[Senate Hearing 111-228]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 111-228
 
  THE ADMINISTRATION'S PROPOSAL TO MODERNIZE THE FINANCIAL REGULATORY 
                                 SYSTEM 

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

                                HEARING

                               before the

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

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                                   ON

  EXAMINING THE ADMINISTRATION'S PROPOSAL TO MODERNIZE THE FINANCIAL 
                           REGULATORY SYSTEM

                               __________

                             JUNE 18, 2009

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate/
                            senate05sh.html

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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman

TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         JIM BUNNING, Kentucky
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          MEL MARTINEZ, Florida
DANIEL K. AKAKA, Hawaii              BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  JIM DeMINT, South Carolina
JON TESTER, Montana                  DAVID VITTER, Louisiana
HERB KOHL, Wisconsin                 MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             KAY BAILEY HUTCHISON, Texas
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado

                    Edward Silverman, Staff Director

              William D. Duhnke, Republican Staff Director

                      Amy S. Friend, Chief Counsel

                   Dean V. Shahinian, Senior Counsel

                          Julie Chon, Counsel

             Jonathan N. Miller, Professional Staff Member

                    Deborah Katz, Legislative Fellow

                  Drew Colbert, Legislative Assistant

                 Charles Yi, Senior Advisor and Counsel

                     Matthew Green, Senior Counsel

                   Lisa Frumin, Legislative Assistant

                Misha Mintz-Roth, Legislative Assistant

                Neal Orringer, Professional Staff Member

                  Laura Swanson, Legislative Assistant

                   Kara Stein, Legislative Assistant

                 Randall Fasnacht, Legislative Detailee

                Grace Katabaruki, Legislative Assistant

                 David Stoopler, Legislative Assistant

                   Jayme Roth, Legislative Assistant

                Michael Passante, Legislative Assistant

                   Matt Pippin, Legislative Assistant

                 Patrick Jackson, Legislative Assistant

                 Jason Rosenberg, Legislative Assistant

                   Hilary Swab, Legislative Assistant

                Nathan Steinwald, Legislative Assistant

                  Andrew Green, Legislative Assistant

                 Layth Elhassani, Legislative Assistant

                Mark Oesterle, Republican Chief Counsel

                Andrew J. Olmem, Jr., Republican Counsel

                  Chad Davis, Republican Chief Counsel

                   Hester Peirce, Republican Counsel

           Brandon Barford, Republican Legislative Assistant

           Mike Nielsen, Republican Professional Staff Member

          William Henderson, Republican Legislative Assistant

            Gregg Richard, Republican Legislative Assistant

          Jennifer Gallagher, Republican Legislative Assistant

          Courtney Geduldig, Republican Legislative Assistant

            Travis Johnson, Republican Legislative Assistant

            Scott Douglas, Republican Legislative Assistant

             Mark Sanchez, Republican Legislative Assistant

                       Dawn Ratliff, Chief Clerk

                      Devin Hartley, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)
















                            C O N T E N T S

                              ----------                              

                        THURSDAY, JUNE 18, 2009

                                                                   Page

Opening statement of Chairman Dodd...............................     1
    Prepared statement...........................................    50

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     4
    Senator Johnson
        Prepared statement.......................................    51
    Senator Brown
        Prepared statement.......................................    51
    Senator Crapo
        Prepared statement.......................................    52

                                WITNESS

Timothy Geithner, Secretary, Department of the Treasury..........     6
    Prepared statement...........................................    53
    Responses to written questions of:
        Chairman Dodd............................................    59
        Senator Shelby...........................................    60
        Senator Reed.............................................    82
        Senator Akaka............................................    85
        Senator Kyl..............................................    87

                                 (iii)


                    THE ADMINISTRATION'S PROPOSAL TO
               MODERNIZE THE FINANCIAL REGULATORY SYSTEM

                              ----------                              


                        THURSDAY, JUNE 18, 2009

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 9:34 a.m., in room SH-216, Hart Senate 
Office Building, Senator Christopher J. Dodd (Chairman of the 
Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. The Committee will come to order.
    Again, I want to welcome my colleagues, welcome the 
Secretary. We are pleased to have you before us again, Mr. 
Secretary, this morning. I welcome our audience that is here 
this morning.
    We will proceed in the following manner: I will make some 
opening remarks. I will ask Senator Shelby as well if he would 
care to make any opening remarks. And then to move things 
along, unless any Member here is so compelled, I would like to 
get right to the Secretary for his comments, then get right to 
the questioning if we can as well. So that is the manner in 
which we will proceed, but I thank everyone for making it here 
this morning. Again, Mr. Secretary, thank you for being with 
us.
    This morning we are going to conduct this hearing on the 
administration's proposal to modernize the financial regulatory 
system, and for those of us--I was there yesterday at the White 
House to hear the President make his presentation, along with 
many others. So good morning and thank you again for being with 
us. I would like to welcome the Secretary, who is here to 
discuss the administration's proposal.
    Mr. Secretary, we applaud your leadership on a very complex 
set of issues intended to restore confidence and stability in 
our financial system, and I, along with my colleagues, look 
forward to exploring the details of your plan and working with 
you and our colleagues here and the other body on this truly 
historic endeavor.
    In my home State of Connecticut and around the Nation, 
working men and women who did nothing wrong have watched the 
economy fall through the floor, taking with it their jobs, in 
many cases their homes, their life savings, and the economic 
security that has always been the cherished promise of the 
American middle class. These people, our constituents across 
the contractor, the American taxpayer, are hurting. They are 
very angry and they are worried, and they are wondering who is 
looking out for them.
    I have seen firsthand how hard people work in my State, as 
I know my colleagues here--and you have, too, Mr. Secretary, 
what they do to support their families, to build financial 
security for themselves. I have seen, as well as my colleagues 
have, how devastating this economic crisis has been for them. 
And I firmly believe that someone should ``have their backs,'' 
as the expression goes.
    So as we work together to rebuild and reform the regulatory 
structures whose failures led us to this crisis, I, along with 
my colleagues here, will continue to insist that improving 
consumer protection be a first principle and an urgent 
priority.
    I welcome the administration's adoption of this principle, 
and I am pleased to see it reflected in the plans that we will 
be discussing this morning.
    At the center of this effort will be a new, independent 
consumer protection agency to protect Americans from poisonous 
financial products. This is a very simple, common-sense idea. 
We do not allow toy manufacturers to sell toys that could hurt 
our children. We do not allow electronic companies to sell 
defective appliances. Why should a usurious payday loan be 
treated any differently than we treat an unsafe toy or a 
malfunctioning toaster? Why should an unscrupulous lender be 
allowed to dupe a borrower into a loan the lender knows cannot 
be repaid? There is no excuse for allowing a financial services 
company to take advantage of American consumers by selling them 
dangerous financial products. Let us put a cop on the beat so 
that this spectacular failure of consumer protection at the 
root of this mess is never repeated again.
    We have been engaged in an examination of just what went 
wrong in the lead-up to this crisis since February of 2007 when 
experts and regulators from across the spectrum testified 
before this very Committee that poorly underwritten mortgages 
would create a tsunami of foreclosures. Those mortgages were 
securitized and sold around the globe. The market is supposed 
to distribute risk, but because for years no one was minding 
the store, these toxic assets served to amplify risk in our 
system.
    Everything associated with these securities--the credit 
ratings applied to them, the solvency of the institutions 
holding them, and the creditworthiness of the underlying 
borrowers--became suspect. And as the financial system tried to 
pull back from these securities, it took down some of the 
country's most venerable institutions--firms that had survived 
world wars, great depressions, down for decades and decades, 
and wiped out over $6 trillion in household wealth since last 
fall alone.
    Stronger consumer protection I believe would have stopped 
this crisis before it started. Consumers were sold subprime and 
exotic loans they could not afford to repay and were, frankly, 
cheated. They should have been the canaries in the coal mine. 
But instead of heeding the warnings of many experts, regulators 
turned a blind eye, and it was regulatory neglect that allowed 
the crisis to spread to the point where the basic economic 
security of my constituents and millions more around the 
country here, including folks who have never seen or heard of 
mortgage-backed securities, was threatened by the greed of some 
bad actors on Wall Street and elsewhere and the failure of our 
regulatory system.
    To rebuild confidence in our financial system, both here at 
home and around the world, we must reconstruct our regulatory 
framework to ensure that our financial institutions are 
properly capitalized, regulated, and supervised. The 
institutions and products that make up our financial system 
must act to generate wealth, not destroy it.
    In November, I announced five principles which would guide 
the Banking Committee's efforts in the coming weeks and months.
    First and foremost, regulators must be focused and 
empowered aggressive watchdogs rather than passive enablers of 
reckless practices.
    Second, we have to remove the gaps and overlaps in our 
regulatory structure that have encouraged charter shopping and 
a race to the bottom in an effort to win over bank and thrift 
clients.
    Third, we must ensure that any part of our financial system 
that poses a systemic wide risk is carefully and sensibly 
supervised. A firm too big to fail is a firm too big to leave 
unmonitored.
    Fourth, we cannot have effective regulation without more 
transparency. Our economy has suffered from the lack of 
information about trillion-dollar markets and the migration of 
risks within them.
    And, fifth, our actions must help Americans remain 
prosperous and competitive in a global marketplace.
    These principles will guide my consideration of the plan 
that you bring to our Committee this morning, Mr. Secretary, 
and I believe that we can find common ground in a number of the 
areas contained in your proposal. And I want to thank you again 
for your leadership on these issues as well as for your 
willingness to consider different perspectives in forging this 
plan. I hope you will view this as a continuation of the 
dialogue that you have had with Members of this Committee, both 
Democrats and Republicans, as we work together to shape a 
regulatory framework that will serve our Nation well into the 
21st century.
    I want to thank all of my colleagues on this Committee as 
well, by the way, who have demonstrated a strong interest in 
this issue and are determined to work together. Senator Shelby 
will obviously give his own opening remarks, but he and I have 
talked on numerous occasions about how this issue that we will 
grapple with here as a Committee may be the most important 
thing this Committee will have done in the last 60 or 70 years 
or the most important thing any one of us is going to do as a 
Members of this Committee for years to come--getting this 
right.
    I do not sense on this Committee any great ideological 
divides. What I do sense is a determination to figure out what 
works best, to get it right, and to get the job done. So I am 
really excited about the opportunity that is being posed by the 
proposal you have put forward and the work in front of us. And 
I want to urge everyone on our Committee and elsewhere to 
remember that at the end of the day, at the end of all of this, 
the success of what we attempt will be measured by its effect 
on the borrower, on the shareholder, on the investor, the 
depositor, the consumers, and taxpayers seeking not to attain 
extravagant wealth but simply to grow a small business, pay for 
college, buy a home, and pass on something to their children. 
That is the American dream, and that is what we are gathered to 
restore.
    Let me just say, while it is not part of my remarks I 
prepared for this morning, when I pick up the morning newspaper 
and I read the first headline here, ``Fault Lines Emerge as 
Industry Groups Blast Plan to Create Consumer Agency,'' what 
planet are you living on? The very people who created the damn 
mess are the ones now arguing that consumers ought not to be 
protected. They are the people who have paid this price. And 
the idea that you are going to first want to attack the very 
clients and customers who depend upon you every day is not the 
place to begin.
    And so I am somewhat upset when I see those kinds of 
remarks when we are trying to look for cooperation and building 
some common ideas.
    With that, I turn to Senator Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman.
    I have said on a number of occasions that reforming our 
financial regulatory system may be, as Senator Dodd has 
indicated, the most significant thing many of us will do while 
serving in the U.S. Senate. We all know how difficult it can be 
to shepherd even minor bills through the legislative process, 
let alone anything as significant as financial regulatory 
reform. We also know equally well that the opportunity to 
accomplish something of this magnitude can be fleeting, which 
presents a bit of a conundrum. We certainly want to strike 
while the iron is hot, but we also want to make the most of the 
opportunity that has been presented.
    The philosopher William James once said, ``He who refuses 
to embrace a unique opportunity loses the prize as surely as if 
he has failed.'' I hope that we do not collectively refuse to 
embrace this unique opportunity because here failure I believe 
is not an option.
    The President has put forward his plan. It deserves our 
careful consideration. That consideration will involve not only 
an evaluation of his proposed reforms but, more importantly, a 
close examination of the facts upon which he based his 
recommendations. The administration's factual predicate can 
then be compared with the Committee's findings as soon as we 
complete our examination of the crisis.
    I have said many times this Committee must first clearly 
identify what went wrong before we even began to consider a 
response. It is my hope that we can take advantage of some of 
the work done by the Secretary and others in the 
administration. It would be helpful if Secretary Geithner could 
share with Congress any and all documents and information used 
in their process in their recommendation.
    As is the case with all legislative efforts, laws are built 
around consensus, and consensus is achieved when all parties 
can agree on either facts or principles. There is one fact upon 
which I believe we have reached a complete agreement. Our 
financial regulatory system is antiquated and inadequate. I am 
not as confident, however, that we have reached agreement on 
what principles should guide our efforts yet.
    As we begin evaluating the President's plan, I want to 
highlight the key considerations that I believe should guide 
our process as we move forward.
    First, notwithstanding the great difficulties we have 
recently experienced, private markets still provide the best 
means for achieving our full economic potential. Risk taking is 
an essential ingredient in these markets, and while we should 
improve our ability to manage risk, we cannot simply eliminate 
risk taking without sacrificing the foundation of our free 
market system. We must also remember that risk is a two-way 
street. Those who take risk must be prepared to suffer the 
losses as well as enjoy the gains. Any reforms we adopt must 
reduce expectations that some firms are simply too big to fail.
    Second, we must establish regulatory mandates that are 
achievable. This is especially true with respect to the 
regulation of systemic risk. And while there is wide agreement 
that we have experienced a systemwide event, we have spent very 
little time discussing the concept of systemic risk, 
determining how best to regulate it, or even establish whether 
it can be regulated at all.
    Third, I believe that regulators should have clear and 
manageable responsibilities and be subject to oversight and 
proper accountability. I am concerned that we already have a 
number of regulators that do not currently meet these criteria, 
and the administration is contemplating giving them additional 
responsibilities. For example, the Federal Reserve already 
handled monetary policy, bank regulation, holding company 
regulation, payment systems oversight, international banking 
regulation, consumer protection, and the lender-of-last-resort 
function. These responsibilities conflict at times, and some 
receive more attention than others. I do not believe that we 
can reasonably expect the Fed or any other agency effectively 
play so many roles.
    In addition, the Federal Reserve was provided a unique 
independent status to assure world markets that monetary policy 
would be insulated from political influence. The structure of 
the Federal Reserve involves quasi-public reserve banks that 
are under the control of boards with members selected by banks 
regulated by the Fed. By design, the board and the reserve 
banks are not directly accountable to Congress and are not 
easily subject to congressional oversight. Recent events have 
clearly demonstrated that the structure is not appropriate for 
a Federal banking regulator let alone a systemic regulator.
    Finally, while we have a responsibility to identify and 
repair the weaknesses of our current regulatory structure, we 
also have a duty to position our regulatory system for the 
future. Since World War I, we have been the world's financial 
market of choice. That is rapidly changing. We must do 
everything we can to not only ensure the safety and soundness 
of our financial system, but also its competitive standing in 
the world.
    The President has now added his voice to the debate, and it 
is now up to us to add ours. As we do, I hope that we will not 
allow the administration's recommendations to limit the debate 
that we are about to undertake. While we have a very difficult 
task before us, I also believe we have a unique opportunity to 
do something significant.
    I urge my colleagues to focus on creating a regulatory 
system for the next century, not one that merely seeks to 
remedy the mistakes of the last few years.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Mr. Secretary, we welcome you once again before the 
Committee and look forward to your testimony. And, by the way, 
any supporting documents and other materials--Senator Shelby 
recommended that it might be helpful for the Committee to see 
and discuss with you and your staff and others the background 
material that you used in formulation of this could be helpful 
as well as we move forward. So I welcome that suggestion by my 
friend from Alabama.
    I would say, by the way, all statements of my colleagues as 
well and any data and supporting material they would like to be 
included in the record of this hearing will be--we will just 
consider that done as well as we move forward.
    Mr. Secretary, welcome.

  STATEMENT OF TIMOTHY GEITHNER, SECRETARY, DEPARTMENT OF THE 
                            TREASURY

    Secretary Geithner. Mr. Chairman, Ranking Member Shelby, 
and Members of the Committee, it is a pleasure to be here. I 
welcome this debate. This is a critically important debate for 
our country, and I think it is time we get to it.
    Over the past 2 years, our Nation has faced the most severe 
financial crisis since the Great Depression. Our financial 
system failed to perform its critical functions. The system 
magnified risks. Some of the largest institutions in the world 
failed. The resulting damage affected the country as a whole, 
affecting virtually every American. Millions have lost their 
jobs and their homes. Hundreds and thousands of small 
businesses have shut down. Students have deferred college and 
education, and workers have had to shelve their retirement 
plans.
    American families are making essential changes in response 
to this crisis. It is our responsibility to do the same, to 
make our Government work better. And that is why yesterday 
President Obama unveiled a sweeping set of regulatory reforms 
to lay the foundation for a safer, more stable financial 
system, one that can deliver the benefits of market-driven 
financial innovation even as it guards against the dangers of 
market-driven excesses.
    Every financial crisis of the last generation has sparked 
some effort at reform, but past efforts have been begun too 
late, often after the will to act has subsided. We cannot let 
this happen this time. We may disagree about the details, and 
we will have to work through these issues. But ordinary 
Americans have suffered too much. Trust in our financial system 
has been too shaken, and our economy was brought too close to 
the brink for us to let this moment pass.
    In crafting our plan, the administration has sought input 
from all sources. We consulted extensively with Members of 
Congress, regulators, consumer advocates, business leaders, 
academics, and the broader public. And we looked at a range of 
proposals made by a number of bodies here in the United States 
over the last several months. We considered a full range of 
options, and we made the judgment that now was the time to 
pursue the essential reforms, those that address the core 
causes of the crisis and those that will help prevent or 
contain future crises.
    I want to be clear. Our plan does not address and does not 
seek to address every problem in our financial system. That is 
not our intent, and we do not propose reforms that, while 
desirable, would not move us toward achieving those core 
objectives of creating a more stable system and addressing 
those vulnerabilities that are critical to our capacity to 
prevent future crises.
    We have laid out the details of our proposals in public, so 
I just want to spend a few minutes explaining some of the broad 
principles that guided our proposals.
    First, if this crisis has taught us anything, it is that 
risks to our system can come from almost any quarter. We must 
be able to look in every corner and across the horizon for 
dangers, and our system was not able to do that.
    While many of the firms and markets at the center of the 
crisis were under some form of Federal regulation, that 
supervision did not prevent the emergence of large 
concentrations of risk. A patchwork of supervisory 
responsibility, loopholes that allowed some institutions to 
shop for the weakest regulator, and the rise of new 
institutions and instruments that were almost entirely outside 
the Government's supervisory framework left regulators largely 
blind to emerging dangers. And regulators were ill equipped to 
spot systemwide threats because each was assigned to protect 
the safety and soundness of individual institutions under their 
watch. None was assigned to look out for the broader system as 
a whole.
    That is why we propose establishing a Financial Services 
Oversight Council to bring together the heads of all the major 
Federal financial regulatory agencies, and this council will 
help ensure that we fill gaps in the regulatory structure where 
they exist and where they emerge. It will improve coordination 
of policy and help us resolve disputes across agencies. And, 
most importantly, it will have the power to gather information 
from any firm or market to help identify and help the 
underlying regulators respond to emerging risks.
    The council will not have the responsibility for 
supervising the largest, most complex, interconnected 
institutions, and the reason for that is simple. That is a 
highly specialized, complicated task, and it requires 
tremendous institutional capacity and organizational 
accountability.
    Nor would the council be an appropriate first responder in 
a financial emergency. You cannot convene a committee to put 
out a fire. The Federal Reserve is the best positioned to play 
that role. It already supervises and regulates bank holding 
companies, including all major U.S. commercial and investment 
banks. Our plan is to give it a carefully designed, modest 
amount of additional authority, and clearer accountability for 
the Fed to carry out that mission, but we also take some 
important authority and responsibilities away from the Federal 
Reserve.
    Specifically, we propose removing from the Federal Reserve 
and other bank regulators oversight responsibility for 
consumers. Historically in those agencies, consumer interests 
were often perceived to be in conflict with the broader mandate 
of the institutions to protect safety and soundness.
    That brings me to our second key priority: consolidating 
protection for consumers and ensuring they understand the risks 
and rewards associated with financial products sold directly to 
them. Before this crisis, many Federal and State regulators had 
authority to protect consumers, but few viewed it as their 
primary mission. As abusive practices spread, particularly in 
the market for subprime and nontraditional mortgages, our 
regulatory framework proved inadequate. And this lack of 
oversight, as the Chairman said, led millions of Americans to 
make bad financial decisions that emerged as a core part, a 
core cause of this crisis. Consumer protection is not just 
about individuals, but it is also about safeguarding the system 
as a whole.
    Now, this Committee, the Congress, and the administration 
have already taken important steps to address consumer problems 
in two key markets--those for credit cards and the beginning 
mortgages--and our view is that those are a sound foundation on 
which to build more comprehensive reform.
    We propose the establishment of a Consumer Financial 
Protection Agency to serve as the primary Federal agency 
looking out for the interests of consumers of credit, savings, 
payments, and other financial products. This agency will be 
able to write rules that promote transparency, simplicity, and 
fairness, including standards for standardized, simple, plain 
vanilla products that have straightforward pricing.
    Our third priority is to make sure that reform, while 
discouraging abuse, encourages financial innovation. The United 
States remains the world's most vibrant and most flexible 
economy in large measure because our financial markets create a 
continuous flow of new products, services, and capital. That 
makes it easier for the innovator to turn a new idea into a 
growing company.
    Our core challenge, though, is to design a system which has 
a proper balance between innovation and efficiency on the one 
hand and stability and protection on the other. We did not get 
that balance right, and that requires substantial reform. We 
think the best way to keep the system safe for innovation is to 
have stronger protections against risk with stronger capital 
buffers, to have greater disclosure so that investors and 
consumers can make more informed financial decisions, and a 
system that is better able to evolve as innovation advances and 
the structure of our financial system changes in the future.
    Now, I know that some suggest we need to ban or prohibit 
specific types of financial instruments as too dangerous, and 
we are proposing to strengthen consumer protections and 
investor protections and enforcement by, among other things, 
prohibiting a range of abusive practices, such as paying 
brokers for pushing consumers into higher-priced loans or 
penalties for earlier repayment of mortgages.
    In general, however, we do not believe you can build a 
system based on--a more stable system based on an approach of 
banning on a periodic basis individual products because those 
risks will simply emerge quickly in new forms. Our approach is 
to let new products develop, but to bring them into a 
regulatory framework with the necessary safeguards in place.
    Our tradition of innovation in the financial sector has 
been central to our prosperity as a country, so our reforms are 
designed to strengthen our markets by restoring confidence and 
accountability.
    Finally, Mr. Chairman, a fourth priority is to address the 
basic vulnerabilities and our capacity to manage future crises. 
We came into this crisis without an adequate set of tools to 
confront and deal with the potential failures of large, complex 
financial institutions. That left the Government with extremely 
limited choices when faced with the failure of the largest 
insurance company in the world and some of the world's largest 
investment banks. And that is why, in addition to addressing 
the root causes of this crisis, putting in place a better 
framework for crisis prevention in the future, we have to act 
to give the Government better tools to manage future crises.
    At the center of this, we propose a new resolution 
authority modeled on the existing authority of the FDIC to 
manage the failure of weak thrifts and banks, and that will 
give us more options in the future that we should have had 
going into this crisis. This will help reduce moral hazard by 
allowing the Government to resolve failing institutions in ways 
that impose costs on owners, creditors, and counterparties, 
making them more vigilant and prudent.
    Now, we have to also minimize moral hazard created by 
institutions that emerge with a scale and size that could 
threaten stability. No one should assume that the Government in 
the future will step in to bail these institutions out if they 
fail. We will do this by making sure financial firms follow the 
example of families across the country and build bigger 
protections, bigger cushions, bigger safeguards as a precaution 
against bad times. We will require all firms to keep more 
capital and more liquidity on hand as a greater cushion against 
future losses and risks, and the biggest, most interconnected 
firms will be required to keep larger cushions, larger shock 
absorbers against future shocks.
    Now, the critical test of our reforms will be whether we 
make the system strong enough to withstand the stress of future 
recessions and strong enough to withstand the failure of large 
institutions in the future. These are our basic objectives. We 
want to make the system safer for failure and safer for 
innovation. We cannot afford inaction. As both the Chairman and 
Ranking Member said, I do not think we can afford a situation 
where we leave in place vulnerabilities that will sow the seeds 
for future crises, so we look forward to working with this 
Committee in the weeks and months ahead to put in place a 
stronger foundation for a more stable financial system in the 
future.
    Thank you very much, Mr. Chairman.
    Chairman Dodd. Thank you very much, Mr. Secretary.
    We have a full complement of Members here this morning, and 
so I am going to be a bit more disciplined about the 5 minutes. 
That way we can get through the Members who are here; 
otherwise, if it goes on too long, we do not get a chance to do 
that. So I will instruct the clerk to put that clock on, and if 
Members would be careful to watch it themselves so we get to 
include everyone in the questioning this morning.
    Let me begin, Mr. Secretary, with a question regarding 
mortgage protections. I strongly support your notion of a 
Consumer Financial Protection Agency. I would point out to you, 
as I know you are aware as well, we gave the authority back in, 
I think, 1994 with the HOEPA legislation. It was not a request 
but it was a mandate that they formulate regulations to protect 
against some of the very abuses that led to the mortgage crisis 
in the country. And so merely designating someone to do a job 
does not always get the job done, obviously, as we have learned 
painfully in all of that.
    What I would like to know is, while it is not included 
specifically--and the other body, the House, has dealt with 
this differently--there is a strong interest on this Committee 
to deal with the mortgage reform provisions in the bill. And 
what I want to get from you, if I can, at the outset, would you 
be willing to work with us on including language as part of 
this overall reform effort that would do that as well?
    Secretary Geithner. Yes. We think that is very important.
    Chairman Dodd. Well, I appreciate the answer to that.
    Let me go to the issue--and, again, I want to state--I 
think all of us have had a chance to talk about this, and 
obviously the debate about, one, whether or not you want a 
systemic risk regulator, which I certainly do, and then the 
question who does it and what authorities do you give them.
    From my standpoint, I am open on the issue. I have not made 
up my own mind what is the best alternative. Obviously, you 
have submitted a plan that gives that authority to the Fed. But 
let me raise some questions that have been raised by others 
about the wisdom of that move to the Fed and not looking at the 
more collegial approach or some other alternative.
    A fellow by the name of Mark Williams, a professor of 
finance and economics at Boston University and a former Fed 
examiner, said the following: ``Giving the Fed more 
responsibility at this point''--and he had a rather amusing 
analogy--``is like a parent giving his son a bigger, faster car 
right after he crashed the family station wagon.''
    SEC former Chairman Richard Breeden testified before this 
Committee, and he said the following: ``The Fed has always 
worried about systemic risk. I remember in 1982 and 1985 the 
Fed talking about that it worried about systemic risk. They 
have been doing that, and still we had a global banking crisis. 
The problems like the housing bubble, the massive leverage in 
the banks, the shaky lending practices, and subprime mortgages, 
those things were not hidden. They were in plain sight.''
    And perhaps most significantly, Chairman Volcker in 
response to a question by Richard Shelby back in February in a 
hearing we had in this Committee testified that he had concerns 
about giving the Fed too many responsibilities that would 
undermine their ability to conduct monetary policy.
    So the question that many are asking, not just myself but 
others on this Committee and elsewhere, is: Given the concerns 
that have been expressed by the former Chairman of the Federal 
Reserve, the former Chairman of the SEC, and others about the 
Fed's track record as well as the multiple responsibilities 
that the Fed already has, why is it your judgment that the Fed 
should be given this additional extraordinary authority and 
power? And does it not conflict in many ways or could it not 
conflict with their fundamental responsibility of conducting 
monetary policy?
    Secretary Geithner. Mr. Chairman, I agree with you. These 
are some of the most important issues we are going to have to 
confront together, and I think that you and many others have 
expressed a number of thoughtful concerns about not just the 
role of the Fed going forward, but how to think about the right 
mix of accountability and authority in these areas. So let me 
just say a few things in response.
    I think you need to start--we need to start with the 
recognition that central banks everywhere around the world, in 
this country and everywhere else, were vested with the dual 
responsibility at the beginning for both monetary policy and 
some role in systemic financial stability. That is true here. 
It is true everywhere. And there is no, I believe, no necessary 
conflict between those two roles.
    For example, the Fed has got an exemplary record of keeping 
inflation low and stable over the last 30 years, even though it 
had the set of responsibilities you outlined that take it into 
the areas of financial stability. So I see no conflict.
    The second point I would make is the following. If you look 
at the experience of countries in this financial crisis who 
have taken away from their central bank, from their equivalent 
of our Federal Reserve, and given those responsibilities for 
financial stability, for supervision, for looking across the 
system to other agencies, I think they found themselves in a 
substantially worse position than we did as a country, with in 
many ways a worse crisis, with more leverage in their banking 
systems, with less capacity to act when the crisis unfolded, 
for a simple basic reason, I think.
    If you require a committee to act, if the people that have 
to act in the crisis, if the fire department has no knowledge 
of the underlying institutions it may have to lend to in 
crisis, it is likely to make less good judgments in that 
context. It may be too tentative to act or it may act less 
with--too indiscriminately in a crisis in that context.
    So if we look at the experience of many countries in the 
docu-differ model, it is not encouraging. The model where you 
take those responsibilities away from the central bank and vest 
them somewhere is not an encouraging model, in our judgment. I 
think you see those countries, if you listen carefully, moving 
in the other direction.
    Just a few other quick things in response. Our proposals 
for the additional authority we are giving the Fed are actually 
quite modest and build on their existing authorities. So, for 
example, the Fed already is the holding company supervisor of 
the major firms in the United States that are banks, or built 
around banks, but it was not given in Gramm-Leach-Bliley clear 
accountability and authority. It was required to defer to the 
functional supervisors responsible for overseeing the banks and 
the broker dealers. That is a bad mix of responsibility without 
authority, but we are proposing just to tighten that up and 
clarify it so they feel perfectly accountable for exercising 
that authority.
    In the payments area, the Fed has a general responsibility 
for looking at payment systems, but very limited, weak 
authority in terms of capital, which is essential to our reform 
proposals and central to any effort to create a more stable 
system. The Fed has some role today in helping set capital 
requirements, but that role is very constrained by the 
requirements of consensus across a very complicated mix of 
other regulatory authorities.
    Those are the key areas where we propose giving the Fed 
modest additional authority and clarify accountability for 
responsibility. They are not a dramatic increase in powers. We 
are proposing to take away from the Fed responsibility for 
writing rules for consumer protection and enforcing those 
rules. That is a substantial diminishment of authority and 
preoccupation and distraction. We are also proposing to qualify 
their capacity to use their emergency powers to lend to an 
institution they do not supervise in the future and to require 
that to exercise that authority, they require the concurrence 
of the executive branch.
    So we proposed what we believe is a balanced package over 
this set of independent regulatory authorities for consumer 
protection, for market integrity, for resolution authority. We 
propose establishing a council that will play the necessary 
coordinating role. That will provide some checks and balances 
against the risk that those underlying agencies get things 
wrong. It provides the capacity to deal with gaps, adapt in the 
future. So those are some of the reasons.
    I want to just say one more thing to end. I don't think 
there is any regulator or any supervisor in our country, and I 
think this is true for all the other major economies, that can 
look at their record and not find things that they did not do 
well enough. That is certainly true of the Fed. On the other 
hand, if you look at where risks were most acute in our 
country, where underwriting standards were weakest, where 
consumer protections were least adequate, again, where systemic 
risk that threatened the system was most acute, those developed 
largely outside the direct and indirect purview of the Fed and 
the Fed was left with no responsibility and no ability to 
contain those basic risks, and that is an important thing for 
us to change if we are going to build a stronger system.
    Chairman Dodd. Well, thank you for that. I only wish that 
the consumer protection had been more of a distraction at the 
Fed. In the HOEPA legislation in 1994, it was certainly an 
example where they dropped the ball entirely and had that 
authority. My time is up, but that is an underlying concern.
    Anyway, let me turn to Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Accountability at the Fed--Mr. Secretary, the Federal 
Reserve System was not designed to carry out the systemic risk 
oversight mission the administration proposes to give it. It is 
not a sole institution run under the direction of a single, 
ultimately responsible leader. Rather, it is a Federal system 
composed of a central governmental agency, the Board of 
Governors, and 12 regional quasi-public Federal Reserve Banks. 
The Board, as you well know, contains seven members. The 
Reserve Banks are run by presidents--you were one--who are 
selected by and subject to the oversight of each individual 
bank's board. Within the system, the Board and the Reserve 
Banks share responsibility for supervising and regulating 
certain banks and financial institutions.
    With decision-making authority dispersed to the Board and 
Reserve Banks, who will be accountable to Congress for the 
systemic risk regulation function as the ``system'' cannot 
appear to testify right here before Congress?
    Secretary Geithner. Senator Shelby, you are right that the 
Federal Reserve structure, the system established by the 
Congress almost 90 years ago for the Federal Reserve, is a 
complicated mix of different things. You are absolutely right. 
And we are suggesting--we do propose in our recommendations 
that the Fed take a close look, in consultation with outside 
experts and the Treasury, and come forward with proposals by, I 
believe we say the end of October, for how to adapt that basic 
governance structure to respond to some of the concerns you 
have raised and we have talked about before. And I think there 
are things that the Fed should reflect on there that would 
provide a better balance, reduce the risk of perceived conflict 
in these areas.
    But I think the short answer to your question is to say the 
Chairman of the Board of the Federal Reserve would be 
accountable, as he is now. And I think in the current framework 
of the Fed as designed by the Congress, the responsibilities 
for supervision, to the extent the Fed has them now, are 
concentrated at the Board of Governors, overseen by a board of 
people appointed by the President, confirmed by the Senate, and 
that Board and that Chairman would be the one accountable to 
you.
    Senator Shelby. Mr. Secretary, the administration's 
proposal chooses to grant the Fed authority to regulate 
systemic risk because, ``it has the most experience to regulate 
systemically significant institutions.'' I personally believe 
this represents a grossly inflated view of the Fed's expertise. 
Presently, the Fed regulates primarily bank holding companies 
and State banks. As a systemic risk regulator, the Fed would 
likely have to regulate insurance companies, hedge funds, asset 
managers, mutual funds, and a variety of other financial 
institutions that it has never supervised before.
    Since I believe the Fed lacks much of the expertise it 
needs to have as an effective systemic regulator, why couldn't 
the responsibility for regulating systemic risk just as easily 
be given to another or a newly created entity, as some have 
proposed?
    Secretary Geithner. Excellent question, and let me say a 
couple things in response. First is we did not envision quite 
that sweeping a scope or authority as you implied in your basic 
question. Our judgment is the core institutions at the center 
of the system that require a stronger framework of consolidated 
supervision and higher capital requirements at this stage--we 
have to go through a careful process to assess this--at this 
stage would largely entail the major banks and investment banks 
in the country today. Now, there are some exceptions to that.
    But we also believe that we want to have a system that is 
flexible enough in the future if other institutions emerge that 
could present the same kind of risks to the system that we saw 
emerge from AIG or from Bear Stearns and Lehman Brothers, that 
we want the system to be able to adapt and bring those 
institutions under the same basic framework of constraints on 
leverage that we think are appropriate for those banks at the 
core of the system that could threaten stability. But we do not 
envision quite as sweeping and broad a net as you suggested in 
your initial remarks, and that is one reason why we think the 
natural place for this is the Fed.
    Now, the Fed--again, the Fed has, relative to any other 
entity in our current system today, much more knowledge about 
how payment systems work. It is, because it does execute 
monetary policy on behalf of the Federal Reserve of the FOMC, 
and because it does fund the government on behalf of the 
Treasury, it has a greater knowledge and feel for broader 
market developments than is true for any other entity in that 
context. These things are all about alternatives and about 
choices. We don't think it is tenable to give those 
responsibilities to a committee, for reasons I think you 
understand. And we do not believe there is another place in the 
system better able to handle those responsibilities. And we 
think to create a new institution from scratch would leave us 
with a risk of losing, or not having in a moment of significant 
challenge, having the necessary expertise and experience.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Dodd. Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman, and I want to 
thank you and congratulate you on the blueprint that you put 
together, Secretary Geithner, because I do believe it will 
close many of the most important regulatory gaps in our system. 
There are a few issues where I think the administration should 
have pushed a bit farther, but this is an excellent framework 
and charts a clear course to fix the problems that led us to 
the crisis.
    Two places I would like to just give you a pat on the back, 
I agree with Senator Dodd, a Financial Consumer Product Safety 
Commission is essential. The Fed failed significantly in this 
responsibility. So while you have got to be leery of starting 
over, in this case, you have to start over and a new agency is 
what is called for.
    Second, of less noticed but of great importance is the idea 
that the mortgage issuer and securitizer must hold a piece of 
the mortgage. That would have stopped Countrywide and others 
like it in its tracks. It certainly would have greatly lessened 
the crisis. It might have even avoided it. So that is a great 
addition, because now they can't issue these junky mortgages 
and then just not hold them and sell them.
    On the systemic risk regulator, we need one, there is no 
question, and the old way is certainly bad. We can criticize 
any proposal, but keeping the present system is worse. Every 
agency had a piece of the system to oversee and protect, but 
nobody had responsibility to mind the whole store rather than 
just looking after individual aisles. I agree with Senator 
Shelby, it is really hard to do. But, tackle it we must, or we 
risk having the same kind of widespread financial crisis that 
we have just been going through. You cannot let the perfect be 
the enemy of the good here or we end up with less, and believe 
me, it is hard to do.
    Who predicted--you could probably count on your hands and 
toes the number of people in financial services, the 
commentators, the press, in government, who predicted 5 years 
ago that mortgages and this mortgage crisis would bring the 
whole system down. It is very hard to see around the corner.
    And my view, I tend to agree--I am not certain, but I tend 
to agree that the Fed is the best answer. There are no great 
ones. A council? That is a formula for disaster in something 
like this. A council, everyone will pass the buck and it will 
stop nowhere. You must have the buck stop somewhere with 
systemic risk.
    So then maybe you should have a new regulator, just someone 
new. The problem is, you need deep, deep knowledge of how the 
financial system works and a new council is going to be much 
slower to start. The Fed has that knowledge. You could argue 
the reason the Fed failed in the past, and it did, was because 
of the attitude of some of the people at the top who were for 
abject deregulation rather than the structure, but to me at 
least, until shown a better example, I think the Fed, at least 
tentatively, is the best one.
    The question I wanted to ask you is about bank 
responsibility. For years, everybody has said one of the 
problems of banking regulation is that it is too divided up. 
The system allowed banks, most recently and notably again 
Countrywide--that has been a nemesis to me--to game the system 
for the slightest regulation possible, yet your plan, while 
consolidating OTS and OCC, leaves significant prudential 
supervisory authority with the Fed and FDIC. If you count the 
new consumer watchdog agency, which I am all for, there would 
be four bodies involved in bank supervision, the same as we 
started with, no consolidation. A multiplicity of regulators 
tends to produce less oversight overall. The whole is greater 
than the sum of its parts when it comes to a symphony orchestra 
or the New York Giants, but with our patchwork system of 
banking regulators, the whole is less.
    So please tell us why you didn't do more consolidation, and 
particularly with the Fed gaining these powers, why do they 
have to be the supervisor of State banks, setting up this 
duplication of systems where you have a Fed regulator, the OCC, 
for the same exact bank who then shops around to be State 
chartered? If you want to remove another power from the Fed, 
which is getting a lot, take it away. Don't have them regulate 
State banks. Why didn't you consolidate the banking regulators 
more?
    Secretary Geithner. Senator, we thought a lot about that, 
and I think nobody would argue if we were starting from scratch 
today that we would replicate the current structure that we 
have of 50 State-level supervisors of banks, one at the Federal 
level--we are proposing one at the Federal level--and it is a 
complicated structure and I don't think anybody would advocate 
starting from that if we were starting from scratch.
    But I think it is fair to say, and the basic principle that 
guided our proposals was we wanted to make sure we are focusing 
on those problems that were central causes of this crisis, and 
we do not want to put you in the position of having to spend a 
lot of time on changes that may be desirable, may leave us with 
a neater system, maybe a more efficient system, but were not 
central to the cause of the problem.
    And in our judgment, the central source of arbitrage 
opportunity, the central problems we had were banks were able 
to evade stronger standards applied by one supervisor--in this 
case, it was the Fed's stronger standards that left Countrywide 
and others to flip their charter to a thrift. The basic problem 
we faced was in the thrift charter.
    Now, there are thousands of thrifts across the country that 
are well managed, were very conservative, demonstrated 
admirable capacity to meet the needs of their community, but in 
the case of too many of the celebrated failures that helped 
magnify this crisis, that arbitrage opportunity was central to 
the problem. So if you just look at AIG, Countrywide, you have 
described many of them, you can see examples of that basic 
problem.
    So we thought it was necessary to fix that problem, but 
while it was not essential to take on that more complicated 
challenge of fundamentally transforming the rest of the system 
where there is a balance now between State and Federal 
supervision of State-chartered banks.
    Now--and again, if you look at the opportunities that exist 
now, problems created by the potential to shift from a State 
charter to a national charter, I think because there are 
stronger, more uniform standards in place now across those 
banks, those problems--they are material in some cases, but 
they are much, much less significant. So we are making a 
pragmatic choice to focus on things that were a central cause 
of the crisis, leaving aside for the moment changes that many 
would support but we don't think are necessary to do just now.
    Senator Schumer. Thank you.
    Chairman Dodd. Senator Bennett.
    Senator Bennett. Thank you very much, Mr. Chairman.
    Mr. Secretary, good to see you and you continue to have 
interesting days in the Chinese sense of that term.
    I don't want to be overly parochial about this, but there 
is one section of this thing that does affect my State pretty 
directly, and since I only have 5 minutes, that is what I will 
focus on.
    Right now, one of the problems we have in the economy is 
that there is not enough credit. We keep hearing, well, I can't 
get a loan. I have got a good deal, but I can't get a loan. I 
can't get any help. And in this proposal, you are killing one 
very major source of credit where there has been no difficulty 
with respect to the crisis. You said, we are trying to deal 
with those that were essential to the crisis. I am talking 
about ILCs. There is not a single ILC that contributed to the 
crisis. There is not a single ILC that went down. And 
interestingly, when Lehman Brothers went down, one of the crown 
jewels of the bankruptcy was, well, at least they have got an 
ILC that is functioning and that is financially sound.
    And you talk about adding a modest amount of increased 
power to the Fed. In this case, it is not a modest amount of 
increased power, it is actually a destruction of the industry. 
We are going to cancel the ILC charter. We are going to cancel 
the industry as a whole.
    So my basic question to you is, why does the elimination of 
ILC, thrifts, and commercial ownership of banks make the system 
stronger and safer when you have a track record, at least with 
the ILCs, that says that they, in fact, by virtue of their 
ownership have been stronger than the banks? So you are going 
to wipe them out as a source of credit, take them out of the 
marketplace where they are providing niche credit for people 
that don't otherwise get it, and I would like to compare that 
track record with the track record of bank holding companies if 
you are going to say, where do you have a source of strength.
    Secretary Geithner. Senator, I agree, this is a very 
complicated issue and it is hard to be sure what the right path 
is here. But let me just try to explain the basic principles 
that underpin this basic reform.
    Institutions that do things like take deposits and make 
loans, institutions that do things that are basic banking 
activities, they transform short-term liabilities into long-
term assets, need to come within a common framework of 
standards and constraints and oversight. That is the basic 
principle we establish. If we do not do that, then people--all 
the risk in the system will migrate to those parts of the 
system where you can do similar activities but not be subject 
to the same basic standards. So our basic principle is a simple 
one, is that we want to eliminate those gaps and loopholes that 
allow institutions to evade those basic standards.
    Now, again, we are trying to be careful to take on things 
that are essential, but that principle, I think, is an 
essential principle. Now, we may disagree on how best to do 
that, and we would be happy to work carefully with you. We want 
to be careful not to do what you suggest that we are doing, 
which is to, in either the near-term or the long-term, diminish 
the credit-creating capacity of this financial system, and I 
don't think our proposal carries that risk. But I understand 
your concern and we will be happy to work with you to make sure 
that we do this carefully.
    Senator Bennett. I just want to make the point that the 
theory is fine. The practice says that this is an area that 
worked. So one of the first things I notice in the President's 
proposal is we are going to take an area that worked and we are 
going to abolish it in the name of trying to make the system 
that hasn't worked a little bit stronger. I just have a very 
serious problem with that.
    Secretary Geithner. Well, as I said, I understand your 
concern and we are happy to work with you and we will work with 
you closely and try to address that concern. But again, it is 
true that the basic opportunity created by our structure, 
particularly in the area of some thrifts, to evade the stronger 
protections that exist for other institutions, did create and 
did add to the substantial degree of vulnerability we saw in 
our system. So we don't want to leave in place the same type of 
vulnerability, allow people to shop for a weaker regime with 
less rigorous standards.
    Senator Bennett. You are engaged in overkill, in my view, 
here. I know that the Fed has been after regulation of the ILCs 
for as long as they have been around. The Fed seems offended 
somehow that the regulation of ILCs is left to people like Utah 
and the FDIC. And so as a matter of principle, the Fed wants to 
control these. We have always prevented the Fed bureaucracy 
from getting their hands on these. So now, well, if we can't 
get our hands on them in the normal fashion, we will just kill 
them. So I think the message I want to give and I hope I have 
given is that we are going to look at this one very, very 
closely.
    Secretary Geithner. One of the great virtues of our system 
is we can't do this without your support and encouragement of 
this body here, and so we recognize in all these areas where 
legislation is required we are going to have to work to try to 
persuade you of the merits of these proposals and take your 
concerns into consideration.
    Senator Bennett. Thank you very much.
    Chairman Dodd. Thank you, Senator, very much.
    Senator Akaka.
    Senator Akaka. Thank you very much, Mr. Chairman.
    Mr. Secretary, our current regulatory structure, I feel has 
failed to adequately protect working families from predatory 
practices. Working families are exploited by high-cost fringe 
financial service providers, such as payday lenders and check 
cashers. Individuals trying to cope with their debt burdens are 
pushed into inappropriate debt management plans by disreputable 
credit counselors or harmed by even debt settlement agencies.
    Mr. Secretary, agencies already have had the 
responsibilities in these areas, but what will be done to 
ensure that the Consumer Financial Protection Agency will be 
able to effectively protect working families?
    Secretary Geithner. Senator, that is an excellent question. 
As you know, we are proposing the following things to try to be 
responsive to those basic failures in consumer protection. The 
first is to create a new agency that would take the existing 
authority, responsibility, and the expertise, put it into one 
place with a single core mission of better protecting consumers 
from the risks they have been exposed to in the marketing of 
products, particularly credit products to consumers. We are 
going to give that agency new--we are going to give it 
exclusive rule-writing authority and primary enforcement 
authority in one single place of accountability.
    We have laid out a set of broad standards and principles 
built in many ways on the credit card legislation that moved 
through this Committee and a range of other proposals from the 
consumer advocates and others that would guide the writing of 
rules and regulations in these areas.
    The basic principles are: Much stronger disclosure, more 
simple disclosure so that consumers understand the risks in the 
products they are being sold; the creation of an option to 
elect for a more simple standardized instrument, standardized 
mortgage product, for example, so that, again, you are less 
vulnerable to the risks of predation in these areas; and, of 
course, there are some practices that we think fundamentally 
are untenable and should not be permitted which we would 
propose to ban. We have laid out some of those broad principles 
in our paper, but that is the approach we recommend.
    Senator Akaka. Mr. Secretary, I have concerns about 
mandatory arbitration clause limitations. I believe we share a 
concern on that and that it has been harmful to consumers. I 
have reintroduced my Taxpayer Abuse Prevention Act. The Act is 
intended to protect Earned Income Tax Credit recipients from 
predatory refund anticipation loans and expand access to 
alternative forms of receiving refunds. The legislation also 
includes a provision that would prohibit mandatory arbitration 
clauses for refund anticipation loans to ensure that consumers 
have the ability to take future legal action if necessary.
    Please share with the Committee why the Consumer Financial 
Protection Agency should have the authority to restrict or ban 
mandatory arbitration clauses.
    Secretary Geithner. Senator, I would ask you to give me a 
chance to reflect on that more carefully and get back to you in 
writing with a more thoughtful response. But I will work with 
your staff, you and your staff and try to make sure we 
understand that risk and see if we can be responsive to that 
concern.
    Senator Akaka. Thank you. Too many Americans, Mr. 
Secretary, lack basic financial literacy. Without a sufficient 
understanding of economics and personal finance, individuals 
cannot appropriately manage their finances, evaluate credit 
opportunities, successfully invest for long-term financial 
goals, or even cope with difficult financial situations. One of 
the root causes of the current economic crisis was that people 
were steered into mortgage products with costs or risks that 
they could not afford.
    Mr. Secretary, the proposal indicates that the Consumer 
Financial Protection Agency will have important financial 
education responsibilities. How will the CFPA interact with the 
Financial Literacy and Education Commission and the President's 
Advisory Council on Financial Literacy?
    Secretary Geithner. Senator, I just want to agree with you 
that I think a better basic education about economics and 
finance is a very important thing for us to work to promote. I 
think it has to happen early in life. It has to happen in what 
we teach people in schools. Experience is the best teacher, and 
this experience will be a searing--this crisis provides a 
searing set of lessons that will, I think, change behavior 
fundamentally.
    But I think we can do a better job as a government in 
trying to support programs that do a better job of promoting 
financial literacy and I think the best thing I can say is they 
are going to work closely together to try to make sure that we 
are using the taxpayers' money as effectively as possible in 
support of those programs.
    Senator Akaka. Mr. Secretary, I appreciate all of your 
efforts to better protect, educate, and empower consumers. I 
look forward to continuing to work with you, the rest of the 
administration, and the Members of the Committee to better 
educate, protect, and empower consumers. This issue is so 
important because it has tremendous potential to improve the 
quality of life for our working families.
    Mr. Chairman, I also appreciate all of your efforts to 
protect consumers. Thank you very much, Mr. Chairman.
    Senator Johnson [presiding]. Senator Vitter.
    Senator Vitter. Thank you. Thank you, Mr. Secretary, for 
being here.
    Mr. Secretary, did Fannie Mae and Freddie Mac, problems 
there, play a role in the recent financial crisis?
    Secretary Geithner. Absolutely.
    Senator Vitter. So going back to the fundamental focus you 
said you all have for this plan to take care of the core 
problems that we saw over the last year, why are we punting to 
the future Fannie Mae and Freddie Mac, maybe we will get around 
to it next year----
    Secretary Geithner. Good point.
    Senator Vitter. ----at the same time regulating areas that 
were not part of the problem in the last year, as Senator 
Bennett mentioned? I mean, to me, at least, it seems like we 
are ignoring a core problem in the governmental sector and we 
are regulating areas in the private sector that were not part 
of the problem in terms of the last year, and that seems very 
much at odds with what you said was your rationale in focusing 
on these items and not others.
    Secretary Geithner. Accepting Senator Bennett's point as I 
did, which we will have to talk--we will have to spend some 
time talking through--I did not believe we are proposing here 
to try to solve problems that were not problems.
    Fannie and Freddie were a core part of what went wrong in 
our system, but Congress did legislate last year a 
comprehensive change in their oversight regime, and just to be 
fair and frank, we did not believe that we could at this time, 
in this timeframe, lay out a sensible set of reforms to 
determine what their future role should be as we get through 
this crisis. We want to do that carefully and well and we did 
not think that was necessary to do at this stage. But as we 
said in the report, we are going to begin a process of looking 
at broader options for what their future should be and what 
should be the future role of those agencies in the housing 
market in the future. We just didn't think it was essential to 
do just now, but it is an essential thing to do. We couldn't do 
it carefully enough, thoughtfully, in this timeframe.
    But as you know, Congress did legislate last year a 
comprehensive new oversight regime in place over those 
institutions. If that had been in place before, that might have 
helped mitigate this crisis.
    Senator Vitter. Well, I just underscore the point that if 
we can consider all of these changes on the private sector 
carefully and thoughtfully in this timeframe, and I have my 
doubts about that, but if we can do that in this timeframe, I 
think we can attack the Fannie-Freddie issue in this timeframe, 
as well.
    Secretary Geithner. Can I just--I think this is a very 
important issue and you are asking a very good question. It is 
a very different challenge. Our challenge with Fannie and 
Freddie now, and this is true about the government's role in 
the housing market more generally, is more a challenge for 
exit, what the future should be. We have to fundamentally 
rethink what the appropriate role of the government is in the 
future. We did not get that right. It was not a tenable balance 
we struck in that situation.
    But it is a different challenge now that we face in putting 
in place the foundations of a more stable system, a clearer set 
of rules of the game, stronger consumer protections. It is more 
about a range of questions we face about how the government 
gets out of and dials back and reverses these extraordinary 
interventions we have been forced to undertake to help protect 
the system from this crisis.
    Senator Vitter. Mr. Secretary, the creation of this Tier 1 
of institutions, tell me why that isn't a big flashing neon 
sign, ``too-big-to-fail''?
    Secretary Geithner. We are very worried about the same 
basic problem, designed as carefully as we could to mitigate 
that risk, but we haven't eliminated it completely. So let me 
just say a few things in response to that concern.
    Right now in the United States of America, we have a set of 
institutions that are of a--play a role in markets, it is 
probably because of size, but it is not principally because of 
size--you know, Bear Stearns and Lehmans were not that large--
but play a role where their health and safety is critical to 
the stability of financial markets. Those institutions need to 
be subjected to stronger, more conservative constraints and 
leverage and we need to have the capacity through resolution 
authority, like we have for banks and thrifts now, to deal with 
their prospective failure in the future.
    Our judgment is the combination of those two things, the 
explicit change in policy now to recognize that those 
institutions need to be subjected to more conservative 
constraints on risk taking, combined with resolution authority 
to give the government better tools to manage their failure 
when that happens, will help mitigate the inherent moral hazard 
risk in any system that comes from the emergence of large 
institutions.
    Now, just one final thing, because this is an important 
kind of thing--an important issue. If you look at our system 
today, we are substantially less concentrated than the banking 
system of almost--I think of any major economy in the world. 
Less so than Canada. Less so than most of the countries in 
Western Europe. We have thousands of small institutions that 
play a critical role in creating a more resilient, more stable 
system. We want to preserve that balance. And by establishing 
this important change in principle of higher standards, higher 
capital requirements on the largest, we will help mitigate the 
risk in the future that we see future consolidation to a point 
that would leave us with a more vulnerable system.
    Senator Vitter. Mr. Chairman, if I could just ask one more 
question quickly, a lot of my concerns also go to the role of 
the Fed and the independence of the Fed and I would note two 
huge concerns. One is that under this plan, to use certain 
expanded powers and emergency steps, the Fed needs approval 
from Treasury. I think that is a big change in terms of the 
independence of the Fed. I think that is really crossing a line 
and a sort of fundamental change in terms of the nature of the 
Fed and I just point that out as a big concern, because all of 
a sudden, the Fed is acting more like a department of the 
government than an independent bank. It is asking Treasury for 
permission in that circumstance.
    Second, my other big concern is that we would be very much 
diluting the focus of the Fed from stable monetary policy. To 
me, getting monetary policy right is a big job, and to me it is 
a crucial job. And I don't think it is any coincidence that 
when we look at the periods of sustained, robust growth, at 
least in my lifetime, they coincided with sustained, 
predictable monetary policy and management. So I also have a 
fundamental fear of diverting the attention of the Fed on what 
is already a really big job and a really important job.
    I know my time has expired. Thank you, Mr. Chairman.
    Senator Johnson. Senator Warner.
    Secretary Geithner. Mr. Chairman? Mr. Chairman, would it be 
possible for me to respond briefly to his two questions at the 
end? I think these are----
    Senator Johnson. Yes. Go ahead.
    Secretary Geithner. I know that we are going to spend a lot 
more time on these issues, but I would like to respond quickly 
on these two points.
    It is very important to our country and exceptionally 
important to the executive branch of the United States and I 
think to the Congress, that the Fed preserve its independence 
and its accountability for achieving sustainable growth and 
price stability over time. At its inception, the Fed was given 
this mix of responsibilities, both for price stability and for 
a range of other responsibilities that stray into the areas of 
financial stability. It is the lender of last resort to the 
country.
    I don't believe there is any conflict between those two 
responsibilities, and I think the record of the Fed justifies 
that judgment. But we want to preserve that. In part because of 
that, we are being careful to make sure the Fed isn't 
overextended. We are scaling back some of their existing 
responsibilities even as we tighten the accountability and 
authority in those core areas.
    You were right that to change the way 13(3) now acts--13(3) 
is the provision of the Federal Reserve Act that gives the 
ability of the Fed in unique and exigent circumstances to lend 
to an institution it does not supervise--to require that action 
require the approval of the Secretary of the Treasury is an 
important change. But we believe, and I believe the Chairman of 
the Federal Reserve believes that is an appropriate, 
justifiable change, in part because of the concerns expressed 
by many of your colleagues, understandably, about the Fed being 
pulled into doing things that go well beyond the classic 
responsibilities of the lender of last resort.
    And I think it is a very consequential act for the Fed to 
lend to an institution it has no supervisory relationship over. 
It creates an enormous risk of moral hazard. And to limit that 
authority in the future, I think is a way to help reduce the 
risk of moral hazard created by the exceptional response that 
the government has made in this case, and if the Congress 
provides resolution authority, it gives us a better ability to 
deal with the potential failure of large systemic institutions 
in the future and there will be less need for the Fed in the 
future to use that 13(3) authority to lend to institutions that 
were not under its supervisory mandate.
    One final point. The Fed was very careful, and I think 
appropriately so, when it acted in this crisis to lend to 
individual institutions. I will just speak directly about Bear 
Stearns, in the JPMorgan and Bear Stearns context and about 
AIG. In that context, because the taxpayer would ultimately 
bear the losses that might come with any of those basic 
judgments, the Fed required the concurrence in writing of the 
Secretary of the Treasury before it took those actions. I think 
that was an appropriate step then, because ultimately this was 
the taxpayers' money at risk, and ultimately it is the 
taxpayers' burden if the government fails to get this balance 
of moral hazard and safeguards right.
    So I think those are some of the reasons why I think this 
is an important step, but I agree with you that it is a 
consequential step.
    Senator Johnson. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman, and thank you, Mr. 
Secretary. I too have some concerns about the administration's 
proposals, but let me perhaps acknowledge as at least a marker 
here, I think there was a piece that Steve Pearlstein wrote in 
The Washington Post recently that if somebody would have said 9 
months ago, 6 months ago, or even 3 months ago that we would be 
sitting near the end of June with the stock market up almost 30 
percent, with banks trying to repay some of their TARP funds, 
and some stabilization in the housing market, I think almost 
any economist or any market maker would have said that was 
perhaps a too optimistic a prediction. So while we have 
concerns, overall directionally I think we are headed in the 
right direction, and I commend your leadership--although I 
would ask--and I know under Senator Reed's leadership, he has 
raised this issue as well. We still have great concerns about 
what we are going to do with the warrants as these banks go 
through a repayment process and that we need an overall policy 
there.
    I also want to echo what Chairman Dodd and Senator Shelby 
have said. I think we realize the responsibility that we have 
got to get it right; that if we mess this up, the unintended 
consequences to not only our economic recovery but the overall 
long-term financial stability for the world is really at stake. 
So I hope with that caveat I can then issue some of my 
concerns.
    I share a lot of my colleagues' concerns about this 
expansion of authority within the Fed. I also share some 
concerns that putting restrictions on the 13(3) powers of the 
Fed could potentially further politicize. I have made 
statements already that I actually believe systemic risk ought 
to be put in a council that would include the Fed, that would 
include the Treasury Secretary, that would include the 
prudential regulators, including the SEC, with an independent 
Chair and a staff that would be solely focused on systemic risk 
evaluation and have the ability and power to act. I do not 
believe it would have to be a debating society, and I actually 
believe that the advisory council that you have set up 
unfortunately, because it has the ability to gather information 
but does not have the ability to act in any way, that it is 
really emasculated, and it will not provide the kind of 
nonsiloed approach that I think we are looking for. I think 
systemic risk by its very nature is not something you can 
predict ahead of time and that the bias out of the Fed will be 
too much financial institution as opposed to securities 
concerns, insurance concerns, or others. So I look forward to 
that conversation.
    But I want to come to--I am happy to address those issues--
have you address those issues, but I would also like you to 
explore a little more on the resolution authority.
    I concur with you that an expanded resolution authority for 
financial institutions inside the FDIC may make some sense. I 
am concerned about how we fund that. I am concerned about 
additional fees placed on community or local banks to, in 
effect, take care of the potential failure of a Citibank.
    I am also concerned that if we fully fund that on the front 
end, though, with these major institutions, that pot of money 
could be too tempting for diversion for other purposes.
    I am also concerned about a resolution authority funding 
cost for nonfinancial institutions that then might be allocated 
against the banking industry.
    If you could spend a little more time--and I think your 
paper acknowledged there were still questions to be answered in 
this area, but you are happy to attack my approach on a 
systemic risk council, but I would also love to hear some 
additional thoughts on resolution authority and how we fund it.
    Secretary Geithner. Excellent questions, and we have not 
claimed to get the details perfectly right on this, and it is 
going to require a substantial amount of additional effort and 
care to get the balance right.
    Let me start with resolution authority first. Again, we are 
proposing a model that takes the structure that works well, we 
have had lots of experience with, and simply adapt it to the 
somewhat more complicated challenge of large institutions built 
around banks but are not only banks in some sense.
    As our funding mechanism, we are proposing no ex ante fund, 
no ex ante fee to fund a fund. What we are proposing is a 
mechanism whereby in the event the Government were to act under 
this authority and were to incur a loss as part of that action, 
then it would be able to recoup that loss--have the obligation 
to recoup that loss--by assessing a fee over time in the future 
applied to bank holding companies.
    That will help make sure that the burden for that is borne 
by bank holding companies, not by the 8,000 other financial 
institutions in the United States that are not smaller 
community banks in that case that were not responsible for that 
error. The scope of this authority would be limited to bank 
holding companies and institutions we designate at the Tier 1 
financial holding companies. We expect those to be principally, 
at least as we see the system today, built around institutions 
that have banks as part of their structure. And we think that 
is a better model than the alternatives. And we have been 
careful, again, not to create something that would be unfair on 
the burden proposed and limit the moral hazard created by the 
existence of authority like that.
    Senator Warner. I know my time has expired, but let me 
just--much more on this, but that would still require, though, 
the public to step in with taxpayer funds as an effective 
short-term bridge until you can assess that. And I would--
assess that additional fee. I might simply add amongst those 
Tier 1 financial institutions--and there are clearly questions 
about designating those Tier 1 financial institutions, which 
other colleagues have raised, I wonder if there might not be 
some, in effect, contingent liability that they could hold on 
their books rather than the public funding this in the interim 
and then coming back. And if they had that contingent liability 
on their books that they could keep as their additional equity, 
that also might help them self-police better amongst their 
colleagues.
    Secretary Geithner. We actually did spend a fair amount of 
time thinking through an idea like that, and it may be that 
something like that would be feasible as part of this. But we 
did not see a way to design that that would provide quite the 
same practical solution to this problem. But it is an 
interesting idea, and I would be happy to talk to you about 
that further.
    I want to come back on the council thing, but we will have 
a chance to come back on it.
    Senator Johnson. Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    I was glad to see last month, Secretary Geithner, in an 
interview with Charlie Rose that ``loose money policy was one 
of the primary causes of the mess we are in.'' That is a quote 
from you. So tell me which part of the plan reins in the Fed's 
loose money policies.
    Secretary Geithner. Our plan does not address a range of 
other causes of this crisis, including policies pursued around 
the world that helped produce a long period of very low 
interest rates and a very, very substantial boom in asset 
prices, housing prices, not just in this country but in 
countries around the world. And I think you are right to 
underscore the basic fact that a lot of things contributed to 
this crisis. It was not just failures in supervision and 
regulation. And as part of what the world does, major countries 
around the world, in trying to reduce the risk we have a crisis 
like this in the future, it will require thinking better 
through how to avoid the risk that monetary macroeconomic 
policies contribute to future booms and asset prices and credit 
bubbles of this magnitude.
    Senator Bunning. Your plan puts a lot of faith in the 
Federal Reserve's ability to spot risk and exercise its power 
to prevent the next crisis. However, if the Fed and other 
regulators have been doing their jobs and paying attention to 
what the banks and other firms were doing earlier this decade, 
they almost certainly could have prevented the mess. And the 
Fed has proven it is unwilling to use its power it has. Let me 
give you an example.
    Just look how slow it addressed the credit card abuses, and 
it took 14 years for the Fed to write one regulation on 
mortgages after we gave them the power to do that. So giving 
them the power and making them act are two different things.
    What makes you think that the Fed will do better this time 
around?
    Secretary Geithner. Well, Senator, as you know, we are 
proposing--and partly for the reasons you said--to take both 
rule writing and enforcement authority for the protection of 
consumers, particularly in the credit product area, and give it 
to a new agency with sole accountability and responsibility. 
Now, that will not ensure that that agency acquits itself 
perfectly over time, but we think that is a necessary step.
    Now, on your first point about the capacity of any 
institution, much less the Fed, to predict and anticipate and 
preempt any future financial crisis, let me just say a basic 
view that I have about this stuff. I think we need to be 
realistic in recognizing that. It will be very hard, perhaps 
impossible, for any authority, any individual to anticipate and 
preempt all potential sources of future risk. And I do not 
think we can design a system that is premised on the ability of 
any institution to carry that out effectively.
    I think the real important thing to do, though, is to make 
sure we establish much stronger cushions in the system, shock 
absorbers in terms of capital and liquidity, better capacity to 
absorb losses, withstand shocks, so that we are better 
positioned to deal with potential sources of risk wherever they 
emerge--and they will emerge. They will emerge. I think that is 
the only real effective defense, the necessary defense, and I 
think the critical failure of policy in this country and many 
countries around the world in coming into this was not to 
establish up front more conservative constraints on leverage in 
good times so the system was better positioned to deal with 
failure wherever it was going to happen.
    Senator Bunning. Thank you. Do you believe these financial 
reforms need to be bipartisan?
    Secretary Geithner. I do.
    Senator Bunning. Then why did the administration provide 
detailed briefings to the entire Democratic side of this 
Committee on Tuesday before the plan was released but refused 
to do the same for all Republicans until after the plan was 
released?
    Secretary Geithner. Senator, I will say personally what I 
did. I did personally host a meeting and invited Members of 
both sides of the aisle to the Treasury several weeks ago to 
talk through broad elements of strategy. We have been careful 
to do that, and we will try to be careful going forward, 
careful to do it in a balanced way, both sides of the aisle 
going forward.
    Senator Bunning. I am speaking about this week on Tuesday.
    Secretary Geithner. Well, as I said, I have been careful to 
try to make sure we are consulting broadly both sides of the 
aisle, and I will do so going forward.
    Senator Bunning. My last question has something to do with 
TARP, because the TARP law allows you as the Secretary of the 
Treasury to extend from the end of this year until next 
October. I think that is a terrible mistake we made, but I also 
thought that the entire TARP program was wrong.
    Yes or no, are you going to use the power to extend your 
TARP authority past December 31st of this year?
    Secretary Geithner. I have not made that judgment yet, and 
I do not think we are in a position today to make that 
judgment. As Senator Warner said, you know, there are some 
important signs of stability, some important signs of healing 
in the financial sector. But I think it is still early yet, 
premature to make that judgment.
    Senator Bunning. Then you think that Treasury should have a 
slush fund of $700 billion under their control, which is what 
TARP is, because if you do not go above $700 billion, you can 
use all the money for other purposes.
    Secretary Geithner. I think what Congress designed in the 
fall of 2008 gave the executive branch an important set of 
authorities for trying to respond to the worst financial crisis 
in generations. I think they did a good job in designing that 
authority. We are being very careful to use it well.
    I want to point out that $70 billion of capital invested by 
my predecessor have now come back into the Treasury. An 
equivalent amount of common equity has now been raised by our 
major banks. And we have not provided any capital to any large 
institution, with one exception--in this case, it is the 
substantial problem we inherited in AIG since the 
administration came into office. So we have been very careful 
to use those funds prudently to protect the taxpayer, and we 
will be going forward. But, on the other hand, we are still in 
the midst of a very challenging recession on a global scale, 
and there are a lot of risks ahead still, and we want to be 
careful and prudent and not prematurely declaring victory and 
depriving ourselves of the capacity to respond if this were to 
intensify again.
    Senator Bunning. Thank you.
    Senator Johnson. Senator Tester.
    Senator Tester. Thank you, Mr. Chairman, and I want to 
thank you, Secretary Geithner, for being here today. I also 
want to thank you very, very much for putting forth an 
initiative that we can start this debate on a real basis.
    That being said, there was a question asked by Senator 
Schumer about starting over, and you said you did not want to 
start over from scratch. When we have a crisis like we have 
had--your own words, ``the biggest since the Great 
Depression''--why not start with a framework that really will 
be the kind of framework we need going into the 21st century 
and beyond?
    Secretary Geithner. I think, Senator, this framework will 
meet that test. I mean, it is designed to make sure we are 
looking forward, not just solving the core problems of this 
crisis. So we are trying to design a framework that has that 
capacity, that is flexible in the future, and we made the 
judgment that--you know, we are proposing--we are proposing for 
your consideration, we made the judgment that much more 
substantial changes to force much more consolidation in our 
oversight structure, although it has much appeal, is not 
necessary and would not necessarily provide substantial return 
in addressing the core vulnerabilities in our system.
    Senator Tester. I look at this from the outside because I 
am not from the banking industry or the insurance industry or 
any part of either one of them. But I can tell you some of the 
concerns brought up by the Chairman and the Ranking Member 
about gaps and overlap, I still have concerns with this 
proposal. And I commend you for the combination of the OTS and 
OCC. I will give you another one that I think could and should 
be combined, and I want to know why not if just for turf, and 
that is SEC and CFTC.
    Secretary Geithner. Excellent question. The Congress has 
considered many times in the past proposals for merging both 
entities. There is a simple, compelling rationale for doing 
that. What we are proposing, though, is to begin by bringing 
the underlying statutes, which are very substantially 
different, even for products that have very similar attributes, 
to bring those underlying statutes more into conformity. We 
think that helps solve most of the substantive problems that 
exist by having separate regulation of securities and futures. 
It will not solve all those problems. But it is a necessary 
step toward any effort to merge anyway, and so we think that is 
a good place, a good challenge to take on right now.
    Senator Tester. So do you anticipate into the future having 
a recommendation to merge those two agencies?
    Secretary Geithner. I do not anticipate that now, but that 
is something, again, the Congress has considered many times in 
the past, and I would expect it to be part of what Congress 
would reflect on now.
    Senator Tester. With some leadership from your office?
    Secretary Geithner. With appropriate leadership, 
suggestions, help, persuasion, analysis from our office.
    Senator Tester. Thank you. Accountability--I think it is 
absolutely critical. It has been brought up here with many of 
the questions that have been brought up with my fellow Senators 
here. I think--and correct me, and I hope you can. I think 
there are still gaps in accountability, holding people's feet 
to the fire that are there to do their job that, quite frankly, 
are either pushing it off on somebody else because we have a 
patchwork system or buffaloing somebody because they are not 
doing their job.
    Can you tell me how this plan improves accountability to a 
point where we can reinstate consumer confidence in the 
marketplace that they are being protected?
    Secretary Geithner. We are trying to do two difficult 
things. One is to make sure there is much clearer 
accountability, matched with authority, in the areas that are 
critical to building a more stable, stronger system, and those 
areas are market integrity, investor protection, combined 
responsibility now of the CFTC and SEC; consumer protection; 
supervision of banks; resolution authority; and the ability to 
deal with systemic threats to the system, which we are 
investing--proposing to invest more clearly with the Fed.
    That will not close all gaps in the system, but those are 
the core functional responsibilities of policy in any financial 
system.
    Now, to make sure that we take an integrated look at the 
system as a whole, to make sure the system has the capacity to 
evolve in the future, we are going to establish this council 
with a mandate to play that basic role, and the council will 
have the ability to make recommendations for changes by the 
underlying functional supervisors where there are gaps and 
problems, boundaries, conflicts, overlap in that context.
    Now, Senator, we are not proposing an elegant, neat 
structure. We are not proposing to put together all those 
functions. I would just say in part because if you look at 
other countries that have done that, I do not believe you can 
show sufficient improvements in outcomes in building a more 
stable system. Many of the countries that adopted a much more 
streamlined, simplified regulatory system still got themselves 
in the position where their banking system grew to a point 
where it is much, much larger relative to the economy than 
happened in the United States. Our banks are roughly one times 
GDP now, even with the investment banks now as bank holding 
companies. In many of the major economies in Europe, banking 
systems got to the point where they were 2, 3, 4, 5, 8 times 
GDP in Switzerland, even with neat consolidations, more elegant 
appearing, simple accountability.
    So the core thing to making the system more stable is 
getting the rules better, smarter, to induce thicker cushions, 
better shock absorbers, better able to withstand risk.
    Senator Tester. My time is up. I look forward to working 
with you on these issues as we go forward. I am not sure that 
the accountability is there for actually getting rough with 
folks, but I appreciate--and I mean this. I appreciate your 
bringing forth an initiative that we can sit down and have an 
honest discussion about how to move this forward.
    Thank you very much.
    Senator Johnson. Senator Johanns.
    Senator Johanns. Mr. Chairman, thank you. And, Mr. 
Secretary, thanks for being here today. Your proposal I do 
think gives us some things to consider and debate, and I think 
your testimony has been very, very thoughtful. But I, like so 
many of my colleagues, do have some concerns.
    Let me, if I could, start with some comments that my 
colleague Senator Warner made about the economy. We certainly 
cannot dispute the fact that the market is better. We can look 
at some other things. Certainly it is painful for all of us to 
see unemployment going up. It does not show any signs of 
subsiding at the moment. That hurts real people.
    We are on this just historic spending spree that I think 
just grows exponentially. You were in China recently. I have 
worked with China as a Cabinet member. I remember the many 
times China, when I wanted to talk about them opening their 
market to beef, they wanted to remind me of how much debt they 
had bought the week before. I think that puts us in a very 
precarious position.
    To use very inartful terminology, I really worry today if 
what we are seeing is kind of a dead cat bounce where all we 
are doing is pushing so much borrowed liquidity into our 
marketplace that we are just setting ourselves up for the next 
cliff.
    So I wanted to say that because I think our debt, our 
spending, our taxing, all of that is a very, very troublesome 
trend, especially as we are starting to think about a whole new 
initiative to spend over a trillion dollars, the health care 
initiative.
    But let me focus in on your proposal. The issue with the 
Fed I think is really a fundamental issue, and I can argue it 
from a lot of different directions about how uncomfortable I am 
to see the Fed get in the middle of this.
    On the one hand, I must admit, although some of my 
colleagues on this side of the aisle would probably argue with 
me, the independence of the Fed has served us well over time. I 
really believe that. I have watched Presidents avoid 
criticizing the Fed as interest rates went up and this and 
that, so that independence I think is a good thing.
    The more we entangle them in managing systematic risk or 
overseeing systematic risk, et cetera, the more we are going to 
be tempted--maybe not us so much, but the next generation, the 
next generation of Congress, the more the temptation is going 
to be to demand that oversight--justifiably so, I might add--
then all of a sudden the independence I believe starts to go 
away.
    I would like to hear your thoughts on that issue, and then 
I would also like your thoughts on--on page 3 of your proposal, 
you talk about the Financial Services Oversight Council dealing 
with identifying emerging systemic risk and then the new 
authority of the Federal Reserve. Was it your attempt there to 
try to blend maybe the idea of this collegial oversight of 
systemic risk with the Federal Reserve actually being a 
regulator here? Talk us through that, because I find that to be 
an interesting concept, actually.
    Secretary Geithner. Senator, let me just begin by saying 
you are right to underscore the risk we still face in the 
economy going forward. You know, what we have achieved is some 
stabilization. Output and demand are no longer falling at the 
same pace it was at the end of last year. That is an important 
beginning. But it is just a beginning. There are substantial 
risks ahead. And I think you are absolutely right that a 
critical part of getting a recovery in place is going to be to 
convince the American people and investors around the world 
that we are going to have the will, working with the Congress 
to bring those deficits down over time. But, remember, we 
started with deficits in the range of 10 percent of GDP when 
the administration came into office because of both the cost of 
the crisis and the impact of policies put in place the last 8 
years, and the additions we have made--we have proposed with 
the Congress to get us out of recession were modest increments 
to those deficits, and we believe they were necessary to avoid 
the risk of a deeper recession, and even higher future 
deficits. But I understand those concerns, and we share those 
concerns. It will be absolutely critical to get our fiscal 
position down to a sustainable position once we get recovery 
back on track.
    In terms of the Fed, I think I just would say it this way: 
We are very committed and it is very important that we preserve 
the independence of the Fed and its basic credibility over its 
responsibilities for monetary policy. And we would not 
recommend proposals that would limit that flexibility or put 
that at risk in some sense because that is important to any 
effort to build a well-functioning economy in the future. If we 
lose that credibility, that would be very damaging.
    So I share that concern very much, and we have been very 
careful not to create risk. In fact, as I said, some of the 
proposals we are making to scale back and limit are designed to 
reduce the risk that in carrying out its core financial 
stability functions we do not put them in the position where it 
would risk greater tensions with that core mandate for price 
stability and sustainable growth in the future.
    You are right, and the council does try to strike a 
balance. The council does bring together at one place around 
one table with clear responsibility for looking at the system 
as a whole. Each of these underpinning parts of the system we 
are preserving do have responsibility because I think they 
could cause systemic damage. That is an important check and 
balance in some sense on the scope of independence, without 
confusing accountability. I think it does not change their 
statutory framework. It does not qualify their authority in 
that context, but it does provide the ability to recommend and 
induce changes if they are behind the curve or their big gaps 
are not closing.
    So we are trying to get that balance right. I agree some 
people will say it is too weak, but we do not believe we could 
give a council the authority and the accountability for doing 
core supervision, for example, of large institutions or for 
responding to crises given the speed with which they can 
evolve.
    Senator Johanns. Mr. Chairman, thank you very much, and, 
again, Mr. Secretary, thanks for giving us this starting point 
here.
    Senator Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman.
    Mr. Secretary, thank you for your service and particularly 
at incredibly challenging times. You know, I have heard some of 
the criticisms already leveled, and while I do not agree with 
every element, I think it is a great foundation, actually. But 
I think it takes a pretty short memory to ignore what got us 
into this crisis and dismiss the need for accountability. That 
is basically like saying let us do this all over in 10 years 
again, and I do not think the American people want to go down 
that road. So I appreciate the effort here.
    You know, throughout these hearings, I have asked a 
fundamental question--at least for me it is a fundamental 
question. If we have institutions that are too big to fail, 
have we not failed already because they create systemic risk, 
and they also leave for potentially bad decisions along the way 
because they know that they will ultimately be bailed out?
    So I saw the road that you have traveled here in trying to, 
I think, deal with that question with reference to increased 
capital requirements, but is that really sufficient to get to 
the heart of that question? You know, I understand bringing up 
those capital requirements now, but how is it going to be a 
continuing function so that we ensure that if that is one of 
our major vehicles to avoid too big to fail, that it will be a 
constant movement that will ensure us that that is a break on 
that possibility?
    Secretary Geithner. Senator, again, this is a critical 
issue. Again, I think the acid test or the critical test of 
credibility of any system is: Is it strong enough to withstand 
the pressures that could come with a failure of a large 
institution? Because if you do not build the system strong 
enough to withstand those pressures, then the Government will 
be forced over time in future crises to intervene to prevent 
their failure, and that will create the risk of greater crises 
in the future. So that is critical to the objective of what we 
are trying to achieve.
    I believe the best way to do that and the really only 
effective way to do that is, again, to make sure there are 
tougher constraints on leverage and risk taking in the future, 
applied not just to every institution that is a bank does 
those--takes those kind of risks, but to the largest in 
particular; that the core markets where institutions come 
together to transact also have thicker safeguards, thicker 
cushions to prevent the contagion that can be caused by default 
of a major institution, and to have better tools for managing 
an orderly failure of a large institution through resolution 
authority.
    I think that mix of proposals I think represents the best 
hope of limiting the moral hazard risk that comes from any 
modern financial system where you can have some institutions 
whose role in markets by definition is so important that, if 
they get in trouble, it is going to risk undermining the 
broader health of the economy as a whole.
    So I think that is the best mix. A lot of people, a lot of 
thoughtful people have ideas in this area. We will be open to 
ideas, and we will look at whatever we think the best balance 
of proposals are to deal with that challenge.
    Senator Menendez. You know, one of the things you propose 
and some of my colleagues have already raised is the oversight 
council, and I think that has a valuable function in watching 
for developments that pose risk to the banking system and 
better coordinating the regulators. My concern, again, is that 
it is basically advisory and it has no power to carry out 
corrective actions that will be needed in response to the 
council's own findings.
    So give me a sense of how do you envision--so the council 
comes up with a series of findings that say, hey, this poses 
risk. What happens if an individual regulatory agency 
disagrees? What happens when, in fact, the council's conclusion 
that a particular product or activity poses a risk to the 
financial system, how is the corrective action going to be both 
considered and acted upon if it is only advisory at the end of 
the day?
    Secretary Geithner. You are right. That goes to the core of 
the basic judgment we are making. We are giving the council the 
power to collect information, the responsibility to look across 
the system, and the power to recommend changes, but not the 
power to compel or force changes because that would 
fundamentally change and qualify the underlying statutory 
responsibilities of those agencies and I think that would 
create the risk of more confusion and less accountability, 
frankly. But that is a difficult balance to get. I am not sure 
we have got the balance perfect, but I think that to invest in 
a committee responsibility to force those kind of changes 
would, I think, lead to more diffusion of accountability and 
more uncertainty.
    Senator Menendez. But under your proposal, you give the 
Federal Reserve significantly, for example, significantly more 
authority, yet the reality is they had knowledge and authority 
to address the mortgage problem long before it became a crisis 
and they didn't act. And so in my mind, how is it that we 
ensure that at the end of the day, the regulators do their job, 
because from my perspective, they were asleep at the switch 
instead of being the cop on the beat. So how do we ensure that 
in this policy?
    Secretary Geithner. Well, that is an important 
responsibility of the Congress. This council does bring them 
together. It does have to provide reports to the Congress. Its 
recommendations will be public. That gives you a little more 
reinforcement in carrying out their oversight responsibility 
and I think that is worth doing.
    Will it--it will not--I cannot tell you, standing here 
today, and say it will prevent all regulatory failures in the 
future, and there may be issues in the future where we fail to 
adapt quickly enough. But it is a substantially better 
structure than we have today and I think it is a better balance 
of authority and accountability than an alternative model that 
would give the council the ability to override qualified change 
fundamentally the existing statutory responsibilities of those 
agencies. I think that would be confusing, confusing to the 
markets, and it would lead to more of this going on.
    Senator Menendez. Mr. Chairman, I know my time is up. I 
look forward to working with you. I have some suggestions and I 
look forward to working with you as we move forward. Thank you.
    Senator Johnson. Senator Martinez.
    Senator Martinez. Thank you, Mr. Chairman.
    Secretary, thank you for being here and thank you for the 
hard work you have been undertaking in the many months you have 
been on the job. I have a question about this whole notion of 
systemic risk. In the past, we saw the government-sponsored 
enterprises, that they, in fact, had an implicit, which became 
explicit, government guarantee. By doing so, they were able to 
borrow at cheaper rates. As they borrowed cheaper than the 
private sector, they essentially squeezed out competition, grew 
larger. As they grew larger, their risk to the economy became 
systemic. They grew yet larger. Competition went further away. 
And they are, as we have discussed here earlier already, a key 
component of what went wrong with our system.
    How do we not come right back into this in a broader sector 
of the economy--this was just securitized mortgages--but doing 
the same thing now in insurance, in other financial services, 
et cetera, by creating a group of entities that are too big to 
fail, therefore having an implied guarantee from the 
government, therefore being able to borrow cheaper money?
    Secretary Geithner. Excellent question and a core concern 
that shaped our recommendations. Just to go back to where you 
started on the GSEs, remember, these institutions were allowed 
to operate with this implicit guarantee. As you said, lower 
borrowing costs take on a huge amount of leverage. They were 
not subjected to remotely conservative--sufficiently 
conservative capital requirements and there was no mechanism 
established in the law for dealing with their potential 
failure.
    Congress created, at least laid a foundation for fixing 
both those problems in the legislation it passed last year. 
That is a beginning, but it is only a beginning. As I said to 
one of your colleagues earlier, we are going to have to come--
we are going to make recommendations once we get through this 
proposing what we do with those institutions in the future.
    What we are proposing for the rest of the system is based 
on that lesson, in many ways, which is stronger, more 
conservative capital requirements where there is the risk of 
moral hazard in the system and a resolution authority that 
gives us the capacity for managing failure. Those are the two 
critical things to do and our core responsibility, I think, is 
to do those key things and that will help mitigate the risk 
that you referred to which we, of course, are deeply concerned 
by, that the actions that we have created and that we have 
taken in this crisis to contain the damage will sow the seeds 
of future crisis by leading people to believe they will be 
insulated from the cost of future mistakes.
    Again, the best protection against that is to make the 
system safe for failure in the future, reduce the risk of large 
pockets of excess leverage with conservative capital 
requirements, and better tools for managing failure, 
orchestrating an orderly unwinding of a large, complex 
institution in the future.
    Senator Martinez. I still don't know how we will avoid 
the--and I agree with you completely that the GSEs were well 
undercapitalized, underregulated, and there was no plan for 
their dissolution. However, how do not a group of companies 
become then those that are too big to fail, which in turn 
allows them to borrow cheaper money? I mean, once the risk of 
failure is diminished by government backing, implicit that 
becomes explicit, aren't they in a position to borrow cheaper 
and therefore squeeze out competition from those who are not 
considered systemically important?
    Secretary Geithner. That challenge is at the heart of bank 
regulation. With the establishment of deposit insurance, with 
access by banks to borrow from the Fed against collateral, you 
do create the risk. You do create a lower borrowing cost and 
you create the risk that there is an implicit support from the 
government coming in crisis.
    The only ways we know to counteract that risk are to make 
sure there is strong oversight, a consolidated basis, more 
conservative capital requirements, and better capacity to let 
institutions fail when they get themselves to the point where 
they have managed themselves to the point of vulnerability. I 
am not trying to oversimplify it, but if we don't get those two 
things right, nothing is possible and they will get us a 
substantial distance to the point where we are limiting the 
moral hazard created by the role they play in the system.
    Senator Martinez. On the GSEs' future, I just wanted to 
find out from you what your thoughts were in terms of when this 
consultation process might conclude and would the FHFA be 
involved in this process? I presume they would be. In other 
words, who will be the coordinating council or whatever this 
group is going to be called that is going to analyze and study 
and make recommendations on the GSEs and what opportunity will 
there be to comment, for people to participate, et cetera?
    Secretary Geithner. To be honest, Senator, we have not 
designed yet the full details of the process we think would be 
helpful in terms of exploring all alternatives. But we will 
involve the FHFA and Department of Housing and Urban 
Development. Treasury will coordinate the process. We will 
consult not just with this Committee, but with your 
counterparts in the House, and we will try to consult broadly 
in the markets and the academic community as we think through 
broad options.
    I actually can't recall what we proposed in the paper in 
terms of a timeframe, but I think it would be reasonable for us 
to start to bring forward recommendations and options sometime 
in the first half of next year.
    Senator Martinez. Thank you, Mr. Chairman.
    Senator Johnson. Senator Bennet.
    Senator Bennet. Thank you, Mr. Chairman.
    Mr. Secretary, it is good to see you. Thank you for your 
efforts here.
    Over the last 5 months or 6 months or whatever it has been, 
what I have discovered is that with respect to the Federal 
intervention in the immediate crisis, I think it is fair to say 
there is very little consensus about the details of that or 
about it as a whole, and I know that presents a huge struggle 
for you and for the administration because everybody is a 
critic but not everybody has to come up with a solution and I 
think you have worked hard to try to get through a lot of this. 
I think there is also limited consensus still about what we 
ought to do to fix the problem we have got prospectively.
    What people have come to understand is that we have come 
out of a decade where our savings rate as consumers dropped to 
zero, the Federal debt ballooned from $5 trillion to $10 
trillion, and banks or financial institutions on Wall Street 
that historically have been levered at 12 times were levered at 
25 and 30 times, all of which, as you said in your testimony at 
the beginning, when it all came crashing down has left our 
families in an unbelievably vulnerable position--jobs lost, 
houses lost, college educations deferred for people all over my 
State and all over the country.
    And I know that we are designing this prospectively, but 
for the folks watching this at home, if we could rewind the 
movie that we just had play out of a period of an absurd amount 
of leverage in our economy, of risky decisions that should 
never have been made by people that should have been known 
better, of risks that were taken actually in plain sight but we 
missed it, all of us, in part because of the way our regulatory 
system was designed, as you rewind that movie in your head, 
looking back, let us imagine that the regime that is being 
proposed was in place and how would things have been different 
as a result of that?
    Secretary Geithner. If what we are proposing today had been 
in place, it is--banks would not have taken on so much risk. 
Institutions that were not regulated as banks would not have 
been permitted to take on that level of risk. Consumers would 
have been less vulnerable to the kind of predation that we saw, 
particularly in mortgage products, and the government would 
have had the ability to act earlier, more swiftly, to contain 
the damage posed by the inevitable pressures that come when 
firms fail. You know, again, we want a system where innovation 
can happen, when firms can fail, where investors are 
accountable for the risks they take in some sense, but you have 
to create a system that is strong enough to allow that to 
happen.
    So that is a simple way to say banks would not have been 
able to take on this much risk. You wouldn't see this much risk 
buildup, leverage buildup outside the banking system to a point 
where it would threaten the stability of the system. And 
consumers would have been less vulnerable to the kind of 
predation we saw, and the government would have been able to 
act sooner.
    Senator Bennet. In sort of the combination of the council 
versus the Fed versus the Consumer Protection Agency and all 
this, who would have detected that we have got these things out 
here called credit default swaps that are mounting on the 
balance sheets of our banks and that is a cause for concern, 
and to whom would they have communicated that and what action 
would have been taken as a result?
    Secretary Geithner. They were a bit of an orphan in the 
current structure. But under this regime, we are giving the SEC 
and the CFTC much more explicit authority. We are pushing the 
standardized piece of those products onto central 
clearinghouses, onto exchanges and transparent electronic 
trading platforms and giving the SEC better authority to deal 
with potential manipulation and fraud in those areas. That 
would have helped. If they were behind the curve and failed to 
act in that context, then the council would have the ability 
and the authority to bring that to light and to urge them to 
fix that problem.
    So I believe under this model, you are going to have the 
Secretary of the Treasury doing something I don't believe you 
have ever asked the Secretary of the Treasury to do, which is 
to come before the Congress on a regular basis and report on 
evolution of risk in the system and whether the overall system 
as a whole is doing an adequate job of responding to those 
risks.
    Now, we won't have the full authority that Congress has 
given to the underlying regulatory agency. They will each have 
a piece of responsibility for that. But in some sense, you will 
be able to look to the executive branch to say, does the whole 
thing work? Are we dealing with gaps? Are we adapting to 
emerging risks? And I think that will be a substantial 
improvement.
    Senator Bennet. And then--Mr. Chairman, one more question--
and then if all that left us in the position where an 
institution that was a bank holding company found itself in 
crisis, we then have a new approach to resolution authority, as 
well, that you are proposing.
    Secretary Geithner. We would. We would have a capacity to 
act earlier, I think more effectively, possibly at less cost to 
the taxpayer to contain the damage to the economy from that 
kind of specific challenge.
    Senator Bennet. Thank you, Mr. Secretary. Thank you, Mr. 
Chairman.
    Senator Johnson. Senator Corker.
    Senator Corker. Mr. Chairman, Mr. Secretary, always good to 
see you. Thank you for your service.
    Secretary Geithner. I am not Mr. Chairman yet, but I----
    Senator Corker. You know, I read parts of this proposal and 
I almost imagined a couple of folks sitting around at the White 
House drinking Diet Cokes, and especially when a lot of the 
heavy lifting wasn't addressed, the GSEs and CFTC and the SEC, 
only portions were addressed, and I think numbers of people on 
both sides of the aisle have alluded to that. And yet I saw 
that the Fed was a clear winner in this. I think everybody on 
this panel would agree with that.
    This administration has received accolades in some quarters 
for trying to make sure there are no conflicts of interests and 
lobbyists can't be hired and all that. I wonder if it would 
make sense, since there will be a lot of interaction with you 
guys and obviously there will be some arm twisting and 
consultations taking place, I am sure--would it make sense for 
the President to, in writing, tell all of us that no one 
involved in creating this at the White House or cabinet will be 
appointed as Fed Secretary, or Fed Chairman?
    Secretary Geithner. No, I don't think that would be 
appropriate, nor do I think it would be necessary.
    Senator Corker. It is interesting to look at the new----
    Secretary Geithner. I think you expected that answer, 
Senator.
    Senator Corker. I actually expected that--I don't know. I 
think it would be good for us to know as we move through that 
none of the folks involved in helping create these new powers 
under the Fed are potential Fed Chairmen. I think that would be 
good to know. But I will leave that to you all.
    Let me just move on. The resolution authority, you and I 
have talked about this since the very first time you came up 
here. It seems to me that what you are doing is, in essence, 
making TARP exist in perpetuity. I know that you have the 
authority to actually cause organizations to not exist, but you 
also hold upon yourself the ability to do exactly what is 
happening in TARP today. I think most of us don't like that 
much. I think most of us would like to see that end.
    I know you were asked earlier whether you were going to 
extend it. And I just wonder, you know, the ad hoc nature of 
what has occurred, I think is what has created much of the 
instability, and yet you resume under yourself under this 
resolution, the power--the ability to do exactly what is taking 
place under TARP and I am just wondering why that makes much 
sense and not going ahead and having something that is very 
clear cut. Some people have talked about a special bankruptcy 
court. Some people have talked about the FDIC resolving. But 
you, in essence, are reserving to yourself the ability to cause 
TARP to go on into the future.
    Secretary Geithner. No, Senator. I know you have said that 
many times, but it is not true and we wouldn't do that. TARP is 
temporary. It will be temporary. It will, fortunately, go out 
of existence when the statute expires, and maybe before that.
    What we are proposing is to take this model that the FDIC 
has presided over, its existing checks and balances, its 
existing authorities, designed for a different financial system 
than we have today, and adapt it to bank holding companies and 
those complex institutions that present similar risks to banks. 
So we are doing the essentially pragmatic, conservative thing 
in taking a model that exists, has a lot of experience, has 
good checks and balances, and adapting to the financial system 
we face today.
    We are not proposing to sustain some indefinite capacity to 
do what Congress authorized on a temporary basis--appropriately 
so--under the TARP. And I would share your concerns, any 
concerns people express with that kind of authority.
    Senator Corker. So you would work with us to make sure that 
you didn't have the ability just to conserve into the future 
and make ad hoc decisions at Treasury regarding entities that 
were deemed to fail?
    Secretary Geithner. Well, again, Senator, the way the FDIC 
mechanism works today, and we are preserving that basic 
balance, any action would require a vote by a majority of the 
Board of the FDIC, a majority of the Governors of the Board of 
Governors of the Federal Reserve System, and the concurrence of 
the Secretary of the Treasury, and institutions that have banks 
at their center. Again, we are preserving that basic balance. 
There is a carefully designed set of statutory criteria for 
exercising that authority which we think fundamentally we can 
replicate in this context. So I think that has a--again, it has 
an established record, good, well understood checks and 
balances, a lot of merit in replicating that basic structure.
    Senator Corker. I know my time is up and I know we are 
going to be talking about this a lot more. The one thing that 
was interesting, I looked at--you know, the 13(3) issue has 
been raised a couple of times and that jumped out. It is 
interesting, and I think a lot of people have asked sort of the 
questions about priorities. You know, the Fed, a lot of people 
think, and I am not necessarily in every one of these camps, 
but some people think that the Fed earlier on failed with 
monetary policy and helped create a bubble. Some people think 
the Fed actually failed somewhat supervisorally. And yet they 
did a pretty good job responding quickly to an emergency.
    And what you all have done here is actually sort of 
hamstrung them as it relates to dealing with an emergency, but 
yet on the other hand given them even greater supervisory 
authority. So it is just an interesting way that you all have 
gone about this and very different than what history has shown 
to be good practices at the Fed itself.
    Secretary Geithner. I agree with some of what you said, and 
I particularly agree that the Fed, I think, in being able to 
move as quickly as it did played a decisive role in avoiding a 
much more catastrophic outcome for the financial system and the 
economy and I think we need to preserve that authority.
    Now, what 13(3) does is to give the Fed the ability to lend 
to institutions it does not supervise, as I said. We are trying 
to fix that basic imbalance between institutions that play a 
critical role in markets and those that come under the Fed's 
basic supervision. By changing the authorities of that 
authority, we will reduce the risk in the future, particularly 
if you give us resolution authority. It will reduce the risk 
the Fed has to use 13(3) in the future to lend to institutions 
outside that basic framework of protection.
    But as I said, even in this crisis, where the Fed acted, I 
think, very swiftly and effectively to help contain the damage, 
where it used 13(3) in particular cases with individual 
institutions, it did ask for the explicit concurrence of the 
Secretary of the Treasury in recognition again of the potential 
losses to the taxpayer that were inherent in those judgments, 
and I think that was appropriate for the Fed to do. As you 
know, I was closely involved in that decision and I think that 
those decisions--and I think that would be appropriate to put 
in place in the future. And I do not believe, but I think this 
is an important concern, that that would constrain the Fed's 
ability in the future.
    Now, it is necessary, though, to tighten up the 
responsibility and authority the Fed has now for those core 
institutions, for payment systems because of the risk they 
present, and for capital. I think in those three areas, the 
Fed's authority is too qualified now. It has got responsibility 
without clear authority and accountability and I think that is 
worth fixing, basic pragmatic case for fixing that.
    Senator Johnson. The Secretary must leave at noon, so I 
remind Members to abide by the 5-minute rule.
    Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman.
    Thank you, Mr. Secretary. Senator Warner also brought up 
the issue of the warrants and the guidance, and another issue 
which is on your long, long list to do is private equity 
involvement in resolutions of failed institutions, and any 
guidance, we would appreciate it at your earliest convenience.
    Let me raise the issue which is going to be debated 
substantively for a long time, which is the Federal Reserve 
role, et cetera. You have suggested, I think, in an earlier 
answer, that the Fed would by October essentially report back 
to us about the changes that they have to make to accommodate 
these new responsibilities. So what are we doing between now 
and October in terms of moving this debate along, if we have to 
wait for the Fed to sort of say, well, this is how we are going 
to do it?
    Secretary Geithner. I don't think you need to wait for the 
Fed on that to proceed with the legislative process on design. 
There is the specific set of questions around how to deal with 
some of the concerns Senator Shelby and others raised about the 
role of the Reserve Bank Boards, the set of firewalls and 
constraints that prevent involvement of Federal Reserve Bank 
Boards in supervision, a range of things like that where we 
think it would be appropriate for the Fed to try to clarify, 
bring recommendations for how to tighten up those kind of 
safeguards and constraints, and I think that can happen on that 
path without getting in the way of your efforts to consider 
legislation.
    I know the Chairman is considering coming together, and 
will be happy, I am sure, to come before the Committee and talk 
about what role they think the Fed should play in looking at 
systemic risk and how to respond to the concerns many of you 
raised that that not distract them from their core 
responsibilities for monetary policy.
    Senator Reed. You know, my sense is that with these new 
responsibilities, there has to come not only new organizational 
arrangements, which we would like to, I guess, have them 
suggest what their recommendations are, and then second, I 
think, is even the issue of culture. That is this issue of is 
it safety and soundness trumps everything else? I think also, 
too, in terms of transparency, one of the--my sense from 
talking in hearings and just generally is that, you know, there 
were rather vigorous debates in the Fed about is there a 
housing bubble, is there not a housing bubble, were savings 
rates too low, et cetera. That never got out.
    How do we have an agency that is going to be transparent in 
terms of these issues? Similarly, will there be an independent 
analytical staff? Will there be someone charged, not just at 
the Board, but a Deputy for Systemic Regulation that may or may 
not be subject to the confirmation process? And then this 
raises the bigger issue which many of my colleagues have talked 
about is just oversight. Ultimately, they are imposing 
legislation. I can recall, along with many others, writing 
several letters, I think, to the Fed about one of these HOEPA 
regulations coming out.
    So these are critical issues and I wonder if you could just 
comment briefly.
    Secretary Geithner. I think you are right that they are 
important questions and you have relayed a number of important 
suggestions about how the basic structure may need to adapt, 
and I think the best way to deal with these is to work through 
them together with the Fed. Again, we suggest that the Fed 
start to think through about what they would propose in that 
area for consideration by the Committee and I don't see any 
reason why that process can't move quickly.
    Senator Reed. Let me just add another issue, too, that will 
be part of this debate about whether the principal systemic 
regulator is the Fed or a committee. FDIC is run by a 
committee, I think. Frankly, aren't you on it?
    Secretary Geithner. I am not on the Board of the FDIC, but 
the head of the OTS and the head of the OCC are.
    Senator Reed. The OCC. Thank you, Mr. Secretary. But they 
seem to do a pretty good job about supervision and also 
resolution and other things. Does that argue for----
    Secretary Geithner. I think you are exactly right. I think 
you--in some ways, the ideal institution has a strong, 
independent, professional, experienced, competent staff of 
experienced people, a strong executive accountable, and a board 
that can provide a broader framework of oversight. I think that 
basic model can work. But I think that is different from 
investing a council with formal statutory authorities to change 
and compel judgments by independent agencies that have a 
different set of statutory responsibilities. I think that is 
the difference I would make.
    Senator Reed. I am going to abide by the Chairman's 
admonition to stay within 5 minutes, but just one final very 
quick comment. That is, I understand your proposal does include 
registration of advisors to hedge funds, which is legislation 
that I proposed and I think it is on the right track and we 
would like to work with you. Thank you.
    Secretary Geithner. Absolutely.
    Senator Johnson. Senator Hutchison.
    Senator Hutchison. Thank you, Mr. Chairman.
    Mr. Secretary, first, I want to say that I think you have 
been very thoughtful and forthcoming today and I am not yet 
ready to say that I am going to give the Fed this new power, 
but I think the points you made in your first answer were very 
compelling so I want to--I am conflicted about the 
independence, which I think has served us so well through the 
years, but yet the potential compromising of that by going into 
more regulation.
    Second, I think that your proposal is attempting to do 
something that is good. I am not sure when the devilish details 
come out that it will be so. But trying to level the playing 
field between banks and S&Ls surely was one of your purposes 
and also streamlining the whole oversight of that. But I think 
S&Ls have had a special place in our country and I want to make 
sure that we still have the services that they have been so 
able to give, which really started out being mortgages but 
evolved into more.
    I also want to make the point that I agree with Senator 
Schumer, who said something earlier today that was said to me 
by one of the great bankers in our State, Tom Frost, who is 
also now the biggest independent banker and has been very 
successful with the Frost Bank. And he said as long as you do 
not require a person who originates a mortgage to keep part of 
it, you are going to have problems. And I think keeping a part 
of it in the originator is a very important concept that we 
need to incorporate into a reform, plus, of course, servicers 
and second servicers and how many iterations of that they have. 
I think we need to have skin in the game, as it is described, 
for everyone that is connected with a mortgage going forward.
    I want to switch just for a moment for my question on TARP, 
and that is to say that every one of us who was here last fall 
feels that we were misled by the original intention of the 
Troubled Asset Relief Program, which was to take the money to 
buy troubled assets in banks to stabilize the banking industry. 
Last year, that was proliferating into other areas, and it has 
continued in your administration as well. So we now have 11 
different programs, none of which is buying assets of banks 
that are troubled.
    So my question is this--as Senator Bunning mentioned, you 
will be able to sign a paper and extend TARP for 10 months at 
the end of this year, and you said you were not sure if you 
were going to. This is my question: Do you believe that these 
11 funds that have been a part of TARP that were not all a part 
of the original purpose of TARP should have more congressional 
oversight? Because I am looking at introducing legislation that 
would provide that. And if so, do you think it would be wise 
for Congress to be able to vote on all of the 11 new programs? 
Or if not, what do you think would be the proper role of 
Congress? Because I am not comfortable with having been misled 
last year, then currently going for 10 months and then--well, 
actually about 6 or 7 months, plus another year in something 
that seems to have no congressional oversight.
    Secretary Geithner. Senator, at the beginning of this 
administration, we said that there were five areas where we 
thought it was going to be appropriate to consider using TARP 
authority Congress provided, and those were to help address the 
housing crisis, to make sure banks have capital where they need 
capital, to help support bringing back the securitization 
markets, targeted programs for small business lending, and a 
program to help restart these markets for loans on the balance 
sheets of banks.
    Now, we have moved forward to put in place programs in each 
of those areas, as we said we would do. We are on the verge of 
putting in place the last of those programs, which is to help 
create a set of funds to help restart these markets for--you 
call them ``toxic.'' We call them ``legacy assets.''
    These programs are subjected to an enormous amount of 
carefully designed oversight, not just by the Congressional 
Oversight Panel you provided, you established under statute, 
but also by a Special Inspector General at the Treasury and by 
the GAO. They report monthly on everything we are doing.
    We have been fully transparent about the specific terms 
underpinning each of these programs so that everyone can look 
at exactly what we are doing and measure their impact and their 
success. We are looking very carefully at every recommendation 
those oversight bodies make for bringing more transparency and 
accountability to them, and where we think they make sense and 
we can do them, we have adapted those recommendations, and we 
will keep doing that.
    It is hard to know what might be necessary in the future in 
terms of using this authority, if any further use will be 
required, but my sense is that if we need to do more in the 
future, that anything we do will fall within those core basic 
framework, which, to reduce them, are about making sure the 
banking system has capital and making sure these markets are 
getting going again.
    Senator Hutchison. So further congressional oversight would 
not be necessary or prudent, in your view?
    Secretary Geithner. Well, again, I think you have put in 
place an enormously powerful set of oversight mechanisms, and I 
think those have done a very good job of helping provide not 
just a second pair of eyes, but three additional sets of eyes 
looking over everything we do. Of course, we would be happy to 
look at ways to sort of strengthen accountability and 
transparency because it is important to our credibility, too. 
But I do not believe you need new legislation in this area.
    Senator Hutchison. Thank you, Mr. Chairman.
    Senator Johnson. We have time for one more question apiece. 
Senator Merkley.
    Senator Merkley. Thank you very much, Senator Johnson. Am I 
limited to just a single question?
    Senator Johnson. Yes.
    Senator Merkley. Thank you, Mr. Chair.
    I would like to praise the plan that you put forward, and 
three things that I had been advocating for were in the plan: 
the Consumer Financial Protection Agency, having a housing 
expert involved in the systemic risk council, and power to 
reform predatory retail mortgage practices. So I certainly 
appreciate those aspects having been addressed.
    In regard to the Consumer Financial Protection Agency, 
would they have the power without additional input--or not 
input so much but authority from some other sector to do things 
such as shut down new tricks and traps introduced into credit 
cards or shut down new tricks and traps introduced into 
mortgage lending practices?
    Secretary Geithner. Yes. Where those practices threaten 
basic standards of consumer protection, they would have that 
authority to set rules to constrain that and to enforce those 
rules.
    Senator Merkley. Thank you.
    Senator Johnson. Staff indicates that you may have your 
full 5 minutes.
    Senator Merkley. Thank you. Thank you very much, Mr. Chair.
    Well, I wanted to go on to ask, in terms of the power that 
would go to the Fed under this plan, I think I have a ways to 
go to see the Fed as the right place to set capital adequacy 
rules, in part because of the situation in the past, for 
example, they fought against keeping leverage ratios. Is that 
the right place to center this kind of power?
    Secretary Geithner. I think so, because I think that if you 
give it to too many people, you do not have accountability for 
when you get it right. And I think that they have got the best 
incentives to make sure that those basic safeguards are strong 
enough to help us withstand future crises.
    Senator Merkley. So let me frame it a little differently. 
We gave power to the Fed in the past that sat unused and 
unexercised in situations where, of course, with the power of 
hindsight--which is always much better than foresight--we would 
have wished they had exercised that power. Is there a way to 
have them address their role in monetary policy at the same 
time having them see this as a major mission, a major 
responsibility, and that they will not fall asleep at the 
switch?
    Secretary Geithner. Senator, I think I need to just say one 
thing which is important to point out. If you look at the 
mortgage market in the United States where practices were 
worse, they were worse the greater distance you had from a Fed-
supervised institution.
    If you look at where the pockets of risk in the financial 
system were worse, where you had leverage go to the point where 
institutions were at the edge of the abyss, no longer could 
decide independently, like in the case of Countrywide, for 
example, and two of the world's largest investment bank, or if 
you look at AIG, those were institutions that the Fed had no 
ability to affect risk taking those institutions. So I do not 
think it is fair to say, looking at the record of performance 
of our system over this period of time--even though, as I said, 
everybody part of this system, there are areas where they could 
have done substantially better. But I do not believe either in 
the mortgage area or in the core things that threaten the 
stability of the system it is fair to say that where those 
things were most acute, they were institutions that were under 
the Fed's supervision. And I did not believe that the 
additional accountability and clarity of responsibility we are 
proposing to give the Fed, building on their existing 
responsibilities today, has any significant risk of undermining 
their capacity to keep growth stable, sustainable over time, 
and keep inflation low and stable in the future.
    Senator Merkley. Well, I appreciate your response. I am not 
fully persuaded, but I do not pretend to be an expert in this 
area. But I will try to dive into it a little more and follow 
up with your team, and thank you very much.
    Secretary Geithner. Again, I want to just say no part of 
the system acquitted itself particularly well, and everybody is 
going to have to do a better job in the future, and that is why 
we are proposing, among many things, a comprehensive assessment 
of the basic record of supervision across agencies in the U.S. 
responsible for that.
    But we have to make choices going forward about how to 
build a stronger system, and what we have recommended, what the 
President recommended I think vests authority where it needs to 
be in institutions with the best capacity to discharge that 
responsibility well.
    Senator Merkley. Well, thank you, and I will yield back the 
balance of my time, and I do feel like the administration has 
put forward a very strong proposal for us to work with. Thank 
you.
    Senator Johnson. Senator Crapo.
    Senator Crapo. Thank you very much, Mr. Chairman. And, Mr. 
Secretary, thank you for being here. I want to indicate at the 
outset that I share a number of the concerns that have been 
raised by my colleagues here in reference to the new 
authorities to be given to the Fed. But since that has been 
gone over a lot, I want to in my short time focus on an issue 
that I do not think has had much attention here yet today, and 
that is the bifurcation of consumer protection from safety and 
soundness regulation.
    It seems to me that we can get the most effective consumer 
protection by not bifurcating those two functions and moving 
forward in a way that allows those who are really connected 
with the regulatory system of our banks to have the ability to 
implement statutory and regulatory policy on consumer 
protection.
    What I would like to do is to read you a statement by the 
Comptroller of the Currency, John Dugan, when he testified 
before our Committee in March, because he made the same points 
and made a number of points about why that is the case, and I 
would like you to respond to his points. He says, ``The best 
way to implement consumer protection regulation of banks, the 
best way to protect consumers, is to do so through the 
prudential supervision.'' He gives these following reasons:
    First, prudential supervisors' continual presence in the 
banks through the examination process put them in the very best 
position to ensure compliance with consumer protection 
requirements established by statute and regulation;
    Second, prudential supervisors' have strong enforcement 
powers and exceptional leverage over bank management to achieve 
corrective action;
    And, third, the examiners are continually exposed to 
practical effects of implementing consumer protection rules for 
bank customers. The prudential supervisory agency is in the 
best position to formulate and refine consumer protection 
regulations for the bank.
    Could you respond to those points?
    Secretary Geithner. Those are thoughtful concerns, and they 
have been made by supervisors in the United States for a long 
period of time, and we have had some experience with that 
model, and it did not work well enough. So our basic judgment 
is we need to change the model, and separating that 
responsibility from the core safety and soundness 
responsibility of bank supervisors is a better way to get a 
better balance on both those functions.
    But you are right and that is a good version of those 
concerns that you quote from John Dugan, and I think those are 
good arguments. But I would just say we have had a good 
experiment in whether that model works, and it did not work 
well enough.
    Senator Crapo. So you are saying that we had adequate 
consumer protection statutory and regulatory authority, but 
that it was not exercised?
    Secretary Geithner. No. I would say that there were 
limitations both in the strength of the rules that were 
established and how those were enforced. The rules themselves 
were probably, I think, almost certainly not sufficiently 
strong, and it is certain that they were not enforced with 
sufficient rigor and evenness across the range of institutions 
that allowed to generate those products.
    Senator Crapo. How do you respond to the concern, though, 
that one of the needs we have to focus on, at least in my 
opinion--and I think this is a pretty broadly held belief--is 
to streamline and make more efficient our regulatory system? 
Before we got into this crisis last October, you know, most of 
the focus on regulatory reform was on how to stop our slide in 
competitiveness with regard to our foreign capital markets or 
the world capital markets. And one of the concerns there was 
that we continue to have this increase in numbers of regulators 
to the point where we have double-digit regulators for any 
financial function, and here we are seeing a proposal once 
again to increase the number of regulatory agencies that will 
now be managing our financial economy.
    Secretary Geithner. Well, on balance, we are not increasing 
the number of agencies. We are reducing the one important 
source of arbitrage and inefficiency, which is between a 
national bank and a national thrift charter. But you are right, 
we are proposing to separate the consumer function from the 
existing safety and soundness function and the other 
authorities that have that and put it in once place with 
accountability for the reasons I said, which is the current 
model with a long record in it, and it did fail in important 
respects.
    I believe that this basic concern about the competitiveness 
of our system remains a very important concern that has to 
guide everything we do. But I do believe our system will be 
stronger, more effective, more competitive, greater 
confidence--enjoy greater confidence around the world if we 
have better safeguards and protections, not just around 
disclosure, which is very important, where I think we still 
lead the world, but in terms of basic protections against 
stability.
    Our system will not be competitive, our institutions will 
not be competitive if we have a system in the future that has 
been as vulnerable as ours had to period crises like this every 
2 to 3 to 4 years.
    Now, this is the first crisis we have had in a long time of 
this severity, but we have had a record over the last three 
decades where every 3 to 5 years we have had a shock of 
significant magnitude, and I think that does not make our 
system or our institutions competitive, and a better foundation 
to stability would be supportive of trying to make sure that 
our system remains in many ways the envy of the world in doing 
this core job of taking the savings of American investors and 
channeling them to where they can be best used in support of 
innovation, new ideas, growing companies.
    Senator Crapo. Thank you. My time is up. I would like to 
pursue this further with you, though.
    Senator Johnson. Senator Bayh.
    Senator Bayh. Thank you, Mr. Secretary. I would like to 
start off with a comment and then two questions.
    First, my comment is I would like to thank you for your 
openness and the dialogue you have established with Members of 
this Committee. There was a comment made previously about the 
timing of briefings and that sort of thing. I was at the 
breakfast that you had a few weeks ago. It was bipartisan. You 
elicited comments from all of us. So I want to just go on the 
record as thanking you for that.
    Second, I want to commend you on the work product you have 
produced here. Very difficult dilemmas to wrestle with. It 
seems to me you have struck the right balance here focusing on 
the core mission, putting off until later some things that are 
desirable, but perhaps can be left to another day.
    That takes me to my question, the first of my two 
questions. I am concerned--and you alluded to this--that there 
were a number of causes of the crisis that we face right now, 
some macroeconomic in nature. I am concerned that your 
excellent work product will go for naught and that we will be 
overwhelmed once again in 5 years, 6 years, 7 years, in a ways 
we cannot anticipate if those are not dealt with. And I refer 
specifically to the imbalance of savings and consumption in the 
world.
    As the crisis, God willing, appears to be abating, I simply 
do not see the willingness on the part of some countries to 
rethink their basic economic models. And so I would be 
interested in your comment about--I am deeply concerned that we 
are going to see a recurrence of this if that is not dealt 
with, so I am interested in your comment about that. In 
particular, you know, on the savings side, I see Americans are 
beginning to save a little bit more. That harms consumption in 
the short run, but in the long run it is probably a prudent 
thing. But isn't it also true that one of the best ways to 
increase national savings is to get our deficit down? And I am 
concerned that if you look at the size of the deficit, this 
year and next year is understandable, but in the out-years it 
looks like it may be larger than GDP growth, that is a 
concerning thing.
    So what about these macroeconomic factors and their ability 
to overwhelm this architecture if they are not addressed? That 
is number one.
    Secretary Geithner. I think you are absolutely right. We 
share that concern, and I think that it is very important as we 
put in place the exceptional measures to try to address the 
crisis, that we don't lay the basis for reigniting those basic 
imbalances which, of course, are the problem.
    Let me just try to take the encouraging side of that 
argument for a second. You are right, private savings now are 
significantly positive. They moved from modest negative to 5 
percent, which is a good start. Historical levels before the 
last three decades were more in the 8 to 9 percent and may go 
that place over time, and that is a healthy development, 
although you are right, it does--it will slow the pace of 
recovery.
    You are absolutely right that we have to bring the fiscal 
deficit down over time. The Government is going to have to 
spend substantially less relative to its resources over time, 
and the President, as you know, is deeply committed to that.
    Our current account balance has now come down from a level 
that was approaching 7 percent of GDP to now below 3 percent of 
GDP. That is helpful and important.
    I would say as consequential, I think there is a 
recognition, not just in China but in many countries around the 
world, that the U.S. consumer is not going to be able to leave 
the global economy out of this crisis, and you are seeing in 
the basic strategy of economic policy, including in China, a 
much greater attention to policies that will shift the sources 
of future growth to domestic demand and consumption and 
bringing about a transition from a less export- , less 
investment-intensive model of growth to one more relying on 
domestic demand. That would be healthy.
    But we are at the beginning of that, but it has to start 
with a recognition. I think you are seeing that recognition, 
but I agree with you, without getting that world economy a more 
balanced foundation of growth, these protections, although 
necessary, could be overwhelmed in the future.
    Senator Bayh. Well, I am glad that they recognize the need 
to transition to a different global economic balance. I hope 
they follow through once the crisis is abated because, as you 
know, the economic models they have pursued are there for a 
reason. They have worked pretty well for them up until now, and 
you do tend to have strong vested interests within those 
societies for maintaining the status quo. But it is just not 
going to work anymore, and we are going to see a repetition of 
this unfortunate situation if that does not change.
    My final question deals with regulatory arbitrage. You have 
dealt with that here domestically. My question is: What about 
global regulatory arbitrage? And just as an example, in the 
whole derivatives area we used to be told, well, we have got to 
deal with this. And then the counter argument was, well, they 
are just going to go to another country, the risky behavior 
will take place, but we will lose jobs and revenue, so it is a 
loss-loss.
    How are we cooperating with other countries to avoid, you 
know, global regulatory arbitrage?
    Secretary Geithner. A very important point, and as you 
know, that is a central piece of the proposals we are making. 
We think there needs to be a level playing field and higher 
standards globally if this is going to work; otherwise, our 
safeguards will be undermined, and our institutions will be 
less competitive.
    We are trying a different approach this time. Rather than 
putting reforms in place here, which raise standards here, and 
then engaging in a long process of negotiations to get the 
world to come to those higher standards, we are going to try 
and do it in parallel from the beginning so we get more quickly 
to a better place and are not left with these big disparities 
where risk will shift where the regulatory standards are worse. 
And there is a very elaborate system of cooperation in place 
under the auspices of this new institution we call the 
Financial Stability Board that is designed to drive consensus 
and change on those core areas, capital, liquidity, resolution 
of large institutions going forward. It is a critical part, and 
we are going to--we should be able to report regularly on how 
much progress we are making as we put in place these reforms.
    Senator Bayh. Thank you very much.
    Senator Johnson. Senator Kohl.
    Senator Kohl. Thanks very much, Mr. Chairman.
    Secretary Geithner, earlier this year I asked the FDIC 
Chairwoman about the possible separation of safety and 
soundness, compliance exams, and consumer protection 
activities, and she replied, and I quote: ``Placing consumer 
compliance examination activities in a separate organization 
apart from other supervisory responsibilities ultimately will 
limit the effectiveness of both programs. Over time,'' she 
said, ``staff at both agencies would lose the expertise and 
understanding of how consumer protection and safe and sound 
conduct of a financial institution's business operations 
interrelate.''
    So how do you explain their objections as well as the 
objections at the OCC to what you have proposed before us 
today? Do you intend to work with them to remedy and alleviate 
their concerns?
    Secretary Geithner. Absolutely, and I think that the 
Committee will have the opportunity to hear from all sides on 
this and from people with lots of experience on both sides. But 
I think I would just say what I said to one of your colleagues, 
which is that we have had a rather searing experience with the 
model that was built on integrating those two functions, and it 
did not work well enough. And a core part of what went wrong in 
our system was because of basic failures in consumer protection 
and in some parts of safety and soundness capital regulation. 
And so I do not think the current model served us well enough, 
and it requires change.
    But, of course, we want a system that is going to work 
better on both those fronts, and our objective is to try to 
make sure this new agency has the right degree of 
accountability and expertise to carry out these important 
functions for rule writing and enforcement of consumer 
protections effectively. But I think Commissioner Bair is a 
thoughtful advocate of those concerns, as is John Dugan and 
others, and, of course, we will listen carefully to those 
concerns because what we want to do is have a more effective 
model.
    Senator Kohl. Thank you, Mr. Secretary.
    Second, I would like to express similar concerns that were 
stated earlier by Senator Bennett about shifting industrial 
loan corporation charters to bank holding charters and the 
possible impact on access to consumer credit as well as 
possible unintended consequences that the changes may have on 
parent companies of ILCs. Are you sensitive to that. Do you 
expect that we can alleviate those problems?
    Secretary Geithner. Again, we would like to work with you 
to try to address your concerns. You know, what we need to do--
and I think we all share this obligation--is to make sure we do 
not leave gaps in the system that in the future could emerge as 
another source of ways to get around stronger safeguards 
applied to a bank. And what we do not want to do is allow 
institutions that do similar functions, create similar risks to 
the economy, to be able to operate outside the set of 
protections we try to put in place.
    We had a kind of searing experience with getting that 
balance wrong, although I think it is fair to say that ILCs at 
the moment were not a principal source of that concern. But 
that kind of gap unevenness is a core vulnerability we need to 
address. But, of course, we will try to work with you to 
address your concerns in that area.
    Senator Kohl. And you are not looking for unintended 
consequences. We anticipate them.
    Secretary Geithner. In everything we do, we have to be 
careful that we are making the system stronger and not making 
it more vulnerable. And we try to be very careful and try to 
anticipate the potential adverse consequences of these changes. 
And, again, we want a system that can adapt in the future, 
because we will not have the foresight today to anticipate and 
deal with preemptively any potential source of a risk. We want 
a system that can adapt more flexibly in the future as our 
system evolves, as innovation proceeds.
    Senator Kohl. Thank you.
    Thank you so much, Mr. Chairman.
    Senator Johnson. Thank you.
    Mr. Secretary, I applaud your recommendation to create an 
Office of National Insurance in your reform proposal. Can you 
expand on other ways the Treasury envisions modernizing and 
improving our system of insurance regulation?
    Secretary Geithner. Senator, we have laid out in this white 
paper a set of broad principles that we should guide policy as 
the Congress considers how to make sure we have a framework for 
insurance regulation in the future that allows us to have that 
competitive, efficient, and stable market for insurance 
products. So with an entity established in the Treasury, with 
accountability for thinking about these things, building up 
expertise, and those broad set of principles, we think we can 
begin a process of thinking about broader reforms.
    Senator Johnson. Does the administration agree that 
reinsurance has a good case for regulation at the Federal level 
rather than the State level? What about life insurance and 
property and casualty insurance?
    Secretary Geithner. Senator, we have not made that judgment 
yet. There are a lot of thoughtful proposals out there for 
establishing the ability to have a Federal charter to engage in 
a range of financial products, insurance products. Some people 
would cast that license, that charter more narrowly. Some 
proposals would cast it very broadly. But we have not taken a 
view yet on what we think the ideal model is.
    Senator Johnson. Thank you, Mr. Geithner, for your 
presence, Mr. Secretary. This hearing is adjourned.
    Secretary Geithner. Thank you, Mr. Chairman.
    [Whereupon, at 12:06 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]
           PREPARED STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
    Good morning. Thank you all for being here. I would like to welcome 
Secretary Geithner, who is here today to discuss the Administration's 
proposal to modernize the financial regulatory system. Mr. Secretary, 
we applaud your leadership on a very complex set of issues intended to 
restore confidence and stability in our financial system. I look 
forward to exploring the details of your plan and working with you and 
my colleagues on this truly historic endeavor.
    In my home State of Connecticut and around the country, working men 
and women who did nothing wrong have watched this economy fall through 
the floor--taking with it jobs, homes, life savings, and the economic 
security that has always been the cherished promise of the American 
middle class. These folks are hurting, they are angry, they are 
worried. And they are wondering: who's looking out for me?
    I've seen first-hand how hard people work in Connecticut to support 
their families and build financial security. I've seen how devastating 
this economic crisis has been for them. And I firmly believe that 
someone should have their backs.
    So as we work together to rebuild and reform the regulatory 
structures whose failures led to this crisis, I will continue to insist 
that improving consumer protection be a first principle and an urgent 
priority. I welcome the Administration's adoption of this principle, 
and I'm pleased to see it reflected in the plans we'll be discussing 
today. At the center of this effort will be a new, independent consumer 
protection agency to protect Americans from poisonous financial 
products.
    This is simple common sense. We don't allow toy companies to sell 
toys that could hurt our kids. We don't allow electronics companies to 
sell defective appliances. Why should a usurious payday loan be treated 
any differently than we'd treat an unsafe toy or a malfunctioning 
toaster? Why should an unscrupulous lender be allowed to dupe a 
borrower into a loan the lender knows can't be repaid? There's no 
excuse for allowing a financial services company to take advantage of 
American consumers by selling them dangerous financial products. Let's 
put a cop on that beat so that the spectacular failure of consumer 
protection at the root of this mess is never repeated.
    We have been engaged in an examination of just what went wrong in 
the lead-up to this crisis ever since February 2007, when experts and 
regulators testified that poorly underwritten mortgages would create a 
tsunami of foreclosures. Those mortgages were securitized and sold 
around the world. The market is supposed to distribute risk, but 
because for years, no one was minding the store, these toxic assets 
served to amplify risks in our system.
    Everything associated with these securities--the credit ratings 
applied to them, the solvency of the institutions holding them, and the 
creditworthiness of the underlying borrowers--became suspect. And as 
the financial system tried to pull back from these securities, it took 
down some of the country's most venerable institutions--firms that had 
survived world wars and the Great Depression--and wiped out over $6 
trillion in household wealth since last fall.
    Stronger consumer protection could have stopped this crisis before 
it started. Consumers who were sold subprime and exotic loans they 
couldn't afford to repay were, frankly, cheated. They should have been 
the canaries in the coal mine. But instead of heeding the warnings of 
many experts, regulators turned a blind eye. And it was regulatory 
neglect that allowed the crisis to spread to the point where the basic 
economic security of my constituents in Connecticut--including folks 
who'd never even heard of mortgage-backed securities--was threatened by 
the greed of some bad actors on Wall Street and the failure of our 
regulatory system.
    To rebuild confidence in our financial system, both here at home 
and around the world, we must reconstruct our regulatory framework to 
ensure that our financial institutions are properly capitalized, 
regulated, and supervised. The institutions and products that make up 
our financial system must act to generate wealth, not destroy it.
    In November, I announced five principles that would guide the 
Banking Committee's efforts.
    First and foremost, regulators must be focused and empowered--
aggressive watchdogs, rather than passive enablers of reckless 
practices.
    Second, we have to remove the gaps and overlaps in our regulatory 
structure that have encouraged charter-shopping and a race to the 
bottom in an effort to win over bank and thrift ``clients.''
    Third, we must ensure that any part of our financial system that 
poses systemwide risk is carefully and sensibly supervised. A firm 
``too-big-to-fail'' is a firm too big to leave unmonitored.
    Fourth, we can't have effective regulation without more 
transparency. Our economy has suffered from the lack of information 
about trillion-dollar markets and the migration of risks within them.
    And, fifth, our actions must help America remain prosperous and 
competitive in the global marketplace.
    These principles will guide my consideration of the plan you bring 
to the Committee today. Mr. Secretary, I believe that we can find 
common ground in a number of areas contained in your proposal. I want 
to thank you, Mr. Secretary, for your leadership on these issues, as 
well as for your willingness to consider different perspectives in 
forging your plan. I hope you will view this as a continuation of the 
dialogue you've had with Members of this Committee as we work together 
to shape a regulatory framework that will serve our country well 
through the 21st century.
    I want to thank all of my colleagues on the Committee who have 
demonstrated a strong interest in this issue. Our continued, bipartisan 
collaboration will be critical to ensuring that we enact sound and 
needed reforms to put our financial system back on solid footing.
    And I want to urge everyone to remember that, at the end of the 
day, the success of what we attempt will be measured by its effect on 
the borrower, the shareholder, the investor, the depositor, and 
consumers seeking not to attain extravagant wealth, but simply to grow 
a small business, pay for college, buy a home, and pass on something to 
their kids. That's the American Dream. That's what we've gathered here 
to restore.
    Thank you.
                                 ______
                                 
               PREPARED STATEMENT OF SENATOR TIM JOHNSON
    Thank you, Mr. Chairman, for holding today's hearing with Secretary 
Geithner to discuss the Administration's new proposal to restructure 
our Nation's financial services regulatory structure.
    As we all know, Federal regulators were forced to make unpopular 
decisions last year based on the belief that weakened financial firms 
were so big and so interconnected that their failure would devastate 
the world economy. Our economy began to nosedive as we faced the worst 
recession since the Great Depression.
    When the TARP bill came through Congress last year, I felt it did 
not go far enough to improve regulation. Instead, we sent companies the 
message that if they are bad actors, the government will step in and 
buy the assets that are dragging their companies down.
    Many of these troubled firms were deemed ``too-big-to-fail,'' and 
thus we bailed them out with tens of billions of dollars in taxpayer 
funds.
    Yesterday, President Obama and his economic team announced some of 
the biggest regulatory changes to our financial system since the 1930s.
    Overall, this is a very complicated task to reform and modernize 
the financial services regulatory structure. All reforms Congress 
considers must help prevent a repeat of the events of the past 9 months 
and must shift the burden away from the American taxpayer and to the 
financial institutions that were reckless.
    While the devil is in the details, it appears that the President's 
plan will give regulators the teeth they need to do the job, but also 
the flexibility to make sure our economy grows.
    Over the coming months, the Banking Committee will work closely 
with the Administration to develop legislation that should make the 
needed changes to our regulatory structure and clear the way for a 
stronger, brighter and more stable economic future. I look forward to 
your testimony, Secretary Geithner, as we learn more details about the 
Administration's proposal.
                                 ______
                                 
              PREPARED STATEMENT OF SENATOR SHERROD BROWN
    Thank you, Mr. Chairman, for convening this hearing on the 
President's plan to improve the regulatory structure of the Nation's 
financial services system.
    Thank you, Secretary Geithner, for appearing before us today and 
for your hard work on this plan.
    Let me say at the outset that I agree with the President that we 
must reform our Nation's financial regulatory system. Why? All you have 
to do is pick up a paper or turn on the television to learn about homes 
being lost, Americans losing their jobs because businesses can't get 
access to credit, and banks being shuttered.
    I believe that one of our Nation's forefathers, James Madison, said 
it best when he wrote that ``If men were angels, no government would be 
necessary.''
    Much has been said and written about how we got here, how we 
arrived at the point of needing a comprehensive overhaul of the 
financial system.
    One way we got here is through the free-wheeling creation and sale 
of complex financial instruments that only a small percentage of the 
world understands. These instruments were largely based on bets that 
the mortgage market would reap huge gains indefinitely and funded by 
loans to homeowners and investors, who often did not fully understand 
their loan terms and in many cases could not afford them.
    The other route we took involved the failure of those charged with 
ensuring the health of our banking and financial services sector. I am 
referring to the patchwork quilt of regulators on whom we have relied 
to ensure that our bank accounts are safe and that we can invest with 
the confidence that all risks have been fully disclosed.
    My priorities for reform are the protection of consumers, 
investors, and jobs and ensuring the stability of the Nation's 
financial infrastructure.
    We must put in place a regulatory structure that will not only 
protect consumers and investors but protect valuable financial sector 
jobs. In the news we heard about the collapse of AIG, Lehman, Fannie, 
Freddie, and Bear Stearns and the numerous banks that have either 
closed down or been purchased by other banks.
    This really hits home in Ohio. National City, an institution that 
has been a pillar of the community for more than a century and a half, 
vanished over the course of a few months. We cannot forget about those 
Americans as we work to put a plan in place.
    It boils down to this: People in my State want their hard-earned 
savings protected. They want to be able to get an affordable loan to 
purchase a home--on terms that they can understand. They want to know 
that when they invest, the institutions handling their investments 
aren't so over-extended that a light breeze causes their house of cards 
to tumble. And small businesses want access to credit without 
impossible-to-meet requirements.
    The Administration plan seeks to:

    promote strong supervision and regulation of financial 
        firms;

    establish comprehensive supervision and regulation of 
        financial markets;

    protect consumers and investors from financial abuse;

    provide the government with tools it needs to manage 
        financial crises; and

    raise international regulatory standards and improve 
        international cooperation among financial institutions and 
        markets.

    As we consider the Administration's plan and what I am sure will be 
numerous competing proposals for regulatory reform, I have several 
questions:

    How will the Administration's plan actually protect the 
        average consumer of credit products and the average investor?

    How can we have confidence that the Fed will be able to 
        effectively execute its new responsibilities?

    How will the components of the new scheme be integrated?

    How will this plan prevent us from coming back to this same 
        spot years from now?

    We need vision and courage going forward. We also need to do more 
than pay lip service to the American consumer that we are ``getting 
tough'' on the institutions that caused this mess. We need to ensure 
that any new powers we give to existing institutions and any new 
agencies we create are designed to produce real results and not more of 
the same.
    We need regulatory reform because, left to their own devices, too 
many financial institutions will act to preserve themselves at the risk 
of the system as a whole. Sensible bankers and insurers will have to 
pay the price for their selfish colleagues who think only in the short 
term. And so will the rest of us.
    We cannot afford the status quo. We must act now to put a plan in 
place that protects consumers and investors, saves jobs, and ensures 
the integrity of our financial system.
                                 ______
                                 
                PREPARED STATEMENT OF SENATOR MIKE CRAPO
    I intend to push for reforms that modernize and rationalize our 
Federal financial regulatory system to handle the challenges of 21st 
century markets while ensuring American financial companies can compete 
in a global economy. Although the Administration's plan takes some 
important steps, it does not link the regulatory structure to the 
reasons why we regulate. Seven Federal regulators with overlapping 
missions and fragmented supervision oversee our markets and financial 
institutions. With the abolishment of the Office of Thrift Supervision 
and the creation of a Consumer Financial Protection Agency we will 
still have seven Federal regulators with overlapping missions. 
Increasing the complexity and fragmented approach to our regulatory 
structure is counter to reports that have identified several regulatory 
problems that hinder the ability of the U.S. to maintain its leadership 
role in financial services globally.
    The goal should be to promote stable, orderly, and liquid financial 
markets so that our financial institutions can support the economy by 
making credit available to consumers and businesses. The recent 
taxpayer funded bailouts and investment scandals demonstrate our 
regulatory system is outdated and largely irrelevant. From banks and 
securities firms to insurance companies and money market funds, nearly 
all sectors of our financial system have experienced failures and 
received significant amounts of government assistance.
    The implications of modernizing our financial regulatory structure 
are significant and we need to fully understand what the intended and 
unintended consequences of these changes are. For example, certain 
companies have not been allowed to fail and taxpayers have paid 
unprecedented amounts to cover the costs of bank failures and to bail 
out financial institutions. Does this white paper institutionalize 
government bailouts in a new resolution authority and does designating 
large and interconnected companies as Tier 1 Financial Holding 
Companies send a signal to the markets that these companies will not be 
allowed to fail?
    Bifurcating safety-soundness oversight from consumer protection 
raises many questions. Good supervision should incorporate elements of 
both safety and soundness and consumer protection. For example, the 
absence of adequate underwriting, which played a role in some of the 
financial market problems that we have recently experienced, was as 
much a safety and soundness issue as a consumer protection issue. By 
putting the two areas into entirely different operations, each agency 
will lack the expertise to understand the issues that matter to the 
other, and the result could be less comprehensive oversight.
    We should proceed carefully and deliberately in creating a new 
systemic risk regulator. Having the Federal Reserve become the systemic 
risk regulator for all large financial institutions concentrates 
enormous power in one agency.
    How does this plan encourage investment and responsible lending to 
spur economic growth and help get our economy moving again?
                                 ______
                                 

                 PREPARED STATEMENT OF TIMOTHY GEITHNER
                               Secretary,
                       Department of the Treasury
                             June 18, 2009

             Financial Regulatory Reform: A New Foundation

Introduction
    Over the past 2 years we have faced the most severe financial 
crisis since the Great Depression. Americans across the Nation are 
struggling with unemployment, failing businesses, falling home prices, 
and declining savings. These challenges have forced the government to 
take extraordinary measures to revive our financial system so that 
people can access loans to buy a car or home, pay for a child's 
education, or finance a business.
    The roots of this crisis go back decades. Years without a serious 
economic recession bred complacency among financial intermediaries and 
investors. Financial challenges such as the near-failure of Long-Term 
Capital Management and the Asian Financial Crisis had minimal impact on 
economic growth in the U.S., which bred exaggerated expectations about 
the resilience of our financial markets and firms. Rising asset prices, 
particularly in housing, hid weak credit underwriting standards and 
masked the growing leverage throughout the system.
    At some of our most sophisticated financial firms, risk management 
systems did not keep pace with the complexity of new financial 
products. The lack of transparency and standards in markets for 
securitized loans helped to weaken underwriting standards. Market 
discipline broke down as investors relied excessively on credit rating 
agencies. Compensation practices throughout the financial services 
industry rewarded short-term profits at the expense of long-term value.
    Households saw significant increases in access to credit, but those 
gains were overshadowed by pervasive failures in consumer protection, 
leaving many Americans with obligations that they did not understand 
and could not afford.
    While this crisis had many causes, it is clear now that the 
government could have done more to prevent many of these problems from 
growing out of control and threatening the stability of our financial 
system. Gaps and weaknesses in the supervision and regulation of 
financial firms presented challenges to our government's ability to 
monitor, prevent, or address risks as they built up in the system. No 
regulator saw its job as protecting the economy and financial system as 
a whole. Existing approaches to bank holding company regulation focused 
on protecting the subsidiary bank, not on comprehensive regulation of 
the whole firm. Investment banks were permitted to opt for a different 
regime under a different regulator, and in doing so, escaped adequate 
constraints on leverage. Other firms, such as AIG, owned insured 
depositories, but escaped the strictures of serious holding company 
regulation because the depositories that they owned were technically 
not ``banks'' under relevant law.
    We must act now to restore confidence in the integrity of our 
financial system. The lasting economic damage to ordinary families and 
businesses is a constant reminder of the urgent need to act to reform 
our financial regulatory system and put our economy on track to a 
sustainable recovery. We must build a new foundation for financial 
regulation and supervision that is simpler and more effectively 
enforced, that protects consumers and investors, that rewards 
innovation, and that is able to adapt and evolve with changes in the 
financial market.
    In the following pages, we propose reforms to meet five key 
objectives:

    1. Promote robust supervision and regulation of financial firms. 
Financial institutions that are critical to market functioning should 
be subject to strong oversight. No financial firm that poses a 
significant risk to the financial system should be unregulated or 
weakly regulated. We need clear accountability in financial oversight 
and supervision. We propose:

    A new Financial Services Oversight Council of financial 
        regulators to identify emerging systemic risks and improve 
        interagency cooperation.

    New authority for the Federal Reserve to supervise all 
        firms that could pose a threat to financial stability, even 
        those that do not own banks.

    Stronger capital and other prudential standards for all 
        financial firms, and even higher standards for large, 
        interconnected firms.

    A new National Bank Supervisor to supervise all federally 
        chartered banks.

    Elimination of the Federal thrift charter and other 
        loopholes that allowed some depository institutions to avoid 
        bank holding company regulation by the Federal Reserve.

    The registration of advisers of hedge funds and other 
        private pools of capital with the SEC.

    2. Establish comprehensive supervision of financial markets. Our 
major financial markets must be strong enough to withstand both 
systemwide stress and the failure of one or more large institutions. We 
propose:

    Enhanced regulation of securitization markets, including 
        new requirements for market transparency, stronger regulation 
        of credit rating agencies, and a requirement that issuers and 
        originators retain a financial interest in securitized loans.

    Comprehensive regulation of all over-the-counter 
        derivatives.

    New authority for the Federal Reserve to oversee payment, 
        clearing, and settlement systems.

    3. Protect consumers and investors from financial abuse. To rebuild 
trust in our markets, we need strong and consistent regulation and 
supervision of consumer financial services and investment markets. We 
should base this oversight not on speculation or abstract models, but 
on actual data about how people make financial decisions. We must 
promote transparency, simplicity, fairness, accountability, and access. 
We propose:

    A new Consumer Financial Protection Agency to protect 
        consumers across the financial sector from unfair, deceptive, 
        and abusive practices.

    Stronger regulations to improve the transparency, fairness, 
        and appropriateness of consumer and investor products and 
        services.

    A level playing field and higher standards for providers of 
        consumer financial products and services, whether or not they 
        are part of a bank.

    4. Provide the government with the tools it needs to manage 
financial crises. We need to be sure that the government has the tools 
it needs to manage crises, if and when they arise, so that we are not 
left with untenable choices between bailouts and financial collapse. We 
propose:

    A new regime to resolve nonbank financial institutions 
        whose failure could have serious systemic effects.

    Revisions to the Federal Reserve's emergency lending 
        authority to improve accountability.

    5. Raise international regulatory standards and improve 
international cooperation. The challenges we face are not just American 
challenges, they are global challenges. So, as we work to set high 
regulatory standards here in the United States, we must ask the world 
to do the same. We propose:

    International reforms to support our efforts at home, 
        including strengthening the capital framework; improving 
        oversight of global financial markets; coordinating supervision 
        of internationally active firms; and enhancing crisis 
        management tools.

    In addition to substantive reforms of the authorities and practices 
of regulation and supervision, the proposals contained in this report 
entail a significant restructuring of our regulatory system. We propose 
the creation of a Financial Services Oversight Council, chaired by 
Treasury and including the heads of the principal Federal financial 
regulators as members. We also propose the creation of two new 
agencies. We propose the creation of the Consumer Financial Protection 
Agency, which will be an independent entity dedicated to consumer 
protection in credit, savings, and payments markets. We also propose 
the creation of the National Bank Supervisor, which will be a single 
agency with separate status in Treasury with responsibility for 
federally chartered depository institutions. To promote national 
coordination in the insurance sector, we propose the creation of an 
Office of National Insurance within Treasury.
    Under our proposal, the Federal Reserve and the Federal Deposit 
Insurance Corporation (FDIC) would maintain their respective roles in 
the supervision and regulation of State-chartered banks, and the 
National Credit Union Administration (NCUA) would maintain its 
authorities with regard to credit unions. The Securities and Exchange 
Commission (SEC) and Commodity Futures Trading Commission (CFTC) would 
maintain their current responsibilities and authorities as market 
regulators, though we propose to harmonize the statutory and regulatory 
frameworks for futures and securities.
    The proposals contained in this report do not represent the 
complete set of potentially desirable reforms in financial regulation. 
More can and should be done in the future. We focus here on what is 
essential: to address the causes of the current crisis, to create a 
more stable financial system that is fair for consumers, and to help 
prevent and contain potential crises in the future. (For a detailed 
list of recommendations, please see Summary of Recommendations 
following the Introduction.)
    These proposals are the product of broad-ranging individual 
consultations with members of the President's Working Group on 
Financial Markets, Members of Congress, academics, consumer and 
investor advocates, community-based organizations, the business 
community, and industry and market participants.
I. Promote Robust Supervision and Regulation of Financial Firms
    In the years leading up to the current financial crisis, risks 
built up dangerously in our financial system. Rising asset prices, 
particularly in housing, concealed a sharp deterioration of 
underwriting standards for loans. The Nation's largest financial firms, 
already highly leveraged, became increasingly dependent on unstable 
sources of short-term funding. In many cases, weaknesses in firms' 
risk-management systems left them unaware of the aggregate risk 
exposures on and off their balance sheets. A credit boom accompanied a 
housing bubble. Taking access to short-term credit for granted, firms 
did not plan for the potential demands on their liquidity during a 
crisis. When asset prices started to fall and market liquidity froze, 
firms were forced to pull back from lending, limiting credit for 
households and businesses.
    Our supervisory framework was not equipped to handle a crisis of 
this magnitude. To be sure, most of the largest, most interconnected, 
and most highly leveraged financial firms in the country were subject 
to some form of supervision and regulation by a Federal Government 
agency. But those forms of supervision and regulation proved inadequate 
and inconsistent.
    First, capital and liquidity requirements were simply too low. 
Regulators did not require firms to hold sufficient capital to cover 
trading assets, high-risk loans, and off-balance sheet commitments, or 
to hold increased capital during good times to prepare for bad times. 
Regulators did not require firms to plan for a scenario in which the 
availability of liquidity was sharply curtailed.
    Second, on a systemic basis, regulators did not take into account 
the harm that large, interconnected, and highly leveraged institutions 
could inflict on the financial system and on the economy if they 
failed.
    Third, the responsibility for supervising the consolidated 
operations of large financial firms was split among various Federal 
agencies. Fragmentation of supervisory responsibility and loopholes in 
the legal definition of a ``bank'' allowed owners of banks and other 
insured depository institutions to shop for the regulator of their 
choice.
    Fourth, investment banks operated with insufficient government 
oversight. Money market mutual funds were vulnerable to runs. Hedge 
funds and other private pools of capital operated completely outside of 
the supervisory framework.
    To create a new foundation for the regulation of financial 
institutions, we will promote more robust and consistent regulatory 
standards for all financial institutions. Similar financial 
institutions should face the same supervisory and regulatory standards, 
with no gaps, loopholes, or opportunities for arbitrage.
    We propose the creation of a Financial Services Oversight Council, 
chaired by Treasury, to help fill gaps in supervision, facilitate 
coordination of policy and resolution of disputes, and identify 
emerging risks in firms and market activities. This Council would 
include the heads of the principal Federal financial regulators and 
would maintain a permanent staff at Treasury.
    We propose an evolution in the Federal Reserve's current 
supervisory authority for BHCs to create a single point of 
accountability for the consolidated supervision of all companies that 
own a bank. All large, interconnected firms whose failure could 
threaten the stability of the system should be subject to consolidated 
supervision by the Federal Reserve, regardless of whether they own an 
insured depository institution. These firms should not be able to 
escape oversight of their risky activities by manipulating their legal 
structure.
    Under our proposals, the largest, most interconnected, and highly 
leveraged institutions would face stricter prudential regulation than 
other regulated firms, including higher capital requirements and more 
robust consolidated supervision. In effect, our proposals would compel 
these firms to internalize the costs they could impose on society in 
the event of failure.
II. Establish Comprehensive Regulation of Financial Markets
    The current financial crisis occurred after a long and remarkable 
period of growth and innovation in our financial markets. New financial 
instruments allowed credit risks to be spread widely, enabling 
investors to diversify their portfolios in new ways and enabling banks 
to shed exposures that had once stayed on their balance sheets. Through 
securitization, mortgages and other loans could be aggregated with 
similar loans and sold in tranches to a large and diverse pool of new 
investors with different risk preferences. Through credit derivatives, 
banks could transfer much of their credit exposure to third parties 
without selling the underlying loans. This distribution of risk was 
widely perceived to reduce systemic risk, to promote efficiency, and to 
contribute to a better allocation of resources.
    However, instead of appropriately distributing risks, this process 
often concentrated risk in opaque and complex ways. Innovations 
occurred too rapidly for many financial institutions' risk management 
systems; for the market infrastructure, which consists of payment, 
clearing, and settlement systems; and for the Nation's financial 
supervisors.
    Securitization, by breaking down the traditional relationship 
between borrowers and lenders, created conflicts of interest that 
market discipline failed to correct. Loan originators failed to require 
sufficient documentation of income and ability to pay. Securitizers 
failed to set high standards for the loans they were willing to buy, 
encouraging underwriting standards to decline. Investors were overly 
reliant on credit rating agencies. Credit ratings often failed to 
accurately describe the risk of rated products. In each case, lack of 
transparency prevented market participants from understanding the full 
nature of the risks they were taking.
    The build-up of risk in the over-the-counter (OTC) derivatives 
markets, which were thought to disperse risk to those most able to bear 
it, became a major source of contagion through the financial sector 
during the crisis.
    We propose to bring the markets for all OTC derivatives and asset-
backed securities into a coherent and coordinated regulatory framework 
that requires transparency and improves market discipline. Our proposal 
would impose record-keeping and reporting requirements on all OTC 
derivatives. We also propose to strengthen the prudential regulation of 
all dealers in the OTC derivative markets and to reduce systemic risk 
in these markets by requiring all standardized OTC derivative 
transactions to be executed in regulated and transparent venues and 
cleared through regulated central counterparties.
    We propose to enhance the Federal Reserve's authority over market 
infrastructure to reduce the potential for contagion among financial 
firms and markets.
    Finally, we propose to harmonize the statutory and regulatory 
regimes for futures and securities. While differences exist between 
securities and futures markets, many differences in regulation between 
the markets may no longer be justified. In particular, the growth of 
derivatives markets and the introduction of new derivative instruments 
have highlighted the need for addressing gaps and inconsistencies in 
the regulation of these products by the CFTC and SEC.
III. Protect Consumers and Investors From Financial Abuse
    Prior to the current financial crisis, a number of Federal and 
State regulations were in place to protect consumers against fraud and 
to promote understanding of financial products like credit cards and 
mortgages. But as abusive practices spread, particularly in the market 
for subprime and nontraditional mortgages, our regulatory framework 
proved inadequate in important ways. Multiple agencies have authority 
over consumer protection in financial products, but for historical 
reasons, the supervisory framework for enforcing those regulations had 
significant gaps and weaknesses. Banking regulators at the State and 
Federal level had a potentially conflicting mission to promote safe and 
sound banking practices, while other agencies had a clear mission but 
limited tools and jurisdiction. Most critically in the run-up to the 
financial crisis, mortgage companies and other firms outside of the 
purview of bank regulation exploited that lack of clear accountability 
by selling mortgages and other products that were overly complicated 
and unsuited to borrowers' financial situation. Banks and thrifts 
followed suit, with disastrous results for consumers and the financial 
system.
    This year, Congress, the Administration, and financial regulators 
have taken significant measures to address some of the most obvious 
inadequacies in our consumer protection framework. But these steps have 
focused on just two, albeit very important, product markets--credit 
cards and mortgages. We need comprehensive reform.
    For that reason, we propose the creation of a single regulatory 
agency, a Consumer Financial Protection Agency (CFPA), with the 
authority and accountability to make sure that consumer protection 
regulations are written fairly and enforced vigorously. The CFPA should 
reduce gaps in Federal supervision and enforcement; improve 
coordination with the States; set higher standards for financial 
intermediaries; and promote consistent regulation of similar products.
    Consumer protection is a critical foundation for our financial 
system. It gives the public confidence that financial markets are fair 
and enables policy makers and regulators to maintain stability in 
regulation. Stable regulation, in turn, promotes growth, efficiency, 
and innovation over the long term. We propose legislative, regulatory, 
and administrative reforms to promote transparency, simplicity, 
fairness, accountability, and access in the market for consumer 
financial products and services.
    We also propose new authorities and resources for the Federal Trade 
Commission to protect consumers in a wide range of areas.
    Finally, we propose new authorities for the Securities and Exchange 
Commission to protect investors, improve disclosure, raise standards, 
and increase enforcement.
IV. Provide the Government With the Tools It Needs To Manage Financial 
        Crises
    Over the past 2 years, the financial system has been threatened by 
the failure or near failure of some of the largest and most 
interconnected financial firms. Our current system already has strong 
procedures and expertise for handling the failure of banks, but when a 
bank holding company or other nonbank financial firm is in severe 
distress, there are currently only two options: obtain outside capital 
or file for bankruptcy. During most economic climates, these are 
suitable options that will not impact greater financial stability.
    However, in stressed conditions it may prove difficult for 
distressed institutions to raise sufficient private capital. Thus, if a 
large, interconnected bank holding company or other nonbank financial 
firm nears failure during a financial crisis, there are only two 
untenable options: obtain emergency funding from the U.S. Government as 
in the case of AIG, or file for bankruptcy as in the case of Lehman 
Brothers. Neither of these options is acceptable for managing the 
resolution of the firm efficiently and effectively in a manner that 
limits the systemic risk with the least cost to the taxpayer.
    We propose a new authority, modeled on the existing authority of 
the FDIC, that should allow the government to address the potential 
failure of a bank holding company or other nonbank financial firm when 
the stability of the financial system is at risk.
    In order to improve accountability in the use of other crisis 
tools, we also propose that the Federal Reserve Board receive prior 
written approval from the Secretary of the Treasury for emergency 
lending under its ``unusual and exigent circumstances'' authority.
V. Raise International Regulatory Standards and Improve International 
        Cooperation
    As we have witnessed during this crisis, financial stress can 
spread easily and quickly across national boundaries. Yet, regulation 
is still set largely in a national context. Without consistent 
supervision and regulation, financial institutions will tend to move 
their activities to jurisdictions with looser standards, creating a 
race to the bottom and intensifying systemic risk for the entire global 
financial system.
    The United States is playing a strong leadership role in efforts to 
coordinate international financial policy through the G20, the 
Financial Stability Board, and the Basel Committee on Banking 
Supervision. We will use our leadership position in the international 
community to promote initiatives compatible with the domestic 
regulatory reforms described in this report.
    We will focus on reaching international consensus on four core 
issues: regulatory capital standards; oversight of global financial 
markets; supervision of internationally active financial firms; and 
crisis prevention and management.
    At the April 2009 London Summit, the G20 leaders issued an eight-
part declaration outlining a comprehensive plan for financial 
regulatory reform.
    The domestic regulatory reform initiatives outlined in this report 
are consistent with the international commitments the United States has 
undertaken as part of the G20 process, and we propose stronger 
regulatory standards in a number of areas.
        RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN DODD
                     FROM TIMOTHY GEITHNER

Q.1. One key issue that will need to be resolved is how the 
Consumer Financial Protection Agency (CFPA) and the National 
Bank Supervisor (NBS) will be funded. Would you subject their 
funding to the appropriations process? Would you rely solely on 
fees charged to the regulated entities? Would you use the 
deposit insurance fund? Do you believe there should be parity 
between State and national charters with respect to the costs 
of their supervision? If so, how would you achieve that?

A.1. Under Treasury's proposed legislation, the CFPA is 
authorized to appropriate ``such sums as are necessary'' for it 
to fully discharge its duties under the statute, and recover 
these appropriations through fees on covered entities. Such 
fees could be assessed only after promulgating rules with 
respect to such fees, which is consistent with methods employed 
by other independent regulators. That rulemaking process would 
include publishing any proposed fees for public notice and 
comment.
    The Office of Management and Budget (OMB) will exercise 
apportionment authority over the CFPA. This authority will 
provide OMB the opportunity for review and discussion with the 
Agency to ensure that CFPA spending is planned and executed 
according to law.
    The CFPA's budget will include the resources used by the 
existing regulators to carry out their financial consumer 
protection functions, which will all be transferred to the new 
agency. The agencies that will transfer functions to the CFPA 
include the Federal Reserve Board and Federal Reserve Banks, 
the Office of the Comptroller of the Currency (OCC), the Office 
of Thrift Supervision (OTS), the Federal Deposit Insurance 
Corporation (FDIC), the National Credit Union Administration 
(NCUA), the Federal Trade Commission (FTC), and the Department 
of Housing and Urban Development. In addition to these 
resources, the CFPA will need funding to provide a level 
playing field by extending the reach of Federal oversight to 
the nonbank providers of consumer financial products and 
services.
    Under Section 1024 of the legislation, the CFPA would have 
a mandate to allocate more of its resources to institutions 
that pose more risks to consumers. Community banks are close to 
their customers and have often provided simpler, easier-to-
understand products with greater care and transparency than 
other segments of the market. Such banks will receive 
proportionally less oversight from the CFPA. Moreover, the 
Administration proposes that community banks will pay no more 
for Federal consumer protection supervision after the 
establishment of the CFPA than they do today.
    Like the OCC, the newly constituted NBS, which will be 
created through the consolidation of the activities of the OCC 
and OTS, will continue to collect fees to cover the cost of 
safety and soundness supervision of institutions with a 
national charter.

Q.2. The Administration's proposal would fund the resolution of 
a large nonbank financial company initially through the 
Treasury, with any losses to the government recouped through an 
assessment on holding companies. Other proposals have called 
for an ex ante funding approach: financial organizations would 
pay assessments into a fund that would be available to cover 
all or part of the costs of resolving a systemically important 
financial institution. Proponents of an ex ante approach argue 
that the fund would reinforce the commitment of the government 
to unwind troubled large financial organizations rather than 
propping them up with taxpayer funds. The assessments, like the 
Administration's proposed higher capital requirements, would 
also provide a disincentive for a company to grow in size or 
complexity to a level that could create systemic risk. Can you 
elaborate on why the Administration instead proposes ex post 
funding with initial reliance on Treasury funds?

A.2. Our proposal for a special resolution regime is intended 
for use only in extraordinary circumstances and subject to very 
high procedural hurdles. It is modeled on the existing systemic 
risk exception under FDIC Improvement Act of 1991 (FDICIA). By 
way of example, that exception was not used at all from the 
time FDICIA became law until the current crisis. Under our 
proposal, the special resolution regime would not replace 
bankruptcy procedures in the normal course of business. 
Bankruptcy is and will remain the dominant tool for handling 
the failure of a bank holding company. The special resolution 
regime would only be triggered by a threat to financial 
stability.
    Because this regime will be used only in exceptional 
circumstances when the system is at risk, we believe that the 
creation of an ex ante fund is not necessary. Moreover, the ex 
ante regime could actually make intervention more likely 
because firms that had paid into the fund would expect to be 
able to access the monies held by the fund and because the 
government may be more likely to expend money to stabilize a 
firm if a readily available fund was accessible for that 
purpose. In our proposal, the high procedural hurdles will help 
ensure that these powers are only used when appropriate.
    An ex post funding mechanism provides large financial firms 
with stronger incentives to monitor the risk taking of systemic 
firms. The funding mechanism entails no assessments on the 
large firms if no systemic firms fail but potentially large 
assessments on the firms if one or more systemic firms fail. As 
such, ex post funding promotes ex ante market discipline of the 
systemic firms.
    Ex post funding provides large financial firms with strong 
incentives to support a private sector recapitalization of a 
systemic firm in severe distress--rather than a government 
resolution with substantial assistance. If large financial 
firms understand that they must pay after-the-fact for the 
clean-up of a systemic firm if it fails, the large firms, which 
will collectively make up a substantial portion of the 
counterparties of the failing systemic firm, will have strong 
incentives to arrange a private sector solution to the problems 
of the failing firm (including, for example, by consenting to 
debt-for-equity swaps).
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
                     FROM TIMOTHY GEITHNER

Q.1. Role of the Fed--Secretary Geithner, the Administration 
proposes to expand the Fed's powers by giving it authority to 
regulate systemically significant nonbank financial 
institutions. This would mean that the Chairman of the Fed 
would not only have to be an expert in monetary policy and 
banking regulation, but also would have to be an expert in 
systemic risk regulation.
    Is it reasonable to expect that any one person can possibly 
acquire the expertise in so many highly technical fields?
    Do you think that one person could possibly oversee a 
complex institution like Citigroup and still have time to be 
fully prepared to make decisions on monetary policy?

A.1. As the supervisor of bank holding companies and financial 
holding companies, the Federal Reserve already supervises all 
large U.S. commercial and investment banking firms. As stated 
elsewhere in my responses to these questions for the record, we 
propose modestly expanding the Federal Reserve's regulatory 
authority over the largest and most interconnected financial 
institutions in large part because we believe that the Federal 
Reserve is the only agency with the depth of expertise in 
financial institutions and markets that such regulation would 
require. The role of banking supervision is closely tied to the 
Federal Reserve's role in promoting financial stability. To do 
this, it needs deep and direct knowledge of the financial 
system through direct supervision of financial firms.
    Moreover, our proposals would also remove responsibility 
for consumer protection supervision and regulation from the 
Federal Reserve because we believe that this mission is better 
conducted by one agency with market wide coverage and a central 
mission of consumer protection. This mission is not closely 
related to the core responsibilities of the Nation's central 
bank. This step should make it easier for the Chairman and the 
Board to focus on core responsibilities.

Q.2. Consumer Protection and Safety and Soundness--In making 
the case for a separate consumer protection agency the 
administration's white paper states ``banking regulators at the 
State and Federal level had a potentially conflicting mission 
to promote safe and sound banking practices, while other 
agencies had a clear mission, but limited tools and 
jurisdiction.''
    Secretary Geithner, please articulate the ``potentially 
conflicting mission'' between safety and soundness and consumer 
protection. It seems clear that a prudently underwritten loan 
will ensure that a consumer is protected, while also ensuring 
that a bank operates in a safe and sound manner.

A.2. While in rare cases there may be conflicts between 
prudential regulation and consumer protection, we agree that 
strong consumer protection supports safety and soundness. We 
reject the notion that profits based on unfair and deceptive 
practices can ever be considered sound. Requiring all financial 
institutions to act fairly and transparently will improve the 
safety and soundness of banks while also providing consumers 
with the protection they need to make sound financial 
decisions.
    For the Consumer Financial Protection Agency (CFPA), 
protecting consumers will be its sole mission, whereas it is a 
secondary mission at the existing prudential regulators. Under 
the current system, consumer protection has always taken a back 
seat to safety and soundness concerns within the prudential 
regulators. In the lead-up to the current crisis, safety and 
soundness regulators failed to protect consumers from exploding 
subprime and exotic mortgages and unfair credit card features, 
and were far too slow in issuing rules to address these 
problems. The CFPA would have the responsibility and authority 
to act more quickly to protect consumers when they face undue 
risk of harm from changing products or practices.
    Our proposals are designed so that the CFPA prescribes 
regulations that are consistent with maintaining the safety and 
soundness of banks. The CFPA would be required by statute to 
consult with each of the prudential supervisors before issuing 
a new regulation. In addition, we propose that the National 
Bank Supervisor would be one of the five members of the CFPA 
board. These measures provide further assurance that the CFPA 
will consider safety and soundness interests when adopting 
regulations. Finally, in the very rare instance that conflicts 
do arise, we propose that the legislation incorporate 
reasonable dispute resolution mechanisms to force the CFPA and 
the prudential regulator to resolve any conflicts that they 
cannot work out on their own.

Q.3. Role for Congress--Secretary Geithner, the 
Administration's Proposal grants the Fed and several other 
agencies vast new powers. It also gives the Treasury authority 
over the use of the Fed's 13(3) loan window. It also gives the 
Treasury, the FDIC, and the Fed authority to decide whether the 
Federal Government will bailout a troubled financial 
institution. Nowhere in the Proposal, however, does it consider 
granting Congress more authority over our regulatory system. 
There is not even a reporting requirement to Congress.
    Do you think that Congress should have a decision-making 
role in our financial regulatory system?
    Do you think that it is consistent with our republican form 
of government to concentrate so much power in independent 
agencies, such as the Fed?
    Would you support requiring Congressional approval before 
the Federal Government could bail out financial institutions?

A.3. I believe that Congress has a strong role to play in 
reforming the financial regulatory system. Critically, it is 
Congress that will consider and enact the legislation that will 
form the framework for our new financial regulatory system. Of 
equal importance will be Congress' ongoing oversight role, 
which will be enhanced by many of our proposals. For example, 
the Financial Services Oversight Council will have the critical 
responsibility of identifying emerging threats and coordinating 
a response--because we know that threats to our economy can 
emerge from any corner of the financial system.
    The Council is required to report to Congress each year on 
these risks and threats and to coordinate action by individual 
regulators to address them. The Consumer Financial Protection 
Agency (CFPA) will have reporting requirements related to its 
rulemaking, supervisory and enforcement activity, and regarding 
consumer complaints. In addition, the Director of the Office of 
National Insurance will be required to submit an annual report 
to Congress on the insurance market.
    In formulating our proposals we were careful to include 
appropriate checks and balances to avoid concentrating 
authority in any single agency. For example, although our 
proposals provide for a modest enhancement of the Federal 
Reserve's powers, our proposals also move consumer protection 
authority from the Federal Reserve to a dedicated agency with a 
single mission and market-wide coverage. Moreover, our proposed 
resolution regime, which is modeled on the existing resolution 
regime for insured depository institutions, requires the 
consent of three separate agencies; Treasury must consult with 
the President, and it must receive the written recommendation 
of two-thirds of the members of the boards of both the Federal 
Reserve Board and the FDIC (or the SEC, if the SEC is the 
institution's primary supervisor).
    Moreover, even after the decision to use the resolution 
authority is made, the choice of the appropriate resolution 
method is not left to one agency. Under our proposals, the 
agency responsible for managing the resolution and Treasury 
must agree on the appropriate method. We expect this process 
will allow for timely decision making during a crisis while 
ensuring that there are appropriate perspectives included and 
that this new authority is exercised only under extraordinary 
circumstances.
    Anytime that this authority is exercised, the Treasury 
Secretary must submit a report to Congress regarding the 
determination, and each determination is also reviewed by the 
Government Accountability Office.

Q.4. Hedge Funds--Secretary Geithner, you favor the mandatory 
registration of advisors to hedge funds, venture capital funds, 
and private equity funds with the SEC. As the Madoff and 
Stanford cases painfully illustrate, being registered with the 
SEC does not guarantee that a firm will be closely monitored. 
The administration white paper cites hedge fund de-leveraging 
as a contributor to the crisis.
    How will the registration of hedge fund advisors prevent 
them from de-leveraging in future crises?

A.4. As noted in the Treasury's report to Congress, at various 
points in the financial crisis, de-leveraging by hedge funds 
contributed to the strain on financial markets. Because these 
funds were not required to register with regulators, the 
government lacked reliable, comprehensive data with which to 
assess this market activity and its potential systemic 
implications. Requiring registration of hedge fund advisors 
would allow data to be collected that would permit an informed 
assessment by the government of the market positions of such 
funds, how such funds are changing over time and whether any 
such funds or fund families have become so large, leveraged, or 
interconnected that they require additional oversight for 
financial stability purposes.
    Among other requirements, all registered hedge fund 
advisors would be subject to recordkeeping and reporting 
requirements, including the following information for each 
private fund advised by the adviser: amount of assets under 
management, borrowings, off-balance sheet exposures, trading 
and investment positions, and other information necessary or 
appropriate for the protection of investors or for the 
assessment of systemic risk. Information would be shared with 
the Federal Reserve, which would determine whether such a firm 
meets the Tier 1 Financial Holding Company (Tier 1 FHC) 
criteria. Designation as a Tier 1 FHC would subject the firm to 
robust and consolidated supervision and regulation as Tier 1 
FHCs. The prudential standards for Tier 1 FHCs would include 
capital, liquidity, and risk management standards that are 
stricter and more conservative than those applicable to other 
firms to account for the risks that their potential failure 
would impose on the financial system.

Q.5. What other problems did hedge funds, private equity funds, 
and venture capital funds cause and how will SEC registration 
of advisors to those funds address the problems caused by each 
of these types of funds?

A.5. Although these funds do not appear to have been at the 
center of the current crisis, de-leveraging contributed to the 
strain on financial markets and the lack of transparency 
contributed to market uncertainty and instability. New advisor 
registration, recordkeeping, and disclosure requirements will 
give regulators access to important information concerning 
funds in order to address opacity concerns. Information about 
the characteristics of a hedge fund, including asset size, 
borrowings, off-balance sheet exposure, and other matters will 
help regulators to protect the financial system from systemic 
risk and help regulators to protect investors from fraud and 
abuse. In addition, this information will allow regulators to 
make an assessment of whether a firm is so large, leveraged, or 
interconnected that it poses a threat to financial stability, 
and thus require regulation as Tier 1 FHC.

Q.6. How should the SEC allocate its examination resources 
between advisors to private pools of capital, on the one hand, 
and advisors to mutual funds and other advisors that serve the 
less affluent in our society, on the other?

A.6. We defer to the SEC to address how resources should be 
allocated. In testimony on July 14, SEC Chairman Mary Schapiro 
addressed strengthening SEC examination and oversight and 
improving investor protection. The Chairman noted that the SEC 
is working towards improving its risk-based oversight, 
including extending that oversight to investment advisers. The 
SEC is recruiting additional professionals with specialized 
expertise, creating new positions in its examination program, 
and making use of automated systems to assist in determining 
which firms or practices raise red flags and require greater 
scrutiny.

Q.7. Credit Rating Agencies--Secretary Geithner, the 
Administration's proposal calls for reduced regulatory reliance 
on credit ratings, but seems focused only on reducing reliance 
on ratings of structured products.
    Will you be recommending a legislative mandate to the SEC 
and other regulatory agencies to find ways to reduce their 
reliance on ratings of all types, not just ratings on 
structured products?

A.7. It is clear that over-reliance on ratings from credit 
rating agencies contributed to the fragility of the system in 
the current crisis--especially as the systematic 
underestimation of risk in structured securities became clear. 
While the regulatory reliance on ratings covers both structured 
and unstructured products, we believe that the problems in the 
markets for structured products were particularly acute.
    Our legislative proposal includes a requirement that rating 
agencies distinguish the symbols used to rate structured 
products from those used for unstructured products. This will 
not directly reduce the use of ratings, but it will require 
that regulators and investors reassess their approaches to 
ratings--in regulations, contracts, and investment guidelines.
    In addition, we are working with the SEC and through the 
President's Working Group to identify other areas in Federal 
regulations where there is a need to reassess the use of 
ratings, with respect to both structured and unstructured 
products. For instance, as part of a comprehensive set of money 
market fund reform proposals, the SEC requested public comment 
on whether to eliminate references to ratings in the regulation 
governing money market mutual funds.

Q.8. Fed Study of Itself--In the Administration's proposal, 
after giving the Fed extensive new regulatory power, you would 
ask the Fed to review ``ways in which the structure and 
governance of the Federal Reserve System affect its ability to 
accomplish its existing and proposed functions.''
    Why should we give the Fed these additional 
responsibilities prior to knowing if they are able to 
administer them?
    Why do you have the Fed study itself'?
    Were other entities considered as alternatives for the 
purposes of conducting the study?

A.8. As the supervisor of bank holding companies and financial 
holding companies, the Federal Reserve already supervises all 
large U.S. commercial and investment banking firms. As stated 
elsewhere in the responses to these questions for the record, 
we propose modestly expanding the Federal Reserve's regulatory 
authority over the largest and most interconnected financial 
institutions in large part because we believe that the Federal 
Reserve is the only agency with the depth of expertise in 
financial institutions and markets that such regulation would 
require. The role of banking supervision is closely tied to the 
Federal Reserve's role in promoting financial stability. To do 
this, it needs deep and direct knowledge of the financial 
system through direct supervision of financial firms.
    The proposed role for the Fed in supervising nondepository 
financial firms will require the Federal Reserve to acquire 
additional expertise in some areas of financial activity. But 
the potential extension of its consolidated supervision 
authority to some nonbanking financial institutions represents 
an evolution rather than a revolution in the Federal Reserve's 
role in the financial markets.
    At the same time, the structure and governance of the 
Federal Reserve System should be reviewed to determine whether 
and, if so, how it can be improved to facilitate accomplishment 
of the agency's current and proposed responsibilities. Every 
agency has the responsibility to review itself periodically to 
ensure that it is organized in a manner that best promotes its 
mission.

Q.9. Congress Needs To Do Its Homework--Secretary Geithner, the 
Administration's Proposal defers making decisions on how to 
address the GSEs, improve banking supervision, modernize 
capital requirements, update insurance regulation, improve 
accounting standards, coordinate SEC and CFTC regulation, and 
even how to define systemic risk. The Administration has said 
that it will study these topics before proceeding.
    Should not Congress wait to pass reform legislation until 
after it has had the benefit of the Administration's studies on 
these topics?
    Would not that help ensure that Congress acts in an 
informed manner and that the final legislation is based on the 
best available information?

A.9. The reform proposals for which we have submitted draft 
legislation in June and July do not depend on completion of the 
studies. It is important that Congress move forward to enact 
legislation to reform our financial regulatory system, while 
regulators, at the same time, move forward to find ways to 
improve the nuts and bolts of supervising U.S. financial firms.

Q.10. Fed v. Systemic Risk Regulator--Secretary Geithner, 
despite strong opposition in Congress to expanding the powers 
of the Fed, the Administration has proposed doing just that. Do 
you recognize that this will create significant hurdles for 
passing regulatory reform?
    Is it more important to you that some entity be charged 
with regulating systemic risk, or must the Fed be the systemic 
risk regulator?

A.10. We chose not to make one agency the ``systemic risk 
regulator'' or ``super regulator'' because our system should 
not depend on the foresight of a single institution or a single 
person to identify and mitigate systemic risks. This is why we 
have proposed that the critical role of monitoring for emerging 
risks and coordinating policy be vested in a Financial Services 
Oversight Council rather than the Federal Reserve or any other 
single agency. Each Federal supervisor will contribute to the 
systemic analysis of the Council through the institution-
focused work of their examiners.
    We did propose an evolution in the Federal Reserve's 
authority to include the supervision and regulation of the 
largest and most interconnected financial firms. The Federal 
Reserve is the appropriate agency because of its depth of 
expertise, its existing mandate to promote financial stability, 
and its existing role as the supervisor for all large 
commercial and investment banking firms, including bank and 
financial holding companies.

Q.11. Basel Capital Accords--Secretary Geithner, in the Obama 
Administration's white paper, you state that the administration 
will recommend various actions to the Basel Committee on 
Banking Supervision (BCBS).
    Previously, the BCBS has approved capital plans that were 
deemed inadequate by many in Congress, as well as the bank 
regulators.
    What will you do if the BCBS returns with measures and 
definitions that raise concerns along the same lines as Basel 
II?
    For the record, will you seek alterations to their 
standards as was done with Basel II, if the new standards are 
considered inadequate?

A.11. The U.S. banking regulators have always played a 
significant role in the Basel Committee's policy development 
process and we strongly believe that they will be highly 
influential in the next phase of capital proposals in ways that 
will address flaws in the Basel II framework that have been 
made manifest by the current economic crisis.
    The U.S. regulatory community considers the Basel Committee 
to be a useful and receptive forum in which international 
supervisors can set consistent international supervisory 
standards. U.S. supervisors have and will continue to push for 
improvements to those standards. For example, the Basel 
Committee just released in mid-July significant enhancements to 
the Basel II framework that increase risk weights for the 
trading book, certain securitizations, and off-balance sheet 
activities, as supported by the President and myself at the G20 
Leaders Summit in April.

Q.12. Basel Leverage Measurement--Mr. Secretary, in the white 
paper, you clearly state that the Obama Administration will, 
``urge the BCBS to develop a simple, transparent, nonmodel 
based measure of leverage, as recommended by the G20 leaders.''
    Please expand on this statement and what manner of 
measuring leverage you envision, including what criteria will 
be used and how you arrived at these answers?

A.12. As we explained in the Treasury Department's September 3, 
2009, ``Principles for Reforming the U.S. and International 
Regulatory Capital Framework for Banking Firms,'' risk-based 
capital rules are a critical component of a regulatory capital 
regime; however, it is impossible to construct risk-based 
capital rules that perfectly capture all the risk exposures of 
banking firms. Inevitably, there will be gaps and weak spots in 
any risk-based capital framework and regulatory arbitrage 
activity by firms will tilt asset portfolios and risk taking 
toward those gaps and weak spots. A simple leverage constraint 
would make the regulatory system more robust by limiting the 
degree to which such gaps and weak spots in the risk-based 
capital framework can be exploited. A simple leverage 
constraint also can help reduce the threats to financial 
stability from categorical misjudgments about risk by market 
participants and the official sector.
    In addition, imposing a leverage constraint on banking 
firms would have macroprudential benefits. The balance sheets 
of financial firms and the intermediation chains between and 
among financial firms tend to grow fastest during good economic 
times but become subject to rapid reversal when economic 
conditions worsen. Supervisors generally have failed to 
exercise discretion to constrain leverage leading into a boom. 
A simple leverage ratio acts as a hard-wired dampener in the 
financial system that can be helpful to mitigate systemic risk.
    It is important to recognize that the leverage ratio is a 
blunt instrument that, viewed in isolation, can create its own 
set of regulatory arbitrage opportunities and perverse 
incentive structures for banking firms. The existing U.S. 
leverage ratio is calculated as the ratio of Tier 1 capital to 
total balance sheet assets. To mitigate potential adverse 
effects from an overly simplistic leverage constraint, the 
constraint going forward should at a minimum incorporate off-
balance sheet items. It is also important to view the leverage 
constraint as a complement to a well designed risk-based 
capital requirement. Although it may be possible for banking 
firms to either arbitrage any free-standing risk-based capital 
requirement or any free-standing simple leverage constraint, it 
is much more difficult to arbitrage both frameworks at the same 
time.

Q.13. Supervisory Colleges--Mr. Secretary, in the white paper, 
you state that, ``supervisors have established `supervisory 
colleges' for the 30 most significant global financial 
institutions. The supervisory colleges for all 30 firms have 
met at least once.''
    Will information from these meetings be made public; will 
there be publication of any agendas, minutes, plans, 
membership, etc.?
    If this information will not be made public, will there be 
the opportunity for Congressional staff to receive reports and 
briefings of the conduct and actions of these colleges?
    Will the firms that are being examined have any opportunity 
to receive any information about these meetings?

A.13. Supervisory colleges are confidential meetings, held by 
regulators from multiple countries, which function as an 
information-sharing mechanism with regards to large cross-
border financial institutions. The information shared in these 
meetings is governed by information sharing agreements signed 
by the participating regulatory organizations.
    Supervisory colleges are not themselves decision-making 
regulatory bodies. The information shared within a supervised 
institution's college is used to assist regulators in 
conducting their supervisory responsibilities over that 
institution. A particular firm may be invited to brief 
regulators on specific topics. However, any resulting 
regulatory actions are conducted by the respective regulatory 
agencies. The Federal Reserve Board of Governors, the Office of 
the Comptroller of the Currency, and the Securities and 
Exchange Commission participate in the supervisory colleges and 
can be contacted for further information.

Q.14. Implications of Resolution Regime--Mr. Secretary, in the 
white paper, you state that the proposed resolution regime 
would provide authority to avoid disorderly resolution of any 
systemically critical firm. You also write that national 
authorities are inclined to protect assets with their own 
jurisdictions. I would hope that our regulators would continue 
to have this mind-set, to spare the U.S. taxpayer from 
additional costs. It seems that this paper takes a negative 
view of this mind-set.
    Can you explain your statement further?
    Also, please explain to the Committee why protecting 
assets, which protects the taxpayer, should not be the focus of 
our national regulators?

A.14. Our proposal presents a new resolution regime, beyond 
what the U.S. already has, only where the failure of certain 
bank holding companies or nonbank financial firms threatens the 
stability of the entire financial system. The authority to 
invoke resolution procedures for these large entities would be 
used only for extraordinary circumstances and would be subject 
to strict governance and control procedures. Furthermore, the 
purpose of the expanded resolution regime would be to unwind, 
dismantle, restructure, or liquidate the firm in an orderly way 
to minimize costs to taxpayers and the financial system; all 
costs to exercise this authority would be recouped through 
assessments and liquidation of any acquired assets, therefore 
sparing the taxpayer.
    The global nature of the current crisis has also shown that 
in the failure of globally active financial firms, there needs 
to be improved coordination between national authorities 
representing jurisdictions that are affected. No common 
procedure exists among countries with respect to the failure of 
a large financial firm. The aim of this cross-border 
coordination should be to establish fair and orderly procedures 
to resolve a firm according to a system of laws and rules that 
investors can rely on as well as to protect the interests of 
U.S. taxpayers in globally active financial firms. The absence 
of predictability in cross-border procedures was a contributing 
factor to the contagion in our financial markets in the fall of 
2008.

Q.15. Federal Reserve Supervision of Foreign Tier 1 Financial 
Holding Companies--Secretary Geithner, you ``propose to change 
the Financial Holding Company eligibility requirements . . . 
but do not propose to dictate the manner in which those 
requirements are applied to foreign financial firms with U.S. 
operations.''
    Please clarify this statement. Do you foresee the Federal 
Reserve getting information from other national supervisors or 
do you see the Federal Reserve conducting examinations of 
foreign Financial-Holding Companies overseas?
    What criteria would you recommend the Federal Reserve use 
when they evaluate foreign parent banks? Many financial 
products differ in other parts of the world, how should the 
Federal Reserve evaluate those products' safety and soundness 
for the parent company balance sheet?

A.15. Treasury intends to work with the Financial Services 
Oversight Council and the Federal Reserve Board to create a 
regulatory framework for foreign companies operating in the 
United States that are deemed to be Tier 1 Financial Holding 
Companies (FHCs). That framework will be comparable to the 
standards applied to domestic Tier 1 FHCs, giving due regard to 
the principle of national treatment and equality of competitive 
opportunity.
    In determining today whether a foreign bank is well 
capitalized and well managed in accordance with FHC standards, 
the Board, relying on the existing Bank Holding Company Act, 
may take into account the foreign bank's risk-based capital 
ratios, composition of capital, leverage ratio, accounting 
standards, long-term debt ratings, reliance on government 
support to meet capital requirements, the anti-money laundering 
procedures, whether the foreign bank is subject to 
comprehensive supervision or regulation on a consolidated 
basis, and other factors that may affect analysis of capital 
and management.
    While not conducting examinations of foreign banks in a 
foreign country, the Federal Reserve Board consults with the 
home country supervisor for foreign banks as appropriate. 
Treasury intends to work with the Federal Reserve Board to 
determine what modifications to the existing FHC framework are 
needed for new foreign Tier 1 financial holding companies.

Q.16. New Financial Stability Board (FSB)--Mr. Secretary, in 
the white paper, you ``recommend that the FSB complete its 
restructuring and institutionalize its new mandate to promote 
global financial stability by September 2009.''
    To whom will the FSB be accountable and from where will it 
receive its funding?
    Will the FSB make their reports and conclusions public?
    Will the Congress be able to have access to FSB documents 
and decisions?

A.16. The G20 Leaders in April 2009 agreed that the Financial 
Stability Forum should be reestablished as the Financial 
Stability Board (FSB) and be given a stronger mandate. Its 
membership was expanded to include all G20 member countries. 
The FSB is composed of finance ministries, central banks, 
regulatory authorities, international standard-setting bodies, 
and international institutions. It is supported by a small 
secretariat provided by the Bank for International Settlements.
    The FSB provides public statements following its meetings 
and may issue papers on important issues from time to time. It 
regularly posts information to its Web site 
(www.financialstabilityboard.org), which is available to 
Congress and the general public. The FSB can provide 
coordination and issue recommendations and principles (e.g., on 
crisis management; principles on compensation; protocols for 
supervisory colleges). The FSB operates as a consensus 
organization and it is up to each country whether and how to 
implement the recommendations of the FSB. The point of 
accountability for decisions and responses lies with each 
national regulator. The U.S. will work through the FSB as an 
effective body to coordinate and align international standards 
with those that we will set at home.

Q.17. Adequacy of the Proposal--Secretary Geithner, the 
Administration's Proposal aims to address the causes of the 
financial crisis by closing regulatory gaps. I would like to 
know more about which gaps in our financial supervisory system 
the Administration believes contributed to the crisis.
    What are two cases where supervisory authority existed to 
address a problem but where regulators nevertheless failed act?
    What are two cases where supervisory authority did not 
exist to address a problem and regulators were unable to act?
    Does the Administration's Proposal address all of the cases 
you cited in your answers?

A.17. There were a number of cases in which supervisory 
authority existed but supervisors did not act in a timely and 
forceful fashion.
    It was clear, at least by the early to mid-2000s, that 
banks and nonbanks were making subprime and nontraditional 
mortgage loans without properly assessing that the borrowers 
could afford the loans once scheduled payment increases 
occurred. Yet supervisors did not issue guidance requiring 
banks to qualify borrowers at the fully indexed interest rate 
and fully amortizing payment until 2006 and 2007. By 
consolidating consumer protection authority into a single 
agency with a focused mission, the CFPA will be able to 
recognize when borrowers are receiving loans provided in an 
unfair or deceptive manner earlier, and it will act more 
quickly and effectively through guidance or regulation to 
address such problems.
    In the securitization markets, regulatory authority existed 
to address the problems that emerged in the current crisis but 
the regulatory actions were not taken. For instance, regulators 
had the ability to address the treatment of off-balance sheet 
risks that many institutions retained when they originated new 
financial products such as structured investment vehicles and 
collateralized debt obligations, but supervisors did not fully 
grasp these risks and did not require sufficient capital to be 
held. Our proposals would increase capital charges for off-
balance sheet risks to account more fully for those risks.
    In addition, in many instances, regulators simply lacked 
the authority to take the actions necessary to address problems 
that existed.
    For example, independent mortgage companies and brokers 
were major players in the market for nontraditional and sub-
prime mortgages at the heart of the foreclosure crisis and 
operated without Federal supervision. Under our proposals, they 
would have been subject to supervision and regulation by the 
proposed CFPA.
    Similarly, AIG took advantage of loopholes in the SHC act 
and was not adequately supervised on a consolidated basis. 
Under our proposals, AIG would have been subject to supervision 
and regulation by the Federal Reserve for safety and soundness, 
with an explicit mandate to look across the risks to the 
enterprise as a whole, not simply to protect the depository 
institution subsidiary.
    As discussed above, the Administration's proposals create a 
comprehensive framework that would have addressed each of these 
failures.

Q.18. Fed as Consolidated Supervisor--Secretary Geithner, I 
find it interesting that, under your proposal, the entire 
financial industry would be within the Federal Reserve's 
regulatory reach. While you have created a shadow consolidated 
regulator, you have not bothered to get rid of the other 
regulators.
    If you are intent on creating a single financial regulator, 
why not move everything into an agency with political 
accountability and eliminate the other regulatory agencies?

A.18. The entire financial industry would not be within the 
Federal Reserve's regulatory reach and we are not intending to 
create a single financial regulator. The Financial Services 
Oversight Council will have the authority and responsibility to 
identify emerging risks to the financial system and will help 
facilitate a coordinated response. In critical markets, like 
those for securities and derivatives, the SEC and CFTC will 
play leading roles. We are also proposing to retain and enhance 
crucial roles for the National Bank Supervisor and the FDIC on 
prudential regulation, and resolution of banks. The Federal 
Reserve would be the consolidated regulator of Tier 1 FHCs and 
would be responsible, as it is today, for prudential matters in 
the basic plumbing of the system--payment, settlement, and 
clearance systems.
    In formulating our proposals we were careful to include 
appropriate checks and balances to avoid concentrating 
authority in any single agency. For example, although our 
proposals provide for a modest enhancement of the Federal 
Reserve's powers, our proposals also strip power from the 
Federal Reserve in the consumer protection area.

Q.19. Regulatory Overlap--Secretary Geithner, the 
Administration's proposal states that jurisdictional boundaries 
among agencies should be drawn clearly to avoid mission overlap 
and afford agencies exclusive regulatory authority.
    How do you reconcile that principle with the proposal to 
expand the Fed's regulatory authority into so many different 
areas, many of which already have primary regulators?

A.19. In Treasury's report to Congress, we articulate a 
principle that agencies should be held accountable for critical 
missions such as promoting financial stability and protecting 
consumers of financial products. The consolidated supervisor of 
the holding company and the functional supervisor of the 
subsidiary each have critical roles to play.

Q.20. Over-the-Counter Derivatives--Secretary Geithner, the 
Administration does not appear to have made much headway in 
fleshing out the details of last month's outline for regulating 
over-the-counter derivatives.
    How will you encourage standardization of derivatives 
without preventing companies from being able to buy derivatives 
to meet their unique hedging needs?

A.20. As you know, we have now sent up detailed legislative 
language to implement our proposal. Any regulatory reform of 
magnitude requires deciding how to strike the right balance 
between financial innovation and efficiency on the one hand, 
and stability and protection on the other. We failed to get 
this balance right in the past. If we do not achieve sufficient 
reform, we will leave ourselves weaker as a Nation and more 
vulnerable to future crises.
    Our proposals have been carefully designed to provide a 
comprehensive approach. That means strong regulation and 
transparency for all OTC derivatives, regardless of the 
reference asset, and regardless of whether the derivative is 
customized or standardized. In addition, our plan will provide 
for strong supervision and regulation of all OTC derivative 
dealers and all other major participants in the OTC derivative 
markets.
    We recognize, however, that standardized products will not 
meet all of the legitimate business needs of all companies. 
That is why our proposals do not--as some have suggested--ban 
customized OTC derivatives. Instead, we propose to encourage 
substantially greater use of standardized OTC derivatives 
primarily through higher capital charges and margin 
requirements on customized derivatives, and thereby facilitate 
a more substantial migration of these OTC derivatives on to 
central clearinghouses and exchanges.

Q.21. Systemically Significant Firms--Secretary Geithner, 
systemically significant firms, or Tier 1 Financial Holding 
Companies, will be required to make enhanced public disclosures 
``to support market evaluation.''
    Don't you believe that giving these firms a special label, 
a special oversight regime, and special disclosure will simply 
send a signal to the market that these firms are too big to 
fail and therefore do not need to be monitored?

A.21. Identification as a Tier 1 Financial Holding Company 
(Tier 1 FHC) does not come with any commitment of government 
support nor does it provide certain protection against failure. 
Instead our proposals would apply stricter prudential standards 
and more stringent supervision. For example, higher capital 
charges for Tier 1 FHCs would be used to account for the 
greater risk to financial stability that these firms could pose 
if they failed. It is designed to internalize the externalities 
that their failure might pose, to reduce incentives to 
excessive risk-taking at the taxpayer's expense, and to create 
a large buffer in the event of failure. In addition, in the 
event of failure, our proposals provide for a special 
resolution regime that would avoid the disruption that 
disorderly failure can cause to the financial system and the 
economy. That regime, however, would be triggered only in 
extraordinary circumstances when financial stability is at 
risk, and bankruptcy would remain the dominant tool for 
handling the failure of a financial company. Moreover, the 
purpose of the special resolution regime is to provide the 
government with the option of an orderly resolution, in which 
creditors and counterparties may share in the losses, without 
threatening the stability of the financial system.

Q.22. Federal Reserve and Systemically Important Firms--
Secretary Geithner, under your proposal, the Federal Reserve 
would identify and regulate firms the failure of which, could 
pose a threat to financial stability due to their combination 
of size, leverage, and interconnectedness. It is unclear just 
what types of companies might fall into this new category of 
so-called Tier 1 Financial Holding Companies, because it will 
be up to the Fed to identify them.
    Could Starbucks--which offers a credit card and would 
certainly affect numerous sectors of the economy if it failed--
be classified as a Tier 1 Financial Holding Company and be 
subjected to Fed oversight?

A.22. Starbucks is not a financial firm and therefore would not 
qualify as a Tier 1 FHC. Starbucks currently offers a credit 
card through an independent financial institution.

Q.23. Financial Services Oversight Council--Secretary Geithner, 
the Administration recommends replacing the President's Working 
Group on financial Markets with a Financial Services Oversight 
Council.
    Aside from having slightly enlarged membership and a 
dedicated staff, how will this Council differ from the PWG?
    Is this anything more than a cosmetic change?

A.23. There are important differences between the President's 
Working Group (PWG) and the Financial Services Oversight 
Council (FSOC or Council). As an initial matter, the PWG was 
created by executive order and the Council would have permanent 
statutory status. In addition, the Council would have a 
substantially expanded mandate to facilitate information 
sharing and coordination, identify emerging risks, advise the 
Federal Reserve on the identification of Tier 1 FHCs and 
systemically important payment, clearing, and settlement 
activities, and provide a forum in which supervisors can 
discuss issues of mutual interest and settle jurisdictional 
disputes. It would also enjoy the benefit of a dedicated staff 
that will enable it to undertake its missions in a unified way 
and to effectively conduct analysis on emerging risks.
    In addition, unlike the PWG, the Council will have 
authority to gather information from market participants and 
will report to Congress annually on financial market 
developments and emerging systemic risks.

Q.24. Identifying Systemic Risk--Secretary Geithner, your 
proposal gives the Federal Reserve the authority to identify 
and regulate financial firms that pose a systemic risk due to 
their combination of size, leverage, and interconnectedness. 
Because neither ``systemic risk'' nor ``financial firm'' is 
defined, it is unclear what types of firms will fall within the 
Tier 1 Financial Holding Company designation. Theoretically, 
the term could include large investment advisers, mutual funds, 
broker-dealers, insurance companies, private equity funds, 
pension funds, and sovereign wealth funds, to name a few 
possibilities.
    What further specificity will you be providing about your 
intentions with respect to the reach of the Fed's new powers?

A.24. In the draft legislation sent to Congress in July, we 
proposed the specific factors that the Federal Reserve must 
consider when determining whether an individual financial firm 
is a Tier 1 FHC. Our proposed legislation defines a Tier 1 FHC 
as a financial firm whose material financial distress could 
pose a threat to financial stability or the economy during 
times of economic stress. Our proposed legislation requires the 
Fed to designate U.S. financial firms as Tier 1 FHCs based on 
an analysis of the following factors:

    the amount and nature of the company's financial 
        assets;

    the amount and types of the company's liabilities, 
        including the degree of reliance on short-term funding;

    the extent of the company's off-balance sheet 
        exposures;

    the extent of the company's transactions and 
        relationships with other major financial companies;

    the company's importance as a source of credit for 
        households, businesses, and State and local governments 
        and as a source of liquidity for the financial system;

    the recommendation, if any, of the Financial 
        Services Oversight Council.

Q.25. Expertise of the Fed--Secretary Geithner, the 
Administration's Proposal chooses to grant the Fed authority to 
regulate systemic risk because it ``has the most experience'' 
to regulate systemically significant institutions. I believe 
this represents a grossly inflated view of the Fed's expertise. 
Presently, the Fed regulates primarily bank holding companies 
and State banks. As a systemic risk regulator, the Fed would 
likely have to regulate insurance companies, hedge funds, asset 
managers, mutual funds and a variety of other financial 
institutions that it has never supervised before.
    Since the Fed lacks much of the expertise it needs to be an 
effective systemic regulator, why could not the responsibility 
for regulating systemic risk just as easily be given to another 
or a newly created entity?

A.25. We are not proposing that the Federal Reserve act as a 
systemic risk regulator. In critical markets, like those for 
securities and derivatives, the SEC and CFTC will play lead 
roles. The bank regulators all play crucial roles as prudential 
supervisors of banks. The Financial Services Oversight Council 
will have the authority and responsibility to identify emerging 
risks to the financial system and will help facilitate a 
coordinated response. We have proposed that the Federal Reserve 
act as the consolidated supervisor of the largest and most 
interconnected financial firms. The Federal Reserve has broad 
expertise in supervising financial institutions involved in 
diverse financial markets through the exercise of its current 
responsibilities as the supervisor of bank and financial 
holding companies. We are confident that it can acquire 
expertise where needed to oversee the supervision of Tier 1 
Financial Holding Companies that do not own a depository 
institution. As noted above, the potential extension of its 
consolidated supervision authority to some nonbanking financial 
institutions represents an evolution in the Federal Reserve's 
responsibilities.

Q.26. Skin-in-the-Game--Secretary Geithner, your proposal would 
require that mortgage originators maintain an unhedged 5 
percent stake in securitized loans.
    Will the administration adopt the same position with 
respect to government programs that assist borrowers in 
obtaining mortgages and require increased down payment 
requirements and other such measures to increase ``skin-in-the-
game?''

A.26. One of the key problems that the financial system 
experienced in the buildup to the current crisis, was a 
breakdown in loan underwriting standards--especially in cases 
where the ability to sell loans in a secondary market allowed 
originators and securitizers to avoid any long-term economic 
interest in the credit risk of the original loans. We are 
proposing that securitizers or originators retain up to a 10 
percent stake in securitized loans to align their interests 
with those of the ultimate investor in those loans. This 
directly addresses the incentives of originators and 
securitizers to consider the performance of the underlying 
loans after asset-backed securities were issued. A family 
buying a home is in a different position from a loan originator 
or securitizer. The household faces substantial tangible and 
intangible costs if it is forced to move. Our proposal would 
not require home owners to increase their down payment. Also 
our proposal specifically gives regulators authority to exempt 
government-guaranteed loans from the skin-in-the-game 
requirement.

Q.27. Insurance Regulation--Secretary Geithner, the Proposal 
states that the Administration will support measures to 
modernize insurance regulation, but fails to offer a specific 
plan. While we all recognize the difficulties involved in 
modernizing insurance regulation, the problems with AIG's 
insurance subsidiaries and the fact that several insurers 
needed TARP money demonstrates that we need to reconsider how 
we regulate insurance companies.
    Will systemically significant insurance companies be 
regulated by the Fed?
    If so, will this effectively require the Fed to act as a 
Federal insurance regulator so that it can properly supervise 
the company?
    Does the Fed have the necessary expertise in insurance to 
regulate an insurance company?
    Would it be more efficient to establish a Federal insurance 
regulator that can specialize in regulating large insurance 
companies?

A.27. Under the Administration's proposals, all firms 
designated as Tier 1 Financial Holding Companies (Tier 1 FHCs) 
will be subject to robust, consolidated supervision and 
regulation. Tier 1 FHCs will be regulated and supervised by the 
Board of Governors of the Federal Reserve System (Board). 
Consolidated supervision of a Tier 1 FHC will extend to the 
parent company and to all of its subsidiaries--regulated and 
unregulated, U.S. and foreign. This could include an insurance 
company, if it or its parent were designated as a Tier 1 FHC.
    For all Tier 1 FHCs, functionally regulated subsidiaries 
like insurance companies will continue to be supervised and 
regulated by their current regulator. However, the Federal 
Reserve will have a strong oversight role, including authority 
to require reports from and conduct examinations of a Tier 1 
FHC and all its subsidiaries, including insurance companies.
    We believe that the current insurance regulatory system is 
inefficient and that there is a need for a Federal center for 
expertise and information on the insurance industry. The 
Administration has proposed creating an Office on National 
Insurance (ONI) to develop expertise, coordinate policy on 
prudential aspects of international insurance matters, and 
consult with the States regarding insurance matters of national 
and international importance, among other duties. The ONI will 
receive and collect data and information on and from the 
insurance industry and insurers, enter into information-sharing 
agreements, and analyze and disseminate data and information, 
and issue reports for all lines of insurance except health 
insurance. This will allow the ONI to identify the emergence of 
problems within the insurance industry that could affect the 
economy as a whole.
    In addition, our proposal lays out core principles to 
consider proposals for additional reforms to insurance 
regulation: Increased consistency in the regulatory treatment 
of insurance, including strong capital standards and consumer 
protections, would enhance financial stability, result in real 
improvements for consumers and also increase economic 
efficiency in the insurance industry. One of our core 
principles for insurance regulation is to increase national 
uniformity of insurance regulation through either a Federal 
charter or effective action by the States. We look forward to 
working with you and others in the Congress on this important 
issue.

Q.28. Resolution Plans--Secretary Geithner, under your 
proposal, systemically significant firms would be required to 
devise their own plans for rapidly resolving themselves in 
times of financial distress.
    Will firms be able to incorporate into their death plans 
the expectation of taxpayer money to cover wind-down expenses?

A.28. No. That is the opposite of what we have in mind. We 
propose that the Federal Reserve should require each Tier 1 FHC 
to prepare and periodically update a credible plan for the 
rapid resolution of the firm in the event of severe financial 
distress. Such a requirement would create incentives for the 
firm to better monitor and simplify its organizational 
structure and would better prepare the government, as well as 
the firm's investors, creditors, and counterparties, in the 
event that the firm collapsed. The Federal Reserve should 
review the adequacy of each firm's plan on a regular basis.
    It would not be appropriate for firms to incorporate in 
such a plan the expectation of taxpayer money to cover wind-
down expenses. As I have stated elsewhere in my responses to 
these questions for the record, identification as a Tier 1 FHC 
does not come with any commitment of government support. 
Moreover, any government support through our proposed special 
resolution regime would be available only in extraordinary 
circumstances when financial stability is at risk and only upon 
the agreement of three different government agencies. In most 
circumstances, bankruptcy would remain the dominant tool for 
handling the failure of a financial company.

Q.29. Citigroup--Secretary Geithner, you mentioned AIG and 
Lehman as being examples of untenable options for firms nearing 
failure during a financial crisis. I would add Citigroup to 
that list of untenable options.
    As you surveyed the landscape to understand the types of 
scenarios that might have to be handled by the new resolution 
authority that you propose, are there any entities that would 
still require ad hoc solutions as Lehman, AIG, and Citigroup 
did?

A.29. Our proposals are designed to provide a comprehensive set 
of tools to address the potential disorderly failure of any 
bank holding company, including Tier 1 FHCs, when the stability 
of the financial system is at risk. It is important to note 
that after the TARP purchase authority expires this year, the 
government will lack the effective legal tools that it would 
need to adequately address a similar situation to that which we 
have seen in the past 2 years.
    We believe that our comprehensive regulatory reform 
proposals would provide the government with the tools necessary 
to wind down any large, interconnected highly leveraged 
financial firm if such a failure would threaten financial 
stability.

Q.30. Accounting Standards--Secretary Geithner, among the 
changes recommended by your proposal are changes in accounting 
standards.
    What is the appropriate role of the administration in 
directing the substantive determinations of an independent 
accounting standard setter?

A.30. It is critical that the FASB be fully independent in 
carrying out its mission to establish accounting and financial 
reporting standards for public and private companies. The 
health and soundness of capital markets depend critically on 
the provision of honest and neutral accounting and financial 
reporting, not skewed to favor any particular company, 
industry, or type of transaction or purposefully biased in 
favor of regulatory, social, or economic objectives other than 
sound reporting to investors and the capital markets. 
Governmental entities with knowledge and responsibility for the 
health of capital markets have an interest and expertise in 
maintaining the health of America's capital markets. These 
entities include the SEC, which has specific oversight of 
disclosure for publicly held firms, the Public Company 
Accounting Oversight Board, which is tasked with overseeing the 
auditors of public companies, and other financial regulators, 
which have oversight over the soundness of the entities they 
regulate.

Q.31. SEC-CFTC Merger--Secretary Geithner, the proposal 
acknowledges the need for harmonization between the SEC and 
CFTC, but stops short of merging the two agencies. Instead, you 
direct the agencies to work their differences out among 
themselves and report back in September.
    Given the tortured history of compromise between the SEC 
and CFTC, why do you anticipate that the two agencies can come 
to agreement in a matter of months?
    Wouldn't a merger of the agencies be a better way to force 
them to work out their differences?

A.31. In the last few months, the SEC and the CFTC have made 
great progress towards eliminating their differences. Treasury 
worked closely with the SEC and CFTC to propose a comprehensive 
framework for regulation of derivatives that is consistent 
across both SEC and CFTC jurisdiction. In addition, the SEC and 
CFTC held joint public hearings in early September to identify 
issues in the process of harmonization and to collect public 
comment on the process. The SEC and CFTC have produced a joint 
report on reducing differences in their two frameworks for 
regulation.
    We considered whether to merge the SEC and CFTC. At bottom, 
however, we are focused on the substance of regulation, not the 
boxes and the lines. In terms of substance, the most necessary 
reform is to harmonize futures and securities regulation 
between these entities, and the SEC and CFTC have begun a 
process to accomplish that.

Q.32. Broker-Dealers and Investment Advisors--Secretary 
Geithner, the Administration's proposal recommends applying a 
fiduciary standard to broker-dealers that offer investment 
advice.
    How will this change affect the way FINRA regulates broker-
dealer activities?
    Do you anticipate recommending a self-regulatory 
organization for investment advisors or eliminating FINRA as an 
SRO for broker-dealers?

A.32. Treasury's report to Congress advocates a fiduciary 
standard for investment advisers and broker-dealers offering 
investment advice. We have not taken a position with respect to 
the role of SROs.

Q.33. Barriers to Entry--Secretary Geithner, in many ways the 
Administration's proposal rewards failure. The Fed, which 
fumbled the responsibilities it had, will get more 
responsibility. The SEC, which failed to properly oversee the 
advisors registered with it, will have more registered 
advisors. And some of the biggest financial firms, the ones 
that made so many miscalculations with respect to risk 
management, stand to benefit from the additional layers of 
regulatory red-tape that your system creates. Yet in your 
statement, you state that the changes you are proposing reward 
innovation, often the product of smaller firms.
    What specific changes in your proposal make the environment 
more conducive to small, innovative firms?

A.33. Under existing law, financial instruments with similar 
characteristics may be designed or forced to trade on different 
exchanges that are subject to different regulatory regimes. 
Harmonizing the regulatory regimes would remove such 
distinctions and permit a broader range of instruments to trade 
on any regulated exchange. For example, we propose the 
harmonization of futures and securities regulation. By 
eliminating jurisdictional uncertainties and ensuring that 
economically equivalent instruments are regulated in the same 
manner, regardless of which agency has jurisdiction, our 
proposals will foster innovation resulting from competition 
rather than the ability to evade regulation.
    Permitting direct competition between exchanges also would 
help ensure that plans to bring OTC derivatives trading onto 
regulated exchanges or regulated transparent electronic trading 
systems would promote rather than hinder competition. Greater 
competition would make these markets more efficient and create 
an environment more conducive to the most innovative 
participants.
    Innovation is advanced by promoting competition among firms 
and between financial products. By eliminating arbitrary 
jurisdictional differences and creating a regulatory regime 
that is stable and promotes transparency, fairness, 
accountability, and access, our proposals will increase 
competition and reward innovation.

Q.34. Bank of America-Merrill--Secretary Geithner, last year, 
Bank of America contemplated not going forward with a merger 
with Merrill Lynch, but was strongly exhorted by the Fed and 
Treasury to proceed with the merger.
    Did you play a role in deliberations about how to handle 
the Bank of America-Merrill merger?
    If the Administration's proposed changes were in place, 
would the Fed and Treasury have had any additional tools in 
their arsenal to deal with the potential fallout of the failed 
merger that would have made it unnecessary to exercise a heavy 
hand behind the scenes to force the merger to close?

A.34. After President Obama advised me that I would be his 
nominee for Treasury Secretary, I no longer participated in 
policy decisions regarding the Merrill-Lynch situation, 
including a possible merger with Bank of America. I was, 
however, kept apprised of developments involving the merger in 
my role as President of the NYFED. Consequently, I was not 
involved in policy decisions regarding Bank of America 
potentially exercising the materially adverse change clause and 
not going forward with the merger.
    While I will not comment on the specifics of the Bank of 
America-Merrill Lynch merger, it is clear that the government 
lacked the tools it needed during this crisis to provide for an 
orderly resolution of a large, nonbank financial firm whose 
failure could threaten financial stability.
    That is why we have proposed a special resolution regime 
for extraordinary circumstances and subject to high procedural 
and substantive hurdles to fill this gap. Under our proposal, 
the government would have the ability to establish a 
receivership for a failing firm. The regime also would provide 
for the ability to stabilize the financial system as a result 
of a failing institution going into receivership.
    In addition, the receiver of the firm would have broad 
powers to take action with respect to the financial firm. For 
example, it would have the authority to take control of the 
operations of the firm or to sell or transfer all or any part 
of the assets of the firm in receivership to a bridge 
institution or other entity. That would include the authority 
to transfer the firm's derivatives contracts to a bridge 
institution and thereby avoid termination of the contracts by 
the firm's counterparties (notwithstanding any contractual 
rights of counterparties to terminate the contracts if a 
receiver is appointed).

Q.35. Multiple Banking Regulators--The administration outline 
states ``similar financial institutions should face the same 
supervisory and regulatory standards, with no gaps, loopholes, 
or opportunities for arbitrage.'' Your plan envisions a 
national banking regulator that combines or eliminates many of 
the various types of banking charters such as thrifts, ILCs, 
and credit card banks. Your plan, however, seeks to eliminate 
only one regulator, the Office of Thrift Supervision, while 
adding one more Federal regulator solely for consumer 
protection. Thus the total number of bank regulators remains 
the same.
    Why did you decide to leave the Federal Reserve and the 
FDIC as the primary supervisor of some commercial banks? If the 
desire is to achieve more accountability from our regulatory 
system why not consolidate the commercial banking regulatory 
structure into one Federal and one State Charter?

A.35. Our proposals for structural reform of our regulatory 
system are focused on eliminating opportunities for regulatory 
arbitrage. Most importantly, we address the central source of 
arbitrage in the bank regulatory environment by proposing the 
creation of a new National Bank Supervisor through the merger 
of the Office of Thrift Supervision and the Office of the 
Comptroller of the Currency. These agencies granted Federal 
banking charters whereas the FDIC and Federal Reserve have 
oversight regarding charters granted by the States. As such, we 
are reducing the potential for arbitrage regarding Federal 
charters. In addition, by recommending closing the loopholes in 
the legal definition of a ``bank,'' we also make sure that no 
company that owns a depository institution escapes firm-wide 
supervision. Moreover, our proposals on preemption and 
examination fee equalization would substantially reduce 
arbitrage opportunities between national and State charters.

Q.36. Resolution Regime--Secretary Geithner, if Lehman had been 
resolved under your proposed resolution regime, how would 
Lehman's foreign broker-dealer have been handled?

A.36. The financial regulatory reform initiative that we are 
proposing is comprehensive. Under the plan, all subsidiaries of 
Tier 1 FHCs, including foreign entities, will be subject to 
consolidated supervision. The focus of this supervision is on 
activities of the firm as a whole and the risks the firm might 
pose to the financial system.
    First, United States Tier 1 FHCs will be required to 
maintain and update a credible rapid resolution plan, to be 
used to facilitate the resolution of an institution and all of 
its subsidiaries (U.S. and foreign) in the event of severe 
financial distress. This requirement will provide incentives 
for better monitoring and simplification of organizational 
structures, including foreign subsidiaries, so that the 
government and the entity's customers, investors, and 
counterparties may be better prepared in the event of firm 
collapse. Second, in the event that the Tier 1 FHC is resolved 
through the proposed special resolution regime, the appointed 
receiver would coordinate with foreign authorities involved in 
the resolution of subsidiaries of the firm established in a 
foreign jurisdiction. This is the same process the FDIC would 
use for failing banks with foreign subsidiaries.

Q.37. Would U.S. taxpayer funds have been used to satisfy 
foreign customer liabilities?

A.37. The resolution regime that we are proposing is not 
designed to replace or augment existing customer protections, 
either domestically or internationally. We would expect 
existing programs to protect insured depositors, customers of 
broker-dealers, and insurance policyholders to continue. The 
resolution regime would allow the receiver to create a bridge 
institution in order to more effectively unwind the firm while 
protecting financial stability and it is possible that 
liabilities held by foreign counterparties could be put into 
the bridge institution. However, the purpose of the special 
resolution regime would be to unwind, dismantle, restructure, 
or liquidate the firm in an orderly way to minimize costs to 
taxpayers and the financial system. All holders of Tier 1 and 
Tier 2 regulatory capital would be forced to absorb losses, and 
management responsible for the failure would be fired. If there 
are any losses to the government in connection with the 
resolution regime, these will be recouped from large financial 
institutions in proportion to their size.

Q.38. Over-the-Counter Derivatives--Secretary Geithner, the 
Administration's plan does not provide much detail about the 
Administration's views as to the proper allocation of 
responsibility with respect to over-the-counter derivatives 
between the Securities and Exchange Commission and the 
Commodity Futures Trading Commission.
    As you devise your recommendations for allocating 
regulatory responsibility over derivatives, how are you taking 
into account the importance of interest rate swaps and currency 
swaps to the debt securities markets.

A.38. As a general matter, our plan allocates responsibility 
for over-the-counter derivatives (swaps) between the SEC and 
CFTC consistent with how existing law allocates responsibility 
over futures. More specifically, we provide the SEC with 
authority to regulate swaps based on a single security or a 
narrow-based securities index; we provide the CFTC with 
authority to regulate swaps based on broad-based securities 
indices and other commodities (including interest rates, 
currencies, and nonfinancial commodities). Given the functional 
similarities between swaps and futures, we believed that it was 
important to have the swaps regulatory jurisdictions parallel 
those of the futures markets. In addition, to ensure that all 
classes of swaps face similar constraints, we have required the 
SEC and CFTC to issue joint rules on the regulation of swaps, 
swap dealers, and major swap participants.
    In designing our swaps framework, we took into account the 
importance of interest rate swaps and currency swaps to the 
debt markets. We believe that our proposals will enhance the 
transparency and stability of those markets. Although our 
proposals require central clearing of standardized derivatives, 
we have preserved the ability of businesses to hedge their 
interest rate and currency risks through customized derivatives 
in appropriate cases.
                                ------                                


         RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
                     FROM TIMOTHY GEITHNER

Q.1. If the Federal Reserve is given more regulatory 
responsibilities, how can we ensure that Congress can fully 
exercise its oversight role while also maintaining the Federal 
Reserve's independence over monetary policy?

A.1. Congress has exercised vigorous oversight over Federal 
Reserve regulation and supervision for decades and we are not 
aware of any evidence that this oversight has infringed on the 
independence of monetary policy. Congress can and does call 
hearings on supervision and regulation where the Federal 
Reserve and other agencies are called to testify. Moreover, all 
of the Federal Reserve's supervisory and regulatory functions 
are subject to review by the GAO. Recent GAO reports on the 
Federal Reserve and other banking regulators have included 
assessments of capital rules, http://www.gao.gov/new.items/
d08953.pdf; consolidated supervision, http://www.gao.gov/
new.items/d07154.pdf; and oversight of risk management systems 
at major banking organizations, http://www.gao.gov/ncw.items/
d09499t.pdf. We believe that this oversight can and should 
continue and we do not perceive a threat to the independence of 
monetary policy.

Q.2. We have spoken about concerns I have about private equity 
acquisitions of banks. As you know I feel strongly that there 
should be a consistent and carefully thought out policy that 
allows us to take advantage of the capital that private equity 
has to offer, while at the same time include strong protections 
to ensure that commercial interests of private equity and other 
firms do not threaten the safety and soundness of institutions 
or the overall stability of our Nation's financial system.
    What is the status of efforts to develop a consistent 
policy among regulators in this area?

A.2. The staff of the Department of the Treasury (Treasury) has 
consulted with staff of the Board of Governors of the Federal 
Reserve System (Board), the Federal Deposit Insurance 
Corporation (FDIC), and the Office of Thrift Supervision (OTS), 
respectively, regarding the standards used to assess proposals 
by private equity investors (Investors) for controlling 
investments in banking organizations. Even though these 
standards have common features, each agency supervises 
different types of banking organizations and must administer 
separate laws with distinct mandates. As these agencies 
continue to develop standards, as summarized below, Treasury is 
mindful of the need to establish consistent policies for 
promoting access to capital, ensuring appropriate supervisory 
oversight over banking firms, aligning the incentives of 
investors with the long-term health of banking organizations, 
and strengthening the wall between banking and commerce. We 
will be working through the President's Working Group on 
financial markets (and in the future through the Financial 
Services Oversight Council if Congress creates one as part of 
regulatory reform) on these matters.

The Federal Banking Agencies Continue To Develop Policies for Investors

The Board

    In September 2008, the Board adopted a policy statement 
regarding noncontrolling investments in banks and bank holding 
companies under the requirements of the Bank Holding Company 
Act (BHCA). As individual transactions may present unique 
structures, the Board addresses controlling investments in 
banks and bank holding companies on a case-by-case basis. The 
Board staff has advised Treasury that, in general, various 
proposals by Investors to establish a fund to acquire control 
of a banking organization have not appeared to satisfy the 
requirements of the BCHA because the Investors also control 
funds that make commercial investments. Although the Board has 
permitted a few groups of investors to establish bank holding 
companies notwithstanding their control of other funds with 
commercial investments, the Board has not recently approved 
such a transaction. According to the Board staff, in each of 
those prior cases, the decision to permit the bank holding 
company to be affiliated with a commercial firm was limited to 
the particular circumstances surrounding the investment and the 
Investors, such as ownership and control of the bank holding 
company by individuals, as opposed to private equity 
organizations.

The OTS

    The OTS has approved private equity investments in thrifts 
under the Home Owners' Loan Act (HOLA). In considering these 
investments and new proposals, OTS staff has advised that the 
agency is focused on balancing the needs to allow investments 
in thrifts and thrift holding companies, as permitted by the 
HOLA, with prudential measures designed to assure the safety 
and soundness of those institutions. For example, OTS indicated 
that in January 2009 the OTS approved the acquisition of 
Flagstar Bank, FSB by eight newly formed private equity funds 
and, among other measures, obtained commitments by the 
Investors barring the Investors from exercising control over 
the management, policies, or business operations of the thrift 
organization and restricting transactions between their 
affiliates and the thrift organization. In this regard, the 
commitments obtained by the OTS were similar to commitments 
obtained by the Board in other transactions by Investors 
approved by the Board. Staff of the OTS has advised Treasury 
that, subject to appropriate prudential measures, certain 
controlling investments in thrifts and thrift holding companies 
by Investors, including Investors that also maintain 
controlling commercial investments, may satisfy the 
requirements of the HOLA.

The FDIC

    The FDIC issued final guidance in August establishing 
principles that would apply to certain applications to acquire 
failed banks (FDIC Policy Statement) by Investors. Under the 
FDIC Policy Statement, certain Investors will have to satisfy 
requirements regarding: capital commitments; cross guarantees; 
transactions with affiliates; limits on entities based in 
secrecy law jurisdictions; continuity of ownership; special bid 
limits on insiders; and disclosure. In particular, Investors 
will be required to ensure that the acquired depository 
institution has a minimum Tier 1 leverage ratio of 10 percent 
for at least 3 years, and thereafter is ``well capitalized'' 
during the remaining period of their ownership, and generally 
will be prohibited from selling or otherwise transferring the 
securities of the holding company or depository institution for 
a 3-year period. In addition, the FDIC Policy Statement makes 
Investors holding 10 percent or more of the equity of a bank or 
thrift in receivership ineligible to be a bidder on that failed 
depository institution. Finally, the FDIC Policy Statement 
states that structure for owning depository institutions where 
the beneficial ownership is not easily ascertained--so-called 
``silo'' structures--will not be approved.

Treasury Is Working To Promote Consistent Policies

    Private equity investments in banking organizations raise 
potentially competing considerations. These investments can 
strengthen our banking system by providing an important 
component of private capital and spurring the timely resolution 
of failed depository institutions. On the other hand, these 
investments can entail risks and raise important policy issues 
relating to the supervisory oversight necessary to protect the 
safety and soundness of banks, such as aligning the incentives 
of investors with the long-term health of banks and 
strengthening the policy of separating banking from commerce. 
Treasury is currently reviewing developments in this area, and 
will continue to work through the President's Working Group on 
Financial Markets (and in the future through the Financial 
Services Oversight Council if Congress creates one as part of 
regulatory reform) to engage independent banking agencies to 
develop consistent policies regarding private equity 
investments in insured depository institutions.

Q.3. Are there legislative changes that are required to 
adequately address this issue?

A.3. The Administration has recommended the closing of certain 
statutory loopholes that historically have permitted the mixing 
of banking and commerce and evasion of supervision under the 
Bank Holding Company Act. The banking agencies have authority 
under current law to balance the Deed for capital in the system 
with the need for appropriate safety and soundness supervision 
with respect to private equity investments. We would be happy 
to discuss the issue with you, including possible legislative 
changes.

Q.4. As you know, I have urged Treasury to use its leverage to 
sell, exercise, or hold warrants after financial institutions 
repay TARP funds to ensure the best return for taxpayers.
    What are Treasury's plans with respect to handling the 
warrants of institutions that repay their TARP funds?
    Will there be a clear written set of policies and 
procedures on this?

A.4. In December 2009, Treasury conducted public auctions for 
its warrants in Capital One Financial Corporation, JPMorgan 
Chase & Co., and TCF Financial Corporation. Each of these banks 
had fully repurchased Treasury's preferred stock investment. 
The auctions were conducted as modified ``Dutch'' auctions 
registered under the Securities Act of 1933, in a format where 
qualified bidders may submit one or more independent bids at 
different price-quantity combinations and the warrants will be 
sold at a uniform price that clears the market.
    Proceeds to Treasury from the auction of its warrants in 
Capital One Financial Corporation, JPMorgan Chase & Co., and 
TCF Financial Corporation, were approximately $148.73 million, 
$950.32 million, and $9.59 million, respectively, with net 
receipts to Treasury after underwriting fees and selling 
expenses of approximately $146.50 million, $936.06 million and 
$9.45 million, respectively. Treasury expects to conduct 
similar auctions in the future.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR AKAKA
                     FROM TIMOTHY GEITHNER

Q.1. Mandatory Arbitration Clause Limitations--Mr. Secretary, 
please provide the written response that you mentioned during 
the hearing on why the Consumer Financial Protection Agency 
should have the authority to restrict or ban mandatory 
arbitration clauses.

A.1. Treasury's proposed legislation authorizes the CFPA by 
rule to prohibit or impose conditions or limitations on pre-
dispute mandatory arbitration clauses if the Agency finds that 
such prohibition, conditions, or limitations are in the public 
interest and for the protection of consumers.
    Many financial products and services providers require 
their customers to agree to contracts containing provisions to 
arbitrate all disputes. Although arbitration may be a 
reasonable option for many consumers to accept after a dispute 
arises, mandating a particular venue and up-front method of 
adjudicating disputes--and eliminating access to courts--may 
unjustifiably undermine consumer interests. There are several 
aspects of mandatory pre-dispute arbitration that have raised 
concern. Many consumers do not know that they often waive their 
rights to trial when signing contracts for financial products. 
Arbitrators are private parties dependent on large firms for 
repeat business, which may give rise to conflicts of interest.
    Rather than banning pre-dispute mandatory arbitration in 
the legislation, our proposal gives the Agency the power to 
study it and, if warranted, impose limitations or ban it to 
ensure fairness for consumers. In addition, under our proposal, 
even if mandatory arbitration were banned, parties would still 
be free to agree to arbitration once a dispute has arisen. 
Post-dispute arbitration is much more likely to be a fair 
process because consumers can evaluate the arbitration process 
in light of the potential or actual dispute before agreeing to 
such an arbitration process.

Q.2. Financial Literacy--Mr. Secretary, what specific financial 
literacy responsibilities will the Consumer Financial 
Protection Agency have?

A.2. We believe that financial education is an important 
component of consumer protection and financial stability. Thus, 
the CFPA will play an important role in efforts to educate 
consumers about financial matters, to improve their ability to 
manage their own financial affairs. and to make their own 
judgments about the appropriateness of certain financial 
products. Once established, Treasury anticipates that the CFPA 
will include an Office of Financial Literacy that will work to 
promote consumer financial education. We also anticipate that 
the Director of the CFPA will be a member of the Financial 
Literacy and Education Commission established by the Financial 
Literacy and Education Improvement Act (20 U.S.C. 9701 et 
seq.), and that the CFPA will coordinate and work closely with 
the FLEC.

Q.3. Promoting Access to Mainstream Financial Services--Mr. 
Secretary, I remain concerned that consumer access to 
mainstream financial services remains limited in underserved 
communities. The proposal indicates that a critical part of the 
Consumer Financial Protection Agency's mission will be 
promoting access to financial services. Other than rigorous 
enforcement of the Community Reinvestment Act, what will the 
CFPA do to promote access to mainstream financial services and 
ensure that the financial service needs of communities are 
being met?

A.3. As part of a legislative requirement to consider the costs 
and benefits of any new regulation, the CFPA will analyze how 
regulations affect consumers' access to financial services. 
Under the Administration's proposal, ensuring access to 
traditionally underserved consumers and communities and 
ensuring ample room for innovation would be a core part of the 
CFPA's mission. As you mention, our proposed legislation gives 
the Agency authority to rigorously enforce the Community 
Reinvestment Act (CRA) in order to ensure that depository 
institutions meet the credit needs of the communities in which 
they operate. In addition, it requires the CFPA to establish a 
community affairs unit with the mission of providing 
information, guidance, and technical assistance regarding the 
provision of consumer financial products or services to 
traditionally underserved consumers and communities. The 
proposed legislation would also require the CFPA to create a 
research unit that will research, analyze, and report on market 
developments, disclosures and communications, consumer 
understanding of financial products, and consumer behavior. 
This unit's work will inform regulatory and market innovation 
that will expand access to financial services to the 
communities that need it most.

Q.4. Financial Budget and Staffing for the CFPA--How large of a 
budget and how many staff members will be needed to ensure that 
the Consumer Financial Protection Agency will be able to 
effectively educate, protect, and empower consumers?

A.4. The CFPA will require a budget and staff that are 
commensurate with its responsibilities, which include both 
existing functions performed by the current financial services 
regulators, as well as expanded authority to strengthen 
protections where they have been weak, particularly regarding 
the nonbank sector. Strong, stable funding will ensure that the 
agency can establish, monitor, and enforce high standards for 
consumers across the financial services marketplace.
    The CFPA's budget will include the resources used by the 
existing regulators to carry out their financial consumer 
protection functions, which will all be transferred to the new 
agency. The agencies that will transfer functions to the CFPA 
include the Federal Reserve Board and Federal Reserve Banks, 
the Office of the Comptroller of the Currency (OCC), the Office 
of Thrift Supervision (OTS), the Federal Deposit Insurance 
Corporation (FDIC), the National Credit Union Administration 
(NCUA), the Federal Trade Commission (FTC), and the Department 
of Housing and Urban Development (HUD). In addition to these 
resources, the CFPA will need to hire staff to provide a level 
playing field by extending the reach of Federal oversight to 
the nonbank providers of consumer financial products and 
services.
    We do not yet have an estimate of what amount will be 
necessary to fund the CFPA. We are in the process of gathering 
information on the resources expended from each of the agencies 
where funds will be transferred, and estimating the additional 
resources that will be required for the functions that are not 
being performed now, including supervision of nonbank financial 
companies that provide consumer financial products or services.
                                ------                                


         RESPONSES TO WRITTEN QUESTIONS OF SENATOR KYL
                     FROM TIMOTHY GEITHNER

Q.1. Anecdotal reports suggest that the regional offices of 
Federal bank regulators are not applying regulatory standards 
uniformly across the Nation, may not be adequately coordinating 
with their State counterparts, and are in some cases advising 
banks not to make loans that would otherwise be profitable.
    Are you aware of this problem?
    If so, what can be done to facilitate coordination among 
the regional offices of our Federal regulators to ensure 
standards are applied uniformly?
    What role would State bank regulators play under the 
Administration's reform proposal?
    How can States be better integrated into a seamless 
regulatory scheme in order to leverage local regulators' unique 
knowledge about their own marketplace?

A.1. Federal bank regulators seek to apply regulatory standards 
uniformly across their organizations. However, this does 
present challenges in that some degree of examiner discretion, 
based on local knowledge and other factors, also plays an 
important role. Moreover, regional economic differences may 
necessitate some flexibility in the application of 
requirements.
    The Administration's regulatory reform proposal preserves 
the role of State chartered banks and State supervision. Today, 
Federal and State banking regulators coordinate their 
examination programs and share information. In 2006, the State 
Liaison Committee (SLC) was added to the Federal Financial 
Institutions Examination Council (FFIEC) as a voting member. 
The SLC includes representatives from the Conference of State 
Bank Supervisors, the American Council of State Savings 
Supervisors, and the National Association of State Credit Union 
Supervisors. The FFIEC is a formal interagency body designed to 
prescribe uniform principles, standards, and report forms for 
the Federal examination of financial institutions by the 
banking regulators and to make recommendations to promote 
uniformity in the supervision of financial institutions. Having 
State regulators represented on the FFIEC should help to 
leverage local knowledge.
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