
also be able to continue to grow their guaranteed MBS books.
As the conservator, FHFA assumed the power of the board and
management. Highly qualified new chief executive officers and
non-executive chairmen have been appointed. They will be
delegated significant powers. In order to conserve over $2
billion in annual capital, the common stock and preferred
dividends were eliminated.
The U.S. Treasury financing facilities, which are critical
to this conservatorship, are all in place and will provide the
needed support to Fannie Mae and Freddie Mac to fulfill their
mission over the long term, while giving upside potential for
taxpayers. FHFA will continue to work expeditiously on the many
regulations needed to implement the new law. The new
legislation adds, importantly, affordable housing, a trust
fund, and mission enforcement to the responsibilities of the
safety and soundness regulator. We are also continuing to work
with the enterprises on loan modifications, foreclosure
preventions, pricing, and credit issues.
The decision to appoint a conservator for each enterprise
was a tough but necessary one. They can now become part of the
solution. Unfortunately, all the good and hard work put in by
the FHFA and the enterprises was not sufficient to offset the
consequences of the antiquated regulatory structure which was
overwhelmed by the turmoil in the housing markets.
Conservatorship will give the enterprises the time to restore
the balances between safety and soundness and their mission.
Working together with the enterprises, Congress, the
administration, and other regulators, I believe we can restore
confidence in the enterprises and, with the new legislation
which you passed, build a stronger and safer future for the
mortgage markets, homeowners, and renters in America.
Thank you. I would be pleased to answer questions.
Chairman Dodd. Thank you very much, Mr. Lockhart.
Senator Tester was presiding over the Senate when we were
gathering here, and everyone else had a chance to make a brief
comment. And, Senator Tester, do you have a brief comment you
would like to make?
STATEMENT OF SENATOR JON TESTER
Senator Tester. I do. Thank you, Mr. Chairman, and thank
you for allowing me to just ask a few questions.
Ten years ago, I got involved in politics because of
electrical deregulation in the State of Montana. It was a total
disaster. I have got plenty of questions to ask about the plan,
and I will as they come forth. But I guess my concern is this:
Six months ago, we heard about Bear Stearns, and then we have
had Fannie and Freddie, and we have had some other ones come
down the pike. A week ago, you came forth with a $700 billion
bailout plan--$700 billion, and it was made clear that this was
going to be--there was going to be nothing added on to it.
Accountability, demand of re-regulation was not going to be
accounted. And my question--and this is the concern I have. You
guys are a lot smarter in financials than I am. I am a dirt
farmer. You guys have been in the business, former Chairman of
Goldman Sachs. Why do we have 1 week to determine $700 billion
that has to be appropriated or this country's financial systems
go down the pipes? Wasn't there some opportunity sometime down
the line where we could have been informed of how serious this
crisis was so we could take some preventative steps before this
got to this point?
That is it. Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator, very much.
Well, again, we will turn the clock on here and try and
move along, and let me pick up sort of on that question. I
appreciate, Chairman Bernanke, your laying out why you think
this particular plan will work. But I would like you, if you
could, to step back, in addition to laying out why you think
the plan would work, tell us--and, again, Senator Schumer
mentioned the other evening when we sat on Thursday night, the
reason why we have to act. Put aside whether or not we are
going to act this week or next week. But for a minute tell us
why you believe it is critically important, one, that we act;
what are the circumstances out there that warrant us responding
as quickly as we are being asked to; and, second, do you
believe that the amount being asked for is going to adequately
address the issue, particularly if we adopt the plan as
suggested by the Secretary?
Mr. Bernanke. Mr. Chairman, the financial markets are in
quite fragile condition, and I think, absent a plan, they will
certainly get worse. But even in the current state, they are
not serving the necessary function to support the economy.
Credit is not being provided. As Secretary Paulson mentioned,
non-financial companies are not able to finance themselves
overnight. Credit is just not going to be available. It is
going to also affect savers because of the values of their
assets that they have.
So even in the current condition, even if things do not get
severely worse--but I think they would get worse without some
kind of action--this will be a major drag on the U.S. economy
and will greatly impede the ability of the economy to recover
in a healthy way.
The amounts involved are intended to be enough. We do not
want to go in and underwhelm the situation. That might be to
suggest more problems down the road. There have been some ways
of looking at it. This is about 5 percent of all the mortgages
outstanding, for example, $700 billion. But it certainly
illustrates the size of these markets and the size of the
problem.
I think it is important to state that, as I mentioned
before, this is not an expenditure of $700 billion. This is a
purchase of assets, and if auctions are done properly, if the
valuations are done properly, the American taxpayer will get a
good value for his or her money. And as the economy recovers,
most all or perhaps more than all of the value will be
recovered over time, as was the case in other similar
situations in the past.
Chairman Dodd. Let me ask you this. Again, we have heard
our colleagues, again, across the spectrum here, both
politically and geographically, talk about the impact this is
having beyond, obviously, the information we are aware of in
terms of firms that have disappeared or been consolidated and
the concerns about what is happening to people in the country,
their homes being lost and the like.
Explain, if you would, what is your concern as Chairman of
the Federal Reserve if we were not to act. Give us some idea of
what you think the implications would be if we did not respond
in one way or another to this situation that you just
described.
Mr. Bernanke. Well, again, I think----
Chairman Dodd. In terms of what happens outside of the
financial services sector, what happens to people out there who
have a job, are getting ready to retire, are worried about
their kids' education? These are matters which are going to be
directly affected, I presume. That is the argument you are
making. Give us some sense as Chairman of the Federal Reserve
why those people's concerns are going to be even more dire
straits than they would be if we did not act.
Mr. Bernanke. Senator, you made my point for me. I am a
college professor. I was criticized for taking the job without
having worked on Wall Street. I never worked on Wall Street. I
do not have those interests, those connections. My interest is
solely for the strength and the recovery of the U.S. economy. I
believe that if the credit markets are not functioning, jobs
will be lost; the unemployment rate will rise; more houses will
be foreclosed upon; GDP will contract; that the economy will
just not be able to recover in a normal healthy way, no matter
what other policies are taken.
I, therefore, think this is a precondition for a good,
healthy recovery by our economy. These institutions provide
credit for homeowners. They provide credit for businesses that
create jobs. It is about the people who need those services and
that credit. It is about people retiring who need to have
assurances about the value of their investments and their
assets.
Again, I think that if this is not done, there will be
significant adverse consequences for the average person in the
United States.
Chairman Dodd. And that is your recommendation as Chairman
of the Federal Reserve?
Mr. Bernanke. Yes, sir, it is, and I do believe we need to
act to stabilize the situation, which is continuing to be very
unpredictable and very worrisome.
Chairman Dodd. Let me, if I can, look just quickly at the
foreclosure mitigation issue. I think there is general
consensus here about oversight and accountability. We may argue
about specifics, but I think every one of us here feels very
strongly that there has got to be strong areas now. I think we
all sort of agree as well on the issue of taxpayer protection,
one way or the other how the taxpayers are going to be covered
in this proposal.
There is, I think, greater debate probably about
foreclosure mitigation, but let me run back, if I can, and
remind you in May what you told this Committee. You said,
``High rates of delinquency and foreclosure can have
substantial spillover effects on the housing market, the
financial markets, and the broader economy. Therefore, doing
what we can to avoid preventable foreclosures is not just in
the interest of lenders and borrowers. It is in everyone's
interest.'' That was Federal Reserve Chairman Bernanke.
Would policies that help American families keep their homes
and prevent foreclosures help address the root cause, in your
view, of the present crisis?
Mr. Bernanke. Well, foreclosures are not all of it, but it
is an important part. The housing market is very central to
this whole issue, and I support and I have supported efforts to
avoid preventable foreclosures. I have spoken about this on a
number of occasions, and I think it would be helpful to the
economy.
I would note that steps have been taken. The GSE
conservatorship, for example, has already lowered interest
rates and has helped to stabilize the mortgage market, which
will be supportive of house prices and, therefore, reducing
foreclosures.
The Federal Reserve is on the board of the Hope for
Homeowners bill that was just passed by this Congress that
involves $300 billion of purchases of mortgages to be
refinanced into the FHA. I am sure much more could be done. I
will support further action.
I would note two things. First, as a minor point, one of
the things that this program being discussed could do would be
to purchase second liens, which have proved to be a very
significant barrier to the resolution of foreclosures. But,
more importantly, the housing market is not going to recover if
the economy is declining, if jobs are being lost, if credit is
not available. And so I do think you cannot separate these as
two completely separate issues. You need to have financial
stability and financial markets working properly for the
economy and the housing market to have a chance to recover.
Chairman Dodd. Well, my quick follow-on question, then, to
Secretary Paulson is--and I understand why you have been
reluctant to get into the oversight and accountability
questions. But given the fact that this is not just a cosmetic
issue and a feel-good issue but it goes to the very core of why
we are here today, and if that is the core reason--and you have
said it over and over again. I have quoted you. It is the ``bad
lending practices'' that went on. Why didn't we include some
mitigation for foreclosure as part of this, not because we want
to send a message that we care about Main Street, but because
if we do not address that, the bad mortgages out there are
still going to be a lingering problem, and our ability to
address this is going to be less.
Secretary Paulson. Mr. Chairman, thank you very much. As we
thought about what is the best thing we could do to minimize
foreclosures and deal with this problem, we thought, first of
all, stabilizing Fannie and Freddie; second, Treasury has a
program where we are going to be buying and holding agency
securities, and now that the Government is really behind them,
it is, I think, a good use of taxpayer money, and it will help
get--it will help the market. And then, of course, we all
believe that the very best thing we can do is make sure that
the capital markets are open and that lenders are continuing to
lend. And so that is what this overall program does, it deals
with that.
Now, as the Chairman said, we both have been very involved
in working with servicers and others in avoiding preventable
foreclosures, and there is no doubt that this program will give
us more leverage in doing that, given the securities that will
be owned, the second-lien mortgages and so on. So that was the
way we looked at it, and we looked at it, let's address the
root cause through these authorities we are asking for.
Chairman Dodd. Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
I would like to address my first question to Secretary
Paulson and Chairman Bernanke. I assume that during your
deliberations dealing with this crisis, you must have
considered a range of proposals before you decided on the one
that you proposed to us. Is that correct? Is that right, you
considered other proposals?
Secretary Paulson. Yes.
Mr. Bernanke. Yes.
Senator Shelby. Could you just in a few minutes describe
several of the proposals that you considered, telling us in
detail in specific terms why those proposals were deemed
inadequate by both the Treasury and the Fed?
Secretary Paulson. OK. I will go first. We have, as you
know, Senator, been talking with Congress and talking among
ourselves for some time about what is going on in the housing
area. And we have worked very hard together to approach the
foreclosure issue. And so there is a lot of work that was done
in dealing with foreclosures, No. 1.
No. 2, as you yourself have said, you saw some case-by-case
approaches, and, you know, I would argue that every one of
those was absolutely essential and was necessary. And as we
looked at this situation, we said the root cause of this is
housing. The root cause is housing and the housing correction,
and until we get at that, we are not going to solve it.
And as we looked at how we get at that, there are some that
said we should just go and stick capital in the banks--put
preferred stocks, stick capital in the banks. And that is what
you do when you have failures. That is what happened in Japan.
That is what happened in other spots.
We have dealt with some failures, and we have dealt with
them where there is capital. But we said the right way to do
this is not going around and using guarantees or injecting
capital--and there have been various proposals to do that--but
to use market mechanisms. And, again, I think that some of the
questions here and some of the frustration here I share, you
know, on compensation and so on. And when you deal with ad hoc
situations, when you deal with an institution that is failing
or about to fail, and you have to buy mortgages or securities
well above value, or you need to put capital in, then you take
tough compensation measures.
But as we looked at it and thought about this--and we
consulted together about this, you know, for a long time--and
said ultimately--and we hope we do not get there. We hope that
this decline can be arrested. But we both had said that until
the biggest part of the correction in housing prices is over,
there is no way to really have a stable financial system. So we
decided that this market mechanism and going out very broadly--
this is broadly to financial institutions all over, and working
on the asset prices and helping develop value that the market
can build around.
Senator Shelby. Do you agree with that, Chairman Bernanke?
Mr. Bernanke. I do, Senator, but let me just add a couple
comments.
As you know, I am a student of financial crises and
financial history, and we have looked at past experiences in
the United States and other countries, like the Homeowners Loan
Corporation, the RTC, the RFC, Japan, other situations. Those
were all situations, again, as the Secretary said, where you
were dealing with failed institutions and having to dispose of
relatively simple assets that were taken over by the
Government. That works in that context, and there are ways to
do that.
The situation we have now is unique and new. It involves
not failing institutions--although we have had a few failures.
Where we had failures, we dealt with them in a very tough way.
You know, we have insisted on, you know, bringing the
shareholder value down close to zero, imposing tough terms and
so on. But the firms we are dealing with now are not
necessarily failing, but they are contracting, they are de-
leveraging, they are pulling back. And they will be unwilling
to make credit available as long as these market conditions are
in the condition they are.
So, in order to address the illiquidity of the market and
how to deal with these complex securities in the hands of going
concerns, the methods used to resolve failed institutions in
other contexts are not really appropriate because that would
involve, I think, a great deal of concern on the part of other
potential investors that if they invest in a bank that the
Government is going to come in and take away their value. So I
think that we are better off trying to address the root cause
of the problem.
Senator Shelby. What banks would be eligible to participate
in this plan, assuming Congress adopted it as you proposed it,
in selling their nonperforming assets to the Treasury or to an
entity? And what size banks would be eligible to participate in
that plan?
Secretary Paulson. Senator, thank you for that question,
because that is where I think there have been broad
misunderstandings, and maybe we did not communicate this
properly. But what we are seeking to address with this is we
are seeking to address--first of all, we are dealing with
complicated securities, mortgage and mortgage related, and we
have got various asset classes here, and we need different
approaches for different asset classes. But when we use the
market mechanisms, we want--we are looking at thousands, you
know, of institutions. Because to make this run properly, we
need to deal with big banks, small banks, S&Ls, credit unions,
because what we are trying to do here--and I think we will be
successful--is to develop mechanisms where we get values out
there, and where there is some value that the market can look
at, then private capital will come in.
Senator Shelby. Are you planning to buy assets of foreign
banks doing business in the United States? And if so, why? And
how do you rationalize that the American taxpayer?
Secretary Paulson. The answer is yes, and it is very easy
to rationalize it to the American people.
Senator Shelby. I need your help here.
Secretary Paulson. OK. Here is how I want to--this is all
about the American taxpayer. That is all we care about. And so
any business, any banking operation in the United States that
is doing business here and dealing with the American public is
important. They are all important to keeping our markets open,
keeping credit flowing. The American public, when they are
dealing with the financial system, does not know who owns that
bank. What they care about is how is the system working. And so
we are doing this to protect the system, and it is about
keeping credit flowing, protecting savings, making it possible
to have car loans, student loans, mortgages.
And, again, if you have operations in the United States and
you are doing business with the American people, that is what
we are focused on. But let me also say to you we have a global
financial system, and when I was on the phone a number of
times, and most recently Monday morning, talking with central
bankers and finance ministers around the world, I urged them
all to put in place where it is necessary similar programs with
similar objectives.
Senator Shelby. What do you say to people that ask us, or
at least ask me--and I am sure others--how do you rationalize
or justify bailing out banks and so forth that cause, are the
root cause of a lot of this problem where they will be made
whole with capital, at least it will strengthen them? And I
understand that strengthens the economy, but they will profit
dearly from this, more than likely.
Secretary Paulson. Senator Shelby, I share your
frustration, so I hate to be on this side of the table, because
this is not something that I ever wanted to ask for.
Senator Shelby. I know.
Secretary Paulson. But it is much better than the
alternative. So what I do is I start off saying I am not only
concerned, I am angry by the things that got us here. OK? But
the greatest protection for the American taxpayer, by far the
greatest protection is having this program work and having it
be effective, because the consequences if it does not are
worse.
When the credit markets--you asked Chairman Bernanke about
what would happen if it did not work. I looked at the----
Senator Shelby. Worst-case scenario under your plan. What
if it does not work? You know, you assume it will work, but you
cannot assure us that you know it is going to work because you
thought some of the other plans would work.
Secretary Paulson. Well, let me say this: With all due
respect, Senator, I believe that Freddie and Fannie worked the
way it was supposed to work. We stabilized that. And in terms
of the other actions, I would very respectfully submit, if the
Federal Reserve had not stepped in on AIG, we would have been
facing a major calamity. So, again, I do not think any--this
problem has been growing for a long time.
But to get to your question about this plan working, it
gets to the root cause--housing; deals with illiquid assets; it
is going to free up the balance sheets, let capital flow; and
it will lead to price discovery, private capital coming in, and
injecting confidence in the markets.
Senator Shelby. What does it do to the homeowner who is
losing their home? And thank you, Senator Dodd, for your----
Secretary Paulson. I would say, regrettably, there is not
every homeowner that is going to save their home. As you well
know, even in normal times, in good times, there are many
foreclosures. There are some people that cannot afford to stay
in their home. But there is a huge effort being made so that
everyone that can afford to stay in the home and want to stay
in the home stays in the home.
But what this plan will do is make financing available. And
I do not think there is anything more important. Lenders have
got to keep lending. If they are not lending and there is not
capital available, homeowners are not going to be able to stay
in the home.
Chairman Dodd. Thank you very much.
Senator Johnson. And let me just remind my colleagues, we
want to try to keep to the time. We are going over, and I want
to give everybody a chance to ask some questions.
Senator Johnson. Secretary Paulson, the Treasury proposal,
it seems to me, rewards the bad actors. Those financial
institutions that engage in irresponsible lending have bad
assets on their books and need help from the Government to stay
afloat. What punitive actions are being taken against these
companies and their CEOs?
Secretary Paulson. Senator, thank you for the comment. The
first thing I wanted to say is this plan is broad based and it
is dealing with the root cause. And when we have needed to come
in and do something to save a failing institution, there have
been very harsh consequences. And when we deal with one-off
situations, I think there always should be very significant
consequences. That is No. 1.
No. 2, in terms of what needs to be done to fix the system,
we could have a long conversation about that, and you are going
to be busy for a long time, and you are going to be busy after
I am gone doing that. I have given you my suggestions, and they
are suggestions that have to do with a totally outmoded and
insufficient regulatory structure.
When I got down here and after about several months on the
job, I was shocked, absolutely shocked, to find it was not
deregulation or too much regulation or too little regulation.
It was just a flawed regulatory structure. It was built for a
different model, for a different financial system. The
financial system changed. The regulatory system did not change.
And so that clearly has to be corrected.
When you look at these mortgages, the vast majority of the
mortgages that were originated with very, very shoddy
procedures were regulated at the State level. OK? You cannot
come down here, come down to Washington at Treasury Secretary
and fix all that. We made a proposal that I think is the right
proposal for this mortgage origination commission, which would
be a Federal commission not to invalidate State regulation but
to make sure there are common standards enforcement.
So there are a lot of things that need to be done, and in
terms of the compensation issue, there are a lot of things that
need to be done there. But I would respectfully submit that we
cannot do those as quickly as it takes to get this system up
and running, because that is what you care about. You care
about the constituents in your State, the average people, and
Americans in terms of what the impact is going to be on them.
And, unfortunately--and it may make you angry; it makes me
angry--when you ask about the taxpayers being on the hook,
guess what? They are already on the hook. They got put on the
hook by the system we have, the system we all let happen, the
system that Congress, the administration, future
administrations let exist. And so if this system is not
stabilized, they are going to bear the costs. The Chairman
explained that. I have explained it. So the best thing we can
do for all of them is to stabilize the financial markets so
that people can continue to get loans, small businesses can get
loans, small farmers in your States can get loans, big farmers
in your States can get loans. And then go to work to make sure
that this does not happen again, and that is going to take a
longer period of time.
Senator Johnson. Given what occurred with AIG, should the
Federal Government regulate some or all insurance companies?
Would an optional Federal charter model be appropriate?
Secretary Paulson. Well, in the regulatory blueprint that
we put forward to there--we put it forward well before we were
in the midst of this crisis, something we had been working on
for a long time. There were a series of recommendations. One
was that the Federal Reserve play the role of macro stability
regulator to look for excesses and problems throughout the
economy. Another was there should be a Federal charter for
insurance companies. I strongly believe that. There is a lot of
debate on both sides of the aisle here. That will take, in my
judgment, a good deal of time to sort out. But that would be my
judgment on that one.
Senator Johnson. Chairman Cox, last week, you issued
several emergency orders regarding short selling. How did the
SEC determine which firms to include? And what happens when the
orders' 10-day period expires?
Mr. Cox. Senator, this is not a step that we took lightly.
With the support of the Federal Reserve and the Treasury and a
unanimous Commission, we took temporary emergency action
directed at financial stocks for the purpose of stabilizing the
market at a time when Congress is considering important
legislation that may deal in a broader way with these problems.
The financial sector is defined according to standards that
the SEC has provided to the exchanges. The exchanges themselves
are making the particular determinations of whether their
listing companies fall within those categories.
When the order expires, which it will because it is an
emergency order, we will segue into sturdy protections against
naked short selling. We already have permanent rule changes
that have just taken place in the last week to make even
stronger the existing ban against naked short selling.
Senator Johnson. Mr. Lockhart, what will the GSEs look like
when they come out of conservatorship? And how long do you plan
on having them in conservatorship?
Mr. Lockhart. We will certainly be working with the two
companies and their new management teams to rehabilitate
themselves and work through the issues. The time period will
depend a lot on what is happening in the housing market and
their ability to raise capital in the future. That may take a
year or even longer. How they will look, to a large extent, may
depend on where Congress wants to go.
The legislation that was passed in July--and I thank you
for passing that legislation--does create a much stronger
regulator with the kinds of tools that would be needed to
regulate these companies going forward.
Chairman Dodd. Thank you, Senator.
Senator Bennett.
Senator Bennett. Thank you, Mr. Chairman.
Chairman Cox, I would like to spend time with you on the
short selling issue. As you know, I have spent a lot of effort
pursuing that, and I want to thank you for the diligence with
which you have pursued that.
Having said that, I am driven by the conversation to
concentrate on Secretary Paulson and Mr. Bernanke, so do not
take my passing over it as a symbol that I am not still
intensely interested, because I am, and that I am not
supportive of what you have done, because I am. I think you
have done an excellent job, and I appreciate that.
Chairman Bernanke, you ran us through a tutorial, true to
your college professor background, which I found very helpful,
talking about the difference in hold-to-maturity prices and
fire-sale prices. And there is going to be an auction,
presumably, to determine what the fire-sale price is or what
the hold-to-maturity price is. What are people going to be
bidding on, do you think?
Mr. Bernanke. Well, we know more or less what the fire-sale
prices are. Those are the marks that a lot of companies have.
You know, there are a lot of different ways--auctions,
auctions combined with expert evaluations and so on--to try to
determine the hold-to-maturity price. So, for example, if the
Government tries to acquire a substantial portion of a
security, the marginal seller would be somebody who has a hold-
to-maturity interest in it, for example. So I think there are
methods to determine that hold-to-maturity price.
Senator Bennett. OK. Well, the best place to determine a
price, obviously, is willing buyer and willing seller. But this
is not going to be your ordinary auction because the Treasury
is going to be there with a $700 billion checkbook. And the
question that arises in my mind is: Who is going to bid against
the Treasury? Against whom is the Treasury bidding? And what
effect will that have on the price?
Mr. Bernanke. It is a reverse auction, which means that
there will be many bidders holding these securities who will be
bidding the lowest price in order to sell them to the Treasury,
which is the reason why you do not want to limit
participation----
Senator Bennett. So that is an offer, not a bid?
Mr. Bernanke. Sorry?
Senator Bennett. That is an offer price, not a bid.
Mr. Bernanke. Well, it is a reverse auction so that people
are bidding in order to sell rather than to buy.
Senator Bennett. OK. Secretary Paulson, do you anticipate
that this might attract some outside capital into this auction
and say that looks like a pretty good price and I would like to
own it at that price?
Secretary Paulson. Not exactly that way, but here is--and,
again, let me come back and say to you the reason we asked for
broad flexibilities--and the Chairman said it earlier--is that
we are dealing with complex securities. We are dealing with
many classes of securities. We are going to need to use
different approaches in different situations. So the reason we
have been general and talked about market mechanisms, we are
going to have to involve experts, we are going to have to use
different approaches. The Chairman said, you know, Treasury, we
are going to need to get some really good asset managers, we
are going to--we will do a certain amount of experimentation.
But if this works the way it should work, that once there is a,
you know, bid from Treasury and there is more learned about
these securities, the thought would be that then it is easier
for private capital to come into the market; and that there
will be some price discovery mechanism.
Now, again, the----
Senator Bennett. Let me just comment on that. The price
discovery mechanism in a simple world--and you are describing a
very complex, un-simple world--has to do with the cash-flow the
underlying asset will produce. And I would think the problem
here is determining what that cash-flow is. Is that what you
are bringing all these experts to determine what----
Secretary Paulson. I wish it were that simple because--and
even that would not be easy. But what the Chairman said, when
he presented, he said no one has been faced with this situation
before. We spent a lot of time thinking about it, and there are
different types of asset classes--mortgage derivatives,
mortgage-backed securities. There are different whole loans.
And so when you look at dealing with this, we are going to have
to use different approaches in different situations, and there
will be market-based approaches, and that is all--even I cannot
sit here and figure out what the auction technique should be
and how to use it and in what situations to use it.
So what we asked for was broad-based authority to use a
series of market-based approaches, and we will be dealing in
different approaches in different situations. We cannot sit
here and say here is the reverse auction we are going to use in
every situation. So we need flexibility.
Senator Bennett. My time is up. I understand that. My time
is up. I just wanted to leave this last comment. This is the
whole core of what you are trying to accomplish, and this is
the whole problem with our giving you blank-check authority to
accomplish it, because in theory it is easy to describe and it
will work, but if you end up paying too little to these
institutions, which mark-to-market accounting might drive you
to, you are not giving them the support that they need. If you
end up paying too much, then there is no upside potential for
the taxpayer when the time comes for you to liquidate these,
and the details of how you find the right balance here are the
ones that all of us need--you, but certainly as much as we--all
of us need to understand better as we make our determination
whether or not to support your proposal.
Secretary Paulson. You are right, and you have defined the
problem, and the problem is easier to define than to solve. And
we believe that we are going to get the right group of experts
and we are going to come up with a solution, and it will be
different with different asset classes and in different
situations. And as I said, this should not be confused--and
some people have confused it--for instances where you need to
go in and, you know, do things that are extraordinary things to
save an institution. So those are two different actions.
But for the system to work the way it needs to work, we
need a broad group of institutions--banks and S&Ls--to want to
participate, and we need them to participate, not just those
that are under immediate pressure. And so for this to be
effective, it has got to be designed to have it work that way.
Senator Bennett. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much.
Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman.
Chairman Bernanke, the equity participation rights which
were a central part of the AIG arrangement, were they punitive
in nature?
Mr. Bernanke. Well, they are 80-percent participation.
Senator Reed. Well, no, was that a way to punish----
Mr. Bernanke. Our terms included, besides 79.9 percent, an
interest rate, which is currently over 11 percent and
essentially a super lien on most of the assets of the company.
So I think that it is a very tough deal that we struck. We did
that because we wanted to protect the taxpayer. At the same
time, we were concerned about the implications for the markets
of the failure of this large company.
I would like to say, I think we do have a serious ``too big
to fail problem'' in this economy. It is much worse than we
thought it was coming into this crisis. And as we go forward,
we need to develop methodologies to reduce that ``too big to
fail'' issue.
Senator Reed. But why wouldn't equity participation rights
work in this arrangement to protect the taxpayers and reimburse
the taxpayers, particularly with the difficult problems of
pricing these securities, the different arrangements that
Secretary Paulson suggested might be undertaken, and the need,
really, to assure the public that this is not a one-way
salvation for Wall Street at the expense of taxpayers?
Mr. Bernanke. The reason is that when we dealt with Bear
Stearns or AIG or Fannie and Freddie, those were situations
where the company was about to fail, had no option. We came in
to prevent failure for systemic reasons. In those situations,
it is appropriate to knock the share values down low to reduce
the moral hazard for subsequent events. But if we are dealing
with going concerns, companies that, you know, are still
operating, have reasonable business prospects, we do not want
to threaten the companies with reducing their share values to
zero because that will obviously----
Senator Reed. Well, no one is suggesting that you reduce
their share values to zero. But I think in that context of
going companies, this program will be strictly voluntary. There
will have to be a business judgment made by the managers of
that company whether it is worth it to them to enter into this
transaction to rid their balance sheets of toxic assets. Right
now the price of admission is zero. I think it is not
inconceivable or inappropriate to demand in that calculation
they recognize if they will benefit from this transaction in
the future--and that is the notion of participation in the
future--that they will share that benefit with the taxpayers
who made the benefits possible.
Mr. Bernanke. We just would note that if you leave the risk
on the balance sheet in that way, you really have not
accomplished anything.
Senator Reed. Well, if a company is willing to accept that
risk, manage those risks themselves, they do not need a
bailout. If they are unwilling to do that or cannot do that,
then they should pay for it, at least in a contingent fashion,
which is the essence of this whole issue of participation
rights or warrants or whatever you would like to call it.
Secretary Paulson. Let me approach it this way. This is a
huge----
Chairman Dodd. Turn on your microphone so we can hear you,
Mr. Secretary.
Secretary Paulson. Approach it this way. When you talk
about what the companies need, this is not about the companies.
This is about the American people. We need something to work.
And for something to work here, rather than going to a group of
troubled institutions that need to sell and saying here we are,
sell to us, you know, here are all the things we want from you
in turn for that, we need--and we want for this to work--a
broad range of institutions to willingly--not that we have to
go and sign them up, but to willingly participate because we
are trying to find value and we are trying to get markets
working, because we do not want to have to deal with a failure.
RTC is about failure. Putting capital in institutions is
about failure. This is about success.
Senator Reed. Mr. Secretary, you are suggesting that these
very brilliant financial people who run these companies would
risk the failure of their enterprise by not participating in
this function because now we have imposed a contingent
reimbursement to taxpayers.
Secretary Paulson. Let me just say one more time. I am as
frustrated as you are about compensation----
Senator Reed. This is not about compensation, Mr.
Secretary. This is not about what they get paid. This is about
when they do well, and if they don't do well, the value of
those warrants are zero.
Secretary Paulson. Here is what I am saying: that if this--
when we protect the taxpayer, the right way is to have the
program work and have the assets appreciate when the economy
appreciates. I am saying that the model you are looking at is a
model where we go to people that absolutely need to sell and
say, If you want to sell, give us something. The model we are
looking at--and what we believe it takes to be successful
here--is to go to a broad group of institutions, a very, very
wide range of institutions that own these assets and have them
participate. And if we deal with it selectively, as we deal
with situations where there is serious trouble, to use a
different approach.
But, anyway, I appreciate your comments.
Senator Reed. Well, Mr. Secretary, the one other way to
describe what you just said is to go to some institutions that
do not need help and we give them help for free. But let me
change the subject, if I may, and I am indulging the Chairman's
time.
In this reverse auction, it is a very difficult set to
price, but one of the principles--would one of the principles
be that someone cannot sell to you or bid to you at a price
higher than what they paid for? Because today there are firms
that are collecting distressed assets at discount prices. If
you do not have some protection like that, they will walk in
and they could very well sell you something that they paid much
less for.
Secretary Paulson. Well, first of all, Senator, we are
going to be dealing and our intent is to be dealing with
regulated financial institutions. OK? That is No. 1.
And, No. 2, the reason we want to deal with it on a broader
basis is so we do not get into that situation.
But, third, let's not focus on one reverse auction. That is
one way of doing it. There will be a number of market
mechanisms. I think a reverse auction--and there are different
forms of that.
Chairman Dodd. It is not regulated.
Senator Reed. Mr. Secretary, then you would not oppose
language in legislation that would restrict this to regulated
financial institutions.
Secretary Paulson. What I would like--rather than
negotiating language here, what I would like is I would like as
much flexibility, but the intend would be to deal with
regulated financial institutions with business operations in
the United States.
Senator Reed. Thank you.
Chairman Dodd. That is a very important point, the
definition of a financial institution and whether or not you
would limit it to regulated financial institutions.
Senator Enzi.
Senator Enzi. Thank you, Mr. Chairman, and I appreciate the
questions that Senator Reed had. I had a number of those, too,
on equity sharing and future assessments. Actually, all the
questions that I have, I would like everybody to answer them,
but we do not have time to do that. So I will ask them of one
person, and I would hope that you would have your staffs get
together and answer for me later, but not very late.
One of the things that follows up on Senator Reed's
question is what happens if Treasury cannot price the assets
accurately. This is for Secretary Paulson. Shouldn't we have
the process designed before we do $700 billion in an
experiment? Treasury has to set the perfect market for the
assets, and I am not sure that I have faith in the ability of
the Federal Government to emulate the free market. How can an
artificial market drive a real market for these assets?
Secretary Paulson. In terms of that, I would say you have
pointed to the complexity and the difficulty. I would very
respectfully say that if the Federal Government tried to
legislate a prescriptive solution, it almost certainly would
not work when you are getting into the market mechanisms.
Again, you are asking me about free markets and how the
Government is going to work better than free markets, and,
listen, I have never been a proponent of intervention. And I
just think we have an unprecedented situation here, and it
calls for unprecedented action. And there is no way to
stabilize the markets and deal with the situation other than
through Government intervention. And so what we are going to
do, we have put forward something we have thought about for a
long time in terms of the issue and different ways of dealing
with the issue. And so what we are asking for is some broad
powers with some good, strong oversight, and we think that is
the best way to protect the taxpayer. That is our view.
Senator Enzi. I want to get into something a bit more
specific on that because I am concerned about the small banks
in this reverse auction situation. A lot of the details are
left out. As you say, you do not want it to be prescriptive.
But the reverse auction that you described in your testimony--
--
Secretary Paulson. We are not just recommending a reverse
auction. That would be one way of handling it.
Senator Enzi. OK, but just on the reverse auction part of
this, I mean, we are going to have questions on all parts of
it, but I think it will help the big banks to sell their toxic
debt. But what about the smaller banks? How are they going to
be able to compete with the Citigroups in the world to sell
their assets? Economies of scale suggest to me that the plan
will bail out the big banks, and our community institutions
might be left holding the bag. What kind of consideration has
been given to that?
Secretary Paulson. Well, that, we are very focused on
that--very focused--because to have this work right we are
going to have to go broadly, because only by going broadly in a
number of these asset classes and these securities are we able
to really deal with the market. And so that is something that
we have very much in mind. And if this were just about going to
a few big banks, we would have designed an entirely different
program with a different structure.
Senator Enzi. Thank you.
Chairman Cox, I am always interested in the accounting
aspects of all of these things and the effect that they can
have on it. And I have been looking at getting some authority
to suspend the mark-to-market accounting. I know that writing
regulations takes a long time, but sometimes if it is included
in congressional language, it can short-circuit that and make
it possible.
Another area that I have gotten a lot of comment from, the
small banks that hold the GSE stock, they prefer that that be
considered a loss to the bank rather than--a loan loss rather
than a stock loss. Some implications like that, I hope that you
are taking a look at them. I know that we have talked about
this being a fire and wanting to put the fire out before we
address the fire code. But I am hoping that we will take a look
at all tools and make sure that this proposal has all the tools
possible so that we are not throwing water on an electrical
fire.
Have you given consideration to whether Congress would need
to act on some of these accounting things or whether you have
enough authority to do that?
Mr. Cox. Senator, both the United States and international
accounting standard setters are very focused on the need to
provide timely guidance on the fair value issues that several
of you have raised here this morning and this afternoon. In
fact, today the FASB's Valuation Resource Group is meeting to
address these very application issues in the context of U.S.
generally accepted accounting principles, with a goal of
providing timely guidance to companies.
Senator Enzi. Thank you. My time has expired. I will have
additional questions.
Chairman Dodd. Thank you very much, Senator.
Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman, and I thank all
the witnesses. This is not an easy day.
One of the things that I mentioned I want to focus on is
taxpayers, and so I have a couple of questions in that regard,
first to Secretary Paulson.
One of the things I have thought about is whether we
shouldn't create an insurance fund, similar to the FDIC, for
the whole financial system. All firms over a certain size would
pay, not small little community banks but everything else. They
would pay a fee, not too onerous or too large, but over time it
could help defray the costs of any losses we might suffer. It
is the financial system that has the trouble and the taxpayers
are bailing it out, as you say, in part because it will help
the taxpayers. But why do the taxpayers have to do the whole
thing?
What would be your initial reaction--I am not asking for a
commitment here--of some kind of broad FDIC that would help pay
for some of these losses from financial institutions, as I
said, above a certain size, whether they participate in the
program or not?
Secretary Paulson. One thing that both the Chairman and I
have talked about a lot, have spoken with the Chairman and
Senator Shelby about, is that we were not left with the
authorities we needed fully to protect the system and the
taxpayer because we have wind-down authorities with insurance
for, you know, savings depositors, FDIC insurance. In 75 years,
you know, we have not had a saver with FDIC insurance lose a
penny.
Senator Schumer. It works. Yes.
Secretary Paulson. You know, for $100,000. So what you need
is if--but if a non-bank or for someone without deposit
insurance fails, in many cases there is just bankruptcy, and
that throws the system into disarray. So----
Senator Schumer. But this would be different, the FDIC----
Secretary Paulson. That is right. And so I am saying so if
you had wind-down authority, then you have got to say, OK, how
do you pay for it? And there are various ways to pay for it,
and one way, as you have mentioned, would be some kind of
broader industry-wide tax. But that is something we did not
have, so----
Senator Schumer. You would be open to it, in other words.
Secretary Paulson. Yes.
Senator Schumer. And would you think it might be a good
idea, Mr. Chairman?
Mr. Bernanke. Potentially, yes. But I think it is more
important----
Senator Schumer. Well, I think I am going to cut you off
right there.
Mr. Bernanke. It is more important to----
[Laughter.]
Mr. Bernanke. It is very important to try to address this
``too big to fail'' problem. It is a big problem.
Senator Schumer. Understood, but I think this--on the
second question, again about protecting the taxpayers, I think
in some of our informal discussions when we ask why $700
billion and over how long a period of time, one of you, I
think--somebody mentioned it would cost about--we would
probably use about $50 billion a month. If that is the case--
and you are certainly not going to use all $700 billion
immediately. And as you can see, there are a lot of questions
about whether this would work. We understand you have done your
best, you think this would work best. But, clearly, we are in
uncharted waters with Scylla and Charybdis around. What about
doing this in tranches? Why couldn't you ask us for $150
billion and on January 15th or January 20th we would come back,
we would assess how this worked, and grant some more money if
it is really working? Maybe, you know, the markets will have
stabilized, and you actually will have made money. Why ask for
the full $700 billion? I never thought I would think that $150
billion is a low sum of money, but compared to $700 billion it
is. And I think it would make people sit--not easily, but at
least a little easier.
Secretary Paulson. I will give you my answer, Senator. I
think you got at it when you said when we come back in January,
because what we need to do is we need to stabilize the system,
and we need to--this is based on market--we need market
confidence, and we need the tools to work with.
Now, of course, we plan to do this in tranches, and, again,
as a number of people have said, this is not an expenditure. I
know that this does not fit into your outlay system in
Congress. The taxpayer is on the hook.
Senator Schumer. Yes, yes.
Secretary Paulson. But, again, it is purchasing assets.
They will be held. They will be resold. Money will come back
in.
Senator Schumer. Understood.
Secretary Paulson. But to your basic question, we think we
need the 440 for that size to do the job and stabilize the
market.
Senator Schumer. Could you live with less?
Secretary Paulson. That does not mean--that does not mean
that it is going to be invested--be spent between now and
January. We are going to----
Senator Schumer. Could you live with less? I think people
would feel better if it were--if we did this and we could come
back and reassess it. As I said, it is uncharted waters, so I
am not asking you to support it now. But, again, could the
system work if we put in the legislation, say, this is the
first tranche and by January 15th, say--just pick a date--
Congress will come back and reexamine?
Secretary Paulson. I think that would be a grave mistake.
Senator Schumer. And why?
Secretary Paulson. Because I think what this is about is
about market confidence and having the tools to do the job. We
are going to do this in tranches, but I am wondering, when
Congress is gone and if we need--if we need this, what it is we
do. And so, again----
Senator Schumer. Well, the President, if there is an
emergency of any type, if this does not work over the next 2
months and the cataclysm that Chairman Bernanke has talked
about, you are going to have to call us back into session if
you need some other type of authority.
I have to tell you, I would ask you to think about this. I
know ideally you would like to just have as much as possible.
But you are not going to use $700 billion in these 3 months. It
is a huge sum of money, even $150 billion. And the confidence
in the markets will be determined by how well it works
initially, not by how much money you have in your pocket next
to your bazooka.
Secretary Paulson. Well, I would say with all due respect,
Senator, you are going to have to decide. The two of us have
made the recommendation of what is required. As you said, this
will not be spent or invested right away. It is going to be
done in tranches. And all we are doing is giving you a--again,
I do not like to be in this position asking for things and, you
know, answering to the American taxpayer on this. I think this
is--it is a sad story, but the American taxpayer, as I said, is
already on the hook.
You know, here is the other thing I want to say to you,
because it is so important. This is not about big financial
institutions. Every American employer depends on money flowing
through our financial system every day, not just to create new
jobs, but to sustain and keep existing jobs. What we are
playing with here is very important, and, again, give us the
tools we need to make this work.
Senator Schumer. Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator Schumer, very much.
Senator Hagel.
Senator Hagel. Thank you, Mr. Chairman.
Secretary Paulson, you have addressed a number of questions
regarding reverse auction elements and how it would work. If
you could explain to the Committee your concept of the
implementation of the plan, focusing first on a framework of
oversight, which you noted in your remarks why that was
important. How do you conceptualize this working? Who would be
the oversight? How would it work? I know Chairman Dodd has laid
some ideas down. And then take us down from that, the oversight
structure and then the implementation of the plan. You have
noted, I think, in your words, the right group of experts that
you would bring in on valuating equities and so on. Walk us
through that.
Secretary Paulson. First of all, in terms of--and this is
what we are working through right now with your Committee and
with others. We need to have transparency here. We clearly need
protections. There has to be oversight. And we are going to
work with you on that group. And we have to be effective and
efficient, and we cannot get slowed down to the point we cannot
do the job. And so this is a balance we are going to need to
work on together.
And, again, as I said, in terms of the market mechanisms,
we can spend--and I know our staffs have spent time together on
this. But, again, there are so many different asset classes,
some held by a very broad range of institutions, that what we
are going to do is look to use market mechanisms and bringing
in some of the very best asset managers and others to work with
our people getting help from within the Government, help from,
obviously, the Fed, other talent we have here, to make this
work. But this is not a situation where we can come up and say,
``Here is what we want to do, here is how we want to price it,
here is exactly how the reverse auction will work.''
Senator Hagel. I understand that, but that is not really
the question. You understand, as does everyone on this panel,
why these hearings are so valuable. They are valuable, in my
opinion, first because they allow you to educate and inform the
American people and the Committee as to how these kinds of
things work. And there is a tremendous amount of
misunderstanding, as you know--and as has been reflected by
comments this morning--about how does this work. Are we just
putting $700 billion of taxpayers' money out here with no
oversight, with no structure?
So what I want to bring you back to is: Are you envisioning
an oversight board, once-a-month meetings? Or just walk me
through in very layman's terms so someone could understand how
are you going to do this. How are you going to implement it?
Also, does the Treasury have the capacity and the capability to
administer something this big?
Secretary Paulson. Well, those are very good questions, and
let me answer them.
First of all, we need an oversight board. OK? We need and
we want it. OK? And so what--and the way I envision this
working is with great transparency so that the board clearly
knows what we are doing. We can explain this to the American
people, as complicated as it is. Again, the process which we
are looking at doing, which I think has been misunderstood, is
something that would be broad based and--to a large extent,
broad based. There may be some parts of it that need to be more
narrowly focused, and then we will deal with that and use
different methodologies and different approaches to deal with
that.
And so it would be something that, as we went along and as
we started, we would probably start with a simpler set of
securities, something simple like mortgage-backed securities as
opposed to something more complicated. And we would go out, and
we would do it--the first tranche would be, obviously, a
smaller tranche, not a significant part of the $700 billion.
And we would get it out quickly into the market. And we would
be very clear to people what it is we have done.
So that is as much right now as I can say to the American
people other than that the key thing for the American people is
that if this works the way it should work, with the assets,
this is not an expenditure. This is an investment, and as the
economy grows, as housing corrects, these assets should
appreciate in value. The cost to the taxpayer will be far below
what is invested in the assets. Some people have mentioned that
under certain circumstances you could actually make money. We
are not committing that. We are saying the taxpayer is at risk.
And we have also said very up front that there is going to need
to be some experimentation because we are dealing with things
that have not been dealt with before. And so there will be
experimentation in terms of experts. We are able to attract and
we have attracted a variety of experts, and we are going to
continue to bring them in. We want the best and brightest
working this as we go through this.
Senator Hagel. Mr. Chairman, thank you.
Chairman Dodd. Thank you, Senator Hagel. Very much.
We turn now to Senator Carper.
Senator Carper. Thank you very much.
First of all, a question for Chairman Cox, if I could. I
have been out of the hearing for a while chairing a hearing on
the census. The census has had its share of problems in the
last year or two as well, and I think we are getting that
resolved. I told the Director of the Census if we can finish
getting the census ready, we might bring him in and help
address this issue, and he offered his assistance.
A question for Chairman Cox. We talked a little bit earlier
this week about short selling and the role that that has played
in getting us into the jam that we are in today. And I know you
have not just some thoughts but have taken a number of steps.
Just a little bit of a Short Selling 101 for us, and what role
do you believe it is playing, it has played in getting us to
where we are today?
Mr. Cox. Senator, the decision to intervene in market rules
in this way was highly unusual and a very difficult one for the
Commission. It is not a step that was taken lightly. It was
taken with the support of and in coordination with the
Secretary of the Treasury, the Chairman of the Federal Reserve,
but also, importantly, international regulators. As you notice,
the U.K. took this step, and we worked very closely to
coordinate our actions with them. We have been in contact with
our counterpart regulators around the world who are taking
related actions in the current circumstances, narrowly focused
on financial stocks. And the reason is based on the connection
between the share price, which we have seen, and confidence in
the institution itself. We have got healthy institutions, or at
least all institutions--perhaps there are none healthy
anywhere, but if that is the case, we have the kind of problem
that the Congress is here to address--that are put at risk if
there is a downward spiral based not on normal information but
on fear.
And so in this climate, we want to make sure that decisions
in the market are going to be made in a way that protects the
overall market and investors in it. But we also want to get out
as quickly as possible. That is why this is an emergency order.
It is very narrowly tailored, and it is time limited.
Senator Carper. All right. Thank you.
I do not know if you all have gotten into this today. Let
me just ask you this. The proposal offered by Senator Dodd
includes the creation of a Special Inspector General. I believe
my understanding from the House bill is they do not create an
Inspector General, but they do call on the General Accounting
Office, the Comptroller General, to play a role with respect to
accountability going forward. And my question is for each of
you.
I am going to start with Mr. Lockhart. I do not know if you
have fielded a lot of questions today, but we are going to make
sure you earn your keep here. We will turn to you first. What
are your thoughts on the creation of an Inspector General to
oversee this program? I am just going to come right down the
line, if you will.
Mr. Lockhart. Thank you, Senator. Actually, we are getting
an Inspector General as part of the new legislation that was
just passed. Inspector Generals are a useful part of the
government process. I have found them useful, and I have
certainly found working with GAO useful in my career as well.
Senator Carper. All right. Thank you.
Mr. Cox, Chairman Cox.
Mr. Cox. I would support it.
Senator Carper. All right.
Mr. Chairman, Chairman Bernanke.
Mr. Bernanke. I think that you have to have rigorous
oversight, and OIGs--the Federal Reserve has an OIG, as do many
other agencies, and they are very effective.
Senator Carper. All right. Thank you.
Secretary Paulson.
Secretary Paulson. I would say the same thing, but I do not
think we can sort of design it here today, but we clearly
want--to protect the American taxpayer and for all our
protections, we want oversight.
Senator Carper. Another question that kind of relates to
the one I just asked, but with respect to conflicts of interest
or the potential for conflicts of interest going forward, the
Treasury plan calls for, as I understand, private sector
portfolio managers to basically run the day-to-day management
of the assets that would be purchased by the Treasury. And
while this may be more efficient than creating a Government
entity, my first thought is to be supportive of what you are
asking for, but it also does create some possibilities for
conflicts of interest.
Let me just ask, what safeguards need to be put in place to
minimize, in your view, any potential conflicts of interest?
Secretary Paulson. Well, I would say we cannot design these
here, but we have been very conscious of this. And when we have
dealt with advisors before, we have been very careful about how
we do it.
But I just cannot emphasize enough to you how important it
is that we have experts available to begin working quickly,
because this is about market confidence, effectiveness, and so
we need to balance. OK? We need to balance the need to go
quickly with the protections we build in. And I want strong
oversight, strong protections, great transparency. And as this
develops, I am sure it will evolve. And it may evolve in
various different ways, but right now we need to get up and
running and deal with the market as it exists.
Senator Carper. Thank you for that response. My time has
expired, and I am not going to ask another question. But I do
want to make a statement, just to follow up on what others have
said, Mr. Chairman, and what I said earlier during my opening
statement.
I went back in time, and I asked us to recall the Chrysler
bailout where the Federal Government did not take an equity
position in Chrysler. The Federal Government did not actually
make a loan to Chrysler. The Federal Government actually
guaranteed loans, and ultimately our guarantee was never
exercised. We did not actually have to use the guarantee,
although it was out there. But at the end of the day, we made
money. The Federal Government and taxpayers made money,
recovered money on behalf of our citizens.
And the Resolution Trust Corporation, when it was
established, my recollection is the Resolution Trust
Corporation did not go in there and take an equity position in
savings and loans. The Resolution Trust Corporation took off
the hands of the S&Ls the nonperforming loans, and a lot of
them were actually good investments--shopping centers,
apartment complexes, and on and on. And because of the
condition of the market, they had fallen in value. They were
actually taken off the books of the S&Ls, held for a period of
time, and as the economy recovered and as property values
recovered, the Resolution Trust Corporation was actually able
to recover a fair amount of money for the Treasury.
We need that kind of thinking. We need to be
entrepreneurial. And I do not know at the end of the day if the
Federal Government ought to have an equity position in these
companies, but at the end of the day, I do not want to go home
unless we can say to the taxpayers in my State, ``We have come
as far as we can, as close as we can to recovering every dime
we put into these companies.'' And, last, we will be able to
look them in the eye and say, ``We have made, to the best we
can, every effort to ensure that no bad behavior is being
rewarded.'' And the people who should not be rewarded in this
financially, they are not going to get rewarded.
Thank you very much.
Chairman Dodd. Thank you, Senator, very much.
I just briefly wanted to make a point because I think this
is something we have missed a little bit. If we were to move
forward with this, the idea of giving the Treasury, with all of
the oversight and accountability built in, is the authority to
deal with this. What I think needs to be said, Mr. Secretary,
unless you are going to tell me this would not be allowed under
your plan, is that if you discover along the way that there is
some better idea or some variations of these ideas that would
work better--and there are a lot of ideas we are all hearing
about from people from the world from which you come--that
there is nothing in here that would prohibit you from using the
flexible notions and thoughts out there on how a better
approach might work, an equity infusion, for instance.
Secretary Paulson. Mr. Chairman, you said it better than I
did, and this is--I am not looking and I did not want to find
myself in this position. I did not want to find myself in the
position of being here asking for these authorities. But under
the circumstances, I think they are better than the
alternative. This is something we will work on together. And as
we learn if there are better ways of doing things, clearly, as
we get in the markets, we are going to learn, and our whole
objective here is going to be to minimize the ultimate cost to
the taxpayer.
Chairman Dodd. Senator Dole.
Senator Dole. I would like to ask Secretary Paulson,
Chairman Bernanke, and Chairman Cox the following question:
According to the Wall Street Journal, the market for credit
default swaps has reached $62 trillion, up from $144 billion as
of 10 years ago. The issue of credit default swaps, as I
mentioned earlier in my opening comments, is one that I have
consistently raised throughout the year, beginning with Bear
Stearns in March: the transparency of this market and what
regulators have been doing to improve oversight of these
securities. Chris Cox has spoken today to the regulatory issue.
At the time, though, the Treasury Department, Federal
Reserve and SEC all testified that these CDS securities did not
play a major role in the situation at Bear Stearns. Now
Americans come to learn that these same securities--credit
default swaps--played a role in the collapse at Lehman Brothers
and the Government intervention of AIG. Simply put, what has
changed? And given that we now know they played a significant
role in the demise of AIG and Lehman Brothers, will the
Treasury Department plan on purchasing some of these illiquid
CDSs?
Secretary Paulson. Senator, there is some confusion here.
Let me explain. This is a huge market, and we have all, from
the day I came down here, my very first meeting--as a matter of
fact, my first meeting with the President talked about these
issues. We have been working with the Fed because there is this
huge market, and the most important thing that needed to be
done was to build the protocols, to build the infrastructure to
handle this.
And so we have all known the risks. As a matter of fact,
the fact is that the reason--one of the major reasons that the
Government helped out in the Bear Stearns situation was to
avoid throwing it into bankruptcy with all the credit default
swaps and not having the infrastructure.
One of the reasons the Chairman has said to Senator
Schumer, even more important than the wind-down in the
insurance, is the ``too big to fail,'' and part of the reason
for the ``too big to fail'' is the lack of all the
infrastructure and protocols and discipline around over-the-
counter derivatives market. But it is not as simple as to just
say let's just regulate it.
This is a market that regulators, led by the New York Fed,
have been making huge inroads in with the industry, and there
is a lot more that needs to be done on this market. So it is a
big problem. We have been focused on it for a long time. How it
got here is another story. But we have been dealing with it.
Mr. Bernanke. Senator Dole, this is an instrument that has
grown extraordinarily rapidly, as you point out, more quickly
than the infrastructure that supports it. And the Federal
Reserve, particularly the New York Federal Reserve Bank, have
been extremely active in working with market participants to
improve the transparency, the clarity of those trades, to
develop protocols in case there is a failure, how to deal with
that, and to move toward a central counterparty that will help
make this a safer market.
So we are working on that and making a lot of progress. It
is part of a broader plan to try to make the system more
resilient, more transparent, so that when we have crisis
conditions that, you know, those problems will be much less
severe.
So we understand your concern, and we have been working
very hard to try to make that market better.
Senator Dole. Yes.
Mr. Cox. Senator, I think that there are several issues
here. One is the infrastructure issue that the SEC is working
on with the Fed, and the Treasury, of course, and the
President's Working Group are very aware of this, and this has
been a leadership effort for some time. It is important to have
an OTC derivatives clearance and settlement infrastructure that
works much better. It is important to have a central
counterparty.
It is also important to note that legislation has expressly
excluded CDS from regulation even of the most modest kind, such
as disclosure. And the lack of disclosure, the lack of
transparency around this market is one of the reasons that we
as a law enforcement agency but also market participants are
very, very concerned about this.
We have seen what happens with these regulatory holes. We
have got a big regulatory hole around investment banking
supervision. We now have right in focus--and we can see how
this works--a bit regulatory hole around CDS.
Holding a credit default swap is ordinarily effectively
taking a short position in the underlying. But CDS buyers do
not have to own the underlying. They do not have to own the
bond or the debt instrument upon which the credit default swap
is based. So they can effectively naked short it. This is a
problem that we have been dealing with with our international
regulatory counterparts around the world with straight
equities, and it is a big problem in a market that has no
transparency and people do not know where the risk lies.
The opportunity, therefore, for fraud and manipulation in
this market can lead to market distortions, market disruption,
and damage to the companies themselves. And it is just vitally
important, as we consider reform of the financial system in the
current crisis, that we regulate this so that we can have
disclosure, so that we can have transparency in this market.
Senator Dole. Thank you, Mr. Chairman. My time has expired.
Chairman Dodd. Thank you very much. I was just asking staff
as to whether or not this is something--I would ask Chairman
Bernanke or Secretary Paulson, is this something we ought to be
thinking about as including in some proposal given the language
of the Chairman of the SEC?
Mr. Bernanke. You mean in part of a reform?
Chairman Dodd. I understand the logic, but I am talking
about more immediately.
Secretary Paulson. You cannot deal with this immediately.
This is a huge market that has built up over a long period of
time. It has also been extraordinarily useful in avoiding
collapses and problems, letting institutions hedge themselves,
as we went through--I could just go through situation after
situation where, you know, Enron failed at great cost and human
suffering, but the markets held up.
So these are really valuable tools. It is a case where they
grew too quickly, and when I talked earlier about we had a
regulatory system that was static and did not change with the
marketplace. And so the first work that has been done--and I
think it would have to be done before you could regulate
anyway--is all the work that Tim Geithner at the New York Fed
has been leading with the industry to work out the
transparencies and the protocols and the discipline in this
market. And so----
Chairman Dodd. The only reason I asked the question is
because, Chairman Cox, there was an urgency in your comments.
Just quickly, do you disagree with the Secretary?
Mr. Cox. Well, I think the Secretary is absolutely right
when he says that these instruments provide a lot of important
support for liquidity in the markets. And so we ought not to
view regulation as somehow going to stamp out credit default
swaps or the derivatives markets or all the functions they
perform. But at the same----
Chairman Dodd. But you are not recommending that as the
amount of this package we are talking about----
Mr. Cox. Well, there is an urgency to what I am saying, but
I do not want to get in the way of your consideration of what
you have before you. On the other hand, giving regulators
authority does not mean that it will be used in ways that
disrupt the market.
Chairman Dodd. I hear you. Senator Menendez----
Secretary Paulson. And I think what the Chairman was
talking about was law enforcement, which you urgently----
Mr. Cox. Well, we have already got the antifraud authority.
What we need is----
Chairman Dodd. There is a statutory gap.
Mr. Cox. Yes, we have a big--somebody in the Government
needs to be able to look at this.
Chairman Dodd. Senator Menendez.
Senator Menendez. Thank you. Thank you, Mr. Chairman.
As I listen here for a while, I get the sense that while
you have given this a lot of thought, by the same token I get
some sense that we are flying by the seat of our pants and that
in that respect, you know, that you want to come in strong and
have the cavalry be there, but you are not quite sure what the
cavalry does once it arrives. And that is part of my concern
here.
The trouble is that these assets are so intertwined and
complex that no one seems to be able to figure out what they
are worth. And, hence, no one has been willing to buy them,
which is why, Mr. Chairman, as you described, they have been in
a lockdown mode.
But you talked about the maturity price, and I just wonder
how, in fact, since they are impossible to value as instruments
at this point in time, how does one actually achieve that? If
the Secretary pays the market rate, presumably if that was
enough to be able to achieve the sale, that would be enough to
persuade banks to sell already, so they would have sold. For
that plan to work, then it would almost seem that you have to
pay some type of a premium. And if that is the case--and I have
heard the Secretary say many times we are going to look toward
market mechanisms. Well, you know, some of us are concerned
that market mechanisms have brought us to where we are today.
So how do you know--how do any of these institutions even
know how to bid, for example, in the reverse auction, if, in
fact, they could not in the first place determine what the
value is? And, therefore, how do we make the determination of
what, in fact, the hold-to-maturity price is so that the
taxpayers do not get left holding the bag?
Mr. Bernanke. The holders have a view of what they think it
is worth. The trouble is it is difficult for those outside to
know what it is worth. And I think that there are
combinations--and I want to be clear. I have not, you know,
specified a specific mechanism, and this is an important thing
to be looking at. But I do believe that there are combinations
of market-based type auction procedures with expert input that
would reveal--just as when you sell a painting at Sotheby's,
you do not know--nobody knows what it is worth until the
auction is over. Then people know what it is worth. I think it
is the same thing here. If you have an appropriate auction
mechanism together with other types of inputs, with flexibility
to address different assets in different ways, I think what you
will do is you will restart this market, and then you will get
a sense of what the more fundamental value is.
Senator Menendez. In essence, what you are going to do is a
massive--ultimately, you create a massive repricing, right?
Mr. Bernanke. On the grounds that the prices that we now
see are what I called fire-sale prices, prices that are seen
when you sell into an illiquid market.
Secretary Paulson. There is no doubt that we are saying
Government intervention. There is no doubt about it. And I
would just add it is not just market mechanisms that have got
us where we are today. It is also a hopelessly failed and
outmoded and outdated regulatory structure that has helped get
us where we are today also.
Senator Menendez. Well, I would add to that, even within
the regulatory structure you have, a lack of pursuing some of
the regulations that we have aggressively in doing that.
Let me ask you, what in this process do you envision not
having the market try to manipulate the process in doing so?
For example, what makes you believe that the institutions will
not sell the very worst of the assets that they have in order
to unload them and, in essence, be able to do that?
Secretary Paulson. What we are going to do is we are going
to do this focusing on one asset class at a time. So we will
start off with maybe simpler asset classes, and it may be that
one of the things we are going to want to do over time is buy
some of the most illiquid asset classes and pay for them
appropriately in order to preserve the system and do all the
things you have heard me emphasize before to protect the
taxpayer.
Senator Menendez. Well, let me ask you, Chairman or Mr.
Secretary, you said the institutions believe there is a value.
They think that there is a value. The question is: When you
have it in the reverse auction, what if they ultimately offer a
value you do not think is appropriate?
Mr. Bernanke. This is one of the reasons, you know, in
response to Senator Bennett, you know, if we narrow--if we keep
the range of participants too narrow, only failing
institutions, for example, then we will not have a robust,
competitive auction. The more participants we have, the more
people who are involved in offering these assets, we will have
a competition. And auctions are good at producing, you know,
relevant prices, even if individuals have an incentive to
underprice.
Senator Menendez. Well, let me ask you this: I have heard
you both make statements today and in the past that would lead
one to believe that, at the end of the day, there is minimal
risk to the taxpayers here. And, in fact, I have heard you say
that there are some who argue that, in fact, we could make
money.
Can you both look at me in the eye and tell me that, as we
increase the debt limit of the United States by $700 billion,
which basically means about $2,333 for every man, woman, and
child in this country, that this will not cost the taxpayers
anything if we pursue what you want us to do?
Mr. Bernanke. I never made any guarantees like that. There
is going to be risk involved for sure.
Senator Menendez. Can you quantify the risk then?
Mr. Bernanke. No. We are going to have to look at it. But I
think that what is clear is that the $700 billion is not an
expenditure. There is going to be a substantial amount of
recovery. Whether it is the full amount is hard to know.
Secretary Paulson. Senator, I think what you heard me say
today is that, unfortunately, there is great risk to the
taxpayer today with what we have. The taxpayer is already on
the hook, through no fault of his or her own. And now the
taxpayer is on the hook because if the system does not work the
way it needs to work, people are not going to get the loans
they need, small businesses are not going to get the capital
they need, farmers are not going to get the loans they need. So
there is risk to the taxpayer.
Now, in terms of what we are doing here, you have not heard
me say that there is not risk to the taxpayer. You have heard
me say there is less risk to the taxpayer in this course versus
not doing it.
Senator Menendez. Can you give us any quantification what
that risk is?
Secretary Paulson. I cannot give you a quantification
because--and I will explain why. We are not making an
expenditure. We are buying the assets, we are holding the
assets, and we are reselling assets. And what the cost to the
taxpayer will ultimately be will depend upon how the economy
recovers, what happens in the housing markets, and how we
execute this program.
And so I wish there were a simple answer. I do not like
being in this position. But I need to tell you the truth. And I
certainly have not told you there is no risk to the taxpayer.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator Menendez.
Senator Crapo.
Senator Crapo. Thank you very much, Mr. Chairman.
I want to go first to you, Chris, and talk about the short
sell rule. Could you give the rationale for why you felt it was
necessary to implement a ban on short selling?
Mr. Cox. Yes, Senator. The decision was taken by the
Commission after a great deal of careful thought, albeit in
urgent circumstances. We consulted very closely with the
Secretary of the Treasury, the Chairman of the Federal Reserve,
the President of the New York Fed, and it was the considered
view and recommendation of all that we take this course, as
well as international regulators--the U.K. Financial Services
Authority, in fact, took this action slightly ahead of the
United States, as have regulators in markets in Europe and
Asia. This has been the subject of a G-7 statement. And the
purpose of it is to ensure that in circumstances that we have
seen where there is panic and fear in the markets, that that
does not lead, because of the close correlation that we have
seen between equity prices and confidence in the institutions,
to a run on the bank. That would affect the entire financial
sector, and that is why this is restricted to financial
institutions. But it is also time limited. The emergency nature
of this makes it time limited. It is not something we would
want to do on a permanent basis.
And what we were looking to accomplish is to give the
Congress an opportunity to consider this legislation in an
environment of relative calm and to segue away from this
emergency order as quickly as possible.
Senator Crapo. But you do deem it to be short term and
limited.
Mr. Cox. It is short term, limited, and focused on the
financial sector.
Senator Crapo. I want to go on to another issue, and I have
short time, so I will get into this with you privately. But as
you know, I am very concerned that the way we have implemented
the rule needs to make necessary exceptions for the kinds of
proper short sales that are important for our markets to work
well. But we can discuss that at a later time.
I want to get to, which Chairman Bernanke and Secretary
Paulson, the question of the run on the bank issue in the
context of the actions that were taken to protect our money
market funds. Could you explain to me just quickly what was
done and what authority was used there?
Secretary Paulson. Yes, Senator, let me explain the
authorities the Treasury used and why we used them, and then
the Chairman can explain what they did to support the
commercial paper market.
We have talked generally about the stresses in the capital
markets when they froze up and when banks stopped lending to
each other and things really slowed down. We have millions of
Americans that have savings in money market funds. We have
institutions that have savings in money market funds. And we
had some of that money start to leave. We had an institution or
two halt redemptions, you know, break the buck in a case. And
there was great concern about this. And so this was not a
normal circumstance.
And so what we did was, at the same time we came to
Congress Thursday night and said we want to address the root
cause, which is housing and capital and we had this big plan,
we also had some tactical steps. And one of the things we did
at Treasury was we have an exchange stabilization fund, and in
our judgment--and we got strong legal opinions that what
happened in the money markets really gets to the stability of
our system and, you know, to our currency and so on. So on this
emergency basis, what we did was guaranteed all investors in
money market funds, and we did it all funds that were there as
of the date. So we did not want to create an uneven playing
field going forward, but what we wanted to do was come up with
this guarantee, and that is what we did. And then individual
institutions will be--as they opt into this, we are working out
the arrangements and the fee.
Senator Crapo. And this is emergency. Do you contemplate
that it needs to be temporary, or does the legislation need to
authorize this?
Secretary Paulson. No, we did this. It is in place for a
year, and we do not think that this is something that needs to
be codified because I do not believe this is something that
needs to be done permanently. And it is something you can look
at as you are looking at broader reform issues.
Senator Crapo. All right. In the limited time that I have
left, I would like to get back once again to the issue that you
have already talked about a number of times here, which is why
we do not look at an approach of obtaining equity for the
taxpayer. And I understand the points you have been making
about the fact that this is different from a failed institution
that we are stepping in to fix and that you are trying to get
broader participation.
What I do not understand is, even given the fact that you
are looking for broader participation, why we could not achieve
that. Or maybe said another way, is it really necessary for us
to go to the level of $700 billion to get more broadly out into
the economy to institutions that are not facing the kinds of
pressures that would require this kind of an emergency response
by Congress? Why aren't we focusing simply on those firms and
those portions of our market that really do need to have the
recapitalization occur quickly?
Secretary Paulson. Well, I will answer it and then let the
Chairman answer it. There were two possible approaches, and
this is by far the best in our judgment. One is to come up with
something that is aimed solely at propping up a relatively
small number of bigger institutions if and when they need it.
OK?
And the other approach, you know--and, again, we have
flexibilities to deal with individual's situations as they
arise. But the approach we thought was the better approach was
to focus on the securities themselves and the markets of the
securities themselves, looking at various security tranches and
asset classes, and by establishing markets, working to
establish values and markets here, to then induce the flow of
private capital. And, again, when you look at all of our
financial institutions, when people say why not recapitalize
them, one of the reasons that capital is not coming into these
institutions is they do not know--investors do not understand
the value of some of these securities, and we need more
transparency.
So that is the approach, and it is--one is an approach to
deal with failure, and the other is to try to make the system--
to get to the system in advance of that.
Mr. Bernanke. Senator, as the Secretary said, those
distressed firms have been a big problem. We have seen a number
of cases, and in those cases, injecting equity and so on has
been the right approach. But this is a systemwide problem. Even
banks that are relatively healthy are contracting their balance
sheets, refusing to lend, not able to raise more capital, and
it is that contraction, even in the absence of failures, that
is creating the pressure in the U.S. economy.
So by trying to address this as a market phenomenon rather
than an institution-by-institution phenomenon and getting wide
participation, we have a much better chance of having a
beneficial effect on credit and on the economy. So I do believe
that is a better approach.
And I will not take your time, but the Fed has done a
number of things to try to help out on the money market mutual
funds as well, trying to avoid--helping them not liquidate in
such a disorderly way.
Senator Crapo. Thank you. My time is up.
Senator Bayh [presiding]. Resisting the temptation as the
temporary Chairman to jump the line, I will recognize Senator
Brown.
Senator Brown. Thank you, Mr. Chairman.
I do not think a single call to my office on this proposal
has been positive. I do not believe I have gotten one yet of
the literally thousands of e-mails and calls we are getting.
Part of this reflects outrage by taxpayers making $30,000,
$40,000, $50,000, $75,000, $100,000 a year, bailing out people
whose country club memberships cost many times that. Part of it
is, I think, an attitude. Wall Street to most people in my
State, I think--certainly to many of them--Wall Street did not
care one bit what it was doing to neighborhoods in Cleveland
and Dayton and Toledo. It did not see the devastation. It did
not feel the pain. And my question for each of you is: Do you
think Wall Street owes the American people an apology?
Mr. Bernanke. Wall Street made a lot of mistakes;
regulators made a lot of mistakes. We are going to have to go
through all that. But let me just say this: People on Main
Street who think that Wall Street is somewhere far away and
whatever happens there has no implications for their lives are
just misinformed, because if Wall Street, if the markets freeze
up----
Senator Brown. Mr. Chairman, people know that what happens
on Wall Street has an effect on their lives. That is not the
question. The question is: Does Wall Street owe the American
people an apology?
Mr. Bernanke. Wall Street itself is an abstraction. There
are many people who made big mistakes and many regulators who
made mistakes, and we need to figure out what those were and
make sure they do not happen again.
Senator Brown. Secretary Paulson.
Secretary Paulson. You know, I share the outrage that
people have. It is embarrassing to look at this, and I think it
is embarrassing for the United States of America. There is a
lot of blame to go around. A lot of blame. And a lot of blame
with the big financial institutions that engaged in--that is
where I started with this--irresponsible lending, the overly
complicated and complex securities that no one understood as
well as they should, and it turns out they did not understand
them themselves; the rating agencies that rated those
securities; blame to the people that made loans they should not
have made to some people that took out loans they should not
have taken out; to regulators.
So there is no doubt about that, but what we are focused on
now is--and what I think your constituents want to hear, is
let's fix the problem in the way that is going to have the
least negative impact on them, and then let's go out and deal
with all these problems and figure out how to make sure that we
minimize the likelihood that it will happen again.
Senator Brown. No disrespect, Mr. Secretary, but they
understand much of that. They do want a solution. But they do
not want the same people that have helped to inflict this pain
on the American people to get the opportunity, because of our
reluctance on executive compensation and our reluctance to do
accountability, to inflict more pain. And I think that is--
well, let me move on from that. I apologize for interrupting.
Senator Bennett raised a good question about troubled
assets, and, Mr. Secretary, how would you determine the price
of a troubled asset if not by a transparent method like an
auction? I am not asking you to commit to a certain way, but
give me an example or two how you could determine the price of
a troubled asset outside of an auction and do it in a
transparent way?
Secretary Paulson. In terms of--when I am talking about
trans, I am talking about how we report to the American people,
how we report to the oversight board. If you are looking for
transparency and being able to explain to you here today or
anyone how some of these securities are valued and the issues
surrounding them, I wish I could tell you, because we do not
have--part of the problem that has gotten us here is excess
complexity. And so we have very complex, illiquid securities,
some tranches are more illiquid than others. And all I can say
to you is we are going to need to use a variety of mechanisms,
market-driven mechanisms as much as possible, bring together
bright people from different backgrounds to work through this
and do it with the main objective of protecting the taxpayer.
Senator Brown. Thank you for that. Let me offer an idea,
and you said part of the reason we got into this was the
complexity. Part of the reason we got into this, too, is that
the various actors had so little or no stake in the ultimate
success of the mortgages. It was like a game of musical chairs.
The appraiser got a fee, the broker got a fee, the investment
bank got a fee, until the music stopped and somebody did not
have a chair in some sense.
Have you given any thought--both Chairman Bernanke and
Secretary Paulson, have you given any thought to creating a
system where the seller determines the price but must retain a
good fraction of the asset, live with the consequences, and
indemnify the Government if it was wrong on the high side?
Mr. Bernanke. I am sorry. I thought you were talking about
securitization processes. Are you talking about this
operation----
Senator Brown. I am talking about when we buy these
troubled assets if there is----
Secretary Paulson. We did not give thought to that, because
I do not think that would be--I do not think that that would be
a successful way to deal with something systemically.
Senator Brown. Why not?
Secretary Paulson. Because what we are looking to deal with
is, as I said, the asset classes broadly and market-based
solutions and getting--reaching out to many institutions to do
that. And so that is--I recognize that there are a lot of
ideas, and I have heard a lot of them. We spent a lot of time
over the last number of months talking through these issues. I
have heard in the last couple days all kinds of ideas that have
come forward. And what we need to do here, I think, is move
quickly and have some flexibility to--we have got some very
good ideas and I think some approaches we spent a lot of time
on. But we are going to have to spend time learning as we go
along also.
Senator Brown. If we subscribe to sort of the theory of the
ownership society, which your administration kind of stands
for, doesn't an idea like that, where there is some ownership
of the asset by the seller to make the price perhaps more real
or more fair to taxpayers, make some sense?
Secretary Paulson. Well, again, I will let the Chairman
respond from his standpoint, but given what we are trying to do
to the system--and, again, the fairness to taxpayers, I am
defining fairness to taxpayers as what is going to create the
least cost to taxpayers, what is going to protect the taxpayers
to the greatest extent. And I believe that by far the most
important thing is addressing the questions that Richard Shelby
and some others have asked: How do we make this work? How do we
make this work so it is going to be effective, keep our economy
going, keep capital flowing, and do something systemically? And
to do something systemically the way we need to do that, I do
not think that is the right way to go.
Mr. Bernanke. Let me just--there are many different
mechanisms for trying to establish value. There are different
ways. Some involve various kinds of copay type arrangements
like you are describing. I think we need to go to experts. I
have received a number of e-mails from world leading auction
experts saying, ``We want to come work with you on this.'' The
thing I would ask you to do is not to put in the legislation
precisely how these mechanisms would work, because that would
prevent us from using the advice of experts and the benefit of
experience in this very novel type of situation to learn the
best way to do it.
Senator Brown. Thank you.
Thank you, Mr. Chairman.
Chairman Dodd [presiding]. Good questions. Thank you very
much, Senator.
Senator Martinez.
Senator Martinez. Thank you, Mr. Chairman.
This is for Mr. Lockhart and Secretary Paulson, if we
could, Director Lockhart. When Fannie and Freddie were put into
the conservatorship, one of the impacts that it has had has to
do with the asset quality or the equity capital of America's
banks. And I am talking now about Main Street; I am talking
about community banks. Apparently, about 11 percent of their
core equity capital was involved in these types of equities
even as a result of the conservatorship, because of this
situation, maybe about--it is believed about $36 billion in
value of the preferred shares has been essentially wiped out.
The question really--and, apparently, the impact on small
and community banks, everyday banks in our towns and our cities
and in Florida towns and cities that are making the loans to
the small business guy, to the car purchasers and so forth are
being impacted by this in a much greater way than was initially
anticipated.
So the question is: How could we restore the value of these
assets to these banks? And when would dividend payments begin
again? And how do we deal with this unintended consequence of
the conservatorship?
Mr. Lockhart. Fannie and Freddie had about $35 billion of
preferred outstanding. It was held across the board, but there
was a concentration in banks, and sometimes in smaller banks.
It was something that was considered at the time, and the view
was that we needed to conserve Freddie and Fannie and those
dividend payments were going to be excessive. So, a decision
was made to stop the dividends.
The preferreds are still in place. If the companies come
out of conservatorship, there is potentially an opportunity
some time in the future for dividends to be restored but not in
the near term.
Mr. Bernanke. Senator, the Federal Reserve and the other
Federal regulators are very aware of this situation. We
understand it is an unusual situation. It wasn't brought about
by bad lending, for example. And we are going to be working
with banks to try to find solutions for them.
Senator Martinez. Good deal. Thank you.
And in the situation that brings us here today, Mr.
Secretary, today, I have heard you say that you welcome
oversight, so as we try to narrow differences and begin to work
in a bipartisan way to find a way of getting to a solution to
this problem, which is not just about Wall Street but is
directly related to what is happening in Miami and Orlando and
Tampa and the small cities across America, so therefore, we
have the idea that you have asked for a blank check or that
Congress would give you a blank check or that Congress--I mean,
we can remove that from the debate. You are not asking for a
blank check. We are not going to give you a blank check. There
will be oversight. And you accept and understand that that is
part of what we have to do?
Secretary Paulson. I accept and understand it. I welcome
it. And as I said earlier, I was told by Congress, by your
Chairman, let us work together. Please don't work out all the
details. So we sent up a simple outline of a bill expecting to
work on an oversight and then I read that I didn't want
oversight. So clearly, the position I am in, I want--I welcome
oversight, protection, transparency, all of that, but we need
to work together to do it and make this effective and very
efficient.
Senator Martinez. And likewise, there needs to be and there
will be transparency in the way in which this is executed in
terms of how you are going to move ahead and whether it is an
auction or reverse auction or exactly how these securities are
going to be valued.
Secretary Paulson. Yes. We will--as I said, there are going
to be various methodologies. We are going to do the things we
think make most sense and with a lot of experts, and then that
is something we are going to need to explain to an oversight
body, and we are, again, going to need to be transparent and I
totally accept that and agree with it. And we all need to
understand this is something that hasn't been done before. It
is something that Congress had never welcomed, authority,
intervention of this size. We weren't recommending it in this
size months ago. We have--we are, again, dealing with a market
situation where we need to move quickly and we need to move
quickly to protect the American taxpayer. And so this will be--
this is something we are going to be working through very
carefully as we go forward here.
Senator Martinez. That issue, quickly, is something that as
we--we first discussed this on Friday, I believe, some of us.
We now are moving down the road to try to get something done,
and obviously it needs to be done right more than it needs to
be done fast. But do you still--and this is also to Chairman
Bernanke--do you both continue to feel the sense of urgency
that was present when we first spoke about this on Friday?
Secretary Paulson. I feel at least as great an urgency
because I believe that what calmed the markets was the
understanding that we were going to do this, and we stood--or I
had a press conference with the leaders of both Houses saying
we are all going to work together to get this done quickly. And
so I feel great urgency and I believe it has got to be done
this week or before you leave.
Senator Martinez. Mr. Chairman?
Mr. Bernanke. I agree with that. I think it is necessary,
at a minimum, to give a very strong indication of exactly what
is happening and very soon so that markets will understand what
is happening. Yes, I do see that urgency.
Senator Martinez. And Mr. Chairman, while we are on that,
you do agree that this is the best and the only way forward
that you know of at this time?
Mr. Bernanke. Well, we haven't specified all the details,
obviously, but the only other model which we have is sort of
the failed bank model we have seen in the S&Ls and other cases
and that just doesn't apply to this particular situation. So
yes, I do believe this is our best shot.
Senator Martinez. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Secretary Paulson. Not only our best shot, it is--we are
going to make it work.
Chairman Dodd. Thank you, Senator.
Senator Casey.
Senator Casey. Mr. Chairman, thank you very much for this
hearing and for the way you have conducted it.
I guess my first question will be directed mostly at
Secretary Paulson and also Chairman Bernanke. Both of you have
said today and on numerous occasions that the root cause of
this, of course, is housing, and you have taken steps, both of
you and others here today have taken steps to deal with that
over time, and I think a lot of the strategies that have been
employed have helped. I think we should enlarge them,
especially at this time when we have an opportunity to do so.
You know the numbers about foreclosures per day. It is
approaching now, by one estimate, 10,000 per day. The Center
for Responsible Lending is predicting that 6.5 million
foreclosures over the next couple of years. And I know that
both Chairman Bernanke and Secretary Paulson today, especially
Chairman Bernanke, have spoken about both fire sale prices and
hold-to-maturity prices. But I believe, and I think the
evidence is compelling, that foreclosure itself forces fire
sale prices of homes. And isn't it true that if these
foreclosures occur, then all home values are going to drop and
drop to the fire sale price and that that forces the hold-to-
maturity price to fall to the fire sale price.
So in essence, what I am asking in a long way is why does
this proposal have this, what I would argue is a gaping hole in
it, with no specific provisions that deal with foreclosure
prevention?
Mr. Bernanke. Well, I certainly agree that we should--every
preventable foreclosure that we can, we should prevent, and we
have a number of actions in that direction, including the bill
that Congress just passed, for example. And I think that we
ought to keep working in that direction.
One of the things that will help will be increased jobs,
stronger income, better credit availability. That is
essentially what we are trying to achieve here. It is not a
substitute for other things, including working with servicers
to develop better methods, insisting the banks work effectively
with their borrowers, using the FHA in the way that we have
been doing through the HELP for Homeowners, HOPE for Homeowners
that the Federal Reserve is part of. So those things need to go
together. But certainly, housing is not going to do well in an
economy which is not growing in which credit is not available.
Senator Casey. And I understand the point that you have
made and Secretary Paulson has made about there is a direct
connection between what is happening in a proposal, or what we
hope happens as a result of the implementation of this proposal
between helping financial institutions and what happens on Main
Street or in the American economy. I get that and I think we
need to say that more.
But what I don't understand is even though we made progress
on HOPE for Homeowners in July--we can help 400,000
homeowners--why not use this opportunity to take another shot
at that and expand that 400,000 to a million or to a million-
and-a-half or two million, whatever it takes to, in two words,
stop foreclosures as best we can? And I don't know whether,
Secretary Paulson, you have some thoughts on that.
Secretary Paulson. Again, I think you know, Senator, that
we have spent a lot of time on this and the HOPE Now Alliance
has helped about 200,000 people a month avoid preventable
foreclosures. And our big focus, one of the things--as you
said, housing is at the root of this. What we are doing with
Fannie and Freddie and what we are doing with this action
should help. And I have also said, and I know the Chairman and
I have talked about this, that with some of the securities we
own, we will have much more leverage to get things done to
avoid preventable foreclosures. But we very much hear your
concern and we understand it and there is no doubt that
foreclosures are a significant problem.
Senator Casey. Because I think when people are looking at
this proposal and they see elements like that and like
transparency, like oversight, like executive compensation, the
warrant question, when they see those missing, I think it gives
further credence to the idea that this is very narrowly
tailored to financial institutions, even though you have made
the case that that has a connection to the larger economy.
I do want to move to the question of how we modify the
mortgage agreement between a lender and a borrower. One of the
ways that has been proposed, and we voted on it before and I
think we should return to it, is the question of bankruptcy.
Can we use bankruptcy procedures, the bankruptcy law, to have
a--to help modify some of these mortgages, in some ways,
frankly, to force people to sit down to do it? I want to get
your perspective on that, because I know it is a source of
convention in our ability to not just come to a resolution on
this proposal, but also on the foreclosure issue itself.
Secretary Paulson. Senator, I will give a quick view and I
am sure the Chairman will. From a policy perspective, you have
heard me express disapproval. I think that that is--although
many people have considered it and advocate it, I very
respectfully think it is a mistake, and when I look at what we
are trying to do here, is to get lending going again and
increase lending, I think this really mitigates against that
and it is in contradiction with what we are trying to do, is to
get lenders to do more if we do these bankruptcy modifications
or cram-downs. But I understand there are differences of
opinion and I respect the other view. I just think it is a
mistake.
Senator Casey. Chairman Bernanke.
Mr. Bernanke. It is hard to know which way that would go,
whether putting things into courts is a way of facilitating
this or not. The Fed didn't take a position on bankruptcy
reform last--a few years ago. We have just basically not taken
a position on this one.
Senator Casey. Well, I would respectfully urge you to
reconsider that, because I think we need a voice like yours,
the voice of the Fed, on something this, I think, essential to
the debate.
I know I might have a minute left, if that. My last
question is in terms of real contention here, obviously,
executive compensation is a huge issue and I think the American
people, even though I think most understand that the dollar
amounts for executive compensation may not impact or compare to
the dollar amounts we are talking about overall here, whether
it is $700 billion or whatever number it ends up being, but I
think the message sent by a failure to address the executive
compensation question in a reasonable way, in a way that we can
have bipartisan forces come together, I think would send the
wrong signal.
And in terms of confidence, we are concerned about market
confidence, but we also--I think part and parcel of that is the
confidence the American people have in us, all of us, to be
able to deal with an essential question of fairness and equity
and real justice. And I guess I want to have you to reiterate
your position on the issue of executive compensation and if
there is any way we can come together on that by providing some
reasonable limits on it, especially with regard to severance
after the fact, after there is a problem.
Secretary Paulson. Again, I will----
Chairman Dodd. Try to be brief in your answer, because we
have got other members here.
Secretary Paulson. I will be very brief, because I
understand how serious the problem is. I just got--and how
great the concern is and the outrage. You know, I hear it
everywhere. But I can just say to you the most important thing
by far, the most important thing is to have something that
works, works well, and works effectively.
Senator Casey. Thank you.
Chairman Dodd. I would just say, almost any plan we are
going to talk about is going to deal with executive
compensation. Count on it. Just count on that one. We will
figure it out, but it is going to be here.
Senator Bunning, I missed, and I apologize----
Senator Bunning. That is all right. Thank you. I was absent
for a while and I understand.
We are trying to get at the housing problem, is that
correct? Secretary Paulson? The problem that the housing mess
has created and spilled over into the rest of our economy and
worldwide.
Secretary Paulson. I would say that is a major cause. I
have called it the root cause, the housing correction.
Senator Bunning. OK. Then why did I read in the paper this
morning that we are now going to include student loans and
credit card debt? How does that fit the housing?
Secretary Paulson. I would say to you, that is certainly
not my proposal, is to--I think the vast bulk of our effort
needs to be aimed at mortgage-related securities. We asked for
broad authorities and various kinds of securities because
again, what we need to do is to free up the----
Senator Bunning. I think you have made that perfectly
clear, Mr. Secretary----
Secretary Paulson [continuing]. So what I am saying, so
that is--that that----
Senator Bunning. Then how are we getting in other things
that are non-related? This is something that--is that untrue?
Secretary Paulson. I would say the reason we want
flexibility to, if we need to, buy some other classes of assets
would be that if the banks--if capital starts to--as capital
flows more freely, it will help the housing, because the fact
that the financial system is gummed up and there is illiquidity
hurts it and it may be that to deal with----
Senator Bunning. Student loans and then credit card debt
are messing up the housing?
Secretary Paulson. That is--I certainly, sir, did not say
we are going to focus on this and that that was going to be the
major focus----
Senator Bunning. I didn't say you said it. I said I read
it.
Secretary Paulson. OK. OK. Well, I am not sure what you
read.
Senator Bunning. I read that included because someone
insisted on it, that you were dealing with--included that we
were going to deal with credit card debt and student loan debt.
Secretary Paulson. I----
Senator Bunning. It is untrue?
Secretary Paulson. I don't know what you are talking about.
What we have said, though, is we have asked for broad
authorities to deal with a variety of securities if we need to,
and a variety of asset classes. But the focus here, the major
focus will be dealing with mortgage and mortgage-related.
Senator Bunning. This is unrelated, but it is essential for
me to get a handle on some prior statement you made earlier
today. How long were you the CEO of Goldman Sachs?
Secretary Paulson. I was the CEO of Goldman Sachs from May
1999 until I left to come down here at the middle of 2006.
Senator Bunning. Now, that is not what I want--I don't need
help from the audience. I can ask the questions on my own. Then
you said in an earlier statement that you didn't realize the
maze of regulatory problems that we have here on the Hill and
that you and other companies like you were CEO of were dealing
with here. You made that statement to us all sitting at this
table.
Secretary Paulson. I said, you have to get down here, look
at the people, look at the plumbing, look at the inadequacies.
I was not studying----
Senator Bunning. You were dealing with it on a daily basis.
Secretary Paulson. I was dealing with all of the best
regulators. So I guess what I said is that you have got to see
it up close and personal and then step back and look at it and
think about it and say, how does this make sense, and that was
my statement, yes, sir.
Senator Bunning. In other words, you didn't know or
somebody in your firm other than you was dealing with the
regulatory burdens that were placed on your firm?
Secretary Paulson. Well, I was dealing with--very well with
the regulatory burdens on my firm, but to look back and say--
look at the broader economy, to look at some of the holes in
the regulatory system as it relates to other institutions, yes,
that is it.
Senator Bunning. Mr. Secretary, do you know if large
Treasury debt holders such as foreign official investors,
Commonwealth Fund, Bank of China, whatever it might be, are
going to go along with a massive debt issue? Have you heard
from any such investors who are complaining about the close to
one trillion or more dollars of debt increase we are looking at
between the GSE plan and the new debt to finance the Fed
activities?
Secretary Paulson. I would say to you, sir, when we had--
when I have had a discussion with central banks and finance
ministers from around the world, their primary concern was that
we deal with this situation and they were very complimentary of
this action. And I believe from the conversations that I have
had with central bankers, China, Japan, around the world, their
first and foremost concern was stabilizing our financial system
because it is so integrated with the rest of the world.
Senator Bunning. OK. I guess maybe I am the only one that
has a problem with this, but one of the big problems I am
having dealing with your plan and Chairman Bernanke's and
others to address this issue is that you are not going to be
here after January 20 of 2009, and I am going to have to answer
to the 4.2 million people in Kentucky and all these other
Senators up here are going to have to answer to their
constituents if this plan does not work. And I am frightful to
the point of almost panic that I don't see a solution in your
plan to address this financial crisis that we are in.
Secretary Paulson. Senator, all I can say to you is I got
here 2 years ago. I am going to--I have been trained all my
life to run toward problems. I have had some big problems to
have to run toward. And I have worked very closely with the
Chairman of the Fed, with the Chairman of the SEC, the
President of the New York Fed, my colleagues, Congress, to
address these issues as they have come up and I believe that
this is my plan to deal with these set of circumstances which
are unprecedented. And so that is what I can say to you.
Senator Bunning. This is my last question. This is for
Chairman Bernanke, also. Your predecessor came up to the Hill
today and said that the $700 billion in this plan is chicken
feed and it won't take care of the problem. I don't necessarily
agree with your predecessor on many things, as you might well
know. And I happen to think that he is wrong here, also. But
what happens if it doesn't? Are you going to come back to us
and say, by the way, the $700 billion is insufficient and now
we have to open the taxpayers' box and bring more money to the
table to get this mess straightened out? Chairman Bernanke,
would you like to----
Mr. Bernanke. Well, Senator, I can't predict the future and
I have been wrong quite a few times now. But we may--we don't
know exactly what is going to happen, but I think this is a
very powerful program and that the amount of money is enormous,
of course. There is a chance we may come back and say we didn't
need it all, but it is very hard to know. But I think this is a
very substantial effort by the Congress to address what is
indeed a very large and serious problem.
Senator Bunning. Thank you, Senator.
Chairman Dodd. Thank you. Thank you, Senator Bunning.
Senator Bayh.
Senator Bayh. Thank you, Mr. Chairman, and thank you,
gentlemen.
Some of this ground has been gone over before, and I
apologize, but I would like to follow up a little bit.
Secretary Paulson, I would like to begin with you. Many of us
would feel a little bit better if we were convinced that
private sector-based solutions had been exhausted in this, or
if at least there were some private sector participation in
this to validate the decisions that the public entities will be
making.
For example, I mean, you said that you have been bombarded
with a variety of suggestions. One I heard was that we require
a 10-percent private sector participation along with the
purchases the government will be making in these options.
Another would be, and one of my colleagues floated this idea,
some sort of guarantee of private sector purchases. That
historically has worked fairly well. It would allow the private
sector companies to--purchasers to purchase closer to the hold-
to-maturity value. Why are those sorts of things not viable?
Why is this the optimal solution to this problem?
Secretary Paulson. Well, we have thought a lot about it. We
need a systemic approach, and again, I think it is--I have
described the systemic approach. I have also heard
conversations about taking equity stakes, various other things,
and I just believe very strongly if you impose these kinds of
conditions, if you impose any kind of punitive conditions, this
program won't work and we will all lose. And----
Senator Bayh. This wouldn't be punitive. This is including
the private sector along with the public sector in answering
the problem and----
Secretary Paulson. Yes----
Senator Bayh [continuing]. They would be validating the
decisions----
Secretary Paulson. Well, I would say in terms of bringing
in the private sector, OK, along with it, I think we have
looked at a number of initiatives. We started off, actually,
with some initiatives with the private sector, some that got
off the ground and others that didn't. I would say with the
private sector as frozen as it is and as concerned as it is and
with the overall system as fragile as it is, now is the time
that we need to do something very strong as a government, and
so that is why we have come up with this plan.
Senator Bayh. Chairman Bernanke, many of my colleagues,
Senator Reed foremost among them, have asked, and I think you
put your finger on the essential point here, and that is how do
we go about valuing the hold-to-maturity price versus the fire
sale price, and I think you would acknowledge--you have
acknowledged it is an inexact science at best. So the taxpayers
do--there is some downside risk here. What do they get in
exchange for bearing that downside risk? Why should they not be
allowed to participate in the potential upside, and then that
gets to the question once again of possible equity
participation.
Mr. Bernanke. Well, first, to go back to your----
Senator Bayh. And I understood your answer about the
difference between failed institutions and contracting
institutions. It seems to me these are different points on the
same continuum and I struggle for a principal differentiation.
I mean, this is a market intervention. The taxpayers are
bearing risk. Aren't they entitled to something in exchange for
that risk if things work out well?
Mr. Bernanke. Well, first, to go back to your earlier
point, as I mentioned earlier, there are various mechanisms for
auctions and for valuation that do involve private sector
participation. I think, you know, that experts ought to look at
that. You know, the bad bank model, for example, is one
approach that we have actually--the Secretary has actually
tried. I guess my just concern is it not be written into the
legislation because we have to work and see what is going to be
most effective.
I am just concerned that we not do anything that limits
participation, because one of the issues with valuation is, as
I mentioned earlier, is to get wide participation in the
auction process. If you are auctioning a--if you only have one
seller, then there is essentially no way to figure out what the
thing is worth----
Senator Bayh. Compensating the taxpayers for the risk they
are bearing would disincent others from participating?
Mr. Bernanke. No, but if you make it a condition of
participation in the valuation process, that is going to--that
is essentially going to cause some not to participate when they
would otherwise be part of the competitive valuation process.
Secretary Paulson. I would say it this way. If we have to
grant--have companies grant equity stakes, grant options, that
would render this ineffective because it just--broadly, because
our approach, as I said, there is different approaches, and if
we dealt with people and institutions that were very fragile
and needed to do something in order to prevent failure, then I
think we have had a really strong record of getting equity
stakes. I think you will see us continue to do that under those
circumstances. But what we want here is a broad array of
institutions to participate and so that just makes it--this
would make this program ineffective if we approached it that
way.
Senator Bayh. I would appreciate at another time when you
are not quite as busy some further explanation about why such a
thing would disincent further participation, because as you can
see, that is a common concern that we have.
Secretary Paulson. Yes.
Senator Bayh. You don't need to answer me further, Mr.
Secretary.
I did have one final thing. I found--Senator Shelby raised
this point, and Secretary, I don't know whether it was you or
the Chairman addressed it, about the participation about
foreign domiciled entities participating in this, and I must be
candid. I found the explanation to be somewhat unpersuasive and
I think many of the American people will probably have a
similar reaction. Forget all that for a moment.
You say you are going to be going to the central banks of
other countries to ask them to help out in dealing with this
problem. Why should it not be a prerequisite for participation
in this that the central banks of the countries in which these
foreign institutions are domiciled agree to participate?
Secretary Paulson. I am leaning on them to participate--not
to participate, but to come up with programs that make sense in
their countries. But we need to go back to what we are saying
here. What we are saying is that institutions that do business
in the U.S., employ people of the U.S., are part of the
financial system of the U.S. They are there to benefit the
American taxpayer. If they have problems, they are our
problems. If they work the way they are supposed to work, they
help get the economy growing.
And so the focus here, although we are clearly dealing with
this and communicating in very strong terms with other
governments, our first concern is the American people, and for
the American people, if any institution has got a major office
here, regulating institution, doing business that is very
important to the American people, those are the--that is the
universe we want to deal with.
Senator Bayh. Well, my time has expired, Mr. Chairman. I
would only say that if this works well, which we all hope that
it does, this will restore balance sheets for these
institutions. Share prices will rise. They will benefit. I
think the American people will find it to be odd, to say the
least, if our government cared more about the financial
integrity of these institutions than the home countries of
these institutions.
Mr. Bernanke. They would. What we are aiming at, of course,
is the market, and it is not just those who participate who
benefit or don't benefit. If prices go up generally, that will
help the entire system. In fact, it will help the global
system, you know, which strengthens financial conditions
generally.
Senator Bayh. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Senator Corker.
Senator Corker. Thank you, Mr. Chairman, and Chairman
Bernanke, I am heartened by your comments regarding the
openness and hopefully desire to look at some of the accounting
standards as it relates to banks that have held--not the banks
we are talking about here, but the banks throughout the country
that have held Fannie and Freddie and now need some
transitional help in accounting. I hope Chairman Cox and others
involved will join in that effort and make it happen.
Mr. Secretary, I don't normally tweak people, especially
someone I respect like you. I noticed in your comments you ad
hoc-ed, if you will, regarding a bazooka comment. I do want to
remind you that the theory behind the bazooka was that if you
have a bazooka in your pocket and the markets know that you
have it, you will never have to use it. And I would like to
point out that you not only pulled that out of your pocket and
used it, huge amounts of ammunition was pulled out of the
taxpayer arsenal to solve that. I think you have done some very
deft things, and I compliment you on that, but the point is
that things don't always work out the way people and their best
efforts think they are going to work out.
And I have to tell you, if we were part of a venture board,
if you will, up here, listening to what is really today a
concept--this is not really a deal--I think most of us in
dealing with our own money would say, you know, come back and
talk to us when you can put a little meat on the bones, OK. At
the same time, I understand where you are and I understand the
severity of the situation which puts some balance in that.
I guess the concern that I have, especially listening to
Chairman Bernanke talking about valuing these in a hold-to-
maturity basis, that would automatically give me the
impression, based on what I know about these securities, is
that we are going to actually be paying above what these
securities are marked to market now in many cases. Do you have
any concern that with you being the only player and with
private capital being on the sidelines that you are crowding
out private capital by, in fact, handling it on this basis?
Mr. Bernanke. I would say I have a number of concerns. That
is clearly not the biggest one, because the private capital has
come in two or three times during this difficult period, this
turmoil in the markets, and each time, it has been overwhelmed
by the leverage in the system, and so private capital isn't
coming into the
system.
And I would also say to you that these securities--we never
said that under certain circumstances, they wouldn't--you
wouldn't do things where we pay above the mark. We are doing--
because these securities are marked with different marks and
different types of institutions. So this is a very complicated
process and so--and it is going to be difficult to get our arms
around valuation, but that is why it is so important that we
cast our net broadly.
Senator Corker. Let me pick up on that comment. I know you
have said several times how excessively complex this is. We
talk about these auctions as if we are auctioning off
securities that are like one another when, in fact, they are
not. I mean, these securities are very different. The
collateral that backs them up is very different. And so to talk
about the due diligence--and I am going to lead up to
something, if I could--the due diligence that one would have to
go about to actually even buy these at anywhere close to an
appropriate rate is going to be massive. Is that true? Would
you say yes or no to that? And that is why you are employing
another----
Secretary Paulson. It is, but I want to correct maybe a
misperception we have left you with. We believe, for the
reasons you outlined, the way to deal with this is to deal with
it by--with similar securities, to deal with it, you know,
looking at the CUSIP numbers, looking at different tranches of
the same security broadly, rather than saying let us have an
auction and put any security you would like into it. But your
point is still the same.
Senator Corker. Tremendous due diligence.
Secretary Paulson. Right.
Senator Corker. OK. And Chairman Bernanke, I heard you say,
and I don't know whether you were being somewhat politic and
trying to help someone with a foreclosure process, but you
mentioned we were going to be buying second liens. Surely we
are not going to be buying second liens with taxpayer money.
Would you expand on that?
Mr. Bernanke. Well, second liens are selling for a few
cents on the dollar and I wouldn't expect them to be worth much
more than that. But I was only pointing out that--I know this
from Governor Duke, who is on the HOPE for Homeowners Board,
that the problem of second liens is a big issue right now
because it prevents renegotiations of the first mortgage. So I
was just saying that a side effect, if we do buy them at a
market value, a few cents on the dollar, would be to help free
up this other issue.
Senator Corker. I know my time is up. I can see the light,
I guess, on the timer. I just want to close by saying there
have been a number of concepts thrown out regarding getting the
private sector involved. I actually think that has not been
explored to the length that it should. I know there have been
some thoughts put forth about maybe a levy on the industry. It
is a huge industry, a $2.5 trillion industry, and that maybe a
levy on the industry to help, if you will, cash-flow this
process until some of the yields can come back to the taxpayers
would be interesting.
But I just want to close by saying, following up on Senator
Schumer's comments, we had a meeting Sunday, and I appreciate
again so much your time. I am struck by the fact that, again,
this is a concept and you want $700 billion to deal with this
concept that no one can explain how it is going to work, and I
am certainly not asking you to do that and you can't do that
today. It seems that what he said makes a tremendous amount of
sense.
You are going to have to figure out a way to do this, if we
agree to do it. It is going to take you--it is not going to be
happening in 14 days. There are going to have to be some
guidelines. People are going to have to be hired with
instructions, the institutions that help support this.
It is very difficult for me, knowing that we really don't
know what this is going to do, it is very difficult for me to
understand why we don't pass legislation that says something
like, we have a goal of $700 billion, but that you are going to
put in place the processes and expand a tranche or two, $50
billion, $100 billion, maybe $150 billion, and you are going to
get this put together in a thoughtful way and we are going to
know who the Treasury Secretary really is and that you bring
back to us a fully baked concept with the markets knowing that
is what you are working through and that we have something
intelligent and well-constructed to actually certify to go to
the lengths that you are talking about doing now.
It seems to me that is very workable, and you would be
sending a signal to the markets. And in fact, over the next 60
to 90 days, you would know which of these things is working and
which is not. That just seems to me to be prudent. And I can't
imagine why that is not acceptable to you, even though--I just
can't imagine that.
Secretary Paulson. Let me comment that under normal
circumstances, that would be a good way to go. These are
extraordinary circumstances. We have been moving quickly
already to get ready to be in the position where we could
implement within weeks something with some of the simpler
things after you all act.
I think what I would come back to you and say, I believe
and the Chairman believes, and we have talked about this a lot,
this is what we need here to deal with this market situation.
We will be going out in a methodical way. There will be plenty
of time to review what is done. There will be plenty of time to
add to transparency over time. We are going to put in strong
protections. And you will have an opportunity to work with the
new Treasury Secretary. We will have flexibilities. We will
have flexibilities to involve the private sector. We will have
flexibilities to move this to another area. But this is--we
know how unusual it was to ask for this, but we have asked for
it because we think it is the best way to protect the taxpayer.
So we both want to do the same thing, sir. You want to
protect the taxpayer. I want to protect them. I am thinking the
best way to protect the taxpayer, and you have a very strong
view of that, is to do something that has got the maximum
chances of working in this marketplace to calm the market, and
so that is our view.
Chairman Dodd. I thank Senator Corker.
Just an editorial comment here. Senator Shelby and I were
talking. Senator Shelby is a young-old appropriator and
sometimes we do things that----
Senator Shelby. Together, we are.
Chairman Dodd [continuing]. But there are times, I would
say to Senator Corker, when we have appropriated funds and then
fenced funds. So they have been appropriated, so it is not just
a goal, and what you then can set up, some conditionality.
I would say, Mr. Secretary, I appreciate your point, but
this is not--we are not going to try and draft legislation
here, but I would leave that door open a little bit. If we are
looking to build the kind of consensus up here to move forward
quickly and thoughtfully and responsibly, I think it is very
important to not reject some of these ideas as a way of getting
something done, and I appreciate very much the spirit in which
Senator Corker has raised an issue as maybe we can begin to
talk about as how we move forward in an expeditious fashion,
but a careful one, as well. So I thank him very much for that
thought.
Senator Akaka.
Senator Akaka. Thank you very much, Mr. Chairman.
This is an historic time in our nation and I want to
commend all of you, the administration as well as the Congress,
for using this spirit of working together to try and find the
best way to work ourselves out of the disaster we are in.
Historically, we have just been through a disaster that is
natural and now we are in a manmade disaster. But we are using
this period of working together to try to make a difference.
Chairman Bernanke, this economic downturn and credit crisis
have produced great public concern, and it has been expressed
here many times. My question to you has to do with human
capital concern. What effect will this troubled assets program
have on the supervisory duties, the supervisory duties of the
Federal Reserve?
Mr. Bernanke. Well, we will continue to evaluate. For those
institutions that we supervise, we will continue to evaluate
their positions, their capital, their risk management, and so
on. But I think this will obviously be helpful in removing some
risk from their balance sheet and allowing them to expand their
lending. So I don't see any problem from this, but we will
certainly keep close track of what is going on.
Senator Akaka. I am also concerned about the statutory as
well as regulatory aspects that what we are trying to do will
affect us. So Chairman Bernanke, the Federal Reserve's
statutory responsibilities focus on monetary policy to promote
maximum employment, stable prices, and moderate long-term
interest rates. My question is, to what extent will the
injection of this $700 billion affect your ability to meet
these goals?
Mr. Bernanke. Well, if the program works, it will be
extremely helpful because we are in a situation now with
financial markets freezing up and it is very difficult for us
to achieve the objective of full employment in a situation
where credit is not available and the financial markets are so
unstable. So I think we have taken the view--we have been
working very hard over the last year using a variety of tools
to try and promote financial stability. That was, in fact, the
historic purpose of the Federal Reserve. But I view it as
essential to the other objectives you just mentioned. Without
financial stability, you are not going to have full employment
and price stability. So we think that is very important and we
have been working together with the Treasury Secretary very
intensely in trying to promote stability in our financial
markets.
Senator Akaka. Chairman Bernanke, should we worry about the
Treasury being given the ability to move $700 billion in and
out of the economy and the potential impact that this could
have on monetary policy, and also the political independence of
the Federal Reserve?
Mr. Bernanke. I don't see any problem in terms of
macroeconomics, only a positive effect in terms of stabilizing
the financial system. The Federal Reserve would like to get out
of dealing with some of these crises we have been dealing with
because there is no broader authority, no broader support, and
we prefer to get back to monetary policy, which is our
function, our key mission.
Senator Akaka. Mr. Secretary, you mentioned about needing
the right group of experts to help in this huge effort. Has
there been any consideration, Mr. Secretary, given to
specifically what parts of the Federal Acquisition Regulations
would need to be waived to get contractors and consultants to
establish this program?
Secretary Paulson. Yes. We have given a lot of thought to
that and we have worked it through very carefully with our
General Counsel.
Senator Akaka. Do you plan to have competitive bidding, and
if not, why not?
Secretary Paulson. Well, we have procedures that are
designed to mitigate against conflicts, but we need to move
very quickly here and so we can't go through all of the normal
processes or it won't work for the markets.
Senator Akaka. Chairman Cox, do you need additional
statutory authority to properly regulate brokerage holding
companies? If not, why not?
Mr. Cox. Senator, the regulatory hole that I have referred
to that still exists gives no regulators the authority or the
responsibility to regulate investment bank holding companies.
The marketplace has dealt with this in the context of the
current market turmoil by investment banks opting to become or
merging or combining to become bank holding companies. But the
problem remains, and if there are to be other investment, pure
investment banks in the future, there is no statutory
responsibility.
The SEC, for its part, does not have legal authority over
the entire investment banking firm. It doesn't have the
authority to require that it maintain capital levels or
liquidity or what have you. We have had a voluntary program
that was put in place 1 year before I arrived. Senator Shelby
referred to our view of that early in the year, prior to Bear
Stearns in March, the trial by fire for this voluntary program.
It was very clear that it was broken and it did not serve the
purpose. Certainly, it did not serve the purpose of looking at
systemic risk, something that the SEC is not assigned to do in
statute.
And so I think with respect to this question, we have now
an MOU that we signed up with the Federal Reserve immediately
in the wake of Bear Stearns so that we could take a look at
information about regulated investment banks' subsidiaries, or
I should say, regulated broker-dealer subsidiaries of bank
holding companies and the Fed could take a look at the same
information for investment bank holding companies. That is
working very well, or was working very well, to broaden our
reach, but the fundamental flaw was that it was voluntary. And
so I think, yes, that needs to be taken care of.
I also mentioned the other regulatory hole, which I think
is urgent in the current circumstances, and that is CDS. We are
looking at effects of short selling, but those same effects,
and indeed greater opportunities for manipulation exist in the
CDS market. No regulator has authority except anti-fraud
authority with respect to credit default swaps.
Chairman Dodd. Thank you, Senator, very much.
Senator Akaka. Thank you, Mr. Chairman.
Chairman Dodd. Senator Tester.
Senator Tester. Thank you, Mr. Chairman. I should request
that we could have gotten this hearing over a lot quicker if
you had just called my name first.
[Laughter.]
We have been at this about four-and-a-half hours. I want to
thank you fellows for being here. I really appreciate it.
My first question is going to be with Secretary Paulson and
Chairman Bernanke. When you were at the last hearing that I was
at--it was on July 15--asking for some sweeping powers to
provide taxpayer equity into the two housing GSEs, I asked you
then if this could in any way affect the credit rating of the
U.S. Treasury. You both at that point in time said no. That
decision is starting to look like a minimum of about $200
billion commitment, followed by $85 billion to AIG and another
$29 billion to Bear Stearns before now. We have an additional
$700 billion now on top of that. Could this threaten the credit
rating of the U.S. Treasury?
Secretary Paulson. Let me comment. First of all, you have
heard why we did what we did----
Chairman Dodd. You have got to get closer to that
microphone----
Secretary Paulson [continuing]. There were obligations, and
that this--when you look at this, this authority is the
authority to invest up to $700 billion. It is not to invest all
of $700 billion. It is up to as much as needed and it will be
investing, buying assets, and then we are selling those assets,
and hopefully for a cost that is--we are buying the assets. We
are not spending it. So it is difficult to determine what the
ultimate cost will be.
Senator Tester. But my question is that, as has been
pointed out about bazookas in people's pockets and the last
housing bill we sent out, I mean, we had the conversation on
the phone. You said, we need it. If I have got it, I am
probably not going to have to use it. You had to use it. I am
not arguing that point.
What I am asking you is that we have got $700 billion in
spending authority. Is this--could this potentially affect our
credit rating to our U.S. Treasury? And really, it is yes or
no.
Secretary Paulson. Well, obviously, everything we do in
some way or other affects the credit rating. But what I am
trying to explain here is that this is different from normal
expenditures or outlays----
Senator Tester. So you don't think it is going to affect
the credit rating?
Secretary Paulson. Anything we do, every expenditure, every
investment has an impact. But we believe this is the right
thing to do, and I will, Ben, let you----
Senator Tester. OK.
Mr. Bernanke. I don't know how they make those decisions. I
don't know. But I do know that a weak economy means lower tax
revenues. So if it goes either way, there is going to be a
fiscal hit.
Senator Tester. OK. I understand. So what you are saying is
the increase in potential debt would not have an impact on U.S.
Treasuries.
Mr. Bernanke. I don't think so, but I don't know how that
rating agency does its analysis.
Senator Tester. Good enough. The ``too big to fail'' issues
have been brought up here several times today, and this is for
Chairman Bernanke. Both you and your predecessor have warned
about the threat of systemic risk to financial markets when
some companies are too big to fail, or we are talking about the
whole system. Chairman Greenspan spoke most frequently about
the systemic risk Fannie Mae and Freddie Mac posed. In response
to the recent crisis, Secretary Paulson, if I can quote you,
you said, ``as we have worked through this period of market
turmoil, we have acted on a case-by-case basis,'' which is
accurate.
In that work, we have forced some marriages of some of Wall
Street's biggest titans, Bear Stearns, AIG, Bank of America and
Merrill Lynch, Morgan Chase, all those. So the question is, are
we posing additional risks by this consolidation in the
marketplace and how do we spread risk as long as this
consolidation is going on, because it appears we are forcing
some of this consolidation.
Mr. Bernanke. Well, I think some consolidation is necessary
in the industry. In particular, in the investment banking
industry, there were real concerns about that model raised by
the recent events, which is part of the reason why Morgan
Stanley and Goldman Sachs have applied to become bank holding
companies.
I think the ``too big to fail'' problem is a very serious
problem, but I think we have to get through this period and
then work through ways to mitigate that problem in the future,
and I have made a number of suggestions along those lines which
I think is very important. That is a very important issue.
Senator Tester. When you have consolidation in any
marketplace, it tends to result in less benefits for the
consumer--this is my perspective, you may disagree--less
benefits to the consumer and need for more regulation. Do you
see both of those things occurring or needing to occur?
Mr. Bernanke. Well, the financial supermarket approach has
benefits and costs. It has some complementarities across
different types of services. It has some market issues, like
you are referring to. I think we need to look at the regulatory
system very extensively, as I said earlier today.
Senator Tester. OK. And the consolidation, do you see it
having an impact, a greater impact on rural America than it
does on urban America?
Mr. Bernanke. I think one of the--in the medium-term, at
least, one of the beneficiaries of these events will be smaller
and community-type banks who have retained those relationships
within their own towns and communities and didn't get into some
of these problems.
Senator Tester. My time has--this is the quickest time in
the world. I cannot believe how fast this time has gone by, and
I apologize. I will just tell you that there is--I am just
going to make a real quick statement.
Chairman Dodd. Senator, you have been patient. Why don't
you take another couple of minutes if you want to?
Senator Tester. I can?
Chairman Dodd. Yes, you can.
Senator Tester. Well, thank you, Mr. Chairman.
Chairman Dodd. I will exercise----
Senator Tester. I appreciate that.
Chairman Dodd [continuing]. Imperial authority I have here.
Senator Tester. Man, you are top flight. I will buy you a
cup of coffee.
[Laughter.]
I want to talk a little bit about foreign entities and
possible dollars going to them. It has been brought up several
times. And I think in your testimony, I heard--and correct me
if I am wrong--that you have been talking to the folks in the
G-8 around the world about the United States's role in propping
up our markets, and have you talked about their role in us
propping up their markets?
Secretary Paulson. Yes. Our system is integrated. We have
clearly talked about their role. They have different policies.
The U.K. had a significant policy action related to their banks
and mortgages. There are actions being taken elsewhere. We are
talking to them. We are urging them. But again, I just want you
to understand that our motive here is not propping up foreign
banks. Our motive here is----
Senator Tester. I understand that, and it is well taken.
But when the taxpayers see us propping up foreign banks, there
are questions that are asked to me and then I ask you
questions. That is the way this process works, I guess.
What is the financial condition worldwide? I mean, and
where I am going with this, just so you know, we passed a bill
here a couple of months ago that we funded a very, very
important project for research that, quite honestly, we are
going to be borrowing money from other countries to fund that
project when other countries in the G-8 should have been
putting in the same kind of money. That is a little convoluted.
But what I am asking is where are the other countries at in
this process, because I think that, unless their economy is--
and you said it is totally integrated, so it is integrated down
on us, too--why aren't they ponying up? Why aren't they
stepping up to the table? Because if we go down, like you say
we could go down, I can't imagine they are going to be in very
good shape.
Secretary Paulson. We didn't say we are going to go down. I
certainly said what we need to do is protect the American
people from a system----
Senator Tester. Bad choice of words. I am sorry.
Secretary Paulson. But I will say this, that all of them
are dealing with their own economies. Economies are slowing
down around the world. We have fragility in the markets around
the world. We have equity markets declining in various parts of
the world. So again, every one of these countries is dealing
with their own situation.
Senator Tester. And so you feel comfortable that they have
stepped up to the plate in a commensurate way?
Secretary Paulson. Well, do I feel comfortable they have
all--I can't speak for every country and every----
Senator Tester. Your assessment.
Secretary Paulson [continuing]. And every----
Senator Tester. Your assessment.
Secretary Paulson. So I can't say that. I say that there
are different approaches to dealing with this with different
situations.
Senator Tester. OK. And I don't want to miss the
opportunity to follow up with Chairman Cox on the whole Bear
Stearns investigation and what went on there and what
transpired and all that. It is still in the back of my mind and
hopefully we can take care of that.
I just, in very quick closing, I want to say this. I
haven't been involved in government all that long, 10 years. I
have been involved in public service at the local level a lot
longer than that. But I can tell you that every time, every
time that I can think of that we made a spur-of-the-moment
decision, that we didn't do our due diligence on, and with the
level of governments I have been involved in, it has been a
wreck.
To quote Senator Menendez, I don't feel a lot of
confidence. I mean, I am not sure we have got the whole
sentence written, much less the ``i''s dotted and the ``t''s
crossed. And I fully feel the urgency, and I know you guys are
frustrated. I am frustrated. Everybody up here is frustrated.
But the truth is that we have to be given the time to do this
right or it is not going to work and we will be back here next
year or in 2 years asking for another $700 billion or more, and
that is a real issue with me because my kids have got to pay
for that.
Thank you. Thank you for being here. I appreciate your
patience.
Chairman Dodd. Senator, thank you very, very much.
Just a couple of points. Let me ask you something, if I
can, Mr. Secretary, that hasn't come up here today. Section 8
of your proposal says the following: Decisions by the Secretary
may not be reviewed by any court of law or any administrative--
order in the room--by any court of law or any administrative
agency. This is rather sweeping, to put it mildly. I am trying
to recall any other example I can think of in my 28 years where
a request has been made of us to basically immunize any agency
from any review.
And it would seem to me that--and I understand, as I
understand, the motivation behind it would be to sort of calm
the markets. We are going to be able to make decisions and they
are not going to be able to be challenged. I almost have the
opposite reaction. It would seem to me it would almost have the
opposite reaction to me. The idea that you are going to have
decisions made that are not subject to review by courts or
agencies is so sweeping that it would be troubling to me, that
you are not going to have that kind of tension that occurs when
decisions are being challenged.
And so, one, I would just tell you, maybe I am speaking for
myself here, there will be real problems with this kind of
language. Now, I understand you want to do some things, but I
have asked the Judiciary Committee and others who spend more
time on this, this language, in my view, cannot last here.
Secretary Paulson. I hear your comment that we need to work
through this. We put this together. It was bare bones. But
again, I will just say to you, this is not a position I wanted
to be in. I didn't want to be in this position. I am the
Treasury Secretary. We moved very quickly to deal with
something and it is very easy to second-guess it and it is very
easy for everyone to--everyone has got to do their job here.
Chairman Dodd. Right.
Secretary Paulson. But we need something that can have
strong oversight. We have got to have the protections. We have
got to have the transparency. You have heard me say that. Would
I like to have months and months to put this together? Yes, I
would. But I don't think that the situation calls for that. And
so what we want to do is have the oversight, have the
protections, but be able to move quickly to implement this.
Chairman Dodd. I hear you.
Secretary Paulson. And again, implementing it does not mean
going out and investing $700 billion immediately.
Chairman Dodd. No, I understand that. But the rule of law
is something that all of us up here, regardless of party, care
deeply about. And the idea that you would ask for such sweeping
authority here, to sweep that aside, I suspect maybe met with
as much concern as I am expressing to you. So I just raise that
with you here. It takes some work. This is a paragraph that is
going to require some work, to put it mildly.
Let me turn to Senator Shelby and we will try to wrap up
here.
Senator Shelby. Thank you, Chairman Dodd.
Chairman Bernanke, have you ever known of any central bank
of any country in the world bailing out foreign banks doing
business in their country other than their own? In other words,
have you ever known any central bank bailing out our banks or
some other banks? I have never heard of it. Now, you are a
student of economic history.
Mr. Bernanke. Well, central banks have an important role as
the lender of last resort----
Senator Shelby. We know that.
Mr. Bernanke [continuing]. To provide liquidity, and we
provide liquidity to any bank that is within the--whose
branches--or, sorry, whose subsidiary is within the boundaries
of the United States and is regulated by U.S. regulators, and
that has been our general policy.
Senator Shelby. We understand that, basically providing
liquidity. But in this, this would provide liquidity, but at a
price. You are talking about buying toxic securities or
securities that there is no market for them from all the banks,
our banks and foreign banks doing business in this country. I
don't--I understand why you are doing that, but I think that is
a bad, bad precedent.
Senator Dodd, I know we are getting toward the end of the
hearing, and I think there are still significant unresolved
issues here. You have brought up several. Foremost is the basic
question regarding whether the plan will actually provide
stability and greater liquidity. I think, as do many of my
colleagues that it appears here today on the Banking Committee,
that the pricing mechanism that we have talked about is the
absolute key to whatever you are doing, assuming you are
playing pass.
Too high and the private money does not return to the
market. There are trillions of dollars--you know this--in the
private market looking for an investment. But they won't return
here if it is not done right. If the price is too low, firms
will become insolvent, fail, and bring instability back to the
market.
Consider this proposition. We spend hundreds of billions of
dollars, maybe a trillion dollars. It leads to the collapse--I
hope not, but it could--of more firms. We have to spend
billions more to recapitalize, among other things, the Federal
Deposit Insurance Fund. There is also the question, as I see
it, Mr. Chairman, as to whether our efforts might be better
directed--something to think about--if we targeted some
resources at homeowners beyond these issues.
I think there are a broad range of questions that haven't
been resolved here and can't be resolved in a short time, such
as taxpayer protection--this goes to the heart of this--GAO
oversight, conflicts of interest, and many others brought
before us today. I think we need better answers and I think
that before we really proceed on this--I don't believe Congress
should just ratify what has been thrown up to them. I
understand the situation is dire, but so is the condition of
the taxpayer out there. And I believe we, as Senators, should
consider this.
And my last statement regarding this, the market is
overwhelmed. I believe some of you used that term, or somebody
did. I think it is overwhelmed by greed, by mismanagement, by
lack of regulatory reform in the past, regulatory oversight.
And the bottom line, as I see it, you are visiting the taxpayer
with it. I think that is shameful, myself. I know there are
better ways. Would it be without pain? Oh, no. There is always
pain. But the best--and Chairman Bernanke, I have heard you say
this, or something to this effect--that the best disciplinary
mechanism we have is the marketplace. The marketplace will
discipline all of us. We are paying, but we learn. I am not
sure people will learn if this goes through.
Thank you, Mr. Chairman.
Chairman Dodd. I see--I know Senator Schumer wanted to ask
one additional question. I presume he is on the way over. But
let me ask Senator Dole if you have a quick question here, or
Senator Corker.
Senator Dole. Yes, just a couple of comments. I want to
underscore, Chairman Dodd, your concerns about the power
assault here, and I would like to ask Secretary Paulson, how
did you or how will you select these so-called unbiased asset
managers? Won't there be a perception of Wall Street helping
Wall Street?
Secretary Paulson. I would say we will design the process
that has as many protections around this as possible to bring
in experts, and we will have the proper oversight. Senator,
that is how we are going to work through this.
Senator Dole. Publicly, you have stated that the long-term
fate of Fannie and Freddie rests with the subsequent Congress
and next administration. In addition, you have expressed that
these GSEs are a relic of the past and burdened by various
conflicts of interest. Given this, before leaving in January,
will this administration commit to releasing its own
recommendations as to what it believes should be the Federal
Government's role in supporting the U.S. mortgage market?
Secretary Paulson. Senator, I have said that in the weeks
or months ahead, that I will express views on different ways to
deal with these conflicts or these ambiguities and some very
specific views.
Senator Dole. Specific written recommendations?
Secretary Paulson. I didn't say written, but I will
certainly express views, because there are--there clearly are
significant issues. There, we had to stabilize the situation to
deal with it, have them continue to play the very important
role they have to play in our economy and our housing markets.
But there is no doubt that the big structural issues have yet
to be dealt with, and there are structural flaws and there are
solutions, in my judgment, to those structural flaws.
Senator Dole. Thank you. Thank you, Mr. Chairman.
Chairman Dodd. Senator Corker, did you have a----
Senator Corker. I think since we are filibustering for
Schumer, I will just----
[Laughter.]
Senator Corker. I know they have to go, and I can't believe
we can keep them unless we are filibustering, but I would just
say to them that I do hope----
Secretary Paulson. We do have to go.
Senator Corker. That is fine.
Chairman Dodd. I know you do.
Senator Corker. Let us end it, then.
Chairman Dodd. Well, let me just say, I just want to make a
couple of quick concluding remarks.
First of all, I just want to--Senator Casey raised about
some modifications to the bankruptcy provisions. We ought to
talk about that, because that could help, I think, on the
mortgage, not to end up in bankruptcy courts, but it is the
incentive to try and do work-outs so you don't end up in
courts, but I will leave that for further discussion.
I hope our witnesses see the value of this. I know it has
taken a lot of time, but it is very important. These are the
people here, at least in this committee, we have been charged
because of jurisdiction to deal with this. And so it is
critically important that my colleagues have a chance to do
this. And through us, the public gets a better understanding of
what is going on. Your answers, I think, have been very good.
They have been further explanation of what needs to be done.
Obviously, there were those who have other ideas, but I think
it has a value and it is important that there be an
appreciation of that.
And again, I can't speak for everyone here, but I think
most of us recognize the gravity of the situation and that it
is important we act. And we are going to need to try and figure
out how to do that. The present system of how we legislate does
not lend itself to a moment like this, where you normally have
this body works, then the other body works, and we meet back
and forth and try and come up with an answer over weeks, in
some cases, months, in some cases.
So I would hope the leadership of our respective bodies,
and I think they are, are thinking about a mechanism by which
we get together. It is not going to do any good just to have
the Secretary negotiating with the House and then try and
negotiate with the Senate. It seems to me we need a different
system right now to begin to go through these ideas and put
together a proposal that may then be adopted by both chambers
and get us to move along. So I am going to recommend that we
have some thought to how that can work.
But again, I think it is extremely important that we work
together on this. And again, my desire here is to try and come
up with something that can work. And so on behalf of all of us
here, we thank you immensely for the time you have spent. It
has been valuable, I think, for the country and valuable for
this committee.
With that, this Committee will stand adjourned.
[Whereupon, at 2:25 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
FROM JAMES B. LOCKHART III
Q.1. Director Lockhart, I was pleased to see your recent
statement affirming your support for the multifamily lending
programs of Fannie Mae and Freddie Mac, and your intention not
to sell the low income housing tax credit interests at either
institution. As you know, Fannie and Freddie are the single
most important sources of financing for affordable multifamily
rental housing, vital to hundreds of thousands of low income
families across the country. The GSEs provide valuable
stability to multi-family rental housing by being active in
this market all the time. Do you agree that this part of the
enterprises' business is fulfilling their liquidity and
stability missions, and that you will continue to support their
financing of this housing, which overwhelmingly serves people
below 100 percent of area median income, and is a significant
contributor to Fannie Mae and Freddie Mac's regulatory housing
goals?
A.1. Yes. Fannie Mae and Freddie Mac historically have provided
valuable stability to the multifamily market by maintaining a
regular presence in the financing of such housing, and they
should continue to do so. Such a presence, however, requires an
innovative and market-oriented approach that reflects the
current financial condition of the Enterprises themselves and
the actual needs of the multifamily market.
Q.2. Given the serious dislocation of the Low Income Tax Credit
market in the absence of Fannie and Freddie investments, are
you planning to permit the companies to reopen that business
line as soon as practicable?
A.2. While we recognize that LIHTC investments have provided
significant assistance to affordable housing markets in the
past, new investments in LIHTC are not economically attractive
for the Enterprises when they are reporting losses. In their
most recent quarterly financial statements, both Enterprises
established valuation allowances for their deferred tax assets,
which are indicative of their potential inability to realize
future tax benefits associated with LIHTC investments.
Part of what needs to be done to assist the LIHTC market is
to broaden participation. Accordingly, FHFA has been working
very hard with the Enterprises to determine how they can play a
key role in achieving that goal. That involves the Enterprises
looking at creative transaction structures, in consultation
with FHFA, as well as conducting outreach to stakeholders,
including housing advocates, lenders, and state and local
housing finance agencies, with the goal of expanding the
universe of these credits. FHFA's meetings with such groups
have been regular, extensive, and productive, and are ongoing.
Q.3. Last year HUD declared the regulatory housing goals
``infeasible'' for both enterprises because of market
conditions. Since then, Congress has adopted a new approach to
the calculation and measurement of the companies' housing
goals, as well as added new ``duties to serve'' specific
populations and markets. I'm sure you agree that given the
current market and the companies' situation it is vitally
important to reaffirm and clarify their housing goals
requirements. What is your plan to quickly issue new
regulations to execute these new provisions and ensure that
both companies have clear direction in meeting these important
requirements, and to publish clear guidance on what FHFA
considers to be the important additional ``duties to serve''
under the statute?
A.3. Given current market conditions, it is vitally important
to reaffirm and clarify the Enterprises' requirements with
respect to housing goals. FHFA has begun the process of
reviewing housing goals for 2009 and will issue proposed goals
for public comment in the first quarter of 2009. In addition,
FHFA has begun the process of implementing regulations to
establish new housing goals, as well as new ``duty to serve''
requirements, for 2010. We expect to issue a proposed
regulation for public comment by the second quarter of 2009 and
to issue a final regulation by the fourth quarter.
Q.4. Over the years the GSEs have provided important services
to populations that are especially hard to serve, such as
Native Americans living on trust lands, and people with special
needs. Fannie Mae also has provided lines of credit and equity
and equity-like investment to community loan funds and
community development lenders. These investments provide
community-oriented lenders with more capital to support
revitalization projects in come of America's hardest hit
communities. They also have developed products such as
Community Express and Modernization Express that help public
agencies finance important public investments in housing. Do
you agree that these specialized lending products are important
extensions of their mission to serve low and moderate income
people and underserved communities, and what role do you
anticipate these specialized and targeted products will play in
their future business?
A.4. Specialized and targeting lending products have made a
significant contribution to the Enterprises' achievement of
their affordable housing mission. FHFA expects that Fannie Mae
and Freddie Mac will continue to develop and market such
products to fulfill that mission in the future, consistent with
safe and sound management of credit risk and maintenance of
adequate capital.
Q.5. Much has been said about the GSEs' affordable housing
mission. Specifically, their mission includes providing
``ongoing assistance to the secondary market for residential
mortgages (including activities relating to mortgages on
housing for low- and moderate-income families involving a
reasonable economic return that may be less than the return
earned on other activities) by increasing the liquidity of
mortgage investments and improving the distribution of
investment capital available for residential mortgage
financing.'' (12 Sec. U.S.C. 1716 and 12 U.S.C. Sec. 1451) The
statute specifically recognizes the need to provide affordable
housing for low- and moderate-income families. It seems to me
that the Affordable Housing Fund and the Capital Magnet Fund
will help ensure that the enterprises fulfill this mission. Do
you agree? Why or why not?
A.5. Section 1337 of the Federal Housing Enterprises Financial
Safety and Soundness Act of 1992, as amended, requires each
Enterprise to set aside an amount equal to 4.2 basis points for
each dollar of the unpaid principal balance of its total new
business purchases as funding for the Housing Trust Fund and
Capital Magnet Fund. Each Enterprise's contributions to those
funds will further its mission of supporting affordable
housing. Section 1337 also authorizes FHFA to suspend the
contributions on a temporary basis. After reviewing the
Enterprises' 3Q 2008 financial results, FHFA exercised that
authority on November 13, 2008, by directing each Enterprise,
until further notice, not to set aside or allocate funds for
the contributions.
Q.6. Director Lockhart, an article in the September 8, 2008
Wall Street Journal stated as follows: ``At both Fannie and
Freddie, so-called Alt-A loans, a category between prime and
subprime, amounted for roughly 50% of credit losses in the
second quarter, even though such loans accounted for only about
10% of the companies' business. Alt-A mortgages include loans
made with less than full documentation of borrowers' income or
assets.'' Is it true that a disproportionate share of Fannie
and Freddie's credit losses are related to mortgage loans that
were made without anyone checking the borrower's income? If so,
do you think it would be prudent, especially now that the
American taxpayer is responsible for insuring loans held by
Fannie and Freddie, for the FHFA to require that Fannie and
Freddie purchase only those mortgage loans for which income
verification has been performed?
A.6. A disproportionate share of each Enterprise's credit
losses have been on Alternative-A (Alt A) single-family
mortgages, which are loans made to borrowers who generally have
limited verification of income or assets or no employer. Fannie
Mae and Freddie have greatly curtailed their purchases of Alt-A
and other low documentation loans in 2008. Beginning in 2009,
neither Enterprise will purchase any such mortgages on a flow
basis (where loans are delivered pursuant to pre-negotiated
contracts and pricing). Acquisitions of pools of such loans on
a negotiated basis will occur only after adequate due diligence
and with appropriate pricing.
Q.7. As I understand it, part of the strategy of the entire
mortgage lending crisis is that it would have been so simple to
verify consumers' incomes. In her April 6, 2008, New York Times
column, Gretchen Morgenson wrote about the IRS 4506-T form,
which is a request for tax transcripts, and how lenders could
have used that form to avoid a considerable part of the
subprime mortgage mess. According to Morgenson's sources,
approximately 90 percent of borrowers signed the form, but
lenders used the form to obtain tax transcripts only 3 to 5
percent of the time--and usually after the loan had closed. Tax
transcripts are prepared by the IRS with data contained in tax
returns, and are therefore unlikely to contain exaggerated
amounts of income. Given that the 4506-T process is cheap and
efficient, do you think IRS tax transcripts should be utilized
to protect the GSEs and therefore the American taxpayer from
bearing the losses for inappropriate mortgages?
Another reason for requiring tax transcripts is that they
provide an easy means for identifying fraud. Section 1379 E of
the Housing and Economic Recovery Act of 2008 contains the
following report requirement:
The Director shall require a regulated entity to submit to the
Director a timely report upon discovery by the regulated entity
that it has purchased or sold a fraudulent loan or financial
instrument, or suspects a possible fraud relating to the
purchase or sale of any loan or financial instrument. The
Director shall require each regulated entity to establish and
maintain procedures designed to discover any such transactions.
A.7. The income verification processes at Fannie Mae and
Freddie Mac have been subject to increased scrutiny by FHFA and
these processes have tightened considerably. Working with FHFA,
the Enterprises have explored the use of a variety of tools,
including IRS forms 4506 and 4506-T, to better verify and
document borrower income. Considering the pros and cons of
those various approaches, the Enterprises have decided to
reduce significantly their purchases of Alt-A mortgages and
other lower documentation loans in 2009 and beyond.
Given the volume of loans Fannie Mae and Freddie Mac
guarantee, it is not operationally feasible for them to
individually review every loan; instead, they rely on lenders
to verify borrower income and assets and other necessary
information. The lenders represent and warrant that mortgages
are eligible for Enterprise purchase; if an Enterprise
identifies a misrepresentation, it requires the lender to
repurchase the questionable loan. Both Fannie Mae and Freddie
Mac now require lenders to verify borrower income, have
increased their quality control reviews, and are issuing
repurchase requests in cases where nonconforming loans are
identified. Such repurchases discourage poor underwriting
practices, including the use of unverified income to establish
borrower eligibility.
Q.8. The FDIC's summer 2007 issue of Supervisory Insights cites
an April 2006 Mortgage Asset Research Institute report for the
fact that ``90 percent of stated incomes [on mortgage loan
application] were exaggerated by 5 percent or more, and 60
percent of stated incomes were inflated by more than 50
percent.'' Given these statistics, do you plan to institute, as
part of your anti-fraud program, a rule requiring Fannie and
Freddie to purchase, re-sell, or otherwise back only loans for
which income verification has been executed and what method
will you recommend for verification?
A.8. Fannie Mae and Freddie Mac are subject to a mortgage fraud
reporting regulation promulgated by the Office of Federal
Housing Enterprise Oversight (OFHEO), one of the predecessor
agencies to FHFA, as set forth in Title 12, Chapter 17, Part
1731 of the Code of Federal Regulations (CFR). That regulation
requires each Enterprise to establish adequate and efficient
internal controls and procedures and an operational training
program to assure an effective system to detect and report
mortgage fraud or possible mortgage fraud. The regulation
defines mortgage fraud broadly in order to give the Enterprises
the flexibility to adapt their internal controls and procedures
to fraudulent practices that may emerge over time within the
industry. FHFA's ongoing examinations include evaluations of
the extent to which the internal policies, procedures, and
training programs of the Enterprises minimize risks from
mortgage fraud and mortgage fraud or possible mortgage fraud is
consistently reported to FHFA.
Fannie Mae and Freddie Mac have also increased quality
control reviews to identify cases of exaggerated income. The
Enterprises are actively requiring lenders to repurchase such
loans. As mentioned in the previous answer, working with FHFA
the Enterprises have decided to significantly reduce the use of
stated income going forward. Any change to that standard will
also require a safety-and-soundness review by FHFA.
Q.9. The 4506-T process for IRS tax transcripts has a proven
track recorded and is currently being utilized by the FDIC in
their efforts to modify loans as the conservator for IndyMac.
In Housing and Economic Recovery Act of 2008, Congress enacted
a requirement pursuant to the HOPE for Homeowners Program that
mortgagors' income be checked via tax transcripts or tax
returns. In the Bankruptcy Reform Act of 2005, Congress
provided debtors the option of producing a transcript of their
tax returns via a 4506-T form in lieu of providing their actual
tax returns to the court. This was to provide consumers
additional privacy protections as well as speed of service.
And, as Housing and Urban Development Secretary Preston well
knows because he used to be the Administration of the Small
Business Administration, the SBA requires a 4506-T form for its
loan applications. Given that this process has been adopted and
recognized so pervasively, do you see any reason that Fannie
and Freddie should not require its use for the loans they
purchase, re-sell, or otherwise deal with?
A.9. As indicated above, Fannie Mae and Freddie Mac have
decided to reduce significantly the use of stated income loans
going forward. The Enterprises give lenders several options for
verifying income, including using tax records for self-employed
individuals. Enterprise lenders use forms 4506 and 4506-T to
obtain borrower permission to request tax transcripts from the
IRS.