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



 
                  EXAMINING THE LINK BETWEEN FED BANK
                    SUPERVISION AND MONETARY POLICY

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

                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

                             MARCH 17, 2010

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 111-112



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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

                              ----------                              
                                                                   Page
Hearing held on:
    March 17, 2010...............................................     1
Appendix:
    March 17, 2010...............................................    59

                               WITNESSES
                       Wednesday, March 17, 2010

Bernanke, Hon. Ben S., Chairman, Board of Governors of the 
  Federal Reserve................................................     6
Gerhart, Jeffrey L., President, Bank of Newman Grove, on behalf 
  of the Independent Community Bankers of America (ICBA).........    51
Kashyap, Anil K., Edward Eagle Brown Professor of Economics and 
  Finance, and Richard N. Rosett Faculty Fellow, Booth School of 
  Business, University of Chicago................................    46
Meltzer, Allan H., The Allan H. Meltzer University Professor of 
  Political Economy, Tepper School of Business, Carnegie Mellon 
  University.....................................................    43
Nichols, Robert S., President and Chief Operating Officer, the 
  Financial Services Forum.......................................    49
Volcker, Hon. Paul A., Chairman of the President's Economic 
  Recovery Advisory Board, and former Chairman of the Federal 
  Reserve........................................................    10

                                APPENDIX

Prepared statements:
    Paul, Hon. Ron...............................................    60
    Watt, Hon. Melvin............................................    61
    Bernanke, Hon. Ben S.........................................    66
    Gerhart, Jeffrey L...........................................    73
    Kashyap, Anil K..............................................    80
    Meltzer, Allan H.............................................    88
    Nichols, Robert S............................................    96
    Volcker, Hon. Paul A.........................................   100

              Additional Material Submitted for the Record

Watt, Hon. Melvin:
    Federal Reserve White Paper entitled, ``The Public Policy 
      Case for a Role for the Federal Reserve in Bank Supervision 
      and Regulation,'' dated January 13, 2010...................   114
Bernanke, Hon. Ben S.:
    Written responses to questions submitted by Representative 
      Baca.......................................................   125
    Written responses to questions submitted by Representative 
      Cleaver....................................................   127
    Written responses to questions submitted by Representative 
      Foster.....................................................   129


                       EXAMINING THE LINK BETWEEN
                          FED BANK SUPERVISION
                          AND MONETARY POLICY

                              ----------                              


                       Wednesday, March 17, 2010

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 2 p.m., in room 
2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Members present: Representatives Frank, Kanjorski, Waters, 
Maloney, Watt, Sherman, Meeks, Moore of Kansas, Hinojosa, 
McCarthy of New York, Baca, Miller of North Carolina, Scott, 
Green, Cleaver, Donnelly, Foster, Speier, Minnick, Kosmas, 
Himes; Bachus, Royce, Paul, Biggert, Hensarling, Garrett, 
Neugebauer, Price, Marchant, Jenkins, Lee, Paulsen, and Lance.
    The Chairman. Will the photographers please stand down? The 
only thing we could see was Mr. Volcker. Now, we can see 
everybody.
    This hearing will come to order. It is an important hearing 
that is relevant to the legislative task before us.
    As members know, the Senate had been considering very much 
the question of what the supervisory reach of the Federal 
Reserve should be. We obviously dealt with it in the bill that 
passed the House.
    We will, I believe, now be going to conference some time in 
April or early May, and one of the questions will be the 
appropriate role for the Federal Reserve.
    This is a subject which the chairman of the Subcommittee on 
Domestic Monetary Policy, the gentleman from North Carolina, 
has given a great deal of attention to.
    Obviously, it is clear to people that many of us felt that 
the Senate's initial instincts here were insufficiently 
recognizing the importance of a role for the Federal Reserve.
    There has been some movement. The differences are less than 
they were. I now believe, as with the legislation in general, 
we are entering a range where the desire and the need for a 
bill will be greater than any individual differences.
    An important part of this will be how should the 
supervisory role of the Federal Reserve be structured, and that 
is why we are very pleased to have the Chairman and the past 
Chairman of the Federal Reserve with us to talk about this.
    While I have the microphone, let me just say I want to make 
a couple of announcements that are relevant. This morning, I 
received letters, first from our colleague from Ohio, Ms. 
Kilroy, and then from Ranking Member Bachus asking for hearings 
into the information that was contained in the examiner's 
report on Lehman Brothers, and that is obviously something we 
should do.
    It is something I believe we address in our legislation, 
this whole question of off balance sheet activity; that is 
important.
    We will have a hearing on that in April. Our hearing 
schedule has gotten pretty crowded. In April, as I told Ms. 
Kilroy and Mr. Bachus, we will be having a hearing. It will be 
a full committee hearing because the people involved include 
some people at the Department head levels and those have to be 
at the full committee. We will be having that hearing.
    We will proceed today with this hearing on the question of 
how to do the regulation.
    I am going to yield back the balance of my time so that it 
can be made available to the chairman of the subcommittee.
    I am going to now recognize the ranking member, but the 
driving force here, and the member who has put the most effort 
and considerable thought into this, is the gentleman from North 
Carolina.
    I am now going to turn the gavel over to the gentleman from 
North Carolina, and he has my remaining 3 minutes, plus his own 
time to allocate as he chooses, and the gentleman from Alabama 
is now recognized for 5 minutes.
    Mr. Bachus. Thank you, Mr. Chairman. As Congress looks at 
ways to reform the country's financial infrastructure, we need 
to ask whether bank supervision is central to central banking.
    It is worth examining whether the Federal Reserve should 
conduct monetary policy at the same time it regulates and 
supervises banks or whether it should concentrate exclusively 
on its microeconomic responsibilities. It is no exaggeration to 
say the health of our financial system depends on getting this 
answer right.
    Frankly, the Fed's performance as a holding company 
supervisor has been inadequate. Despite its oversight, many of 
the large complex banking organizations were excessively 
leveraged and engaged in off balance sheet transactions that 
helped precipitate the financial crisis.
    Just this past week, Lehman Brothers' court-appointed 
bankruptcy examiner report was made public. The report details 
how Lehman Brothers used accounting gimmicks to hide its debt 
and mask its insolvency.
    According to the New York Times, all this happened while a 
team of officials from the Securities and Exchange Commission 
and the Federal Reserve Bank of New York were resident 
examiners in the headquarters of Lehman Brothers.
    As many as a dozen government officials were provided 
desks, phones, computers, and access to all of Lehman's books 
and records. Despite this intense on-site presence, the New 
York Fed and the SEC stood idle while the bank engaged in the 
balance sheet manipulations detailed in the report.
    This raises serious questions regarding the capability of 
the Fed to conduct bank supervision, yet even if supervision of 
its regulated institutions improved, it is not clear that 
oversight really informs monetary policy.
    If supervision does not make monetary policy decisions 
better, then the two do not need to be coupled.
    Vince Reinhart, a former Director of the Fed's Division of 
Monetary Affairs and now a resident scholar at the American 
Enterprise Institution, said that collecting diverse 
responsibilities in one institution is like asking a plumber to 
check the wiring in your basement.
    It seems that when the Fed is responsible for monetary 
policy and bank supervision, its performance in both suffers. 
Microeconomic issues cloud the supervisory judgments, therefore 
impairing safety and soundness.
    There are inherent conflicts of interest where the Fed 
might be tempted to conduct monetary policy in such a way that 
hides its mistakes by protecting the struggling banks it 
supervises.
    An additional problem arises when the supervision of large 
banks is separated from small institutions. Under Senator 
Dodd's proposal, the Fed would supervise 40 or 50 large banks, 
and the other 7,500 or so banks would be under the regulatory 
purview of other Federal and State banking agencies.
    If this were to happen, the Fed's focus on the mega banks 
will inevitably disadvantage the regional and community banks, 
and I think on this, Chairman Bernanke, you and I are in 
agreement, that there ought to be one regulator looking at all 
the institutions.
    H.R. 3311, the House Republican regulatory reform plan, 
would correct these problems. It would refocus the Fed on its 
monetary policy mandate by relieving it of its regulatory and 
supervisory responsibilities and reassign them to other 
agencies. By contrast, the regulatory reform legislation passed 
by the House in December represented a large expansion of the 
Fed's regulatory role since its creation almost 100 years ago.
    Senator Dodd has strengthened the Fed even more. His 
regulatory reform bill empowers the Fed to regulate 
systemically significant financial institutions and to enforce 
strict standards for institutions as they grow larger and more 
complex, adopts the Volcker Rule to restrict proprietary 
trading and investment by banks, and creates a new consumer 
financial protection bureau to be housed and funded by the Fed.
    In my view, the Democrats are asking the Fed to do too 
much.
    Thank you again, Mr. Chairman, for holding this hearing. I 
look forward to the testimony.
    Mr. Watt. [presiding] I thank the gentleman for his opening 
statement.
    Let me see if I can try to use some of the chairman's time 
and my time to kind of frame this hearing in a way that we will 
kind of get a balanced view of what folks are saying.
    The Federal Reserve currently has extensive authority to 
regulate and supervise bank holding companies and State banks 
that are members of the Federal Reserve System, and foreign 
branches of member banks, among others.
    Last year, the House passed our financial services reform 
legislation that substantially preserved the Fed's power to 
supervise these financial institutions. The Senate bill 
recently introduced by Senator Dodd, however, would strip the 
Fed's authority to supervise all but approximately the 40 
largest financial institutions.
    This hearing was called to examine the potential policy 
implications of stripping regulatory and supervisory powers 
over most banks from the Fed, especially the potential impact 
this could have on the Fed's ability to conduct monetary policy 
effectively.
    Proponents of preserving robust Fed supervision authority 
cite three main points to support their position that the Fed 
should retain broad supervisory powers.
    First, they say that the Fed has built up over the years 
deep expertise in microeconomic forecasting of financial 
markets and payment systems which allows the effective 
consolidated supervision of financial institutions of all sizes 
and allows effective macro prudential supervision over the 
financial system. Proponents of retaining Fed supervision say 
this expertise would be costly and difficult if not impossible 
to replicate in other agencies.
    Second, the proponents say that the Fed's oversight of the 
banking system improves this ability to carry out central 
banking responsibilities, including the responsibility for 
responding to financial crises and making informed decisions 
about banks seeking to use the Fed's discount window and lender 
of last resort services.
    In particular, proponents say that knowledge gained from 
direct bank supervision enhances the safety and soundness of 
the financial system because the Fed can independently evaluate 
the financial condition of individual institutions seeking to 
borrow from the discount window, including the quality and 
value of these institutions' collateral and their overall loan 
portfolio.
    Third, proponents say that the Fed's supervisory activities 
provide the Fed information about the current state of the 
economy and the financial system that influences the FOMC in 
its execution of monetary policy, including interest rate 
setting.
    On the flip side, there obviously are many critics of the 
Fed's role in bank supervision. Some of these critics blast the 
Fed for keeping interest rates too low for too long in the 
early 2000's, which some say fueled an asset price bubble in 
the housing market and the resulting subprime mortgage crisis.
    Consumer advocates and others accuse the Fed of turning a 
blind eye to predatory lending throughout the 1990's and 
2000's, reminding us that Congress passed the HOEPA legislation 
in 1994 to counteract predatory lending, but the Fed did not 
issue final rules until well after the subprime crisis was out 
of control.
    Other critics accuse the Fed of ignoring the consumer 
protection role during supervisory examinations of banks and 
financial institutions across a wide range of financial 
products, including overdraft fees and credit cards and other 
things.
    Perhaps the appropriate policy response lies somewhere 
between the proponents and critics of the Fed bank supervision.
    I have tried to keep an open mind about the role of the Fed 
going forward, and hope to use today's hearing to get more 
information as we move forward to discussions with the Senate, 
if the Senate ever passes a bill.
    We are fortunate to have both the current Chairman and a 
former Chairman who are appearing today to inform us on these 
difficult issues, and with that, I will reserve the balance of 
our time and recognize Dr. Paul, my counterpart, the ranking 
member of the subcommittee.
    Dr. Paul. I thank the chairman for yielding.
    Yesterday was an important day because it was the day the 
FOMC met and the markets were hanging in there, finding out 
what will be said at 2:15, and practically, they were looking 
for two words, whether or not two words would exist: ``extended 
period.'' That is, whether this process will continue for an 
extended period.
    This, to me, demonstrates really the power and the control 
that a few people have over the entire economy. Virtually, the 
markets stand still and immediately after the announcement, 
billions of dollars can be shifted, some lost and some profits 
made.
    It is a system that I think does not have anything to do 
with free market capitalism. It has to do with a managed 
economy and central economic planning. It is a form of price 
fixing. Interest rates fixed by the Federal Reserve is price 
fixing, and it should have no part of a free market economy. It 
is the creation of credit and causing people to make mistakes, 
and also it facilitates the deficits here.
    Congress really does not want to challenge the Fed because 
they spend a lot. Without the Fed, interest rates would be very 
much higher.
    To me, it is a threat to those of us who believe in 
personal liberty and limited government. Hardly does the 
process help the average person. Unemployment rates stay up at 
20 percent. The little guy cannot get a loan. Yet, Wall Street 
is doing quite well.
    Ultimately, with all its power, the Fed still is limited. 
It is limited by the marketplace, which can inflate like crazy. 
It can have financial bubbles. It can have housing bubbles. 
Eventually, the market says it is too big and it has to be 
corrected, but the mistakes have been made.
    They come in and the market demands deflation. Of course, 
Congress and the Fed do everything conceivable to maintain 
these bubbles.
    It is out of control. Once the change of attitude comes, 
when that inflated money supply decides to go into the market 
and prices are going up, once again the Fed will have 
difficulty handling that.
    The inflationary expectations and the velocity of money are 
subjectively determined, and no matter how objective you are 
about money supply, conditions, and computers, you cannot 
predict that.
    We do not know what tomorrow will bring or next year. All 
we know is that the engine is there, the machine is there, the 
high powered money is there, and of course, we will have to 
face up to that some day.
    The monetary system is what breeds the risky behavior. That 
is what we are dealing with today. Today, we are going to be 
talking about how we regulate this risky behavior, but you 
cannot touch that unless we deal with the subject of how the 
risky behavior comes from easy money, easy credit, artificially 
low interest rates, and the established principle from 1913 on 
that the Federal Reserve is there to be the lender of last 
resort.
    As long as the lender of last resort is there, all the 
regulations in the world will not touch it and solve that 
problem.
    I yield back.
    Mr. Watt. I thank the gentleman for his opening statement. 
I think we have about 1 minute and 30 seconds left, which is 
yielded to Mr. Sherman.
    Mr. Sherman. Thank you, Mr. Chairman. ``Too-big-to-fail'' 
is ``too-big-to-exist.'' As we examine the power of the Fed, it 
begs the question, what about the provisions that prevent an 
audit of the Fed? The Fed is exempted from audits, not only in 
the area of monetary policy but also foreign agreements.
    All of the efforts by the Fed to defend their exclusion 
from audit have focused on well, that could affect monetary 
policy, which begs the question, why is the Fed demanding an 
exemption or continuation of an exemption of its foreign 
agreements from the audit process?
    If supervision informs monetary policy, then we have to ask 
why the other bank supervisors are unwilling to share 
information with the Fed and why economic statistics are not 
being shared, not only with the Fed but with the American 
people.
    Finally, as the Supreme Court decides that corporations who 
hold government posts by spending unlimited amounts of money on 
campaigns, at least there in order to get a particular person 
selected for governmental authority, they have to convince 
humans to vote for them.
    The one exception to that is the Fed regional boards where 
corporations get to select who sits on these boards and who 
exercises governmental power without them being responsible to 
the voters at all.
    In a democracy, every agency of governmental power should 
be responsible for the electorate.
    I yield back.
    Mr. Watt. I thank the gentleman for his opening statement.
    We are fortunate to have the Chairman of the Board of 
Governors of the Federal Reserve, the Honorable Ben Bernanke, 
and the Chairman of the President's Economic Recovery Advisory 
Board, and former Chairman of the Federal Reserve, the 
Honorable Paul Volcker.
    We will recognize the Chairman first, and then, Mr. 
Volcker.

STATEMENT OF THE HONORABLE BEN S. BERNANKE, CHAIRMAN, BOARD OF 
                GOVERNORS OF THE FEDERAL RESERVE

    Mr. Bernanke. Thank you, Chairman Watt, Ranking Member 
Bachus, and other members of the committee.
    I am pleased to have the opportunity to discuss the Federal 
Reserve's role in bank supervision and the actions that we are 
taking to strengthen our supervisory oversight.
    Like many central banks around the world, the Federal 
Reserve cooperates with other agencies in regulating and 
supervising the banking system.
    Our specific responsibilities include the oversight of 
about 5,000 bank holding companies, including the umbrella 
supervision of large complex financial firms, the supervision 
of about 850 banks nationwide that are both State chartered and 
members of the Federal Reserve System, so-called ``State member 
banks,'' and the oversight--
    Mr. Watt. Will the gentleman pause for just a second? 
Ma'am, you are going to have to take that sign out of here. I 
am sorry. You are breaking the rules. You are either going to 
have to leave or we will have to have you removed or you will 
have to take the sign out.
    Any time today would be nice, ma'am. Thank you.
    Chairman Bernanke, you can resume.
    Mr. Bernanke. The Federal Reserve's involvement in 
regulation and supervision confers two broad sets of benefits 
to the country. First, because of its wide range of expertise, 
the Federal Reserve is uniquely suited to supervise large 
complex financial organizations and to address both safety and 
soundness risks and risks to the stability of the financial 
system as a whole.
    Second, the Federal Reserve's participation in the 
oversight of banks of all sizes significantly improves its 
ability to carry out its central banking functions, including 
making monetary policy, lending through the discount window, 
and fostering financial stability.
    The financial crisis has made it clear that all financial 
institutions that are so large and interconnected that their 
failure could threaten the stability of the financial system 
and the economy must be subject to strong consolidated 
supervision.
    Promoting the soundness and safety of individual banking 
organizations requires the traditional skills of bank 
supervisors, such as expertise in examination of risk 
management practices. The Federal Reserve has developed such 
expertise in its long experience supervising banks of all 
sizes, including community banks and regional banks.
    The supervision of large complex financial institutions and 
the analysis of potential risks to the financial system as a 
whole requires not only traditional examination skills, but 
also a number of other forms of expertise, including: 
macroeconomic analysis and forecasting; insight into sectoral, 
regional, and global economic developments; knowledge of a 
range of domestic and international financial markets, 
including money markets, capital markets, and foreign exchange 
and derivatives markets; and a close working knowledge of the 
financial infrastructure, including payment systems and systems 
for clearing and settlement of financial instruments.
    In the course of carrying out its central banking duties, 
the Federal Reserve has developed extensive knowledge and 
experience in each of these areas critical for effective 
consolidated supervision.
    For example, Federal Reserve staff members have expertise 
in macroeconomic forecasting for the making of monetary policy, 
which is important for helping to identify economic risks to 
institutions and to markets.
    In addition, they acquire in-depth market knowledge through 
daily participation in financial markets to implement monetary 
policy and to execute financial transactions on behalf of the 
U.S. Treasury.
    Similarly, the Federal Reserve's extensive knowledge of 
payment and settlement systems has been developed through its 
operation of some of the world's largest such systems, its 
supervision of key providers of payment and settlement 
services, and its long-standing leadership in the International 
Committee on Payment and Settlement Systems.
    No other agency can or is likely to be able to replicate 
the breadth and depth of relevant expertise that the Federal 
Reserve brings to the supervision of large complex banking 
organizations and the identification and analysis of systemic 
risks.
    Even as the Federal Reserve's central banking functions 
enhance supervisory expertise, its involvement in supervising 
banks of all sizes across the country significantly improves 
the Federal Reserve's ability to effectively carry out its 
central bank responsibilities.
    Perhaps most important, as this crisis has once again 
demonstrated, the Federal Reserve's ability to identify and 
address diverse and hard-to-predict threats to financial 
stability depends critically on the information, expertise, and 
powers that it has as both a bank supervisor and a central 
bank, not only in this crisis, but also in episodes such as the 
1987 stock market crash and the terrorist attacks of September 
11, 2001.
    The Federal Reserve's supervisory role was essential for it 
to contain threats to financial stability.
    The Federal Reserve making of monetary policy and its 
management of the discount window also benefit from its 
supervisory experience.
    Notably, the Federal Reserve's role as the supervisor of 
State member banks of all sizes, including community banks, 
offers insights about conditions and prospects across the full 
range of financial institutions, not just the very largest, and 
provides useful information about the economy and financial 
conditions throughout the Nation. Such information greatly 
assists in the making of monetary policy.
    The legislation passed by the House last December would 
preserve the supervisory authority that the Federal Reserve 
needs to carry out its central banking functions effectively.
    The Federal Reserve strongly supports ongoing efforts in 
the Congress to reform financial regulation and to close 
existing gaps in the regulatory framework. While we await 
passage of comprehensive reform legislation, we have been 
conducting an intensive self-examination of our regulatory and 
supervisory performance and have been actively implementing 
improvements.
    On the regulatory side, we have played a key role in 
international efforts to ensure that systemically critical 
financial institutions hold more and higher quality capital, 
have enough liquidity to survive highly stressed conditions, 
and meet demanding standards for company wide risk management.
    We also have been taking the lead in addressing flawed 
compensation practices by issuing proposed guidance to help 
ensure that compensation structures at banking organizations 
provide appropriate incentives without encouraging excessive 
risk-taking.
    Less formally, but equally important, since 2005, the 
Federal Reserve has been leading cooperative efforts by market 
participants and regulators to strengthen the infrastructure of 
a number of key markets, including the markets for security 
repurchase agreements and the markets for credit derivatives 
and other over-the-counter derivative instruments.
    To improve both our consolidated supervision and our 
ability to identify potential risks to the financial system, we 
have made substantial changes to our supervisory framework so 
that we can better understand the linkages among firms and 
markets that have the potential to undermine the stability of 
the financial system.
    We have adopted a more explicitly multi-disciplinary 
approach, making use of the Federal Reserve's broad expertise 
in economics, financial markets, payment systems, and bank 
supervision, to which I alluded earlier.
    We are also augmenting our traditional supervisory approach 
that focuses on firm by firm examinations with greater use of 
horizontal reviews and to look across a group of firms to 
identify common sources of risks and best practices for 
managing those risks.
    To supplement information from examiners in the field, we 
are developing an off-site enhanced quantitative surveillance 
program for large bank holding companies that will use data 
analysis and formal modeling to help it identify 
vulnerabilities at both the firm level and for the financial 
sector as a whole.
    This analysis will be supported by the collection of more 
timely detailed and consistent data from regulated firms.
    Many of these changes draw on the successful experience of 
the Supervisory Capital Assessment Program (SCAP), also known 
as the ``banking stress test,'' which the Federal Reserve led 
last year.
    As in the SCAP, representatives of primary and functional 
supervisors will be fully integrated in the process, 
participating in the planning and execution of horizontal exams 
and consolidated supervisory activities.
    Improvements in the supervisory framework will lead to 
better outcomes only if day-to-day supervision is well 
executed, with risks identified early and promptly remediated.
    Our internal reviews have identified a number of directions 
for improvement. In the future, to facilitate swifter and more 
effective supervisory responses, the oversight and control of 
our supervisory function will be more centralized, with shared 
accountability by senior Board and Reserve Bank supervisory 
staff and active oversight by the Board of Governors.
    Supervisory concerns will be communicated to firms promptly 
and at a high level, with more frequent involvement of senior 
bank managers and boards of directors and senior Federal 
Reserve officials.
    Greater involvement of senior Federal Reserve officials and 
strong systematic follow-through will facilitate more vigorous 
remediation by firms.
    Where necessary, we will increase the use of formal and 
informal enforcement actions to ensure prompt and effective 
remediation of serious issues.
    In summary, the Federal Reserve's wide range of expertise 
makes it uniquely suited to supervise large complex financial 
institutions and to help identify risks to the financial system 
as a whole.
    Moreover, the insights provided by our role in supervising 
a range of banks, including community banks, significantly 
increases our effectiveness in making monetary policy and 
fostering financial stability.
    While we await enactment of comprehensive financial reform 
legislation, we have undertaken an intensive self-examination 
of our regulatory and supervisory performance.
    We are strengthening regulations and overhauling our 
supervisory framework to improve consolidated supervision as 
well as our ability to identify potential threats to the 
stability of the financial system. We are taking steps to 
strengthen the oversight and effectiveness of our supervisory 
activities.
    Thank you, and I would be pleased to respond to questions.
    [The prepared statement of Chairman Bernanke can be found 
on page 66 of the appendix.]
    Mr. Watt. We will now hear from the Honorable Paul Volcker, 
Chairman of the President's Economic Recovery Advisory Board, 
and former Chairman of the Federal Reserve.

  STATEMENT OF THE HONORABLE PAUL A. VOLCKER, CHAIRMAN OF THE 
   PRESIDENT'S ECONOMIC RECOVERY ADVISORY BOARD, AND FORMER 
                CHAIRMAN OF THE FEDERAL RESERVE

    Mr. Volcker. I appreciate your invitation to address 
important questions concerning the link between monetary policy 
and Federal Reserve responsibilities for the supervision and 
regulation of financial institutions.
    Before addressing the specific questions you have posed, I 
would like to make clear my long-held view, a view developed 
and sustained by years of experience in the Treasury, the 
Federal Reserve, and in private finance.
    Monetary policy and concerns about the structure and 
condition of banks in the financial system more generally are 
inextricably intertwined, and if you need further proof of that 
proposition, just consider the events of the last couple of 
years.
    Other agencies, certainly including the Treasury, have 
legitimate interests in regulatory policy, but I do insist that 
neither monetary policy nor the financial system will be well 
served if our central bank is deprived from interest in and 
influence over the structure and performance of the financial 
system.
    Today, conceptual and practical concerns about the extent, 
the frequency, and the repercussions of economic and financial 
speculative excesses have come to occupy our attention.
    The so-called ``bubbles'' are indeed potentially disruptive 
of economic activity. Then important and interrelated questions 
arise for both monetary and supervisory policies. Judgment is 
required about if and when an official response, some form of 
intervention is warranted. If so, is there a role for monetary 
policy, for regulatory actions, or for both?
    How can those judgments and responses be coordinated and 
implemented in real time in the midst of crisis in a matter of 
days?
    The practical fact is the Federal Reserve must be involved 
in those judgments and that decision-making, beyond this broad 
responsibility for monetary policy and its influence on 
interest rates. It is the agency that has the relevant 
technical experience growing out of working in the financial 
markets virtually every day.
    As a potential lender of last resort, the Fed must be 
familiar with the condition of those to whom it lends.
    It oversees and participates in the basic payment system, 
domestically and internationally.
    In sum, there is no other official institution that has the 
breadth of institutional knowledge, the expertise, and the 
experience to identify market and institutional 
vulnerabilities.
    It also has the capability to act on very short notice. The 
Federal Reserve, after all, is the only agency that has 
financial resources at hand in amounts capable of emergency 
response.
    More broadly, I believe the experience demonstrates 
conclusively that the responsibilities of the Federal Reserve 
with respect to maintaining economic and financial stability 
require close attention to manage beyond the specific confines 
of monetary policy, if we interpret monetary policy narrowly, 
as influencing monetary aggregates and short-term interest 
rates.
    For instance, one recurring challenge in the conduct of 
monetary policy is to take account of the attitudes and 
approaches of banking supervisors as they act to stimulate or 
to restrain bank lending, and as they act to adjust capital 
standards of financial institutions.
    The need to keep abreast of rapidly developing activity in 
other financial markets, certainly including the markets for 
mortgages and derivatives, has been driven home by the recent 
crisis.
    None of this to my mind suggests the need for regulatory 
and supervisory authority to lie exclusively in the Federal 
Reserve. In fact, there may be advantages in some division of 
responsibilities.
    A single regulator may be excessively rigid and insensitive 
to market developments, but equally clearly, we do not want 
competition and laxity among regulators aligning with 
particular constituencies or exposed to narrow political 
pressures.
    We are all familiar in the light of all that has happened 
with weaknesses in supervisory oversight, with failures to 
respond to financial excesses in a timely way and with gaps in 
authority. Those failings spread in one way or another among 
all the relevant agencies, not excepting the Federal Reserve.
    Both law and practice need reform. However these issues are 
resolved, I do believe the Federal Reserve, our central bank, 
with the broadest economic responsibility, with a perceived 
mandate for maintaining financial stability, with the strongest 
insulation against special political or industry pressures, 
must maintain a significant presence with real authority in 
regulatory and supervisory matters.
    Against that background, I respond to the particular points 
you raised in your invitation.
    I do believe it is apparent that regulatory arbitrage and 
the fragmentary nature of our regulatory system did contribute 
to the nature and extent of the financial crisis. That crisis 
exploded with a vengeance outside the banking system, involving 
investment banks, the world's largest insurance company, and 
government-sponsored agencies.
    Regulatory and supervisory agencies were neither reasonably 
equipped nor conscious of the extent of their responsibilities. 
Money market funds growing over several decades were 
essentially a pure manifestation of regulatory arbitrage.
    Attracting little supervisory attention, they broke down 
under pressure, a point of significant systemic weakness, and 
the remarkable rise of the subprime mortgage market developed 
through a variety of channels, some without official oversight.
    There are large questions about the role and supervision of 
the two hybrid public/private organizations that came to 
dominate the largest of all our capital markets, that for 
residential mortgages.
    Undeniably, in hindsight, there were weaknesses and gaps in 
the supervision of well-established financial institutions, 
including banking institutions, major parts of which the 
Federal Reserve carries direct responsibility.
    Some of those weaknesses have been and should have been 
closed by more aggressive regulatory approaches, but some gaps 
and ineffective supervision of institutions owning individual 
banks and small thrifts were loopholed, expressly permitted by 
legislation.
    As implied by my earlier comments, the Federal Reserve, by 
the nature of its core responsibilities, is thrust into direct 
operational contact with financial institutions and markets.
    Beyond those contacts, the 12 Federal Reserve banks 
exercising supervisory responsibilities provide a window into 
both banking developments and economic tendencies in all 
regions of the country.
    In more ordinary circumstances, intelligence gleaned on the 
ground about banking attitudes and trends will supplement and 
color forecasts and judgments emerging from other indicators of 
economic activity.
    When the issue is timely identification of highly 
speculative and destabilizing bubbles, a matter that is both 
important and difficult, then there are implications for both 
monetary and supervisory policy.
    Finally, the committee has asked about the potential impact 
of stripping the Federal Reserve of direct supervisory and 
regulatory power over the banks and other financial 
institutions, and whether something can be learned about the 
practices of other nations.
    Those are not matters that permit categorical answers good 
for all time. International experience varies. Most countries 
maintain a position, often a strong position, and a typically 
strong position for central banks' financial supervision. In 
some countries, there has been a formal separation.
    At the extreme, all form of supervisory regulatory 
authority over financial institutions was consolidated in the 
U.K. into one authority, with rather loose consultative links 
to the central bank. The approach was considered attractive as 
a more efficient arrangement, avoiding both agency rivalries 
and gaps or inconsistencies in approach.
    The sudden pressure of the developing crisis revealed a 
problem in coordinating between the agency responsible for the 
supervision, the central bank, which needed to take action, and 
the Treasury.
    The Bank of England had to consider intervention with 
financial support without close and confident appraisals of the 
vulnerability of affected institutions. As a result, I believe 
the U.K. itself is reviewing the need to modify their present 
arrangements.
    For reasons that I discussed earlier, I do believe it would 
be a really grievous mistake to insulate the Federal Reserve 
from direct supervision of systemically important financial 
institutions.
    Something important but less obvious would also be lost if 
the present limited responsibilities for smaller member banks 
were to be ended. The Fed's regional roots would be weaker and 
an useful source of information lost.
    I conclude with one further thought. In debating regulatory 
arrangements and responsibilities appropriate for our national 
markets, we should not lose sight of the implications for the 
role of the United States in what is in fact a global financial 
system.
    We necessarily must work with other nations and their 
financial authorities. The United States should and does still 
have substantial influence in those matters, including 
agreement on essential elements of regulatory and supervisory 
policies.
    It is the Federal Reserve as much as and sometimes more 
than the Treasury that carries a special weight in reaching the 
necessary understandings. That is a matter of tradition, 
experience, and of the perceived confidence in the authority of 
our central bank.
    There is a sense of respect and confidence around the 
world, matters that cannot be prescribed by law or easily 
replaced.
    Clearly, changes need to be made in the status quo. That is 
certainly true within the Federal Reserve. I believe regulatory 
responsibilities should be more clearly focused and supported. 
The crisis has revealed the need for change within other 
agencies as well.
    Consideration of broader reorganization of the regulatory 
and supervisory arrangements is timely. At the same time, I 
urge in your deliberations that you do recognize what would be 
lost, not just in the safety and soundness of our national 
financial system, but in influencing and shaping the global 
system, if the Federal Reserve were to be stripped of its 
regulatory and supervisory responsibilities, and no longer be 
recognized here and abroad as ``primus inter pares'' among the 
agencies concerned with the safety and soundness of our 
financial institutions.
    Let us instead strengthen what needs to be strengthened and 
demand high levels of competence and performance that for too 
long we have taken for granted.
    Thank you, ladies and gentlemen.
    [The prepared statement of Chairman Volcker can be found on 
page 100 of the appendix.]
    Mr. Watt. I thank both the Chair and former Chair for your 
statements. We will now recognize the members for 5 minutes of 
questions. I will remind the members that there is a second 
panel of witnesses, so we want to try to stick to the 5 
minutes.
    I will recognize myself first for 5 minutes.
    Chairman Bernanke, the current system we have has a 
division of supervisory responsibilities between the Fed, the 
FDIC, the OCC, and I guess a fourth agency that would be 
consolidated under the House bill. How has that worked and how 
have you been able to compensate for the things that you say 
are so critical in that framework?
    Mr. Bernanke. Mr. Chairman, I think there were some flaws 
at each level. There were flaws at the level of the legislative 
structure. There were flaws at the level of execution. I think 
we need to look at all of those.
    I think there are two main lessons from the crisis. One is 
that every systemically critical large institution needs to 
have a consolidated supervisor that can look at the whole 
company and understand the risks that are faced by that 
company.
    Many of the worst problems in the investment banks and AIG 
and in other companies and markets were areas where there was 
no strong supervisor, where there was just a gap. We need to 
fix that as we go forward.
    We also, I think, need to strengthen the concept of 
consolidated supervision. We currently have a system where each 
supervisor is assumed to defer to the functional regulator of 
each subsidiary, and in some cases, that is not appropriate. 
When a consolidated supervisor sees a problem in a subsidiary, 
it needs the authority to go in and look at that.
    The other broad concern, the other thing we learned from 
the crisis at the very highest level, is the need to look at 
the system from a systemic perspective, not just look at each 
individual firm, but to look at broad risks to the whole 
system.
    I think that some of the ideas which have been advanced in 
the House bill and Senator Dodd's proposal, such as creating a 
systemic risk council, and broadening the responsibilities of 
some of the regulators, would help address that problem, and 
together with tougher regulations like higher capital 
standards, I think that would improve our oversight 
considerably.
    Mr. Watt. The Dodd bill that was recently introduced sets a 
$50 billion threshold for supervision of the Fed. Is there any 
rationale for either that $50 billion threshold or any other 
threshold? How does this cut in terms of actual need to be able 
to be involved in these things to determine or set monetary 
policy?
    Mr. Bernanke. Mr. Chairman, we are quite concerned by 
proposals to make the Fed a regulator only of the biggest 
banks. It makes us essentially the ``too-big-to-fail'' 
regulator. We do not want that responsibility.
    We want to have a connection to Main Street as well as to 
Wall Street. We need to have insights into what is happening in 
the entire banking system to understand how regulation affects 
banks, to understand the status of the assets and credit 
problems of banks at all levels, all sizes, and smaller and 
medium-sized banks are very valuable to us and they provide 
irreplaceable information, both in terms of making monetary 
policy and in terms of us understanding the economy, but also 
in terms of financial stability.
    Let's not forget that small institutions have been part of 
financial crises in the past, including in the 1930's, in the 
thrift crisis, and other examples.
    We think it is very important for the Federal Reserve not 
to be just the big institution regulator. We need to have 
exposure to the entire economy and to the broad financial 
system.
    Mr. Watt. Chairman Volcker, you indicated that some 
division of supervisory and regulatory responsibility is 
appropriate. I am trying to get a better view of what you think 
that division should be if neither the Senate bill nor the 
House bill is necessarily ideal.
    Mr. Volcker. If you are going to have more than one 
regulatory agency, and I have some sympathy for that, you have 
to have some division of responsibility.
    Just where you place that, I do not know. I do not know the 
implications of the $50 billion. I do not know how many banks 
are below $50 billion offhand, and if the Federal Reserve 
maintained a small number of member bank supervision, what the 
FDIC would have and what the OCC would have. I think that is a 
practical and maybe pretty arbitrary matter in the last 
judgment.
    I do think we do not want to signal out some institutions 
as ``too-big-to-fail.'' I think we want a system in which 
particularly non-banking institutions can fail. That brings up 
many other issues in financial reform that do not rest 
significantly on precise quantitative amounts.
    Mr. Watt. My time has expired. I will recognize the 
gentleman, Mr. Bachus.
    Mr. Bachus. Thank you. Chairman Bernanke, was the New York 
Fed aware that Lehman Brothers was using an accounting gimmick, 
repo 105?
    Mr. Bernanke. Congressman, first of all, the Federal 
Reserve was not the supervisor of Lehman Brothers, and indeed, 
one of the issues I was talking about was that under the 
existing system, an investment bank like Lehman Brothers would 
not have a consolidated supervisor. We did not have that 
information.
    We had only a couple of people in the company whose primary 
objective was to make sure we got paid back the money we were 
lending to Lehman through our primary lender credit facility. 
We were not the supervisor, and in any case, we would not have 
had the authority to address accounting and disclosure issues 
in that context.
    Mr. Bachus. The Federal Reserve had run three stress tests 
on Lehman and in the course of those stress tests, would you 
not have found out they were using this accounting gimmick?
    Mr. Bernanke. No, sir. These were liquidity stress tests. 
The objective was to discover whether they had enough liquidity 
to deal with a stressed situation, and they failed all three 
tests. That was information we shared with the SEC and with 
Lehman Brothers.
    Mr. Bachus. The argument that you and former Chairman 
Volcker have used is as the lender of last resort, you must 
have direct access to bank data to assess the creditworthiness 
and collateral of a would-be borrower, but the New York Fed 
made the discount window available for cheap money with this 
going on.
    I will ask Chairman Volcker, does that not trouble you? 
Then, I will ask Chairman Bernanke.
    Mr. Bernanke. We assess the value of the collateral. We put 
in an extra haircut because we were concerned about the 
solvency of the company, and we were repaid fully. That part of 
it worked fine.
    Again, we were not charged with supervising the company. 
Clearly, it was a very troubled company. If we had some kind of 
provision to take a non-bank into receivership, we would have 
applied that in the case of Lehman.
    Mr. Bachus. All right. Thank you. Chairman Volcker?
    Mr. Volcker. I think this is an example of why we need some 
pretty thorough reform, so that an institution of that size 
would have some official oversight.
    I would also hope that if we have the kind of reform that 
is being talked about, the issue of the Federal Reserve lending 
to those institutions, non-bank institutions, would not be 
relevant because if push came to shove and they were failing, 
it would come under the so-called ``resolution authority'' that 
would have the power and resources to provide a suitable 
liquidation or merger of that institution.
    The Federal Reserve would not have to get directly involved 
as a lending organization.
    Mr. Bachus. They should not be lending money to failing 
institutions?
    Mr. Volcker. Not ordinarily.
    Mr. Bachus. Through the discount lending window.
    Mr. Volcker. Quite true. We want a system so they would not 
be put in that dilemma, to save the rest of the market, so to 
speak. We want to have a system that can provide--
    Mr. Bachus. Do you support our efforts to not allow under 
Section 13(3), the bailouts that you have seen in the last 
year? Senator Dodd says 13(3) cannot be used, and the House 
Republicans also had a provision saying 13(3) cannot be used 
for an ad hoc bailout of a non-bank financial institution. Do 
you agree?
    Mr. Volcker. If you had the resolution authority, you would 
not need 13(3).
    Mr. Bachus. Let me ask you, you said in your testimony in 
debating regulatory arrangements and responsibilities 
appropriate for our national markets, we should not lose sight 
of the implications for the role of the United States in what 
is in fact a global economy. We necessarily must work with 
other nations and their financial authorities.
    How about the Volcker Rule? What if the proposed 
limitations on proprietary trading--what if other countries do 
not adopt that? Would that put us at a disadvantage, and could 
we instead use sort of capital requirements and maybe 
restrictions on leveraging or restrictions on coming to the 
discount window for cheap money?
    Mr. Volcker. I think that question is a little premature. 
The first thing we ought to do is get other countries to go 
along, and then we would not face that kind of a problem. I am 
hopeful that will be the result.
    Mr. Bachus. If they do not?
    Mr. Volcker. If they do not, I think we should still apply 
it in the United States, but in American institutions, I think 
it would present relatively minor problems.
    Mr. Bachus. All right.
    Mr. Volcker. These activities we are talking about, just so 
I am clear, are a small part of the activity of very few 
American banks.
    Mr. Bachus. Thank you.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from Pennsylvania, Mr. Kanjorski, is recognized for 5 minutes.
    Mr. Kanjorski. Thank you very much, Mr. Chairman.
    Chairman Bernanke, if I may ask, I heard you refer to some 
loopholes and legislative holes in things you can or cannot do.
    It brought to mind, has the Federal Reserve done a critique 
of the legislation put together by this committee and passed in 
the House, and a critique of the Dodd bill, so that we can have 
a criticism as to whether or not any loopholes exist that 
should be covered or if not covered, what the impact will be?
    Mr. Bernanke. No, sir. We do not have a specific critique 
of these individual bills. We have been pretty clear about what 
we think is the right approach. I would be happy to discuss any 
specific item.
    Mr. Kanjorski. Could I make the request of you, and I 
appreciate the discussion and having an open discussion like 
that, but could I ask you if you could have your experts really 
make those thorough reviews so that if there are any loopholes 
that have to be closed or considered or at least identified--
there are many members of the committee, including myself, who 
would not recognize a loophole if we walked into it.
    I am sure the expertise of the Federal Reserve sees them 
and sees the tilt light go off that they are there. I would 
like to be informed about it.
    If you could have your experts at the Federal Reserve 
review our piece of legislation that passed the House and the 
Dodd bill and any other bill that ultimately comes out of the 
Senate, to give us that critique so that we may use that 
critique when we go to the conference committee to address 
those loopholes?
    Mr. Bernanke. Congressman, what we have been doing is 
trying to provide technical assistance on each issue. We do not 
want to overstep our bounds and say, this is good and that is 
bad. We like to help wherever we can.
    Mr. Kanjorski. That is part of the legislation I am 
responsible for. Do not worry about overstepping bounds.
    Mr. Bernanke. Okay.
    Mr. Kanjorski. Mr. Volcker, unfortunately, we did not have 
the Volcker Rule before us when we went through the House side 
of regulatory reform, but now obviously, it is included in the 
Dodd bill.
    I guess I have two questions: one, did the Dodd bill 
include the entire Volcker Rule or are there important portions 
of it that have been left out that you think we should look at 
or address if we go to conference; and two, if you could for 
the record indicate why you think it is so important that we 
have mandatory provisions such as the Volcker Rule?
    Mr. Volcker. The first part of your question, I do think 
the Dodd bill makes a big step forward. There may be a few 
areas where I think maybe additional clarification would be 
desirable.
    I am out of office so I have no reluctance to overstate my 
ability to make comments.
    Mr. Kanjorski. I am inviting you to.
    Mr. Volcker. I do think it has to be mandatory because I 
have been a regulator, I have been a supervisor, and I have 
observed regulators and supervisors. It is very hard to take 
tough restrictive measures before the crisis, and after the 
crisis, of course, it is too late.
    I really think in an area like this where the rationale to 
me at least is quite clear, the law should say as specifically 
and as mandatorily as possible, and I think the Dodd bill, as I 
understand it, goes considerably in that direction.
    Mr. Kanjorski. Very good. In view of the fact that there 
are so many members, Mr. Chairman, I will yield back what 
balance of time I have.
    Mr. Watt. I thank the gentleman. The gentleman from Texas, 
Dr. Paul, the ranking member of the subcommittee.
    Dr. Paul. Thank you, Mr. Chairman. I have a question for 
Chairman Bernanke.
    During the early part of the decade, a lot of the free 
market economists keet saying, well, interest rates have been 
too low for too long, and there was a financial bubble and a 
housing bubble, and there had to be a correction.
    Of course, we did in 2008. Since 2008, many of the 
mainstream economists have more or less agreed with that 
assessment because frequently we will hear them say interest 
rates were held too low for too long, and I think even 
Secretary Geithner has made that statement.
    Where do you come down on that perception? Do you think 
interest rates were held too low for too long?
    Mr. Bernanke. Congressman, I have given a speech on this. I 
think the bottom line is, nobody really knows for sure, but 
that the evidence is really quite mixed.
    I would say even if they were too low for too long, the 
magnitude of the error was not big enough to account for the 
huge crisis we had. I think what caused the crisis were the 
failures of regulation. I would fault the Fed here, too, 
because some of those failures were ours in the sense that we 
did not do enough, and I have admitted this and acknowledged 
this many times, we did not do enough on mortgage regulation.
    I think it was the weakness of the regulatory system, not 
monetary policy, that was most important here.
    Dr. Paul. Of course, I do not agree with that, but if you 
assume for a minute that it was too low for too long, and you 
had perfect regulations, what is the harm done by interest 
rates being too low for too long? Do you see any damage by 
interest rates being artificially low for a long period of 
time? Let's sort that away from regulations for a second.
    Mr. Bernanke. Certainly, one possibility which my 
colleagues to the left know a lot about is that if you keep 
rates too low for too long, you get inflation. Every central 
banker wants to be sure that the price level remains stable. 
That is an important consideration.
    Dr. Paul. Do you think the investor, the businessman, makes 
mistakes if interest rates are lower than say the market? Are 
not low interest rates an indication there are savings and if 
there are no savings but the interest rates are low because of 
newly created credit by the Fed, does that not send a false 
signal to some investors and to some business people?
    Mr. Bernanke. If interest rates are below their normal 
levels, it is because the economy is operating at a very low 
level. Currently, we are not in anything an economist would 
call optimum equilibrium or anything like that.
    We certainly are in a situation where a lot of people are 
out of work and consumption is well below its normal levels and 
low interest rates serve the function of increasing demand and 
putting people back to work.
    Dr. Paul. You do not think that if interest rates are 2 and 
3 percent instead of 6 percent, without artificially low 
interest rates, there would not be a temptation for people to 
build too many houses or people to try to capitalize on the 
fact they are anticipating price inflation and in the bubble?
    Mr. Bernanke. Congressman, interest rates are very low 
right now, and I do not think building too many houses is 
really a problem.
    Dr. Paul. That makes a very important point. In the boom 
part of the cycle, the low interest rates cause people to do 
things that might not be proper and best for the economy, and 
then when the bust comes, we resort to the same policy of 
keeping interest rates extremely low for too long.
    What are the chances--do you think there is any chance in a 
year or two or three from now we will look back and say well, 
not only were they too low for too long in the early part of 
the decade, they were too low for too long in the latter part 
of the decade?
    When the prices start to go up, it is sort of a little bit 
too late, and then you have the job of reigning that all in.
    Mr. Bernanke. It is a difficult--central banking is an art 
and we need to balance our dual mandate. Our dual mandate is to 
maximize employment and price stability. We need to try to find 
an appropriate policy that gets us as close as we can to both 
sides of that mandate.
    Dr. Paul. The free market people say the dependency on 
regulation is just imaginary because the fault is all these 
mistakes being made because they have false information.
    Price fixing, nobody is advocating wage and price controls 
because of all the false information. You cannot run the 
economy with price fixing. That is why socialism fails.
    If you fix the price with interest rates, it is one-half of 
the economy because you are messing around with the monetary 
system, and then all of a sudden instead of dealing with that, 
we say we just need more and smarter regulations and we are 
going to solve all these problems.
    That does not concern you at all?
    Mr. Bernanke. You need some system to set the money supply. 
I guess you are a gold standard supporter.
    Dr. Paul. I am for the Constitution.
    Mr. Bernanke. Every major country currently in the world 
uses a central bank which must make some decision about the 
money supply, whether it is to keep it stable or to move it 
around. Nevertheless, it is a choice that is made.
    Dr. Paul. Then there is no good information for the 
investor, unfortunately.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from California, Mr. Sherman, is recognized for 5 minutes.
    Mr. Sherman. Thank you, Mr. Chairman.
    I do not think the folks in the financial world understand 
the permanent damage done to our social and political 
institutions, done to the social contract by the Wall Street 
bailouts and the prospect of future bailouts which exist as 
long as we allow to exist institutions that we brand as ``too-
big-to-fail.''
    Chairman Volcker, with three Federal prudential supervisors 
plus various States, how can we in the future get consistent, 
comprehensive, and effective regulation and supervision of all 
banks and similar institutions?
    Should there not be a single body for setting out one set 
of rules that all the supervisors would comply consistently?
    Mr. Volcker. Conceptually, there could be one supervisor. I 
think that is the way to go. Many countries have it that way. 
We have a particularly big and complex country and financial 
markets with their own traditions. That has led to a 
multiplicity of regulatory agencies, and I think it is fair to 
say, a certain amount of confusion. We have to do better in 
coordinating what they do. We have been left with extremely 
weak supervision outside the banking system as a matter of 
historic development.
    Let me say on the other side as I said in my statement, and 
this is basically a political decision, there are some 
advantages in having more than one regulator. In many 
instances, I think, countries find a single regulator gets 
pretty rigid in its bureaucracy and there are legitimate 
complaints by the financial institutions that there is too 
little room for innovation and flexibility and freedom.
    On the other hand, I do not want regulatory agencies 
competing with each other in liberalism.
    Mr. Sherman. I can agree with you on that.
    Mr. Volcker. I think what this comes down to--
    Mr. Sherman. I need to interrupt you, because I have two 
other questions to squeeze in.
    Chairman Bernanke, you have outlined the advantages of 
mixing monetary policy and bank supervision. I want to address 
one of the perceived disadvantages. I will ask you not to just 
offset it by saying, well, here are all the advantages, but 
rather address the disadvantages.
    Bureaucracies hate bad headlines. They will often do 
desperate things behind the scenes to avoid that big headline 
from breaking. Prudential regulators are going to get bad 
headlines if a big institution fails, particularly under some 
circumstances, and they can prevent that failure if they can 
just put it off for 6 months. Their reputations and careers can 
be saved.
    Monetary policy, just cutting the interest rate by a 
quarter of a point, can save a troubled institution. How can we 
be sure that monetary policy is not influenced by the natural 
human desire of bank supervisors to save one or two 
institutions for at least long enough for them to move over to 
another department? How do we make sure monetary policy does 
not meet the career needs of bank supervisors?
    Mr. Bernanke. I do not think that is a very realistic 
scenario. If a bank was really that sick, I do not think a 
quarter point interest rate change would help it very much and 
the consequences--
    Mr. Sherman. Every dying patient is on the borderline at 
some point. Yes, there can be circumstances where it is touch 
and go.
    Mr. Bernanke. Again, I do not think that is an efficient 
way or effective way even to achieve that objective. The 
central bank chairman would nevertheless still be presumably 
around and concerned about his or her reputation when the 
economy has excessive inflation or whatever problem might arise 
from that interest rate policy.
    I do not think there is much evidence for that particular 
issue.
    Mr. Sherman. I am going to squeeze in one more question. 
You may have to respond for the record.
    Why should our statutes exempt the Fed from audits of--I 
will quote the statute--``Transactions for or with a foreign 
central bank, government of a foreign country, or a non-profit 
international financial organization,'' and are you willing to 
provide for the record a description of all such transactions 
from the 1990's, where they are old and gold, so we can get an 
idea of what the bank was doing internationally?
    Mr. Bernanke. We have told you--
    Mr. Watt. You have been invited to submit your answer for 
the record.
    Mr. Bernanke. Okay. Thank you.
    Mr. Watt. I think you have already done it on several 
occasions, but do it again.
    Mr. Volcker. Can I make just a brief comment on the 
previous question? I think you put your finger on what is 
sometimes called the ``not on my watch syndrome'' and it does 
not have to be by monetary policy. It could be a direct rescue 
of an institution.
    That is why it is so important to get this resolution 
authority enacted into law in a rigorous way, so that the 
policymaker is not faced with what seems to me to be an awful 
dilemma of letting the institution fail in a messy kind of way 
or rescuing it and contributing--
    Mr. Sherman. I sure hope that resolution authority is not 
just a TARP bailout.
    Mr. Watt. The gentleman's time has expired.
    Mr. Sherman. I thank the chairman.
    Mr. Watt. The gentleman from Texas, Mr. Neugebauer, is 
recognized for 5 minutes.
    Mr. Neugebauer. Thank you, Mr. Chairman.
    Chairmen, I want to go to this process of the Fed being a 
prudential regulator. I go to this point. We have had a lot of 
people coming in here.
    For the last 18 months, we have been trying to find out who 
the bogeyman was in all of the calamity that has happened in 
the financial markets. Everybody who comes in says well, it was 
not my fault.
    I think the bottom line here is under the proposed 
structure by the House version or the Senate version, basically 
in many cases, the Fed had regulatory authority over many of 
these entities that people are saying was part of the problem.
    I guess the question I have is, if it did not work before, 
how does it work now? The second part of that is these very 
large financial institutions, if you had gone into them, let's 
say 18 months ago, and said, we are a little concerned about 
what is going on here, and they said well, we have record 
earnings, we are making lots of money, we have good liquidity, 
we have good balance sheets, our ratios are in place. What do 
you mean you want us to stop originating more mortgages? What 
do you mean you want us to slow down our securitization 
activity? What do you mean you want us to get out of the credit 
default swap business?
    How did you miss it and how would you have done it 
differently? If you are not going to do it differently, then we 
are moving in the wrong direction here.
    I will start off with Chairman Bernanke.
    Mr. Bernanke. That is the $64 billion question you just 
asked.
    Mr. Neugebauer. No, it is the trillion dollar question.
    Mr. Bernanke. There were mistakes and problems throughout 
the system. Regulators, the Federal Reserve, the private 
sector, and even Congress made mistakes in this crisis. The 
only thing we can do is go forward and fix the mistakes.
    We are working at every level. We, of course, are 
recommending changes to the overall statutory structure to 
address gaps and other problems in the system, but we are also 
taking actions ourselves.
    We are strengthening our capital requirements, for example. 
Liquidity turned out to be a big issue in this crisis. We have 
been working internationally to strengthen that substantially.
    I think execution is very important. Within our own 
supervisory system, we have been doing a lot of soul searching 
and a lot of changes and those changes are both at the level of 
the framework for supervision, which we believe needs to be 
more systemic, more so-called ``macro-prudential,'' but also in 
terms of execution.
    We have found situations just like you described, where we 
were not fast enough, we were not forceful enough. We need to 
change our culture, our structure, and our instructions to 
examiners and so on to make sure we do a better job next time.
    Everyone has to do a better job. We are working to do a 
better job. We think there are structural reasons that the 
central bank needs to be involved in this process.
    Mr. Neugebauer. Chairman Volcker?
    Mr. Volcker. Let me make a general point. We have a lot of 
discussion about supervision and gaps and supervisory policies. 
Supervision is a tough job.
    You are dealing with a very complex situation with some 
known and some unknown factors in a political world where your 
tools are limited and you have to be able to explain what you 
are doing, which is very hard to take restrictive rules when 
things are going well.
    Do not put more burdens on the supervisors than are 
necessary. If there are some structural factors in the market 
that you want to promote or eliminate, do it by legislation and 
do not leave everything up to the supervisor, or give the 
supervisor a very clear framework within which to work. The 
more you do that, I think the better off we will be in terms of 
supervision.
    Mr. Neugebauer. I do not disagree with that, Chairman 
Volcker. I am a ``less regulation'' person but I think the 
point is we actually had regulation in place. We had regulators 
in place. I think there is an unreasonable expectation here 
that somehow we are going to fix this.
    We have bank regulators today and we have over 100-some 
banks fail, and the question is, I think some people think 
well, by expanding or reshuffling the deck that we are going to 
have a better outcome. I think we would have had a much better 
outcome if we had people who were doing the job they were 
already supposed to be doing.
    Mr. Volcker. I cannot deny that. There were gaps in 
regulations, gaps in authority. One was large gaps in the 
investment banking area, in my opinion, where a lot of the 
crisis arose.
    You had gaps in the subprime mortgage. You had some 
regulatory authority over some parts of it, but none over other 
parts of it.
    You had a big gap given what we know now, and I keep coming 
back to it because I think it is important, in the resolution 
authority. There was no resolution authority that gave the 
supervisors a reasonably effective and efficient way of closing 
down a non-bank institution with minimal damage.
    That is something you have to legislate.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from New York, Mr. Meeks.
    Mr. Meeks. Thank you, Mr. Chairman. Thank you, Chairman 
Bernanke, and former Chairman Volcker, for your testimony.
    Let me ask Chairman Bernanke first, we have this language 
in the House bill empowering regulators to deal with systemic 
risk. My question to you is, do you think the language that we 
have in the House bill is strong enough to expedite a removal 
of systemic risk or do we need--there was a question, do we 
need something mandatory like the Volcker Rule?
    Mr. Volcker, I would like to get your response on that, 
too.
    Mr. Bernanke. I would like to maybe answer you in writing 
on that because it is a very complicated bill. I think the 
general direction is good, but there are some areas where we 
think if we had our preference, we would make some changes. It 
is a complicated bill.
    Mr. Neugebauer. I would gladly wait for you to give us a 
response in writing, because I want to see if you think you 
have the authority from what we put in there or do not.
    Mr. Volcker?
    Mr. Volcker. I will give you a particular example of what I 
am concerned about and responsive to the previous comment.
    On the so-called ``Volcker Rule,'' a prohibition of 
proprietary trading and hedge funds and equity funds, the House 
bill has a provision and it is kind of voluntary, just turns it 
over to the regulators and the supervisors. In my opinion, it 
is very unlikely that the regulators and supervisors would 
invoke a strict prohibition until a crisis came and then it is 
too late. That is why you want it in legislation.
    Mr. Meeks. The question, I guess, or part of it, and I will 
wait for Chairman Bernanke's response in writing, is would the 
Volcker Rule at least set a floor from which to work?
    I know you said it will be in writing, so I look forward to 
hearing that.
    Let me ask you, Chairman Bernanke, if you added up the 
cumulative working hours at the Fed, could you tell me about 
what percentage of work is spent on bank oversight, on consumer 
protection, on monetary policy, and on monetary systemic risk? 
Is there any way you could tell us how much time is spent 
there?
    Mr. Bernanke. We have separate divisions that work on each 
of those areas to some extent. We are also doing a lot of cross 
disciplinary/multi-disciplinary work. Once again, if I could 
send you data on the number of people in each area, that would 
be more exact than just taking a guess off the top of my head, 
if that would be okay.
    Mr. Meeks. That would be great. Mr. Volcker, from your 
experience when you were Chair of the Fed, could you tell me at 
that time if you know how the Fed spent the majority of its 
time? Was it on bank oversight, bank regulation, or whatever, 
from your experience?
    Mr. Volcker. I must say, through history, I think the 
Federal Reserve activities in this area have varied quite a 
lot, depending upon the leadership in the place.
    Specifically, during my term in office when we had some big 
problems, we were fortunate at one point in having an extremely 
effective head of the supervision area and the regulation area.
    That made a big difference in the effectiveness of the way 
we went about our work, which I think emphasizes the importance 
of having effective people on the job and effective leadership 
in the organization.
    I have been an advocate of something that is in the Dodd 
bill, of having a new position in the Federal Reserve or new in 
the sense of one of the Governors designated as Vice Chairman 
for Supervision.
    I think you need that continuing focus and clear sense of 
responsibility so that the attention that the Federal Reserve 
pays is less subject to ups and downs over time.
    Let's build it into the organization in a way that it has 
not been built, and as conclusively as it should have been, in 
the past.
    Mr. Meeks. I basically agree. Sometimes, and I know in our 
congressional offices, for example, sometimes you have to 
prioritize. An office might prioritize something as being more 
important than others, and those priorities, sometimes in my 
office, that means something else might be subordinate. 
Generally, that is the way things work.
    I am concerned about that but I will wait to see what the 
Chairman sends back. I do have some concerns there. That is 
just generally what people do in offices.
    Mr. Volcker. I think that is why you need this vice 
chairman, to give continuity. It is his priority by law to pay 
attention to this and report to the Congress as appropriate and 
be designated and confirmed on the basis that he had a 
particular responsibility for overseeing the Federal Reserve's 
efforts in that area.
    Mr. Meeks. Thank you.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from California, Mr. Royce, is recognized for 5 minutes.
    Mr. Royce. Thank you, Mr. Chairman.
    Chairman Bernanke, watching the trends in the market for 
Treasuries, it appears as though the two major creditors, which 
would be Japan and China, have begun to scale back their 
purchases of U.S. Government securities.
    Filling the void in demand have been other foreign 
governments or other foreigners, as they say, and I would 
assume that would be foreign banks and hedge funds, and then 
also U.S.-based financial institutions.
    Clearly, there is market play here, the carry trade is in 
effect here by these banks, which essentially amounts to 
borrowing at next to nothing from central banks and lending it 
back to the U.S. Government at 1 or 2 percent, depending on how 
far out they go on the yield curve.
    Have we backed ourselves into a corner here? Essentially, 
if you raise interest rates, the carry trade evaporates, as 
does the demand in the Treasury market, and our ability to 
finance the $1.5 trillion deficit this year.
    Who is going to lend to us if we do that? If foreign 
governments are scaling back and financial institutions can no 
longer make money in this market, where will the demand for 
Treasuries come from?
    Mr. Bernanke. This is a very large and deep market. Indeed, 
when you see stress in other areas around the world, perhaps in 
other countries' fiscal positions, for example, the dollar 
tends to strengthen because money flows into U.S. Treasuries.
    I have not seen any reduction in demand for U.S. 
Treasuries. The foreign demand remains quite strong. I do not 
anticipate any problem.
    I guess there is always the question of price. There, the 
question is, will all our creditors, including domestic 
creditors, remain confident in the long-run fiscal stability of 
the United States, and there, I think it is very, very 
important for the Congress to be devising a plan to create a 
trajectory whereby we have a more stable debt position going 
forward. That is very important.
    Mr. Royce. I concur on the points you have made on that 
publicly. Getting back to the question of the extent that we 
are dependent upon the carry trade to finance our debt, do you 
think there is an element of truth to that point?
    Mr. Bernanke. Sometimes, there is a misunderstanding that 
the carry trade is an arbitrage for pure profit opportunity. It 
is not. When you borrow to buy a long-term security, you are 
taking on considerable risk associated with the longer-term 
life of the security.
    I think what will happen is if short-term interest rates go 
up because the economy strengthens, then long-term rates might 
go up as well. That would affect our cost of financing our 
deficit, another reason to get the deficit under good control.
    The interest rate will do what is necessary to attract the 
demand for our securities. Again, I do not see any reason to 
think there will not be demand for those securities.
    Mr. Royce. Let me ask a question of Mr. Volcker, too. With 
the introduction of Mr. Dodd's legislation in the Senate, we 
now have regulatory reform bills in each chamber that 
institutionalize rather than eliminate this ``too-big-to-fail'' 
concept.
    The ultimate cost of ``too-big-to-fail'' will be borne by 
our capital markets and the broader economy.
    The approach put forward in these bills essentially 
bifurcates our financial system and those institutions that 
will be labeled systemically significant will likely see lower 
borrowing costs and greater access to capital compared to their 
smaller competitors.
    That would give these firms a significant competitive 
advantage. This is what happened with Fannie Mae and Freddie 
Mac. They wiped out the competition and they formed a duopoly 
over the prime secondary mortgage market because they were 
perceived to be government-backed.
    Mr. Volcker, are we recreating the moral hazard problem 
found at Fannie and Freddie by labeling these institutions 
``too-big-to-fail?'' How would you expect creditors and 
counterparties of these institutions to react to this label or 
even make the label official?
    Mr. Volcker?
    Mr. Volcker. When you talk about Fannie and Freddie in 
particular, and the moral hazard in the mortgage market, the 
moral hazard with respect to those institutions, I think it is 
very real and it will be a real challenge to change that in the 
future. You are not going to do it right now.
    The mortgage market is wholly dependent or mostly dependent 
on government participation, including support for Fannie Mae 
and Freddie Mac. You are stuck with it.
    I do not think we want to get ourselves in that position in 
the future. I hope that is on your agenda next year, and we 
reorganize the mortgage market.
    So far as other financial institutions are concerned, I 
hope your opening comment that both bills institutionalize 
``too-big-to-fail'' is not correct. I understand your concern 
about labeling an institution implicitly as ``too-big-to-
fail.'' I do not want to do that, which is part of the reason 
hiding behind or in the forefront of the kind of proposal I 
like, I do not want that presumption to exist particularly for 
non-banks. I want it to exist for banks as little as possible 
but banks do have access to the Federal Reserve. I do not think 
we are going to change that. They do have deposit insurance. 
They also are heavily regulated, and that is the balance. They 
do not have that much competitive advantage.
    The other ones, I do not want to have any competitive 
advantage. If they are extremely vulnerable, they will get some 
regulation, but they should not have any expectation they are 
going to be bailed out.
    Mr. Watt. The gentleman's time has expired.
    Mr. Royce. Thank you, Mr. Volcker.
    Mr. Volcker. That is the point behind my concerns.
    Mr. Royce. I understand.
    Mr. Watt. The gentleman's time has expired. The gentlelady 
from New York, Ms. Maloney.
    Mrs. Maloney. Thank you. Welcome, particularly to Paul 
Volcker, who is a proud resident of the great State of New 
York, and we are very proud of your many years of contributions 
to our country and your public service.
    There is a great deal of concern about the proposal in the 
Dodd bill in the Senate regulatory reform proposal that limits 
the Fed's banking supervision to banks that are larger than $50 
billion. First of all, do you see a need to make the 
distinction between large and small banks?
    I would specifically like to comment on the Federal 
Reserve's interest rate setting body, the Federal Open Market 
Committee, which met yesterday. It is comprised of Federal 
Reserve Governors, the President of the New York Fed, and on a 
rotating basis, the presidents of five of the 11 regional 
Reserve Banks.
    Would reducing the number of institutions supervised by the 
Federal Reserve have an impact on the FOMC's activities? First, 
Mr. Bernanke, and then Mr. Volcker.
    Mr. Bernanke. Yes, we are very concerned about being the 
regulator of only the big banks. We think that is a bad idea. 
We need to see the broad financial system. We need to have the 
information about the broader economy. We need to know what is 
going on across the country, not just in the great State of New 
York, for example.
    There is a close connection between the need for the 
Federal Reserve to look at banks of all sizes and our regional 
structure. It is exactly why we have a regional structure. We 
have policymakers drawn from 12 districts around the country 
who speak to local people, including local bankers, and get 
information about what is happening in their part of the 
country.
    Both the regional structure of the Federal Reserve and the 
supervision of small and medium-sized banks, 5,000 holding 
companies, 850 State member banks across the country, both of 
those things together provide us with information, qualitative 
information, which cannot be obtained really any other way.
    Mrs. Maloney. You would say it is important to monetary 
policy to have supervision over all the banks?
    Mr. Bernanke. Both to monetary policy, but also to 
financial stability because we need to see what is happening in 
the entire banking system, and indeed, small banks can be part 
of a financial crisis.
    Mrs. Maloney. Mr. Volcker, do you have a position on this?
    Mr. Volcker. I think I have similar views to Chairman 
Bernanke, which should not surprise you.
    Let me make one comment again on this ``too-big-to-fail.'' 
There was a $50 billion limit. I would not interpret that as 
$50 billion is a limit between who will be saved and who will 
not be saved. From that criteria, $50 billion is much too low 
in my opinion.
    It is a difficult and rather arbitrary decision as to which 
size banks would be regulated by the Federal Reserve apart from 
losing the contact through the Federal Reserve of the smaller 
banks.
    Mrs. Maloney. It is interesting. I have received a number 
of calls today on this proposal, many from small banks who are 
concerned that they would not be part of the Federal Reserve 
supervisory system, that they want to be a part of it.
    Mr. Bernanke, could you comment on the Federal Reserve's 
supervisory powers over your member institutions on various 
financial activities in which they operate? What is your role 
with derivatives, lending and custodial services?
    Why is it important that you have a supervisory or role 
over these particular activities and what is your role in those 
activities?
    Mr. Bernanke. We operate the way all the bank regulators 
do, which is we want to make sure the banks are safe and sound, 
so to the extent they are taking derivative positions or 
hedging their risk, we want to make sure they are doing so in a 
way that is safe, that takes into account counterparty risk, 
takes into account the full range of risks they face.
    Clearly, safety and soundness is a big part of our mission. 
We want to make sure those banks are safe.
    At the same time, the stability of the entire system 
depends on the operation of derivatives markets, for example. 
We saw in the crisis how problems with credit default swaps and 
other types of derivatives caused broader issues in the 
economy.
    As a regulator of the banking system, we will be able to 
see what is happening and be able to make better decisions 
about how to address any potential risks to the broad system 
that those kinds of products might pose.
    Mrs. Maloney. Mr. Volcker, any comments?
    Mr. Volcker. No, I do not think I have anything to add to 
that.
    Mr. Watt. The gentlelady's time has expired.
    Mrs. Maloney. Thank you.
    Mr. Watt. The gentleman from Texas, Mr. Hensarling, is 
recognized for 5 minutes.
    Mr. Hensarling. Thank you, Mr. Chairman. Chairman Bernanke, 
welcome. Chairman Volcker, welcome.
    Chairman Bernanke, I have been an outspoken proponent for 
having a Federal Reserve that restricts itself to conduct 
monetary policy tied to specific inflation targets.
    In your testimony, you posit that it is a critical element 
of conducting monetary policy to have the prudential regulator 
role. I certainly have an open mind to that argument. Is not 
our own historical evidence and international examples--is not 
the empirical evidence kind of murky, if you look at the U.K., 
if you look at Japan, and if you look at Germany, clearly they 
did de-couple the two. They had similar economic challenges 
that we had. We did not de-couple.
    Can you please elaborate on the evidence that is out there 
that might be convincing to members of this committee?
    Mr. Bernanke. Congressman, those three examples are quite 
interesting because, as you point out, in each case there was a 
decoupling, to some extent, of the regulatory function and the 
central banking function.
    I believe in all three--certainly in Germany and the UK--
the current trend is very strongly towards giving supervisory 
authority back to the central bank. And, indeed, in Europe the 
ECB, the European Central Bank, is being made, essentially, 
also the financial stability regulator for the entire 
continent.
    I think the perception was in each of those countries that 
moving the central bank out of regulation deprived it of 
information it needed to be effective in the financial crisis, 
including executing its lender of last resort function.
    Mr. Hensarling. But, Mr. Chairman, we--
    Mr. Bernanke. So, again, in each case the tendency is to go 
back towards--
    Mr. Hensarling. But clearly, we have not decoupled here. 
And yet, we did not avoid the panic. We did not avoid the 
recession.
    Mr. Bernanke. That's absolutely right. And--
    Mr. Hensarling. So what should I derive from that?
    Mr. Bernanke. Well, the question is, can we identify 
problems? I have already tried to identify some. I think there 
are some in the structure of our regulatory system, and there 
are some in the execution. Certainly there were problems. And 
I'm not saying this is the one and only issue. But I think the 
lessons of history are generally on the side of having 
integration of monetary and supervisory functions.
    Mr. Hensarling. On the next panel we are going to hear from 
Dr. Meltzer, who is sitting over your left shoulder there. I 
notice he was kind enough to quote me in his testimony, so I'm 
going to return the favor. I have looked through his testimony.
    He says, ``Setting up an agency to prevent systemic risk 
without a precise operational definition is just another way to 
pick the public's purse. Systemic risk will forever remain in 
the eye of the viewer. Instead of shifting losses onto those 
that caused them, systemic risk regulation will continue to 
transfer costs to the taxpayer,'' which clearly, again, takes 
us back to the whole question of ``too-big-to-fail.''
    So, I guess I have a two-part question here, and that is, 
is the concept of a systemically significant firm really in the 
eye of the beholder?
    And if so, in order for you to execute your charge of 
maximum employment and price stability, is it not 
counterproductive to have any type of designation of a fund 
that creates the impression, again, that there are firms that 
are ``too-big-to-fail?''
    Is there not another method--a resolution authority, as you 
have argued for--that would avoid creation of an explicit fund? 
And would there not be--could not the proper application of 
capital and liquidity standards be used in order to avoid the 
designation of ``too big-to-fail,'' but essentially solve the 
problem?
    Mr. Bernanke. I think what you just said was very, very 
cogent. I agree with most of it. I think the fund could very 
well be exposed, which would mean that the industry, not the 
taxpayer, would bear any cost.
    I think it's very important to have tough ex-ante 
regulation on capital and liquidity and other aspects, to make 
sure that if an institution threatens the institution if it 
fails, we need to be especially careful with it, and make sure 
that it's as safe as possible.
    But in particular, going back to a question that was raised 
earlier, we really have to address ``too-big-to-fail,'' and 
that means that the resolution regime that we devise has to be 
one that makes sure that all the providers of capital, 
including subordinated debt and convertible capital and so on, 
will be wiped out, that they will not be protected, and that 
the authorities have the ability to go further up the 
obligations to the extent that it's consistent with stability.
    So, we need to create market discipline. We can only do 
that if people actually believe they're going to take losses. 
We didn't have the flexibility in 2008, when we were dealing 
with these crises--we didn't have the flexibility, in many 
cases, to impose losses without creating the bankruptcy that we 
were trying to avoid.
    So, with a well-designed resolution regime, we can impose 
losses, and that will bring market discipline back to the 
system.
    Mr. Watt. The gentleman's time has expired. The gentlelady 
from New York--I'm sorry, the gentlelady from California, Ms. 
Waters, is recognized for 5 minutes.
    Ms. Waters. Thank you very much, Mr. Chairman. I would like 
to thank both Mr. Volcker and Chairman Bernanke for being here 
today. And while we are not going to get into the Volcker Rule 
today, I understand that we are going to hold a hearing to talk 
about it more. I understand the President is very interested in 
what he calls the Volcker Rule. And I want to learn a lot more 
about it, too.
    But we are very pleased that you are here. We have 
respected your work for so many years. And I am looking forward 
to having you back with us again, so we can talk about the 
Volcker Rule.
    Having said that, I want to go to Chairman Bernanke. It was 
not until 2008, well after the predatory mortgage loan products 
had done their damage, that the Fed finalized its rule-making 
for the Home Ownership and Equity Protection Act, which 
Congress passed in 1994, mandating that the Federal Reserve 
prohibit unfair, deceptive, or abusive acts or practices in 
mortgage lending.
    I know the work that you have done, and you mentioned the 
intensive self-examination that the Federal Reserve has taken 
of its regulatory and supervisory performance, and I really do 
appreciate that. I am not going to get deeply into the consumer 
financial protection agency that has been talked about so much, 
and what's happening with the Dodd bill.
    But here is what I really wanted to try and focus on. I 
have this notion that there are some products that are so bad, 
that are so predatory, that they should never have been on the 
market, should not be on the market. It seems to me that flies 
in the face of what those of you in the industry think about, 
the ways that you think about it.
    You feel that in a free market society, businesses are able 
to come up with all kinds of ideas about how they want to 
provide products or services or what have you, and it's up to 
you to regulate them, not to prohibit them and say, ``You can't 
do that.''
    I don't understand why a regulator can't take a look at a 
product and say, ``This is so bad, this is so predatory, that 
it shouldn't be on the market, and we're not going to allow it 
to be on the market,'' or, ``We're going to discourage it from 
being on the market.'' And that's one of the reasons I am so 
interested in the Consumer Financial Protection Agency, because 
I think they can start to see these things in different ways 
than they have been seen in the past.
    Do you feel that, as a regulator, you should have the 
ability to say, ``No, you can't put that product on the market. 
It is just too bad. It is too predatory.''
    Mr. Bernanke. Absolutely, and we have done it.
    Ms. Waters. Really?
    Mr. Bernanke. Credit cards, for example. We have banned a 
number of practices, like double-cycle billing, for example. If 
there are practices which serve no good business purpose, and 
which the consumer cannot understand, there is no reason to 
allow them.
    Ms. Waters. Yes.
    Mr. Bernanke. And we have banned them.
    Ms. Waters. But if I may, Mr. Chairman, those were banned, 
I think, after they had been so abusive and out in the market 
for such a long period of time. We don't get to see these 
mortgage products, for example.
    They are calling my office every day--and I am looking at 
an elderly couple who took out an interest-only loan and, after 
5 years, that loan adjusts. They had something called a 30-year 
adjustable rate, which is kind of a contradiction in the way 
that they showed that loan to work.
    And what happens is that loan that they took out was at 
about 4.5 percent a few years ago. And that loan could go up to 
9 percent in this 30-year adjustable after it resets. The 
couple was over 65, and in the next 5 to 10 years, it could go 
up to 9 percent. We don't know what the interest rates are 
going to be. And they said that they didn't have that when they 
first took out the loan, but that an amendment was slipped in 
somewhere into this package of papers, and they signed off on 
it.
    What can we do about that kind of thing?
    Mr. Bernanke. Well, the Federal Reserve, or whoever is in 
charge of consumer protection, needs to make sure that the 
products are safe for people to use. And we have done--you are 
right to criticize the Federal Reserve for being late in doing 
the mortgage regulation. You are correct about that. We did do 
some things, but we didn't do enough.
    But once we did it--and under my chairmanship, we have 
worked hard in these areas--we banned a lot of bad practices. 
You can't offer a mortgage that has those practices any more, 
like a pre-payment penalty for a short ARM, for example.
    I don't know about this particular case you're talking 
about, we would have to look at it, but we are looking at 
features of mortgages and other financial instruments. And some 
of them we just ban, because we don't think they serve any 
purpose, and they're not--the public can't understand what 
they're about.
    Ms. Waters. Thank you, Mr. Chairman.
    Mr. Watt. The gentlelady's time has expired. The gentleman 
from New Jersey, Mr. Garrett, is recognized for 5 minutes.
    Mr. Garrett. Thank you, Mr. Chairman. Thank you, both of 
you Chairmen.
    A quick question off point in all this. I have a bill in 
that deals with the GSEs, that suggested the GSEs should be on 
budget by the OMB, the same way the CBO does it. So, a quick 
question to you is, do the GSE's obligations--are they 
sovereign debt?
    Mr. Bernanke. The government has been pretty vague about 
that, and your chairman says--
    Mr. Garrett. I thought I knew where the chairman stood, but 
now I don't know where the chairman stands, after his first 
comment and after his second comment. Where do you stand?
    Mr. Bernanke. Well, it's my interpretation that the 
government is standing behind the--
    Mr. Garrett. We're paying it, but do you think it is 
sovereign debt?
    Mr. Bernanke. Whether it's legally sovereign debt or not, I 
am not equipped to tell you. I don't know.
    Mr. Garrett. Okay. Mr. Volcker, Chairman?
    Mr. Volcker. I agree with--
    Mr. Garrett. You agree that it's--you're not equipped to 
tell. Okay.
    Mr. Volcker. The government is standing behind it, and it's 
a bad arrangement, where you have this--
    Mr. Garrett. Right.
    Mr. Volcker. --quasi-private organization and the 
government--
    Mr. Garrett. Right.
    Mr. Volcker. --stands behind it.
    Mr. Garrett. Well then, let's move back to the other 
questions. The report in the paper, with regard to the Lehman 
situation. I heard the question earlier and your answer to 
that. It seems as though the answer you gave--and I was 
outside, listening to that--was you were not the primary 
regulator in that case.
    But let me just ask it this way. The Fed was there on 
scene. The paper reports your folks being over at Lehman's, 
embedded, as they say, over there. Was the Fed aware of the 105 
repo situation, and the accounting irregularities going on?
    Mr. Bernanke. No.
    Mr. Garrett. So you were not?
    Mr. Bernanke. No.
    Mr. Garrett. And the reason that you were not aware of them 
was?
    Mr. Bernanke. They were hidden. We are currently the 
principal regulator of Goldman Sachs, and we have about a dozen 
people onsite, and another dozen people who are looking at the 
company. We had, in this case, I think two people assigned to 
Lehman. And their main obligation was to make sure we got paid 
back our loans.
    So, it was not our responsibility, or our capacity, in the 
middle of the crisis, to look at that.
    Mr. Garrett. So when the paper reports--all I know is what 
I read in the paper on this one--what the paper reports is that 
there were a dozen people over there. Only a couple of them, 
two, were yours?
    Mr. Bernanke. I don't think--yes.
    Mr. Garrett. The rest of them were the SEC's?
    Mr. Bernanke. That's my information, yes.
    Mr. Garrett. And should there have been more, and as much 
as--before, Lehman would not have had access to the discount 
window up until this period of time. Correct?
    Mr. Bernanke. Well, again, our objective was to make sure 
our loan was safe, and they were safe. We got paid back.
    Mr. Garrett. Well, you did get paid back, but is that 
because the collateral was adequate? And how would you know 
that, if not an adequate investigation was going as far as 
their accounting was being done?
    Mr. Bernanke. Well, it was largely the collateral. Also, 
the loan we made was to the brokerage, and not to the holding 
company. So that was a bit of a distinction, as well. But we 
took collateral, and we took extra large haircuts, to make sure 
that it was safe.
    Mr. Garrett. You intrigue me when you say that you only 
have a couple of folks over at Goldman--and I guess that's as 
we speak.
    Mr. Bernanke. There about a dozen folks who come--
    Mr. Garrett. A dozen folks over there?
    Mr. Bernanke. I got that number this morning.
    Mr. Garrett. Okay, all right.
    Mr. Bernanke. About a dozen folks who go to work at Goldman 
every day.
    Mr. Garrett. Okay, and I'm not going to hold you to the 
number on that.
    In light of these reports, is that something that we should 
be concerned about, activity of these other houses, as well? Is 
that something that we should be concerned about? Is that 
something the Fed should be concerned about?
    Mr. Bernanke. Well--
    Mr. Garrett. And are you looking into it?
    Mr. Bernanke. Lehman, of course, obviously is no longer in 
existence. But Goldman and Morgan Stanley and Merrill, etc., 
are now under the Fed's consolidated supervision. And so now 
it's our responsibility, and we are paying attention to these 
issues.
    Mr. Garrett. And so you are--are you specifically looking 
at their accounting procedures, to see whether this same sort 
of activity is going on now, or was it going on at that time, 
as well?
    Mr. Bernanke. I don't know. I would have to check and see 
whether we have been looking at that. This report just came out 
this week.
    Mr. Garrett. Right. Would that be one of the gaps, then, 
that we should be concerned about, going forward?
    Mr. Bernanke. If we are the consolidated supervisor, then 
it's our responsibility, and we need to do a good job to do 
that. But, of course, there are lots of things to look at.
    I have to say, in the case of Lehman, it was pretty clear 
that they were in weak condition, independent of this 
particular piece of accounting.
    Mr. Garrett. Well, that's interesting that you say that, 
because the New York Fed did not one, not two, but three actual 
stress tests, right?
    Mr. Bernanke. Liquidity stress tests.
    Mr. Garrett. Liquidity stress tests. And each time, they 
came back as they failed those stress tests, correct?
    Mr. Bernanke. Right.
    Mr. Garrett. Right. Were any recommendations then made to 
Lehman before additional funds were lent to them?
    Mr. Bernanke. We pushed them, and Secretary Paulson pushed 
them, and I'm sure the SEC pushed them to improve their 
financial position and to raise capital, if at all possible. 
But they were unable to raise sufficient capital.
    Mr. Garrett. Well, my understanding is, according to the 
examiner's report, the New York Fed required no action from 
Lehman in response to the stress test. Is that an incorrect 
understanding?
    Mr. Bernanke. The key word there is ``required.'' We have 
no authority to require them to do anything.
    Mr. Garrett. And did you indicate this to their regulator, 
that their regulator should require that, then, of them?
    Mr. Watt. The gentleman's time has expired.
    Mr. Bernanke. I don't have the exact information that 
you're asking.
    Mr. Garrett. If you could, get back to me on that last 
point.
    Mr. Watt. The gentleman's time has expired.
    Mr. Garrett. Thank you.
    Mr. Watt. The gentleman from Kansas, Mr. Moore, is 
recognized for 5 minutes.
    Mr. Moore of Kansas. Thank you, Mr. Chairman. Chairman 
Bernanke and former Chairman Volcker, thank you both for your 
testimony this afternoon. And thank you for your public 
service. You both have had to take some very unpopular actions 
during economic downturns. But I believe without your efforts, 
which I approve and applaud, and without an independent Fed, I 
don't think we would be where we are today in our recovery from 
the financial crisis.
    Last year, this committee and the House approved a strong 
bill creating an independent consumer financial protection 
agency. And Senator Dodd's recent proposal has a truly 
independent consumer financial protection bureau located in the 
Fed.
    Chairman Volcker, would you support separating safety and 
soundness regulations from consumer protection, so that each 
can focus on one mission and do their job better? Is that 
something you can support, sir?
    Mr. Volcker. I think you can separate consumer protection 
from safety and soundness. I think there is some overlap, 
because some of the consumer protection has implications for 
safety and soundness. But, by and large, I think they are 
distinct enough so that you can separate them, yes.
    Mr. Moore of Kansas. Thank you. And with respect to the 
Fed's bank supervision powers contained in the Senate's recent 
proposal, I am concerned that it will turn the Fed's focus away 
from smaller financial institutions, and focus it only on the 
largest banks and institutions on Wall Street. Do you share 
this concern, Chairman Bernanke?
    Mr. Bernanke. Very much so. We value very greatly our 
connections to small and medium-sized banks. We learn a lot 
from them. We learn a lot about the economy. It keeps us in 
contact with the country, as a whole, and not just Wall Street. 
And we hope very much to retain those connections.
    Mr. Moore of Kansas. Okay, thank you. And if the Senate's 
proposal became law, what would that mean for community banks, 
smaller financial institutions, and our local economy back in 
Kansas? Any thoughts there, sir?
    Mr. Bernanke. The law would give the oversight to the FDIC 
for State member banks, or State banks. But what it would do, 
from our perspective, besides being quite disruptive for both 
the banks and the regulators, what it would do from our 
perspective is close off an important source of information and 
connection to the broader economy.
    Mr. Moore of Kansas. Thank you. Any thoughts, sir? Mr. 
Volcker?
    Mr. Volcker. This is one area where the discussion came up 
earlier as to whether you have one regulator, or there is some 
value in having a variety of regulators.
    There are a lot of small banks. And we now have divided 
direct supervisor authority over them. I think this is one area 
where it is possible to argue that having more than one 
supervisor is not a bad thing. It doesn't pose the same kind of 
systemic risk that the big institutions do, but there is value 
to the Federal Reserve, and maybe some value in having more 
than one agency concern there. Because the FDIC has a 
legitimate interest in knowing what's going on among a lot of 
institutions that it may have to--does provide insurance for.
    Mr. Moore of Kansas. Thank you. Another issue I'm 
interested in is in looking at how we become dependent on debt 
across the board: corporations; consumers; governments; and 
especially financial firms.
    In a letter to Senators, Tom Hoenig, the president of the 
Kansas City Fed, wrote last month, ``This financial crisis has 
shown the levels to which risk-taking and leveraging can go 
when our largest institutions are protected from failure by 
public authorities. A stable and robust financial industry will 
be more, not less, competitive in the global economy. Equitable 
treatment of financial institutions will end the enormous 
taxpayer-funded competitive advantage that the largest banks 
enjoy over the regional and community banks all over the 
country.''
    As we think of how overleveraged the largest financial 
firms became leading up to the crisis that we have experienced, 
if the Fed is disconnected from smaller financial institutions 
who were not overleveraged, and leaving the Fed with nothing to 
compare to, would that hinder the Fed's supervision of the 
largest institutions? Any thoughts there, Chairman Bernanke?
    Mr. Bernanke. I think it's helpful to know what's going on 
in the whole banking system, because you can learn about the 
asset quality. You can learn about the impact of regulation. 
And small banks can be involved in financial crises, as well. 
So I think there is a lot to be learned from not restricting 
yourself narrowly to one class of institutions.
    And I agree with his basic point, that we have to get rid 
of ``too-big-to-fail,'' and that theme has come up today quite 
a few times. We have to have a system where the creditors of--
and shareholders of a large organization can take losses when 
the firm can't meet its obligations.
    Mr. Moore of Kansas. Thank you, Mr. Chairman. Again, thanks 
to both of you for your service to our country.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from Minnesota, Mr. Paulsen, is recognized for 5 minutes.
    Mr. Paulsen. Thank you, Mr. Chairman. And I want to thank 
both of you for taking the time to testify here again today.
    Chairman Bernanke, a document that you sent to the Senate 
Banking Committee contains the statement, ``We recognize, of 
course, that bank supervision, including ours, needs to be more 
effective than in the past. And we have reviewed our 
performance, and are making improvements at multiple levels.''
    I just came from a meeting with a bunch of local bankers 
from Minnesota, and they talked about how they have money to 
provide for credit, and they want to lend it out into the 
market. And their overwhelming concern was in regards to the 
uncertainty or the inconsistency that is being created by the 
regulators: the OCC, and the FDIC. These regulators are being 
inconsistent in the sense that when they come in and visit with 
the banks, from visit to visit, their demands essentially are 
changing, and they're preventing good loans from being 
continued or from even being made in the first place.
    I know we had a hearing in this committee, along with the 
Small Business Committee just a few weeks back. And I think 
every single member--nearly every single member--of this 
committee raised this issue. And the FDIC and the OCC responded 
essentially by saying they have told their people in the field 
to kind of take a step back in regard to what is actually 
happening. But I think there is still a disconnect that's going 
on.
    And so, I am just wondering, knowing that I met with 30-
some bankers, and it seems like nothing has really changed in 
recent times regarding the examinations that are going on with 
the banks, what can the Federal Reserve do better to handle 
this issue and create some consistency for the bankers so more 
credit is available to be put out into the market?
    Mr. Bernanke. This has been one of our top priorities. It's 
very, very important. What you need to do here is get an 
appropriate balance, on the one hand, between making sure the 
banks are safe and sound, making good loans. On the other hand, 
making sure that credit-worthy borrowers can get credit, and 
that the economy can grow.
    So we need to find the appropriate balance there, and we 
have done that in a number of ways. We have taken the lead on 
issuing guidance to our examiners and to the banks on small 
business lending, on commercial real estate lending, where the 
emphasis is on finding that appropriate balance. And it's 
giving lots of examples to the banks and the examiners, where 
you can look at the example and it gives you some insight into 
what criteria to apply when you're looking at a loan.
    And, in particular, one point that we have made repeatedly 
is that just because the asset value underlying a loan, the 
collateral of the loan has gone down, doesn't mean that it's a 
bad loan. Because as long as the borrower can make the 
payments, that still can be a good loan, and we shouldn't 
penalize the banks for making those loans.
    So, we have issued those guidances, and we have done an 
enormous amount of training with our examiners to make sure 
they understand it. We have been gathering information and 
feedback from the field, including asking for more data and 
more information, but at each of the reserve banks around the 
country, having meetings that bring in small businesses, banks, 
and community leaders, to try and get into the details of 
what's going on.
    We have also tried to support the small business lending 
market with our TALF program, which has helped bring money from 
the securities markets into the small business lending arena. 
So it is a very important priority for us.
    We were asked before about the interaction between being 
responsible for the macro-economy and being a supervisor. Well, 
here is one case where knowing what's going on in the banking 
system is extremely important for understanding what's going on 
in the economy broadly. And we take that very seriously.
    So, I realize it's still an issue. It's going to be a 
concern, because certainly standards have tightened up. 
Certainly some people who were credit-eligible before are no 
longer eligible, because their financial conditions are worse. 
But we really think it's very important that credit-worthy 
borrowers be able to get credit, and we are working really hard 
on that.
    Mr. Paulsen. Okay. Mr. Volcker, can you add some comments 
on that, based on your history?
    Mr. Volcker. I would be glad to add a comment, because I 
think this is an old problem.
    I remember when I was a young fellow writing about the 
Federal Reserve. And the long-standing chairman of the Federal 
Reserve in the 1930's was one Marriner Eccles, who repeatedly 
complained in the 1930's, in the midst of the recession, that 
the other banking--the sole responsibility for banking 
supervision and other agencies--they were being too tough 
because they had had a lot of losses on their watch, and they 
were overreacting, in terms of strict regulations at a time 
when it was inappropriate, because the economy was mired in 
recession.
    There have been other times when, if you're just looking at 
banking regulation, that's your only responsibility, maybe 
you're going to be too easy when things are going very well, 
and the economy is on the verge of--you know, the party is 
getting a little too ebullient.
    I think, really, that the Federal Reserve is in a better 
position to get a balanced regulatory position, regulatory 
approach, simply because they are responsible for monetary 
policy and responsible for business activity, too. That is one 
of the strengths in keeping the Federal Reserve in the 
regulatory business, in my view.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from Georgia, Mr. Scott, is recognized.
    Mr. Scott. Thank you very much, Mr. Chairman. And welcome 
to both Chairman Bernanke and Chairman Volcker.
    Let me ask you, Chairman Bernanke, as we grapple with this 
whole issue of stripping the Fed of its supervisory authority 
and concentrating on the larger banks only--and I must admit, 
you make a good argument, but I'm torn for this one reason. Let 
me give you an example where there has been a massive failure 
on the part of the Fed, in my opinion, to be able to handle 
both the big banks and the smaller banks.
    I represent the State of Georgia. And in the State of 
Georgia, over the last 36 months, there have been 27 bank 
failures of these smaller banks. And that accounted for 26 
percent of all of the bank failures in this country, 1 State.
    The issue becomes, where was the Fed in this? Is this not a 
sign of a realization as to why maybe we're asking too much of 
the Fed, as we move into this new economic climate? And I'm 
wondering, where was the Fed? How did this happen under your 
watch, where 1 State accounted for 26 percent of all the bank 
failures, and over a short period of just 36 months, 27 banks 
failed in 1 State?
    Mr. Bernanke. Well, I would make two points. The first is, 
of course, that there are multiple regulators. And the question 
you have to ask is where--did the Fed do as good a job as 
everybody else? And I think the answer is, on a national basis, 
that we have done a good job with small and medium-sized banks.
    But we have been actually leaders in this area. Because one 
of the key issues--and particularly in Georgia, particularly 
for small and medium-sized banks, has been commercial real 
estate. The Federal Reserve, back in 2000, took lead in 
developing some guidance on commercial real estate about not 
having too much, about managing the risk better, about not 
having too much geographic concentration--which has been an 
issue, I know, in the southeast. We got resistance on that, and 
it took longer to do, and the banks resisted. It took longer to 
get done than it should have taken.
    But that was something that we pushed, and we thought was 
very important. And banks that were particularly careful about 
managing their commercial real estate have done better because 
that has been one of the main risk areas. So, I would say that 
we took those issues into consideration, and did a good job, at 
least in trying to address them.
    Mr. Scott. How can you say you did a good job, when the 
Fed's policy became--made a decision not to examine the books, 
but to allow the banks to examine themselves? That--not to 
examine their portfolios, when we saw that some of these banks 
had a 78 percent portfolio just in this real estate?
    So, if there is a problem area here that I have been able 
to detect, it was in the Fed's failure to--or willingness, or 
laxity, whichever, to allow these banks to self-examine, to 
assess themselves. And do you think that, going forward, should 
continue? Or do you not agree that might have been an area 
where the Fed fell down?
    Mr. Bernanke. No, I don't agree with that. We examined the 
banks, and we made sure that they met appropriate capital and 
liquidity standards.
    Now, it turns out that they should have been tougher. And 
we have done a lot of work, internationally, to strengthen 
those standards.
    Mr. Scott. I have here where--and it might not be with 
you--but the Fed announced that the Fed would no longer 
directly examine banks' portfolios, but would instead rely on 
bank self-examination and self-assessments.
    Mr. Bernanke. That's not our policy.
    Mr. Scott. So that policy has changed, and this is 
inaccurate?
    Mr. Bernanke. It probably relates to the notion of Basel 
II, and the structure of banks using proprietary models as a 
way of evaluating the risks of some of their positions. Basel 
II was never implemented, and clearly, it's very important that 
whenever models are used, that they be closely vetted and 
closely evaluated. This is what we do.
    And again, we are going to be very careful to make sure 
that banks are meeting the appropriate standards.
    Mr. Scott. And so, you were aware--or were you not aware--
that the portfolios of these banks were averaging between 75 
and 80 percent total concentration in real estate?
    Mr. Watt. The gentleman's time has expired. And I am kind 
of being tough on him, because we have just been called for 
votes. I would like to try to get the other three members who 
are here, who have been here for a while, in. So, if you can 
respond to that in writing, that might be helpful to us.
    The gentleman's time has expired. And I will now recognize 
the gentleman from Texas, Mr. Marchant, for 5 minutes, and I 
encourage the members to exercise as much restraint as they 
can, in an effort to get all three members in who are still 
here, allow us to release this panel, and be set to go with the 
next panel immediately after this series of votes is over. Mr. 
Marchant?
    Mr. Marchant. Thank you, Mr. Chairman. Chairman Bernanke, I 
would like to ask you about the inter-connectedness of Fannie 
Mae, which is owned--the largest shareholder is the United 
States Government in conservatorship. And, arguably, every loan 
that is originated today in Fannie Mae is explicitly guaranteed 
by the Treasury.
    When the mortgage-backed security--when Fannie Mae packages 
the mortgage-backed securities, the Fed is a principal holder 
of mortgage-backed securities. You have $1 trillion with 
authority, I think, to go to $1.25 trillion.
    Fannie Mae, every month, is accruing a loss on the loan 
that the Treasury is making it. And the Treasury is assessing 
Fannie Mae at a rate of 11 percent every month. This loan--and 
they're loaning Fannie Mae the money to make the interest 
payment.
    At what point--who exits first? Does Fannie Mae slow its 
lending down, so that the flow of the mortgage-backed 
securities slows? Does the Treasury lower the interest rate to 
Fannie Mae, so that the losses are less? Or does the Fed exit 
the mortgage-backed security--its holdings in mortgage-backed 
securities? Which will move first? Which part will move first?
    Mr. Bernanke. First, just very quickly, as Chairman Volcker 
indicated, the Federal Reserve was very concerned about Fannie 
and Freddie for many, many years. This was an issue that we 
pointed out and noted the moral hazard with the implicit 
government guarantee.
    My assumption is that sometime soon, the Congress will 
reform Fannie and Freddie, perhaps break them up, perhaps make 
them officially governmental. At that point, then there will 
have to be decisions made about whether the government is going 
to stand behind their securities and, if so, in what way.
    My assumption is that the mortgage-backed securities, which 
are already outstanding, will be grandfathered, and will retain 
the U.S. Government backing that they currently have.
    So, at some point there will be a change in the structure, 
and there will be no more of the current type of MBS created. 
But the existing MBS, I assume, will be protected until such 
time as they either expire or are purchased back.
    Mr. Marchant. A couple of weeks ago, I read that the 
Treasury had sold $200 billion worth of notes, paper, and had 
deposited that with the Fed. And the explanation for that was 
to provide a liquidity for the Fed, if the Fed decided to begin 
to liquidate its position in mortgage-backed securities. Is 
that correct?
    Mr. Bernanke. The Treasury has restored what it had last 
year, which was a $200 billion account at the Fed. We pay 
interest on that account--
    Mr. Marchant. Right.
    Mr. Bernanke. --so that the taxpayer is not losing any 
money. And it has the advantage that it reduces the amount of 
reserves in the banking system for the given amount of 
mortgage-backed securities that we hold. And that gives us more 
flexibility as we manage policy, going forward.
    Mr. Marchant. And my last question, how does the Fed 
acquire the mortgage-backed securities? Does it acquire them 
directly from the agencies' auctions? Or do they acquire them 
as collateral from banks that are borrowing against them?
    Mr. Bernanke. We buy them in the open market.
    Mr. Marchant. Okay. Thank you, Mr. Chairman.
    Mr. Watt. The gentleman's time has expired. The gentleman 
from Kansas City, Mr. Cleaver, is recognized.
    Mr. Cleaver. I will do this quickly. Thank you very much 
for being here. My district office is 3 blocks from the Kansas 
City Fed. I have gotten to know Tom Hoenig very well. In fact, 
we flew in together on Monday. So I am concerned about some of 
the regional issues.
    And first, Chairman Volcker, here in this post-economic 
crisis, how should the Fed and the regional banks relate? Right 
now, it appears we have two seats of power: the one you lead, 
Mr. Bernanke; and the one in New York. And so, I am concerned 
about what happens to the regional banks. Are we going to 
emasculate them any further?
    How should we, in this moment of reorganization, create the 
relationship between the Federal Board and the regional banks?
    Mr. Volcker. Well, I take off on a basic point that 
Chairman Bernanke has been emphasizing about the importance of 
the regional banks, in terms not just of information, but in 
terms of contact with regional financial institutions and 
regional publics right around the United States. It has been a 
great strength of the Federal Reserve.
    That is anchored, to some extent, in their supervisor 
responsibilities. Supervisory responsibilities are shared 
between the Board in Washington and the banks. But it's 
fundamentally, in the end, the responsibility of the Board of 
Governors in Washington. But it is delegated, in substantial 
part, to the banks. And I think that works out to the mutual 
interest.
    And what you do in terms of parceling out these regulatory 
responsibilities, supervisory responsibilities, will inevitably 
bear on the point of the organization of the Federal Reserve, 
if not immediately, over time. And I think it's something you 
ought to take into account.
    Because for who knows how many years now--95 years almost--
I think this kind of regional system is clearly controlled at 
the center here in Washington, but nonetheless has regional 
participation, and has served the country well. It served the 
independence of the Federal Reserve and the credibility of the 
Federal Reserve, I think, through many decades.
    Mr. Cleaver. So it should remain the way it is now?
    Mr. Volcker. Pardon me?
    Mr. Cleaver. It should remain the way it is now?
    Mr. Volcker. Yes.
    Mr. Cleaver. The relationship. Mr. Hoenig would probably 
consider this heresy, what I'm about to ask you, Mr. Bernanke. 
He may even jump out of the window if he just knew I asked this 
question. But the regional bank presidents and regional boards 
could be viewed as captive, somewhat as captives, of the 
regional banks industry, since the presidents are chosen by the 
member banks' directors in the regions. And to break it down, 
three of the regional bank board directors are chosen by the 
Fed in D.C., and three are chosen by regional bank members.
    What would you think of having the three who are chosen by 
the region, chosen by the Federal Board?
    Mr. Bernanke. To begin with, I just want to make clear that 
the perception of a conflict is more perception than reality. 
The members of the boards are completely insulated from 
supervisory decisions, and the presidents are all approved by 
the Board of Governors in Washington. So the conflict isn't 
quite as great as is sometimes made out to be.
    That being said, I think we would be open to discussing 
changes of that type that you just described, to try to make 
sure that everybody understands that the role of those boards, 
regionally, is to represent their area, their broad public, and 
to give us the feedback and information that is provided by 
banks, but is also provided by other folks: community 
development people; business leaders; and so on. And we want a 
broad representation on those boards.
    Mr. Cleaver. Really quickly?
    Mr. Watt. You have 5 seconds.
    Mr. Cleaver. Then, I surrender.
    Mr. Watt. Which you have just lost. The gentleman's time 
has expired, and I have to go to Mr. Foster from Illinois, as 
the last questioner.
    Mr. Foster. Thank you both for waiting around to the end 
here.
    In the Wall Street Journal's list of the recommendations 
for what should be done to reform the financial system, the 
number one recommendation was to improve capital standards, 
including the incorporation of contingent capital, into the 
capital structure of large financial firms.
    I was the author of the amendment that passed out of this 
committee, authorizing contingent capital requirements. And I 
understand it's being dealt favorably in the Senate proposal, 
as well.
    So, what I was interested in was what--do you view the role 
of the Fed in administering standards for contingent capital, 
and possibly administering the stress test that's often talked 
about as the trigger mechanism for the debt conversion? Do you 
think that's an appropriate Federal--one that's likely to 
happen?
    Mr. Bernanke. We have a couple of roles. One is the 
international agreements discussions that take place in 
developing international capital standards, and we have put the 
contingent capital idea on the table, internationally.
    Then, assuming we maintain our consolidated supervision and 
oversight of holding companies, we would be working with the 
functional regulators to develop stress tests at that level. So 
we would be, obviously, very much involved in both the setting 
of the standards, and analyzing whether or not the contingent 
capital should be converted or not.
    We think that's a very intriguing idea. There are some 
issues to be resolved, and some details to be worked out, but 
we are looking at it pretty actively at the Federal Reserve.
    Mr. Foster. Thank you. And, let's see, countercyclical 
mortgage underwriting standards are being implemented at 
various levels in different countries around the world. And, 
simply put, what this means, when a housing bubble begins to 
develop, you turn up the downpayment that's required.
    And I guess my first question to Chairman Bernanke is that 
had these type of policies been in place in the previous 
decade, how effect would they have been at damping down the 
housing bubble, even in the presence of very loose monetary 
policy?
    And more--and secondly, in respect to the subject of this 
hearing, would countercyclical underwriting requirements be 
easier to implement in the context of consolidated Fed 
supervision?
    Mr. Bernanke. It's a somewhat speculative question. I can't 
give you a precise answer. But there are some countries where 
they are using variable LTVs. And I think we have discussed 
this before. I think that's an interesting idea. And it's clear 
that because of piggyback mortgages and other kinds of 
instruments, loan-to-value ratios got way too high in the 
United States and, going forward, the financial system and the 
regulators were being much more conservative.
    I think that's another interesting idea to look at.
    Mr. Foster. Yes. I have a concrete proposal that I will get 
to you in writing. I would like your reaction, if possible, in 
writing afterwards.
    Thank you. I yield back.
    Mr. Watt. The gentleman yields back. I ask unanimous 
consent to insert into the record the Fed's policy statement 
entitled, ``The Public Policy Case for a Role for the Federal 
Reserve in Bank Supervision and Regulation.''
    Hearing no objection, is is so ordered.
    Mr. Watt. I ask unanimous consent to submit for the record 
my full opening statement.
    Mr. Watt. Hearing no objection--nobody else is here to 
object--it is so ordered.
    We thank both of these distinguished gentlemen for their 
patience and their time. We will release them, and I will 
announce that as soon as the votes are concluded, we will 
convene the second panel, and we will be back promptly.
    We stand in recess until after the votes.
    [Recess.]
    Mr. Watt. The hearing will reconvene, and I will introduce 
the witnesses. I'm told that Mr. Meltzer has a time constraint 
in that he needs to be on a plane at 6:30.
    Mr. Meltzer. My plane is at 6:30.
    Mr. Watt. Your plane is at 6:30. Okay. So I'm totally happy 
to have you testify first and allow you to leave, if it's all 
right, because otherwise, you are not going to make it. So let 
me quickly introduce the witnesses. I will not elaborate on 
bios so as to save time. Our panel consists of: Mr. Anil 
Kashyap, Edward Eagle Brown professor of economics and finance, 
and Richard N. Rosett faculty fellow at the Booth School of 
Business, University of Chicago; Mr. Allan Meltzer, the Allan 
H. Meltzer university professor of political economy, Tepper 
School of Business, Carnegie Mellon University; Mr. Rob 
Nichols, president and chief operating officer of the Financial 
Services Forum, which I have had some dealings with; and Mr. 
Jeffrey L. Gerhart, president, Bank of Newman Grove, on behalf 
of the Independent Community Bankers of America.
    And with everyone's consent, we will allow Mr. Meltzer to 
go first, so he can scoot out the door and catch his flight. 
Your full statements will be made a part of the record, so 
please summarize in 5 minutes, if you can.

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

    Mr. Meltzer. Thank you, Mr. Chairman. Happy St. Patrick's 
Day. It's a pleasure to be here again. Both Houses of Congress 
have worked hard to develop means of reducing greatly the risk 
of future financial crises. I believe they have neglected to 
remove completely the two most important causes of the recent 
crisis.
    First, in my opinion, the disastrous mortgage and housing 
problem, especially the rules as followed by Fannie Mae and 
Freddie Mac and all recent Administrations. If they had not 
existed, the crisis would not have happened.
    Second, without advance warning, the Treasury and the 
Federal Reserve ended a 30-year policy of ``too-big-to-fail'' 
in the midst of a recession by letting Lehman fail.
    The first reform, the one that is ignored most is, I 
believe you need to put Fannie Mae and Freddie Mac on the 
budget the way--with a subsidy on the budget. It's not a 
question of whether there should be a housing and mortgage 
policy; it's where it should be located. It should not be 
located as a subsidy through the financial markets, subsidies 
in a well-run democratic country are on the budget.
    After the failure, after the mistake of allowing Lehman to 
fail, the Fed acted forcefully, directly, aggressively, and 
intelligently to prevent the failure from spreading. What we 
want to consider is what might be done to avoid a repeat of 
government policy failure. ``Too-big-to-fail'' encouraged some 
large bankers, to use the word of the then-chairman of 
Citigroup, ``to get up to dance when the music was playing.'' 
That was a mistake. That mistake, I believe, would not have 
happened if there were not--if he didn't believe that he could 
take the risks and allow the taxpayers to pay the losses. The 
taxpayers, indeed, paid for the losses. So did he.
    We need a system that protects the public. The current 
system leans toward protecting the banks. It's important, most 
important, to end ``too-big-to-fail'' in a way that will work 
in crises. Regulation often fails. We have the examples of 
Madoff, Stanford, the structured--the SIVs that circumvented 
the Basel Accord Basel regulated risks. The markets 
circumvented it. Ask yourselves what happened to FDICIA. This 
committee, in 1991, passed a rule that said we're going to try 
to do early intervention before companies fail, before banks 
fail. It didn't happen. FDICIA has been missing. Is that 
unusual? No. It's the common effect of regulation.
    The first law of regulation, my first law of regulation is 
that bureaucrats, lawyers make regulations. Markets learn to 
circumvent the costly ones. The second law of regulation is 
regulation is static; markets are dynamic. If they don't figure 
out how to circumvent them at first, they will after a while. 
That's what has happened very often in the case of regulation.
    So you need to do something. You must regulate, but you 
have to regulate in ways that rely on incentives that affect 
the way the bankers behave. And my proposal is, you want to tie 
the capital standards to the size of the bank. Let the banks 
choose their size. Beyond some minimum size, say $10 billion, 
for every 1 percent they increase their assets, they have to 
increase their capital by 1.2 percent. That way, the capital 
ratio will go up and up and up with the size of the bank and 
that will limit the size of the bank and it will put the 
stockholders and the management at risk. That's the way to 
prevent failures.
    One other step: If failures occur, markets require 
something to be done about the counterparties. In the 96 years 
of its history, the Fed has never announced or followed a 
consistent lender of last resort policy. Never. They have never 
announced it. They have discussed it internally many times. 
They have never had a consistent policy. Congress should insist 
on a lender of last resort policy and it has to be one that the 
Congress will honor in a crisis. So it should negotiate with 
the management of the Fed to choose a lender of last resort 
strategy that the Congress is willing to honor.
    Let me say a few other things in my remaining 10 seconds. 
First, the regulators talk about systemic risk, and there's a 
systemic risk council. No one can define systemic risk in an 
operational way. You and your colleagues will properly say 
there is a large failure in your district. It's a 
responsibility to do something about it. That's a systemic risk 
as far as you're concerned. Who will decide on systemic risk? 
The Secretary of the Treasury. Who has been the person most 
active in bailouts? The Secretary of the Treasury. Therefore, 
moving to a systemic risk council with the Secretary of the 
Treasury as its chairman is an invitation to continue to do the 
things we have been doing: bailing them out.
    Mr. Watt. Mr. Meltzer, you are putting yourself in systemic 
risk of missing your flight.
    Mr. Meltzer. My time is up.
    [The prepared statement of Professor Meltzer can be found 
on page 88 of the appendix.]
    Mr. Watt. Your time is up, and at least one of our 
members--I don't have any questions for you, but at least one 
member has a question, maybe two.
    So, Dr. Paul?
    Dr. Paul. Thank you, Mr. Chairman. And welcome, Dr. 
Meltzer. It's good to see you. I have a very brief question and 
I don't think it will take 5 minutes, but I want to follow up 
on a question I asked earlier in the day, and that is, dealing 
with the flaws of monetary policy and whether or not all we 
have to do is write regulations to take care of it.
    Most of us recognize the fact that rising prices is a 
monetary phenomenon. Price inflation comes from monetary policy 
so--but not many people, anyway there are not that many 
economists around now who say the solution to price inflation 
is wage and price controls. Most people would say correct the 
monetary policy. But there are other problems with monetary 
policy, other types of consequences from a flawed monetary 
policy. When that happens, is it wise to believe that we can 
compensate by just having more regulators and more regulations 
to compensate for bad monetary policy?
    Mr. Meltzer. No. I mean, monetary policy--I have just 
completed 15 years of working on the history of monetary 
policy. If you listen--if you ask yourself what are the good 
years, what are the years in which the congressional mandate, 
which came later, but the congressional mandate, which said 
let's have low unemployment and low inflation. Well, there's 
1923 to 1928, there are a few years in the 1950's and early 
1960's, and then there's a period that we just went through 
when they were following, more or less following, the Taylor 
Rule, and we had for about 15 years, we had low inflation and 
low unemployment.
    The rest of the time, we haven't had that. So it hasn't 
been a very successful enterprise, and it needs to be changed. 
Independence of the Fed began under the gold standard. When the 
gold standard came off, so did the limits on what the Fed could 
do. Congress needs to do something to replace those standards. 
It needs to legislate something which would say, look, we have 
told you to have low inflation and low unemployment. Now what 
we want you to do is announce and agree with us, or with the 
Secretary of the Treasury or with the President, what you're 
going to do over the next 2 to 3 years. Tell us what you are 
going to do, what you are going to achieve. If you achieve it, 
fine. If you don't achieve it, you can offer--you should offer 
your resignations and an explanation.
    There are lots of valid reasons why you might not achieve 
it. There may be an oil shock, there may be a devaluation of 
the dollar. A lot of things can happen. The weather may be bad. 
So then Congress can accept the regulation, can accept the 
explanation, or they can accept the resignation, but we need to 
discipline the Fed.
    Dr. Paul. Thank you.
    Mr. Watt. Mr. Hensarling is recognized for one question.
    Mr. Hensarling. Thank you, Mr. Chairman, and I understand, 
Dr. Meltzer, you have to run. Your testimony was very helpful, 
and I certainly could not agree with you more that but for 
Fannie and Freddie and misguided housing policies, this--I 
believe you said, ``These actions converted a garden variety 
recession into worldwide crises.'' And I could not agree with 
you more.
    My precise question, before you have to leave, is I'm a 
little uncertain as to precisely what type of lender of last 
resort policy you may be advocating for the Federal Reserve. 
You state that 13(3) should be removed because, I believe, it 
was used in the AIG case, which was institution-specific. So 
are you advocating a policy of clearly articulated standards 
that would open the discount window to non-depository 
institutions on a pre-stated basis that Congress would agree 
to, or could you elaborate on what you are advocating, sir.
    Mr. Meltzer. Yes. First, let me just say about 13(3); 13(3) 
was passed in the Great Depression. It was there to help small 
and medium-sized borrowers who couldn't get accommodation, very 
much like some of them now. That was the idea of 13(3). It 
never was very important. The Fed made some loans under 13(3), 
but not very much. It was never intended to be used to bail out 
something like AIG. That's a complete perversion of the spirit 
of that legislation.
    What do I mean by a lender of last resort agreed to by the 
Congress? Well, if you don't agree to it, it won't--if Congress 
doesn't agree to it, it won't work. That is because you--the 
pressures on the Fed will be just too great. So you have to 
agree to it, what should you agree to.
    There was something called Bagehot's Rule, which the Bank 
of England used. The Bank of England was an international 
lender, similar to what the United States is now. It had loans 
all over the world. It said, look, if you have good collateral, 
you can borrow. If you don't, goodbye. They had bank failures, 
big ones in some cases, but no crises. Why? Because the 
borrowers knew that they had to come with collateral and they 
held collateral.
    We have to go back to a system in which the responsibility 
is on the banker. I want a system where the chairman of the 
bank goes in every morning and says to his number two guy, 
``How the devil did we get that junk on our balance sheet? Get 
rid of it at once.'' That way, we'll have safety and soundness.
    Mr. Hensarling. Dr. Meltzer, I think the chairman is trying 
to do you a favor. The 5:00 traffic--
    Mr. Watt. I have been trying to do him a favor, and he 
seems to be resisting me doing him a favor.
    Mr. Meltzer. Mr. Chairman, I thank you.
    Mr. Watt. Before you do that, Mr. Meltzer, I do need to 
make you aware that some members may have additional questions 
for you, and other members of this panel, that they may wish to 
submit in writing. Without objection, the hearing record will 
remain open for 30 days for members to submit written questions 
to these witnesses and to place their responses in the record. 
So we may be following up with you with written questions.
    Mr. Meltzer. Of course.
    Mr. Watt. You are excused unless you have something else.
    Mr. Meltzer. No. I just want to thank you for your 
forbearance.
    Mr. Watt. Okay. Well, I hope you make your flight.
    Now, we will recognize Professor Kashyap.

 STATEMENT OF ANIL K. KASHYAP, EDWARD EAGLE BROWN PROFESSOR OF 
 ECONOMICS AND FINANCE, AND RICHARD N. ROSETT FACULTY FELLOW, 
        BOOTH SCHOOL OF BUSINESS, UNIVERSITY OF CHICAGO

    Mr. Kashyap. Thank you, Chairman Watt, and members of the 
committee. Besides my affiliation at Chicago Booth, I want to 
mention I'm also a member of the Squam Lake Group, since I'm 
going to tout a couple of their recommendations. Today, I'm 
going to consider whether and how the Fed supervisory role 
should change by considering three specific questions.
    First, I want to ask how the most costly mistakes in the 
United States regarding individual institutions might have 
differed if the Fed had been stripped of its supervisory 
powers; second, I want to review the U.K. evidence where the 
Central Bank was not involved in bank supervision and ask if 
those outcomes were particularly good; and third, time 
permitting, I'll look at the overall financial system and ask 
what might have been done to protect the whole system better. 
I'm going to skip large parts of my written testimony, but I 
would be happy to take up questions about that.
    So let's look at the biggest individual supervisory 
failures. As has already been mentioned here today, by far the 
most expensive rescue was for Fannie and Freddie. CBO's latest 
estimates put the costs to the taxpayer at over $200 billion 
and the problems of these institutions were well known, and as 
Chairman Bernanke indicated, the Fed was testifying as early as 
2004 about the risks that they posed. So it seems hard to put 
the blame for these two on the Fed.
    The next most expensive rescue was for AIG. The cost of 
this intervention was estimated at probably upwards of $30 
billion. In this case, the Fed wrote the check for the rescue, 
and the Fed actions, particularly regarding the transparency 
around the transaction, have been legitimately and heavily 
criticized. AIG's primary regulator was the Office of Thrift 
Supervision, which had absolutely no experience in 
understanding what was happening inside AIG Financial Products.
    So when the decisions that had to be made about AIG were 
taken, the Fed was flying blind. Chairman Bernanke has said the 
AIG case causes him the most trouble of anything that happened 
in the crisis, and I think it also provides the best example of 
why stripping the Central Bank of its supervisory authority 
would likely make problems, such as AIG, more probable in the 
future.
    No one thinks it's possible to have a modern financial 
economy without a lender of last resort facility. So let me 
offer an analogy. As a lender of last resort, you're never sure 
who is going to come through the door and ask for a date. When 
your date shows up on Friday night and it's AIG, the question 
at hand is, would you like to know something about them or 
would you rather have to pay $85 billion to buy them dinner. If 
we mandate that the Fed is not involved in supervision, then we 
make hasty, uninformed decisions inevitable whenever the lender 
of last resort has to act.
    The third most expensive rescue is likely to turn out to be 
Bear Stearns. Here again the primary regulator, in this case 
the SEC, was clueless about what was going on as Bear's demise 
approached. The Fed crossed the rubicon in this rescue, but as 
with AIG, it was forced to act on short notice with very 
imperfect information about Bear's condition and with no 
supervisory authority to shape the outcome.
    Whatever the criticisms one wants to make about the Fed's 
actions regarding Bear Stearns, the problems didn't come 
because of incompetent Fed supervision of Bear. If anybody 
wants to ask about Citigroup, we could talk about that as well. 
That is a case where the Fed had direct responsibility.
    My point in reviewing these cases is not to absolve the 
Fed. As we say in this town, plenty of mistakes were made. But 
I think this quick summary shows that if another supervisor had 
taken over the Fed's responsibilities, the U.S. taxpayer still 
would be on the hook for billions of dollars.
    One obvious objection to the way I have been reasoning is 
that I took the rest of the environment as given in 
contemplating a supervisory system without the Central Bank. 
Perhaps if the Fed had been out of the picture, other 
supervisors would have stepped in and built a better system. 
Here the lessons of the United Kingdom are particularly 
informative.
    The U.K. has deep financial markets with many large 
financial institutions and London is a financial center. The 
U.K. separated the Central Bank from supervision in the 1990's 
and set up a separate organization--the Financial Services 
Agency--to focus on bank supervision. The agreement that was 
reached required the treasury, the Central Bank, and the FSA to 
agree on any rescues.
    The first real test of this system came when Northern Rock 
got into trouble. The management of Northern Rock notified the 
FSA of its problems on August 13, 2007; the Bank of England 
found out the next day. It took over a month of haggling 
between the Bank of England, the treasury, and the FSA to 
decide what to do before the Bank of England eventually 
announced its support for Northern Rock. Even that support was 
not enough to prevent a run, and the first failure related to a 
run in the U.K. since 1866.
    While the distribution of blame is debated, there is 
complete agreement that the situation was mismanaged and the 
lack of coordination was important. Besides Northern Rock, 
several other large British banks, including Lloyd's and Royal 
Bank of Scotland, required government assistance in the United 
Kingdom. The total taxpayer burden from these interventions is 
guesstimated as being about 20 to 50 billion pounds.
    I expect that if we formed a council to oversee the U.S. 
financial system, we would arrive at the same arrangement as in 
the U.K. In particular, it would rely on consensus, and 
information sharing amongst the different agencies would be 
poor. The events in the U.K. suggest when this system was 
actually adopted, it didn't work. And I see no reason to expect 
it would work in the United States.
    So, what should we do? Well, the problems with the existing 
regulatory structure go far beyond the question of which 
organizations do the supervision of individual institutions. 
The gaps in supervisory coverage were critical. The fact that 
institutions could change regulators if the regulator became 
too tough is appalling, and that let the risks in the system 
grow for no good reason.
    But the crisis has also shown us that while there were many 
sources of fragility, nobody was watching the whole financial 
system. And when individual regulators did see problems, they 
were often powerless to do anything about them. Thus, a 
critical step in reforming regulation must be the creation of a 
systemic risk regulator that is charged with monitoring the 
whole financial system. The regulator must have the authority 
and tools to intervene to preserve the stability of the system.
    I know Mr. Watt's subcommittee held some very nice hearings 
in July on exactly this issue, and the lack of progress on this 
front is disappointing. But even with a vigilant systemic risk 
regulator, it seems likely that most of the problems in the 
crisis would have appeared anyway.
    The Squam Lake Group has argued that the cost of the AIG 
rescue could have been substantially reduced if we had a 
package of reforms. And this package would have included: one, 
just designating the Fed as systemic risk regulator; two, 
increasing the use of centralized clearing of derivatives; 
three, creating mandatory living wills for financial 
institutions and bolstering resolution authority; four, 
changing capital rules for systemically important institutions; 
five, improving the disclosure of trading positions; and six, 
holding back pay at systemically relevant institutions. I would 
be glad to discuss this in the question-and-answer period.
    I just want to close with one last thought, which is I 
don't want to sound like I think that the Fed has a role or 
comparative advantage in all types of financial regulation, and 
I want to reiterate the Squam Lake Group's recommendation to 
get the Fed out of the business of consumer protection 
regulation. This is a case where there are very few synergies 
between the staffing requirements of consumer protection and 
other essential Central Bank duties. The Fed would be far 
better off handing off these duties to another regulator. Thank 
you.
    [The prepared statement of Professor Kashyap can be found 
on page 80 of the appendix.]
    Mr. Watt. Thank you very much for your testimony.
    Next, Mr. Nichols of the Financial Services Forum.

 STATEMENT OF ROBERT S. NICHOLS, PRESIDENT AND CHIEF OPERATING 
             OFFICER, THE FINANCIAL SERVICES FORUM

    Mr. Nichols. Chairman Watt, Ranking Member Paul, thank you 
for the opportunity to participate in today's hearing, to share 
our views regarding the Federal Reserve, and specifically, the 
relationship of supervisory authority to the Central Bank's 
effective discharge of its duties as our Nation's monetary 
authority.
    By way of background, the Financial Services Forum is a 
non-partisan financial and economic policy organization 
comprised of the chief executives of 18 of the largest and most 
diversified financial institutions doing business in the United 
States. Our aim is to promote policies that enhance savings 
investment in a sound, open, competitive financial services 
marketplace. Reform and modernization of our Nation's framework 
of financial supervision is critically important. We thank you, 
Mr. Chairman, Ranking Member Paul, and all the members of this 
committee for all of your tireless work over the past 15 
months.
    To reclaim our position of financial and economic 
leadership, the United States needs a 21st Century supervisory 
framework that is effective and efficient, ensures 
institutional safety and soundness, as well as systemic 
stability, promotes the competitive and innovative capacity of 
our capital markets, and protects the interests of depositors, 
consumers, investors, and policyholders.
    In our view, the essential elements of such a meaningful 
reform are enhanced consumer protections, including strong 
national standards, systemic supervision ending once and for 
all ``too-big-to-fail,'' by establishing the authority and 
procedural framework from winding down any financial 
institution in an orderly non-chaotic way in a strong, 
effective, and credible Central Bank, which in our view 
requires supervisory authority.
    On the 11th of December, your committee passed a reform 
bill that would preserve the Federal Reserve's role as a 
supervisor of financial institutions. On Monday of this week, 
Chairman Dodd of the Senate Banking Committee released a draft 
bill that would assign supervision of bank and thrift holding 
companies with assets of greater than $50 billion to the Fed.
    While we think that it is sensible that the Fed retains 
meaningful supervisory authority in that bill, we also believe 
the Fed and the U.S. financial system would benefit from the 
Fed also having a supervisory dialogue with small and medium-
sized institutions, a point which is well articulated by Jeff 
Gerhart in his testimony. You will hear from him in a moment.
    As this 15-month debate regarding the modernization of our 
supervisory architecture has unfolded, some have held the view 
that the Fed should be stripped of all supervisory powers, 
duties which some view as a burden to the Fed and distract the 
Central Bank from its core responsibility as the monetary 
authority and lender of last resort. Mr. Chairman, we do not 
share that view. Far from a distraction, supervision is 
altogether consistent with and supportive of the Fed's critical 
role as the monetary authority and lender of last resort for 
the very simple and straightforward reason that financial 
institutions are the transmission belt of monetary policy.
    Firsthand knowledge and understanding of the activities, 
condition and risk profiles of the financial institutions 
through which it conducts open market operations, or to which 
it might extend discount window lending, is critical to the 
Fed's effectiveness as the monetary authority and lender of 
last resort. It must be kept in mind that the banking system is 
the mechanical gearing that connects the lever of monetary 
policy to the wheels of economic activity. If that critical 
gearing is broken or defective, monetary policy changes by the 
Fed will have little, or even none, of the intended impact on 
the broader economy.
    In addition, in order for the Federal Reserve to look 
across financial institutions and the interaction between them 
and the markets for emerging risks, as it currently does, it is 
vital that the Fed have an accurate picture of circumstances 
within banks. By playing a supervisory role during crises, the 
Fed has a firsthand view of banks, is a provider of short-term 
liquidity support, and oversees vital clearing and settlement 
systems.
    As former Fed Chairman Paul Volcker observed earlier this 
afternoon, monetary policy and concerns about the structure and 
condition of banks and the financial system, more generally, 
are inextricably intertwined. While we don't see eye-to-eye 
with former Chairman Volcker on everything, we sure do agree 
with him on that.
    As Anil Kashyap noted, U.S. policymakers should also be 
mindful of international trends in the wake of financial 
crisis. In the United Kingdom--I'll point to the same example 
as Anil--serious consideration is being given to shifting bank 
supervision back to the Bank of England, which had been 
stripped of such powers when the FSA was created in 2001. It 
has been acknowledged that the lack of supervisory authority 
and the detailed knowledge and information derived from such 
authority likely undermined the Bank of England's ability to 
swiftly and effectively respond to the recent crisis.
    Thank you for the opportunity to appear before you today.
    [The prepared statement of Mr. Nichols can be found on page 
96 of the appendix.]
    Mr. Watt. Thank you for your testimony.
    Finally, Mr. Gerhart is recognized.

  STATEMENT OF JEFFREY L. GERHART, PRESIDENT, BANK OF NEWMAN 
   GROVE, ON BEHALF OF THE INDEPENDENT COMMUNITY BANKERS OF 
                         AMERICA (ICBA)

    Mr. Gerhart. Chairman Watt and members of the committee, I 
am Jeff Gerhart, president of the Bank of Newman Grove in 
Newman Grove, Nebraska. I'm also a former director of the 
Federal Reserve Bank of Kansas City. The Bank of Newman Grove 
is a State member bank supervised by the Federal Reserve with 
$32 million--that's ``M'' in million, not ``B'' in billion--in 
assets. Our bank was founded in 1891, and I'm the fourth 
generation of my family to serve as the bank's president.
    Newman Grove is an agricultural community of 800 in the 
rolling hills of northeast Nebraska. Our bank works hard to 
ensure Newman Grove is a vibrant community through loans to our 
local farmers, small businesses, and consumers. I am pleased to 
testify on behalf of the Independent Community Bankers of 
America and its 5,000 community bank members nationwide at this 
important hearing to link the Fed's examination--or supervision 
of monetary policy.
    Some in Congress have proposed that the Federal Reserve's 
supervision of State member banks be eliminated and that a 
supervision over holding companies be eliminated or limited to 
the very largest companies. Although the primary responsibility 
of the Federal Reserve is to conduct monetary policy, the ICBA 
opposes separating the Federal Reserve's monetary policy role 
from its role as financial supervisor. For decades, the Federal 
Reserve has played a critical role in the banking regulatory 
system as a supervisor of State member banks and holding 
companies.
    ICBA believes the local nature of the regional Federal 
Reserve banks, working in harmony with State bank regulators, 
gives them a unique ability to serve as a primary regulator for 
State member banks, the vast majority of which are community 
banks serving consumers and small businesses. This, in turn, 
gives the Federal Reserve an efficient means for gauging the 
soundness of the banking sector, information that is critical 
to developing and implementing sound monetary policy.
    Federal Reserve Chairman Bernanke recently testified that 
the Federal Reserve's supervision of community banks gives the 
Fed insight into what has happened at the grass roots level to 
lending and to the economy. This is particularly true with 
respect to the vital small business sector. While community 
banks represent about 12 percent of all bank assets, they make 
40 percent of the dollar amount of all bank small business 
loans under a million dollars. The Federal Reserve monetary 
policy is to promote this important sector of the economy. The 
Federal Reserve's supervision of community banks must be 
maintained.
    In addition, regulation of community banks gives the 
Federal Reserve a window on the vast array of local economies 
served by community banks, many of which are not served by any 
larger institutions at all. The inside gain from the 
supervision of State member banks and holding companies, both 
large and small, allows the Federal Reserve to identify 
disruptions in all sectors of the financial system in order to 
meet its statutory goal of ensuring stability of the financial 
system.
    The record shows the Federal Reserve has been a very 
effective regulator of community banks, and this role should be 
preserved. ICBA is very concerned that limiting the Federal 
Reserve's oversight to only the largest or systemically 
dangerous holding companies could lead to a bias and favor the 
largest financial institutions. This is a risky approach to 
financial reorganization and a path that the United States 
should not go down.
    The Federal Reserve Bank of Kansas City, the Federal 
supervisor of my bank, brings to its bank supervisory role a 
highly regarded expertise in the agricultural economy. The 
Federal Reserve's expertise in agriculture enhances its ability 
to supervise Midwestern community banks like mine with a 
significant ag loan portfolio. It would be a mistake to remove 
the Federal Reserve's economic expertise from the country's 
financial supervisory structure.
    Having multiple Federal agencies supervising depository 
institutions provides valuable regulatory checks and balances 
and promotes best practices among those agencies. The 
contributions and views of the Federal Reserve have been an 
important part of this regulatory diversity, which would 
significantly be diminished if the Federal Reserve were 
stripped of all or most of its supervisory authority.
    I want to thank you for inviting me here today, and I would 
be glad to answer any questions.
    [The prepared statement of Mr. Gerhart can be found on page 
73 of the appendix.]
    Mr. Watt. Thank you for your testimony.
    Mr. Foster has been so patient and diligent. He has been 
here the whole time. I think I'm going to reward him by 
recognizing him first for 5 minutes to ask questions.
    Mr. Foster. Well, thank you. Let's see. My first question, 
briefly, if you could all three comment on where you are on the 
discussion that was touched on with Chairman Bernanke about 
whether it was monetary policy or regulatory failure that was 
responsible for the crisis we have just gone through. So just 
go down in order, if you could.
    Mr. Kashyap. Many more regulatory problems, I mean, the 
banks ate their own cooking. You have to remember the most 
financially sophisticated banks ended up sitting on these AAA 
sub-prime securities that ended up coming back to haunt them. 
And I think if we had somebody looking out across the system 
seeing those concentrations of risks and being able to adjust 
things like loan to value ratios in the housing market and also 
haircuts and margins on those securities, you would not have 
the deleveraging that I think was so dangerous.
    Mr. Foster. Thank you.
    Mr. Nichols. Congressman Foster, I think it was a perfect 
storm of activities, activities, conditions, behaviors, 
failures, in a lot of places. So like Chairman Bernanke pointed 
to two or three different factors, I even think it's broader 
than that. Certainly, the industry played a role in terms of 
internal controls and risk management; lack of mortgage 
origination standards; the role of credit rating agencies; even 
our trade imbalance, a lot of money coming in for yield, 
interest rate policy. There was a perfect storm of failures. 
People were overleveraged. Some Americans bit off more than 
they could chew. It was really--I don't think you could just 
point to one thing that led to the housing bubble. There were a 
lot of accelerates and a lot of contributors to it, but it's a 
dozen different factors all intertwined, in my humble opinion.
    Mr. Foster. Thank you.
    Mr. Gerhart. Would you be kind enough to repeat the 
question?
    Mr. Foster. Where are you on the debate over the extent to 
which monetary policy was responsible for the crisis we just 
went through versus regulatory failure?
    Mr. Gerhart. Honestly, that is not an area as a day-to-day 
banker that I dwell on very often. So I would respectfully take 
a pass on that. Thank you.
    Mr. Foster. Okay. Let's see. I guess I would like to first 
make a couple comments on the Squam Lake Group, which actually 
led me to discover the concept of contingent capital, which I 
thought was one of the really positive lessons that I think 
we're going to carry out of this. And I was wondering what the 
status of work in the academic sector is on contingent capital 
or on the commercial sector. Is there a baseline implementation 
that people are talking about? Are there ongoing series of 
conferences? What is the actual status of that concept besides 
sort of secret deliberations in the Federal Reserve?
    Mr. Kashyap. Well, I pointed a member of your staff earlier 
today towards one working paper I know that has been written on 
this, but I think there is still active discussion over what 
the trigger should be. I understood your question to Chairman 
Bernanke to be asking whether or not should there be a 
regulatory trigger that would convert the debt. Was the Fed to 
be the regulator to pull the trigger? I don't think that's the 
way he answered it, but that's what I thought you were asking.
    I know that the rating agencies have said that if that 
trigger is enacted, they may not be willing to rate the debt. 
So there has been some discussion about what other triggers 
could be used with convertible debt that would still preserve 
the features that would add to the loss bearing capacity of the 
debt, but maybe not prevent rating agencies from being able to 
assess the risk. So that's one area. But generally, I think, 
there's a holding pattern until some of the regulatory bodies, 
namely the Financial Stability Board in Basel, come out with 
their assessments, which I understand to be coming soon.
    Mr. Foster. And I understand a couple of European banks 
have actually issued some of those what they call CoCo 
securities?
    Mr. Kashyap. Yes. Well, the first issue was a U.K. bank, 
but that was a bank that was under the control of the British 
government. And so there was some skepticism as to whether 
those terms were indicative and informative. I'm not sure if 
any continental banks have issued any in the last month or two, 
but--
    Mr. Foster. Okay. So as of yet, you don't think there is 
any relevant market experience with them.
    Mr. Kashyap. No. There were actually some issued in Canada 
in around 1999, but ironically, the Canadian regulators decided 
it shouldn't count as capital. So it was done on a small scale 
and they were ready to issue it en masse, and they couldn't get 
the regulatory treatment they needed.
    Mr. Foster. Okay. Thank you. I yield back.
    Mr. Watt. I thank the gentleman for being here all day, and 
for his good questions.
    I recognize myself for 5 minutes. I have to apologize for 
Mr. Paul having to leave. He had another commitment.
    Mr. Gerhart, I know the hearing today is about the Fed's 
supervisory role and the impact it has on monetary policy, but 
from your perspective as the supervised bank, could you tell me 
how your life would change if your supervisor were the FDIC or 
the OCC or somebody other than the Fed, as you perceive it?
    Mr. Gerhart. I have been a national bank. So I have been 
examined and supervised by the Comptroller of the Currency. We 
converted to a State charter in 2005, made the choice that we 
would like to remain a Fed member bank, so we applied with the 
Nebraska Department of Banking and Finance, along with the 
Federal Reserve Bank of Kansas City, and that is who our 
regulators are. What it does is it takes away from the dual 
banking system if you remove the Federal Reserve system from 
regulating us. They are--
    Mr. Watt. I understand that from--
    Mr. Gerhart. Okay.
    Mr. Watt. --the bank's--from the Fed's side. But from your 
perspective, what difference would it make?
    Mr. Gerhart. Well, it takes away choice because right now, 
I have a choice. Do I want to have the FDIC? Do I want to have 
the Federal Reserve Bank? I can pick one of the two, which both 
do a good job. A State member bank either has a choice of 
remaining with just the FDIC as their other Fed regulator or 
they can choose the Federal Reserve. So taking away choices is 
very important. Or I could go back to being a national bank and 
apply for a national bank charter.
    So that's extremely important. I can tell you, honestly, in 
fact, we just had an examination last week. The Fed is 
extremely thorough, the State is extremely thorough, and the 
OCC was extremely thorough. They look under every rock, and we 
are very well supervised in my book.
    Mr. Watt. I don't have any question about that. I'm just 
trying to figure out what, I mean, what difference would it 
make to you, other than you wouldn't have a choice between the 
Fed and some other regulator. Would the level of regulation and 
supervision be any different as you perceive it?
    Mr. Gerhart. Well, taking away choices is a pretty big--
    Mr. Watt. I understand that.
    Mr. Gerhart. Okay.
    Mr. Watt. But would the level of supervision and regulation 
be any different if you had a different regulator?
    Mr. Gerhart. I think it could be.
    Mr. Watt. How so?
    Mr. Gerhart. If I go back to my days as a national bank, 
those folks, the Comptroller's office, did a good job, but 
having the State as our--one of our regulators allows me to 
have somebody that is a little bit better fit, a little bit 
more in tune with rural agricultural economy. And I think that 
goes along with our choice for the Federal Reserve Bank of 
Kansas City. Their tenth district encompasses a lot of 
agriculture. And again, it was an option, and it gives us a 
good choice, and I think that needs to remain out there. I 
don't--
    Mr. Watt. Do you have a particular position on the consumer 
financial protection agency, whether it should exist, and if 
so, where it should exist.
    Mr. Gerhart. We would like to see that at $10 billion or 
above, and if there's a cutoff for the community banks, we feel 
like we're very well taken care of protecting consumers for all 
the products that come out. And for the most part, it wasn't 
community banks that had products to their consumers that 
people got in trouble with.
    Mr. Watt. You're nicely avoiding my question. Do you have 
an opinion of whether it should exist?
    Mr. Gerhart. It could exist.
    Mr. Watt. Regardless of who--I mean, I assume you're saying 
it doesn't--it really wouldn't have any impact on your bank 
because you wouldn't be under the House bill; we exempted you. 
But--
    Mr. Gerhart. We may be exempt, but I think in the end, yes, 
it will have some impact as far as that goes. And we're 
certainly comfortable--
    Mr. Watt. I need your opinion on whether it should exist, 
and if so, where it should exist.
    Mr. Gerhart. In the Fed.
    Mr. Watt. And if now, why it shouldn't exist.
    Mr. Gerhart. In the Fed or the FDIC, but it should--it 
needs to be fair to everybody.
    Mr. Watt. But you do think there is a need for a consumer 
financial protection agency somewhere.
    Mr. Gerhart. Somewhere.
    Mr. Watt. Okay. All right.
    Mr. Nichols, what's your opinion on the CFPA and where it 
should exist, whether it should exist?
    Mr. Nichols. Sure, Mr. Chairman. We are--as we have 
discussed before--in heated agreement with you that we need to 
enhance consumer protections. I think among the many, many, 
many lessons learned from the crisis, that's certainly one of 
them.
    We are--I mean, our view, candidly, is that probably 
tethering the enhanced consumer protections with the safety and 
soundness a prudential regulator does--is sensible. We're 
interested to learn more about the proposal that's being--that 
was unveiled a couple of days ago. So but with regard to the 
overall goal of enhancing consumer protections, as identified 
in this testimony, that's a critical, critical issue that we 
think absolutely has to happen.
    Mr. Watt. You haven't--you are giving me trouble getting 
you pinned down on this issue.
    You have been pretty direct about this, Professor. In your 
oral testimony, you said that you did not really think it had 
any particular reason that it needed to be in the Fed and they 
ought to jettison it. Elaborate on your position on that, if 
you would.
    Mr. Kashyap. Well, first of all, I think some aspects of it 
are inherently politicized. And the Fed has enough political 
troubles, as we have seen from the questions and answers today, 
I don't see why they need to be borrowing other issues to be 
testifying about and arguing with when it's not central to 
being the Central Bank. There is no synergy between deciding 
whether or not a mortgage is abusive or a credit card shouldn't 
be able to have certain add-on fees and deciding anything about 
monetary policy or deciding anything, frankly, about the 
stability of the financial system.
    Mr. Watt. Where would you put it and what authority would 
you give it?
    Mr. Kashyap. I don't have a strong view as to whether it 
needs to be completely independent or it could go into another 
agency. I think whoever is supervising that staff has to be 
accountable to Congress and should be a specialist. Like 
Chairman Volcker said, maybe the Fed should have a vice 
chairman for financial stability. If this was to go into 
another organization, I think there should be a special 
designee to sit on top of it and have to come to talk to you. 
But whether it should be set up from scratch, I don't know.
    I think the staff would largely be lawyers. And that's 
another reason why the culture of the Fed is more one of 
economists. There is no reason to put the two together. So I 
would house it in an organization where you can get the right 
staff and where they are going to be suitably accountable.
    Mr. Watt. Mr. Nichols, if you tethered it, as you said, 
with the supervisory agency, how would you avoid the potential 
of three inconsistent consumer protection attitudes if you had 
three different supervisory agencies?
    Mr. Nichols. Well, that's the key question. One of the 
things that policymakers have been grappling with, and we are 
grappling with ourselves, is how do you deal with, if there is 
a--how do you come up with a reconciliation mechanism between 
the safety and soundness regulator and the consumer 
protections? So I don't know today precisely how--
    Mr. Watt. I'm dwelling on how you reconcile the three 
consumer protection agencies now, not even the safety and 
soundness part of it, if you have three different consumer 
protection agencies: one at FDIC; one at the Fed; and one at 
the OCC. How would you avoid having three different consumer 
protection standards, aside from the safety and soundness 
aspects of it?
    Mr. Nichols. Right. Well, we think--well, with regard to--
first, one thing. With regard to national standards, we 
actually think we should come up with--during this policymaking 
process, it's probably a sensible thing to come up with a 
strong national standard with regard to consumer protection. So 
that is one--that is a side issue, but one that is probably 
worth sharing.
    But I do think part of it, when--your specific question 
with regard to the individual regulators and the consumer 
protections housed within them, you know, obviously, for 
example, what is happening at the SEC, the products that are 
overseen by the SEC are a little different at times and within 
the banking regulator. So I think the fact that you do have--
    Mr. Watt. Now Mr. Gerhart just told me, you know, yes, but 
supervisors are a little bit different for financial 
institutions. You have banks and you have banks. They are not 
securities. Why would you have three different consumer 
protection agencies?
    Mr. Nichols. Well, I wouldn't propose having three 
different agencies. I'm just thinking--I'm suggesting just 
tethering them, if that makes sense.
    Mr. Watt. I don't know what you mean by tethering. That is 
why I asked the question. I thought you were saying if you 
needed to tether them to their--to the particular regulator, 
which would mean to me, if I'm reading what you say correctly 
or if I'm understanding what you say correctly, you would have 
one tethered to the FDIC, one tethered to the Fed, and one 
tethered to the OCC. That is three different regulators. How 
would--maybe I don't understand the word ``tethered.''
    Mr. Nichols. I'm sorry. I'm doing my best to answer your 
question. I do think pairing them makes sense. And so is your 
question to me is, will you have inconsistent standards if you 
have different groups of different regulators?
    Mr. Watt. Yes. How can you avoid that if you have three 
different tethered--
    Mr. Nichols. Right. One idea--
    Mr. Watt. --consumer protection?
    Mr. Nichols. One idea that was explored in this body is to 
have a council of, you know, an office--a council of consumer 
protection offices within the different regulatory bodies that 
would perhaps report to Congress, directly to you, that they 
would share best practices, that they would gather together and 
talk about and communicate and coordinate and consult with one 
another to see what's happening.
    Walt Minnick from Idaho had a concept that was obviously 
debated before this body--and I think there was some merit to 
that--which would get directly to your question. Sorry I didn't 
hit on it earlier.
    Mr. Watt. Why would you do that with consumer protection 
and not do it with safety and soundness? You have the FDIC. You 
have the Fed responsible for safety and soundness of Mr. 
Gerhart's bank, the FDIC dibbling and dabbling in safety and 
soundness with respect to his bank. The OCC is not dibbling and 
dabbling in safety and soundness with respect to his bank. Why 
would you want two different agencies dibbling and dabbling in 
the consumer protection part of it?
    Mr. Nichols. Well, to some extent, on safety and soundness, 
that proposal is being considered. Both this--both your body, 
as well as the Senate, are talking about proposing the 
creation, which I think is a sensible idea, of a systemic 
stability council.
    Mr. Watt. That's the great big guys. I'm talking about the 
smaller banks. For systemic people, you are looking across a 
whole array of financial institutions. You are big enough to 
have a significant adverse systemic impact on the whole 
economy. I have jumped across that hurdle. I'm talking about 
the guys that don't fall into the systemic risk category. Why 
would you set up a different standard when it comes to consumer 
protection than the standard you would apply to safety and 
soundness?
    Mr. Nichols. I take your question, Congressman, and I would 
be glad to get back to you on a further answer. I just--
    Mr. Watt. Okay. I mean, these are not trick questions.
    Mr. Nichols. Sure.
    Mr. Watt. At every hearing, I have been very transparent in 
what I have said. I want a consumer protection agency that is 
just as robust, just as independent as the safety and soundness 
people. I think that is what the consumers deserve. And if you 
are going to make compromises on consumer protection, then 
those same compromises ought to be considered for the safety 
and soundness.
    I'm not suggesting that, but I think it's the--you know, 
I'm good with Mr. Gerhart having only one safety and soundness 
regulator, but I don't know why we would set up a three-party 
consumer protection agency, if we're not setting up a three-
party safety and soundness person. It seems to me that would 
just signal to the public that we are treating consumer 
interest as second-class, and I think it sends the wrong 
signal.
    Mr. Nichols. I do agree with you that we cannot send a 
signal that consumer protections are not utterly, utterly 
important.
    Mr. Watt. Think about it. I'm well over my time. Of course, 
nobody is objecting, except the staff who want to go home. So 
I'm delighted to have all of you here. I really apologize that 
we got caught in a bind and you had to be here all day and--but 
that is the cost of doing business, or whatever it is called.
    The Chair notes that some members may have additional 
questions for this panel, which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 30 days for you to respond to in writing, if you would 
like, to this question that I posed to you, and for other 
members to submit written questions to these witnesses and to 
place their responses in the record.
    I thank you all so much for your patience and for your 
persistence and for being here, and the hearing is adjourned.
    [Whereupon, at 5:55 p.m., the hearing was adjourned.]


                            A P P E N D I X



                             March 17, 2010


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