[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
SYSTEMIC REGULATION, PRUDENTIAL
MATTERS, RESOLUTION AUTHORITY,
AND SECURITIZATION
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
OCTOBER 29, 2009
__________
Printed for the use of the Committee on Financial Services
Serial No. 111-88
U.S. GOVERNMENT PRINTING OFFICE
55-814 WASHINGTON : 2009
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HOUSE COMMITTEE ON FINANCIAL SERVICES
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
C O N T E N T S
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Page
Hearing held on:
October 29, 2009............................................. 1
Appendix:
October 29, 2009............................................. 97
WITNESSES
Thursday, October 29, 2009
Bair, Hon. Sheila C., Chairman, Federal Deposit Insurance
Corporation.................................................... 38
Baker, Hon. Richard H., President and Chief Executive Officer,
Managed Funds Association (MFA)................................ 66
Bowman, John E., Acting Director, Office of Thrift Supervision
(OTS).......................................................... 42
D'Arista, Jane, Americans for Financial Reform................... 76
Dugan, Hon. John C., Comptroller, Office of the Comptroller of
the Currency (OCC)............................................. 39
Geithner, Hon. Timothy F., Secretary, U.S. Department of the
Treasury....................................................... 8
Kandarian, Steven A., Executive Vice President and Chief
Investment Officer, MetLife, Inc............................... 71
Menzies, R. Michael S., Sr., President and Chief Executive
Officer, Easton Bank and Trust, Co., on behalf of the
Independent Community Bankers of America (ICBA)................ 73
Ryan, T. Timothy, Jr., President and Chief Executive Officer,
Securities Industry and Financial Markets Association (SIFMA).. 79
Sullivan, Hon. Thomas R., Insurance Commissioner of the State of
Connecticut, on behalf of the National Association of Insurance
Commissioners (NAIC)........................................... 43
Swagel, Hon. Phillip L., Visiting Professor, McDonough School of
Business, Georgetown University................................ 67
Talbott, Scott, Senior Vice President, Government Affairs, the
Financial Services Roundtable.................................. 69
Tarullo, Hon. Daniel K., Governor, Board of Governors of the
Federal Reserve System......................................... 41
Trumka, Richard L., President, American Federation of Labor and
Congress of Industrial Organizations (AFL-CIO)................. 64
Wallison, Peter J., Arthur F. Burns Fellow in Financial Policy
Studies, the American Enterprise Institute..................... 74
Yingling, Edward L., President and Chief Executive Officer,
American Bankers Association (ABA)............................. 77
APPENDIX
Prepared statements:
Garrett, Hon. Scott.......................................... 98
Bair, Hon. Sheila C.......................................... 99
Baker, Hon. Richard.......................................... 117
Bowman, John E............................................... 127
D'Arista, Jane............................................... 138
Geithner, Hon. Timothy F..................................... 150
Kandarian, Steven A.......................................... 155
Menzies, R. Michael S., Sr................................... 166
Ryan, T. Timothy, Jr......................................... 188
Sullivan, Hon. Thomas R...................................... 219
Swagel, Hon. Phillip L....................................... 229
Talbott, Scott............................................... 236
Tarullo, Hon. Daniel K....................................... 291
Trumka, Richard L............................................ 308
Wallison, Peter J............................................ 312
Yingling, Edward L........................................... 321
Additional Material Submitted for the Record
Frank, Hon. Barney:
Written statement of Andrew W. Lo............................ 335
Written statement of the Property Casualty Insurers
Association of America (PCI)............................... 346
Garrett, Hon. Scott:
Excerpt from the Congressional Record, dated October 3, 2008. 371
Dear Colleague letter from Representative Brad Sherman, dated
October 29, 2009........................................... 374
Paulsen, Hon. Erik:
Written statement of the Commercial Mortgage Securities
Association (CMSA)......................................... 376
Letter to Chairman Barney Frank and Ranking Member Spencer
Bachus from the American Land Title Association, et al.,
dated October 28, 2009..................................... 383
D'Arista, Jane:
Addendum to written testimony................................ 385
Swagel, Hon. Phillip:
Additional information provided for the record in response to
a question posed by Representative Watt during the hearing. 386
SYSTEMIC REGULATION, PRUDENTIAL
MATTERS, RESOLUTION AUTHORITY,
AND SECURITIZATION
----------
Thursday, October 29, 2009
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 9:30 a.m., in
room 2128, Rayburn House Office Building, Hon. Barney Frank
[chairman of the committee] presiding.
Members present: Representatives Frank, Kanjorski, Waters,
Watt, Sherman, Meeks, Moore of Kansas, Hinojosa, Clay, McCarthy
of New York, Baca, Miller of North Carolina, Scott, Green,
Cleaver, Ellison, Klein, Perlmutter, Donnelly, Foster, Carson,
Speier, Minnick, Adler, Driehaus, Kosmas, Himes, Peters,
Maffei; Bachus, Royce, Paul, Manzullo, Biggert, Capito,
Hensarling, Garrett, Neugebauer, McHenry, Putnam, Bachmann,
Marchant, McCotter, Posey, Jenkins, Lee, Paulsen, and Lance.
The Chairman. The hearing will come to order. I apologize.
I was delayed a few minutes and I regret that. We will have 10
minutes on each side for opening statements and the gentleman
from Illinois is recognized for 3 minutes.
Mr. Gutierrez. Thank you, Mr. Chairman. First of all, I
would like to thank the Secretary for coming here today; and,
while I support most of the legislation, I am apprehensive
about the way we propose to create a fund to pay for the costs
associated with the resolution of a failed, systematically
significant financial institution. It seems to me that behavior
that was reckless, dangerous, and risky in the past has
generated huge profits and gains and allowed Wall Street
executives to line their pockets with hundreds of millions of
dollars, if not become billionaires in this process; that
greed, that avarice, should it ever raise its ugly head once
again, there should be an insurance fund paid for them. These
are good times.
We read all about how good the Wall Street giants are doing
once again and how their profitability is there. They should
set aside some of that money. Most of us don't die and then buy
a life insurance policy. Most of us say, in case something
happens to Luis, let me make sure if I owe people money and if
I have responsibilities, that I leave my family and all of
those to whom I have a responsibility, that I set aside some
money and I buy some insurance. It would be wonderful that one
day I would just wake up cold and that all my debtors and
everybody would say, oh, let's go take the life insurance
policy on Luis.
That's not the way it works. The way it works, and Wall
Street has to learn, because I read in the paper this morning,
Mr. Secretary, they're complaining. Record profits on Wall
Street, and they're complaining that the Congress of the United
States might require them to set aside some of those billions
of dollars in earnings so that in the eventuality that they
might become systematically risky to us and fail, that there be
money set aside for that.
No more American taxpayer money should be set aside in case
we have the kind of tragedy and economic failure that we saw in
the last couple of years. So my basic premise today is, look,
they were greedy. They should pay for future insurance policy
payouts. The fund should be set up just in case their behavior,
their reckless and dangerous and risky behavior, raises its
ugly head again. And I look forward not only today but to the
process of designing legislation that makes sure that those
risky institutions are paying into a fund now, today--not after
the fact.
Thank you very much, Mr. Chairman.
The Chairman. The gentleman from Alabama is recognized for
5 minutes.
Mr. Bachus. Mr. Chairman, as you know from the letter you
received from the House Financial Services Committee
Republicans yesterday, the process for considering the most
far-reaching reforms of our financial system since the Great
Depression should be deliberative and not hurried.
The draft legislation that was supposed to be the subject
of this hearing was not received until Tuesday afternoon. I
doubt that any of today's witnesses, with the possible
exception of Secretary Geithner, have had an opportunity to
fully comprehend the legislation in its entirety or to arrive
at informed views on its merits. Under the rules of this
committee, the witnesses' written testimony was due 2 days
before this hearing, which is to say it was due before the
draft bill was released.
The written testimony, therefore, cannot and does not
address in any meaningful way the legislation we are marking up
early next week. Although we have had the draft bill for less
than 48 hours, even a cursory reading shows that the
Administration has chosen to continue its failed policy of
costly taxpayer bailouts orchestrated behind closed doors by
officials of the Treasury and the Federal Reserve.
The Democrats' talking points that their new proposal ends
the era of ``too-big-to-fail'' are just that--talk. Their
proposal places taxpayers first in line to bear the losses when
the government invokes its resolution authority; and, for those
who believe that those taxpayer losses will subsequently be
recouped from surviving firms, I would direct their attention
to the recent examples of GM, Chrysler, Fannie Mae, Freddie
Mac, and AIG, and the even more recent example of GMAC, where
the prospects for full taxpayer reimbursement are fanciful.
In fact, in testimony before this committee last month,
former Federal Reserve Chairman Paul Volcker warned that a
resolution authority with the power to lend or provide money
would encourage the ``too-big-to-fail'' syndrome. Although he
advises the Obama Administration, his caution has been rejected
in this draft. And in an attempt to naming the institutions it
deems ``too-big-to-fail,'' the Administration's legislative
proposal foregoes the transparency and full disclosure that are
the hallmark of America's capital markets. In the place of an
open process, it substitutes a regulatory regime built around a
secret list of ``too-big-to-fail'' institutions.
It is foolish to assume such a list will be kept secret.
Are we so gullible as to believe that the regulatory
authorities for eight government agencies will be able to
impose increased capital requirements and a host of other
regulatory constraints on the so-called identified firms
without market participants quickly figuring out which firms
are on the list? Are companies expected to treat this
information as immaterial for purposes of filing reports with
the SEC?
Until these questions are answered, it's simply
irresponsible for this committee to accept such a foundation on
premise and move forward with this legislation. The
Administration's desire to get something, anything done to
satisfy some arbitrary deadline imposed on the chairman will
result in this committee passing a product that has not
received the careful deliberation necessary to ensure sound
legislation.
Mr. Chairman, is it too much to ask the members of this
committee and the people they represent that they have enough
time to read and understand the far-reaching implications of
this legislation?
In conclusion, this committee's haste also stands in marked
contrast to the views expressed by Federal Reserve Vice
Chairman Donald Kohn, who said: ``I hope we build a regulatory
structure that's good for a couple of decades and it's worth
taking our time to get it right. The economy is fragile, and we
learned this morning that it continues to lose jobs. We need to
promote job creation and growth--not more uncertainty.''
I share Vice Chairman Kohn's hope that we fulfill our
obligation to do this in a deliberative manner, not the haste
that we are witnessing this morning. I yield back the balance
of my time.
The Chairman. The gentleman from Pennsylvania is recognized
for 2 minutes.
Mr. Kanjorski. Thank you, Mr. Chairman.
Mr. Chairman, I understand that we are under pressure to
get some things done, and unfortunately we have not had a great
deal of time to spend in analyzing this proposition. I wanted
to address my remarks simply to the Secretary that in his
presentation can help us out.
I discern that there is a great interest in America for us
to have this type of power at the Federal level to prevent
future disasters of the kind we have experienced within the
last year; but, I also feel that the American people are
speaking to this Congress and very broadly to the world that
they cannot understand how we just support the safety
mechanisms for the bailout and cannot put caps or limitations
on the huge conglomerations of money that we are causing by our
own very bailout.
It seems to me that if Treasury was able to come up with
proposals like this, they also should have the burden and at
this time use this offer as a balancing act to come up with the
mechanism in place so that we can act to start limiting the
unlimited power of the Goldman Sachs of the world and other
huge conglomerations of money. And that may sound strange. It
may sound revolutionary, but we are almost in revolutionary
times. But, clearly, if Treasury and the Executive Branch have
come to the conclusion that the danger to our system was so
great that we have to use the Interstate Commerce Clause to
create tremendous executive authority without much restraint.
I just read the chairman's letter and I think he makes some
good points in his letter. If we are going to have that kind of
a transfer of authority, it seems to me it is the obligation of
Treasury to come forth and say how we are going to prevent
this, so this never happens again in the future, by really
curtailing and tailoring down the size of the institutions,
particularly the financial institutions of this country so that
we do not have systemic risk.
The Chairman. The gentleman's time has expired. I am going
to go to a couple of members on the Republican side, because we
have just a spattering of people. The gentleman from Texas, Mr.
Neugebauer, for 1 minute.
Mr. Neugebauer. Thank you.
I thank Secretary Geithner and Chairman Frank for their
work on this new draft. While they have addressed some of the
concerns raised from prior proposals, the overall concept
doesn't seem to have changed much. This draft will still allow
regulators to identify firms that are ``too-big-to-fail,''
although those firms will now be kept secret. This version
still keeps the government in the bailout business while a line
of credit for the taxpayers will be used, and may or may not be
paid back.
These two ideas for me are non-starters. Rather than an
arbitrary, government-run resolution, we need a stronger
bankruptcy process that holds firms and creditors to the rule
of law. Rather than picking winners and losers behind closed
doors, the council should require regulators to look at risks
across financial entities and review capital requirements to
ensure that all firms are holding the necessary capital for the
risk that they are taking.
We need a reform plan that puts the taxpayers and the
economies first rather than making bailouts permanent. And,
like the ranking member, I think this process needs to be
slowed down some, because these are probably some of the more
important things that we'll do on this committee in the next
few months, and we need to get it right. I yield back.
The Chairman. The gentleman from California, Mr. Royce.
Mr. Royce. Thank you, Mr. Chairman. Apparently, the ``too-
big-to-fail'' model is ``too-hard-to-kill.'' I thought we would
have learned our lesson from Fannie Mae and Freddie Mac. Prior
to their failure, it was widely perceived that the government
would be there to bail them out when they ran into trouble.
That implicit guarantee translated into real advantages for the
GSEs in terms of lower cost of capital which facilitated their
dominance in the marketplace.
The explicit backstop already provided to the largest of
our financial institutions is having an eerily similar effect.
A recent study by the Center of Economic and Policy Research
found that the ``too-big-to-fail'' doctrine has translated into
a tangible subsidy for the 18 largest bank holding companies
worth $34 billion per year with a 78 basis points lower cost of
capital when compared to their smaller competitors. Instead of
granting permanent bailout authority and institutionalized in
the ``too-big-to-fail'' doctrine which this legislation does,
we should set up a structure that will allow for an orderly
liquidation of an institution through an enhanced bankruptcy
without the use of government funds. I yield back.
The Chairman. The gentlewoman from Illinois, Ms. Biggert,
for 1 minute.
Mrs. Biggert. Thank you, Mr. Chairman. My initial review of
the chairman and Secretary's financial stability plan is that
it would do the complete opposite: create further financial
instability; and facilitate risky behavior in financial firms.
And while the headlines have said that a deal has been reached,
I would argue that this is no deal for the American people and
especially the taxpayers.
While I support a strong council of regulators, including
Federal and State regulators at the table, and I support
stronger and smarter regulation, I don't think that the
resolution authority under this proposal is the right answer.
It is my hope that instead of supporting more proposals to
increase the power of the Federal Government, the
Administration will strongly consider a new chapter to the
Bankruptcy Code.
In addition, it is my hope that we can also consider
proposals addressing two of the biggest financial failures of
our time: Fannie Mae and Freddie Mac. Never again can we allow
regulators to fall asleep at the wheel or another bailout, or
the government picking winners and losers of private
businesses. I yield back.
The Chairman. I will yield myself 5 minutes.
We are in a difficult situation. History has apparently
been somewhat rewritten. All of the bailouts that the gentleman
from Alabama referred to, where we are not going to get money
back, were the result of an absence of policies to deal with
this set of situations; and, every one of those bailouts was of
course requested by the Bush Administration, by Secretary
Paulson and Chairman Bernanke.
Now, as of April 2008, Secretary Paulson said we needed to
do some things to keep this from happening. It happened very
quickly, and we were unable to avoid those. The question of
simply allowing bankruptcy to be the way to deal with it,
there's nothing theoretical about that.
That's the Lehman Brothers situation. The Lehman Brothers
went bankrupt and the Bush Administration officials had two
responses: first, to use Federal Reserve authority without any
congressional approval, and even prior notification, to begin
the process of providing funds to pay off the creditors of AIG.
That was done by the Federal Reserve last September under the
Bush Administration with no congressional involvement other
than to be told after the fact.
Second, they came and asked us for authority to spend some
money to provide some forms of cash so other institutions
didn't go under. Congress agreed with some conditions, I think,
and avoided worse dangers. It could have been administered
better.
Our whole purpose today was to change that situation and to
prevent it. Yes, it is true that we had these previous
problems. That's because we didn't have a set of rules. What we
do today is to begin deliberation on a proposal that does.
There are two problems that were raised with regard to the
bailouts: one, the use of taxpayer money; and this is a set of
proposals that will prevent taxpayer money from being used.
Members say, ``Oh, this requirement that it come from the
financial industry, that won't work. Congress will do it
instead.'' They have a very different Congress in mind than the
one I have served in. I do not believe there is any remote
chance that Congress would come to the rescue of the financial
industry that this bill will have required and said substitute
taxpayer money. If that's their intention, they can try.
I think they will be outvoted if they feel that's what has
to happen. Secondly, there is the moral argument. There is the
argument that once people know that certain institutions are of
a certain size, they'll be protected. That's why many of us
protected the notion that there will be a list published
beforehand. What we have here is this. A group of regulators
that will be monitoring institutional behavior, both cumulative
institutional behavior, like subprime loans, and the behavior
of a large, irresponsible institution like AIG.
There will be no notification to the public or privately
that a particular institution is in that category without
simultaneous restrictions on the institution. There will be no
prior notification, so the institution will then be free to
attract investment, because it will be shown to be so big. It
will become manifested. This institution is covered. The day
that the regulator says you must significantly increase your
capital, you must reduce your activity. We will be adding to
this. It's in here--an ability to take the kind of restrictions
that existed under Glass-Steagall nationwide and impose them
institution by institution.
Now, there is a threshold question. Is it possible to go
forward in this situation without any funds ever being used to
prevent the kind of cataclysm of failure leading to failure
leading to failure that the Bush Administration felt very much
we had to avoid. We, I think, minimized this in a couple of
ways. First of all, the penalty for being such an institution
will be very severe. There will be death panels enacted by
Congress this year, I hope, but they will be for those large
institutions, which will be put out of business, whose
shareholders will be wiped out, whose executors will be fired,
whose boards of directors will be replaced.
There will also be no guarantee in any case that the
creditors are going to receive 100 cents on a dollar. Classes
of creditors will be allowed to be exempted entirely from any
repayment. Other creditors will have it reduced. You can't do
that under bankruptcy. General bankruptcy makes it harder to
have that kind of thoughtful selection. We are using the
constitutional power of bankruptcy, but in a way that is more
thoughtful.
Finally, I would say this: This is not the only piece. We
are regulating derivatives over the objection of my Republican
colleagues. I hope we will be imposing some restrictions on
your ability to securitize 100 percent of the loan. We are
doing other things. We are requiring other people to register.
There will be other restrictions that will keep us from getting
to that situation.
And, now, I recognize the gentleman from Texas, Mr.
Hensarling, for 1 minute.
Mr. Hensarling. Thank you, Mr. Chairman.
I find it somewhat curious that we are having a hearing on
systemic regulation, and nowhere do I see the Director of the
FHFA, the regulator of Fannie and Freddie, the same Fannie and
Freddie that were compelled to buy the lion's share of poorly
underwritten loans in this Nation; the same Fannie and Freddie
that have now cost the taxpayer over $1 trillion.
The Administration has now submitted to us legislation to
regulate pawnshops and grocery stores, but no legislation
dealing with the greatest systemic risk within the system:
Fannie and Freddie. The bill we are considering today will
simply institutionalize ``too-big-to-fail,'' paving the way for
more Fannies and Freddies in perpetual taxpayer bailouts.
According to the Wall Street Journal, the Administration is not
done with taxpayer funded bailouts, as apparently GMAC is now
in for their third multi-billion-dollar bailout.
To borrow from a title of the song from the Commodores:
``Once, Twice, Three Times a bailout;'' enough is enough. I
yield back.
The Chairman. The gentleman from New Jersey, Mr. Garrett,
for 1 minute.
Mr. Garrett. Mr. Chairman, I seek unanimous consent to
enter into the record the statement by Congressman Brad Sherman
regarding, ``Let's Not Adopt TARP On Steroids,'' an appropriate
analysis of exactly what this legislation stands for.
The Chairman. Without objection, it is so ordered.
Mr. Garrett. Okay. Thank you. And secondly, I wish to enter
into this record the ``Congressional Record'' from the day in
which the TARP legislation was passed by this House of Congress
and indicate in that day of the ``Congressional Record'' that
the chairman was the manager of that legislation as it passed
through a Democratic Congress, without objection.
The Chairman. Without objection, it is so ordered.
Mr. Garrett. There you go. Thank you.
Mr. Chairman, do I begin my time now?
The Chairman. Start the minute now.
Mr. Garrett. Thank you. Mr. Chairman, I find this
legislation draft proposal, which is a continuation of bailout
legislation, absolutely incredible. Over the last several
months, it was my impression that there was a developing
consensus that the Federal Reserve should be given less power
and not more. But in reading over this discussion draft in the
very limited time that we have had to review probably the most
important legislation the members of this committee will ever
consider in our lifetimes, I am just struck by how much power
the Federal Reserve is given.
Although it is not singled out as a systemic uber-regulator
in name, don't anyone be fooled. This Fed is given primary
supervision over systemic firms and can override lesser
regulators that don't comply with its wishes. In the name of
mitigating systemic risk, the Fed is given almost unlimited
authority to systemically dismantle a private company. This is
a lot more than imposing capital standards.
I for one, given the extraordinary government intervention
into private firms we have already seen with the trampling of
the rule of law in order to benefit some political favorites in
the auto industry, for instance, I am very uncomfortable with
giving this sweeping, unchecked power to the same entity that
failed to effectively mitigate many of the large bank holding
companies already under its purview. Thank you.
The Chairman. The Secretary of the Treasury is now
recognized for his statement.
STATEMENT OF THE HONORABLE TIMOTHY F. GEITHNER, SECRETARY, U.S.
DEPARTMENT OF THE TREASURY
Secretary Geithner. Thank you, Mr. Chairman. It's a
pleasure to be here again.
I want to begin with a few comments on the economy. Today,
we learned that our economy is growing again. In the third
quarter of this year, the economy grew at an annual rate of 3.5
percent, the first time we have seen positive growth in a year,
and the strongest growth in 2 years. Business and consumer
confidence has improved substantially since the end of last
year. House prices are rising. The value of American savings
has increased substantially. Americans are now saving more and
we are borrowing much less from the rest of the world.
Consumers are just starting to spend again. Businesses are
starting to see orders increase. Exports are expanding. And
these improvements are the direct result of the tax cuts and
investments that were part of the Recovery Act and the actions
we have taken to stabilize the financial system and unfreeze
credit markets. But, this is just the beginning.
Unemployment remains unacceptably high. For every person
out of work, for every family facing foreclosure, for every
small business facing a credit crunch, the recession remains
alive and acute. Growth will bring jobs, but we need to
continue working together to strengthen the recovery and create
the conditions where businesses will invest again and all
Americans will have the confidence that they can provide for
their families, send their kids to college, feel secure in
retirement. And we have a responsibility as part of that to
create a financial system that is more fair and more stable,
one that provides protections for consumers and investors, and
gives businesses access to the capital they need to grow.
That brings me to the topic at hand. This committee has
made enormous progress in the past several weeks. In the face
of a substantial opposition, you have acted swiftly to lay the
foundation for far-reaching reforms that would better protect
consumers and investors from unfair, fraudulent investment
lending practices to regulate the derivatives market, to
improve investor protection, to reform credit rating agencies,
to improve the securitization markets, and to bring basic
oversight to hedge funds and other unregulated activities.
Today, you carry this momentum forward.
One of the most searing lessons of last fall is that no
financial system can work if institutions and investors assume
that the government will protect them from the consequences of
failure. Never again should taxpayers be put in the position of
having to pay for the losses of private institutions. We need
to build a system in which individual firms, no matter how
large or important, can fail without risking catastrophic
damage to the economy.
Last June, we outlined a comprehensive set of proposals to
achieve this goal. There has been a lot of work by this
committee and many others since then. The chairman has
introduced new legislation to accomplish that. We believe any
effective set of reforms has to have five key elements. I am
going to outline those very, very quickly, but I want to say
that the legislation, in our judgment, meets that test.
The first test is the government has to have the ability to
resolve failing major financial institutions in an orderly
manner with losses absorbed not by taxpayers, but by equity
holders and by unsecured creditors. In all but the rarest
cases, bankruptcy will remain the dominant tool for handling
financial failure, but as the collapse of Lehman Brothers
demonstrates, the Bankruptcy Code is not an effective tool for
resolving the failure of complicated global financial
institutions in times of severe stress.
Under the proposals we provided, which are very similar to
what already exists for banks and thrifts, a failing firm will
be placed into an FDIC-managed receivership so they can be
unwound, dismantled, sold or liquidated in an orderly way.
Stakeholders of the firm would absorb losses. Managers
responsible for failure would be replaced.
A second key element of reform: any individual firm that
puts itself in the position where it cannot survive without
special assistance from the government must face the
consequences of that failure. That's why this proposed
resolution authority would be limited to facilitating the
orderly demise of the failing firm, not ensuring its survival.
It's not about redemption for the firm that makes mistakes.
It's about unwinding them in a way that doesn't cause
catastrophic damage to the economy.
Third key point: Taxpayers must not be on the hook for
losses resulting from failure and subsequent resolution of a
large financial firm. The government should have the authority,
as it now does, when we resolve small banks and thrifts. The
government should have the authority to recoup any losses by
assessing a fee on other financial institutions. These
assessments should be stretched out over time as necessary to
avoid amplifying adding to the pressures you face in crisis.
Fourth key point, and I want to emphasize this: The
emergency authorities now granted to the Federal Reserve and
the FDIC, should be limited so that they are subject to
appropriate checks and balances and can be only used to protect
the system as a whole.
Final element: The government has to have stronger
supervisory and regulatory authority over these major firms.
They need to be empowered with explicit authority to force
major institutions to reduce their size or restrict the scope
of their activities, where that is necessary to reduce risks to
the system. And this is a critically important tool we do not
have at present.
Regulators must be able to impose tougher requirements,
most critically, stronger capital rules, more stringent
liquidity requirements that would reduce the probability that
major financial institutions in the future would take on a
scale of size and leverage that could threaten the stability of
the financial system. This would provide strong incentives for
firms to shrink simply to reduce leverage.
We have to close loopholes, reduce the possibilities for
gaming the system, for avoiding these strong standards. So
monitoring threats to stability will fall to the responsibility
of this new financial services oversight council. The council
would have the obligation and the authority to identify any
firm whose size and leverage and complexity creates a risk to
the system as a whole and needs to be subject to heightened,
stronger standards, stronger constraints on leverage.
The Federal Reserve under this model would oversee
individual financial firms so that there's a clear,
inescapable, single point of accountability. The Fed already
provides this role for major banks, bank holding companies, but
it needs to provide the role for any firm that creates that
potential risk to the system as a whole. The rules in place
today are inadequate and they are outdated. We have all seen
what happens, when in a crisis the government is left with
inadequate tools to respond to data damage.
That is a searing lesson of last fall. In today's markets,
capital moves at unimaginable speeds. When the system was
created more than 90 years ago, and today's economy given these
risks requires we bring that framework into the 21st Century.
The bill before the committee does that. It's the
comprehensive, coordinated answer to the moral hazard problem
we are also concerned about.
What it does not do is provide a government guarantee for
troubled financial firms. It does not create a fixed list of
systemically important firms. It does not create permanent TARP
authority; and, it does not give the government broad
discretion to step in and rescue insolvent firms. We are
looking forward. We are looking to make sure we provide future
Administrations and future Congresses with better options than
existed last year. This is still an extremely sensitive moment
in the financial system.
Investors across the country and around the world are
watching very carefully your deliberations, our debate, our
discussions; and, I want to make sure they understand that
these reforms we're proposing are about preventing the crises
of the future, while we work to repair the damage still caused
by the current crisis.
The American people are counting on us to get this right
and to get this done. I want to compliment you again for the
enormous progress you made already and I look forward to
continuing to work with you to produce a strong package of
reforms.
Thank you, Mr. Chairman.
[The prepared statement of Secretary Geithner can be found
on page 150 of the appendix.]
The Chairman. I want to begin and use my 5 minutes
essentially to make some points. I know there will be no dearth
of questions, Mr. Secretary. So while I will not be asking you
any questions, I do not think you will feel ignored by the end
of this morning.
First, let me address the timing issue. The ideas that we
are talking about here really were first formulated for major
public debate by former Treasury Secretary Paulson in April of
2008, and they have been under serious discussion since then.
Various versions have gone forward. This particular draft,
reflecting a lot of conversations a lot of people have had was
recently released. We won't get to mark it up until next week,
and probably not until Wednesday now, because we have a couple
of things to finish up from Tuesday.
The argument that we should wait, we are more open to the
criticism that we haven't moved quickly enough rather than we
are moving too quickly in this. There was a paralysis in the
financial system, but that is happily ending. And we don't want
to get behind that curve. Second, I want to address the
question of Fannie Mae and Freddie Mac. I am astounded by the
notion that we have to regulate them. We did.
In 2007, as chairman of this committee, I made as our first
major order of business adopting the regulation of Fannie Mae
and Freddie Mac that the Bush Administration wanted. We did
that in the House. We did not get prompt action in the Senate,
surprisingly, and when the first stimulus bill came up in
January of 2008, I urged that they take our Fannie/Freddie
reform, which was approved by the Bush Administration, and make
it part of the bill.
They weren't able to get agreement with themselves to do
it. The Senate did act on our reform in 2008--too late to stall
off the crisis--but the fact is that the Fannie and Freddie
that exist today are already the ones that were strictly
regulated. Now, they have collapsed. They are not acting as
they did before. It is important for us going forward to
totally revise the functions of the secondary market and
whether or not the subsidy should be a part of that.
That certainly will be on our agenda next year. But, Fannie
and Freddie are not out there doing what they did before: (A)
they are subject to regulation; and (B) there is a collapse. It
is not a case that they are two unregulated entities working
out. I think part of this debate suffers from serious cultural
lag with a little partisan motivation.
Next, I want to talk about the comparison between this year
and last year. In the events leading up to the collapse of last
year, there was no regulation of subprime lending, a major
contributing factor. We adopted legislation to control subprime
lending in the House. It didn't get enacted in the Senate. The
Fed is still active. We have that as part of this bill. We will
not have the unrestricted, unregulated, irresponsible subprime
lending that led in part to the collapse because so many of the
securities that fell apart were of that sort.
We had no regulation of derivatives. AIG was engaged in
wild speculation and these things all interact. You had bad
subprime mortgages that shouldn't have been issued. Then you
had AIG without any restriction ensuring against the default of
these bad subprime mortgages. That again will be corrected by
the time we go forward. We will have hedge fund registration,
private equity registration, much more data collection than we
had before.
We, as I said, have Fannie and Freddie playing a very
different role. You had an unregulated Fannie and Freddie
before this House began the process of regulating for 2007. You
had unregulated subprime mortgages. You had unregulated
derivatives. All those things are now incorporated, so yes, we
want to avoid the ``too-big-to-fail.'' Part of it is that we
have restrictions here that will keep these institutions: (A)
from getting too big; (B) from being likely to fail; and (C)
having fewer consequences when they do.
So the comparison of today to before, as I said, is serious
cultural lag. We will have severely restricted the kind of
irresponsible activity in derivatives in subprime lending; and
another piece that I mentioned, in securitization. I myself
think one of the biggest causes that happened here was that 30
years ago people who lent money to other people were the people
who were expected to be paid back.
Once they were able to get rid of all of those loans, the
discipline of the lender-borrower relationship diminished, so
we are severely--we are going to reform securitization with
some risk retention. We are restricting irresponsible subprime
loans. We are regulating derivatives. There will be no
unregistered, large financial enterprises going forward. We
will have the ability to significantly increase capital
requirements, more than proportionally, so all of those things
are there.
Yes, in the absence of all of those, we had greater
problems. We are talking about a regime that puts all those in
a place and then in the end says, for all of that, somebody
fails. We step in and we hammer them pretty hard and we protect
the taxpayers.
The gentleman from Alabama.
Mr. Bachus. Secretary Geithner, this list of companies is
to be kept secret? Is that correct?
Secretary Geithner. Congressman, the central imperative is
to make sure that institutions that could threaten the
stability of the system are held to tougher constraints on
leverage and risk-taking.
Mr. Bachus. And capital and prudential--
Secretary Geithner. Capital and liquidity--
Mr. Bachus. Yes--
Secretary Geithner. And risk-taking generally.
Mr. Bachus. Right.
Secretary Geithner. That's the central lesson of this
crisis, the central imperative of reform. To do that, they have
to know who they are.
There should not be a fixed list. It may change over time,
because the system changes over time. But the central
imperative is, if you take on or could risk the stability of
the system as a whole--
Mr. Bachus. But you have to designate, it has to come on a
list, or it has to be designated, if you're going to increase
capital on them, or prudential regulations, or--
Secretary Geithner. Exactly. And in some ways--
Mr. Bachus. So you will have a list. There will be these
companies that you know of.
Secretary Geithner. What I state is this--and this is the
system that exists today, although it didn't work as well as it
needs to--right now--
Mr. Bachus. I'm not talking about that, I'm just saying--
Secretary Geithner. No, but this is important. Right now,
if you were a globally active bank, the capital requirements
you are held to are different from and tougher than if you were
a regional or community bank.
So that's the system we have today. Now those banks know
who they are, they exist, and they're designated as globally
active banks.
Mr. Bachus. I understand. But for instance, the SEC, these
companies have to file with the SEC. They would have to make a
material disclosure as to that they were--
Secretary Geithner. Yes. And it won't be a secret that
they're held to tougher standards. It's very important that
they are held to the tougher standards, and you know that they
are held to the tougher standards.
Mr. Bachus. So it will not be a secret?
Secretary Geithner. No, it can't be. Because again, they
have to be--the purpose of it is so that they're held to
tougher standards.
Mr. Bachus. So if it is not a secret, then people will
know. I think it's a given that people can figure out quite
quickly, when you raise capital restraints, require more
capital, that will be disclosed.
Secretary Geithner. If they weren't held to higher capital
requirements, we would be making a mistake. If they were held
to it, but nobody knew it, it wouldn't do any good.
Mr. Bachus. You say in this legislation that you can
increase the capital requirements.
Secretary Geithner. Of course, exactly. And that's why I
think it's designed this way, and it's very appropriate.
Mr. Bachus. And the market and the investors or
shareholders, they'll know that in fact the companies would
have to disclose that--
Secretary Geithner. Absolutely. Again, for the capital
requirements, they have to exist to be tougher.
Mr. Bachus. Right.
Secretary Geithner. And the market will have to know
they're held to tougher standards.
Mr. Bachus. So the public would almost immediately realize
who these companies were.
Secretary Geithner. True. But Congressman, I think we're
missing the key point. What you don't want to do is by
identifying a list of companies that are going to be held to
tougher standards, create an expectation that government will
step in and protect them, if they screw up.
Mr. Bachus. Well--
Secretary Geithner. It's a difficult balance. That's the
balance you have to strike.
Mr. Bachus. I know that you won't release--it says that
there will not be a release of the companies on a list. Okay?
But by putting new requirements on them, people will
realize quite quickly, in fact those companies will have to
disclose to investors and to the market, and to the SEC and
other regulators that they're under those constraints.
Secretary Geithner. I don't think we're disagreeing,
Congressman. I think, if I understand you correctly, you're in
favor of making sure that these firms can be held to higher
standards. This is a way of doing that. And--
Mr. Bachus. No, and let me say this, I'm not in favor of
them being held to higher standards. But if we are to hold them
to higher standards, I think the market is going to have to
know.
Secretary Geithner. But you would not impose tougher
standards on the largest, most risky institutions, than apply
to a community bank or a regional bank?
Mr. Bachus. All right. Let me ask you this. I'm not,
because what you then do, you say that you can loan these
companies money.
Secretary Geithner. No. I think that's a
mischaracterization of this. What this does is makes sure, if
in the future, they get themselves in the position where they
can't survive on their own--
Mr. Bachus. Right--
Secretary Geithner. Then the only authority we would have
is to manage their failure without causing the economy to go
through what this economy went in this crisis. That's the
basic--
Mr. Bachus. But under 1109, even a solvent company, you can
have capital injections, you can invest in those institutions,
you can buy their assets.
Secretary Geithner. Again, Congressman, the important thing
to recognize is--and it's just worth going back to what it was
like last fall--without the ability for the government to step
in and manage the failure of a large firm, and contain the risk
of the fire spreading, we'll be consigned to repeat the
experience of last fall.
It's a stark simple thing. And I know of no person who has
stood in my seat--this is true for Secretary Paulson--in any
central bank in any major country, who would say the country
should be run with no authority to step in and act in that
case.
Mr. Bachus. Let me ask you--
Secretary Geithner. I don't think there's any credible--
Mr. Bachus. Let me ask you this, Secretary--this will be my
last question. You impose a tax on large and medium-sized
financial institutions to--
Secretary Geithner. Only if, as part of protecting the
system from their failure, the government is exposed to losses.
In that case and only to that extent, would there be a fee
assessed on the institutions to cover it.
Mr. Bachus. But that's a tax on their competitors, is it
not?
Secretary Geithner. But that's again--Mr. Kanjorski, can I
borrow my time?
Mr. Kanjorski. [presiding] A second, to finish.
Secretary Geithner. Okay.
Mr. Kanjorski. But no further questions.
Secretary Geithner. Okay.
This is a very important key thing. The system Congress
designed for small banks and thrifts today works in a similar
way. It's different because it's part of an explicit insurance
regime. But in that case, if the government has to step in--and
the FDIC does this every week, step in and manage the failure
of a bank--if in that case, the government assumes any risk of
loss, it has to put a fee on institutions to recoup that loss
over time, so the taxpayer is protected.
What we are doing is a very simple thing. We're taking that
basic framework, and we're adapting it to the system we have
today. We should have done that 10 years ago, but we didn't do
it.
But it's a very simple thing. If the government is exposed
to loss when it acts to protect the system--any risk of loss--
it should assess a fee on banks over time to recoup that loss.
That's to make sure the taxpayer is not in the position of
absorbing those losses. That's the basic premise.
Mr. Bachus. Of course, I think we all know that what they
do now is--
Mr. Kanjorski. The gentleman's time has expired.
Mr. Bachus. A fee on the insured deposit is what it is--
Mr. Kanjorski. The gentleman's--
Secretary Geithner. No, it goes beyond that.
Mr. Kanjorski. Look, time has expired, and the Chair is
going to ask for cooperation here.
Mr. Bachus. Okay. Thank you.
Mr. Kanjorski. All right.
And now the Chair is going to take its time, 10 minutes,
right? No, I'm serious.
[laughter]
Mr. Kanjorski. I am going to follow up on the questions
that the ranking members asked. If I listened to what he was
saying--and I that your answers were off the point, Mr.
Secretary--he is asking you on what authority is this
extraordinary centralization of executive authority contained?
Do you have some particular provision of the Constitution
that says that this Congress has a right to transfer this
amount of authority to the Executive Branch of Government?
And that should be a pertinent question that we all
address. There are a lot of things in this country we would
like to do, should do, or could do to protect the people. But
there is a little document that they executed some 233 years
ago or 223 years ago, that does not allow us to do that.
Now what is the basis for your authority?
Secretary Geithner. It's--you can just look at the system
today, and I think there's--I'm not a lawyer, and of course our
lawyers would love a chance to study this very carefully--but
Congressman, right now, the Congress grants to a series of
agencies created by the Congress the authority to set capital
requirements on banks.
Mr. Kanjorski. Yes.
Secretary Geithner. And right now, the Congress has given
the Executive Branch the authority for banks and thrifts--
Mr. Kanjorski. Mr. Secretary, I agree with that.
Secretary Geithner. Yes.
Mr. Kanjorski. But that is because those institutions
exercise the right of being insured under statutes that this
Congress has passed.
Secretary Geithner. No, it's not solely because of that,
because the protections that exist today that Congress has
given the Executive Branch the authority or the responsibility
for executing go beyond simply the explicit insurance of
deposits.
Mr. Kanjorski. Mr. Secretary, I am not a man who fears this
Administration or you. But I do fear the accumulation of power
exercised by someone in the future that can be extraordinary.
Now you and I know that in this last disaster, Treasury was
able to determine that General Motors and the auto industry
were banks, financial institutions, so they could have access
to TARP.
I am not sure I agree with that. But at the time, it was
certainly essential, if we were going to save those
institutions.
But what we are doing is allowing a board or council, or
organization to make determinations in a time of extremity--no
question about that--that some of us may not agree that
authority rests in those entities, or was constituted, or we
even had the authority in this Congress to give that type of
authority.
Secretary Geithner. You get to choose now what mix of
authorities and limits and executive power are going to be
appropriate for the future. That's the choice you're going to
be debating and making.
Now, then, what we propose, though, has a very carefully
designed set of checks and balances, and it does limit very
substantially the authority of the Executive Branch.
But again, that's the choice you'll have to make in that
case. But we're using a model that exists today, building on
that model.
Mr. Kanjorski. Okay. I am going to make the assumption you
have the authority, your lawyers have said you have the
authority, you have a good constitutional basis.
If you do, what is our excuse for not exercising that same
type of authority to stop these ``too-big-to-fail''
organizations from occurring and existing? Why can you not in
this legislation say, ``No, this bank is just too large, it has
to cut up and split up,'' with authority?
Why should the American people have to sit out there and
see us creating mammoth organizations that nobody says we have
the authority to control or limit, but we have the authority to
help them when they get into trouble?
Secretary Geithner. I agree with you, and that's why this
bill would provide authority to not just impose higher capital
requirements on them, constraints and leverage; it would have
the authority to limit the scope of their activities, to compel
them to shrink and separate.
That is a very important thing, and I agree with you about,
and I think the chairman does too.
Mr. Kanjorski. You believe we have the authority, or you
will under this bill have the authority to preemptively seize
these corporations, and take them under the control of Federal
authority, with no judgment, no due process, or no thought on
their part?
Secretary Geithner. No. I think you need to separate two
different things. One is about prevention, and it's what about
what you do in the event of a severe crisis. On the prevention
front, what this does is make it clear that regulators would
have the responsibility and the authority to limit risk-taking,
limit the scale and scope of activities, size if necessary, if
that's necessary to protect the system.
That's a very important thing. We did not have that in this
crisis for a large part of the financial system. That fixes
that.
Mr. Kanjorski. So let me understand. You are interpreting
this statute to give Treasury the authority to look at an
organization that is not in difficulty or extreme, but is huge;
and potentially it is not determined to be monopolistic at this
point, but it is huge and could have systemic risk
characteristics to it that you have the right to summarily
seize that organization--
Secretary Geithner. No, no--
Mr. Kanjorski. Disband the assets of that organization--
Secretary Geithner. No, no, no, no. That--you're slightly
conflating two different things. It gives the responsible
regulatory authority--
Mr. Kanjorski. There are some organizations that have no
regulators. General Motors did not have a regulator until you
came in and interpreted that it was a bank.
Secretary Geithner. That wasn't my judgment, that was my
predecessor's judgment--
Mr. Kanjorski. I understand. But then do you sustain what
judgment was made there, that in fact, it was a bank and
subject to Federal Government regulation?
Secretary Geithner. Congressman, again, I don't think
that's quite the right way to think about that. Again, that was
a judgment made by my predecessor under authority given to him
by the Congress, under the Emergency Economic Stabilization
Act.
I think he made the right judgment there, but that was his
judgment, in that context.
Mr. Kanjorski. Okay.
Secretary Geithner. But I don't think that's what this bill
is about.
Mr. Kanjorski. I wish we had more time, Mr. Secretary. We
don't--
Secretary Geithner. We will--
Mr. Kanjorski. But we certainly should engage in the
future. And if I could make a recommendation that we perhaps
break down into sections with this committee on both sides, so
some of these questions, fundamental questions, should be
answered.
Mr. Neugebauer, you are recognized for 5 minutes.
Mr. Neugebauer. Yes. Thank you, Mr. Chairman.
I want to go back to a little bit of what the ranking
member was talking about, Mr. Secretary, because I'm a little
confused now.
On page 11, Confidentiality, ``The Committee of the
Congress, receiving Council's report, shall maintain the
confidentiality of the identity of the companies described in
accordance with paragraph A3, the information relating to
dispute resolutions described in accordance with paragraph''--
Then I'll go over to page, I believe it is 17, and it says,
``The Council and the Board''--which is the Fed--``may not
publicly release a list of companies identified under this
section.''
And what they're talking about is the identification of
financial companies for heightened prudential standards for
financial stability purposes.
So what are those companies? The determination for those
companies would be their capital structure, number one. And
those would be categorized into well-capitalized, which we hope
all companies are well-capitalized--but then we have
undercapitalized, significantly uncapitalized, and critically
undercapitalized companies.
And the council is going to make, I guess along with their
prudential regulator, make that decision of what categories
they fall into.
And you're telling me that you're going to disclose that
information? The bill says you can't disclose that information.
And I'm a little concerned about what is the answer to the
question? Yes or no?
Secretary Geithner. I guess we can start with a simple
thing. It does make sense to the system in which community
banks and regional banks are held to the same standards that
are necessary to protect the system from the risk posed by
large complicated financial institutions.
You need to have a different regime, tougher set of
constraints applied to them, because they pose more risk--
Mr. Kanjorski. Mr. Secretary, with the different regimes, I
just want to know, are going to disclose the companies or not?
And are you going to disclose the--
Secretary Geithner. But you have to start with this thing.
They need to be subject to a different set of constraints. I
have heard nobody suggest that what's appropriate for a
community bank is appropriate for a major global firm. Now, if
that's true--
Mr. Kanjorski. Leave the banks out of it. Let's just talk
about the large banks.
Secretary Geithner. If that's true, then they have to
subject to higher standards, and I am sure, for the reasons
many of you have said, they will be disclosing the regime
they're operating under to their creditors, their equity
holders. Analysts will know. And it will be clear how much
capital they're holding.
And I think that's the best way to get the balance right.
Again, what you want to avoid, I think--as many of you said
in the past--is you want to have the sense there's a fixed list
of companies out there, that are going to benefit from special
support.
We want to avoid that risk. And that's why the chairman
tried to strike the balance in the draft the way it's done.
Mr. Neugebauer. I want to reclaim my time, because there
will have to be a list, this bill calls for a list to be
determined, because that's the council's responsibility.
Secretary Geithner. Would you prefer it be a public list?
Mr. Neugebauer. I think we have to decide, because I don't
know how you can keep it secret, because these companies--if
I'm a creditor or a shareholder of a company, and it's not
disclosed to me that I'm investing in a company that's
critically undercapitalized--does the government have some
fiduciary responsibility that--
Secretary Geithner. I think--
Mr. Neugebauer. You're withholding information from--
Secretary Geithner. I'm not sure we're disagreeing. I think
that the company will be held to tougher standards. It will
have to disclose how much capital it holds. The analysts that
cover it, its creditors, its equity holders will understand
that. And that's probably the right way to get the balance.
Mr. Neugebauer. Where I'm headed with this is that the
resolution now that is proposed under this bill basically
doesn't necessarily--and we haven't in some of the resolution
of these entities followed what would be the rule of law--and
in the sense that certain creditors were given preferences in,
for example, GM. Or they were intimidated into taking a
position that they didn't necessarily want to take.
Secretary Geithner. Now GM was managed under the
established bankruptcy procedures of the laws of the land. The
Congress recognized many, many years ago that those procedures
do not work for banks, because banks borrow short, they take on
leverage, they cannot function effectively under that kind of
regime.
Thus, a different regime, very much modeled on the
Bankruptcy Code, that establishes clear priorities for
creditors. But again, that system exists today for banks and
thrifts.
Mr. Neugebauer. Why not--
Secretary Geithner. Now--
Mr. Neugebauer. Why not just go ahead and use the
Bankruptcy Code as a Republican alternative, and set up a
special--
Secretary Geithner. But if you--again, I don't think this
is complicated.
Look what happened to Lehman, in the wake of Lehman.
Bankruptcy Code was the only option available in that context.
It caused catastrophic damage.
That's why in the wake of the S&L crisis--and actually well
before that--Congress recognized that for banks, and they
operate like banks, they need to have a special set of
protections to allow for the equivalent of bankruptcy.
Mr. Neugebauer. But had we had a different provision in the
Bankruptcy Code for a Lehman-like or financial institution, we
could have done that and made sure that--
Secretary Geithner. That is effectively what this does.
That is effectively what this is designed to do.
Mr. Kanjorski. The gentleman's time has expired.
And now we will recognize the gentlelady from California,
Ms. Waters.
Ms. Waters. Thank you very much, Mr. Chairman.
Let me ask Mr. Geithner, do you have a list of
systematically significant organizations that are basically in
the definition of ``too-big-to-fail?'' Do you have a defined
list?
Secretary Geithner. I do not have a defined list today. But
I want to come back to one thing. Right now the way the--
Ms. Waters. Excuse me, please. I just want to know that.
Secondly, in this legislation, where you're asking for
broad authority, do you have authority to bail out, to rescue--
Secretary Geithner. In this proposal?
Ms. Waters. Yes.
Secretary Geithner. What this proposal does--
Ms. Waters. Just, do you have the authority to spend money
to bail out any of these systemically significant organizations
after they get in trouble? Not just resolution authority to
break them up and to assign the management of their failed
assets, etc., etc. Do you have the authority to spend the
taxpayers' money to bail them out if you deem that to be a good
way of handling that situation?
Secretary Geithner. No.
Ms. Waters. Describe what authority you have to resolve
them, if you don't have bailout authority.
Secretary Geithner. What you have is the authority to wind
them down, to separate the bad from the good. To sell the good
businesses, to put them out of existence in a way that doesn't
cause catastrophic damage to the economy.
And if in that process, the taxpayer is exposed to any
losses, then we propose to recoup those losses, as we do now
for banks and thrifts, by imposing a fee on banks--
Ms. Waters. Okay. I think I have the answer. You're not
asking for any monetary bailout authority, as you do the
resolving of any of these systemically significant
institutions. That's what you're saying.
Secretary Geithner. We want the ability to let them fail,
without the taxpayer being exposed to losses.
Ms. Waters. You're not asking for the authority to bail
them out. Okay, I got that.
Have you suggested to any of these systemically significant
organizations that they should be winding down the size of
their organizations? We know that AIG, for example, started to
sell off, started to wind down.
You have to some systemically significant organizations
that are in trouble now. Citi is in trouble. What are you
suggesting they do?
Secretary Geithner. I would be happy to go into detail as
to what I think the Chairman of the Fed--and go through exactly
the conditions that have been put on a range of institutions to
make sure they emerge from this safe, and not relying on the
taxpayers' money.
But I want to emphasize one very important thing. Since I
came into office, we have had $70 billion of capital taken back
out of the financial system, replaced with private capital. The
financial system has changed very dramatically.
Those major institutions are smaller, they have less
leverage today, they are beginning to run more safely. The
riskier part of their business has been wound down very
dramatically, and it's a very important--
Ms. Waters. All right. I want to take back my time. But the
question really is this, if you know who they are, and there is
a possibility they could cause the same kind of meltdown that
we have experienced in this economy, have you suggested, before
they get into trouble again, that they should be downsizing,
they should be selling off--
Secretary Geithner. Exactly, of course--
Ms. Waters. They should be reducing their size?
Secretary Geithner. Of course, absolutely.
The Chairman. Will the gentlewoman yield to me for 10
seconds?
Ms. Waters. Yes.
The Chairman. I do want to say precisely the purpose of
this bill is to give them powers to do more of that than they
now have. They do not have the powers in a binding way to do
exactly what the gentlewoman is suggesting. And this bill would
give them more powers to make those not just as suggestions,
but as binding orders.
Secretary Geithner. Before they need money from the
government.
Ms. Waters. Let me just finish. As we take a look at what
has happened in the past, with the bailout that we have
supported, and we have found that these institutions that we
bailed out, froze the credit, didn't make credit available,
they increased interest rates, they did all of that, perhaps we
had the power to put some mandates on them, some dictates on
them about what they should do in exchange for getting the
bailout.
For example, our small regional community banks don't have
capital now. And you say to them, ``You have to go out and you
have to get capital, or we're going to close you down.'' Or
FDIC or somebody says that. And we have bailed out some of
these big banks, who are now richer. Goldman Sachs is a lot
richer, because we bailed them out.
Banks lend money to each other, but they're not lending
money to the small community banks and regional banks and
minority banks.
What can you do, or what have you done to make that happen?
Secretary Geithner. Congresswoman, this is a very important
issue. Small businesses are much more reliant on credit from
banks, including small banks. For again, to get that credit,
banks have to have the capital they need to lend. The President
proposed last week two important new initiatives to make sure
small banks can get that capital, as well as community
development and finance institutions as well.
And I think Congress needs to work with us to help make
those banks more comfortable, coming to get capital from the
government. If they do that, then they'll have a better
capacity to provide credit to small businesses. And we think
that's a very important thing to do.
The Congress also passed in the Recovery Act some important
changes to help encourage small business lending by the SBA.
Lending by the SBA since those actions were taken has increased
very dramatically.
But I think you're absolutely right that for many small
businesses across the country, they're still not getting the
credit they need to grow and expand. And we need to work with
you to try to fix that problem.
The Chairman. This is obviously a very important question;
let me just reinforce what the gentlewoman said. Absent the
addressing of this, I think we will have a great deal of
problems going forward in any broad way.
The gentleman from California, I believe, is next.
Mr. Royce. Thank you, Mr. Chairman.
Mr. Geithner, I asked you about a provision in your White
Paper earlier this year, and I would come back to that. And
that's this idea of providing direct funding to an operating
institution to keep it from failing.
Such authority of course, we would be markedly different
from a resolution authority that would entail an orderly
unwinding of a failed firm.
Some have compared this idea that's in the White Paper to
the open bank assistance authority at the FDIC. It appears as
though you've maintained this idea in the discussion draft that
was issued earlier this week.
And I would ask, is it your belief, should this legislation
become law, that the government should have the authority to
prop up an operating institution with Federal dollars, without
ever unwinding it?
Secretary Geithner. And my answer to that is no. But let
me--it's a little more complicated than that.
You need two authorities we don't have today. One is for a
large institution that is courting failure and whose failure
could cause catastrophic damage, you need to be able to act and
unwind them with less damage to the economy, without the
taxpayers being exposed to loss.
We don't have that authority today; thus the traumatic
damaging experience of last fall.
You also need to make sure that you can protect solvent,
liquid institutions in the rest of the system from losing their
capacity to operate and fund. In classic financial panics, what
happens is the weakness of one spreads to the strong.
You need to arrest that to contain panics to fix panics.
And that's why in this bill there is some authority reserved
for the Fed and the FDIC to contain the risk of panic spreading
to healthy institutions.
We propose to limit that authority, relative to what exists
today. But you need to have both those provisions for it to
work.
Mr. Royce. But under that interpretation, the government
would have the authority to prop up that operating institution
with Federal dollars, without unwinding it, because of your
presumption at some point that you're eventually going to be
able to restabilize it.
I think--
Secretary Geithner. No, I wouldn't--that's not quite right.
Think of a world in which you have one bank that is large and
complicated and can no longer survive without government
assistance. And you have the rest of the system that is still
relatively strong and healthy.
What you want to do is take that one institution that
managed itself to the edge of the abyss, and you want to put it
out of the existence safely.
Now you can't flip a switch and do that. It's a complicated
task. In Continental Illinois, it took 10 years. But you have
to have the capacity to do that as quickly as you can and
safely.
But you need to make sure the rest of the system does not
suffer a calamitous loss of funding--
Mr. Royce. But there's--
Secretary Geithner. And you need that basic--it's like a
firebreak kind of--
Mr. Royce. Right, I understand your argument on that. Part
of the problem here are the unintended consequences. And unless
we set very clear parameters on this authority, we run the risk
of the market really interpreting the worst here.
Let me give you an example, and this has to do with moral
hazard. It was often stated by several individuals, including
members of this committee, that the government would not bail
out Fannie Mae and Freddie Mac when they ran into trouble.
But because there was a level of ambiguity, the market
perceived these institutions as government-backed. At times, we
asserted they were not, but the market perceived that they
were, which, by the way, turned out to be the case. Economists
pointed this out at the time.
With respect to the chairman's comments, it's true that
several members often raise the example of Fannie and Freddie.
We do this not simply because the GSEs were at the center of
the mortgage market meltdown--and I feel they were. When you
put a mandate from Congress that one half of your portfolio has
to be either Alt-A or subprime, when you manage to bully the
system into a way where you have zero downpayment loans and so
forth, and when it ends up being 85 percent of the losses of
these institutions, I think you can see how some of us would
believe that played a large role in the market turning into a
bubble.
I think that many in the Fed believed it did too. And I
think, going back to what happened over on the Senate side, the
fact that Senate Democrats blocked the real reforms that passed
the Senate Banking Committee, on a party-line vote, and I think
the fact that Fannie's and Freddie's political pull prevented
real reforms during the years--because I certainly saw them up
here, lobbying against the reforms that would be necessary to
deleverage these institutions until it was too late--I think we
can see out of that how we ended up with moral hazard in the
system. And creating more GSEs would compound that problem.
The Chairman. A brief response, if you wish?
Secretary Geithner. I believe I agree with you. You cannot
allow a system to be created again where institutions exist and
operate with the expectation there will be government support
if they mismanage themselves to the extent they can't survive
with that.
That's the central lesson of this crisis, and the central
responsibility that we have to make sure that doesn't happen.
And that requires us to make sure we have strong constraints on
risk-taking and leverage, and we limit dramatically any
expectation of government support.
The Chairman. The gentleman from Illinois.
Mr. Gutierrez. Thank you, Mr. Chairman.
First of all, Secretary Geithner and Chairman Frank, I
think the proposal is really a step in the right direction in
terms of imposing the tougher standards, in terms of the
constraints, in terms of allowing us to create a system that
will prevent to the extent humanly possible the kind of
calamity that we have suffered already.
And to that extent, let's move forward, let's get that job
done. That's the last piece that we need to get done. We have
done a lot of work here, and we really need to this last piece
done.
It's really not my issue here this morning or with the
proposal. The main issue with the proposal is that we have this
reckless and dangerous and risky behavior, which we have no
evidence is going to cease to exist. So we should assume that
Wall Street and those on Wall Street, the Goldman Sachs of the
world, are going to continue to conduct themselves and behave
as they have in the past.
And so therefore, we have these new powers and this new
regime to constrain them. But we also know that they were great
at getting around those constraints in the past.
We also know that, with all due respect to you, that in the
past, we had one CEO of Goldman Sachs after the another in your
job. How do we know the next Secretary of the Treasury won't be
the former CEO of Goldman Sachs, as they have been in the past?
They seem to be interwoven. And that's what the American
public sees. They see this interconnectedness in terms of their
power, their influence, and always to their benefit.
So as we see American workers' dreams of retirement being
delayed and postponed, and vanquished, and we see them losing
their homes, as we see them losing their small businesses, we
see record profits over at Goldman Sachs.
And so I think we have a responsibility here to say, if
indeed in the future, after we have used all of our power, all
of our intelligence, every power that we have, to make sure
that doesn't happen, that they be the ones paying for this.
So my proposal is very simple: No more TARP. No more
bailouts. Let them create the fund, the systemic risk fund that
will guarantee that the American taxpayer will no longer have
to be involved, should they cause such a crisis ever again.
You said to us here this morning--I think we're headed in
the right direction--you said to us here this morning that you
would like there to be a resolution of a systemically risky
financial institution, much in the same way that the FDIC deals
with banks.
Good. We have an FDIC insurance corporation. They pay into
the fund. Let's create the fund, just like the FDIC, so that
when you need to resolve it, it stands. Your argument is, ``Oh,
but Luis, moral hazard. If the fund exists, they'll ask
risky.'' I don't see banks racing to the precipice of
destruction and bankruptcy because the FDIC exists. Nor do I go
to an insurance company and take out a life insurance policy on
myself and the next day decide, ``Wow, maybe I'll just start
smoking. Maybe I'll start drinking. Maybe I'll start driving my
car in a crazy manner. Maybe I really don't care whether or not
I live or die. I have life insurance. What the hell if I die?
Everything's taken care of.''
No, that's not the way it works. And if that is the way it
works, then you should use your new power to say, ``You will
not drive, you will not smoke, you will not exist, because we
will not allow that kind of behavior to incur a debt to the
insurance fund.''
So I think you can use your new power to make sure that
they don't behave recklessly any more. And at the same time,
should they escape you--because that's why we take insurance--
should they escape you and there is an accident, that the
American taxpayer is not once again asked to repay.
So can we work to create the fund, like the FDIC fund, and
make sure that those who engage in riskier behavior are the
ones who pay more into the fund, and the greater your
likelihood of creating a debt to the fund that you pay into the
fund? Can we talk about that?
Secretary Geithner. I think we generally agree. But this is
a very important issue. And the difference between doing a fund
in advance versus assessing a fee on banks to cover any losses
in the event is a very important thing. And this is not quite
like an insurance.
Deposit insurance is explicit insurance. Explicit contract
for insurance. In that case, it makes a lot of sense to
establish a pre-existing fund to help give depositors
confidence there will be money there to protect their deposits.
We don't want to provide explicit insurance for creditors.
If you create a fund in advance, there is a risk you're going
to create more moral hazard. People will live the expectation,
where the government will come in and protect them.
We don't want to create that expectation. That's why we
think it's better to do it after the fact.
The Chairman. The gentleman's time has expired.
The gentleman from Texas?
Dr. Paul. Mr. Secretary, more and more people today are
looking critically at the Federal Reserve and wondering what's
going on and of course, the people are asking more questions
and they want to know exactly what role the Federal Reserve has
played in our financial crisis.
In the past, the Federal Reserve was held in very high
esteem; that they produced prosperity and full employment and
stable prices. Today, they are viewed somewhat differently. And
many economists are joining in this. Today the Congress is, by
the number of 307, who are asking for more transparency of the
Federal Reserve. But also, everybody agrees that we have a
financial crisis and we're working very hard on regulations.
And I think, sometimes, we get misdirected in this because
if indeed the source of our problem is coming from the Federal
Reserve, then you're depending too much on regulations without
looking at the real cause. We're treating symptoms rather than
the cause. Just the idea that the Federal Reserve is the lender
of last resort, contributes horrendously to moral hazard,
especially when we're dealing with the reserve currency of the
world. But everybody knows that, no matter what happens, the
lender is going to be there to bail them out.
But, you had an interview this year and you were asked what
you thought were the really, the causes of this crisis, and I
was fascinated with your answer. Because, in a way, it seems
like you might have agreed a little bit with what I'm saying.
Because you listed as number one, you say, one, the monetary
policy was too loose, too long, and that created this just huge
boom in asset prices, money chasing risk, people trying to get
a higher return. That was just overwhelmingly powerful. And I
think that really makes my point and unless you deal with that,
and the suggestion is, is that what we do is move in with more
regulations and hope and pray that'll work.
But again, if this is true, that a monetary policy way too
loose lasted too long, how can the solution be speeding it up?
How can you say, this is the real problem, so we'll double the
money supply. Interest rates were too low at 1 percent, let's
make them \1/4\ percent. I can't reconcile this. How can you
reconcile this on just common sense?
Secretary Geithner. Congressman, there is one part of that
quote you omitted, which is, I said, monetary policy around the
world was too loose, too long. But I think it's very, you're
right to say that this crisis was not just about the judgment
of individuals to borrow too much or banks to lend too much. It
wasn't just about failures in regulation supervision. It was
partly because you had a set of policies pursued around the
world that created a large credit boom, asset price boom.
And I think you're right to emphasis that getting those
judgments better in the future is an important part of the
solution.
Dr. Paul. Okay. On the issue that it's worldwide and we
don't have the full responsibility, there's a big issue when
you are running and managing the reserve currency in the world
and other countries are willing to take those dollars and use
those as their asset and expand and monetize their own debt, so
it's all, we're not locked in a narrow economy, it's a
worldwide economy and it's our dollar policy and our spending
habits and our debt that really generated this worldwide
crisis. That's why it's not a national crisis; it's a worldwide
crisis.
Secretary Geithner. And again, I'm not sure we disagree,
but I would say it slightly differently, which is that a bunch
of countries around the world made the choice to tie their
currencies to ours and effectively adopt our monetary policy
and that made monetary policy too loose in their countries.
But it also created this wave of investment and savings
into U.S. financial assets, which pushed interest rates down
here and pushed up asset prices here, but you're right to say,
you have to look at the global mix of policies. We have
responsibilities to get that right, but we can't do that on our
own. And that's important to think about, not just about
regulation.
Dr. Paul. I do think we do have responsibility on our own,
if we're managing the world reserve currency, we can deal with
that, we can deal with our spending policies, our deficits, the
pressure on the Fed to inflate, so I think if we do what's
right, it will benefit the entire world.
Secretary Geithner. I agree with that.
Dr. Paul. In your testimony, you also talk about a new
international accord and that you're working on
internationalizing regulations, which literally scares me. I
think we have way too many already and they don't solve the
problem.
But, in those negotiations, since this issue of a new
reserve currency is being discussed in the ordinary media you
hear reports. Just this morning, I read, U.N. planning a new
reserve currency. In these accords, could you tell me, every
time this conversation comes up, and what is being talked
about, and how you relate to what the Chinese are saying, yes,
they would like to see a new reserve currency, they would like
to participate--
The Chairman. The gentleman's time has expired.
Dr. Paul. And it seems like that would be some very
important information for us.
Secretary Geithner. I would be happy to come and talk to
you about that privately or in another context.
The Chairman. The gentleman's time has expired and I
recognize myself for questions next. Secretary Geithner, I have
started to review the draft, the discussion draft that has been
introduced and just want to clarify for the record one thing,
and I think I know the answer to this without you answering it,
but I just want to get it in the record.
I noticed that in the council that is created, the
financial services oversight council, there is not a
designation of the consumer protection financial agency
representative. I presume that is because no such agency
currently exists, but as part of this whole reform process, if
we create a consumer protection financial agency, am I correct
in assuming that person, the director, would be on this
council? Is that your intention?
Secretary Geithner. Yes.
The Chairman. Okay. I thought that was the case. It just
doesn't exist yet.
Secretary Geithner. And you had the right explanation for
why it's not explicitly named there.
The Chairman. All right. Let me kind of pose the question
Mr. Gutierrez has posed in a slightly different way because one
concern that has been raised by banks is the integrity of the
FDIC, the insurance fund itself. I take it that resolution
authority, this new resolution authority is different than what
currently exists under the FDIC because there's already in
place a mechanism for resolving banks that are regulated and
insured under the FDIC.
It could involve the resolution of a non-bank. Is that
correct?
Secretary Geithner. Yes. We're creating a system modeled on
the existing system for banks and thrifts to make sure they
could be used for a major bank holding company.
The Chairman. But it could be, theoretically, a non-bank
entity that's causing systemic risk or acting out of control in
some way. That's true, right?
Secretary Geithner. Yes, carefully constrained authority
with a lot of checks and balances. That's correct.
The Chairman. So, one concern that has been raised is, what
are the implications of that for the integrity of the FDIC
fund, the insurance fund itself? Are we sending a message that
we may be in someway endangering that because that has become
an asset of the public, so, how do we clarify that? Is there a
way to create an entity that, for bigger systemically risky
entities or non-financial entities that may be systemically
risky that makes it absolutely clear that the insurance fund
itself is not going to be put at risk in any way?
Secretary Geithner. You're making a very important point.
And the insurance fund cannot be used for this; it needs to be
separate and completely protected.
The Chairman. Okay, so--
Secretary Geithner. The mechanism we're proposing for these
large institutions would be completely separate.
The Chairman. So, how do you do that without creating some
kind of separate fund that's separate from the FDIC fund,
itself, or do you just say, we're going to take care of this,
but there at least needs to be a guarantee in here that you're
not using FDIC funds.
Secretary Geithner. I think that can be done very clearly
and explicitly and therefore, create no risk that the fund, the
existing fund, could be used for these other purposes. That
would be an important to do. I would support that.
The Chairman. Where would you contemplate getting funds to
do that outside the FDIC?
Secretary Geithner. Again, the way the FDIC framework works
today, the FDIC does have the authority to go out and
temporarily use resources that are not in the fund to do its
job to manage the failure of banks. But, it has to recoup any
losses that might produce by imposing a fee on banks in the
future.
The Chairman. But, we don't want to impose that fee on
banks in the future because they weren't responsible in this
context, so--
Secretary Geithner. But again, we're really talking about
what are effectively banks. They're just not small banks and
thrifts. And I think the basis principle of fairness is the
right one in this context, which is, if in the future, the
government's exposed to any losses as it acts to protect the
economy from the failure of those institutions, then I think
that the taxpayer shouldn't bear the cost of that. And the cost
of that should be imposed on the banks that benefitted from the
action.
And what the bill proposes to do is to make sure that banks
below, I believe, $10 billion is the threshold in the statute,
would not be exposed to fees to cover any losses from this
authority.
The Chairman. Okay. We need to keep talking about this, but
my time has expired and we obviously can't do it right now.
Ms. Biggert is recognized.
Mrs. Biggert. Thank you, Mr. Chairman. Secretary Geithner,
it seems to me that an ex post assessment proposal that you
have been talking about to pay for the failure of a firm, that
the government deems ``too-interconnected-to-fail,'' could
create perverse incentives. The firm that fails and their
creditors don't have to pay the cost of clean up, but the
survivors, those other firms, who had no control over the
firm's risk taking, do. So, as a result, no individual firm,
and none of the creditors, has an incentive to minimize the
firm's risk-taking because the gains are internalized and yet,
the losses are borne by others. More than that, knowing that
the firms that act prudently will end up at a competitive
disadvantage to those firms that are taking the risk, and be
having to pay for the failure of those firms, undermines the
incentives to manage risks.
Secretary Geithner. If the proposal did that, I would agree
with you. But, that's not what it is designed to do. In fact,
it's quite the opposite. We want to make it very clear and
credible that again, if a firm manages itself to the point
where it's at the edge of the abyss, can't survive without the
government, then equity holders and creditors would be exposed
to losses in that context. And that would happen before the
taxpayer was exposed to any loss.
And if the taxpayer was exposed to any loss, then you would
have to recoup that loss with a fee on the industry. And I
think that, again, that's the model we have today for small
banks and thrifts and it makes sense because other banks will
benefit from the actions taken to protect them from the risks,
that the panic spreads to them.
So, I think it's fair in that sense.
Mrs. Biggert. What happens, though, is that the taxpayer is
the interim lender, aren't they?
Secretary Geithner. But again, this is taking a model that
Congress designed for small banks and thrifts, and just
adapting it to a system that has outgrown that framework. But
that system exists today and I think it's the best way to do
it. The alternative way, which is again, to create an ex-ante
insurance fund that would create an expectation of explicit
insurance, I think would create more moral hazard.
Mrs. Biggert. Wouldn't bankruptcy be faster? I think that
this proposal, you have what, 60, I forget what it is, 60
months or something to settle this while bankruptcy--
Secretary Geithner. Bankruptcy just, again, I think Lehman
makes this clear and compelling. And it's why Congress designed
a bankruptcy-like system, but it's a different kind of system.
We call it resolution authority for banks and thrifts because
banks are different. And if they lose the capacity to fund,
then they can cause enormous damage to the system as whole. So,
you need a slightly different regime for banks because banks
are different from regular companies.
Mrs. Biggert. Okay, if just, let's say, an institution the
size of Citi or Bank of America failed, how many institutions
would have to be assessed to cover the cost of that resolution?
Secretary Geithner. Again, the proposal we made is that
banks above a certain size would have to pay a fee, because
they would benefit indirectly and directly from the actions
taken to contain the risk of panic. So, I think it's fair--
Mrs. Biggert. They would benefit because there's one less
competitor? Is that what you're saying?
Secretary Geithner. No, no, no, no. Because in the absence
of action to manage the failure in a way that's safer for the
system, does convey some broader benefits. So, it's not like,
and so again, they should bear some, now, the choices, which we
don't think should--
Mrs. Biggert. What would be those benefits?
Secretary Geithner. Well again, the way financial panics
work, is that viable institutions face the risk they lose their
funding and therefore, have to collapse. That's what financial
panic did to define the second half of the 19th Century, the
first quarter of this century, help produce the Great
Depression, led the Congress, this government to act in the
Great Depression to set up some protections for that. What we
didn't do is extend those protections to institutions that are
very much like banks.
Again, the alternative approach, which we would not
support, is to say, the taxpayer would be there in the front of
the line absorbing the cost of that failure. That, we think, is
not necessary and would be a mistake.
Mrs. Biggert. All right. Then, do you think that the
government control and concentration of power and the increased
unchecked powers to control both the consumers and businesses,
as outlined in your plans, is the answer? Isn't this really a
huge amount of power that's going to the Administration?
Secretary Geithner. Again, let's just step back. Right now,
the Congress of the United States has given more than four
Federal agencies and a whole number of other agencies the power
to do consumer protection. They just did not do it well and
we're proposing to consolidate that responsibility in one place
so that it can be done better.
Now, outside of consumer and investor protection, what
we're proposing to do is to make sure the government has the
same tools to manage risk it now has in small banks and thrifts
for institutions that now define our modern financial system
and can bring the economy to the edge of collapse. That's a
necessary function for governments to do because banks can pose
enormous risk. If you don't constrain the risk-taking of banks,
we'll be consigned to repeat the crisis we just went through.
Mrs. Biggert. I yield back.
The Chairman. The gentleman from California.
Mr. Sherman. Thank you. Mr. Secretary, you have submitted
about 900 pages of proposed legislation. I strongly agree with
well over 90 percent, I commend your work and that of your
staff and the chairman and his staff. I hope my colleagues have
gotten this ``Dear Colleague'' letter that I have distributed.
If anybody doesn't have it, please ask me, I do have a few
extra copies. And Mr. Garrett has already put it in the record.
Unfortunately, you have in here what I call ``TARP on
steroids.'' You have permanent, unlimited bail-out authority.
This is the most unprecedented transfer of power to the
Executive Branch to make decisions about both spending and
taxes in history, all without congressional approval and in a
sharp departure from our Constitutional values. And depending
upon what some future executive chooses to do, it authorizes
the greatest transfer of money from Treasury to Wall Street,
ever.
The bill allows for the bailout of both solvent and
insolvent financial institutions and Mr. Secretary, the last
time you were here, I asked you to embrace a $1 trillion limit
on this total bail-out power and I'm still waiting for that
embrace.
Specifically, Section 1109 allows the Executive Branch to
loan unlimited amounts to any solvent financial institution.
When such a loan is made, the executives keep their jobs, the
shareholders retain ownership of the company, and their
shareholder and company value is dramatically enhanced.
Section 1604 allows for the bailout of troubled financial
institutions with unlimited loans and unlimited investments in
the equity of the troubled firm. Now, when the troubled
institution gets bailed out, the chief beneficiaries are its
creditors. This will cause creditors to lend money on favorable
terms to the systemically important institutions. Because after
all, if the institution fails, the creditor will probably get
paid by the government.
However, the shareholders of the bailed-out institutions
also stand to benefit handsomely. The taxpayer takes the
enormous risk, perhaps investing in the entity or lending money
to it. And if things go well, the taxpayers get their money
back and the shareholders get a previously comatose and now
revived giant institution that they reassume ownership of.
Now, Sections 1109 and 1604 provide a multi-step process
for bailouts. The first step is that we transfer billions,
perhaps over a trillion dollars to Wall Street. The second step
is that the taxpayers are supposed to get their money back from
a new tax imposed on large and medium-sized institutions. The
proposed statute directions the Executive Branch to get our
money back within 60 months and then specifies, or such longer
amount of time as the Executive Branch decides. So, it could be
60 years.
I find it difficult to think how we would ever recoup from
a single financial industry, particularly one in extremis, the
hundreds of billions of dollars which might be necessary to
repay the taxpayer from the next bailout.
Now, the Executive Branch is empowered, and look at this
from a Constitutional perspective, the Executive Branch is
empowered to write the new tax law. So, how much money is paid
by a medium-sized financial institution in your district,
whether it is $100,000 or $100 million, is totally at the whim
of the Executive Branch and can go up or down by that factor,
depending upon what the Executive Branch wants to do.
The law will allow those institutions that are systemically
important to borrow at a lower cost. This will help the largest
institutions get larger so that they become greater systemic
risk. And by becoming a greater systemic risk, such an
institution becomes even more bail-out eligible, further
lowering its cost of funds.
Now, those institutions that are medium-sized are going to
have to pay whatever tax the Executive Branch chooses to
impose. However, they're not going to be able to get money at
lower rates because savvy investors are not going to believe
the local regional banks are going to get bailed out. So, the
medium-sized institutions will fund the program, which benefits
only their large competitors.
It's like being forced to pay insurance on your
competitor's business while yours goes uninsured.
Now, this tax is sometimes referred to as ``polluter
pays,'' but it's hardly that. The financial institution that is
the polluter, the one that took big risks and became insolvent,
pays nothing. Instead the prudent financial institutions have
to compete with the high fliers and then pay to bail them out
in the bad times. I yield back.
The Chairman. The gentleman's time has expired. The
gentlewoman from West Virginia, Ms. Capito.
Mrs. Capito. Thank you. Thank you, Mr. Secretary for being
here today.
Secretary Geithner. Excuse me. Mr. Chairman, am I going to
have a chance to respond to Congressman--
The Chairman. Yes, if there is no objection, we will take a
minute to respond.
Secretary Geithner. I'll just say very briefly because--
The Chairman. Let me say to the Secretary, you will
probably have many opportunities to respond.
Secretary Geithner. Can I just say one thing? I actually
think, Congressman Sherman, we agree on much more than 90
percent. And what you were describing is something I would
oppose. And it is not what we have proposed. And I share, very
much, your basic concern that we not create a system that would
create those risks. I would be against that. I would not
support it. I would not want to have to live under it and
administer it. And it's just not the proposal we're describing.
Mr. Sherman. If the Secretary wants to correct any of my
statutory citations, I hope he does for the record. I yield
back.
The Chairman. The gentlewoman from West Virginia.
Mrs. Capito. Thank you, Mr. Chairman. Thank you, Mr.
Secretary. Quickly, I would like to ask, are you now imposing
larger capital requirements on the systemically ``too-big-to-
fail'' institutions at this moment?
Secretary Geithner. The current rules which are old and
outdated and did not work do establish slightly different ones,
but they're not conservative enough, they're not tough enough,
and they weren't applied broadly enough.
Mrs. Capito. So, you are or you aren't? Requiring higher
capital?
Secretary Geithner. They are somewhat different than what
would apply to community and regional banks, but they're not
different enough, they're not conservative enough, they're not
tough enough, they're not designed well enough, they're not
applied broadly enough.
Mrs. Capito. All right. Well then, let me go to GMAC, which
announced yesterday the Treasury was looking seriously, I guess
by November, to decide whether to do another infusion to them
of taxpayer dollars for the third time. And they're under this
regime of trying to raise more capital. Is that correct?
Secretary Geithner. I'm glad you raised that--
Mrs. Capito. How would this bill be different then, in
terms of GMAC?
Secretary Geithner. This bill has nothing to do with GMAC.
Mrs. Capito. Okay, but let's put GMAC under this bill.
Right now, today.
Secretary Geithner. It wouldn't fit, so let me explain and
clarify this.
Mrs. Capito. But wait a minute, but I thought--
Secretary Geithner. But let me explain and clarify this.
It's very important. My predecessor, the Secretary of the
Treasury, made the judgment under the authority Congress gave
him in the fall of last year, in the middle of the worst
financial crisis in 3 generations, to lend money to 2
automobile industries and to 2 auto finance companies,
including GMAC.
When I came in, we put the major institutions, including
GMAC, through a very tough stress test forcing them to disclose
what their losses might be, how much capital they would need,
in the event of a worse recession. At that time, we disclosed
to the market and to the world, including for GMAC, what their
likely capital needs would be. And we committed in the event
that they would be able to raise capital from the market, that
the government would put that capital in.
Now, GMAC, at the time, there was no prospect, frankly,
they were going to be able to raise that capital from the
market. All the other institutions, in contrast, have been able
to go out and raise that capital from the market. The only
thing we're doing is making sure we follow through on that
commitment and in fact, although I don't want to go into any
detail here, in fact, we're likely to have to put in less
capital than we expected.
Now, no government should be in the position of having to
do this kind of thing again. And we want to make sure that our
role in those institutions is limited, we're not in there a
minute longer than necessary, we get the taxpayers' money back
as quickly as possible, with interest, and that is what we are
doing for the major banks already where you've seen $70 billion
in capital come out, more than $12 billion in returns to the
taxpayer on those investments, and we're going to work very,
very hard to unwind those positions as quickly as possible.
But, those initial judgments were not my judgments,
although I support them, and we would like to make sure we get
out of this as quickly as we can.
Mrs. Capito. The fact is, this is the third infusion of
TARP funds, taxpayer dollars into GMAC. I don't know what
category they would fall in and so I would say, I think that
the adaptability issue that you talked about on the resolution,
I would like to see an enhanced bankruptcy resolution that
provides that partition from the government into the court
systems. I think we can create an enhanced bankruptcy through
our court system that could address these adaptability issues
and the GMAC issue and other issues.
And even some of your fellow Presidents of the Federal
Reserve have spoken in favor of this because, and I'll just
take one quote, there's a widespread relief that public funds
will soften the blow to private creditors.
And I think this is an option we need to look at as we're
working this through.
My last comment, question, sort of, and clarification would
be, the whole secrecy issue here. You even, in questioning the
gentleman from Alabama, basically said, once everybody is
required to have larger capital requirements, those will be out
in the public realm.
There really is no secret in Washington, D.C., for long;
they are not too easy to keep, so I think we think that there
will be, in the public domain, knowledge of these institutions,
and there will be, they will be in a separate class from our
community bankers, our credit unions and our other financial
institutions.
And I think that's problematic because I think that does
bring about, whether it says it or not, brings about the ``too-
big-to-fail'' concept that we have just seen over the last
year.
Secretary Geithner. That's exactly what we're trying to
prevent. But if you want the big banks to have different,
tougher capital requirements than small banks, you want them to
have different standards because they create more risk, then
you have to hold them to tougher standards. And if you hold
them to tougher standards, they will disclose how much capital
they hold and that's a good thing, not a bad thing.
Mrs. Capito. No, disclosure's great. Transparency--
The Chairman. The time has expired. What I want to do is, I
think we can get two more questions in. We have several votes.
We're then going to have to excuse the Secretary. We'll come
back to the panel of regulators. So, we can go to the gentleman
from New York, the gentleman from Texas, if we hold right to
the 5 minutes on the first vote. The gentleman from New York.
Mr. Meeks. Thank you, Mr. Chairman. And thank you for the
hard work you have been doing on this committee. Thank you, Mr.
Secretary. Mr. Secretary, I would like you to consider, for the
sake of this question, that we pass this bill. Say if had we
passed this bill as currently drafted 5 years ago, and if that
had been the case, I would like to know, one, do you think that
Lehman bankruptcy would have still occurred, or would it have
been averted? Two, if it had occurred, could you please walk us
through how it would have played out differently than it
actually did, specifically how and why the system as a whole
would have been better able to withstand the shock, and what
would have been the consequences or the sequence of events from
the moment the precarious state of the firm was identified to
when the resolution plan for the firm would have been
implemented and finally, how long, in your opinion, would the
resolution of such firm have taken place and how much would it
have cost the taxpayers?
Secretary Geithner. Excellent questions, complicated
questions and I won't be able to do them justice this quickly,
but, let me make a quick attempt. If this set of authority and
constraints had been in place ahead of this crisis, then you
would have not have had AIG, you would not have had the world's
largest investment banks, you would not have had firms like
Countrywide and a bunch of other thrifts across the country,
take on a level of risk that they could not manage.
That would have been preventable. You would not have
allowed a bunch of insurance companies to write a whole bunch
of commitments in derivatives they did not have capital to
support. That would have been enormously effective in limiting
the risk, the build-up of pressures, that helped produce this
crisis.
You would not have let this terrible set of practices in
mortgage underwriting, separate and lending in a bunch of other
areas, get to the point they did. They would have been arrested
more quickly. People would have been held to a level playing
field with tougher requirements to constrain risk-taking.
Now, firms will still make mistakes, even within a regime
designed well like that. But if they do, then what this regime
would allow for is us to take a firm, like Lehman, and have
that put them out of existence, have the good businesses sold
off, have them resolved, in a situation that would have caused
less risk of broad panic and not put the position where you had
millions of Americans, millions of investors, people who held
pension funds, municipalities, counties across the country who
invested money in money market funds that had funded Lehman.
They would not have been exposed to that scale of losses and
you would not have the extent of the panic you saw last fall,
which did threaten the viability of a whole range of other
institutions.
In that case, what happened is, because the authority
didn't exist, the government had to come in and do much more
dramatic things, that created much greater risk of moral
hazard, provided much greater protections to firms that should
not have been exposed to those protections. And that's the
basic rationale for this framework and that's what it would
have provided.
But, we will have firms in the future that make mistakes,
we just don't want those mistakes to come at the expense of
well-managed institutions and at the expense of the taxpayer.
Mr. Meeks. Let me, and I want to go to the, in the short
time that I have, there are two other things that I'm concerned
about, of course. One of the major challenges in dealing with
systemic risk going forward will also be the international
coordinate and what will be necessary to handle systemic risk
posed by financial firms with a global footprint.
Could you please clarify for me how this plan before us
today would manage the systemic risk posed by firms for which
we are the home country, i.e., the firms that are headquartered
in the United States but have major operations internationally,
and for those where we are the host country from financial
firms headquartered abroad but have major interests or major
operations in the United States.
Secretary Geithner. Again, a very complicated but excellent
question. Two quick responses. These constraints on capital, on
funding, on leverage, on risk-taking, they have to be
negotiated and applied internationally so there's a level
playing field. So, you want to make sure that other major
institutions that compete with U.S. institutions but are Swiss
or German or are British, are held to the same standards.
Now, in the event, again, they manage themselves to the
edge of failure, you make sure that in each of these major
financial centers, you have the types of authorities that we're
proposing to Congress establish in law today.
If you have that authority to better manage failure, then
you can better manage the unwinding dismantlement of these
major globally active firms. Now, we're going to have to, once
we have these national authorities in place, we're going to
have to do a better job of coordinating than was possible in
the Lehman case, for example. But the real problem in the
Lehman case was the absence of resolution authority, both here
and in the U.K., frankly.
So, establishing at the national level first is probably
the most important thing to do to achieve the objective that we
both share.
The Chairman. The gentleman's time has expired. The
gentleman from Texas.
Mr. Hensarling. Thank you, Mr. Chairman. Mr. Secretary,
welcome. Chairman Frank and I will continue to debate the
effectiveness of the GSE legislation that he brought to the
Congress. What the facts are today, we have essentially 80
percent government control of Fannie and Freddie, their
conforming loan limits have increased, increasing their
exposure. Their market share has increased precipitously.
Taxpayers, between the Treasury and the Federal Reserve now
have roughly $1 trillion exposure out of a potential of $2
trillion.
Does the Administration plan to offer GSE reform
legislation before year's end?
Secretary Geithner. No.
Mr. Hensarling. Thank you. But if not, when?
Secretary Geithner. But I am looking forward to that
discussion with you because you're absolutely right, that the
system we have in place we cannot live with going forward and
that's why we have committed--
Mr. Hensarling. Is there a timetable for the Administration
to propose GSE reform legislation?
Secretary Geithner. What we have said is, that we believe
early in the year, we're going to outline at least our initial
ideas on options for having to do that, so we need to begin
that process soon. I agree with you and I look forward to it.
Mr. Hensarling. Thank you, Mr. Secretary. I understand, I
believe the Administration is endorsing the chairman's bill
that we are discussing today. Did I understand that from your
testimony?
Secretary Geithner. We worked very closely with the
chairman on the bill and as I said, we think it needs the
critical test of the strong package of reforms.
Mr. Hensarling. Initially, under this bill then, taxpayers
would shoulder the initial burden of ``too-big-to-fail,'' then
I believe that we hope that the institution may be
resuscitated, they may be able to pay, eventually, if that
doesn't happen, competitors may end up having to foot the bill.
Secretary Geithner. No, I wouldn't say that.
Mr. Hensarling. This is not your understanding?
Secretary Geithner. Resuscitated is the wrong word, exactly
the wrong word. As I said in my statement, the chairman said
this, too. You don't want the government in that context to act
with the objective of saving the institution to allowing it to
live for another day. That would be a mistake. What you want to
do is to make sure they live with the consequences of their
failure and they can be unwound and sold and disassembled.
Mr. Hensarling. I heard the chairman use the phrase ``death
panels'' again in his opening statement, but as I have been
able to read the 253 page bill, I do not believe that type of
resolution is required. It certainly is permitted. I did not
see where it was required. Perhaps I have missed that in the
bill. That is the ultimate goal.
Secretary Geithner. That's our objective, and I think it's
a very important objective.
Mr. Hensarling. I agree. Let me ask you this question, Mr.
Secretary. In thinking through this idea that firms that are in
the marketplace will be able to either repay money or their
competitors will, do you believe, what portion of the $128
billion that AIG has received, do you believe, ultimately, they
will be able to pay back?
Secretary Geithner. We are in the process now, as required
by law, to provide a comprehensive evaluation of the range of
actions the government was forced to take in this crisis, both
my predecessor and me, and we're going to be putting out that
report in mid-December.
Mr. Hensarling. Do you have a range now of what you expect
the taxpayer to recover?
Secretary Geithner. I can't give you a range now, but will
be able to give it to you soon.
Mr. Hensarling. Okay. How about with respect to General
Motors and the roughly $63 billion?
Secretary Geithner. It is in the same case.
Mr. Hensarling. Same category?
Secretary Geithner. So, we're going to provide a set of
independent assessments of what the range of potential losses
and gains are across those programs.
Mr. Hensarling. Mr. Secretary, we have had this discussion
before about what was written into the ESSE statute. The bottom
line is, that GM and Chrysler, de facto, have been considered
financial institutions under the TARP statute, have received
extensive government funding or were designated essentially
systemic firms.
To many of us, that suggests that ultimately the number of
perhaps Fortune 50, Fortune 100, companies that ultimate could
receive government bail-out assistance, is not, unfortunately,
a limited universe. And when I think about this regime where
one's competitors pay to essentially clean up your mess, if
WalMart were to become insolvent, how smart or how fair is it
to impose that cost upon Target and Costco?
Secretary Geithner. Right now, Congressman, who bears the
cost when firms screw up? What happens now is, is that
companies, families, businesses, taxpayers, community banks,
bear that cost. We're proposing to change that. For the simple
reason, it's not fair. And what is fair, we believe, is that in
the end, because banks are special and risky, if they manage
themselves to the point where they're imperiling the system,
then if the government--
Mr. Hensarling. Should Ford bear the cost of compensating
the taxpayer for what happened to GM and Chrysler?
Secretary Geithner. Look, I think you're making a good
point, but you have to look at the alternatives. The
alternatives to what we are proposing, which is based on the
existing framework for banks and thrifts, we're under the
existing framework for banks and thrifts, under the laws of the
land established by Congress. What happens is, if the
government has to act to close an institution and it's exposed
to any loss, it imposes a fee on banks. It's just, it's very
simple, it's compelling and it's better than the alternatives.
The Chairman. The gentleman's time has expired. The
gentleman from Alabama has a brief request.
Mr. Bachus. Thank you. As a unanimous consent request, I
would like to submit for the record a series of questions to
Secretary Geithner on various aspects of this highly--
The Chairman. Without objection, let me say that same right
will be extended to any member who wants to submit questions.
Mr. Bachus. And to get the answers, if possible, and or
implore the Treasury Department to answer some of these
questions and make them available for us.
The Chairman. I would say, implicit in the request for
questions would be a request for answers.
Mr. Bachus. That's right.
The Chairman. But if there's a need to make it explicit, we
will do that.
Mr. Bachus. Thank you.
The Chairman. We are in recess.
[recess]
The Chairman. The committee will reconvene, and the next
panel will take their seats. I don't know whether ``panel'' is
a singular or collective verb, but the members of the panel
will each take their seats, so each take his or her seat. And
we have had all the opening statements, and we have everyone
here, I guess. Yes, we have Commissioner Sullivan.
This is a panel of the Federal regulators plus a
representative of the National Association of Insurance
Commissioners. I just would note that throughout this process,
we have stayed in close contact with the State bank supervisors
and with the National Association of Insurance Commissioners,
who are very much a part of this operation.
We are going to start the process now. I have to leave for
a quick session. It is my plan, let me tell my friend from
Kansas, who as the ranking subcommittee chairman here will be
presiding, our intention would be to start with him and go down
the list. That is, members who already asked questions of
Secretary Geithner on our side will not ask again. So he will
begin with himself, and go down the list in seniority, so that
we do not have that duplication.
And with that, I am going to turn this over to the
gentleman from Kansas as we begin our opening statements with
the Chairman of the Federal Deposit Insurance Corporation.
STATEMENT OF THE HONORABLE SHEILA C. BAIR, CHAIRMAN, FEDERAL
DEPOSIT INSURANCE CORPORATION
Ms. Bair. Chairman Frank, Ranking Member Bachus,
Congressman Moore, and members of the committee, I appreciate
the opportunity to testify today regarding proposed
improvements to our financial regulatory system. The proposals
being considered by the committee cover an array of critical
issues affecting the banking industry and financial markets.
There is an urgent need for Congress to address the root causes
of the financial crisis, particularly with regard to resolution
authority.
In the past week, this committee passed a bill to create a
Consumer Financial Protection Agency, a standard-setting
consumer watchdog that offers real protection from abusive
financial products offered by both banks and non-banks. The
committee is also considering other important legislation
affecting derivatives and securitization markets.
However, today, I will focus on two issues that are of
particular importance to the FDIC. First, a critical need
exists to create a comprehensive resolution mechanism to impose
discipline on large interconnected firms and end ``too-big-to-
fail.'' I truly appreciate the efforts of the committee in
moving forward with legislation to address this crucial matter.
Second, changes need to be made to the existing supervisory
system to plug regulatory gaps and effectively identify and
address issues that pose risks to the financial system. One of
the lessons of the past few years is that regulation alone is
not enough to control imprudent risk-taking within our dynamic
and complex financial system. So at the top of the must-do list
is a need to ban bailouts and impose market discipline.
The discussion draft proposes a statutory mechanism to
resolve large interconnected institutions in an orderly fashion
that is similar to what we have for depository institutions.
While our process can be painful for shareholders and
creditors, it is necessary and it works. Unfortunately,
measures taken by the government during the past year, while
necessary to stabilize credit markets, have only reinforced the
doctrine that some financial firms are simply ``too-big-to-
fail.''
The discussion draft includes important powers to provide
system-wide liquidity support in extraordinary circumstances,
but we must move decisively to end any prospect for a bailout
of failing firms. For this reason, we would suggest changes
that take away the power to appoint a conservator for a
troubled firm and eliminate provisions that could be
interpreted to allow firm-specific support for open
institutions. Ending ``too-big-to-fail'' and the moral hazard
it brings requires meaningful restraints on all types of
government assistance, whatever its source. Any support should
be subject at a minimum to the safeguards existing today in the
systemic risk procedures.
To protect taxpayers, working capital for this new
resolution process should be pre-funded through industry
assessments. We believe that a pre-funded reserve has
significant advantages over an ex-post fund. All large firms,
not just the survivors, would pay risk-based assessments into
the fund. This approach would also avoid assessing firms in a
crisis. The assessment base should encompass only activities
outside insured depository institutions to avoid double
counting.
The crisis has clearly revealed regulatory gaps that can
encourage regulatory arbitrage. Therefore, we need a better
regulatory framework that proactively identifies and addresses
gaps or weaknesses before they threaten the financial system. I
believe a strong oversight council should closely monitor the
entire system for such problems as excessive leverage,
inadequate capital, and overreliance on short-term funding. A
strong oversight council should have authority to set minimum
standards and require their implementation. That would provide
an important check to assure that primary supervisors are
fulfilling their responsibilities.
To be sure, there is much to be done if we are to prevent
another financial crisis. But at a minimum, we need to
establish a comprehensive resolution mechanism that will do
away with ``too-big-to-fail'' and set up a strong oversight
council and supervisory structure to keep close tabs on the
entire system. The discussion draft is an important step
forward in this process, and I look forward to working with you
on these proposals.
Thank you.
[The prepared statement of Chairman Bair can be found on
page 99 of the appendix.]
Mr. Moore of Kansas. [presiding] Mr. Comptroller?
STATEMENT OF THE HONORABLE JOHN C. DUGAN, COMPTROLLER, OFFICE
OF THE COMPTROLLER OF THE CURRENCY (OCC)
Mr. Dugan. Mr. Moore, Mr. Bachus, and members of the
committee, thank you for the opportunity to discuss the
discussion draft of the Financial Stability and Improvement
Act.
We support many of its key initiatives but also have
significant concerns about certain provisions; and we are
continuing to review the draft in detail to provide additional
comments to the committee. Let me briefly comment here on four
key parts of the draft. First, we believe the Financial
Services Oversight Council established by the draft has
appropriate roles and responsibilities. The Council would be
well-positioned to monitor and address developments that
threaten the financial system, identify regulatory gaps in
arbitrage opportunities, and make formal recommendations to
individual regulators.
The Council would also have the responsibility, which is
appropriate, for identifying those financial companies and
financial activities that require heightened prudential
supervision and stricter prudential standards.
Second, the discussion draft expands the role of the
Federal Reserve in two fundamental ways: as consolidated
supervisor and standard-setter for all systemically significant
financial firms; and as the standard-setter for financial
activities that pose systemic risk. We support extending the
Federal Reserve's consolidated supervisor authority beyond bank
holding companies to any other type of financial company that
the council identifies as posing systemic risk. The lack of
such authority over such non-banking companies as AIG, Bear
Stearns, and Lehman Brothers was a key contributor to the
financial crisis, and is imperative to eliminate this
supervisory gap.
In terms of setting and implementing standards for these
companies, the discussion draft is an improvement over the
Administration's bill in terms of the role played by primary
supervisors in the process. While the Federal Reserve would
have authority to establish such standards for holding
companies and their subsidiaries, the primary supervisors of
regulated banks, if they disagreed with such standards, they
would have the authority not to impose them if they explained
in writing why they believed imposing them would be
inappropriate.
As a practical matter, this will provide banking
supervisors with the opportunity to provide meaningful input
into the design of the standards. This is appropriate given
that in many cases, primary supervisors will have more
expertise with respect to the impact of particular standards on
the firms they directly supervise than will the Federal
Reserve.
We are very concerned, however, about the separate
authority provided to the Federal Reserve to establish
standards for any financial activity that the council deems to
present systemic risk. There, the Board's authority is much
broader in that the banking supervisor could in essence be
compelled to apply the standard to the bank even if it objected
in writing. As a practical matter, this would significantly
diminish the banking supervisor's ability to provide that
meaningful input to the standards. We believe this expansion of
authority is too broad. And, more generally, we believe that
there should be a meaningful consultation requirement with all
primary supervisors before the Federal Reserve adopts any
heightened standard for identified financial firms that
meaningfully affects institutions regulated by primary
supervisors.
We also have concerns about Fed authority to act on
divestitures or acquisitions affecting the bank and about
continuing gaps in supervision of non-bank holding company
affiliates.
Third, we support the agency consolidation provisions of
the discussion draft. These would transfer the bulk of the
functions of the Office of Thrift Supervision to the OCC, while
providing a framework in which the Federal Thrift Charter is
preserved. The mechanics of the proposed transfer appear to be
sensible and workable, and fair and equitable to employees of
both agencies.
There are, however, important technical areas, including
assessments, transfer of property and personnel, and
clarification of the agency's independence where we will have
additional comments.
Finally, the discussion draft includes important new
measures to address the so-called ``too-big-to-fail'' problem.
It would establish a new regime primarily administered by the
FDIC to facilitate the orderly resolution of failing
systemically important financial firms. As it has with failing
banks, the FDIC would have the authority to operate the
financial firm, enforce or repudiate its contracts, and pay its
claims. It could also provide the firm with emergency
assistance in the form of loans, guarantees or asset purchases
but only with the concurrence of the Secretary and only after
determining such assistance is necessary to preserve financial
stability. And in doing so, however, there would be a strong
presumption that the FDIC as receiver would remove senior
management.
Even more important, shareholders, subordinated creditors,
and any other provider of regulatory capital to the firm could
never be protected. Instead, they would always absorb first
losses in the resolution to the same extent as such
stakeholders would in an ordinary bankruptcy. This mandatory
exposure to first loss by shareholders and creditors is a
substantial change from the Administration's original proposal.
We believe it is an appropriate and effective way to maintain
market discipline and address the ``too-big-to-fail'' problem
while protecting systemic stability.
Thank you very much.
Mr. Moore of Kansas. Thank you very much, Mr. Dugan.
Governor Tarullo, please.
STATEMENT OF THE HONORABLE DANIEL K. TARULLO, GOVERNOR, BOARD
OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Tarullo. Thank you, Mr. Chairman, Ranking Member
Bachus, and members of the committee.
We have three panels, lots of witnesses today, so let me be
brief. Systemic crises typically reveal failures across the
financial system, and that has certainly been the case with the
crisis that has beset our country in the last few years. There
were profound failures of risk management in many private
institutions. There were supervisory shortcomings at each of
our financial regulatory agencies. Supervisory changes need to
be and are being made. But we also need changes in legislative
authority and instructions under which the regulatory agencies
operate.
In this regard, the discussion draft put forward by the
chairman today provides a strong framework for achieving a
safer, more stable financial system. The draft contains the key
elements of an effective legislative response to systemic risk
and ``too-big-to-fail'' problems. It reflects the need for
multiple tools in containing these problems: stronger
regulation; more effective supervision; and improved market
discipline. In particular, creation of the kind of resolution
mechanism contemplated in the discussion draft will give the
country a third alternative to the current, often unwelcome,
options of either a bailout or disorderly bankruptcy.
As a complement to the regulatory and other changes in the
legislation, it will give the government a means for letting
even a very large institution fail while still safeguarding the
financial system. This mechanism will move us away from a
situation in which severe financial distress for large
financial firms has led to a risk of loss being borne by
taxpayers in order to safeguard the system to one in which in
losses are borne by shareholders, creditors, managers and, if
necessary, other large financial institutions.
As always, Mr. Chairman, we would be pleased to work with
the committee on any issues that arise as you move this
legislation forward. Thank you very much.
[The prepared statement of Governor Tarullo can be found on
page 291 of the appendix.]
Mr. Moore of Kansas. Thank you, sir. Mr. Bowman, you are
recognized for 5 minutes, sir.
STATEMENT OF JOHN E. BOWMAN, ACTING DIRECTOR, OFFICE OF THRIFT
SUPERVISION (OTS)
Mr. Bowman. Good afternoon, Congressman Moore, Ranking
Member Bachus, and members of the committee. Thank you for the
opportunity to present the views of the Office of Thrift
Supervision on the Financial Stability Improvement Act of 2009.
As Acting Director of OTS, I have testified several times
about various aspects of financial regulatory reform, including
OTS' strong support for maintaining a thrift charter,
supervising systemically important financial firms,
establishing resolution authority over systemically important
financial firms, establishing a strong Financial Services
Oversight Council, establishing a Consumer Protection Agency
with rule-making authority over all entities offering financial
products, and addressing real problems that caused this
financial crisis and could cause the next one.
I have also testified about OTS' opposition to
consolidating bank and thrift regulatory agencies, believing
that such an action would not have prevented the current
crisis, and that the existence of charter choice was not a
cause of the crisis.
During this time, I have told OTS employees that based on a
review of the Administration's initial proposal, they could
take some comfort in assurances that whatever happened, they
would be protected, treated fairly, and valued equally with
their counterparts at other agencies. After reviewing the draft
bill, I can only conclude that this is no longer the case. We
know that major changes were made to this portion of the bill
recently. Instead of abolishing both OTS and the Office of the
Comptroller of the Currency and establishing a new agency
called the National Bank Supervisor, the bill would merge the
OTS into the OCC. What we do not know is why these changes were
made.
If Congress concludes that merging agencies would
accomplish an important public policy goal, then we believe
Congress should build a Federal bank supervisory framework for
the 21st Century by establishing a strong, new agency with a
name that is recognizable to consumers and accurately reflects
its mission.
If this bill were to pass as currently drafted, OTS
employees would be unfairly singled out and cast under a
shadow. The impact of this approach would be particularly
onerous for the one third of all OTS employees who are not
examiners and who would not work in the OCC's proposed new
Division of Thrift Supervision. Instead of having an equal
opportunity to obtain a position in the reconstituted agency
based on merit and on-the-job performance, they would be folded
into current divisions of the OCC. I believe that if all
employees had an equal opportunity to compete for positions,
then the resulting agency would be more cohesive and would
benefit from the most qualified and capable workforce and
leadership.
It is also critical that the bill include strong
protections for all employees of the reconstituted agency, most
importantly the same 5-year protection from a reduction in
force that is contained in the bill to establish the Consumer
Financial Protection Agency.
I am concerned that OTS employees could regard the current
bill as punitive, and that such an approach would send the
wrong signal, not only to the OTS workforce but to all Federal
employees about how they would be treated in a similar
situation. The timing of such a signal could hardly be worse
when a large percentage of Federal employees are nearing
retirement age and Federal agencies are redoubling their
efforts to attract the workforce of the future to respond to
the call of Federal service.
In conclusion, Congressman Moore and members of the
committee, I strongly urge you to affirm that Congress values
the service of all Federal employees and to ensure that this
bill would promote a fair, even-handed approach that would
result in a harmonious agency with employees hopeful about the
future of their agency and their role in it.
Thank you, and I would be happy to respond to questions.
[The prepared statement of Acting Director Bowman can be
found on page 127 of the appendix. ]
Mr. Moore of Kansas. Thank you, Mr. Bowman. The Chair next
recognizes Commissioner Sullivan for 5 minutes.
STATEMENT OF THE HONORABLE THOMAS R. SULLIVAN, INSURANCE
COMMISSIONER OF THE STATE OF CONNECTICUT, ON BEHALF OF THE
NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS (NAIC)
Mr. Sullivan. Thank you, Mr. Moore, Ranking Member Bachus,
and members of the committee for the opportunity to testify at
today's hearing. My name is Thomas Sullivan. I am the insurance
commissioner for the State of Connecticut. I am also a member
of the National Association of Insurance Commissioners, serving
as Chair of its Life Insurance and Annuities Committee. Today,
I represent the views of my fellow regulators on behalf of the
NAIC.
With respect to the proposals being considered by Congress
to prevent or manage systemic risk, we continue to stress the
following principles.
First, we believe that any new system must incorporate, but
not displace, the State-based system of insurance regulation.
State insurance regulators are on the front lines in resolving
approximately 3 million consumer inquiries and complaints each
year. And that daily attention to the needs of individuals and
businesses must remain a cornerstone to any effort of reform.
Our national solvency system is resilient and any group capital
standards should supplement, but not supplant, the requirements
of the functional regulators.
Second, Federal legislation should ensure effective
coordination, collaboration, and communication among all
relevant State and Federal financial regulators in the U.S.
financial stability regulation as it relates to insurance can
only be stronger with the added expertise of the 13,000 people
who currently work in our Nation's State and territorial
insurance departments. As such, State insurance regulators must
have a meaningful seat at the table of the proposed Financial
Services Oversight Council. In order to provide a complete view
of the financial system, regulators at the State and Federal
level must also have appropriate authority to share
information.
Third, group supervision of complex holding companies that
includes functional regulators is necessary, but preemption of
State regulators, if ever necessary, should result only after
State efforts have been exhausted. There is a great benefit to
having multiple sets of eyes looking at an institution such as
what exists today with the current State-based insurance
regulatory system. Preemption and putting a single regulator in
charge would take away a crucial fail-safe of allowing real and
potential oversights by one regulator to be spotted and
corrected by another.
Additionally, we would also stress that systemic
supervision should consider the unique expectations of
consumers and that different regulatory structures for
different entities within a holding company. The health of a
well-regulated subsidiary must not be sacrificed to preserve
another unregulated subsidiary.
To reiterate, systemic resolution authority must continue
to allow State regulators to protect the assets of sound
insurance entities from the plundering by unsound, poorly
regulated subsidiaries or the broader holding company. State
receivership authority prioritizes policyholders as creditors
of failed insurers, and we have extensive experience in
unwinding insurers.
In conclusion, we urge caution in pursuing any proposal
that could impact our ability to adequately regulate the
insurance market and protect insurance consumers. And we ask
that our perspective be considered by this committee in the
critical days and weeks ahead.
Thank you for the opportunity to testify at today's
hearing, and I would be happy to answer any questions.
[The prepared statement of Commissioner Sullivan can be
found on page 219 of the appendix.]
Mr. Moore of Kansas. Thank you, Commissioner Sullivan. The
Chair first recognizes himself for 5 minutes of questions.
Chairman Bair, I believe we must end ``too-big-to-fail.'' I
appreciate the work Chairman Frank and the Treasury Department
put into improving the systemic risk and resolution authority
title. Taxpayers must be fully protected and creditors,
shareholders, and management must be fully accountable before
taxpayers step in, in my opinion. The discussion draft takes us
in that direction, but the Systemic Risk Council and resolution
process must be more accountable, efficient, and transparent.
Page 17 of the discussion draft states, ``The Federal
Government will not publicly release a list of firms that pose
systemic risk.'' I understand the intent for a private list is
to eliminate any competitive advantage for being an identified
firm but does not the marketplace already know who most of
these firms are? And the firms that will be put at a
competitive disadvantage will be the ones near the borderline,
not the obvious ones, like Goldman Sachs, Citigroup, and Bank
of America.
Additionally, if the point of putting creditors and
shareholders on notice is that they stand to be wiped out if a
firm posing systemic risk fails, how will they know the value
of their investments legal claims if the list of firms is not
public? If the cost and burdens put on these firms are not
great enough to offset any perceived advantage, I would prefer
to increase those costs instead of trying to hide the list. Why
not make the list public? Chairman Bair, do you have any
thoughts on that? Or at least require identified firms to
notify their shareholders?
Ms. Bair. I think that it is probably unrealistic to think
that a list like that is going to be kept secret. Everyone will
already know the obvious firms. I understand the intent of that
provision is to try to not make it look like these institutions
are ``too-big-to-fail,'' but I think you take care of that
problem with a robust resolution mechanism. So, at the end of
the day, I am not really sure it is realistic to try to keep
those confidential. In any event, they may very well be
required to be disclosed as material under the SEC rules. And
we have always asked for institutions to fully comply with
securities disclosures. So, my sense is it is perhaps not
realistic to require that the list be confidential.
Mr. Moore of Kansas. Would anybody else like to address
that question? Yes, sir?
Mr. Dugan. There is a fundamental conundrum between wanting
to be able to impose higher requirements on companies that pose
systemic risk and trying to keep that quiet or secret somehow.
I think at some level, when you impose the requirement, you
have to know who they are. And when you do this, if they are
significant, people will understand who they are. So I think it
is going to be hard not to disclose in some way, shape or form
who they are.
Mr. Moore of Kansas. Governor Tarullo, do you have a
statement, sir?
Mr. Tarullo. I think, Mr. Chairman, that Comptroller Dugan
has summed it up. Surely we can keep the list private if that
is what the Congress wants us to do, but through some
combination of self-mandatory disclosures to shareholders and,
frankly, just financial analyst observation of their behavior,
capital, set-asides and the like for the firms, it is likely
that most, if not all, of the institutions so identified would
eventually be known to the public. And I think, as someone
suggested, you may have a bit of a problem if an incorrect
inference is drawn. So while again, there is a reason to try to
avoid an increase in moral hazard, we should probably be
realistic here about what will and will not be known.
Mr. Moore of Kansas. Thank you, sir. Mr. Bowman and Mr.
Sullivan, any comments?
Mr. Bowman. I do not think I have anything to add to that,
Congressman.
Mr. Moore of Kansas. All right. Okay. Next question very
quickly. Another issue I would like to discuss is the
requirement for firms with assets over $10 billion to
contribute to the systemic risk fund after a large firm fails
and goes through the resolution process. Why not make only the
firms that have been identified to pose a systemic risk pay for
the clean-up? Would not this further incentivize firms to not
become ``too-big-to-fail?''
Additionally, instead of simply paying back the principal
for the use of taxpayer funds to help wind down a failing firm,
I would suggest adding that any interest paid to service the
national debt and the use of these expenses should also be
repaid. What are your views on this? Chairman Bair, do you have
any thoughts on that?
Ms. Bair. First and foremost, it is very important to make
clear that the assessment base would only apply to activities
outside of an insured depository institution. Given such an
assessment base, smaller institutions would really not pay
significantly because most of their assets and liabilities are
inside the insured bank.
It is hard to know in advance which institutions might pose
systemic risk. So the rationale behind the $10 billion
threshold was to try to identify those we could say with
confidence would not be systemic. However, clearly it is likely
that they would be significantly higher in assets if they were
systemically significant.
If you design the assessment base appropriately, the
smaller regional institutions would not pay significantly. But
I think there needs to be some cut-off. It is just very
difficult to know completely in advance who would or who would
not need to be put into this type of resolution authority.
Mr. Moore of Kansas. Thank you, Chairman Bair. And my time
has expired. If any of the other members of the panel have
thoughts they would like to express, please put those in
writing to us if you would.
The Chair next recognizes, for 5 minutes, Mr. Garrett.
Mr. Garrett. I thank the Chair, and I thank members of the
panel. First of all, I assume everyone here was listening to
the last panel when the Secretary was here? Okay. Oh, you heard
it before. You have heard him testify before on two occasions.
I do not mean for this comment to be flippant, but he did say
it twice when he said that when we do hear the regulators, I
know some are regulators, some are not, that--he did not say
this, I am paraphrasing, we should take it all with a grain of
salt because they are all just protecting their turf. If that
is the case, then I guess I should take everything he says with
a grain of salt as well because he is probably just protecting
his turf, so I do not know why we have any of these panels. But
I do really appreciate the testimony that we have heard so far.
One of the questions is, and I am going to go up and down
the row. Ms. Bair, do you think that we should be extending
this overall program beyond depository institutions, first of
all?
Ms. Bair. Yes, I do think there is a need for this ability.
We think the Systemic Risk Council should be able to decide if
there are institutions that pose systemic risk that have not
already been identified.
Mr. Garrett. Yes. Now if you were listening to Secretary
Geithner, he said something to Ms. Capito, which I do not
understand, about the auto companies. First of all, he said he
was not around back then, but he agreed with what they did. I
would have asked him would he have done it again. Since he
agreed with them, I assume he would have done it again. He also
said that GMAC would not come under this legislation. Does
anybody here understand why GMAC would not come under this
legislation? No? So you all assume that it would?
Ms. Bair. We would hope that this only applies to financial
intermediaries, number one. And, number two, I do not comment
on open operating institutions, so I would rather not opine on
the second part of the question. I think it would be a
determination for the council as to whether a non-bank entity
would go under this legislation.
Mr. Garrett. Here is the thing. When I read this--and I
read the beginning and went three quarters, and then I went to
the last page to see how it all ended. But if you are reading
the definitions to find out who all the council is dealing
with, it has a two part standard to define them. One, they must
be a corporation registered here in the country, yada, yada,
yada.
Two, they must be an institution that engages directly or
indirectly in financial activity. That would be my dry cleaners
who has to take a loan out in order to operate his business.
That would be the Drudge Report, which has reported in a local
paper as having an influence on the value of the dollar. That
would be just about any corporation in this country. That may
even be me if I am a candidate who has a corporation for my
candidacy because we engage in financial activity. So just
reading what they gave us, it is pretty broad as to who comes
under the council's authority.
Does anybody have a reason to believe that it is not that
broad by the language in here, not just by intent?
Ms. Bair. Congressman, I was out of town yesterday, and I
have been speed reading this myself. That did catch my
attention, and we think it could be a little bit more narrow.
We would be happy to work with the committee on that technical
matter. It is a very broad definition. I would agree with you.
Mr. Garrett. Anybody else? And that is a neat little
comment. Who else had to be like I did speed reading this
thing? I think that is a fair assumption, and I appreciate the
candor. I did too. I am not a speed reader. It takes me a long
time to read this stuff.
Ms. Bair. We appreciate that the committee did consult with
us on a lot of the pieces on resolution authority. I do not
mean that as a criticism. I am just apologizing that I have not
had a chance to read it all.
Mr. Garrett. Yes, we all did and this is pretty darn
complicated stuff. And that is why I wonder if the next
portion, let's take the worst-case scenario that you actually,
and I will get back to Ms. Bair on the other question, and the
rest of you too can chime in as to whether it should be ex-anti
or ex-post as far as the assessment, but it is ex-post in here.
I read it to say that what happens is if something goes down,
you need to collect money from other companies, institutions,
financial institutions over $10 billion, right, again reading
this, I could say that does not just apply to financial
institutions as I would think of them, as banks and what have
you, it could apply across-the-board.
It could apply to all the car companies. It could apply to
all the biotech companies. It could apply to everyone in this--
just about any corporation that is over $10 billion in size,
that they would be responsible for, heaven forbid, that BOA has
a problem. Did anybody else read it that this cannot go across-
the-board as far where they get it from a $10 billion
assessment?
Ms. Bair. I do not think that is the intent of the
discussion draft. Again, the language can be further refined.
But I do not think that is anyone's intent, not as it has been
explained to me.
Mr. Garrett. Okay. I am just going by the language. Intent
is one thing but the way that regulators effectively carry
things out is not always as Congress intends.
The other question is, and I don't know if I have the time,
the sell-off ability. Once you have an institution that you
define, you might want to sell off its assets, it goes back to
what Mr. Kanjorski was raising before, I do not see any due
process elements in here. On page 19, mitigation of systemic
risk section, if the Board determines, they can sell off assets
at will.
Is there any due process in the language of the bill?
Mr. Moore of Kansas. The gentleman's time has expired. And
the witnesses will have an opportunity to present any responses
they have in writing for the record.
Mr. Garrett. Can I get a yes or no real quick?
Mr. Moore of Kansas. If somebody has a quick yes or no?
Ms. Bair. There is due process in the FDIC's procedures
against which this has been patterned, and we can give you a
more thorough answer in writing on that, yes.
Mr. Garrett. Thanks. Thanks, Mr. Chairman.
Mr. Moore of Kansas. Thank you. The Chair next recognizes
the gentlelady from New York, Ms. McCarthy.
Mrs. McCarthy of New York. Thank you, Mr. Chairman. It is
interesting listening to the testimony, and I guess when we
received this some time late last night, obviously why it is in
this small print, I have no idea. At my age, I need it a little
bit bigger. Forget about even speed reading. But with that
being said, the whole idea about having these hearings and
having the different witnesses come in front of us is so that
we can go through this, can work through it and certainly make
the adjustments that need to be done. We have done that with
every piece of legislation as we have gone through this whole
process in the last several months.
But I guess, Chairwoman Bair, one of the questions that we
constantly hear, with the amount of authority that you are
going to be having, and it is certainly extensive between the
resolution authority and the supervising State charter thrifts,
how do you respond to those critics that are saying that this
is going to be too much, too far of a reach for you and your
group to be able to do everything that they are supposed to do?
Ms. Bair. I do not think the State-chartered thrifts will
be a significant burden--there are 472 of them. They are
primarily smaller institutions. We regulate nearly 5,200
institutions already. So I do not think that would be a
significant resource demand.
On the resolution authority, obviously this is cyclical
work. Somebody needs to do it. We are the best equipped of the
agencies to do it. We set up a group to look at what the
resource needs would be. We do not think resources would be
significant on a start-up basis. We have a lot of contractors
that we rely upon. That is the whole idea of the FDIC, to be
able to expand quickly because of the cyclical nature of this
work. Some agency has to do it, and we certainly have the
infrastructure already that can be built out to assume more of
this responsibility.
My hope is that this is not something that is going to have
to be used a lot, if ever. The whole idea of having a robust
resolution mechanism is to put better market discipline back
into the system, especially to tame some of these larger
institutions so that investors and creditors will be more
demanding. We want them to understand what kind of risk the
institutions are taking, whether they are well-managed, and
whether they are transparent because investors and creditors
know their money will be at risk if the institution gets into
trouble.
The hope and expectation is that the new Systemic Risk
Council combined with these resolution authorities will help
take a lot of risk out of the system. But you will always have
cycles, and you will always have instances where institutions
get into trouble. So, some mechanism is needed. But, I think
that the primary benefit of that is the strong signal it sends
to the market that these are the rules. You will take losses if
you fund or invest in high risk-taking institutions that get
too big. If these institutions are going to be closed, you will
take losses.
Mrs. McCarthy of New York. I agree with you on that. I
would like to throw it out to the rest of the panel. Being that
obviously your staff has probably gone through each section
that would affect each and every one of you as far as your
interests, have you seen anything that you would want to add to
the legislation as we go forward to either improve it or do you
think--I have heard some complaints there that some parts, that
you do not agree to, but what we are missing in this piece of
legislation?
Mr. Dugan. Mrs. McCarthy, as I indicated in my longer
written statement, we have thought for some time that there is
an unevenness that goes on right now inside of bank holding
companies in the sense that banks are extensively regulated but
holding company affiliates, even if they are engaged in the
very same activity, are not subject to this same examination
and supervision on a regular basis. We think we ought to level
that playing field so that you do not have any potential for
arbitrage between different parts of the holding company
because we did see some of that in previous times.
Mrs. McCarthy of New York. Governor?
Mr. Tarullo. Thank you. I think all of us would agree that
there will be places where we can make suggestions and
recommendations. A couple that come to my mind, first, I do not
think we want, the Federal Reserve I do not think wants to be
on the board of the FDIC. I do not think we bring a whole lot
to that enterprise. So that would be one change.
I suspect that we will, working with many of you, see
opportunities for perfecting a lot of the other areas as well.
And we are not unsympathetic to what Mr. Dugan said at the
outset about needing to make sure that the allocation of
authorities among agencies preserves the strongly and
effectively collegial relationship that we do have certainly in
working with the OCC within the bank holding company context.
Mr. Bowman. In my opening statement, I made a couple of
remarks regarding the proposed merger and some of the issues
that are there. And we will be happy to provide written
suggestions in that regard.
Another area we would like to look at is a loss of a fairly
fundamental advantage for smaller institutions that have
holding companies. That is the consolidated holding company
approach where you have the same regulator for the holding
company and the institution, as distinguished from larger
institutions or entities that have multiple affiliates, perhaps
as Comptroller Dugan talks about, where you need a different
kind of regulator.
In a case of a single institution, perhaps smaller, with a
holding company and not a lot of other activities, consolidated
supervision of those two entities, the holding company and
institution, are real advantages to the smaller community
institutions.
Mr. Moore of Kansas. I am sorry, the gentlelady's time has
expired. And I would ask if Commissioner Sullivan, if you have
additional comments, we would like to have those in writing for
the record, please. And I apologize. But Mr. Manzullo, you are
recognized, the gentleman from Illinois, for 5 minutes.
Mr. Manzullo. Thank you. I have a couple of questions. Mr.
Dugan, on page 5 of your testimony you state, dealing with
Federal Reserve separate authority and impose heightened
prudential standards and safeguards concerning certain
financial activities and practices, and then you say, ``Once
the Council makes this identification, the Federal Reserve
would have unilateral authority to establish a broad range of
standards and safeguards for such activities and practices but
without seeking public comment and without consulting with
primary supervisors even where the primary supervisor has
greater expertise and experience with respect to such
activities.'' It is obvious you do not like that authority?
Mr. Dugan. I think it could be adjusted, and I take the
comments of Governor Tarullo to heart. I think there are some
places where there needs to be more of a recognition of the
respective roles that we have on different things. For
example--
Mr. Manzullo. I have a question that goes along with that.
Mr. Dugan. Okay.
Mr. Manzullo. And I did not mean to cut you off, but you
made your point quite clear here, and I respect that. Have you
been following all the debate on the Consumer Financial
Protection Act?
Mr. Dugan. Yes, I have.
Mr. Manzullo. You realize that what this new piece of
legislation attempts to do is exactly what the CFPA would do on
safeguarding activities and practices? Maybe you do not realize
that but it--
Mr. Dugan. It is a different slice, it is more on the
safety and soundness prudential side of things, and it is
trying to get at a broader range of institutions where the CFPA
is focused on consumer protection.
Mr. Manzullo. Ostensibly, but if you read the CFPA Act, it
is so broad. I can see a huge fight going on over who is going
to do something, and then this bill says the Fed can move
unilaterally without talking to the people who have authority
on it.
The second question, Mr. Sullivan, I do not want you to
fall asleep over there, no one has asked you any questions.
Your testimony I think is very, very pointed. On page 5, you
identify the blame that many in this town refuse to recognize.
When you start at--on page 5, line 3, ``The insurance
industry in general does not pose a systemic risk to the
nation's financial markets to the extent we have seen in the
bank and securities sectors. Rather, insurance companies are
more often the recipients or conduits of risk. Mortgage and
title insurance, for example, do not generate systemic risk.
They simply facilitate underlying loan transactions.'' Is not
the problem with the financial collapse that we have had in
this country due to the fact that these subprime mortgages were
allowed to take place with very little underwriting standard
supervision?
Mr. Sullivan. And I would point to the area that we
regulate, the dominion that we have authority over, insurance
has very high capital standards. And as a consequence, we have
not seen failures within the insurance industry. I can count on
one hand over the last 3 years the insurance affiliates that
have failed during the most significant upheavals in the
financial market while we have seen hundreds of banks fail
during the same time.
Mr. Manzullo. Then some witnesses here want to pool the
entire insurance industry.
Mr. Sullivan. And we are very skeptical about any grab of
such authority when we have a proven system that works.
Mr. Manzullo. That is my question--the only people around
here who do not seem to be getting any recognition or any
respect are the people who have been doing their jobs back home
in the State insurance authorities, and then all of a sudden
people say, let's bring it together.
The third question is open to everybody, actually to the
Governor. The Feds already had the authority, it has had it for
years, to set underwriting standards for mortgages. I am
talking subprimes. And do ridiculous things, such as requiring
written proof of a person's earnings. And yet the Fed never put
those regulations into effect until October 1st of this year.
So why should the Fed be given more authority under a brand new
organization set up when it had that authority in the first
place and simply failed to act? And the failure did not occur
during Mr. Bernanke's term. By the time he got in, it was too
late.
Mr. Tarullo. So, Congressman, before I was on the Board, I
was actually quite critical in my former capacity as an
academic of the failure of the Board, indeed of the government
more generally, to move to do something about subprime lending
problems, both directly in their consumer implications, and
indirectly in their safety and soundness implications.
And, as you indicate, I think Chairman Bernanke came, when
he became chairman, he took a look at those prudential and
consumer regulatory issues and under his leadership, the Board,
I think, has enacted a good set of mortgage related as well as
credit card related regulations. So the short answer I guess to
your question is that the Congress can give mandates to
agencies and then give authority to agencies, but the decisions
that the people leading those agencies make and the context in
which they make them matter. And to that degree, I think we all
just have to recognize that the policy orientations of
appointees to these agencies are important things for you and
your colleagues on the other side of the Hill to consider.
Mr. Manzullo. Thank you.
Mr. Moore of Kansas. Thank you, Mr. Manzullo. And next, the
Chair recognizes the gentleman from Texas, Mr. Green, for 5
minutes.
Mr. Green. Thank you, Mr. Chairman. I thank you and the
ranking member for hosting the hearing. Mr. Bowman, I respect
you for speaking up for and standing up for your employees. How
many are we talking about? And I am going to ask that you
answer as quickly as possible because I have a series of
questions that are of concern. How many employees are we
talking about?
Mr. Bowman. I believe as of tomorrow, it will be 1,040,
approximately.
Mr. Green. And is it your opinion that under the current
proposal, these employees will not receive a fair and equitable
transition?
Mr. Bowman. Our brief review of the legislation we received
the other evening would suggest that two-thirds of the
employees, the examination workforce, who are specialized and
trained, would probably make out quite well. For those who
provide other services, there is a difficulty in terms of how
they will be merged with the OCC.
Mr. Green. For additional edification, when you say
``others,'' are we talking about clerks, are we talking about--
tell me what the others consist of?
Mr. Bowman. We are talking about economists. We are talking
about legal. We are talking about IT specialists. We are
talking about compliance specialists who are not examiners,
those who would not go to the CFPA.
Mr. Green. And have you examined any information or any
document that would help someone such as myself, who is
concerned, something that you have codified that might help me
to help those employees, is there something available?
Mr. Bowman. There are two places to start, and we will get
you the information if you would like. One is the merger of the
old Federal Housing Finance Board and the Office of Federal
Housing Enterprise Oversight where they took two agencies and
merged them into one, even though they had different charters
and different purposes.
We would suggest that the second starting point would be
the Administration's original proposal. It started off by
creating a new agency, and then having the OCC and the OTS come
together on equal footing.
Mr. Green. I will be candid with you, that may be difficult
at this point, but I would like to hear more about what you
propose. And I will look to work with you and your office and
to see what we can do.
Mr. Bowman. Thank you, and I look forward to that.
Mr. Green. Thank you. And I will come to you, Mr. Dugan.
Let me ask one quick question because I have to make sure that
I get this in, a comment first. ``Too-big-to-fail,'' without
question, is the right size to regulate. It is also the right
size to eliminate. I am of the opinion that we absolutely want
to prevent ever having ``too-big-to-fail.''
And the question becomes, can we allow institutions to grow
so large that they can be resolved and not cost the taxpayers
dollars. The paradigm that we are proposing provides for
resolution. The question that the taxpayers are interested in
is this. If we had in place what we are proposing, would we be
able to wind down AIG and not use one penny of taxpayer money?
Ms. Bair? And if you can, give me a yes or a no. I know
everyone is tempted to give a long explanation.
Ms. Bair. Yes.
Mr. Green. Your opinion is, yes, we could with the current
proposal, all right. Mr. Dugan?
Mr. Dugan. Yes, I think we could too, but it is hard to go
backwards in time and see exactly. I think if you put all these
proposals in place, the answer is yes.
Mr. Green. All right. Sir?
Mr. Tarullo. I think that is correct, Congressman. I do not
think it would have cost the taxpayers a penny in the end.
Mr. Green. In the end, not a penny, current proposal in
place?
Mr. Tarullo. Yes, the question would be would there have
been any temporary liquidity support provided in the interim,
but that could have been fully collateralized and repaid.
Mr. Dugan. I would say yes, but of course, the devil is in
the details.
Mr. Sullivan. And the only concern we have from a State
regulator's perspective is protecting policyholders. So if the
wall of the assets that protect policyholder liabilities, and
so if the unwinding--
Mr. Green. I am going to take that as a yes.
Mr. Sullivan. As long as we protect policyholders, that is
our--
Mr. Green. I have to move on. Final comment and then Mr.
Dugan is this. Once that list is codified, my assumption is
that it will become public knowledge. Once more than one person
knows about it, in the world that we live in today, things just
do not remain esoteric. And I think we should provide for the
possibility that it will be public more than private.
Now, Mr. Dugan, your comment?
Mr. Dugan. Yes, very quickly, Mr. Green. I just wanted to
say that on the transfer of personnel and fairness issues, we
absolutely want to work with you to make sure that we provide
information to you as well as OTS to make sure that it is fair
and orderly.
Mr. Green. Thank you. Thank you, Mr. Chairman.
Mr. Moore of Kansas. Thank you. If any other witnesses care
to respond to Mr. Green's question, you are welcome to do that
for the record. The Chair next recognizes Mr. Paulsen for 5
minutes.
Mr. Paulsen. Thank you, Mr. Chairman. Let me just follow
up. We had some discussion earlier this morning about the
repayment from the AIG loan and the GM bridge loan to nowhere
as being far from certain that those payments are going to be
repaid. And I think many of us here have had concerns that this
Administration may be using the extension of TARP, for
instance, as a continued ATM or walking around money and having
those funds out there.
And Mr. Volcker recently testified before the committee
here. He said that, ``The proposed overhaul of financial rules
would actually preserve the policy of `too-big-to-fail' and
could lead to future banking bailouts.'' I am just curious, Mr.
Geithner has left now, but from your perspective, can you just
comment, what in this plan really prevents or assures that we
are not going to have those future bailouts occur after we
heard that testimony from the former Chair of the Federal
Reserve?
Ms. Bair. We think there are areas where this proposal
could be strengthened, but it prohibits any type of open bank
assistance for an individual firm. That is number one. It
prohibits capital investments of any kind. It does under
extraordinary circumstances allow the government to provide
some liquidity support for healthy institutions, but that needs
to be done through a systemic risk process, which is a fairly
extraordinary procedure.
It also says that if there are any losses, a tenet with any
of this, that it would be borne by the industry through an
industry assessment. There would be no more one-off bailouts
under this. There would be a fund. Whether we think it should
be pre-funded or funded after the fact, any cost or unexpected
losses associated with the resolution activity would be borne
by the industry.
It does not provide for a guarantee of liabilities. Such
obligations should not be affirmed for individual firms. This
is far different from the type of thing you saw with AIG. There
would be no capital investments, for one thing. It would be a
closed system.
Again, we do not expect significant losses, as this is a
wind-down process. It is more akin to a bankruptcy process in
terms of the losses being imposed on shareholders and
creditors. You would not have bondholders being taken out at
par the way you had with some of these bailouts, for instance.
And shareholders would be completely wiped out whereas they
might live to fight another day with some of the bailouts that
had been done so far. So this is a profoundly different process
from what you have seen in the past. And that is not a
criticism, we did what we had to do. There were no tools
available, but this will be very different going forward.
Mr. Paulsen. And many of us I think would advocate for the
bankruptcy process to recede, and we had discussions earlier
even this morning about the moral hazard argument. What in the
plan really encourages companies to not engage in risky
behaviors, to actually grow larger to a size where they will be
deemed systemically important or at risk?
Mr. Tarullo. So, Congressman, there, the question you just
asked brings up the important point that we need to have
mutually reinforcing pieces of this system. Chairman Bair has
just described how market discipline can be brought to bear
when you have a robust resolution mechanism. I would add to
that, bringing into the parameter of companies that are
regulated, firms like AIG and Bear Stearns, stops you from
getting to a situation which is very high leverage in some
unregulated firms.
In terms of the question of, does this provide an incentive
to become big or a disincentive to become big, I think it is
incumbent on all of us to make sure that the incentives in the
system make--require firms to internalize the costs of their
bigness and their interconnectedness. It requires the
counterparties of those firms to internalize them when they
enter into transactions. It requires the firms themselves
because of the imposition of special liquidity and capital
requirements to internalize them.
So when we put all three pieces together, regulation,
supervision, and market discipline, we should make sure that
each firm, small, medium or large, is able to provide financial
services to the businesses and consumers of our country but
only in such a way that their safety and soundness is assured.
Mr. Paulsen. And before I just run out of time, Mr.
Chairman, I want to ask Commissioner Sullivan, who is now on
the end as well, do you have any concerns about Treasury, the
Treasury Department or the Federal Government essentially
obtaining authority to regulate insurance under the draft plan
or concerns about Federal interference down the road as a State
commissioner?
Mr. Sullivan. Indeed, with respect to any preemption what
we do today, yes. So if capital requirements are set higher
than what we set today in the State regulatory system, have at
it. But do not undermine or preempt what we do today, as I
stated in my comments, our record is proven and it speaks for
itself.
We have not had any failures of insurance enterprises and
that is because they are strictly regulated from a financial
solvency perspective. So do not preempt us from a resolution
authority perspective. Do not preempt us from a capital
requirement perspective. Do not preempt us in any of those ways
because our system works.
Mr. Paulsen. Mr. Chairman, I just wanted to ask unanimous
consent to submit two letters for the record, one from CMSAA
and one from the American Land Title Association.
Mr. Moore of Kansas. Certainly, they will be received for
the record. Thank you, sir.
The Chair next recognizes the gentleman from North
Carolina, Mr. Miller, for 5 minutes.
Mr. Miller of North Carolina. Thank you, Mr. Chairman. Ms.
Bair, Mr. Garrett asked earlier whether if there was a
resolution under these powers, a manufacturer who is just
minding their own business might be surprised to get an invoice
declaring that they were a financial company, and they had
assets of more than $10 billion. And what would keep that from
happening. And you said that you did not think that was
intended by the legislation.
Page 165, 166 includes a definition of financial company,
which is a bank holding company as defined in Section 2(a) of
the Bank Holding Company Act. An identified financial holding
company is defined in Section 2(5) of the Financial Stability
Improvement Act, any company predominately engaged in
activities that are financial nature, for purposes of Section
4(k) of Bank Holding Company Act or any subsidiaries of any of
those. And all of those are defined statutory terms.
And with respect to the ``predominately engaged in
activities,'' there is a procedure for notice that the company
is regarded as predominately financial and they have an
opportunity to contest that. Does that support your argument
that no manufacturer minding their own business is just going
to get an invoice?
Ms. Bair. It certainly attempts to. Again, my apologies, as
I have not had a chance to read this entire bill. I think we
all understand we want this confined to financial
intermediaries. If there are further refinements in the
language, we are happy to work with the committee. But, yes, I
think that is clearly the intent. And, as it is drafted here,
that is what is expressed. But, there are other provisions I
know my staff had concerns over, and I need a chance to read
the entire bill before I can respond.
Mr. Miller of North Carolina. Okay. All right. Thank you.
There has been a substantial discussion about whether banks
should not do certain things. Any systemically significant firm
should not engage in some inherently risky procedures. We have
had that comment from economists for several months now as part
of this debate. Mervyn King, the Bank of England governor, said
there should be--banks should be broken up into casino
functions and utility functions.
And Paul Volcker, testifying here last month, said that
much the same thing, and specifically gave the example of
proprietary trading. Do you agree that there are some functions
that systemically significant firms should not do, among other
reasons, because it is almost entirely impossible for their
board of directors or even their CEO to know what they are
doing if they are engaged in all manner of complex activity, do
you agree with that? And do you agree specifically with respect
to proprietary trading?
Ms. Bair. Right.
Mr. Miller of North Carolina. And does this bill give
sufficient authority to do that?
Ms. Bair. I think he was saying that insured depository
institutions should not do that.
Mr. Miller of North Carolina. Right.
Ms. Bair. Those that benefit from the deposit insurance. I
do not think he was saying nobody should do that. I think his
preference would be basically to do away with Gramm-Leach-
Bliley so that you have banking operations that take deposits
and make loans separate from securities and insurance activity.
So, we have somewhat of a hybrid approach. We would like much
more definitive walls of separation, both legally and
functionally, between insured depository institutions and other
affiliates in a bank holding company.
We also would agree with Comptroller Dugan that regulatory
standards for the holding company activity should be higher.
The capital standards should be at least as high for holding
companies as they are for insured depository institutions. The
quality of capital should be just as high.
If you are going to have an insured depository institution,
you should be in a position of strength, not weakness. We would
like some strict separation of proprietary trading and a lot of
these complex securitizations, etc., should be outside the
insured depository.
We also were very grateful that the bill does propose
giving us some back-up authority for holding companies so that
when a holding company affiliate is doing something that puts
the insured institution at risk, we would have some back-up
ability to come in there and work with the Federal Reserve,
presuming the Federal Reserve is the holding company
supervisor, to remediate that situation.
We do want greater walls of separation between the banks
and other types of activities, but we would not say that they
could not co-exist within a broader holding company structure.
Mr. Miller of North Carolina. I am sorry. Say the last bit
again?
Ms. Bair. So we would like greater separation between the
insured depository and the affiliates that do other types of
higher risk activities, though we would not say that the
insured institution has to be taken completely out of the
holding company structure. They could co-exist in a holding
company structure.
Mr. Miller of North Carolina. Okay. Mr. Dugan?
Mr. Dugan. The one thing that I would add is that there is
a notion that you can stop financial companies from engaging in
this risky activity, and that will solve the problem, but the
problem is somebody will continue to do those activities.
Mr. Miller of North Carolina. Right.
Mr. Dugan. They will get systemically significant and big.
That is what happened last year. We had companies that weren't
banks that did that, and we ended up having to do something
about it. So I guess the approach of this bill is you cannot
ignore the fact that they can become systemically significant.
And that being the case, you ought to have ways to go regulate
them.
Mr. Miller of North Carolina. And I support that approach.
Mr. Moore of Kansas. The gentleman's time has expired. The
Chair will next recognize the distinguished ranking member, Mr.
Bachus.
Mr. Bachus. Thank you, Mr. Chairman. One thing, the State
regulators I know under the FFIEC, you all are voting members
under that council. This is a council that presently exists,
and I think I would agree with my colleagues who say that the
States ought to have voting members there. It is kind of
letting you serve on something and not giving you a vote or a
voice is I do not think it is acceptable.
Mr. Green mentioned the OTS and the employees, and it
definitely seems like they are receiving shabby treatment, as
has Mr. Bowman. And you also have a concern that if the OTS is
simply merged into another agency, and Republicans have
proposed that as well as Democrats, so I am not casting any
aspersions on anyone, but it obviously would have a net effect
of diminishing the thrift charter. I know that everyone seems
to be proposing that, but I appreciate your testimony. I think
you outlined ways it can be done.
I know the American Bankers Association wants a strong
thrift charter, but I do not know that you can have a strong
thrift charter if you do not have an agency whose primary
responsibility is to the thrift. And most of those are small, a
lot of them are Main Street banks at a time when we are
concerned about concentration and ``too-big-to-fail.'' And it
seems like that principle works against the purpose of the
bill.
Mr. Tarullo, the Federal Reserve gains an awful lot of new
authority under this draft. What role did the Federal Reserve
have in drafting the text?
Mr. Tarullo. So far as I am aware, Mr. Bachus, we had no
role in drafting the text. We did not do the drafting. We
certainly, along the way, over the last 6 months, but more
recently over the last few weeks, were asked our views, I think
as my colleagues were, by people in the Administration and
people on the committee staff and elsewhere. But we were not
involved in the drafting of the text itself.
Mr. Bachus. Were you consulted throughout the process? Were
you consulted during the writing of it?
Mr. Tarullo. There were certainly some consultations in the
sense that we were asked by the Administration our views on
certain things, and we had meetings, the President's Working
Group and elsewhere, among many of us on that topic. But if you
are asking whether there was some sort of particular, our
particular role as opposed to that of our colleagues, I think
the answer to that is no. We were all certainly talking to one
another.
Mr. Bachus. All right. Now, under this, you would pick up
the power to force companies into bankruptcy or require them to
divest segments of their company, would you not?
Mr. Tarullo. I believe there are provisions in the bill
which would do those two things, yes, sir.
Mr. Bachus. Okay, all right. It also gives you the ability
to overrule your colleagues at other Federal banking agencies,
are you aware of that?
Mr. Tarullo. Yes, and I think that is what Mr. Dugan was
alluding to in his opening statement. And, as I said, I think
there are a lot of things that went wrong in supervision and
regulation over the last 10 years in this country, but one of
the things that I found when I came to the Fed earlier this
year that actually goes right is the cooperation between the
OCC and the Fed and the regulation of holding companies that
have national banks. And I do not think we want to undo that.
I think we want to have a collegial relationship, not one
of trying to set up situations which are overruling one
another. So we certainly want to come out with an accommodation
that achieves the safety and soundness ends that I think the
drafters intended to achieve on the one hand, while preserving
that collegial relationship on the other.
Mr. Bachus. And I think you will agree that some of the
policies by the Fed leading up to the events of the last 2
years actually probably contributed to the overextension of
credit.
Mr. Tarullo. So, Congressman, this may be my academic self
speaking, but I can identify a lot of policies by a lot of
entities who contributed to this, including the Fed.
Mr. Bachus. Thank you. I appreciate that. Chairman Bair,
Republicans have pretty much uniformly rejected the idea of a
continuing permanent bailout mechanism, but I know Chairman
Frank in this legislation sets up--funds two different
basically bailout authorities. Can you explain or give us some
of your concerns with a system that pays for failure after the
fact or one that assesses surviving competitors of failing
institutions as this plan does?
Ms. Bair. We do think there are some areas where it could
be strengthened and are happy to keep working with the
committee. There is a suggestion of a conservatorship for
failing institutions. We think the process should be a
receivership with the goal to be a prompt wind-down of the firm
or breaking it up and returning it to the private sector.
I think it is very positive that it prohibits capital
investments of any kind. If there is truly a system-wide
problem, such as an international destabilizing event, and
there is a system-wide problem where even healthy institutions
cannot get liquidity support, I think there should be some
ability for the government to step in. But that should be only
with the systemic risk procedures. We think that should apply,
whether it is us giving the support or the Federal Reserve
giving support.
The intent is a wind-down authority, not a bail-out
authority. That is our understanding of the intent. And we are
happy to keep working with the committee to effectuate that.
But you are certainly right, the whole purpose of doing
this is to send a strong signal to investors and creditors that
they will be the ones taking losses and to management that they
will be replaced if they get themselves into trouble. It is
very important that the bill sends that message.
Mr. Bachus. And the ability to loan money to a failing
corporation.
Mr. Moore of Kansas. The gentleman's time has expired.
Ms. Bair. No, we would not support that.
Mr. Moore of Kansas. I would ask the gentleman and the
Chairman to have any additional comments in writing please for
the record. Next, Mr. Perlmutter from Colorado, is recognized
for 5 minutes.
Mr. Perlmutter. Thank you, Mr. Chairman. I will try to keep
it under 5 minutes. Many of you have appeared probably a dozen
times, if not more than that, in the course of the last year
before this committee. I just kind of have to go back to this
time last year. And in any of your experiences, had you ever
seen a banking system in such peril or the economy in such
peril in September, October, November of last year? And I would
say let the record reflect people are shaking their heads no.
Ms. Bair. No.
Mr. Tarullo. Absolutely not.
Mr. Perlmutter. Okay. So now after all the times you have
appeared, all of you have been thinking about how do we manage
the system so that we can deflect the failures that we saw last
fall from happening again, at least during our lifetimes. The
next generation will do whatever it does.
And I know it is almost premature asking you this question,
but in your commenting to the Treasury Department or in the
time that you have had to kind of skim this bill, are we
missing something to try to constrain and be able to respond to
the free fall that we had last fall? And, Ms. Bair, it is an
open-ended question, if you can kind of give me a quick answer,
I would appreciate it.
Ms. Bair. No, I think the things that we consider to be
most important are in this bill. We would like to see a
stronger council. I think one of the benefits of the council is
the ability to identify and address regulatory gaps, as well as
to serve as a check on all of us to make sure we do our job. We
believe the council should have the ability to set its own
rules, that it would increase standards if individual
regulators are not doing what they are supposed to.
Mr. Perlmutter. And I appreciate your saying that because I
did want to respond to Mr. Garrett. I kind of agreed with his
point about when Secretary Geithner did not think GMAC Finance
would be part of this. And then his next point, but he thought
his dry cleaner would be part of it. Just looking at page one,
he did not get very far in the bill, because on page one, it
defines the financial company as any incorporated, any
organization incorporated in the United States, and it talks
about banks. And then it says, ``that is in whole or in part
engaged in financial activities.''
So that is a lot of companies. Then there is a limitation
that I hope would get rid of his dry cleaner, and that is on
page 13, where it says that the council determines is a
material financial distress that could pose a threat to the
financial stability of the economy. Now, I hope his dry cleaner
is not so big that it would pose a financial threat to the
economy. But it does seem to me, Ms. Bair, that you do have a
very broad roof that you can--
Ms. Bair. That is right. As I told Congressman Miller
earlier, our staff were a little concerned about this in whole
or in part, directly or indirectly. But you are right. It would
have to be systemic for the council to get involved, so clearly
the dry cleaner could not at all be subject to this. A large
commercial entity, perhaps. This should be clarified because I
think we all are talking about financial intermediaries. But,
absolutely a dry cleaner could not be included in this.
Mr. Perlmutter. So General Electric, major manufacturer,
major company but also has a major financing arm. I would
expect it would be, in some facet or another, covered by this.
And not to pick on them, I am just trying to figure out who is
covered and who is not?
Ms. Bair. Right, I think we're talking about institutions
of significant size and complexity. Yes, that would be my
assumption.
Mr. Perlmutter. That if they were to get into trouble, it
could have a domino effect.
Ms. Bair. That is right.
Mr. Perlmutter. Just starting with IndyMac, then Fannie Mae
and Freddie Mac and then Merrill Lynch and AIG and Lehman and
all that, it was dominoes.
Ms. Bair. Right.
Mr. Perlmutter. And it was a painful experience. So, Mr.
Dugan, I will ask you this, kind of changing the subject. There
is a question, and there seems to be some debate, I am a
bankruptcy lawyer, all right. That was 25 years I did Chapter
11's. And it bothers me a little bit that people are being so
free and loose with the word ``bankruptcy'' because there are
all sorts of bankruptcies. There are liquidating bankruptcies.
There are reorganizing bankruptcies. There are different
varieties. And we should not use it as one thing.
Do you think that there should be the ability to reorganize
or do you think there should be an orderly liquidation of
companies that potentially are systemically risky and are in
the financial business? For the most part, we do orderly
liquidations of it.
Mr. Dugan. It is a good question, and I am not sure. I am
not a bankruptcy lawyer, and I think there is a very important
technical bankruptcy point in here about the reorganization
question. I think what the draft gets at and what people have
been so concerned about is, however you do it, the shareholders
of the company and the subordinated creditors bear the losses,
so even if it is reorganized, others senior in the chain might
get there.
It has been viewed as somewhat impractical, I gather,
historically, to do this in the financial institution context.
I do not really understand why, but I think it is a perfectly
legitimate question. And let us give it some more thought, and
we will provide something for the record.
Mr. Perlmutter. Thank you.
Mr. Moore of Kansas. The gentleman's time has expired.
Votes have been called. We are going to have one more set of
questions. Ms. Bachmann from Minnesota, please?
Mrs. Bachmann. Mr. Chairman, thank you. Again, with the
253-page bill that just came out less than 48 hours ago and
another several thousand page bill on the horizon with the
healthcare, this is a lot to take in. And I think two
adjectives that come to my mind are breathtaking and stunning
when I look at the Resolution Authority. And I think on both
sides of the aisle I think there is bipartisan concern about
the unprecedented level of power that seems to be centralized
under this.
So it seems to me prudent that we would exercise serious
due diligence on the part of establishing what the chairman and
the President have called a Resolution Authority to break up
systematically risky institutions.
And here is my question. The proposal looks to me like we
are codifying--and I am sure you have gotten this comment
before of what our constituents were outraged about last year
when Congress passed TARP, except under this proposal we, the
Congress, wouldn't have to take a vote each time an institution
needs a bailout; and the bill would give the FDIC the authority
to extend credit on the backs of taxpayers whenever it wants.
Do you think that is an accurate characterization, or am I
wrong? And that is for anyone on the panel.
Ms. Bair. No. I don't think that is an accurate
characterization. I think the bill carefully constrains what we
can and can't do. And we clearly cannot provide any kind of
assistance, nor can the Federal Reserve, I might add, on an
individual basis, to an individual failing firm. There is a
process for a systemic support if you had a major destabilizing
event where the government needed to step in and stabilize a
system, or even healthy institutions could not access
liquidity.
But no, the whole point of this is to make sure that the
shareholders and creditors are the ones that take losses, and
there is an orderly wind-down. You may need to have some
temporary liquidity support into a bridge financial institution
as you break it up and sell it off.
But I think those short-term liabilities are already fully
secured. So, that would not be imposing any losses on the
receivership that wouldn't otherwise be obligated, whether as a
bankruptcy practice or the statutory resolution process. Based
on our experience with bridge banks, we think that those
preserve value and minimize losses if you can maintain the
short-term funding relationship.
This is not a bailout mechanism. This is a wind-down
mechanism. We think it is very important that this be clear and
understood.
Mrs. Bachmann. Let me follow up then. With the Republican
alternative that several of my colleagues are offering, it is
clear that bankruptcy is the end game for those who make
mistakes or the risky banks. And that is what our plan does, to
strengthen market discipline by making it clear that a failing
institution's creditors and counterparts would bear the cost of
the financial mistakes, not the taxpayers.
And I know I heard Treasury Secretary Geithner say earlier
that he didn't believe that this would fall on the back of the
taxpayers. But there was a certain amount of incredulity on the
part of us as Members of Congress, especially when we heard the
$81 billion that has already been forwarded to the auto makers.
We can expect that the taxpayers won't be paid back.
And I think that we are very concerned when we look at the
wind-down authority and wondering, how is that a speedier
resolution of a company than what we would find in bankruptcy?
Ms. Bair. The bankruptcy process is what we have had, and
it led to all of these bailouts.
Mrs. Bachmann. But we haven't had, perhaps, a modification
of that, that would anticipate--
Ms. Bair. We don't differ profoundly in where we want to
end up. We believe the claims priority that should apply to the
receivership process, which is what we have now for insured
banks, is much along the lines of what you have in bankruptcy.
Mrs. Bachmann. I think that may be accurate, that we may
not differ in where we want to end up other than authority. Who
has that power? Who has the authority?
And I think that is the real concern here, is that taking
away a power from the Congress and giving that over to the
Executive Branch. And again, I think Mr. Kanjorski asked a very
good question earlier of the Treasury Secretary when he said,
where in the constitution would you find that authority?
Mr. Kanjorski said he didn't believe that Congress even had
the authority to devolve to the Executive Branch of the
taxpaying function, or the tax-assessing function. And I would
agree with Mr. Kanjorski on that.
On an unrelated question--this would be for Chairman Bair--
on October 7th, I sent you a letter requesting examination of
the role of ACORN, what they play in helping banks satisfying
their Community Reinvestment Act obligations. And as you know,
ACORN has earned a reputation with the public for extremely
poor systemic controls that have led to persistent unethical
behavior, and repeated disregard for voter registration and
other Federal and State laws.
So as chairman of the Federal Financial Institutions
Examination Council, I requested that you and your fellow
council members conduct a thorough examination of the issue and
prohibit financial institutions from receiving CRA credit by
donating to or partnering with ACORN.
Have you seen my letter? Are you willing to consider such
an examination?
Ms. Bair. I have seen your letter, and we are in the
process of consulting with our fellow regulators and giving you
a good response.
Mrs. Bachmann. Do you have any idea when I would anticipate
a reply?
Mr. Moore of Kansas. The gentlelady's time has expired.
Ms. Bair. We will try to do it as promptly as possible. We
will give you a thoughtful response.
Mrs. Bachmann. Thank you very much.
Mr. Moore of Kansas. If the gentlelady has additional
questions--
Mrs. Bachmann. I thank the chairman.
Mr. Moore of Kansas. --or comments from the panel, that is
fine. We have Mr. Foster for 2 minutes, and then we are going
to go for votes. Votes have been called.
Mr. Foster is recognized for 2 minutes, sir.
Mr. Foster. Thank you. My questions are in regard to
subtitle (f) on risk retention during the asset-backed security
process. And it is my reading of it that you have very wide
authority to set it not just at 10 percent, but to eliminate it
entirely or make it significantly higher.
My concerns are with the macroeconomic effects and possible
politicization of this. It is obvious this could exert a very
powerful, and possibly beneficial, damping influence on, for
example, real estate price bubbles. If someone had said several
years ago that, look, you are securitizing out of Las Vegas,
you don't have to put 10 percent down but 25 percent down, it
could have had a very beneficial macroeconomic effect.
And so my question is, how do you anticipate this will
actually be exercised? Do you anticipate varying the risk
retention by asset class? By industry sector? By geographical
region, in the case of mortgage securitization? Governor
Tarullo?
Mr. Tarullo. Thank you, Congressman. Obviously, it will
depend on how you all write the bill in the end. But I think
our preference would be for the capacity to do just what you
suggest. That is, the variety of asset classes which can be
subject to securitization, the variety of the credit
circumstances under which they are so subject, and,
importantly, the role of servicers as well as originators of
securitized assets, are such as to make the retained risk a
very useful instrument, but one that needs to be deployed in a
fashion that takes account of the centers that vary across
asset class.
Mr. Foster. So you contemplate using it in concert with
monetary policy? For example, to cool off a real estate bubble?
Mr. Tarullo. I think that provision, as I read it, is
intended to be a safety and soundness rather than macroeconomic
provision. And unless instructed otherwise, I think that is the
way we would read it, which is to say, how does risk retention
ensure that the loans in question, when securitized, are
themselves risk appropriate?
So I don't think we look at it as a monetary policy
instrument as such, although I think your question--
Mr. Foster. It certainly would have an effect because
even--
Mr. Tarullo. It would have an effect, and one would need to
think about it. That is correct.
Mr. Moore of Kansas. The gentleman's time has expired. I
want to thank the second panel for your testimony and for your
appearance here today before this committee. Votes have been
called. After votes, we will resume with the third panel.
The committee stands in recess. Thank you all.
[recess]
The Chairman. We will reconvene. I apologize to everyone
except Mr. Baker for this delay. He knew what he was getting
into.
As for the rest of you, we apologize. We thank you for
being here.
Let's get right to the statements, and we will begin. Mr.
Trumka, I know you have some time constraints, so if at any
point you have to leave, we understand. Mr. Baker, too.
Mr. Trumka. Thank you.
The Chairman. And actually, if you leave, it will be like
the old days when we used to have pairing, one on each side. So
you can leave together.
We will begin with Richard Trumka, President of the AFL-
CIO.
STATEMENT OF RICHARD L. TRUMKA, PRESIDENT, AMERICAN FEDERATION
OF LABOR AND CONGRESS OF INDUSTRIAL ORGANIZATIONS (AFL-CIO)
Mr. Trumka. Thank you, Mr. Chairman. And thank you to
Ranking Member Bachus. My name is Rich Trumka, and I am the
president of the AFL-CIO.
The AFL-CIO is a federation of 57 unions representing 11\1/
2\ million members. Our members were not invited to Wall
Street's party, but we have paid for it with devastation to our
pension funds, lost jobs, and public bailouts of private sector
losses. Our goal is a financial system that is transparent,
accountable, and stable, a system that is the servant of the
real economy rather than its master.
The AFL-CIO is also a coalition member of Americans for
Financial Reform, and we join that coalition in complimenting
the committee for its work on the Consumer Financial Protection
Agency, and we endorse the testimony of AFR's witness here
today; however, we are concerned with the working draft, that
the committee's work thus far on the fundamental issues of
regulating shadow financial markets and institutions will allow
in large part the very practices that led to the financial
crisis to continue.
The loopholes in the derivatives bill and the failure to
require any public disclosures by hedge funds and private
equity funds fundamentally will leave the shadow markets in the
shadows. And we urge the committee to work with the leadership
to strengthen these bills before they come to the House Floor.
The subject of today's hearing, of course, is systemic
risk. And the AFL-CIO strongly supports the concepts in the
Treasury Department White Paper, that a systemic risk regulator
must have the power to set capital requirements for all
systematically significant financial institutions, and be able
to place a failing institution in a resolution process run by
the FDIC. We are glad to see that the committee bill actually
does those things.
Although we have some concerns with the discussion draft
that was made public earlier this week, we really haven't had a
chance to go through it. And our understanding so far is that
some of the intention of the committee, we may have read things
at variance with that, and we think they can be worked out. But
our concern is that this bill gives pretty dramatic new powers
to the Federal Reserve without reforming the governance by
ending the banks' involvement in selecting the boards of the
regional Fed banks, where the Fed's regulatory capacity is
located.
The discussion draft would appear to give power to the
Federal Reserve to preempt a wide range of rules regulating the
capital market, power which could be used, unfortunately, to
gut investor and consumer protections. If the committee wishes
to give more power to the Federal Reserve, we think it should
make clear that this power is only to strengthen safety and
soundness regulation, and that it must simultaneously reform
the Federal Reserve's governance. These powers must be given to
a fully public body, and one that is able to benefit from the
information and perspective of the routine regulators of the
financial system.
We believe a new agency with a board made up of a mixture
of the heads of the routine regulators and direct presidential
appointees would be the best structure. However, if the Federal
Reserve were made a fully public body, it would be an
acceptable alternative. Unfortunately, it is reported today
that the Fed has rejected Treasury Secretary Geithner's request
for a study of the Fed's governance and structure.
We are also troubled by the provision in the discussion
draft that would allow the Federal Government to provide
taxpayer funds to failing banks and then bill other non-failing
banks for the costs. We realize that it is not intended that
this be a rescue, but rather a wind-down.
The incentive structure created by this system seems likely
to increase systemic risk, from our point of view. We believe
it would be more appropriate to require financial institutions
to pay into an insurance fund on an ongoing basis. Financial
institutions should be subject to progressively higher fee
assessments and stricter capital requirements as they get
larger, and we think this would actually discourage ``too-big-
to-fail.''
Finally, the discussion draft appears to envision a
regulatory process that is secretive and optional. In other
words, the list of systemically significant institutions is not
public, and the Federal Reserve could actually choose to take
no steps to strengthen the safety and soundness regulation of
those systemically significant institutions. We think that in
these respects, the discussion draft appears to take some of
the problematic and unpopular aspects of the TARP and make them
a model for permanent legislation.
In closing, Mr. Chairman, I would say that instead of
repeating some of the things we did in the bank bailout,
Congress should be looking to create a transparent, fully
public, accountable mechanism for regulating systemic risk and
for acting to protect our economy in any future crises.
On behalf of the AFL-CIO, I want to thank you for the
opportunity to testify today.
[The prepared statement of Mr. Trumka can be found on page
308 of the appendix.]
The Chairman. Next is Richard Baker, president and chief
executive officer of the Managed Funds Association.
STATEMENT OF THE HONORABLE RICHARD H. BAKER, PRESIDENT AND
CHIEF EXECUTIVE OFFICER, MANAGED FUNDS ASSOCIATION (MFA)
Mr. Baker. Thank you, Mr. Chairman. It is a pleasure to be
here today. I shall wait to the end of the proceedings to come
to a resolution thereon.
MFA is the primary advocate for sound business practices in
industry professionals in hedge funds, funds of funds, and
managed futures, as well as industry service providers. MFA is
committed to playing a constructive role in the regulatory
reform discussion as it continues, as investors' funds have a
shared interest with other market participants and policymakers
in seeking to restore investor confidence and achieving a
stable financial system.
In considering the topic of a Systemic Risk and Resolution
Authority, it is important to understand the nature of our
industry in taking action. With an estimated $1.5 trillion
under management, the industry is significantly smaller than
the U.S. mutual fund industry or the $13 trillion U.S. dollar
banking industry. Because many hedge funds use little or no
leverage, their losses have not contributed to the systemic
risk that more highly-leveraged institutions contributed.
A recent study found that 26.9 percent of managers do not
deploy leverage at all, while an FSA study in 2009 found that,
on average over a 5-year period, leverage of funds was between
2 or 3 to 1, significantly below most public perception. The
industry's relatively modest size and low leverage, coupled
with the expertise of our members at managing financial risk,
means we have not been a contributing cause to the current
difficulties experienced by the average investor or the
American taxpayer.
Although funds did not cause the problems in our markets,
and though we certainly agree with recent statements by
Chairman Bernanke that it is unlikely that any individual hedge
fund is systemically relevant, we believe that the industry has
a role in being a constructive participant as policymakers
develop regulatory systems with the goal of restoring stability
to the marketplace.
We believe the objectives of systemic risk can be met
through a framework that addresses participant, product, and
structural issues, which include: a central systemic regulator
with oversight of the key elements of the entire system;
confidential reporting by every institution, generally to its
functional regulator, which would then make appropriate reports
to the systemic regulator; prudential regulation of
systemically relevant entities, products, and markets; and a
clear, single mandate for the systemic risk regulator to take
action if the failure of a relevant firm would jeopardize broad
aspects of economic function.
We believe these authorities are consistent with the
authorities contemplated by the discussion draft. We believe
the objectives of systemic risk regulation are best met not by
subjecting non-banks to the Bank Holding Company Act, but by
developing a framework that adopts a tailored regulatory
approach that addresses the different risk concerns of the
business models, activities, and risks of the systemically
significant firms.
For example, when firms post collateral when they borrow
from counterparties, like hedge funds customarily do and as
major market participants will be required to do under the OTC
bill recently passed by this committee, the potential systemic
risks associated with that borrowing are greatly reduced, a
factor that should mitigate in determining what prudential
rules should apply to various market activities.
We believe that smart regulation, facilitated by the OTC,
the Advisor Registration, and the Investor Protection bills
recently passed by the committee also will greatly reduce the
likelihood that a Resolution Authority framework will even need
to be implemented.
To the extent that a regulator does need to implement such
authority, however, we believe that it should be done in a
manner to ensure that a firm's failure does not jeopardize the
financial system. However, it should be explicitly stated that
this authority should not be used to save firms from failing.
It is unclear at the moment whether the authority granted by
the proposal would enable assistance to be extended to a firm
not leading to resolution of the entity being assisted.
There are other issues that have been raised by members'
questions and the testimony earlier today that we would also
address. But for the sake of time, I shall conclude by saying
we believe that the Systemic Risk and Resolution Authority
framework discussed above will address the concerns underlying
the Systemic Risk and Resolution Authority bills, while
minimizing unfair competitive advantages and moral hazards that
can result from market participants having an implied
government guarantee.
It is important this framework be implemented in a manner
that allows investors, lenders, and counterparties to
understand the relevant rules and have confidence those rules
will be applied consistently in the future. When investors do
not have that confidence, they are less likely to put their
capital at risk. And when market function is impaired, we all
pay a price.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Baker can be found on page
117 of the appendix.]
The Chairman. Next, Professor Phillip Swagel, visiting
professor at Georgetown.
STATEMENT OF THE HONORABLE PHILLIP L. SWAGEL, VISITING
PROFESSOR, McDONOUGH SCHOOL OF BUSINESS, GEORGETOWN UNIVERSITY
Mr. Swagel. Thank you, Chairman Frank, Ranking Member
Bachus, and members of the committee. Thank you for the
opportunity to testify.
I am a visiting professor at the McDonough School of
Business at Georgetown University, and a nonresident scholar at
the American Enterprise Institute. I was previously Assistant
Secretary for Economic Policy at the Treasury Department from
December 2006 until January of 2009. I will focus now briefly
on the provisions in the legislation, the draft legislation,
for enhanced Resolution Authority.
The critical steps that provide certainty to market
participants and lead them to believe that costs will be
imposed in a crisis will change risk-taking behavior and help
make a future crisis less likely. But the enhanced resolution
authority in the draft bill does the opposite.
In the end, it provides complete discretion for the
government. Put simply, this is a proposal for a permanent and
supercharged TARP. The government could deploy public money
without further authorization from the Congress, making this a
permanent TARP. The government could repudiate contracts,
making this a supercharged TARP.
This expansive new Resolution Authority does not provide
the certainty that would help avoid future crises, and it would
allow the Executive Branch to usurp Congress's prerogatives in
this area. Let me mention briefly two specific concerns.
The first is moral hazard. Even though the resolution
regime can impose losses on creditors, the fact that ultimately
it gives complete flexibility to the government inevitably
gives rise to moral hazard. There is a tradeoff between
certainty and flexibility, but there should be no doubt that
the legislation being discussed today falls squarely on the
side of flexibility.
My second concern is that with flexibility to deploy public
resources and change contracts outside of a judicial process,
there comes a potential for enormous mischief--in the end, the
temptation to use the new power in inappropriate ways, ways
that were not contemplated when the power was granted.
This is not a theoretical concern. Enhanced resolution
authority would allow the government to put money into a
private firm and to change contracts. And both of these were
done in the recent automobile bankruptcies. Contracts were
changed, with the capital structure rearranged to favor junior
creditors over senior ones. And the two firms were used as
conduits to transfer resources to favored parties.
Now let me be clear at the very beginning. It is entirely
legitimate for the President or others to propose the use of
public funds to ensure that workers and retirees maintain
access to health insurance. That is absolutely legitimate.
But the dedication of such resources should be done through
a vote of the Congress, and not embedded in a financial rescue.
Moreover, the reordering of the capital structure has the
potential to lead to higher costs of financing for future
projects, and thus less investment and slower economic growth
and less job creation.
It would be difficult for any Administration to resist the
temptation to transfer public resources through regulatory
authority rather than new legislation. And yet the
Administration did not resist this temptation. Even when it
must have been clear, absolutely clear, that this action would
have a direct negative implication for their own proposal to
obtain non-bank resolution authority.
In the event of a future crisis, it would be preferable for
Congress to decide to deploy fiscal resources. In the meantime,
a better way to provide certainty would be to pursue an
improved bankruptcy regime. H.R. 3310 includes such an
approach.
My written statement touches upon other aspects of the
legislative proposals.
Mr. Chairman and Ranking Member Bachus, thank you again for
the opportunity to appear today.
[The prepared statement of Mr. Swagel can be found on page
229 of the appendix.]
The Chairman. Next, Mr. Scott Talbott, who is the senior
vice president at the Financial Services Roundtable.
STATEMENT OF SCOTT TALBOTT, SENIOR VICE PRESIDENT OF GOVERNMENT
AFFAIRS, THE FINANCIAL SERVICES ROUNDTABLE
Mr. Talbott. Chairman Frank, Ranking Member Bachus, and
members of the committee, I am Scott Talbott, as the chairman
said, senior vice president of government affairs for the
Financial Services Roundtable. Thank you for the opportunity to
allow us to appear before you today and address the committee
draft on systemic risk, prudential standards, failure
resolution, and securitization.
Steve Bartlett would have liked to have been here himself,
he was looking forward to it, but he fell victim to H1N1 and
felt it was better not to expose his fellow panelists to the
flu.
The Chairman. Let me just say, you can tell Mr. Bartlett I
have a general rule. No one need ever apologize for not coming
here.
[laughter]
Mr. Talbott. I will let him know.
The Roundtable supports greater systemic risk oversight. We
support creation of a resolution mechanism. We support more
effective prudential supervision. And we agree with asking
mortgage securitizers to retain some risk. As such, we commend
the committee in addressing these necessary reforms through the
creation of a financial services oversight council.
We oppose the idea of ``too-big-to-fail,'' and believe that
if a firm is going to fail, it should be allowed to fail.
Creative destruction is part of the market system. The key here
is to strengthen the regulatory framework to spot developing
trends, and then if the firm does fail, to minimize the effects
of its demise on the entire system.
Let me turn to the discussion draft and offer our
perspectives on a few of the details. First of all, the draft
allows for better coordination between prudential regulators.
This is a very crucial step necessary to break down the silos
that allow, in part, this crisis to develop as it was.
There are other ways, however, to increase the coordination
and communication between the prudential regulators. One would
be to have a Federal insurance regulator on the council. I know
there are proposals working their way through Congress to
create an FIO, and we believe that once it is created, like we
heard earlier today with the CPA, they should be added to the
council.
Additionally, we believe that the Financial Accounting
Standards Board should be underneath the council's purview.
Accounting standards are integral to protecting the investor,
and we believe they should be part of the council.
Next, the discussion draft preserves thrift charters and
grandfathers industrial loan charters and their lawful
affiliations in commercial companies. However, the limits on
cross-marking between the parents and ILCs would restrict
activities and their abilities to meet their customers' needs.
These standards would freeze the ILCs in time, and would force
a company to choose between keeping its ILC and satisfying the
ever-changing demands of customers and the markets.
The discussion draft correctly focuses on the U.S.
financial firms and does not extend beyond its borders. We
should ensure that this regulation, as well as any others, are
examined to ensure that they do not conflict or overlay with
home country regulations. The G-20 is focusing on this area,
and we think they are headed in the right direction.
The draft, unfortunately, focuses, we feel, too much on
size and the complexity of the identified financial holding
company, and we think that there is excessive authority that is
focused, as I said, based solely on size or complexity. And
these two factors are not necessarily an indicator of risk to
safety and soundness, and we believe that other factors should
be considered. And those include liquidity, assets, the quality
of assets, and the strength of management.
The discussion draft also places an excessive focus on
capital as the answer to safety and soundness concerns. While
capital is important, it should not become the siren song, and
could overpower economic growth. Any increase in capital, we
believe, should be based on activities rather than the size of
the institution, and should be applied across the industry
regardless of size.
In addition to capital, we recommend a comprehensive
approach that focuses not just on capital but activity
restrictions where appropriate, prudential supervision,
liquidity requirements, as well as prudential standards. We
oppose the idea of requiring firms to issue contingent capital
as a debt they can convert to equity if the company runs into
trouble. This would greatly increase the costs of raising
capital.
The standards used in the draft must be examined carefully
as well to ensure that the power that is granted under this
authority is not exercised unless there is an extreme
emergency. You want to make them high enough that they aren't
triggered unnecessarily.
On securitization, the draft proposes a 10 percent risk
retention requirement for mortgage lenders as well as
securitizers. We support the concept of risk retention, but
believe that the risk retention provisions contained in H.R.
1728, which called for a 5 percent requirement, are the right
one; 5 percent should be the ceiling and not the floor.
Furthermore, the 10 percent risk requirement is unstudied.
There have been no hearings on the matter. And we believe that
this is a crucial piece that should be discussed further, and
should not apply to the FHFA, to Ginnie Mae, as well as the GSE
standards. It could have the unintended consequence of
significantly limiting securitization and subsequent the
ability of a home mortgage finance company, and limit the
ability of customers who are trying to seek to purchase a home.
The discussion draft would subject derivative transactions
between the bank and its affiliates to a quantitative limit
contained in Section 23(a), and we oppose this. We believe that
the arm's length standard contained in 23(b) is sufficient.
Additional, the discussion draft would mandate haircuts for
unsecured creditors, and we think this would raise the costs of
capital going forward.
On the issue of costs, we have heard a lot of testimony
today. We support having a post-event assessment. We believe
that the $10 billion should be studied so it is not over-
inclusive as well as under-inclusive. We believe it should be
fair and equitable assessment, possibly on a sector-by-sector
basis, or even limited to possible stakeholders.
Finally, the discussion draft should be one--going forward,
we should focus on the concept of balance. We want to make sure
that we regulate properly, but we don't hinder the ability of
markets to serve consumers to promote and sustain economic
growth.
I look forward to any questions you may have. Thank you.
[The prepared statement of Mr. Talbott can be found on page
236 of the appendix.]
The Chairman. Our next witness is Mr. Stephen Kandarian,
who is executive vice president and chief investment officer of
the Metropolitan Life Insurance Company.
STATEMENT OF STEVEN A. KANDARIAN, EXECUTIVE VICE PRESIDENT AND
CHIEF INVESTMENT OFFICER, MetLife, INC.
Mr. Kandarian. Chairman Frank, Ranking Member Bachus, and
members of the committee, thank you for inviting me to testify
today. You have asked MetLife for its perspective on the
proposals under discussion today. MetLife is the largest life
insurer in the United States. We are also the only life insurer
that is also a financial holding company.
Because of our financial holding company status, the
Federal Reserve serves as the umbrella supervisor of our
holding company, in addition to the various functional
regulators that serve as the primary regulators of our
insurance, banking, and securities businesses, including our
State insurance regulators, the OCC, and the SEC.
While I'll comment on certain aspects of the Administration
and congressional proposals, I can best contribute to the
dialogue on systemic risk and resolution authority by providing
some thoughts about the potential impact of the proposals being
discussed. My written statement also includes some suggested
guidelines that we believe are important to keep in mind as you
consider how to improve the securitization process.
Let me start by saying that we support the efforts of
Congress and the Administration to address the root causes of
the recent financial crisis and to better monitor systemic risk
within the financial system. We applaud your thoughtful and
deliberate approach to these very complex issues.
The discussion draft proposes to establish a new regulatory
structure to oversee systemic risk within the financial system,
enhance prudential regulation, and authorize Federal regulators
to assist or wind-down large financial companies whose failure
could pose a threat to financial stability or economic
conditions in the United States.
We recognize the need to identify, monitor and control
systemic risk within the financial system, but we are concerned
that creating a system under which companies will be subjected
to differing requirements based on their size will result in an
unlevel playing field and will create new problems.
As proposed, the concept of designating tier one financial
holding companies and subjecting such companies to enhanced
prudential standards and new resolution authority may address
some of the problems we have seen in the financial markets, but
it may also create new vulnerabilities, including the creation
of an unleveled playing field if tier one status is assigned to
only a small number of companies in industry.
Systemic threats can stem from a number of sources in
addition to large financial institutions. For example, in 1998,
the hedge fund Long-Term Capital Management was not
particularly large, but it created a significant amount of
potential systemic risk when it was at the brink of failure
because of its leverage and the volatility in the financial
markets.
Attempting to address systemic risk by focusing a higher
level of regulation on a discrete group of companies under a
tiered system could result in little or no oversight of those
other sources of risk, leaving the financial system exposed to
potentially significant problems.
We suggest that Congress consider regulating systemic risks
by regulating the activities that contribute to systemic risk
without regard to the type or size of institution that is
conducting the activity. Linking regulatory requirements to the
activity will help close existing loopholes and prevent new
regulatory gaps that could be exploited by companies looking to
operate under a more lenient regulatory regime.
The discussion draft also introduces a new resolution
authority based on the premise that large institutions must be
treated differently than smaller ones. While we are pleased
that the drafters have excluded certain types of institutions
from the enhanced resolution authority provisions, including
insurance companies, we are concerned about the potential
conflicts the new resolution system may create.
For example, what if the new Federal resolution authority
decided to wind-down a financial holding company that also has
a large insurance subsidiary? Given their different missions,
the Federal resolution authority might seek one treatment of
the insurance subsidiary that is in direct conflict to the
desires of the State insurance regulators.
As a result, creditors, counterparties, and other
stakeholders will likely find it difficult to assess their
credit risks to these institutions. These large financial
institutions will have to pay a higher-risk premium because of
this uncertainty, placing them at a competitive disadvantage
both domestically and globally and leading to higher costs that
will ultimately be borne by consumers and shareholders.
We believe the current system of functional regulation has
worked well in the insurance industry. In our experience, the
Fed and the functional regulators have worked cooperatively,
sharing information and insights that allow each regulator to
perform its function.
In light of the issues outlined here and in my written
statement, I will conclude by suggesting that Congress regulate
activities that contribute to systemic risk rather than
creating a system of regulation that uses size of the financial
institution as a key criterion. We believe that such a system
can be more effective, easier to administer, and result in
fewer unintended consequences then the proposed tiered
structure. Thank you.
[The prepared statement of Mr. Kandarian can be found on
page 155 of the appendix.]
The Chairman. Now, we will hear from Mr. Michael Menzies,
who is the president and chief executive officer of Easton Bank
and Trust, testifying on behalf of the Independent Community
Bankers of America.
STATEMENT OF R. MICHAEL S. MENZIES, SR., PRESIDENT AND CHIEF
EXECUTIVE OFFICER, EASTON BANK AND TRUST, CO., ON BEHALF OF THE
INDEPENDENT COMMUNITY BANKERS OF AMERICA (ICBA)
Mr. Menzies. Chairman Frank, Ranking Member Bachus, and
members of the committee, it's an honor to be with you again.
And I'm especially proud to be the chairman of the Independent
Community Bankers of America. We represent 5,000 community bank
members throughout the Nation.
ICBA appreciates the opportunity to comment on the joint
discussion draft that has just been released. Based on our
early review, we believe the draft is a substantial improvement
over earlier proposals, and we commend you, Mr. Chairman, and
your committee for these efforts.
Just a year ago, due to the failure of our Nation's largest
institutions to adequately manage their highly risky
activities, key elements of the Nation's financial system
nearly collapsed. Even though our system of locally-owned and
controlled community banks were not in similar danger, the
resulting recession and credit crunch have now impacted the
financial cornerstone of our local economies, community banks.
Accordingly, we recommend that Congress move quickly on this
legislation.
We strongly support the provisions of the discussion draft
that designate the Federal Reserve as the systemic risk
regulator, and that appear to give it sufficient authority to
carry out its responsibilities.
We also support the enhanced authority of the Financial
Services Oversight Council over the Federal Reserve's
decisions. While the Federal Reserve has the expertise and
experience to deal effectively with these matters, they are so
critical that other agencies must be involved as well.
ICBA is especially pleased that the discussion draft
provides the Federal Reserve the authority to require a
systemically risky holding company to sell assets or terminate
activities if they pose a threat to the company's safety and
soundness or the Nation's financial stability. This authority
gets to the heart of many of the problems that led to the
Nation's financial meltdown.
Some institutions have become so large that they cannot be
effectively managed or regulated, and must simply be downsized.
ICBA recommends that the legislation direct the Federal Reserve
to intensely study each identified financial holding company to
determine if it should be subject to this new authority.
The draft legislation appears to give the FDIC ample
authority to responsibly resolve systemically risky holding
companies. The bill gives the Treasury Secretary the sole
authority to appoint the FDIC as receiver for a failed holding
company. This vests a politically appointed official with
tremendous power over the Nation's economy.
We recommend that the legislation specifically empower the
FDIC, as an independent agency, to recommend to the Secretary
that he or she exercise his authority. Downsizing and resolving
systemically risky institutions are key to eliminating ``too-
big-to-fail'' from the financial system.
Another important part of the solution of the ``too-big-to-
fail'' problem is contained in the Bank Accountability and Risk
Assessment Act introduced by Representative Gutierrez. This
bill would make the funding of deposit insurance more risk-
based and equitable. We urge the committee to incorporate this
measure into broader financial reform.
ICBA recommends that funding for the resolution process for
systemically risky holding companies be provided by the largest
institutions in advance, rather than after the fact. We believe
that a pre-funded resolution process has many advantages. It
avoids the initial call on taxpayer funds that would be likely
if an institution were to fail unexpectedly, which of course is
what happens. It places the cost on institutions that may later
fail rather than only on institutions that haven't failed,
providing an important equitable balance. And prefunding avoids
procyclical effects, tapping the industry for modest,
predictable contributions when the times are good.
We strongly support the revisions in the discussion draft
that block the creation of additional industrial loan companies
that may be owned by commercial firms. This is the last
loophole that would allow the mixing of banking and commerce.
Even though the OTC would be merged into the OCC, ICBA is
particularly pleased that the discussion draft retains the
thrift charter; the vast majority of Federal thrifts have
served their communities well.
In that vein, we appreciate continued support of the
chairman and the Administration for the current regulatory
system as it applies to community banks. It provides valuable
checks and balances that would be lost to a single regulatory
scheme. I want to convey our appreciation for your efforts and
thank you for the opportunity to testify today.
[The prepared statement of Mr. Menzies can be found on page
166 of the appendix. ]
The Chairman. Next is Mr. Peter Wallison, Arthur Burns
fellow in financial policy studies at The American Enterprise
Institute.
STATEMENT OF PETER J. WALLISON, ARTHUR F. BURNS FELLOW IN
FINANCIAL POLICY STUDIES, THE AMERICAN ENTERPRISE INSTITUTE
Mr. Wallison. Thank you very much, Mr. Chairman, and thank
you, Ranking Member Bachus, for holding this hearing. The
discussion draft of October 27th contains an extremely
troubling set of proposals, which if adopted will turn over
control of the financial system to the government, sap the
strength and vitality of our economy, and stifle risk-taking
and innovation.
Rather than ending ``too-big-to-fail,'' the draft makes it
national policy. By designating certain companies for special
prudential regulation, the draft would signal to the markets
that these firms are ``too-big-to-fail,'' creating Fannies and
Freddies in every sector of the economy where they are
designated.
These large companies will have funding and other
advantages over small ones, changing competitive conditions in
every sector of the financial system. The draft suggests that
the names of these companies can be kept secret. That can't
happen. The securities laws alone will require them to disclose
their special status.
For designated companies, new activities, innovations, and
competitive initiatives will be subject to government approval.
Companies engaged in activities that the regulators don't like
will be forced to divest. That power will ensure that nothing
will be done in New York that wasn't approved in Washington.
Commercial companies would be separated from financial
activities even though these activities are never separated in
the real world. All companies--retailers, manufacturers and
suppliers--finance their sales. It's a puzzle how U.S.
companies will compete with other foreign companies when they
can't finance their own sales.
Another flawed idea in this draft is that there is some
kind of discernable line between finance and commerce. That
line is political, it's imaginary. For example, to protect the
Realtors against competition from banks, Congress has stopped
the Fed from declaring that real estate brokerage is a
financial activity. Can anyone describe why securities
brokerage is financial but real estate brokerage is not? Of
course not.
Every industry will be asking for special treatment or
exemption if this draft is adopted. The resolution authority is
based on the faulty assumption that anyone can know in advance
whether a company will--if it fails--cause a systemic
breakdown. This is unknowable, but government officials are
supposed to make this determination anyway.
With unfettered discretion, officials will follow a better-
safe-than-sorry policy, taking over companies that would only
create economic disruptions, not full-scale systemic
breakdowns. General Motors and Chrysler are an example. They
were not systemically important but they were politically
important. Their failure would not have caused a systemic
breakdown, but would have caused a loss of jobs and other
economic disruption.
Companies like these will be rescued, while smaller ones
with less political clout will be sent to bankruptcy. The
markets will have to guess which will be saved and which will
not, creating moral hazard and arbitrary gains and losses.
Worse than giving government officials this enormous
discretionary authority is what the draft authorizes them to do
with it. They can rescue some companies and liquidate others,
pay off some creditors and not others, and using government
funds keep failing companies operating for years and competing
with healthy companies.
This will not only create uncertainty and moral hazard, but
will again give large and powerful firms advantages over small
ones. Those that seem likely to be taken over by the government
will have an easier access to credit at lower rates than those
likely to be sent to bankruptcy.
In other words, the draft proposes a permanent TARP. It
will use government money to bail out large or politically
favored companies and then will tax the remaining healthy
companies to reimburse the government for its cost of competing
with them.
That concludes my testimony, Mr. Chairman.
[The prepared statement of Mr. Wallison can be found on
page 312 of the appendix. ]
The Chairman. The next witness is Jane D'Arista, from
Americans for Financial Reform.
STATEMENT OF JANE D'ARISTA, AMERICANS FOR FINANCIAL REFORM
Ms. D'Arista. Thank you, Chairman Frank, Ranking Member
Bachus, and members of the committee for inviting me. And I
want to say that I'm representing a very large group of
organizations that are consumer and non-financial or nonprofit
and concerned with the issues of reform, not just consumer
issues but the entire panoply.
I would say that President Trumka has laid out many of our
concerns about this draft legislation today. I'm going to take
the opportunity, if I may, to go into something else, which is
to say that obviously it is important that we begin by dealing
with crisis management, as you have done in this legislation.
But we must not forget that the important thing to do is
not just manage these problems but to prevent them. And I find
that the legislation so far comes up short in the preventive
era. I would like to talk about two particular issues.
One of them is what I see as an equally important
underlying cause of the crisis, and that's the combination of
excessive leverage, proprietary trading, and the new funding
strategies that go into the repurchase agreements, markets and
the commercial paper markets, etc., for financial institutions.
We have here a situation in which leverage has, in effect,
monetized debt, because assets are used as backing for new
borrowing to add more assets. The evidence of this is that the
financial sector has grown 50 percent in the decade from 1997
to 2007, rising to 114 percent of GDP. That is pretty shocking
in and of itself.
Proprietary trading is an issue that must be addressed, and
it is of concern for a lot of different reasons, one of which
of course is that it erodes the fiduciary responsibility of
intermediaries.
But equally important is the issue of the fact that what is
at stake here is institutions trading for their own bottom line
without any contribution to their customers or to the economy
as a whole. What money goes in to the financial sector comes
from our earnings and our savings, and they have skimmed it off
to game it. It is our money that is at risk in this game.
The funding strategies that have been used in order to
support leverage and proprietary trading have been the major
contribution, in my view, to the interconnectedness of the
financial sector. These institutions are borrowing from one
another, not from, primarily, from the outside non-financial
sector, as a result of which over half of those positions are
supplied by other financial institutions. This is the
counterparty issue, this is what we were dealing with when we
were dealing with Lehman, AIG, etc., and it is something that
absolutely must be addressed.
Finally, briefly, about securitization. Securitization has
changed the structure of the U.S. financial system. We have
gone from a bank-based system to a market-based system with new
rules of the game. We have eroded the bank-based rules that
shielded the consumer and the household in this country since
the 1930's. These new rules expose households to interest rate
risks, market rate risk, etc., but they do so to institutions
as well because of the mark to market phenomena they require.
You cannot have a market without marking it to market.
But the chart drops against capital that we have seen here,
and we have not fully evaluated, have turned capital of our
financial institutions into a conduit to insolvency--not a
cushion, but a conduit to insolvency.
So what I think is that this committee has a very large
plate to deal with going into the future as a preventive set of
resolutions. I would urge you to do so not in the direction
you're going now, which is to give discretion to too many
institutions that we know--the Federal Reserve in particular--
but to actually craft the rules of the game that need to be
followed in the future.
Thank you very much.
[The prepared statement of Ms. D'Arista can be found on
page 138 of the appendix.]
The Chairman. Next, Mr. Edward Yingling, who is the
president and chief executive officer of the American Bankers
Association.
STATEMENT OF EDWARD L. YINGLING, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, AMERICAN BANKERS ASSOCIATION (ABA)
Mr. Yingling. Chairman Frank, Congressman Bachus, and
members of the committee, thank you for inviting me to testify.
It has been over a year since I first testified before this
committee in favor of broad financial reform. This week, the
committee is considering legislation that addresses the
critical issues that we identified in that testimony, and the
ABA continues to support such reform.
The key issues addressed include the creation of a systemic
oversight council, addressing key gaps in the regulation of
non-banks, addressing ``too-big-to-fail,'' and establishing a
regulatory approach to the payment system.
My written testimony addresses these issues more fully, and
I want to emphasize we appreciate the progress that has been
made in these areas, the areas that are most critical to
reform. One very important change in the draft from the
original Administration proposal is that the draft maintains
the thrift charter. The ABA wishes to thank Chairman Frank for
his leadership on this important issue.
In my remaining time, I want to talk about a few areas that
need further work, in our opinion. First, there is one glaring
omission in the Administration's original proposal and in the
draft, the failure to address accounting policy. A systemic
risk oversight council cannot possibly do its job if does not
have oversight authority over accounting rule-making.
Accounting policies are increasingly influencing financial
policy and the very structure of our financial system. Thus,
accounting standards must now be part of a systemic risk
calculation. We believe the Federal Accounting Standards Board
should continue to function as it does today, but it should no
longer report only to the SEC. The SEC's view is simply too
narrow. Accounting policies contribution to this crisis has now
been well-documented, and yet the SEC is not charged with
considering systemic or structural effects. ABA has strongly
supported H.R. 1349, introduced by Representatives Perlmutter
and Lucas, in this area.
Second, I want to reiterate the ABA's strong opposition to
using the FDIC directly for non-bank resolutions. Several weeks
ago, the ABA provided a comprehensive approach to resolutions
and to ending ``too-big-to-fail.'' The draft, in many ways,
mirrors that proposal. However, using the FDIC directly as
opposed to indirectly is fraught with problems and is
unnecessary.
Putting the FDIC directly in charge of such resolutions
would greatly undermine public confidence in the FDIC's
insurance for the public's deposits. This confidence is
critical and it's the reason we have had no runs on banks for
over 70 years, even during this very difficult period.
The importance of this public confidence should not be
taken for granted. Witness the lines that formed in front of
the British bank, Northern Rock, at the beginning of this
crisis, where they did have classic runs. Yet our own research
and polling shows that while consumers trust FDIC insurance,
their understanding of how it works is not all that deep.
Headlines saying, ``FDIC in charge of failed XYZ non-bank''
would greatly undermine that trust. Just imagine if the FDIC
were trying to address the AIG situation this year, dealing
with AIG bonuses and that type of thing. We urge the Congress
not to do anything that would confuse consumers or undermine
confidence in the FDIC.
We also believe it's a mistake to use existing bank
resolution policies in the case of non-bank creditors. Basic
bankruptcy principles should be applied in those cases.
Finally, we want to work with the committee to achieve the
right balance on securitization reform. We want to work with
you to provide for skin in the game on securitization. We
understand why there is interest in that, but we need to
address the very thorny accounting and business issues involved
in having skin in the game.
ABA has been a strong advocate for reform. A good deal of
progress has been made through the constructive debate in this
committee, and we really appreciate the consideration members
have given to our views. Thank you.
[The prepared statement of Mr. Yingling can be found on
page 321 of the appendix.]
The Chairman. I thank you, and we now have--our last
witness is Mr. Timothy Ryan of the Securities Industry and
Financial Markets Association.
STATEMENT OF T. TIMOTHY RYAN, JR., PRESIDENT AND CHIEF
EXECUTIVE OFFICER, SECURITIES INDUSTRY AND FINANCIAL MARKETS
ASSOCIATION (SIFMA)
Mr. Ryan. I want to thank the committee for this
opportunity to appear today. We believe that systemic risk
regulation and resolution authority are the two most important
pieces of legislation focused on avoiding another financial
crisis and solving the ``too-big-to-fail'' problem.
I testified in support of a systemic risk regulator before
this committee nearly a year ago. It is vital to the taxpayers,
the industry, and the overall economy that policymakers get
this legislation right.
We believe that the revised discussion draft gets most
aspects right. We support the general structure it sets up, but
given its breadth and its complexity and the short time we have
had to review it, we have already identified a number of
provisions in the revised draft that we believe could actually
increase systemic risk instead of reduce it.
We understand your need to act quickly, but please try to
do no harm through the legislative process. My written
testimony provides details on the proposals weaknesses. We urge
the committee to take the time to correct them. We will work
day and night to suggest constructive changes.
Just two examples. We support the idea of an oversight
council. We think it should be chaired by the Secretary of the
Treasury. We believe it will be beneficial to have input from a
number of key financial regulatory agencies. We're also pleased
to see that the Federal Reserve would be given a strong role in
the regulation of systemically important financial companies.
But we are not sure of the size and composition of the
council. We're concerned that the influence of agencies with
the greatest experience and stake in systemic risk will be
diluted and possibly undermined with a lesser stake. This
structure must be reviewed carefully to ensure the council is
designed to achieve its goal of identifying and minimizing
systemic risk.
Second, resolution authority. We strongly support this new
authority, essential to contain risk during a financial crisis
and to solve the ``too-big-to-fail'' problem. The bank
insolvency statute is the right model for certain aspects of
this new authority.
A Federal agency should be in charge of the process. It
should be able to act quickly to transfer selected assets and
limit the liabilities to third party. It should have the option
of setting up a temporary bridge company to hold assets and
liabilities that cannot be transferred to a third party so that
they can be unwound in an orderly fashion.
But the bank insolvency statute is the wrong model for
claims processing and for rules dividing up the left-behind
assets and liabilities of non-bank financial companies. The
right model is the Bankruptcy Code. The Code contains a very
transparent judicial claims process and neutral rules governing
creditors rights that markets understand and rely upon.
By contrast, the bank insolvency statute, the Federal
Deposit Insurance Act, contains a very opaque administrative
claims process and creditor-unfriendly rules. These may be
appropriate for banks, where the FDIC as the insurer of bank
deposits is typically the largest creditor. But the bank
insolvency claims process and creditor-unfriendly rules are
inappropriate for non-banks which fund themselves in the
capital markets, not with deposits.
So there is a very important reason to preserve the
bankruptcy model for claims processed for non-banks. If you
don't, the new resolution authority will seriously disrupt and
permanently harm the credit markets for non-banks, increasing
systemic risk instead of reducing it.
We urge the committee to revise the resolution authority so
that it takes the best parts of the bank insolvency model and
the best parts of the bankruptcy model. That way it will
reflect the strengths of both models without reflecting either
of their weaknesses.
We and our insolvency experts stand ready to work with you
immediately to improve the highly complex and technical
resolution authority section.
Finally, we also question whether the FDIC has the
necessary experience to exercise resolution authority over the
large, complex, interconnected, and cross-border financial
groups that are the targets of this legislation. We believe
that adding the Federal Reserve to the FDIC board is a step in
the right direction, but in order to ensure that the right
experience is brought, we think we need a new primary Federal
resolution authority.
And I thank you very much, Mr. Chairman, for your courtesy.
[The prepared statement of Mr. Ryan can be found on page
188 of the appendix.]
The Chairman. Mr. Trumka, I appreciate your staying. I know
you had some schedule issues. Let me--one thing you point out,
which has to be correcting in the drafting, any ambiguity on
preemption of existing statutes would be cleared up. They will
be allowed to do capital standards, etc., but no investor
protection, no consumer protection. We will make it very clear
that is not intended. As some of you have heard me say, I have
a favorite phrase to put in the legislation, this bill does not
do what this bill does not do. It will not do that.
Secondly, as to reforming the Federal Reserve structure, I
had a study done; 90 percent of the dissents at the Federal
Open Market Committee are from regional bank presidents and 90
percent of the 90 percent are for higher interest rates. Those
are inappropriately placed private businessmen or women,
occasionally, picked by other private businessmen and
occasionally women, and they should not be setting public
policy.
I don't care that the Fed rejected what the Treasury said.
That may be a nice discussion among gentlemen. The Fed will not
reject it when we, I promise you, next year take up
legislatively the issue--and I think it's very clear--you
should not have private citizens like the presidents of the
regional banks voting on policy, and I guarantee you that won't
happen.
So those are two things that we do very much intend to deal
with, and I appreciate your calling them to our attention.
Let me just go to Mr. Ryan and--I have to say, you have
actually strengthened my view, in one sense, as to how you do
the resolution authority. You say that you don't like what we
have picked because it is creditor unfriendly. Yes, that's what
we want to be.
Here's the problem, the whole question of moral hazard is
one that seemed too creditor-friendly. The argument for moral
hazard is that once people think a particular bank is going to
be involved in this, they put their money there, they become
the creditors of that institution, because they think they are
going to be protected.
So frankly, I wasn't quite sure about where the differences
are. Yes, we want to be creditor-unfriendly because we want to
generate the uncertainty here, because it is the lack of
certainty and it is the sense that we are too creditor-friendly
that causes the problem.
Now, we also want to address the question of the list. One
of my favorite Marx Brothers movie quotes is between Chico and
Groucho negotiating a contract, and they're going through each
clause, and Chico doesn't like this clause and that clause, and
they keep ripping it up, and finally, Chico says, ``What's
this?'' He said, ``That's the sanity clause.'' And Chico says,
``You can't fool me. There ain't no sanity clause.'' Well,
``There ain't no list, either.''
There may have been a misinterpretation of what I said.
Here's my view of this. I will insist that in this legislation,
in order to get my support--which is helpful in getting it out
of here, not enough, but it's necessary, albeit not
sufficient--there will be no identification of a systemically
important institution until the hammer falls on it. That is,
there will be no two-step process--they're important, what do
we do about it? They will know that there is concern about them
the day they are given higher capital requirements or told to
divest this entity.
Now that's not supposed to be secret. There may have been a
misinterpretation. When I said I didn't want there to be a
list, people said, we won't tell you what's going on. No, that
will be made public. The draft has to be revised. Yes, the
regulators will say that's a potentially troublesome
institution. I believe that this will be a scarlet letter. I
think it will be the opposite of moral hazard.
There will be no list, this is a systemically important
institution. There will be a list of the institutions that were
considered troubled, and therefore were given higher capital
requirements or told they couldn't issue as many of this
instrument, or may be broken up, because I want to put in here
a kind of institution-by-institution Glass-Steagall that they
can put in there.
So I did want to clear those up. Ms. D'Arista, let me just
say, I agree in part. As to securitization, we are addressing
it. Some people think we're being too tough on it. One other
issue, though, that you raised that's intriguing, Paul Volcker
has said it, the question of proprietary trading by banks, both
risky and anti-competitive. I'm asking the bank to trade for me
and they're trading for themselves. In a pinch, who gets the
better deal?
And I appreciate it, but I tell you, I have become a little
weary of people telling me to solve the problem. You help me
solve the problem. You raised it, you say, make rules.
Seriously, let me just ask you this, what would you have us do
about proprietary trading? I mean that seriously. I think
that's on the table. Should we ban proprietary trading by
depository institutions or put limits on it? What would we do?
Ms. D'Arista. Certainly ban it by depository--
The Chairman. What's that?
Ms. D'Arista. Ban it by depository institutions, yes,
because they are in conflict with their clients. But it is a
very large problem. I think proprietary trading goes on
globally.
The Chairman. All right, well then send us something in
writing. I understand the large--
Ms. D'Arista. Okay, all right. The problems--
The Chairman. You do us no service when you tell us the
problem--
Ms. D'Arista. Leverage will help, and if you were to extend
the idea of the National Bank Act to limit lending to financial
institutions, that would be very helpful.
The Chairman. Let me ask you to do that in writing, because
I do think the issue of proprietary trading is one that we
would like to work on. If you can send us that in the next week
or so--
Ms. D'Arista. I would be happy to do that, thank you.
The Chairman. That would be helpful. Mr. Ryan, I am over my
time, but I talked about you. So I will give you a few seconds.
Mr. Ryan. Thank you. Just on uncertainty, there is some
uncertainty that we don't like. It's uncertainty that causes a
pricing impact--
The Chairman. No, but here is what we have been told. When
we get into--when we're talking about those that would be
subject to resolution authority, we're told that there is a
moral hazard there because people will now say, ``Oh, they're
going to be resolved. That means I should put the money
there.''
I want that to be less creditor-friendly. I want
creditors--I want the uncertainty that says, ``You know what?
That institution is somewhat troubled. Maybe I won't deal with
them because I want the institution to have an incentive to
stop doing what's troubling people.''
Mr. Ryan. May I just say--
The Chairman. Yes.
Mr. Ryan. --what I fear? What I fear is that uncertainty
will cause significant disruptions in the intra-daily markets
and--
The Chairman. Mr. Ryan, isn't it likely to cause--and I
apologize, if I can go--isn't it likely to cause a transfer
from one institution to another? After all, there will be some
institutions that will be on this list and some that won't.
So, what I am trying to do is to convert the fear that
being put on the list is a badge of honor into making it a
scarlet letter. And I don't see how it would be disruptive,
unless there are a whole lot of institutions there. But if only
a few institutions are there, they can put their money
elsewhere.
Mr. Ryan. We will try to come back to you with some ideas
which will get to your--
The Chairman. All right, I appreciate it.
Mr. Ryan. Thank you.
The Chairman. I appreciate the indulgence. Let me just say
that I want to put into the record an article on the
feasibility of systemic risk management by Andrew Lo at MIT--
because there is no point in pretending you can do any of this
unless you can get the data and make sense of it, and he says
you can--and also testimony from the Property Casualty
Insurance Association of America on this hearing.
So, I ask unanimous consent that they be put in the record.
The gentleman from Alabama is recognized.
Mr. Bachus. Thank you, Mr. Chairman. Mr. Chairman, I would
like to ask each of the panelists--and maybe just a yes or no,
or a very brief response, have you had time since the
discussion draft was issued to thoroughly analyze the bill, as
far as strengths and weaknesses?
Mr. Trumka. No.
Mr. Baker. No, sir, not enough.
Mr. Swagel. No.
Mr. Talbott. No.
Mr. Kandarian. No.
Mr. Menzies. No.
Mr. Wallison. Certainly not all, Mr. Chairman.
Ms. D'Arista. No.
Mr. Yingling. No.
Mr. Ryan. No.
Mr. Bachus. All right. We hadn't, either, so I appreciate
that.
The chairman mentions creditors. I guess you can't have
credit without creditors.
So, let me see. There are so many questions I would like to
ask. Professor Swagel, you were at Treasury last year. You said
that the enhanced resolution authority would create a permanent
super-charged TARP?
Mr. Swagel. Yes.
Mr. Bachus. Secretary Geithner and Chairman Frank have
repeatedly said that the resolution authority does not provide
for bailouts. But you disagree. Is that correct?
Mr. Swagel. I do disagree. I listened carefully to the
Secretary's testimony, and I understand--his testimony was
about what he would intend to do, and I believe him and respect
him.
My concern is that the legislation allows much more. And I
look at what happened with the TARP. I don't think anyone
anticipated all the manifold activities that the TARP would get
into. And that's essentially what the text of the legislation
allows, as well.
Mr. Bachus. Mr. Wallison, Secretary Geithner said that the
chairman's discussion draft does not provide for the
possibility of future bailouts. So what's your perspective on
that?
Mr. Wallison. I was very puzzled to hear the Secretary say
that, because there is language in here that does permit things
that anyone would consider to be a bailout. That means
assistance to an institution that is failing, and then
permitting that institution to be brought back to solvency.
Now, under any person's interpretation of what a bailout
might be, that is a bailout, because government funds are then
used to bring the institution back to solvency, and set it off
again competing with others.
In my prepared testimony as well as in my oral testimony, I
said that this doesn't seem like either an equitable or
sensible thing to do. Because then the costs of the government
in keeping that other institution alive, to compete with the
existing healthy institutions, are then taxed to the healthy
institutions, which have just been weakened by that assistance.
So, I could not understand what the Secretary was saying,
and I would be delighted for someone to interpret it.
Mr. Bachus. Maybe they hadn't had sufficient time to read
the bill.
Mr. Wallison. Maybe not.
Mr. Bachus. Mr. Kandarian, you said, and I have said this
before, that I think a better approach would be to regulate
activities, not institutions. Does anyone else on the panel
agree with that, that it would be a better approach? Maybe
start with Mr. Trumka.
And let me say this. When you decide that certain
institutions will be bailed out and some will not, you make a
decision not only that institutions are ``too-big-to-fail,''
you make a determination that 99 percent of institutions--or
99.9--are ``too-small-to-save.'' And that doesn't seem very
fair. Mr. Trumka?
Mr. Trumka. Would you please repeat the first part of the
question?
Mr. Bachus. Yes. Do you have a problem with--I will just
say the last part. Do you have a problem with ``too-big-to-
fail,'' as far as from a fairness standpoint?
Mr. Trumka. We have a problem with ``too-big-to-fail.'' We
would like to prevent people from becoming ``too-big-to-fail.''
Because once they are there, you do not have a lot of choice
but to bail them out. So, the goal should be to try to prevent
that from happening.
Mr. Bachus. All right.
Mr. Trumka. And make sure that systemic risk doesn't
aggregate, even--
Mr. Bachus. You believe that it's--that activities within
an--it's an activity that creates the risk, and it's an
institution--I guess I will just go to Mr. Baker, going down.
What do you think about the approach where you regulate
activities, and not institutions, as a--
Mr. Baker. Activities should be the focus, not necessarily
assets under management.
Mr. Bachus. All right, thank you.
Mr. Swagel. I would agree with that.
Mr. Talbott. I agree. It's not the size; it's the riskiness
of the activities.
Mr. Bachus. Thank you. Mr. Kandarian? We will just go on
down the line.
Mr. Kandarian. Yes, those were my comments, so certainly I
support--
Mr. Bachus. Yes, you would support it.
Mr. Menzies. I disagree. Our activities are unbelievably
regulated right this minute. It's the size of the institutions.
Mr. Bachus. What about subprime lending? Do you think it
was regulated, or--
Mr. Watt. [presiding] I--
Mr. Bachus. Can I get the rest of the answers--
Mr. Watt. I am trying to get the rest of your answers in--
Mr. Bachus. All right, Mr. Wallison?
Mr. Watt. --but you can't--
Mr. Bachus. You're right. I have--
Mr. Watt. --ask another question and then expect the rest
of the--
Mr. Bachus. You're right. Mr. Wallison?
Mr. Wallison. As I have testified to this committee before,
I don't think any institution can create systemic risk, no
matter what its size, unless it is an insured commercial bank.
Ms. D'Arista. No, I think size is important. Yes,
activities must be regulated. I have advocated that for many
years. But management of a very large institution runs another
problem that has to be addressed.
Mr. Bachus. All right. Mr. Yingling?
Mr. Yingling. I think we need more subtle approaches than
just having a somewhat arbitrary list.
Mr. Bachus. You mean of institutions or activities?
Mr. Yingling. Of institutions.
Mr. Bachus. Okay. Mr. Ryan?
Mr. Ryan. I agree with Ed's comments.
Mr. Watt. The gentleman's time has expired. And I will
recognize myself for 5 minutes, just to say that every effort
that we have tried to regulate as an activity, my colleagues
have said they don't want to regulate either.
So, this is one of those situations where it seems to me
we're damned if we do and damned if we don't. If we do it based
on size, they oppose it. If we do it based on activities, we
oppose it. I guess that's what the Minority is designed to do,
just oppose something, as opposed to propose something that
will solve a problem. But that's--I won't belabor that point.
Now, I know there are people on this panel who are
unalterably--maybe they have moderated a little bit--but at
least still opposed to the concept of a CFPA. I understand
that. But assuming that there is a CFPA, is there anybody on
this panel who thinks that the director of that agency
shouldn't be on the council that is set up under this bill?
I am not looking for a speech about whether you like CFPA
or not. I just want to know whether you think they ought not to
be on the council. Yes, sir?
Mr. Swagel. Yes, I would not put the director of the CFPA
on the systemic risk--
Mr. Watt. We need to do something about your microphone.
Mr. Swagel. Sorry about that. I would not put the director
of the CFPA on the systemic risk council.
Mr. Watt. Okay. Anybody else who will agree with that?
[No response.]
Mr. Watt. Okay. I won't go into your reasons. Give me your
reasons in writing.
Mr. Swagel. Okay.
Mr. Watt. I won't take the time to do that. Mr. Yingling,
you raised an issue that I raised this morning with the
Secretary about dividing the funds, the FDIC fund, which has a
brand, obviously, that the public relies on from whatever fund
gets created to--either after the fact or before the fact--to
deal with this resolution of systemically risky institutions. I
think some of the others of us are concerned about that.
You support setting up a fund in advance of a resolution or
after the fact?
Mr. Yingling. I would do it after the fact. I think your--
Mr. Watt. Okay, and who would you tax with the--with
putting up the money to put into that fund?
Mr. Yingling. I think, unfortunately, you end up with
something similar. We would have some changes in what the
Administration proposed, but some--
Mr. Watt. All right. I understand that. I'm asking you who
you would tax. Would it be all financial institutions? Would it
be some financial institutions? Would it be institutions above
$10 billion? Would it be--who would you tax?
Mr. Yingling. What we said in our proposal was very similar
to what the Administration proposed. We didn't put a number on
it.
Having said that, one thing we would like to see is a much
stronger provision relating to the fact--and Chairman Bair
mentioned this--that you get credit for the fact that you're
already paying deposit insurance. So those--
Mr. Watt. Would it be set--
Mr. Yingling. Those liability--
Mr. Watt. --up as a separate fund, I take it?
Mr. Yingling. Oh, absolutely--
Mr. Watt. Totally separate from the FDIC?
Mr. Yingling. Oh, absolutely, but--
Mr. Watt. Called something else? A resolution fund?
Mr. Yingling. A resolution fund, and we think the agency
should not be called the FDIC, it should be called the systemic
resolution agency. That is what it is. And that the--
Mr. Watt. Anybody else on the panel--
Mr. Yingling. You get credit for the fact that you are an--
Mr. Watt. --disagree with that?
Mr. Yingling. --insured depository.
Mr. Watt. Mr. Menzies, you disagree with--
Mr. Menzies. I--
Mr. Watt. --separating the funds?
Mr. Menzies. I'm a victim of my experience as a community
banker. We set aside reserves--
Mr. Watt. I don't want to provide a platform for you to
give--
Mr. Menzies. Okay.
Mr. Watt. --a speech about it. I understand you say that.
Mr. Menzies. We should pre-fund--
Mr. Watt. But this is about the fund, Mr. Menzies.
Mr. Menzies. We should pre-fund that.
Mr. Watt. You should pre-fund it?
Mr. Menzies. Absolutely. We should--
Mr. Watt. What are the arguments in favor of pre-funding
it, as opposed to doing it after the fact?
Mr. Menzies. The same logic as applying loan loss reserves.
Mr. Watt. And who would contribute to that fund?
Mr. Menzies. Those who present some form of systemic risk
to our system.
Mr. Watt. And how would you designate those without knowing
who they are in advance?
Mr. Menzies. The industry is not going to be designating
those. That's what Congress and the regulators need to do.
Mr. Watt. So we ought to just pick it out of the--Congress
ought to make a decision about it and put them on a list? Okay.
We keep going around and around in a circle here. My time
has expired. And, let's see, Mr. Royce is next.
Mr. Trumka. Mr. Chairman, I was supposed to be out of
here--
Mr. Watt. Oh, I'm sorry. I was supposed to make apologies.
Mr. Trumka had indicated beforehand that he had to leave, and I
was supposed to announce that--
Mr. Trumka. At 2:30.
Mr. Watt. --so that it didn't look like he was running out
on Mr. Royce. I hope nobody has any objection to that. He has
to leave anyway, but you can put your objection in the record,
so--
Mr. Bachus. If he has to leave, he has to leave.
Mr. Watt. You are excused without objection, I believe. You
are excused without objection.
Mr. Trumka. Thank you.
Mr. Watt. And don't take that out of Mr. Royce's time.
Start his clock over.
Mr. Royce. Fair enough. Thank you, Mr. Chairman. I had a
question for Mr. Wallison, and it went to memory of some of the
hearings, and some of the comments.
Back when he was Chairman of the Federal Reserve, Alan
Greenspan often mentioned that he believed deposit insurance
had an effect of weakening market discipline. He noted that the
benefits of deposit insurance are great. But he said,
``Explicit safety nets weaken market discipline. It encourages
institutions to take on excessive risk.''
And I am not arguing here against the benefits of deposit
insurance, obviously. But I am concerned that this legislation,
by extension, would expand that perceived safety net throughout
our financial system, that it wouldn't just be any longer a
question of accounts covered by deposit insurance. Suddenly it
becomes a problem that ripples throughout the entire financial
system.
And I would like to hear your comments on that, or your
thoughts on it.
Mr. Wallison. Thank you very much, Congressman. I think it
should be obvious that deposit insurance does enable the taking
of risk, and reduces market discipline.
In fact, I think that's why banks are regulated, because
once the government is backing their deposits, the only way for
the government to protect itself against excessive risk-
taking--because the creditors, then, and at least the
depositors--have no significant incentive not to lend to an
institution that is backed by the government. That is, of
course, the whole reason why everyone is supposed to be
concerned about ``too-big-to-fail.'' And I was quite surprised
by the chairman's comments about ``too-big-to-fail.''
But if we have a system in which any institution is looked
upon as though when it fails, there will be no serious losses
to people--and that's what this legislation does--we're in the
same position as we are when we have institutions that are
covered by deposit insurance--people will have much less
concern about lending to them. They will get much more
favorable terms.
And, unfortunately, that will enable them to take more
risks. And eventually, we end up with failed institutions.
Fannie Mae and Freddie Mac are the poster children for exactly
that. That was systemic risk writ large, and the American
people are now going to have to spend something like $200
billion to $400 billion to pay for the losses that are embedded
in their balance sheets right now.
Mr. Royce. Now, the chairman's draft legislation would give
regulators the ability to shield creditors from losses. Do you
agree that making public funds available to soften the blow to
private creditors would weaken market discipline, as deposit
insurance does?
Mr. Wallison. Of course. It's the same thing as deposit
insurance, and it doesn't really matter very much that
eventually the public funds made available to these
institutions are then recouped from the rest of the industry or
whoever is going to be required to pay these costs.
The important point is the fact that creditors know in
advance that they have a much better chance of being paid
politically or in some other way through a resolution system
than they would have if the companies went into bankruptcy.
Mr. Royce. So political pull, or the importance of it,
starts to replace market discipline or market forces. And I
suspect we could see a lot more activity by those who suddenly
begin to focus on that issue.
As the Richmond Federal Reserve has pointed out, roughly
half of our financial system--at least in 1999--had some degree
of government backing, whether it was explicit or implicit.
I think the critical question in this regulatory reform
effort is whether or not our system will benefit from a
government safety net covering what is likely today well over
half of the liabilities in our credit markets. Considering the
unintended consequences that have come about from these types
of market distortions, I have a hard time believing this is a
good development. And I think we should look to ways to scale
back that safety net and enhance market discipline in the
system.
And I would ask if you had any additional thoughts on that
matter?
Mr. Wallison. I agree. And one of the problems with the
draft legislation is that it actually expands the safety net in
very significant ways: reduces market discipline, and
guarantees there will be more risk-taking by large
institutions--it favors large over small.
And what will happen in the end is the same thing that
happened with Fannie Mae and Freddie Mac. We will face huge
losses in very large companies that have not been properly
disciplined by the market.
Mr. Royce. Thank you. Thank you, Mr. Chairman. Thank you,
Mr. Wallison.
Mr. Watt. The gentleman, Mr. Himes, is recognized.
Mr. Himes. Thank you, Mr. Chairman. I have two kind of
esoteric questions, which may or may not elicit a response. I
hope they do.
The first is on the topic of securitizations.
Securitization structured products, like so much of what we're
talking about, are real double-edged swords, inasmuch as, used
correctly, they increased credit and liquidity. Used
incorrectly, or kept off balance sheet, or poorly rated, they
contributed to the place we find ourselves in today.
I am a big believer in the idea incorporated in this
proposed legislation of retention, that you keep a piece of
whatever it is that you create. I think it's very elegant. It
prevents us or the regulators from having to try to sort
through securities, because, really, the creator of a
structured product, to some extent, will eat his or her own
cooking.
I do have real concerns, though, about the stipulated
level. The legislation says that you will hold 10 percent of a
structured product, perhaps down to 5 percent, no lower than 5
percent. And my problem with that is that I think structured
products can have wildly different credit characteristics. You
could have a structured product full of agency and treasuries,
you could have a structured product full of high-risk stuff.
So, I am really--and I am thinking about, is there some way
to link the retention to the credit risk of the product, or to
the fees associated with the product, which presumably are
higher, if the product is more complex.
I am wondering if there is any comment on what is proposed,
vis-a-vis the 5 to 10 percent retention, and whether these
ideas I have thrown out maybe have any merit.
Mr. Ryan. Our view--and it has been consistent here--and I
believe the chairman asked the same question about a year ago,
did we support retention, and I said yes.
We have been working also in Brussels with the European
Commission. They are basically at a 5 percent number. We hope
they will also provide some flexibility.
Based on your esoteric question--because it really is
different risks, depending on the assets that are held. So what
we would like to see is 5 percent, not 10 percent, as the
high--5, but the flexibility for this systemic council or some
other regulator to determine a standard that could be used
below that.
Mr. Yingling. I would agree with your comment, that there
needs to be flexibility.
The other problem we have is, particularly for smaller
banks, you can only keep 5 percent, and it looks like you have
95 percent off your books. But for accounting and other
reasons, you still treat it as though you have 100 percent. So
that's the other issue.
Mr. Himes. Yes, sir?
Mr. Talbott. Yes, H.R. 1728, which was, I think, approved
by the House, started with 5 percent as the ceiling, and we
think that's the right place to start. And I agree with the
comments. Start with 5 percent, and then adjust the risk based
on the riskiness of the underlying asset.
Mr. Himes. I am sensing a general assent that maybe one of
the guiding principles to retention ought to be the riskiness
of the structured product itself. Is that maybe a place to
start? Okay. I'm seeing lots of nods.
Mr. Talbott. Yes.
Mr. Himes. Okay. One other esoteric question. Embedded
finance companies--I happen to have GE and Pitney Bowes in my
district. And, of course, there are other companies that have
finance arms that have operated for a long time. Certainly, the
way I think about this project we're embarked on is that we
look very hard at those entities that screwed up and
contributed to the mess. We look a little less hard, but we
look nonetheless at entities that maybe weren't involved, but
could--hedge funds, others.
It does seem to me that these embedded companies really
weren't part of the problem. And I am glad to see that, versus
the original draft, we're not requiring separation. But I am
concerned about some of the restrictions, cross marketing, that
are in this draft.
So, again, I just would like a general comment on whether
you think this threads that needle in a competent way. Yes,
sir?
Mr. Talbott. Yes, we're pleased that the--it's
grandfathered, but the provisions that you mentioned, like the
cross marketing, as well as changing ownership, those
essentially freeze them in time, and prevent the ILC from
changing as the markets change. You risk, if you make a change,
that the ILC goes away. And so you lose that flexibility, going
forward, to be able to adapt as the markets change.
Mr. Himes. Thank you. Yes, sir?
Mr. Wallison. If I can just make a comment on this, the
legislation assumes that it is possible to separate finance and
commerce. I don't think they can be separated. This has been
shown again and again when the Federal Reserve has been
required to decide what is a financial activity and what is not
a financial activity.
Here, what we are proposing is to take financial
activities, whatever they are--and that's going to be a very
heavily debated question right here in this committee and in
the halls of Congress, generally--separate them from the
operations of the company, and then impose restrictions on what
that separate financial company can do to help the original
parent. That is a very troubling thing to do.
Mr. Himes. Thank you, Mr. Chairman.
The Chairman. Time has expired, but I am going to ask for
10 seconds just to say to Mr. Yingling--and you have mentioned
this before--I am sympathetic here.
You have talked about the accounting impact. We would be
glad to receive from you language that would allow
securitization that would not have those broader accounting
implications. We are not trying to interfere with accounting,
but where we're creating something, we have a right to create
it clean.
So, you're right, that should not--that's a serious
impediment, and please give us language. We will try to clean
that up.
Mr. Yingling. Thank you, Mr. Chairman.
The Chairman. The gentleman from North Carolina.
Mr. Miller of North Carolina. Thank you, Mr. Chairman. Ms.
D'Arista, before you raised the question of proprietary trading
and the chairman followed up with it, I had asked the previous
panel about that.
Ms. D'Arista. I heard you, sir.
Mr. Miller of North Carolina. In part, because while
Chairman Volcker had testified last month that proprietary
trading by systemically significant firms should be prohibited,
that perhaps customer trading should be allowed, but not
proprietary trading.
And Ms. Bair seemed to agree, with respect to the
depository institutions, but thought it would be okay in an
affiliate within a holding company.
And then Mr. Dugan, not surprisingly, found a reason not to
do it at all, and that was that if you required it to be by a
separate entity, the entity would still grow to be so large
that it would be systemically significant. It certainly
occurred to me that there are still reasons to do it, even if
all the different entities end up being really big.
One is the market discipline--to use the term that others
have used today--that if you're dealing with a company that
just does one thing, you focus on that, and do not assume that
because they're so big they're going to be good for their
debts. Who could imagine Citigroup not being good for their
debts? Obviously, it could never ever happen--or Bank of
America.
It's impossible to manage a company. Obviously, the CEOs,
and certainly the boards of directors, had no idea what the
different parts of their companies were doing, the ones that
got into trouble.
And finally, it's impossible to regulate. Again, not
surprisingly, we have had other discussions of Freddie and
Fannie. Everybody seems to have agreed right along that the
regulator for Freddie and Fannie was not up to the task,
because Freddie and Fannie was so complex.
And they had derivatives in case interest rates went up,
they had derivatives in case interest rates went down. And
there were only a handful of people on the planet who could
figure out what it all meant. And the more lines of business
there are that are all complex and opaque, the harder it is to
regulate.
Do you agree that even if the separate entities end up
being really big, and probably systemically important, that
proprietary trading should not be done at the same entity
that's doing--that is a depository institution that's doing
lending?
Ms. D'Arista. I would agree, and I would think that you
need to limit proprietary trading across the entire financial
system, not only within the conglomerate, but with other
institutions.
Typically, this was the province of investment banks in the
past, who have changed muchly, as we know.
Mr. Miller of North Carolina. Right.
Ms. D'Arista. I think as I began to say--and I will submit
some information about my thinking on this--we could go at this
in a number of ways: limiting leverage; limiting counterparty
exposure; etc. This will reduce the amount of counterparty
trading, or proprietary trading, that is going on.
But you have to understand that the proprietary trading is
what blew up, inflated into a balloon, our financial system. We
are not Iceland, but we're getting there, if we don't do
something about it. In other words, size is important Because
of what it means in terms of gross domestic product, in the
size of the financial institution itself, of the financial
sector, etc.
Where does it get to the point where we don't produce
enough in the economy to cover the exposure of our financial
sector?
Mr. Miller of North Carolina. All right. Mr. Yingling,
should depository institutions do proprietary trading?
Mr. Yingling. I don't think they should do it directly in
the depository institution. I would agree with Ms. Bair's
response to you earlier.
Mr. Miller of North Carolina. That affiliates within the
holding company should do proprietary trading, but--
Mr. Yingling. Yes, with careful regulation and capital
requirements and leverage limits.
Mr. Miller of North Carolina. Mr. Ryan, you seem to want to
be recognized. Were you raising your hand?
Mr. Ryan. I do. Thank you.
Mr. Miller of North Carolina. Yes.
Mr. Ryan. That's why I came, to answer questions like this.
Mr. Miller of North Carolina. Okay.
Mr. Ryan. And my view is, first of all, there are different
types of proprietary trading. Some have excessive risk, some do
not. And that's an important question.
What we have proposed--and I think that your bill proposes,
or the Administration's bill proposes--is this type of activity
would be in the domain of the systemic risk regulator. They
would look to see, are they taking excessive risk? Or, more
importantly, are they capable of managing the risks that
they're taking?
That is the way I would approach it, because there is such
a wide difference between excessive risk in proprietary
trading, and some proprietary trading that is not that risky.
The Chairman. The gentleman from Missouri.
Mr. Cleaver. Thank you, Mr. Chairman. Ms. D'Arista, you
said we're not quite Iceland, but we're getting there. Are you
suggesting we're going to lose McDonald's?
[laughter]
Ms. D'Arista. No, and I perhaps exaggerated for effect.
Mr. Cleaver. I am--that's--yes. It came through clearly.
But I do have a serious--my kids would think that's
serious. But I have an even more serious question. The World
Bank president on Monday--Mr. Zoellick--made a speech. And it
was a little surprising in the fact that he said that Treasury,
rather than the Fed, should be given the authority to regulate
systemic risk, because Treasury is an executive department, and
that both Congress and the public would have more involvement
in how this authority is used than if the Fed is given this
authority.
Where do you come down on that?
Ms. D'Arista. As President Trumka said, if the Fed were a
reform, we would not have a problem with the Fed having the
responsibilities that they have been given. I think we do have
a problem with the Treasury. The Federal Reserve is an agency
of the Congress. And I think that the Congress needs to
undertake greater responsibility for overseeing the Fed, both
in terms of monetary policy and regulatory policy.
But the idea that the Treasury, the Administration, should
assume such a large role is, in my view, a problem.
Mr. Cleaver. So you are saying that it is de-politicized--
I'm asking the question--it is de-politicized if the Fed has
the responsibility and authority, as opposed to Treasury, which
is appointed by the President and confirmed by the Senate?
Ms. D'Arista. Yes and no. I really--looking at the
Constitution, and what--
Mr. Cleaver. We don't do that in here.
Ms. D'Arista. Well--
[laughter]
Mr. Cleaver. Go ahead.
Ms. D'Arista. You have the responsibility for creating
money and maintaining its value. And that is a responsibility
that you passed on to the Federal Reserve.
I don't think you have--I don't think this body has, in
recent years, done the job it should have done with the Federal
Reserve. But the Federal Reserve is an important institution,
it is the central bank, and it has knowledge and reach, and it
goes into the issues of external markets, etc.
I think it should be on the council, but not dominate the
council. I want the council to have more responsibility, but I
don't feel that it should be under the thumb of the Treasury.
Mr. Cleaver. Mr. Baker, as a former Member of this August
body, do you differ with Ms. D'Arista?
Mr. Baker. Certainly, we feel that a council-like structure
would be more appropriate in providing balance and perspective.
I understand the concerns Members have with regard to the
Federal Reserve unilaterally engaging. There are certain
questions with regard to monetary policy obligations and
resolution of particular systemically significant entities,
which could create issues. Go back to Mr. Volcker during the
Mexican currency crisis, when it was advocated that banks
extend credit, notwithstanding concerns about creditworthiness,
which created considerable concerns about the integrity of
monetary policy formulation and bank lending activity.
This is a very carefully constructed question that I think
we should take time to examine. But certainly having a
Presidential appointee unilaterally make the decision or have
the Federal Reserve make the decision, both are fraught with
inappropriate resolution ability.
Mr. Cleaver. Are any of you aware of any other central bank
that has the responsibility for supervising systemic banking
risk and managing monetary policy? Any other central bank that
does--yes, sir, Mr. Wallison?
Mr. Wallison. There are other central banks that do that. I
think the French central bank does that.
The Chairman. Did you say the French central bank?
Mr. Wallison. Yes.
The Chairman. But I thought they lost monetary policy to
the European Bank. So they don't have monetary any more, ECB
does.
Mr. Wallison. Yes, I suppose it's possible, if the ECB has
taken over all the central bank responsibilities. But I think
the national central banks do continue to have some
responsibility for monetary policy within those countries. But
I just wanted to mention that they are proposing to do this in
the U.K., to return some responsibility to the Bank of England
that was taken away.
But it is a troubling idea, because the central bank has
important responsibilities, and the idea of giving it
responsibilities that would otherwise be handled by a political
organ of the government, in some ways, compromises its
independence. And in the United States this is very troubling,
because to weaken the dollar through compromising--
The Chairman. Time has expired.
Mr. Wallison. --the independence of the central bank is a
problem.
The Chairman. The time has expired.
Mr. Cleaver. Thank you, Mr. Chairman.
The Chairman. I think many of the national central banks
will welcome your restoring to them powers that I understand
they all lament having lost.
The gentleman from California is now recognized.
Mr. Sherman. Let me ask the independent bankers, under the
recapture provisions, your members could be taxed if they have
assets of over $10 billion. Are you confident that every future
Administration will not hit you with any significant taxes for
the cost of bailing out the big folks on Wall Street?
Mr. Menzies. I think the answer is, what's the right
number? Should it be $10 billion? Should it be $50 billion?
Should it be $100 billion? I think that is an economic question
and a political question, and I don't have the answer to
either.
Mr. Sherman. Do you believe any of your members are singly
and by themselves systemically important? Not that--yes,
obviously, community bankers, as a group, are systemically
important. But would you put any of your members in that
category?
Mr. Menzies. We do not believe we have systemically
important members. And we do believe we are systemically
important to every community we serve.
Mr. Sherman. You were saying that you do not believe that
any one of your members meets the statutory definition of
being--
Mr. Menzies. Of being systemically important, no.
Mr. Sherman. So, none of your members is going to be able
to benefit from an implicit Federal guarantee that says, ``You
are `too-big-to-fail,' and unsecured creditors will get some
sort of bail-out assistance in order to safeguard our economy
from systemic risk.'' Your uninsured creditors don't get any of
that, right?
Mr. Menzies. No. If we fail, we fail. Our uninsured
creditors are not paid. It's as simple as that.
Mr. Sherman. So do you think that the tax should be imposed
on any entity that is too small to be considered ``too-big-to-
fail?''
Mr. Menzies. Absolutely not.
Mr. Sherman. Okay. Mr. Baker, welcome back.
Mr. Baker. Thank you.
Mr. Sherman. Hedge funds are often under $10 billion. But
you folks--some of your members engage in pretty
sophisticated--some would say risky--investment strategies. You
were careful to point out that many of them don't.
Do you believe that a $9 billion hedge fund with tens of
billions of dollars of contingent liabilities should be subject
to this tax so that we can recoup the costs of bailing out a
systemically important institution?
Mr. Baker. I think the whole manner of who is assessed, and
to what extent, for the failure of an unrelated enterprise--for
example, if I am understanding the mark properly, it could be
an insurance company that has activities totally unrelated to
the hedge fund sector performance. The question becomes, how
far does one go in extending the assessment on--financial in
nature--outside the sector in which you are performing? So I--
Mr. Sherman. Do you think that if we bail out an insurance
company, only the insurance companies should pay the tax, and
if we bail out a commercial bank, only the commercial banks
should pay the tax?
Mr. Baker. It's unclear as to the economic resolution at
the scale of the--the difficulty and the assets of the
particular sector. It certainly is something worth a
discussion. I would say, as far as my members will go, we are
not looking for bailouts. We haven't received a bailout. Now,
we--
Mr. Sherman. Well--
Mr. Baker. --fortunately, because of the length of the
future, and how uncertain it is, we may be subject to
resolution. But the distinction between the two is pretty
significant.
Mr. Sherman. Let me interrupt and go to Mr. Swagel.
Can you run a modern economy if the major players do not
believe that the major players are likely to be bailed out,
should it come to that? Can we run this country without
bailouts being available when Treasury thinks they ought to be?
Mr. Swagel. Right. If the major players think that there is
a possibility of a bailout, that will affect their behavior.
If, for some reason, as you--
Mr. Sherman. So--oh, yes. Obviously, if you go out and tell
everybody, as we apparently--unbeknownst to me--did, prior to
Lehman Brothers, that everybody like Lehman Brothers is going
to get bailed out, and then you don't do it, then you're
building the house of cards and then you're not protecting
those cards from the wind.
But my question is, can you--
The Chairman. The gentleman's time has expired.
Mr. Swagel. I would just briefly note that Lehman's senior
debt was trading at 10 cents on the dollar before it failed,
and the auction cleared at 9 cents on the dollar. So people had
a pretty good sense of what was going to happen to Lehman.
The Chairman. The hearing is now adjourned. I thank the
witnesses for their persistence in staying through a couple of
votes.
And let me say anyone who wants to--we have asked
specifically of Ms. D'Arista--but anybody who has any further
information to send in, we will be glad to get it.
[Whereupon, at 3:40 p.m., the committee was adjourned.]
A P P E N D I X
October 29, 2009
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