[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]



 
                  REGULATORY RESTRUCTURING: BALANCING

                    THE INDEPENDENCE OF THE FEDERAL

                    RESERVE IN MONETARY POLICY WITH


                        SYSTEMIC RISK REGULATION

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



                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON

                        DOMESTIC MONETARY POLICY

                             AND TECHNOLOGY

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                              JULY 9, 2009

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 111-53


                 HOUSE COMMITTEE ON FINANCIAL SERVICES



                  U.S. GOVERNMENT PRINTING OFFICE
53-234                    WASHINGTON : 2009
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing 
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC 
area (202) 512-1800 Fax: (202) 512-2104  Mail: Stop IDCC, Washington, DC 
20402-0001



                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
RUBEN HINOJOSA, Texas                SHELLEY MOORE CAPITO, West 
WM. LACY CLAY, Missouri                  Virginia
CAROLYN McCARTHY, New York           JEB HENSARLING, Texas
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York

        Jeanne M. Roslanowick, Staff Director and Chief Counsel
        Subcommittee on Domestic Monetary Policy and Technology

                MELVIN L. WATT, North Carolina, Chairman

CAROLYN B. MALONEY, New York         RON PAUL, Texas
GREGORY W. MEEKS, New York           MICHAEL N. CASTLE, Delaware
WM. LACY CLAY, Missouri              FRANK D. LUCAS, Oklahoma
BRAD SHERMAN, California             JIM GERLACH, Pennsylvania
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            BILL POSEY, Florida
KEITH ELLISON, Minnesota             LEONARD LANCE, New Jersey
JOHN ADLER, New Jersey
SUZANNE KOSMAS, Florida

                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    July 9, 2009.................................................     1
Appendix:
    July 9, 2009.................................................    45

                               WITNESSES
                         Thursday, July 9, 2009

Berner, Dr. Richard, Chief Economist, Morgan Stanley.............    29
Galbraith, Dr. James K., Lloyd M. Bentsen, Jr., Chair in 
  Government/Business Relations and Professor of Government, LBJ 
  School of Public Affairs, University of Texas..................    28
Kohn, Donald L., Vice Chairman, Board of Governors of the Federal 
  Reserve System.................................................     6
Meltzer, Dr. Allan H., The Allan H. Meltzer University Professor 
  of Political Economy, Tepper School of Business, Carnegie 
  Mellon University..............................................    33
Meyer, Dr. Laurence H., Vice Chairman, Macroeconomic Advisers....    26
Mishkin, Dr. Frederic S., Alfred Lerner Professor of Banking and 
  Financial Institutions, Graduate School of Business, Columbia 
  University.....................................................    24
Taylor, Dr. John B., Mary and Robert Raymond Professor of 
  Economics, Stanford University.................................    32

                                APPENDIX

Prepared statements:
    Berner, Dr. Richard..........................................    46
    Galbraith, Dr. James K.......................................    50
    Kohn, Donald L...............................................    57
    Meltzer, Dr. Allan H.........................................    71
    Meyer, Dr. Laurence H........................................    77
    Mishkin, Dr. Frederic S......................................    83
    Taylor, Dr. John B...........................................    86

              Additional Material Submitted for the Record

Watt, Hon. Melvin:
    Written statement of Thomas F. Cooley, Professor of 
      Economics, Stern School of Business, New York University...    90
    Written statement of the Financial Services Roundtable.......    96
    Responses to questions submitted to Donald Kohn..............   106
    Responses to questions submitted to Dr. Allan Meltzer........   108
    Responses to questions submitted to Dr. Laurence Meyer.......   109


                       REGULATORY RESTRUCTURING:


                       BALANCING THE INDEPENDENCE


                       OF THE FEDERAL RESERVE IN


                          MONETARY POLICY WITH


                        SYSTEMIC RISK REGULATION

                              ----------                              


                         Thursday, July 9, 2009

             U.S. House of Representatives,
                  Subcommittee on Domestic Monetary
                             Policy and Technology,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 1:44 p.m., in 
room 2128, Rayburn House Office Building, Hon. Melvin L. Watt 
[chairman of the subcommittee] presiding.
    Members present: Representatives Watt, Sherman, Green, 
Ellison, Adler; Paul, Castle, Gerlach, Posey, and Lance.
    Ex officio present: Representative Bachus.
    Also present: Representatives Perlmutter and Garrett.
    Chairman Watt. Unfortunately, we have been notified that we 
will have a series of votes, four or five votes pretty soon, so 
we are going to try to get as far as we can into the process. I 
am going to go ahead and get started.
    Let me call this hearing of the Subcommittee on Domestic 
Monetary Policy and Technology to order. Without objection, all 
members' opening statements will be made a part of the record, 
and I will recognize myself for an opening statement, which I 
will try to get in before we get called for votes, and maybe we 
can get the opening statements in before we get the call to the 
Floor.
    This hearing is entitled, ``Regulatory Restructuring: 
Balancing the Independence of the Federal Reserve in Monetary 
Policy With Systemic Risk Regulation.''
    Our current regulatory system, created largely as a 
response to the Great Depression in the 1930's, has proven 
ineffective and outdated at preventing and addressing the 
financial crisis we are currently experiencing. Recognizing 
this, the President recently put forth a proposal for 
comprehensive financial regulatory reform. This hearing will 
examine one aspect of that proposal, the part that proposes to 
delegate to the Federal Reserve Board new powers, including the 
power to serve as the systemic risk regulator for all large, 
interconnected financial firms.
    As the systemic risk regulator, the Federal Reserve would 
be empowered to structure and implement a more robust 
supervisory regime for firms with a combination of size, 
leverage, and interconnectedness that could pose a threat to 
financial stability. This hearing will examine whether and how 
the Fed could perform and balance the proposed new authority as 
systemic risk regulator with its current critical role as the 
independent authority on monetary policy.
    While recent events have caused many to reevaluate and 
question the role and the extent of independence accorded to 
the Federal Reserve, the Fed's independence from political 
influence by the Legislative and Executive Branches of 
Government has long been viewed as necessary to allow the Fed 
to meet the long-term monetary policy goals of low inflation, 
price stability, maximum sustainable employment, and economic 
growth. Most central banks around the world, including the 
Federal Reserve, the Bank of England, the Bank of Japan, and 
the European Central Bank, have had a strong tradition of 
independence in executing monetary policy. Many scholars and 
commentators agree that an independent central bank that is 
free from short-term political influence and exhibits the 
indicia of independence, such as staggered terms for board 
members, exemption from the appropriations process, and no 
requirement to directly underwrite government debt, can better 
execute the long-term goals of monetary policy.
    The important question that our hearing today is focused 
upon is whether the Fed can maintain its current role as the 
independent authority on monetary policy, and take on a new 
role, a significantly new role, as the systemic risk regulator.
    Some scholars and commentators argue that the Fed is 
uniquely positioned to become the systemic regulator because it 
already supervises bank holding companies, and through its 
monetary policy function, helps manage microeconomic policy. 
Others argue that the Fed is already stretched too thin, and 
has strayed from its core monetary policy function, 
particularly by using its powers under section 13(3) of the 
Federal Reserve Act to purchase securities in distressed 
industries under existing emergency circumstances.
    As Congress and the President work to enact financial 
regulatory reform, it is critical for us to examine carefully 
the extent to which proposed new rules may conflict with 
existing roles and whether the Fed can effectively juggle all 
of these roles while performing its vital function as the 
Nation's independent authority on monetary policy.
    For our economy to function effectively, the Fed's monetary 
activities, such as open market operations, discount window 
lending, and setting bank reserve requirements must be 
independent and free from political influence. We need to get a 
clear handle on the extent to which the Administration's 
proposals could compromise or interfere with what the Fed 
already is charged to do.
    I look forward to learning more about how and whether the 
Fed can effectively carry out additional regulatory 
responsibilities while maintaining its current role as the 
independent authority on monetary policy. I now recognize the 
ranking member of the full committee for 4 minutes, Mr. Bachus 
from Alabama.
    Mr. Bachus. I thank the chairman.
    Mr. Chairman, I don't think there is anything that is in 
such sharp contrast as the Administration's proposal for the 
Fed's role and that of the Republicans in the House. We 
particularly object to what we see is allowing the Fed to 
become a permanent bailout agency. We believe that is most 
troubling, and we believe if that is allowed to happen, they 
will sacrifice their independence. It is absolutely impossible 
to make them an independent agency and allow them to function 
as they are and yet give them the opportunity to guarantee or 
loan billions of dollars without substantially increasing their 
accountability and transparency.
    But I do thank you for holding this hearing. Whether 
regulatory power and sweeping new powers really should be 
centralized and given to the Federal Reserve at a time when our 
country is facing unprecedented fiscal, economic, and monetary 
policy challenges, we believe, is very problematic.
    We have some foremost experts, Governor Kohn and our second 
panel, so we look forward to the testimony.
    During the past 2 years, we watched as the Federal Reserve 
has responded to dislocations in the financial markets with 
far-reaching interventions in virtually every corner of our 
economy. To confront the crisis, the Fed has used its emergency 
authority to bail out failing institutions--we believe, 
particularly with AIG and others, but particularly with AIG and 
with some of the auto companies, this was unwise--to provide 
loans and loan guarantees; to revive the credit markets, which 
I think has had success; and lowering the target Fed funds rate 
almost to zero; and more than doubling its balance sheet. 
Regardless of how one views these extraordinary Fed actions, I 
think we all agree that as we go forward, we do need a more 
transparent institution with a more clearly defined role.
    Republicans believe that the Fed's core mission--and I 
stress this--is to conduct monetary policy and that mission 
will be seriously undermined if its supervisory 
responsibilities are dramatically expanded, as proposed in the 
Obama Administration's White Paper. Indeed, the proper role of 
the Fed represents, as I said, the critical difference between 
the Administration's proposal, which would statutorily bless 
what we consider an unwise cycle of bailouts, picking winners 
and losers, and obligating the taxpayers from our plan, which 
does none of those things.
    The Administration would reward past regulatory and 
monetary policy mistakes by giving the Fed the preeminent role 
in regulating the financial system and determining which 
financial institutions are ``too big to fail.'' This stretches 
the Fed's resources; I think we all agree on that. It 
complicates its ability to carry out monetary policy functions 
at a time when our country faces crippling--well, let me say 
this: I believe if we continue to do these things, continue to 
have stimulus packages and deficits, we are going to have 
crippling inflation. And I think the Fed will have its hands 
full dealing with inflationary pressures without being 
distracted and overextended by these new powers.
    The Republican plan would therefore relieve the Fed of some 
of its current regulatory responsibilities and allow it to 
focus on monetary policy missions.
    So thank you very much, Mr. Chairman. But most importantly, 
I am going to close by saying we need to end the bailouts in 
which the Fed has been instrumental, I think, in carrying out 
over the last 18 months, and I mean the ad hoc bailouts of 
individual institutions. Thank you.
    Chairman Watt. The ranking member of the subcommittee, the 
gentleman from Texas, Mr. Paul, is recognized for 4 minutes.
    Dr. Paul. Okay. Thank you, Mr. Chairman.
    And welcome, Chairman Kohn.
    I am delighted you are holding this hearing today because 
it deals with a subject that I have talked about for many 
years, and--we have had earlier discussions, and the Fed's 
position, of course, is that they do reveal a lot of 
information. And even in the testimony that we will hear today, 
they still argue their case for exceptions, the argument being 
that they don't want the independence of the Fed threatened and 
they don't want it to be politicized.
    Well, a lot of us think of independence--we put another 
word in there automatically, that means ``secret'' and 
``clandestine'' and ``serving special interests.'' It is a nice 
word--independence. But politicize, there is no goal, I don't 
have a goal of making it political other than the fact that the 
whole system deserves political attention, and yet it gets so 
little attention; it has not had much attention over these 
many, many years.
    But there is good evidence that it has been politicized 
already. There have been journal articles written and books 
written about how the Fed has been influenced by the Presidents 
over time, and that when a reappointment time was coming up, 
policies were designed to serve certain Administrations. And so 
I would say that to argue the case that it should never be 
politicized is, you know, an argument against what we have, 
because it has been known to be politicized.
    One other point I want to strongly make is, the bill that I 
have offered, H.R. 1207, has been challenged at times, and I 
think it is justified to at least question; and that is, how 
much would my bill affect monetary policy? And it doesn't. It 
doesn't affect it in any way whatsoever.
    We are not looking for the Congress to run monetary policy. 
We just want to know what is going on and why and the 
discussions. Why wait 5 years to hear the debate? There is a 
strong argument made that the sooner the markets know what you 
are thinking and what you are doing and what the plans are, the 
better off you are.
    When I first came to Congress, we weren't even allowed to 
know what the targets were going to be, and the markets--
immediately after the meetings, they agitated, what are they 
doing? They figured it out, and all of a sudden they started 
announcing it. It wasn't the end of the world, yet they argued, 
well, no, you are not allowed to know.
    There is a strong argument now that the more we know about 
what has been going on in this last year, the more it would 
have helped the markets. It is the unknown. And that is why we 
need a much more open Fed.
    And the people are demanding it. They want transparency. 
``Transparency'' is a good word, but to say that a little bit 
of transparency is good, but we can't have a lot of it, there 
are certain things we don't want you to know--what we are doing 
when we are talking to foreign central banks, foreign 
governments, international organizations; what kind of 
agreements do we have with the IMF?
    We have an obligation, a moral obligation, here in the 
Congress to know exactly what the agreements are. And we are 
not doing this to preempt anything. This is the reason why the 
support for this bill that I have is now up to 255, and it is 
across-the-board--liberals, conservatives, progressives, 
populists, libertarians, they are supporting this because--and 
there is no agreement among those groups of what monetary 
policy ought to be.
    They don't want to make it a political football. They are 
not asking for Congress to participate in FOMC meetings, but to 
know what the strategy is and what the plans are. That is 
legitimate information, and we shouldn't be afraid of it. We 
shouldn't be afraid of the truth.
    There have been arguments over the years made about 
transparency. And I can give quotes--and may later--quotes from 
Alan Greenspan, how important. And when you look at those 
quotes generically, they are very, very good. But when it comes 
down to the bottom line, they say, well, we want you to know 
what is going on on the unimportant things, but when it comes 
to the important things, we want secrecy.
    I yield back.
    Chairman Watt. I thank the gentleman for his opening 
statement. The gentleman from Delaware, Mr. Castle, is 
recognized for 1 minute.
    Mr. Castle. Well, thank you, Mr. Chairman. I have sort of 
enjoyed these opening statements because I happen to agree with 
all sides and all positions being taken by everybody.
    And let me just say, Mr. Watt, that I agree with you. I 
think you have asked the basic, right question that a lot of us 
are concerned about, and that is, can the Federal Reserve 
maintain its role in shaping monetary policy at the same time 
that it is expanding itself is to cover systemic risk in this 
country? I think that is a very serious question that needs to 
be answered, and I certainly couldn't answer it now.
    I don't know if we can get that answer today, but we need 
to continue to work on that.
    But I would add another element to that, and that is all 
the bailouts, whatever you want to call them, that have been 
going on beyond just the monetary policy issue under Section 
13(3). I mean, there is a lot of money that the Fed, without 
any constrictions from the Congress, has been putting forth to 
help these various entities. And I am not necessarily being 
critical of that, but I am very concerned about the role of the 
Fed and how it has expanded.
    I happen to agree with Mr. Paul. Mr. Paul and I don't 
always agree, but I happen to agree with him with respect to 
his legislation and with the idea that we do need more 
transparency from the Fed. I think that would help a lot of us 
in terms of understanding and perhaps embracing some of this. I 
think his legislation, which I believe is H.R. 1207, is 
actually very positive legislation.
    I think it is interesting to see the number of cosponsors 
that he has. I think a lot of other people feel that perhaps 
the time has come for the Federal Reserve to be more 
transparent in terms of what it is doing.
    But I think we need a clear, coherent vision of exactly why 
the Federal Reserve would be the right choice if we are going 
to have a systemic risk regulator, which I happen to believe in 
conceptually. But I am not 100 percent sure that the President 
and others who advocate this have targeted the right source to 
do it, and hopefully we can start to work that out today.
    Thank you, Mr. Chairman. I yield back.
    Chairman Watt. I thank the gentleman for his opening 
statement.
    The rules provide for 10 minutes per side for opening 
statements. The Republican side has 1 more minute, so I am 
going to yield it to Mr. Paul.
    Dr. Paul. Thank you, Mr. Chairman. I probably won't use the 
entire minute, but it gives me my opportunity to quote Alan 
Greenspan.
    In a speech in 1996, Alan Greenspan was addressing this 
subject, and he said, ``If we are to maintain the confidence of 
the American people, it is vitally important that the Fed must 
be as transparent as any agency of government. It cannot be 
acceptable in a democratic society that a group of unelected 
individuals are vested with important responsibilities without 
being open to full public scrutiny and accountability.''
    And I know those terms are general, and he probably might 
disagree with a little bit of my bill, but those are good 
words. And I am just carrying through on that because I think 
it is so important for the American people to know.
    I mean, the protectors of the value of our currency are all 
powerful, and we need to know everything conceivable about how 
that policy is designed. We don't want to set the policy, but 
what we want to know is how it has been done and whose 
interests are being served.
    Chairman Watt. I thank the gentleman for his opening 
statement. I thank all parties for their opening statements.
    Mr. Perlmutter is here. He is not a member of the 
subcommittee. We welcome him. I haven't recognized him for an 
opening statement, but we are going to proceed without 
recognizing him for an opening statement.
    We are delighted today to have on the first panel the only 
witness, Mr. Donald Kohn, the Vice Chairman of the Board of 
Governors of the Federal Reserve.
    Without objection, Vice Chairman Kohn, your written 
statement will be made a part of the record, and you will be 
recognized for 5 minutes to summarize your testimony. I now 
recognize you for your statement.

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

    Mr. Kohn. Thank you, Chairman Watt, Ranking Member Paul, 
and members of the subcommittee. I do appreciate this 
opportunity to discuss with you the important public policy 
issues associated with the Congress' grant to the Federal 
Reserve of a substantial degree of independence in the conduct 
of monetary policy and the interaction of this degree of 
independence with the possible enhancement of our 
responsibilities for financial stability.
    A well-designed framework for monetary policy includes a 
careful balance between independence and accountability. In 
1977, the Congress amended the Federal Reserve Act by 
establishing maximum employment and price stability as our 
monetary policy objectives. At the same time, the Congress has 
correctly, in my view, given the Federal Reserve considerable 
scope to design and implement the best approaches to achieving 
those statutory objectives, subject to a well-calibrated system 
of checks and balances in the form of transparency and 
accountability to the public and the Congress.
    Considerable experience shows that this approach tends to 
yield a monetary policy that best promotes economic growth and 
price stability. Operational independence, that is, 
independence to pursue legislative goals, reduces the odds on 
two types of policy errors that result in inflation and 
economic instability. First, it prevents governments from 
succumbing to the temptation to use the central bank to fund 
budget deficits; and second, it enables policymakers to look 
beyond the short term as they weigh the effects of their 
monetary policy actions on price stability and employment.
    The current financial crisis has clearly demonstrated the 
need for the United States to have a comprehensive and 
multifaceted approach to containing systemic risk. The 
Administration recently released a proposal for strengthening 
the financial system that would provide new or enhanced 
responsibilities to a number of Federal agencies, assigning to 
the Federal Reserve certain new responsibilities for overseeing 
systemically important financial institutions and payment 
clearing and settlement arrangements. These incremental new 
responsibilities are a natural outgrowth of the Federal 
Reserve's existing supervisory and regulatory responsibilities.
    The Federal Reserve already regulates bank holding 
companies, which now include large investment banks, and we 
have been moving to incorporate a more macroprudential approach 
to our supervision and regulatory programs, as evidenced by the 
recently completed Supervisory Capital Assessment Program.
    The Federal Reserve has also long been a leader in the 
development of strong international risk management standards 
for payment clearing and settlement systems, and we have 
implemented these standards for the systems we supervise. In 
our supervision of bank holding companies, and our oversight of 
some payment systems, we already work closely with other 
Federal and State agencies. These responsibilities and close 
working relationships have not impinged on our monetary policy 
independence, and we do not believe that the enhancements to 
our existing supervisory and regulatory authority proposed by 
the Administration would undermine our ability to pursue our 
monetary policy objectives effectively and independently. Our 
independence in the conduct of monetary policy is accompanied 
by substantial accountability and transparency.
    For instance, the Federal Reserve reports on its efforts to 
achieve its statutory objectives in the semiannual monetary 
reports and associated testimony. The Federal Open Market 
Committee releases a statement immediately after each regularly 
scheduled meeting and detailed minutes of the meeting on a 
timely basis. We publish summaries of the economic forecasts of 
FOMC participants 4 times a year, and Federal Reserve officials 
frequently testify before the Congress.
    In addition, the Federal Reserve provides the public and 
the Congress with detailed annual reports on the consolidated 
financial activities of the system. These are audited by an 
independent public accounting firm. We publish a detailed 
balance sheet on a weekly basis.
    This year, we expanded our Web site to include considerable 
background information on our financial condition and our 
policy programs. We recently initiated a monthly report to 
Congress on Federal Reserve liquidity programs that provides 
even more information on our lending, associated collateral, 
and other facets of the programs established to address the 
financial crisis.
    The Congress also recently clarified the GAO's ability to 
audit the Term Asset-Backed Securities Loan Facility, a joint 
Treasury-Federal Reserve initiative, and it granted the GAO new 
authority to conduct audits of the credit facilities extended 
by the Federal Reserve to single and specific companies under 
the authority provided by Section 13(3) of the Federal Reserve 
Act.
    As this committee is aware, the Federal Reserve is already 
subject to frequent audits by the GAO on a broad range of our 
functions, including, for example, supervision and regulatory 
functions. The Congress, however, has purposefully and for good 
reason excluded monetary policy deliberations and operations 
from the scope of potential GAO audits.
    The Federal Reserve strongly believes that removing the 
statutory limits on GAO audits of monetary policy matters would 
be contrary to the public interest. Financial markets likely 
would see the grant of such authority as tending to undermine 
monetary independence, and this would have adverse consequences 
for interest rates and economic stability.
    An additional concern is that permitting GAO audits of the 
broad facilities the Federal Reserve uses to affect credit 
conditions could reduce the effectiveness of these facilities 
in helping promote financial stability, maximum employment, and 
price stability.
    Thank you, Mr. Chairman, for inviting me to present the 
Board's views, and I look forward to answering your questions.
    [The prepared statement of Vice Chairman Kohn can be found 
on page 57 of the appendix.]
    Chairman Watt. I thank the gentleman for his testimony.
    The bad news is that we just got called for at least five 
votes on the Floor of the House. The good news is that once we 
get through this series of votes, we will probably be able to 
proceed uninterrupted through the balance of this witness and 
the next panel, we hope, although it is a little dicey on the 
Floor today.
    So I would at this point declare the subcommittee in 
recess, subject to the call of the Chair, and encourage the 
members to please return promptly after the last vote on the 
Floor in this series of votes. I hate to inconvenience all of 
the witnesses, but I guess you all have been through this 
before, so you know how it works.
    The committee stands in recess.
    [recess]
    Chairman Watt. We will reconvene now. I will recognize 
myself for 5 minutes to ask Mr. Kohn questions.
    I am interested in getting a better understanding of what 
your view is of what specific things a systemic risk regulator 
does, so let me start there--or would do, I guess, to make it a 
theoretical question as opposed to a--
    Mr. Kohn. Chairman Bernanke has made a useful distinction 
between microprudential regulation and macroprudential 
regulation. And microprudential regulation is looking at each 
individual institution and making sure they are robust and 
resilient and safe.
    In a macroprudential context, you want to look at not only 
the individual institutions, but how they relate to each other 
and how they relate to the system as a whole. And sometimes it 
is not so much the size of the institution, but its 
interconnectedness--whether it is at the center of a web of 
relationships which, if disrupted, would have knock-on domino 
effects.
    So I think the job of the systemic risk regulator would be 
to take account of those interrelationships--the markets and 
how they are developing, and the institutions and how they fit 
into the markets--and look at the overall risk to the system as 
well as the risk of the individual institution, how that fits 
in.
    And I think the Federal Reserve is well positioned to play 
a role in that. We have not only our supervisory authority over 
bank holding companies, which now include all the major 
investment banks, but we have staff who are familiar with 
markets, the macro economy, and have responsibility for 
financial stability of the system through our lender-of-last-
resort facilities.
    So I think it requires a little bit of a different 
perspective than we are used to exercising. And I think the 
Fed's in good position to do that.
    Chairman Watt. Not unexpectedly, you focused on the 
synergies that exist between the two responsibilities. Let me 
ask you if you could candidly focus on the prospects or 
possibilities of conflicts.
    What are the areas in which those possibilities of 
conflicts might arise?
    Mr. Kohn. I think there are minimal possibilities. I think 
some people have asked whether, if we see a systemic risk from 
the individual institution, that would affect our monetary 
policy deliberations. But in my view, I think there really is a 
congruence between the stability of the financial system and 
monetary policy. We can achieve our objectives of maximum 
employment and stable prices much more readily in a stable 
financial system. So I just don't see important instances in 
which there would be conflicts.
    Chairman Watt. What kind of staff would you anticipate 
would be necessary, additional staff would be necessary, to 
perform the systemic risk regulatory function versus what you 
are already doing?
    Mr. Kohn. Recalling that in our view, the systemic risk 
regulatory function that the Treasury has suggested for us is 
an incremental change to what we are doing now, it is not a big 
change, because we already have the systemically important 
institutions under our authority.
    I think it would require some more staffing, both on the 
side of the economists and the side of the supervisors, to 
evaluate systemic risk in a more systematic way, but I don't 
think this is a major change in our responsibilities that would 
require a substantial increase in what we are doing.
    Now, we have had to staff-up over the last year because we 
have several large investment banks, for example, that are now 
bank holding companies, and we have had to change and adapt to 
our new responsibilities. And we are doing that.
    Chairman Watt. My time is about to expire. Actually, it 
just did.
    But let me just squeeze in, because one comment you just 
made raised somewhat of an interesting question, because I had 
understood that a lot of the jurisdiction that you would be 
assuming for systemic risk regulation is not in existing 
entities that you already regulate.
    You said that you have all of these systemic risk 
regulators already under your supervision. Is that, in fact, 
the case?
    Mr. Kohn. I don't know that we have all of them, Mr. 
Chairman. I think that would be something that in consultation 
with this council--remember that the Treasury is setting up a 
council of regulators to look at the systemic implications of 
the markets and the institutions. We would consult with them as 
to whether they saw some institutions that weren't currently 
under our purview that were systemic. But at this point, I 
think that would be very, very few institutions.
    Chairman Watt. I thank you. My time has expired.
    And I will recognize the gentleman from Texas for 5 
minutes.
    Dr. Paul. Thank you, Mr. Chairman.
    Sometimes definitions of words are pretty important, and I 
alluded to that in my opening statement, about what 
``independent'' might mean to others.
    For me, independent usually is a code word for ``secret,'' 
so we can't get the information. But one of your arguments for 
the independence of the Fed or the secrecy of the Fed is that 
those central banks that do have independence--and they are 
less monitored in public, they tend to have lower and more 
stable rates of interest--but how can you compare that to what 
we have noticed under the Federal Reserve?
    You know, I remember when I first started looking at what 
the Federal Reserve was doing, we had 21 percent interest 
rates. That sort of got my attention. And today we have 
interest rates of less than 1 percent.
    So that is hardly stable. And to me, the real mischief 
comes not only because they are unstable and they fluctuate 
radically, but also the mischief it causes because these are 
artificial.
    I am a believer that interest rates, like prices, should be 
set by the marketplace. And control of prices and wages is the 
most serious abuse you can put onto an economy. And yet this 
fixing of prices seems to give us this trouble. And even the 
Secretary of the Treasury now, Mr. Geithner, you know, just a 
few months ago recognized that during the time he was in the 
Fed, the Fed kept the interest rates way too low for too long.
    So how can you defend the Fed's maintaining independence or 
secrecy in order to maintain stable rates and to even try to 
achieve a stable economy which--obviously, nobody argues we 
have a stable economy?
    Mr. Kohn. So I do not equate independence to secrecy. In 
fact, I agree with the underlying premise, I think, of your 
question, which is independence and secrecy in a democratic 
society are antithetical. And I think the Federal Reserve has 
been quite transparent and has become much more transparent 
under Chairman Bernanke about what we are doing and why we are 
doing it. And I think we can retain our independence and your 
ability to trust what we are doing only by explaining to you 
what we are doing and why we are doing it.
    We have not only the statements, which you mentioned in 
your opening statement, after every meeting explaining what we 
did and why we did it, but we also have minutes. You have 
hearings. There are Monetary Policy Reports. There are other 
hearings that you hold.
    So I think there are many, many opportunities for us to 
explain why we are doing what we are doing. And those 
opportunities and that transparency is absolutely essential for 
retaining our independence.
    Dr. Paul. Okay. But I still think we can do better. Like I 
mentioned early on, there was a time when the Fed did not 
reveal immediately what their targets were.
    Mr. Kohn. That is right.
    Dr. Paul. Why can't we consider releasing the details, 
instead of in 5 years, why not in 5 weeks? What is the big deal 
that you have to have this information?
    And the other argument you use: It is in the public's 
interest, that one really baffles me. The public is served by 
you having more information that we don't have access to unless 
it is maybe 5 years? It seems like there are other interests; 
it allows the suspicion to build.
    Whose interests are you really protecting? Because you say, 
it is the public's interests, I don't think reassures a lot of 
people, because all of a sudden we think, well, what are you 
doing? Are you protecting the bankers' interests? Are you 
protecting some international--another government, another 
central bank or what? So I don't see how you can protect the 
public's interest.
    It seems like we in the Congress should have the 
responsibility for protecting the public interest by knowing 
more about what you are doing.
    Mr. Kohn. Within 3 weeks, Congressman, we release minutes 
of our meetings, which give detailed explanations of why we did 
what we did, including the arguments back and forth, the 
minority opinions if people disagree.
    I think you are talking about transcripts, which we release 
after 5 years. I would be very concerned that releasing those 
transcripts earlier would inhibit debate. I think it is in the 
public interest that we have an unfettered debate within the 
Open Market Committee and that we are able to speculate among 
ourselves--what if we did this, what if we did that, where are 
things going--that there be no inhibition on the back-and-forth 
within the Open Market Committee.
    I have been at the Federal Reserve for several decades now, 
and in my view, publishing the transcripts themselves has had a 
somewhat inhibiting effect on the way the debate is carried 
out. There are many more prepared statements read at Open 
Market Committee meetings now than before the transcripts were 
published.
    Participants would be very worried if their remarks were 
going to be made public very, very quickly. They would be very 
worried about what they would say, and they would be much more 
careful about what they are saying. And that is not in the 
public interest, provided we are willing to explain to you, as 
we are, why we did what we did and what the minority views are. 
And we do do that.
    Dr. Paul. Of course, you know, without an audit we never 
know.
    It just seems that it would be of benefit to us to know 
what the detailed discussion is. Why is there any value? I just 
don't quite agree with that, because it is really the 
discussion that we have. Like I made my point in the opening 
statement, this is after the fact. This is after you have had 
your meeting; it is after you have done something.
    And also, the more information the market gets, the better 
the market operates. And if they know what you are thinking 
about and what you are planning--you know, 5 years for the 
minutes is really way too long.
    Chairman Watt. The gentleman's time has expired, but the 
witness may answer.
    Mr. Kohn. Well, I think we do explain what we are doing and 
why we are thinking what we are thinking within 3 weeks. And 
you have ample opportunity to question Chairman Bernanke when 
he comes up for hearings about why he is doing what he is 
doing.
    We would be glad to work with you on how your ideas about 
how we could be more transparent and more helpful.
    I agree with you that for the most part transparency, where 
it doesn't inhibit debate and exchange of ideas, is better for 
the public. And we have taken huge steps in that direction over 
the past 3 years.
    Chairman Watt. The other gentleman from Texas, Mr. Green, 
is recognized for 5 minutes.
    Mr. Green. When you say, ``the gentleman from Texas'' and 
don't say which one, many microphones are opened up. Thank you, 
Mr. Chairman.
    I thank the witness for his testimony. And I apologize for 
not being here to hear you in your entirety in terms of your 
testimony.
    There are those who would like to have an independent Fed. 
Obviously, that has worked well. The autonomy of the Fed has 
inured to our benefit. And there are those who contend that if 
the Fed acquires these new powers and remains as independent as 
it has been, then the Fed becomes this awesome giant that would 
be beyond the control of Congress, of the Executive and 
Legislative Branches.
    How do you respond to those folks who conclude that this is 
risky, to give the Fed this much power?
    Mr. Kohn. I think there are two avenues for response, 
Congressman. One is the additional authority we are getting is 
incremental to what we already have, so it is not a huge 
increase in our authority.
    And the second is, for the authority we already have, we 
are held accountable. We work closely with other agencies, with 
the FFIEC, with the other regulatory agencies, on the 
President's Working Group, with the Treasury.
    The Government Accountability Office does audit our 
activities in the supervision and regulation area; they perform 
many audits like that. So we have been able to do that and be 
held accountable, work with other Agencies without sacrificing 
the independence that we need to exercise for monetary policy.
    So I think we are already doing it, and this wouldn't be 
that big a change.
    Mr. Green. How would the H.R. 1207 audit differ from the 
GAO audit?
    Mr. Kohn. I am not sure. The H.R. 1207 would do what? That 
is Mr. Paul's?
    Mr. Green. That is the audit bill that Mr. Paul--
    Mr. Kohn. As I understand it, and I don't understand it 
perfectly, but I think it would make everything we do subject 
to GAO audit.
    Right now, since 1978, the GAO has been able to audit most 
of our activities except where they touch monetary policy and 
our interactions with foreign central banks and foreign 
authorities. And I think Mr. Paul's bill would remove that 
exemption, so the GAO would be auditing our monetary policy as 
well as all the other things we would do.
    Our concern is that would be perceived as impinging to some 
extent on our independence to meet the objectives that you have 
given us for price stability and full employment.
    Mr. Green. And as a final question, how can Congress--if 
you have an opinion--be of assistance in making this transition 
if the transition is to take place? Is there something more 
that we need to do to help you transition to the regulatory 
reform side?
    Mr. Kohn. No. I think the hearings that you hold and mutual 
understanding of what is involved in this, with us and the 
Treasury and others who want to make this transition, you have 
every right, and you ought to be asking us, as the chairman 
did, what additional resources we would need in order to do 
this, how we would carry this out.
    So I think a dialogue between the Congress and the Federal 
Reserve is not only appropriate, but would be very useful to 
define what this is about.
    Mr. Green. Thank you.
    Thank you, Mr. Chairman. I will yield back.
    Chairman Watt. The gentleman yields back the balance of his 
time.
    Mr. Adler, the gentleman from New Jersey, is recognized for 
5 minutes.
    Mr. Adler. Thank you, Mr. Chairman.
    Mr. Vice Chairman, you a moment ago articulated Congress' 
mandate to the Federal Reserve with respect to maximum 
employment and to price stability.
    To what extent, if any, do you think additional 
responsibility as a systemic risk regulator would in any way 
distract the Federal Reserve from its 1977 congressional 
mission?
    Mr. Kohn. Congressman, I don't think it would distract us 
at all. I see the two missions, the macroeconomic goals of 
price stability and maximum employment and systemic stability 
as being completely congruent. I think the more stable the 
financial system is, the easier it will be for us to pursue 
successfully the goals of maximum employment and stable prices.
    Certainly we have seen a demonstration of that in the last 
2 years. The instability in the financial system has resulted 
in very high unemployment and has made it very difficult for 
the Federal Reserve to reach our objectives of maximum 
employment and stable prices.
    So I don't see a conflict between those types of 
objectives.
    Mr. Adler. You heard the gentleman a moment ago ask 
questions about the potential lack of accountability of the 
Federal Reserve as a sort of private entity, not completely 
under government control. Others have been concerned there is 
too much political interference with the Federal Reserve in the 
carrying out of its mission.
    I wonder if you could comment about what additional 
political interference you think the Federal Reserve might 
encounter if it undertakes this responsibility as a systemic 
risk regulator.
    Mr. Kohn. I think we can separate our accountability as a 
systemic risk regulator from our independence in carrying out 
your goals for monetary policy. So I don't see additional 
political interference with the objectives that you gave us.
    We will be accountable as the systemic risk regulator. We 
will be accountable through the Government Accountability 
Office. We will be accountable to the Congress. We will be 
working closely with those other regulators in the financial 
system.
    And we have been successfully doing that for years, and 
this would sort of increase our interactions, but I don't think 
there should be a risk that giving us this additional authority 
would impede our monetary policy independence.
    Mr. Adler. Mr. Vice Chairman, I thank you.
    Mr. Chairman, I yield back the balance of my time.
    Chairman Watt. The gentleman yields back the balance of his 
time.
    We welcome Mr. Gerlach from Pennsylvania, and recognize him 
for questions, if he has any.
    Mr. Gerlach. None right now. Thank you.
    Chairman Watt. And we welcome the gentleman from 
California, Mr. Sherman, and recognize him for questions, if he 
has any.
    Mr. Sherman. I do.
    Chairman Watt. The gentleman is recognized for 5 minutes.
    Mr. Sherman. Mr. Vice Chairman, I think you are aware of 
13(3) of the Federal Reserve Act.
    Mr. Kohn. I am.
    Mr. Sherman. It is breathtaking in its scope, but even more 
breathtaking in the amounts.
    I have talked to your Chairman. Almost facetiously, I asked 
him whether a $12 trillion limit on the total exposure under 
13(3) would be acceptable to him, and believe it or not, he 
said yes.
    Chairman Bernanke has interpreted before this committee 
13(3) as allowing the Fed only to take risks that are the 
equivalent of triple A, that is to say, only to extend the 
credit of the Federal Reserve under that section where there 
was the lowest risk that a credit rating agency would evaluate.
    Do you agree with that constrained view of 13(3) or not?
    Mr. Kohn. Under section 13(3), the Reserve bank making the 
loan needs to be secured to its satisfaction. We have insisted 
on security on every loan that we have made. We have been 
releasing more and more information about those loans.
    I think, for the most part, those loans are safe. The 
credit risks--
    Mr. Sherman. I am asking you not for your prior practice 
but for your legal interpretation.
    Let's say that the Secretary of the Treasury called you in 
the middle of the night and said, ``By God, we need another 
$700 billion to shore up institutions on Wall Street. We need 
to do it right now or the entire world comes to an end; and 
those idiots in Congress, they won't vote for another TARP. So 
the only way we are going to save civilization as we know it is 
for the Fed to take some substantial risks and become a general 
creditor of banks that would otherwise become insolvent and 
other financial institutions.''
    Do you believe that you or your successors have the legal 
right to say, ``Yes, Mr. Secretary, we couldn't agree with you 
more; we will have a vote on it and we will extend the 
credit?''
    Mr. Kohn. I think we need a new resolution authority 
through the Congress.
    Mr. Sherman. I am not asking you what new law should be 
passed. I am not asking you what your practice has been in the 
past.
    I am asking you what are the legal authorities you have 
under present law right now?
    Mr. Kohn. We need to be secured.
    I think one of the issues is--
    Mr. Sherman. So you can't take a double A risk; you can 
only take a triple A risk?
    Mr. Kohn. We need to have enough security that we feel that 
the loan has good prospects of being repaid, that we are not 
taking fiscal risk.
    Mr. Sherman. Let's say you were buying paper that if you 
worked for a credit rating agency, you would rate at single A. 
Is that the kind of risk that you are legally allowed to take 
under 13(3)?
    Mr. Kohn. Only if it is discounted to an extent so that the 
collateral value would be less than the par value.
    And that is what we do. We take paper at the discount 
window that isn't triple A, but we don't give it full par 
value; we discount it. And I think we protect the public purse 
in that way.
    Mr. Sherman. It sounds like you have the power to do 
another TARP almost, but not quite.
    Shifting to another direction, in a democracy it is 
supposed to be one person, one vote. Every institution of the 
government is supposed to reflect the results of elections held 
in polling booths. Yet you have these--at least your regional 
Boards of Governors are selected on the basis of--I will call 
it ``one bank, one vote,'' to oversimplify.
    Does it make any sense to invest with the image of 
governmental power, and everybody--I mean, you can say there is 
a difference between the Fed and the branches of the Fed, 
although throughout business, ``branch'' means, in effect, 
another office, not even a separately incorporated subsidiary, 
so most of the world is going to view your branches as part of 
your tree.
    Do you think it is appropriate to have privately elected 
Governors serve in what appears to everyone to be a 
governmental capacity?
    Mr. Kohn. The boards of directors of the Reserve banks have 
served a valuable function in the Federal Reserve.
    Mr. Sherman. Well, sir, in Germany before World War I, they 
had what many people thought was a very good government, but 
your voting power, your control over government agencies 
depended upon how rich you were. And you can argue it was a 
very good government that made very good decisions right up 
until Sarajevo.
    I am not asking you whether it is good government--whether 
you have made good decisions. What I am asking is, is it 
consistent with what we celebrated on the 4th of July to have 
such governmental power in the hands of those elected on the 
basis of one bank, one vote?
    Mr. Kohn. I think Congress, from 1913 on, has considered it 
consistent with its authorities and how it wished to carry them 
out.
    Mr. Sherman. That is before we gave you the enormous 
additional power we are considering.
    Chairman Watt. The gentleman's time has expired.
    Mr. Sherman. I yield back.
    Chairman Watt. And while I would be a lot more generous, we 
have a little time bind that we are operating in.
    The gentleman from Delaware, Mr. Castle, is recognized.
    Mr. Castle. Thank you, Mr. Chairman.
    Mr. Kohn, I am concerned about conflicts here. As you deal 
with the 13(3) bailouts, or whatever you want to call them, and 
as you deal with monetary policy, and then you, the Fed, would 
get into the systemic risk regulator issue, do you at least see 
the potential for--and if you do, could you articulate what it 
would be--for conflicts of interest in terms of the different 
responsibilities the Federal Reserve would have if you had all 
those powers?
    Mr. Kohn. Congressman, no, I really don't see the potential 
for major conflicts here. I think we carry out our monetary 
policy mission much more easily in a systemically sound 
financial system.
    We have seen the demonstration of that over the last 2 
years, what happens when the system isn't sound. It makes it 
very, very difficult for us. On the other hand, I don't see us 
using our monetary policy authority in any way that wouldn't be 
consistent with the objectives you gave us for macroeconomic 
stability and price stability.
    So I really think the two are congruent, not conflicting.
    Mr. Castle. I mean, I interpret from your opening 
statement, and what you have been saying is that the Board of 
Governors of the Fed welcome this responsibility--at least you 
seem to.
    Is there any conflict at all among the Board or discussion 
about, should we be doing this or is it better left to an 
independent agency or some other agency?
    Mr. Kohn. I think members of the Board have had different 
views about a broad grant of authority, but--I haven't polled 
all the members of the Board.
    Mr. Castle. I am not asking you to speak for them, just 
what you observed.
    Mr. Kohn. I see this as an incremental change from where we 
are right now, and, therefore, I am not aware of any dissent on 
the Board about the particular proposal that the Treasury has 
made.
    Before the Treasury made the proposal, there was a lot of 
discussion of some systemic risk regulator with unspecified 
authorities and unspecified responsibilities. I think there was 
concern on the Board, which I shared, that it was impossible to 
carry the responsibilities out because we didn't have the 
authorities and because the expectations were way too high in 
terms of what was possible in a market economy that naturally 
has ups and downs.
    But I see the proposal on the table as more modest, which 
is taking what we currently do, but giving a little more 
macroprudential shape to it, thinking about the implications 
and being sure that the core institutions, the ones that have 
caused the problems that have given rise to what you call the 
``bailouts,'' are safe and are not subject to the kinds of 
risks and the kinds of knock-on effects to the rest of the 
market that have caused us to intervene this time.
    Mr. Castle. How would you interact with other regulatory 
bodies that have jurisdiction over some of these entities, be 
it an SEC or whatever it may be? How do you think that would 
fundamentally work?
    Mr. Kohn. We would work closely with them. We already do 
work with the other banking regulators on FFIEC. We would be 
part of this council that the Treasury has looking at systemic 
risk and identifying systemic activities, systemic problems.
    We have close working relationships with the SEC, and I see 
that continuing. We basically rely on them for supervision of 
the individual institutions. But I think this would give us 
some authority to make sure not only that the individual 
institution is safe, but that the system is safe, too.
    Mr. Castle. What would be your responsibility with large 
insurers, hedge funds, and even private equity-type funds as 
you view it if you were to be under this legislation given that 
responsibility?
    Mr. Kohn. It would depend upon whether those entities were 
considered systemically important. And to the extent that they 
weren't systemically important, we would have no particular 
authority over them.
    To the extent that they were, after consulting with the 
council, which would have the responsibility for identifying 
these issues, I think if we saw there was a gap in regulation 
that threatened the stability of the financial system, it would 
be up to us to try and fill that gap.
    Mr. Castle. I don't know this, but I would assume, because 
insurance is generally regulated at the State level, that you 
get into that whole issue of State-Federal. I don't know if you 
discussed that or not.
    Mr. Kohn. Right. But I think your proposal is to create a 
Federal entity, isn't it?
    Mr. Castle. Well, it is being discussed.
    Mr. Kohn. I think the problem perhaps isn't so much the 
insurance companies; at least thinking back to our very bad 
experience with AIG, it wasn't the insurance companies, it was 
the stuff that was going on next to the insurance companies. 
And I would hope if we saw something like that happening, we 
would find a way of containing that risk.
    Chairman Watt. The gentleman from Minnesota.
    Mr. Ellison. Thank you, Mr. Chairman. And I thank the 
chairman for calling for this work. Do you believe it is 
appropriate for the Fed, particularly in light of the systemic 
risk?
    Mr. Kohn. I don't think the fact that our power might be 
expanded is by itself a reason to relinquish the consumer 
authority. My personal view is that the Federal Reserve is well 
placed to do a good job in the public interest on consumer 
regulation. These are congruent, with good consumer regulation, 
give us a way of balancing issues having to do with consumer 
regulation. I think in the last years we have stepped up to the 
plate on high-cost mortgages, on consumer credit. We have 
revised truth in lending regulations coming out at the end of 
this month. I would hope that the Congress might think about 
whether there are ways of strengthening the Federal Reserve's 
commitment to consumer regulation as an alternative to creating 
a new regulator.
    Mr. Ellison. Would you allow, Mr. Vice Chairman, that the 
Fed was slow to the game in addressing some of these consumer 
issues you just pointed out, particularly in mortgages, credit 
cards? I mean, some of the issues that the more recent 
legislation addressed have been longstanding.
    Mr. Kohn. I agree that we did not see the abuses as 
widespread as they were, and we were slow to react to them. And 
I think if you kept consumer regulation in the Federal Reserve, 
if you were to decide to do that, you need to strengthen our 
commitment to that regulation. I agree.
    Mr. Ellison. Do other central banks around the world have 
consumer protection as part of their mandate?
    Mr. Kohn. I don't know.
    Mr. Ellison. Is the Fed currently working on consumer 
concerns right now with regard to overdraft fees and things 
like that?
    Mr. Kohn. I am not sure, Congressman.
    Mr. Ellison. Has the Fed addressed issues like among bank 
staff that--sort of like sales practices that would push 
products, push selling accounts, having quotas for selling a 
certain number of accounts on a given day or a given week 
without regard to the consumer's best interest? So, for 
example, if a bank were to say to a personal banker staffer, 
you must produce 10 new savings accounts today, and then that 
staffer were to go try to get 2 and 3 accounts from the same 
person in a day, is that something that the Fed has focused its 
attention on now?
    Mr. Kohn. I think our focus in that regard has been 
transparency, making sure that people knew what they were 
getting, the terms on what they were getting, and what the 
alternatives are. I know that we have focused on that in the 
mortgage area.
    Mr. Ellison. Has the Fed focused on that issue? 
Particularly now, I mean, overdraft fees are a significant part 
of bank profit.
    Mr. Kohn. We have focused to some extent in the past. I 
don't know whether we still are focused on that.
    Mr. Ellison. And if I may be allowed a final question, I 
agree, I think that some of the work that Fed has done recently 
has been very laudable, and I want to let you know that I feel 
that way. Some of the findings you made regarding credits cards 
and other things are just great. But I will say that given the 
Fed's mandate of focusing on monetary policy, I wonder--and I 
wonder if you wouldn't mind commenting--if there are not some 
occasions in which consumer protection takes a back seat to 
some of the other issues that the Fed is required to focus on.
    Mr. Kohn. I think that has happened in the past. I don't 
think it has happened over the past 3 or 4 years.
    Mr. Ellison. I will agree with that.
    Mr. Kohn. And I think there could be changes in our law 
making consumer protection explicitly a part of our mandate 
that would help to prevent that from happening in the future. 
But it has happened in the past, I agree.
    Mr. Ellison. Thank you, Mr. Vice Chairman.
    Chairman Watt. The gentleman yields back the balance of his 
time.
    The gentleman from New Jersey. We welcome Mr. Lance. If the 
gentleman has questions, we will recognize him for 5 minutes.
    Mr. Lance. Thank you, Mr. Chairman. Good afternoon.
    Regarding the powers of the Fed at the moment and then this 
huge debate regarding a systemic regulator, many of us on our 
side are concerned, Mr. Vice Chairman, with whether or not this 
should exist, and if it does exist, whether it should exist in 
the Federal Reserve Board, given your core mission as 
established, I gather, under Woodrow Wilson in 1913, perhaps. 
And perhaps you have answered this before I entered the room, 
and I apologize if you have, but if you could elaborate on your 
views personally, sir, regarding whether you believe a systemic 
regulator should be housed in the Fed.
    Mr. Kohn. I think the Federal Reserve is well positioned to 
carry that mission out in the public interest. I think we bring 
a variety of perspectives that are important to that. We have 
everyday contact with the markets, so we know what is going on 
there. We have supervision, so we have a view of what is 
happening within individual institutions. Our responsibilities 
for the macroeconomy give us a perspective on the intersection 
of financial markets in the macroeconomy. So I do think the 
Federal Reserve is well positioned to exercise some oversight 
in the systemic risk area.
    Mr. Lance. Do you believe that there might be an inherent 
conflict given your responsibilities in managing the 
macroeconomy?
    Mr. Kohn. No, I don't. Several of your colleagues have 
asked that question. I just don't see the conflict. I see this 
as one of them supporting the other. I think macroeconomic 
stability will support financial stability, and financial 
stability will support macroeconomic stability.
    The Federal Reserve is inevitably involved in financial 
stability, because we are the lender of last resort and because 
we have the responsibilities that you gave us for macroeconomic 
stability. So it doesn't matter in some sense who the financial 
stability regulator will be. In the end the Federal Reserve 
will have to be involved. And I think there are synergies for 
giving the Federal Reserve a little extra power to do that 
given our current authorities.
    Mr. Lance. Thank you.
    And in a completely unrelated area, I am personally 
concerned with the purchase by the Fed recently in an 
increasing amount of long-term T-bills, and I am not sure the 
American public is fully aware of this situation. It is 
obviously arcane and something that may not be on the front 
pages of newspapers.
    Could you update us on your recent purchases and where they 
are in relationship to where they might have been a year ago, 
sir?
    Mr. Kohn. In March, the Federal Open Market Committee 
decided to purchase up to $300 billion of Treasury--
intermediate and long-term Treasury securities. We did that 
because we thought it would be helpful not for the Treasury per 
se, but because we thought it would push down interest rates 
for businesses and households at a time when the economy was 
falling very rapidly, very weak, and we needed to free up the 
credit markets so businesses and households would face lower 
charges and lower cost of capital, and then do some more 
spending.
    I am not exactly sure where we are in that process. I think 
we are about halfway through. We said, I think, it would be 
done by the end of September. At our last meeting we didn't 
make any change in that plan.
    Mr. Lance. So if I just might follow up, Mr. Vice Chairman. 
It is your expectation that you will not continue this beyond 
the September date, at least to the extent that you are 
currently involved in that area?
    Mr. Kohn. We have made no decision on that. That would be a 
decision the Open Market Committee would have to make.
    Mr. Lance. Thank you. Obviously we on this committee would 
like to be apprised of that, and that is certainly an area of 
grave concern to me.
    Thank you very much, Mr. Vice Chairman.
    I yield back the balance of my time, Mr. Chairman.
    Chairman Watt. The gentleman yields back the balance of his 
time.
    We welcome the member of our full committee, Mr. Garrett, 
who is not a member of the subcommittee, but I would ask 
unanimous consent that he be given 3 minutes to ask questions. 
I would actually ask for longer, but we already displaced a 
meeting that was scheduled to start in this room at 4:00. There 
is another meeting that is scheduled to start in this room at 
5:00, and we have another panel, but I would happily grant the 
gentleman 3 minutes, unless one of your members has an 
objection.
    Mr. Garrett. I appreciate that. And, who knows, they might. 
But is there anything more important than this meeting and the 
Chairman that you are leading right now? But thank you, Mr. 
Chairman.
    Just a couple of questions. You know, you are familiar with 
the proposal the Administration has laid out, and I assume that 
you at least have the opportunity to know that the Minority 
party, the Republicans, have thrown out a proposal as well to 
deal with the situation. I don't know whether you have gotten 
into the weeds of it at all.
    Mr. Kohn. I haven't gotten into the weeds of the Republican 
alternatives.
    Mr. Garrett. Well, we will be certain to send you an 
annotated version.
    One of the provisions in it, in our plan, says, with regard 
to Section 13--and stop me if someone else threw this question 
out to you--that 13(3) should be reined in to some extent, the 
powers under 13(3), and one of the aspects of it to limit the 
ability for the Fed to actually pick, as it has in the past 
instance, particular institutions and proverbially bail them 
out as opposed to--prohibit that, but instead still allow them 
to use Section 13(3) in a larger, institutional-wide basis, if 
that is clear.
    Mr. Kohn. Yes.
    Mr. Garrett. Comment?
    Mr. Kohn. So I think that is consistent, if I understand it 
correctly, Congressman, with our own position, which is with 
respect to the resolution of systemically important 
institutions, we don't want to be involved in making those 
loans; that there needs to be some way of doing that. We need 
to have orderly resolution of these institutions, but that is 
not the job of the Federal Reserve. We would be consulting, we 
would be part of the process, but it ought to be a Treasury 
Department-led process.
    Mr. Garrett. But there would be a distinction, though, to 
simply say that we should set up this wind-down authority as 
the Administration proposes.
    Mr. Kohn. Right.
    Mr. Garrett. And not putting a limitation on the Fed, 
Federal Reserve; or, as we are suggesting if it goes through, 
that you actually have a wind-down authority as you suggest 
over in the Treasury, so you wind things down, but clearly in 
statute saying, going forward, Federal Reserve shall not have 
the authority to do so. Would you concur with that?
    Mr. Kohn. I would have to see the exact wording. Certainly, 
I agree with the idea.
    Mr. Garrett. And I know the whole discussions with regard 
to moral hazard and what has occurred in the past has already 
been laid out here.
    One of the things--another issue that is totally unrelated 
that is in the news is with regard to the Fed Chairman and the 
allegations or the--with regard to pressure that has been put 
on certain institutions, what have you, in the past. And they 
only name specific institutions in those allegations, right? We 
are sending a letter to the White House just to try to get some 
more information on that, and so I will just throw the question 
to you right now.
    Are you familiar with any other institutions that the Fed 
or any officials at the Fed have exerted any pressure on in any 
way, shape, or form, or whether the Treasury has exerted any 
influence as those allegations are suggesting?
    Chairman Watt. The gentleman's time has expired. And since 
that is really a subject that is not within the parameter of 
this hearing, I wish the gentleman would ask the question in 
writing, if he wouldn't mind, since we are under some time 
pressure.
    Mr. Garrett. Can you give me just a yes or no?
    Mr. Kohn. I would have to see the question in writing. We 
supervise lots of institutions, and in the process of 
supervising those institutions, we make lots of requests to 
them to change their practices. So I am not sure exactly what 
you are getting at. So perhaps the chairman's suggestion of a 
written question would be best.
    Chairman Watt. The gentleman's time has expired.
    The gentleman from Alabama, the ranking member of the full 
committee, is recognized for 5 minutes.
    Mr. Bachus. Thank you.
    Governor, do we have an exit strategy from these ad hoc 
bailouts of failing institutions?
    Mr. Kohn. We have an exit strategy from the provision of 
reserves that we have made, the very high level of reserves 
that we now have in the system. We believe we have the tools to 
absorb those reserves, to raise interest rates when the time 
comes to do so.
    With respect to the individual institutions, I think each 
institution, like AIG, for example, is putting in place a 
business strategy to sell pieces of itself, repay the Federal 
loans and repay the U.S. taxpayer. So there are strategies 
being put in place for the individual institutions.
    Mr. Bachus. To me, the Obama Administration proposal 
actually puts in place a permanent bailout agency, and that is 
the Federal Reserve. It empowers you to bail out through loans 
or guarantees failing institutions, does it not?
    Mr. Kohn. That is not my understanding, Congressman.
    Mr. Bachus. Okay.
    Mr. Kohn. We are in agreement with the Administration that 
a separate resolution authority for failing systemic 
institutions needs to be established under the oversight of the 
Treasury, not the Federal Reserve.
    Mr. Bachus. Would that include--would that be an enhanced 
bankruptcy proceeding?
    Mr. Kohn. It would be a substitute for bankruptcy 
procedure, just as we have today for banks and depository 
institutions under the FDIC.
    Mr. Bachus. So the Federal Reserve as the systemic 
regulator would have no right to guarantee or loan money to an 
individual institution.
    Mr. Kohn. That wasn't the process of failing. That would be 
the resolution of that institution, like Bear Stearns, AIG, 
would be the province of the Treasury Department.
    Mr. Bachus. But the Fed over the past year has guaranteed 
some of the obligations and made loans; has it not? You 
participated--
    Mr. Kohn. We have been in a second and third guarantee 
position for some obligations of Citigroup. Is that what you 
are referring to?
    Mr. Bachus. And AIG also.
    Mr. Kohn. And AIG.
    Mr. Bachus. And what is the total obligation to AIG?
    Mr. Kohn. I think we have about $45 billion of loans 
outstanding to AIG, plus some special-purpose vehicles that 
have assets that they have taken over from AIG probably total 
about $40 billion or $45 billion.
    Mr. Bachus. Do you anticipate or would you be opposed to a 
provision in any law that we pass to prohibit the Fed or the 
Treasury from loaning billions of dollars of taxpayer money to 
these institutions or to guaranteeing their obligations?
    Mr. Kohn. I think somebody in the government, not the 
Federal Reserve, needs to have the authority to resolve 
systemically important institutions in an orderly way so they 
don't threaten the jobs of Americans.
    Mr. Bachus. I would agree with you that there needs to be 
an orderly resolution.
    Mr. Kohn. That is right.
    Mr. Bachus. I would not agree with you that that would 
include taxpayer funding or--you know, either guarantees or 
loans, in the case of, as you say, Citi and AIG, was in the 
tens of billions of dollars, actually hundreds of billions of 
dollars.
    Do you believe that too big to fail--do you believe in that 
doctrine? Do you believe in the fairness of that doctrine?
    Mr. Kohn. I think too big to fail is a very difficult, 
troublesome issue. I agree with the thrust of your question 
that we need to deal with. I think there is a terrible moral 
hazard involved in that. And my thinking is that the 
Administration proposal, something like the Administration 
proposal is very helpful in that regard. It has two things. One 
is that the largest institutions that might be too big to fail 
face much tougher scrutiny, higher capital, greater liquidity, 
more robust risk management systems so that they won't fail; 
and, secondly, that there be a resolution authority that would 
enable the government to resolve these in an orderly way, that 
might impose costs on the creditors, but in an orderly way 
outside of bankruptcy.
    Chairman Watt. The gentleman's time has expired.
    The Chair notes that some members may have additional 
questions for this witness which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 30 days for members to submit written questions to this 
witness and to place his responses in the record.
    We thank Vice Chairman Kohn for his patience and for his 
responses, and we will excuse this witness and call up the 
second panel.
    While the second panel is coming forward, I ask unanimous 
consent to enter into the record the following statements: The 
statement of Thomas F. Cooley, professor of economics, Stern 
School of Business, New York University, dated July 9, 2009; 
and the statement of the Financial Services Roundtable, dated 
July 9, 2009. Without objection, it is so ordered.
    The Chair will now briefly introduce the second panel, 
without giving them all of their glory in the introductions. We 
will put the full introductions into the record in the interest 
of time. But this panel includes Dr. Frederic Mishkin, Alfred 
Lerner Professor of Banking and Financial Institutions at the 
Graduate School of Business, Columbia University; Dr. Lawrence 
Meyer, vice chairman, Microeconomic Advisers; Dr. James K. 
Galbraith, Lloyd M. Bentsen, Jr., Chair in Government/Business 
Relations and professor of government, LBJ School of Public 
Affairs, University of Texas; Dr. Richard Berner, chief 
economist at Morgan Stanley; Dr. John B. Taylor, Mary and 
Robert Raymond Professor of Economics at Stanford University; 
and Dr. Allan Meltzer, The Allan H. Meltzer University 
Professor of Political Economy, Tepper School of Business, 
Carnegie-Mellon University.
    We welcome each one of you, and we will recognize each of 
you. Your full statements will, of course, be made a part of 
the record, and each of you will be recognized for 5 minutes to 
summarize your statement.
    And I will start with Dr. Mishkin.

 STATEMENT OF DR. FREDERIC S. MISHKIN, ALFRED LERNER PROFESSOR 
   OF BANKING AND FINANCIAL INSTITUTIONS, GRADUATE SCHOOL OF 
                 BUSINESS, COLUMBIA UNIVERSITY

    Mr. Mishkin. It is a great pleasure to be here to discuss 
what is a very important issue, which is what role the Federal 
Reserve should have as a systemic risk regulator.
    I want to boil this down to three questions, even though we 
were asked four, but I think three that are quite relevant to 
these issues. And the first question is the essential one, 
which is, should the Fed be the systemic risk regulator? And I 
am going to answer yes to that question, and there are four 
reasons that I take that view.
    The first is that the Federal Reserve is involved in daily 
interaction with the market, and in terms of being a systemic 
risk regulator, that kind of information or that contact is 
extremely useful.
    The second is that there is a synergy between thinking 
about macroeconomic stability and financial stability, and that 
is, I think, extremely important in terms of performing the 
appropriate analysis to do systemic risk regulation in the best 
way possible.
    The third is that there is a synergy between the actions 
that are required in terms of promoting macroeconomic stability 
and financial stability. And so we have seen this, of course, 
in very major ways during this recent crisis. This involves the 
role of the Federal Reserve as a so-called lender of last 
resort, providing liquidity to the financial system to, in 
fact, make sure that macroeconomic stability is preserved.
    And, finally, the Federal Reserve is one of the most 
independent of government agencies. In order to be an effective 
systemic risk regulator, the kind of independence the Fed has 
had in the past and has used in the past would be also very 
helpful in this regard.
    So when I look at this issue of the Fed being a systemic 
risk regulator, I think that, from my viewpoint, it really is 
the appropriate logical choice when we think about the nature 
of this role.
    The second issue is should the Fed relinquish some of its 
other roles if it became the systemic risk regulator? And I 
think the answer here is yes. In particular, the Treasury plan 
has suggested that the Federal Reserve no longer be a consumer 
protection regulator, and I concur with this view.
    There are three reasons why I think that the Fed should no 
longer be involved in this activity if, in fact, it is handed 
these additional responsibilities. The first is that being a 
consumer protection regulator is not at the core mission of 
what the Federal Reserve does, where I actually do see 
macroeconomic stability and financial stability is part of that 
core mission.
    The second is that it uses a very different skill set. And 
so in the context of thinking about the synergies, I do not see 
them to be nearly as relevant.
    And the third, I think, is really the most important, which 
is that consumer protection regulation is very political. 
Everybody cares about it. In the past I testified on credit 
cards. Everybody has issues in terms of their dealing with the 
credit card companies. In that context, the possibility of 
there being more pressure, political pressure, put on the 
Federal Reserve system is, in fact, greater. And so again I 
think that this is another reason why having something that is 
not in your core mission which is, in fact, something that 
tends to get more political could be harmful to the 
independence of the Fed, something that I am going to turn to 
later.
    The third question is, are there dangers from the Federal 
Reserve taking on this role of systemic risk regulator? And I 
think the answer is yes. There are three dangers that do 
particularly concern me. I will argue, however, that even 
though these dangers exist, that the Federal Reserve still 
should be the risk regulator, systemic risk regulator, and 
there are steps that the Congress can take to, in fact, ensure 
that the Federal Reserve can do its job adequately both in 
terms of monetary policy and in terms of promoting financial 
stability.
    So the first danger is that the Federal Reserve might lose 
its focus on price stability. Clearly there are concerns in the 
marketplace about this issue about the credibility of the Fed 
as an inflation fighter and steps that it needs to take in 
terms of making sure that inflation is not too high. And in 
this context I have argued elsewhere, both when I was a 
Governor at the Federal Reserve and also afterwards in op eds, 
that one way of dealing with this would be to have the Federal 
Reserve to have an explicit numerical objective in terms of 
inflation, something that it does not have at the current time.
    The second issue is, could systemic risk regulation 
interfere with the independence of the Fed? And I think there 
is some danger here. The danger, of course, is that systemic 
risk regulation, particularly in the context of having to deal 
with an institution which has to be reined in, could actually 
mean that there is some pressure put on the Federal Reserve in 
that context. And so I think that there is some danger here.
    But, again, I think that the issue here is that the 
Congress has to be aware that the independence of the Federal 
Reserve is very much in the national interest. Indeed, this is 
a very major concern that I have right now, given concerns 
about the Federal Reserve's independence and people who have 
been saying the Federal Reserve needs to be reined in, I think 
it actually is something that can damage the Federal Reserve's 
ability to maintain price stability and also macroeconomic 
stability. But, furthermore, I think that there is also an 
issue that--in that context that we could actually have even 
problems currently with concerns about Fed's credibility, which 
is actually something that can raise interest rates, something 
that I think has indeed happened.
    The third issue is something that is not really discussed 
as much as I would like to see discussed, which is the Federal 
Reserve's resources have been stretched to the limit by this 
crisis. And this is particularly true of the Board of 
Governors. I saw this as a member of the Board of Governors 
where the staff was working extremely long hours and was 
exhausted. And I left in September of 2008, before the crisis 
really got bad. So there are issues in terms of the Fed having 
enough resources and the support of the Congress for the Fed to 
acquire the resources that it needs. And I think, again, that 
is something that is quite important.
    So the bottom line here for me is that one of the important 
lessons from this crisis is that we absolutely desperately need 
a systemic risk regulator. And then I look at the issue about 
who can do that the best, and my view is that the Federal 
Reserve is, in fact, best positioned to do so.
    On the other hand, there are some dangers here, but this is 
why I think the Congress needs to, in fact, support the Federal 
Reserve in its independence in terms of the resources that it 
needs to do this job. And as a result, I think that we would be 
better served having the Fed pursue this role.
    Thank you very much.
    [The prepared statement of Dr. Mishkin can be found on page 
83 of the appendix.]
    Chairman Watt. I thank you, Dr. Mishkin, for your 
testimony.
    And, Dr. Meyer, you are recognized for 5 minutes.

      STATEMENT OF DR. LAURENCE H. MEYER, VICE CHAIRMAN, 
                     MACROECONOMIC ADVISERS

    Mr. Meyer. Thank you very much. And thank you for giving me 
this opportunity to testify before you this afternoon.
    The independence of central banks with respect to monetary 
policy is absolutely essential. Policies that are focused on 
financial stability, on the other hand, require a more 
cooperative approach, including, in the United States, the 
central bank, functional regulators of banks and nonbank 
subsidiaries, and a clear role for the Treasury. But there 
needs to be a bright line between the more cooperative approach 
to financial stability policy and the independence of the Fed 
with respect to monetary policy.
    Supervising systemically important financial institutions 
is, of course, a central part of financial stability policy. I 
don't believe there is a conflict between the current or newly 
proposed role for the Fed as systemic risk regulator and the 
traditional role as independent authority on monetary policy. 
But then, again, I do not see the Treasury proposal as 
conferring on the Fed vast new authority as systemic risk 
regulator.
    The Fed is already bank holding company or consolidated 
supervisor for all financial institutions that have a bank. Of 
the systemically important financial institutions today, most 
are already bank holding companies. Other institutions that 
might be designated systemically important could be a couple of 
insurance companies, a few other large financial firms that are 
not supervised today, and, in principle but not likely in 
practice initially, very large and highly leveraged hedge 
funds.
    It also should be recognized that there are functional 
supervisors of the bank and the investment banking and 
insurance subsidiaries of bank holding companies, and they do 
much of the heavy lifting in overseeing the risks in their 
respective parts of the bank holding company.
    There has always been a debate about whether the Fed's role 
in bank and bank holding company supervision complements or 
conflicts with its role in monetary policy. One of the cases 
for a complementary role is that the Fed's responsibility as 
hands-on supervisor of some banks and all bank holding 
companies provides firsthand information about the state of the 
banking sector, which can be a valuable input into the 
assessment of the economic outlook, especially in periods of 
extreme stress like today.
    The counterargument is that the Fed's concern for the 
health of the banking system, derived from its role as bank and 
bank holding company supervisor, can encourage the Fed at times 
to sacrifice its macro-objectives in order to help the banking 
system when it is ailing. When I was on the Board, I never 
witnessed any conflict in practice between these two roles. I 
don't see why the debate should change as a result of the 
marginal increase in supervisory reach under the Treasury 
proposal.
    A basic premise for my view is that a central bank should 
always have a hands-on role in bank supervision. First, central 
banks always have at least an informal responsibility for 
monitoring systemic risk, and the banking system is a major 
source of such risk. Second, the central bank is always a 
source of liquidity to and lending to banks, and must therefore 
have firsthand knowledge of their creditworthiness, and this is 
especially true at times of stress. Finally, the central bank 
will always be called upon to cooperate with Treasury at times 
of interventions in particular institutions where the Fed will 
sometimes provide the liquidity, and Treasury should take all 
the credit risk.
    Given the Fed's role already as consolidated supervisor of 
most systemically important financial institutions, the choice 
may be whether to remove the Fed from its role in banking 
supervision altogether, or expand its role modestly to cover 
all systemically important financial institutions. This seems 
like an obvious choice for me. I also don't see the need to 
isolate these two functions from each other within the Federal 
Reserve, at least more than they are today.
    Now, if the Fed were getting substantial new powers as 
systemic regulator and had to devote considerable new resources 
to this new responsibility, then it seems reasonable that it 
should give up some of its current responsibilities. If 
something is to be given up, the most obvious choice is 
consumer protection and community affairs. These are not seen 
around the world as core responsibilities of central banks. In 
addition, the case for giving up consumer protection and 
community affairs is strengthened by the Treasury proposal to 
unify these responsibilities in a single agency.
    The bottom line is that the Fed is the best choice for 
consolidated supervision of systemically important financial 
institutions in addition to its role as independent authority 
on monetary policy, and these joint roles are much more 
complementary than they are conflicting. Indeed, there is a 
very natural fit between these two roles.
    Thank you.
    [The prepared statement of Dr. Meyer can be found on page 
77 of the appendix.]
    Chairman Watt. Thank you, Dr. Meyer.
    Dr. Galbraith, you are recognized for 5 minutes.

  STATEMENT OF DR. JAMES K. GALBRAITH, LLOYD M. BENTSEN, JR., 
    CHAIR IN GOVERNMENT/BUSINESS RELATIONS AND PROFESSOR OF 
 GOVERNMENT, LBJ SCHOOL OF PUBLIC AFFAIRS, UNIVERSITY OF TEXAS

    Mr. Galbraith. Thank you very much, Mr. Chairman. And as a 
member or an alumnus of this committee staff, it is again a 
pleasure and privilege to be here.
    I want to begin with a comment on this question of 
independence which has been touched on repeatedly. Vice 
Chairman Kohn said, and I think with very carefully chosen 
words, that the Congress granted a substantial degree of 
independence to the Federal Reserve. That independence is, of 
course, independence from the Executive Branch. It is not and 
cannot be independence from the Congress itself. The Federal 
Reserve may be delegated certain functions by the Congress, but 
the Congress can always choose to hold it accountable, and this 
committee, of course, has the responsibility of oversight 
precisely for that reason. So I think we should be very clear 
that, when speaking of the independence of the Federal Reserve, 
it is a legal independence of a kind that other regulatory 
institutions have had over the course of our history. It is not 
an independence which is specific to monetary policy per se.
    The question before us is whether the Federal Reserve is 
the best agency to take on the responsibility for regulating 
systemic risk, and I have some reservations about that, and I 
would classify them in three broad categories. The first one we 
might call constitutional, and I would pick up the point that 
was already made this afternoon by Congressman Sherman, 
concerning the fact that the Federal Reserve is constituted in 
part of regional Federal Reserve, of Federal Reserve district 
banks, who have boards of directors who are formed from the 
member banks themselves. And it is, of course, true that the 
district banks are represented on the Federal Open Market 
Committee with a voting power whose constitutionality, 
incidentally, was challenged in court by the chairman of this 
committee back in the 1970's when I was serving here on the 
staff. The issue was never resolved on the legal merits.
    It is also the case, as I understand it, that the examiners 
under a systemic risk supervision regime would actually reside 
in the district banks rather than at the Federal Reserve Board, 
and it seems to me this does raise a question at least of 
perception; that is to say, whether it is appropriate to have 
systemic risk regulators who are part of institutions that 
report in part and are accountable in part to boards of 
directors consisting in part of the member banks of those 
institutions for two reasons. One, there may be a systematic 
conflict between the interests of the member banks and the 
interests of system stability. And, secondly, there may be 
conflicts between the interests of member banks and the 
interests of other Tier I financial holding companies who are 
not member banks. So it seems to me that is at least a question 
which is worth considering as you think about the architecture 
of this particular system.
    The second concern that I would have is institutional. It 
is whether, in an agency whose primary functions are 
macroeconomic, one would ever have a commitment to the systemic 
risk regulation, to the supervisory responsibilities that are 
commensurate with the importance of that particular function. 
It seems to me worth pointing out that there is in the Treasury 
proposal basically a two-stage process, one of which is 
analytical, and the other one has more of an enforcement 
character.
    The analytical question is to determine what is a 
systemically dangerous institution to be classified as a Tier I 
financial holding company. That, it seems to me, would be an 
appropriate function to vest in the Federal Reserve Board, 
where an office that is incremental in the sense that Vice 
Chairman Kohn stipulated could decide amongst the relatively 
small number of large institutions who is and who is not in 
that category. The enforcement, the supervision, and the 
regulation of the behavior of the institutions, it seems to me, 
naturally would be more appropriately placed in an agency for 
whom that is the primary priority, an agency such as the FDIC.
    The third concern that I have is a question of really the 
leadership of the Federal Reserve. Historically this is--the 
chairmanship of the Board of Governors of the Federal Reserve 
is an extremely high-profile appointment. It is an individual 
who tends to be close to and to need the confidence of the 
financial markets, and there is a real question as to whether 
there is any record in the history of the Federal Reserve of 
effective response to systemic risk in advance of crisis.
    This was not the case of Benjamin Strong of the 1920's, who 
was the leading figure at the time, although not the Chairman 
of the Board. It was not the case of Alan Greenspan in the run-
up to the latest crisis. We had a doctrine which, in effect, 
denied that systemic risk could, in fact, bring down the 
system. That doctrine was articulated at the peak of the 
Federal Reserve, and it seems to me that we had a test of that 
proposition, and it came up wanting. So it does seem to me that 
there are reasons to be worried about investing the authority 
for systemic risk in the Federal Reserve.
    Thank you very much.
    [The prepared statement of Dr. Galbraith can be found on 
page 50 of the appendix.]
    Chairman Watt. I thank you for your testimony.
    And, Dr. Berner, you are recognized for 5 minutes.

   STATEMENT OF DR. RICHARD BERNER, CHIEF ECONOMIST, MORGAN 
                            STANLEY

    Mr. Berner. Thank you, Mr. Chairman, Ranking Member Paul, 
and other members of the committee. Thanks for inviting me to 
this hearing to address this important question, the role of 
the Federal Reserve in systemic risk regulation.
    I think the broader question here is how should we address 
the significant weaknesses in our financial system and our 
financial regulatory structure that the current financial 
crisis has exposed?
    Among market participants, and I talk to many of them, I 
think there are two policy changes that are needed that are 
well recognized: first, strengthen our regulatory 
infrastructure; and second, adopt appropriate regulation 
oversight to mitigate systemwide risks across financial market 
instruments, markets, and institutions. In addition, I believe 
that macroeconomic policy should lean against asset and credit 
booms, which create financial instability.
    In my view, the Federal Reserve is best equipped to take 
the lead on systemic risk regulation and oversight. Like 
others, I think this function is an essential and natural 
extension of the Fed's traditional monetary policy role and of 
its responsibilities as lender of last resort.
    Three factors support that claim: First, the Fed is the 
ultimate guardian of our financial markets, and so it should be 
the agency that ensures the safety and soundness of the most 
important financial institutions operating in those markets.
    Second, the process of intermediation through traditional 
lenders in the capital markets has become increasingly complex. 
Supervision of the institutions involved will enhance the Fed's 
ability to make the right monetary policy decisions.
    And, finally, the Fed's expertise in financial markets and 
institutions makes it the natural choice for this role. The 
Fed's leadership in the Supervisory Capital Assessment Program 
demonstrated that expertise.
    In short, good monetary policy and financial stability, in 
my view, are complementary. Asset booms and busts destabilized 
the economy and financial system at great cost. A financial 
stability mandate for the Fed requires that focus on asset and 
credit booms as well as systemic regulation and oversight. And 
the policy tools required for each overlap substantially.
    That may explain why the other countries that separate such 
responsibilities from the traditional role of the central bank 
have fared no better than we did in this crisis. The U.K. is a 
good example. While the Bank of England and the Financial 
Services Authority clearly have collaborated in the recent 
crisis, their separation of powers did not help manage the 
current crisis more successfully than U.S. regulators.
    However, naming the Fed to this role won't solve all of our 
problems that I just enumerated. To see why, in the rest of my 
time, I outline some related remedies. I will conclude by 
answering the four questions you posed.
    In my view, our regulatory system has three major 
shortcomings: First, we supervise institutions rather than 
financial activities, which allows some firms to take on risky 
activities with inadequate oversight. A focus on systemic risk 
is one remedy for that problem. Designating the Fed to take the 
lead will limit risky activities and important market 
information slipping through the cracks, and it will promote 
supervisory accountability.
    Second, our regulatory safety net is excessively prone to 
moral hazard, encouraging inappropriate risk-taking. 
Concentration, as you have all alluded to in this hearing, in 
our financial services industry has created institutions that 
are too big to fail.
    Remedies needed should include: more extensive oversight 
and supervision of large, complex financial institutions; an 
explicit regulatory charge on such institutions to help us 
offset the moral hazard created by an implicit guarantee; and a 
strong resolution framework that is understood by all before 
crisis hits. An ad hoc approach creates uncertainty and reduces 
the credibility of policy.
    The third problem is procyclicality. Our regulatory 
infrastructure encourages excessive leverage, which magnifies 
financial market volatility. Three remedies needed here are: 
First, we need a stronger system of capital regulation that 
should improve financial stability and help monetary policy 
lean against the wind of asset booms. We must resolve the 
tension between accountants who want to limit reserves and 
regulators who want to build them--in favor of the regulators. 
Second, securities must be more transparent and homogeneous and 
less reliant on credit ratings. And third, to reduce settlement 
and payment system risk, we need greater use of central 
counterparties for over-the-counter derivatives.
    I want to conclude by answering your four questions. Are 
there conflicts with the Fed's traditional role here? Yes, 
there can be. In a crisis, decisions about particular firms 
likely would involve the Fed in inherently political 
considerations and the use of taxpayer funds that could 
compromise its independence.
    We should insulate the Fed's independence with two 
firewalls. First, the resolution of troubled financial 
institutions should fall to the FDIC; and, second, and 
globally, we must change institutions now too big to fail into 
being too strong to fail. Remedies will include many of the 
options I just discussed. Both firewalls should strengthen the 
Fed's role as lender of last resort by reducing moral hazard, 
especially by reducing the chance that we will keep nonviable 
institutions alive, a concern you have expressed.
    What are the policy pros and cons here? In my view, the 
pros outweigh the cons. Interconnectedness means that 
supervision must look horizontally across instruments, markets, 
institutions, and regions rather than in vertical silos. In my 
view, the Fed has the most expertise and reach to provide that. 
The Fed is also best positioned to prescribe and enforce 
remedies to procyclicality and to build financial shock 
absorbers.
    Now, I hasten to state the obvious: The Fed is imperfect. 
As the guardian of our financial system, the Fed in the past 
has come up short in a number of ways. I would only say that 
while we consider making the Fed the lead systemic regulator, 
the Fed and we must examine how it can improve its functioning 
to take on these new duties.
    What about the arguments against? Well, ensuring financial 
stability may be too big a job for just one regulator. Even if 
the Fed takes the lead, coordination with other regulators will 
be essential for success. Coordination with regulators and 
central banks abroad may be even more critical than being in 
sync with regulators at home. Our markets and institutions are 
global, but our regulation is largely local. So I like the 
President's recommendations for the Financial Services 
Oversight Council and international cooperation and 
coordination especially.
    Last, what about reassigning some Federal responsibilities 
to other agencies? Regulators should do what they do best. And, 
for example, as others have said, consumer protection and 
promotion of financial literacy could go to another agency, but 
I think that the Fed may still play a useful role in supporting 
these areas.
    Mr. Chairman, let me add that these views are mine and not 
necessarily those of my employer, Morgan Stanley, or its staff. 
I want to thank you for your attention. I am happy to answer 
any questions.
    [The prepared statement of Dr. Berner can be found on page 
46 of the appendix.]
    Chairman Watt. Thank you for your testimony.
    Dr. Taylor, you are recognized for 5 minutes.

   STATEMENT OF DR. JOHN B. TAYLOR, MARY AND ROBERT RAYMOND 
          PROFESSOR OF ECONOMICS, STANFORD UNIVERSITY

    Mr. Taylor. Thank you, Mr. Chairman, Ranking Member Paul, 
and members of this subcommittee, for inviting me to testify on 
this important subject.
    In my view, the Administration's plan would grant to the 
Fed significant new powers, more powers than it has ever had 
before. These powers would include determining whether a 
financial firm is a threat to financial stability. These 
designated firms by the Fed would then be put in a special 
group called Tier I FHCs, financial holding companies. The Fed 
would then have the power to supervise and regulate this newly 
defined group. And the firms in this group would be subject to 
this new resolution regime chosen by the Fed.
    Taken as a whole, these powers mean that the Fed would be a 
systemic risk regulator. Though that term is not defined in the 
documents, I take it as a definition these new powers. In my 
view, these new powers will negatively affect the Fed's role as 
an independent monetary authority. I have four main concerns.
    First, it seems to me that the additional powers and 
responsibilities would dilute the key mission of the Federal 
Reserve, which is to maintain overall economic and price 
stability by controlling the growth of the money supply and 
thereby influencing the overall level of interest rates in the 
economy. My experience in government, including the U.S. 
Treasury and elsewhere, is that institutions work best when 
they focus on a limited set of understandable goals and are 
held accountable to the public for achieving these goals. As 
the number of goals and the lack of clarity increases, the 
effectiveness and the performance generally decline.
    My second concern is that responsibility for these new Tier 
I financial holding companies would reduce credibility of the 
Federal Reserve by involving it directly in potentially 
controversial decisions. In fact, it seems to me the experience 
of the last few months illustrates this problem. The Fed's 
credibility is an extraordinarily valuable asset, and it would 
be terrible to lose that asset.
    My third concern is that the plan would create a conflict 
of interest. Indeed, this has been discussed widely already at 
this hearing with the Vice Chairman and others. In my view, 
firms in the Tier I financial holding company category would be 
perceived as too big to fail and perhaps even too big to 
resolve to go through that complicated process that is being 
proposed. In my view, there will therefore be a temptation to 
adjust the instruments of monetary policy, the money supply or 
the interest rates to help protect these institutions. It is a 
natural evolution. Lower interest rates, whether or not 
appropriate, will be harmful to the economy, and a larger Fed's 
balance sheet when not appropriate would be harmful to the 
economy.
    My fourth concern is that by giving so much new power to 
the Federal Reserve, that the plan would actually threaten the 
Fed's independence regarding monetary policy. Why would this be 
the case? In my view, sooner or later the increased power will 
result in checks and limits on it, perhaps through micromanaged 
political interference or perhaps through legislative change. 
It would be impossible, as some have suggested, in practice to 
prevent such interference from spreading from the new 
regulatory powers and supervisory powers to the traditional 
monetary function of the Fed. After all, they are in the same 
institution, and they are run by the same CEO.
    I think this loss of Federal Reserve independence is a 
serious issue, especially at this time of rapidly growing 
Federal debt and greatly expanded Federal Reserve balance 
sheet. Actually, I could not do any better than to quote a 
former Secretary of the Treasury, also former Secretary of 
State, Secretary of Labor, and Director of the Budget, 
Secretary George Shultz, who, after studying carefully the 
events of the last few months, came up with the following 
statement. And I quote Secretary Shultz:
    ``Observing this process, the question comes forcefully at 
you, has the accord gone down the drain?''
    The Secretary, of course, is referring to the 1951 accord 
where the Fed regained its independence from the Treasury, 
which it had lost during World War II, and was committed to 
pegging Treasury interest rates. And then he goes on to say:
    And remember how difficult it was for the Fed to 
disentangle itself from the Treasury in the post-World War II 
period.
    So these are very serious concerns, my four concerns, and I 
would be happy to answer any questions you have about them.
    Thank you, Mr. Chairman.
    [The prepared statement of Dr. Taylor can be found on page 
86 of the appendix.]
    Chairman. Watt. Thank you, Dr. Taylor.
    Dr. Meltzer, you are recognized for 5 minutes.

    STATEMENT OF DR. ALLAN H. MELTZER, THE ALLAN H. MELTZER 
  UNIVERSITY PROFESSOR OF POLITICAL ECONOMY, TEPPER SCHOOL OF 
              BUSINESS, CARNEGIE MELLON UNIVERSITY

    Mr. Meltzer. Thank you, Chairman Watt. And greetings to my 
old friend, Congressman Ron Paul, and to the members. Thank you 
for the opportunity to present my appraisal of the 
Administration's proposal for regulatory changes. I will 
confine most of my comments to the role of the Federal Reserve 
as a systemic regulator, and will offer an alternative proposal 
much closer to the Republican proposal.
    I share the belief that change is needed and long delayed, 
but appropriate change must protect the public, not the 
bankers.
    During much of the past 15 years, I have written three 
volumes entitled, ``A History of the Federal Reserve.'' Working 
with two assistants, we have read virtually all of the of the 
minutes of the Board of Governors, the Federal Open Market 
Committee, and the Directors of the New York Federal Reserve 
Bank. We have also read many of the staff papers and the 
internal memos supporting decisions. I speak from that 
perspective.
    Two findings are very relevant for the role of the Federal 
Reserve. First, I do not know of any single clear example in 
which the Federal Reserve acted in advance to head off a crisis 
or a series of banking and financial failures. We all know of 
several where it failed to act in advance.
    Members of Congress should ask themselves this question: 
Can you expect the Federal Reserve or anyone else as systemic 
regulators to close Fannie Mae and Freddie Mac after Congress 
has decided that it declined to act? What kind of a conflict is 
that going to pose? And how is it going to be resolved?
    Second, in its 96-year history, the Federal Reserve has 
never announced a lender of last resort policy. It has 
discussed internally the content of such a policy several 
times, but it rarely announced what it would do. And the 
announcements that it made, as in 1987, were limited to the 
circumstances of that time.
    Announcing and following a policy would alert financial 
institutions to the Fed's expected actions and might reduce 
pressures on Congress to aid failing entities. Following the 
rule in a crisis, the lender-of-last-resort rule in a crisis 
would change bankers' incentives and reduce moral hazard.
    A crisis policy rule is long overdue. The Administration 
proposal recognizes the need, but doesn't propose the rule. 
Experiences in the past from the history suggest three main 
lessons:
    First, we cannot avoid banking failures, but we can keep 
them from spreading and creating crises;
    Second, neither the Federal Reserve nor any other Agency 
has succeeded in predicting crises or anticipating systemic 
failure. It is hard to do, in part because systemic risk is not 
well defined. Reasonable people will differ, and since much is 
often at stake, some will fight hard to deny that there is a 
systemic risk.
    One of the main reasons that Congress in 1991 passed 
FDICIA, the Federal Deposit Insurance Corporation Improvement 
Act, was to prevent the Federal Reserve from delaying closure 
of failing banks, increasing losses, and weakening the FDIC 
fund. The Federal Reserve and the FDIC have not used FDICIA 
against large banks in this crisis. That should change.
    The third lesson is that a successful policy will alter 
bankers' incentives and avoid moral hazard. Bankers must know 
that risk-taking brings both rewards and costs, including 
failure, loss of managerial position and equity, followed by 
sale of continuing operations.
    Several reforms are needed to reduce or eliminate the cost 
of financial failure to the taxpayers. Members of Congress 
should ask themselves and each other, is the banker or the 
regulator more likely to know about the risks on the bank's 
balance sheet? Of course, it is the banker, and especially so 
if the banker is taking large risks that he wants to hide. To 
me, that means the reform should start by increasing the 
banker's responsibility for losses.
    The Administration proposal does the opposite, by making 
the Federal Reserve responsible for systemic risk. Systemic 
risk is a term of art; I doubt that it can be defined in a way 
that satisfies the many parties involved in regulation. Members 
of Congress will properly urge that any large failure in their 
district is systemic. Administrations and regulators will have 
other objectives. Without a clear definition, the proposal will 
bring frequent controversy, and without a clear definition, the 
proposal is incomplete.
    Resolving the conflicting interests is unlikely to protect 
the general public. More likely, regulators will claim that 
they protect the public by protecting the banks.
    I think that is wrong. I believe there are better 
alternatives than the Administration's proposal. First step, 
end ``too big to fail.'' Require all financial institutions to 
increase capital more than in proportion to the increase in the 
size of their assets. ``Too big to fail'' is perverse; it 
allows banks to profit in good times and shifts the losses to 
the taxpayers when crises or failures occur.
    Second step, require the Federal Reserve to announce a rule 
for ``lender of last resort.'' Congress should adopt a rule 
that they are willing to sustain. The rule should give banks an 
incentive to hold collateral to be used in a crisis period. 
Bagehot's Rule from the 19th Century Bank of England is a great 
place to start.
    Third step, recognize that regulation is an ineffective way 
to change behavior. My first rule of regulation states that 
lawyers regulate, but markets circumvent burdensome regulation. 
The Basel Accord is a current example. It told banks to hold 
more reserves if they held more risky assets. So they put the 
assets off their balance sheets. Later, after the fact, they 
had to take them back, but that was after the fact.
    Fourth step, recognize that regulators do not allow for the 
incentives induced by their regulations. In the dynamic 
financial markets, it is difficult, perhaps impossible, to 
anticipate how clever market participants will circumvent the 
rules without violating them.
    The fifth step, either extend FDICIA to include holding 
companies or subject financial holding companies to bankruptcy 
law. Make the holding company subject to early intervention 
either under FDICIA or under bankruptcy law. That not only 
reduces or eliminates taxpayer losses, but it also encourages 
prudential behavior.
    Other important changes should be made. Congress should 
close Fannie Mae and Freddie Mac and put any subsidy for low-
income housing on the budget. The same should be done to other 
credit market subsidies. The budget is the proper place for 
subsidies.
    Three principles should be borne in mind:
    First, banks borrow short and lend long. Unanticipated 
large changes can and will cause failures. Our problem is to 
minimize the costs of failures to society.
    Second, remember that capitalism without failure is like 
religion without sin. It removes incentives for prudent 
behavior.
    Third, those that rely on regulation to reduce risks should 
recall that this is the age of Madoff. The Fed, too, lacks a 
record of success in managing large risks to the financial 
system, the economy, and the public. Incentives for fraud, 
evasion, and circumvention of regulation often have been more 
powerful than incentives to enforce regulation that protects 
the public.
    Thank you, sir.
    [The prepared statement of Dr. Meltzer can be found on page 
71 of the appendix.]
    Chairman Watt. I thank the gentleman for his extensive 
statement. I am going to recognize the members for questions, 
and I will just reserve my questions until last if we have 
time, because we have to be out of here by 5 o'clock. There is 
another meeting.
    I recognize the gentleman from Texas, Mr. Paul, for 5 
minutes.
    Dr. Paul. I thank you, Mr. Chairman, and I welcome the 
panel. It is especially nice to see Dr. Meltzer here.
    I would like to start with a question of Dr. Meltzer 
because I wanted to follow up on his testimony about the Latin 
America crisis, where you mention that the Federal Reserve went 
to the IMF and instructed the IMF to pay interest to those 
banks that were exposed. And, of course, that was without 
congressional permission, and I think it makes a point, one of 
the points I have been trying to make, and that is transparency 
of the Federal Reserve.
    Now it sounded to me like the majority here is for 
independence, which is a code word for secrecy and in 
opposition to transparency. And it is always used for the 
public interest. Of course, I think the public interest is 
served by exposure and knowing what is going on and whose 
interests are being served, and that is why I would like to see 
a lot more transparency.
    But the question I have for Dr. Meltzer is, since he is 
aware of this, he has published this, is this a good reason for 
us to know a lot more about the agreements that the Federal 
Reserve makes? Because they can make agreements with 
international banking institutions, and we have no right--we 
may have a right under the Constitution that we should, but we 
don't--and we have given up that right, we have given up that 
privilege.
    Would this be a good example of why we need to know more of 
what exactly the Federal Reserve is doing?
    Mr. Meltzer. Yes.
    Let me begin by saying independence, to me and, I believe, 
to many of the members of the panel, does not mean lack of 
transparency. It means protection. The reason we have 
independent central banks is so that they don't expand under 
pressure from Congress, from the Administration, from the 
banking community, and from others. We want them to be 
independent, to make their judgments without--because they are 
obligated by law to maintain high employment and low inflation.
    Now, that law doesn't work very well, at least in my 
opinion, but that is why we want independence.
    So transparency, how can you be against transparency? But I 
believe the Congress would be more effective in its oversight 
of the Federal Reserve if it concentrated much more on outcomes 
and much less on process. Let them make their decisions the way 
they want to make them and monitor the process. They are not 
living up to the mandate to maintain full employment or high 
employment and low inflation, and that is what we should be 
concerned about.
    Dr. Paul. I thank you. And I am going to hurry along 
because our 5 minutes runs out rather quickly.
    But I wanted to ask Dr. Galbraith a question, because he 
has worked here and he knows the system, so I have been rather 
shocked at what you presented here. You actually talked about 
the Constitution. Didn't you find out that we are not supposed 
to do that around here? We don't have that much concern about 
it.
    So I was delighted, from my viewpoint, that you brought 
this up and reminded us about Henry Ruess's concern about the 
constitutionality of the FOMC. And, of course, I agree with 
that.
    But I wanted to see if there was a little bit more that you 
might agree with, because there are some who believe that we 
shouldn't be doing anything unless it is explicitly authorized. 
And, of course, the central bank is not authorized. It has been 
ordained by the courts and the Congress, but it was never 
explicitly authorized.
    But the point, the more practical point that I might be 
able to get you to comment on is the concept of the budget. I 
mean, the Fed is a government unto itself. You know, they hire 
and make their wages and it doesn't go through the ordinary 
process. The Constitution says it should all go through the 
constitutional process.
    And also maybe you could comment on these foreign 
agreements. These are like treaties. The Federal Reserve goes 
and makes these agreements, and they pass out money.
    Does this strike you as maybe that too might be challenged 
if you happen to come at this from a constitutional viewpoint?
    Mr. Galbraith. Well, I think under the Constitution, the 
Congress has every right for whatever information it seeks from 
the Federal Reserve. And if the Congress were to decide to 
change the way the Federal Reserve is funded, it would also 
have the right to do that. It seems to me it would be an 
appropriate decision for Congress to make.
    Dr. Paul. So they would then have a right--so my proposal 
that we find out more, you would say that would be right and 
proper to find out what type of agreements they have made with 
other governments, other central banks, international banking 
organizations?
    Mr. Galbraith. My own view on this is that as a Member of 
Congress, you are entitled to that information. That would be 
the position I would have understood to be the case when I was 
working here 30 years ago.
    Dr. Paul. Thank you.
    Chairman Watt. The time of the gentleman has expired.
    The gentleman from Delaware, Mr. Castle, is recognized for 
5 minutes.
    Mr. Castle. Thank you very much, Mr. Chairman.
    Let me just say, I thought this was a very good panel. I 
think you had some good ideas. Whether one agrees or not with 
the concept of where we are going to go, I would hope that 
staff and all of us will take note of what you stated here 
today. I think it makes a difference.
    I might start with you, Dr. Meyer. You basically indicated 
that in going to systemic risk regulation, it wouldn't be a 
great change as far as the Fed is concerned. I don't mean to 
put words in your mouth, but that was my impression of what you 
stated.
    And if that is the case--and others have indicated that the 
Fed did not anticipate particularly well the problems which 
have arisen in the banking industry in the last year or two, 
but if that is the case, is it arguable that the Fed had some 
of this power and did not succeed in carrying out the 
responsibility of dealing with systemic risk to the limits they 
had before, and therefore we should question whether they 
should expand or not?
    Mr. Meyer. First, let me reiterate what I said before, and 
I agree with Vice Chairman Kohn here, that what the Treasury 
proposal does is very incremental and not very dramatic, not a 
vast expansion of powers--basically asking the Fed to do what 
it has been doing as bank holding company supervisor and 
extending that reach to a modest degree over systemically 
important financial institutions that don't have a bank.
    I think it is clear that the Federal Reserve didn't 
distinguish itself in carrying out its responsibilities as 
supervisor and regulator of banks and bank holding companies. 
This is an extraordinary period; it is the first financial 
crisis since the Great Depression, and I don't believe any 
other financial supervisor or regulator carried out its 
responsibilities to protect the safety and soundness of the 
banks and institutions under their control in this circumstance 
either.
    So I think what we need to do is not only ask the Fed to 
carry out its responsibilities, but to encourage it to do what 
I think it would otherwise do, to change capital standards that 
make them more onerous for systemically important institutions, 
carry out more macroprudential supervision than it has done 
before, although, let me say, the Treasury proposal separates 
that out and gives that responsibility mainly to Treasury--
well, mainly to the risk council that is staffed by Treasury 
and chaired by the Secretary.
    Mr. Castle. Thank you. I am not sure I understand all that 
quite yet, but I will try to absorb it. But I appreciate your 
answer.
    Dr. Berner, you indicated that coordination with other 
regulators will be essential on this. Can you be more explicit 
about that?
    What other regulators? I assume the FDIC and others. And 
exactly what that coordination would be? Would this be 
something that the Federal Reserve would do on its own, or 
should there be some sort of a council in which they would meet 
on a regular basis? How would that coordination occur, in your 
mind at least?
    Mr. Berner. Well, I mentioned that there are probably two 
aspects to that coordination. One is within our own boundaries 
in the United States and for U.S. financial institutions. But I 
also think that we need to coordinate globally, since our 
markets and institutions are global as well.
    As far as the United States is concerned, you know, we have 
a multiplicity of regulators. And even in the sweeping proposal 
from the Treasury or in other regulatory proposals, I haven't 
heard any move to, you know, to consolidate them all into one. 
And as I indicated, it is not clear to me that doing so would 
produce a better outcome.
    So the coordination would have to take place among the 
various regulators that we have, however we reshape them, so 
that information doesn't slip through the cracks, so that we 
don't miss the activities of institutions who are regulated by 
one group or one regulator, but who are engaged in activities 
that are properly the responsibility of--if you will, 
collectively all the regulators.
    That extends, I think, across borders because markets are 
global. And so we need to coordinate, or the Federal Reserve 
and other regulators will need to coordinate across borders 
with their counterparts overseas, taking into account what 
institutions are doing either to, as Dr. Meltzer indicated, 
avoid regulation by doing things in one place rather than in 
another, so that they are aware of what is going on and so that 
they can appropriately safeguard markets and institutions.
    Mr. Castle. I think what you have just discussed is vitally 
important. And I hope everybody gives a lot of thought to 
exactly how that would be done, because I think ultimately that 
is something that is going to have to happen no matter which 
way we go.
    Dr. Galbraith, you indicated, I thought--
    Chairman Watt. The gentleman's time has expired.
    Mr. Castle. I am sorry. I yield back. I may write to you 
about that question.
    Chairman Watt. The gentleman from New Jersey, Mr. Lance, is 
recognized for 5 minutes.
    Mr. Lance. Thank you, Mr. Chairman. Let me agree with my 
colleagues that I believe this is an extremely distinguished 
panel, and it is my privilege to participate this afternoon.
    Dr. Galbraith, to follow up on some of the questioning of 
Ranking Member Paul, you indicated one way out of the 
difficulty might be the elimination of the boards of directors 
of the regional Federal Reserve Banks, or alternatively, to 
remove the voting power of the regional bank presidents on the 
FOMC.
    Realistically, is that likely to occur?
    Mr. Galbraith. As a witness, it is not my responsibility to 
be the most realistic person.
    Mr. Lance. We do rely on your expertise, however.
    Mr. Galbraith. I do think that one has to look at this 
question of the perception of a privileged position to whom the 
presidents of the regional districts are responsible.
    Mr. Lance. Absolutely.
    Mr. Galbraith. An alternative, of course, is not to put the 
examining power in the regional Federal Reserve Banks, to leave 
it in the hands of a tough cop who is entirely autonomous.
    Mr. Lance. Yes. I think on our side of the aisle we have 
great difficulty with reposing these powers in the Federal 
Reserve Board at all.
    To Dr. Taylor and Dr. Meltzer, regarding the establishing 
of Tier I financial holding companies, I think many of us have 
a concern that if that were to occur, there would be some sort 
of assumption that they would have the backing of the Federal 
Government. We already may be in that place in some areas, and 
certainly we were in that place regarding Fannie Mae and 
Freddie Mac.
    Your comments, both of you as distinguished persons 
regarding this area of your expertise, could you elaborate on 
that a little bit for me?
    Mr. Taylor. Yes. I think the reason why I would 
characterize this proposal as giving significant, not 
incremental powers to the Federal Reserve, largely lies in this 
ability to distinguish certain institutions as a threat to the 
financial system as defined by the Treasury. And so once an 
institution--we don't know, quite frankly, how many there will 
be; it is not clear. I think that would be a good question to 
ask Treasury or the Fed, but it could be quite large.
    Mr. Lance. In your opinion, could you give us an estimate 
as to how many you think it might be?
    Mr. Taylor. I have no idea. That is one of the problems.
    Mr. Lance. Yes, sir.
    Mr. Taylor. Operationally, there is no definition of 
``systemic risk'' here, and so it could be quite large.
    It might not be, by the way, this Federal Reserve, these 
people, who make the decision; it could be their successors.
    Mr. Lance. Yes, sir.
    Mr. Taylor. And so I think the danger is, just as you say, 
once these institutions are in this group, then they do become 
too big to fail, certainly--in fact, probably too big to 
resolve because it will look like a black mark. And so they 
could become Fannie Maes and Freddie Macs of the future.
    Mr. Lance. Yes. Thank you.
    Dr. Meltzer?
    Mr. Meltzer. Yes, I like your emphasis on realism. That 
is--
    Mr. Lance. I am new here, so I am sure I will get over it.
    Mr. Meltzer. Try hard not to. The realism, to me, says what 
would the systemic risk regulator do with the Tier I holding 
companies? In my opinion, it would be Fannie Mae and Freddie 
Mac, writ large.
    Mr. Lance. That is my concern.
    Mr. Meltzer. These are going to be banks or institutions 
that are going to have branches all over the country. Every 
Member will feel an obligation to say, we can't let that happen 
in our district and in our districts. And so too big to fail 
will really become an even greater problem now.
    How can you limit the risks that bankers, some bankers, are 
going to take? Make them bear the risk.
    Mr. Lance. Thank you. Thank you very much.
    I yield back the balance of my time, Mr. Chairman. Thank 
you.
    Chairman Watt. The gentleman yields back.
    The gentleman from Alabama, Mr. Bachus, is recognized for 5 
minutes.
    Mr. Bachus. Thank you, Mr. Chairman.
    Mr. Meyer, you described the proposed changes as 
incremental to the Federal Reserve?
    Mr. Meyer. Right.
    Mr. Bachus. Reading the Treasury proposal on what they say 
about it, they say this report proposes a number of major 
changes to the formal powers and duties of the Federal Reserve, 
including the addition of several new financial stability 
responsibilities. These proposals would put into effect the 
biggest changes to the Federal Reserve's authority in years--or 
decades.
    Mr. Meyer. I think you have to read the rest of the report 
and see whether you agree with that.
    I read the rest of the report, and I don't see that there 
is this vast new power. The Administration possibly wants to 
look at this as a more sweeping set of proposals than perhaps 
it is.
    Mr. Bachus. Okay.
    Mr. Meyer. But as Vice Chairman Kohn said, that is just not 
the case.
    Mr. Bachus. Okay. So actually, you don't agree with their 
description of--
    Mr. Meyer. Absolutely not.
    Mr. Bachus. --their own plan? Okay.
    Let me ask the panelists, can you function as a systemic 
risk regulator of significant institutions without a robust 
examination and supervision authority? Can you do that?
    Mr. Meyer. Impossible.
    Mr. Bachus. Impossible?
    Mr. Galbraith. I agree.
    Mr. Mishkin. I completely agree here that clearly part of 
this issue of being a systemic risk regulator is that you have 
to go in and know what is going on in the institutions that you 
are regulating. And so I think it is essential that this be 
part of the role.
    And I think clearly that there is already an element of 
this, a very strong element in what the Federal Reserve does 
now with the bank holding companies.
    Mr. Bachus. Do you think the Federal Reserve had a robust 
supervision and examination of those institutions that failed, 
including AIG?
    Mr. Mishkin. Well, certainly the Federal Reserve did not 
have this responsibility for AIG.
    Mr. Bachus. Well, they were a holding company, were they 
not?
    Mr. Meyer. Not a bank holding company.
    Mr. Mishkin. Not a bank holding company.
    Mr. Bachus. How about Citi?
    Mr. Meltzer. But they have people monitoring Citigroup and 
all from the New York Fed every day. Did they find anything at 
Citigroup? Nothing that they were willing to do anything about.
    Mr. Bachus. And I guess Wachovia was a bank holding 
company.
    Does the Fed--do they have, you think, the robust 
examination or supervision, or is that something that the OCC 
or the FDIC does on a day-to-day basis?
    Mr. Meyer. The OCC and the FDIC have never been responsible 
for consolidated supervision. They have no history of doing 
that. The FDIC does not have a supervisory staff that has any 
expertise in the complex banking situation of the institutions 
we are talking about. The OCC is already involved and was the 
bank supervisor of many of the institutions that have gotten 
into trouble. And in most of the large institutions, OCC is the 
bank supervisor and the Fed is the holding company supervisor, 
and they both have to work together.
    Mr. Bachus. Yes. And they didn't do that in the last--
    Mr. Meyer. Well, I think--let's say, neither distinguished 
themselves.
    Mr. Bachus. Okay. I agree.
    Do we need to determine the causes of the present financial 
crisis before we start legislating a fix? And have we done 
that?
    Mr. Galbraith. It would be very helpful, in my view, to 
conduct a full and independent investigation into the cause of 
the financial crisis, similar to the Pecora Committee 
investigations of the early 1930's.
    Mr. Bachus. How about Dr. Mishkin? Do you agree?
    Mr. Mishkin. Well, I think that clearly we do have to think 
more about these issues and that, in particular, the rush to do 
regulatory reform is something that I have been concerned 
about.
    I do actually think, however, that the need for a 
resolution authority is absolutely critical. And so--
    Mr. Bachus. And I don't disagree.
    Mr. Mishkin. And I think that one of my concerns has been 
that if we go down the route of worrying about the big picture 
and then don't do anything, that we are actually in a situation 
which not only means institutions can get in trouble, and we 
can't do anything about them, but also we are in a very weak 
position to get them to fix things because we have no 
ammunition.
    Mr. Bachus. Let me say this. The Republican proposal is for 
an enhanced resolution, a bankruptcy-like proceeding for 
nonbank financial companies.
    I don't know. Have you all looked at the Republican 
proposal?
    Mr. Taylor. Not in detail.
    Chairman Watt. The gentleman's time has expired. And I 
would encourage him to send each of these witnesses the 
Republican proposal.
    Mr. Bachus. How about a second round of questions?
    Chairman Watt. Unfortunately, there is another meeting 
scheduled, as I had previously announced, in this room at 5 
o'clock. If we had been more expeditious on the Floor, perhaps 
we could have had more time to do what we do in committee.
    And I am not trying to be mean about it. I just--
    Mr. Bachus. I don't think you are being mean.
    Chairman Watt. I can't give more time than the room allows 
me to give. The gentleman's time has expired.
    Dr. Galbraith, let me just ask one question. You 
distinguished between the two responsibilities on the bottom of 
page 2 and top of page 3 of your testimony. One was to identify 
as Tier I financial holding companies considered to be so large 
and interconnected; and then the second was the institution of 
a regime of examination and regulation.
    If the first part of that--the first one of those, I take 
it you concluded, was not constitutionally suspect to be done 
by the Fed?
    Mr. Galbraith. It could be done in the Federal Reserve 
Board, and it would be an incremental responsibility of the 
kind that Vice Chairman Kohn described, yes.
    Chairman Watt. And then I take it that you are recommending 
that the second part of that be undertaken by the FDIC.
    Mr. Galbraith. By an agency for whom it is the highest 
priority and for whom it is a major mission, yes.
    Chairman Watt. Even for institutions that are not federally 
insured. What about--
    Mr. Galbraith. Yes.
    Chairman Watt. Okay. The Chair notes that members may have 
additional questions for this panel which they may wish to 
submit in writing. Without objection, the hearing record will 
remain open for 30 days for members to submit written questions 
to these witnesses and to place their responses in the record.
    I thank the witnesses for their unending patience 
throughout the afternoon, and regret that we have to rush out 
of the room. Otherwise, we would be happy to go another round. 
But I am sure the members will follow up with vigorous written 
questions, and I encourage you to answer them as expeditiously 
as you can so that we can continue the process moving along. I 
thank you for coming.
    And the hearing is adjourned.
    [Whereupon, at 5:06 p.m., the hearing was adjourned.]


                            A P P E N D I X



                              July 9, 2009

[GRAPHIC] [TIFF OMITTED] 53234.001

[GRAPHIC] [TIFF OMITTED] 53234.002

[GRAPHIC] [TIFF OMITTED] 53234.003

[GRAPHIC] [TIFF OMITTED] 53234.004

[GRAPHIC] [TIFF OMITTED] 53234.005

[GRAPHIC] [TIFF OMITTED] 53234.006

[GRAPHIC] [TIFF OMITTED] 53234.007

[GRAPHIC] [TIFF OMITTED] 53234.008

[GRAPHIC] [TIFF OMITTED] 53234.009

[GRAPHIC] [TIFF OMITTED] 53234.010

[GRAPHIC] [TIFF OMITTED] 53234.011

[GRAPHIC] [TIFF OMITTED] 53234.012

[GRAPHIC] [TIFF OMITTED] 53234.013

[GRAPHIC] [TIFF OMITTED] 53234.014

[GRAPHIC] [TIFF OMITTED] 53234.015

[GRAPHIC] [TIFF OMITTED] 53234.016

[GRAPHIC] [TIFF OMITTED] 53234.017

[GRAPHIC] [TIFF OMITTED] 53234.018

[GRAPHIC] [TIFF OMITTED] 53234.019

[GRAPHIC] [TIFF OMITTED] 53234.020

[GRAPHIC] [TIFF OMITTED] 53234.021

[GRAPHIC] [TIFF OMITTED] 53234.022

[GRAPHIC] [TIFF OMITTED] 53234.023

[GRAPHIC] [TIFF OMITTED] 53234.024

[GRAPHIC] [TIFF OMITTED] 53234.025

[GRAPHIC] [TIFF OMITTED] 53234.026

[GRAPHIC] [TIFF OMITTED] 53234.027

[GRAPHIC] [TIFF OMITTED] 53234.028

[GRAPHIC] [TIFF OMITTED] 53234.029

[GRAPHIC] [TIFF OMITTED] 53234.030

[GRAPHIC] [TIFF OMITTED] 53234.031

[GRAPHIC] [TIFF OMITTED] 53234.032

[GRAPHIC] [TIFF OMITTED] 53234.033

[GRAPHIC] [TIFF OMITTED] 53234.034

[GRAPHIC] [TIFF OMITTED] 53234.035

[GRAPHIC] [TIFF OMITTED] 53234.036

[GRAPHIC] [TIFF OMITTED] 53234.037

[GRAPHIC] [TIFF OMITTED] 53234.038

[GRAPHIC] [TIFF OMITTED] 53234.039

[GRAPHIC] [TIFF OMITTED] 53234.040

[GRAPHIC] [TIFF OMITTED] 53234.041

[GRAPHIC] [TIFF OMITTED] 53234.042

[GRAPHIC] [TIFF OMITTED] 53234.043

[GRAPHIC] [TIFF OMITTED] 53234.044

[GRAPHIC] [TIFF OMITTED] 53234.045

[GRAPHIC] [TIFF OMITTED] 53234.046

[GRAPHIC] [TIFF OMITTED] 53234.047

[GRAPHIC] [TIFF OMITTED] 53234.048

[GRAPHIC] [TIFF OMITTED] 53234.049

[GRAPHIC] [TIFF OMITTED] 53234.050

[GRAPHIC] [TIFF OMITTED] 53234.051

[GRAPHIC] [TIFF OMITTED] 53234.052

[GRAPHIC] [TIFF OMITTED] 53234.053

[GRAPHIC] [TIFF OMITTED] 53234.054

[GRAPHIC] [TIFF OMITTED] 53234.055

[GRAPHIC] [TIFF OMITTED] 53234.056

[GRAPHIC] [TIFF OMITTED] 53234.057

[GRAPHIC] [TIFF OMITTED] 53234.058

[GRAPHIC] [TIFF OMITTED] 53234.059

[GRAPHIC] [TIFF OMITTED] 53234.060

[GRAPHIC] [TIFF OMITTED] 53234.061

[GRAPHIC] [TIFF OMITTED] 53234.062

[GRAPHIC] [TIFF OMITTED] 53234.063

[GRAPHIC] [TIFF OMITTED] 53234.064

[GRAPHIC] [TIFF OMITTED] 53234.065

[GRAPHIC] [TIFF OMITTED] 53234.066

[GRAPHIC] [TIFF OMITTED] 53234.067

[GRAPHIC] [TIFF OMITTED] 53234.068

[GRAPHIC] [TIFF OMITTED] 53234.069

