[Senate Hearing 111-638]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 111-638



                               before the

                              COMMITTEE ON
                          UNITED STATES SENATE


                             SECOND SESSION




                            FEBRUARY 4, 2010


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

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

61-651                    WASHINGTON : 2011
For sale by the Superintendent of Documents, U.S. Government Printing 
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC 
area (202) 512-1800 Fax: (202) 512-2104  Mail: Stop IDCC, Washington, DC 


               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          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 KAY BAILEY HUTCHISON, Texas
MARK R. WARNER, Virginia             JUDD GREGG, New Hampshire

                    Edward Silverman, Staff Director

              William D. Duhnke, Republican Staff Director

                     Marc Jarsulic, Chief Economist

                  Joe Hepp, Professional Staff Member

                      Amy S. Friend, Chief Counsel

                  Drew Colbert, Legislative Assistant

                Mark Oesterle, Republican Chief Counsel

              Heath P. Tarbert, Republican Special Counsel

              Jeffrey M. Wrase, Republican Chief Economist

           Rhyse Nance, Republican Professional Staff Member

                       Dawn Ratliff, Chief Clerk

                      Devin Hartley, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor


                            C O N T E N T S


                       TUESDAY, FEBRUARY 4, 2010


Opening statement of Chairman Dodd...............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby
        Prepared statement.......................................    39


E. Gerald Corrigan, Managing Director, Goldman, Sachs and Co.....     4
    Prepared statement...........................................    39
Simon Johnson, Ronald A. Kurtz Professor of Entrepreneurship, 
  Sloan School of Management, Massachusetts Institute of 
  Technology.....................................................     6
    Prepared statement...........................................    45
John Reed, Retired Chairman, Citigroup...........................     7
    Prepared statement...........................................    49
Hal S. Scott, Nomura Professor of International Systems, Harvard 
  Law School.....................................................     9
    Prepared statement...........................................    50
Barry L. Zubrow, Executive Vice President and Chief Risk Officer, 
  JPMorgan Chase and Company.....................................    11
    Prepared statement...........................................    63




                       TUESDAY, FEBRUARY 4, 2010

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:39 p.m., in room SD-538, Dirksen 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.


    Chairman Dodd. The Committee will come to order. Let me 
first of all apologize to my colleagues and our witnesses. I 
was just chatting with Senator Shelby. Our colleagues from 
North Carolina invited me to come by this morning and speak to 
the North Carolinian community bankers, and so--I can see all 
the heads nodding. I am going to be speaking to every community 
banking group here on this table, I guess, before long. But I 
spent a few extra minutes with them and I apologize for being a 
few minutes late.
    Senator Warner. You have some extra time now.
    Chairman Dodd. I am sorry, Senator?
    Senator Warner. You have some extra time on your hands.
    Chairman Dodd. Yes, extra time on my hands.
    Senator Johnson. The South Dakota community----
    Chairman Dodd. South Dakota, that will be next.
    Well, we are going to meet again this morning. As all of 
you know, we met last Tuesday, or this Tuesday, with Paul 
Volcker and Neal Wolin who testified about the so-called 
``Volcker Rule'' and we welcome our witnesses here this 
morning, as well, many of whom I know well and some I am 
welcoming back to the Committee. Mr. Reed, it is good to see 
you again back before this Committee. It has been a long time 
and you are always welcomed here.
    The ``Implications of the `Volcker Rules' for Financial 
Stability.'' And I am going to make a couple of brief opening 
comments, turn to Senator Shelby, and then we will turn to our 
witnesses, beginning with you, Gerry, at that end of the table, 
and then work down. I will ask you to be relatively brief, if 
you can, in your comments. I read, Gerry, your testimony--there 
is nothing brief about your testimony--last evening, another 
voluminous and----
    Mr. Corrigan. I cannot resist.
    Chairman Dodd. I know. Everything is big at Goldman, you 
    Chairman Dodd. So we are going to make sure it is included 
in the record, along with any other supporting documents and 
evidence that all of you would like to offer this morning, and 
then I will turn to my colleagues for some questions here.
    We have some votes around 12:30, so we are going to try and 
move along if we can this morning, rather than bring you back 
again in the afternoon. I again thank all of you for being 
    As I said a moment ago, this is our second hearing this 
week on the Obama administration's proposal to crack down on 
excessive consolidation and risk taking within our financial 
    I would like to start by clarifying something that I said 
on Tuesday. Folks may have noticed I sounded a little 
frustrated, and they were correct in that observation. The fact 
is, I think all of us are to one degree or another frustrated 
with the present situation in our country and all anxious to 
see us get back on our feet and back on track again.
    The issues that Senator Shelby and I and the Members of the 
Committee are grappling with are difficult, they are 
complicated, and they are terribly important. But as we have 
been debating them for months--in fact, some of these issues we 
have been debating for years in this institution as well as 
elsewhere. But nearly 2 years after the collapse of Bear 
Stearns, we still have not updated the laws governing our 
financial sector, leaving our fragile economy with the same 
vulnerabilities that led to the economic crisis in the first 
place. I think we are at a critical point and juncture at this 
particular hour.
    Now, as my colleagues know, I laid out a discussion draft 
in November and Members of this Committee have been working 
together across the aisle to come up with a compromise, if we 
can, ever since, and I thank all of them. This has been a very 
difficult job, but they have spent countless hours on working 
on proposals here that we could present to our colleagues, and 
more importantly, to the country as to how we think we ought to 
fill in these gaps and move forward. We are now getting to the 
point where we need to sort of pull the trigger, in a sense, 
because hard-working American families can't wait much longer 
for a return to economic security and certainty.
    If I have heard one word over and over and over again, it 
is the lack of certainty that is out there, and part of our job 
is to help clarify and provide some certainty as to where we 
are headed, and our hope is with our legislation to do that.
    It is tough to take on another issue at this point. I made 
that point. There are wonderful ideas out there. There are a 
lot of things that we need to be talking about in the area of 
financial services. It was never my intention or, I believe, 
the intention of this Committee to solve every issue 
surrounding the financial services sector. We tried to focus on 
some critical ones that we think would make a fundamental 
difference, but never the assumption we could take on all the 
issues that people would like to raise in a moment like this.
    And we need to not only talk about filling in the gaps of 
the problems that existed, but looking ahead, which is our 
responsibility. What can we do to set up an architecture that 
would minimize the kind of problems we saw occurring again. If 
not in this particular environment or sector, where else could 
they emerge? And are we building the structural institutions 
that will minimize that from happening again beyond what we can 
imagine today, something 10 years, 20 years from now? And that 
is also part of our function and obligation, in my view, on 
this Committee.
    But while the specific proposals announced by the 
Administration have come late in the game, they deserve our 
serious consideration, as well, and I believe the 
Administration is on the right track, but finding a way to 
implement these proposals is no easy feat, as well. These are 
complicated issues meant to address complicated problems that 
leave our Nation's economy at risk and we need to find a 
balance between giving them their due consideration and 
appreciating the urgency with which we need to act given what 
is at stake.
    On Tuesday, we heard from Chairman Volcker and Treasury 
Secretary Wolin, and I appreciate the strong cases that they 
made for the Administration's proposals, as well as their 
thoughts on how we ought to move forward.
    Today, we have before us a very impressive panel of experts 
from the industry and academia to discuss the possible 
consequences of these proposals. I look forward to hearing from 
each and every one of you. What is more, I understand that for 
our industry friends, this might be a little like walking into 
the lion's den. But our intention here is to probe these ideas 
and solicit your thoughts and background and experience as to 
how to move forward.
    Let me just say, we did not embark on financial reform 
because we wanted to punish the industry. I certainly didn't, 
at all. We all want to create a system where business, large 
and small, can thrive, and that the users, the customers, the 
people who come through your doors, can have that confidence 
restored that our system is sound, it is safe, and they can 
rely on it, whether depositing their paycheck, buying a stock, 
an insurance policy, taking out a mortgage. It is the people 
not in this room today that want to know whether or not we get 
it and you get it, and we are going to create that structure 
that allows them then to have that sense of confidence and 
optimism that is the critical element for our economy recovery, 
in my view.
    So I have heard the arguments again and the industry's 
refusal, and I am not going to single out our witnesses, but 
the refusal of large firms to work constructively with Congress 
on this effort. It borders on insulting to the American people 
who have lost so much in this crisis. And from where I am 
sitting, it looks like instead of investing in improvements 
that would secure their financial strength, too many people in 
the industry have decided to invest in an army of lobbyists 
whose only mission is to kill the common sense financial 
reforms that we are working so hard up here to try to achieve, 
and we have been working on for a number of months.
    I have heard all the arguments for business as usual, but 
the American people have been through too much. Unemployment is 
still too high. The economy remains too vulnerable to support 
the status quo. That is unacceptable and we need to move 
    So I am determined as ever to get this strong bill to the 
floor of the Senate in an appropriate amount of time to allow 
full consideration of us here on this Committee and then by our 
colleagues, and then to work out our differences with the House 
and put a bill on the desk for his signature.
    So with that, let me turn to Senator Shelby for any opening 
comments, and then we will turn to our witnesses.
    Senator Shelby. Mr. Chairman, I would just like to ask you 
to put my statement in the record so we can go on with the 
    Chairman Dodd. Done. Consider it done.
    Does anyone feel obligated to speak? Otherwise, the Corker 
Rule prevails.
    Our first witness is Gerald Corrigan, Managing Director 
with Goldman Sachs. He has been there for a long time. Prior to 
that, he was the Vice Chairman of the Federal Open Market 
Committee. Mr. Corrigan is also a native of the town of 
Waterbury, Connecticut. We don't often get to say that about 
witnesses here, that they come from Connecticut. We are proud 
of Gerry. He earned his Bachelor's degree from Fairfield 
University in Connecticut, as well.
    Simon Johnson is the Ronald A. Kurtz Professor of 
Entrepreneurship at MIG Sloan School of Management. He also 
serves as a Senior Fellow at the Peterson Institute for 
International Economics. Previously, Professor Johnson was the 
IMF's Chief Economist, from 2007 to 2008.
    John Reed, I have already mentioned here, is the former 
Chairman of Citigroup. He was also Chairman of the New York 
Stock Exchange from 2003 to 2005. He currently serves on the 
MIT Leadership Center Advisory Council, and John, we welcome 
you back to the Committee.
    Hal Scott is the Nomura Professor and Director of the 
Program of International Financial Systems at the Harvard Law 
School. Again, he has been before this Committee on numerous 
occasions in the past. He has taught there since 1975. Much of 
his work focuses on international financial issues. He is also 
the Director of the Nonprofit Committee on Capital Markets 
    And Barry Zubrow, again, who we know well, is the Chief 
Risk Officer and Executive Vice President for JPMorgan Chase, 
and again, someone we are very familiar with on this Committee. 
Prior to that, he was the Chief Operating Officer of Goldman 
Sachs, where he has worked since 1979.
    We thank all of you for being here this morning on 
relatively short notice, as well, to share your thoughts on 
this issue and related matters, and Gerry, we will begin with 

                         SACHS AND CO.

    Mr. Corrigan. Thank you very much, Mr. Chairman. I have 
again provided the Committee with a rather long statement which 
seeks to provide for you and your staffs some meaningful 
perspective on this financial reform process as a whole. And 
trust me, I am not going to go into the details of that, except 
to say that one key fact that we have to keep in mind 
throughout these deliberations is that the single most 
important proximate cause of the financial crisis was lending 
in all of its forms. I might just remind the Committee, 
probably not necessary, that based on my association with 
crises back in the 1980s and early 1990s, that was also true in 
those episodes, as well.
    My starting point for all of this, Mr. Chairman, is that I 
fully and enthusiastically agree that we have to put ``too big 
to fail'' behind us. My statement includes a summary of what I 
consider to be the financial reform agenda, the architecture, 
to use the word that you used, Mr. Chairman, and all I would 
say about that is that it is urgent that we move ahead with 
this. The execution will be very challenging. It is a package 
deal. If you fail on part of it, it will compromise other parts 
of it. And again, it is just a very, very difficult task.
    I think as a matter of perspective, it is important to keep 
in mind that there are a rich framework for existing rules and 
regulations out there already that are being enhanced by the 
legislative process that I think deal quite effectively with 
some of the issues that were raised by Chairman Volcker. I 
certainly do think that well managed and well supervised large 
institutions play a necessary and constructive role.
    Now, with regard to the Volcker plan itself, I would just 
make a couple of quick introductory remarks. First of all, 
there are many important definitional and details that yet need 
to be clarified, and in those circumstances, I have to say that 
it is not at all clear to me, at least at this stage, that the 
focus is on the issues that really were at the heart of the 
crisis itself. Certainly, we need greater clarification on 
    Much of the focus is on so-called ``proprietary trading,'' 
and that, too, is a very difficult subject to define. But what 
I can say, based on my own kind of common sense effort to 
define proprietary trading at Goldman Sachs, is that over the 
cycle, the net revenues associated with so-called ``proprietary 
trading'' are 10 percent or less of firmwide revenues at 
Goldman Sachs.
    I also think that client-driven market making and hedging 
and risk management activities are, in my judgment, natural 
activities for well managed and well supervised banking groups. 
I think the outliers can be dealt with on a case-by-case basis, 
either with existing rules, much less with the enhanced rules 
that I am sure will flow out of the reform process.
    I also included in my statement, Mr. Chairman, a discussion 
of the issues associated with resolution authority, and 
resolution authority is critical to dealing with the ``too big 
to fail'' problem. And I have spelled out certain principles 
and prerequisites that I think are absolutely essential if we 
are to make resolution authority work, and ultimately, that, 
together with the other parts of the agenda I have specified, 
is how we will find success in the future and a safer, sounder, 
and more efficient financial system, while at the same time 
putting ``too big to fail'' behind us.
    I should also in closing, Mr. Chairman, say that, as I 
think you and others know, my respect and admiration for 
Chairman Volcker is unlimited. He is, in my judgment, one of 
the great, great figures of the past half-century or more. So 
it is not altogether the easiest thing in the world for me to 
take exception at least with some of the details that the 
Chairman has suggested. But I want to assure you and everyone 
else that I have more respect and more admiration for Paul 
Volcker than I do for any man or woman alive.
    Thank you very much, Mr. Chairman.
    Chairman Dodd. Thank you very much, Gerry. I appreciate it 
very much.
    Mr. Johnson.

                    INSTITUTE OF TECHNOLOGY

    Mr. Johnson. Thank you, Senator. I strongly support the 
Volcker Rules, as everybody is starting to call them, in terms 
of the principles they put forward.
    I think there are two main principles. The first is that we 
should redesign the size cap that does already exist for U.S. 
banks, the size cap from the 1994 Riegle-Neal Act. We should 
redesign it to reflect current realities. And second, we should 
address the issue that has arisen, in particular over the past 
few years, of U.S. Government backing for very large financial 
enterprises that have basically an unlimited ability to take 
risk around the world.
    I do not, however, think that the exact formulation of the 
Volcker Rules as put forward is the right way to go. I think, 
actually, you should consider tightening the restrictions on 
the largest banks and reducing the size cap, and I would 
emphasize that our banks are now already much larger as a 
percent of the--our largest banks as a percent of the economy, 
a percent of total financial assets, than we have ever seen 
before in the United States.
    Our largest six banks have assets worth over 60 percent of 
GDP. This reflects, in addition to what has happened in the 
financial crisis and the bailout and the rescue, it reflects 
the underlying concentration of these financial markets. So the 
big four banks now have more than half of the mortgage market 
in this country and two-thirds of the market for credit cards. 
This is unfair competition. Because these banks are too big to 
fail, they have lower funding costs, they are able to attract 
more capital, they make more money over the cycle, and they 
continue to get larger. And I do not think that we have seen 
the end of this.
    If you look at the European situation today, for example, 
it is much worse than what we have in this country with regard 
to the size of the largest banks. Just as one example, the 
Royal Bank of Scotland peaked with total assets at 125 percent 
of U.K. GDP. That is a seriously troubled bank that is now the 
responsibility of the U.K. taxpayer. If we allow our biggest 
banks to continue to build on these unfair market advantages 
and the lower funding costs, we will head in the same 
    I think I would suggest to you that you consider imposing a 
size cap on banks relative not to total normal assets or 
liabilities, which is the Volcker proposal, because that is not 
bubble-proof. If you have a massive increase in house prices, 
real estate prices, such as happened in Japan in the 1980s, you 
will have a big increase in the normal size of bank balance 
sheets. And when the bubble bursts, you are going to have a big 
problem. I think the size cap should be redefined as a percent 
of GDP.
    And I think that while the science on bank size is, to be 
sure, incomplete and inexact, there is no evidence that I can 
find of any kind, and I have spent a lot of time talking to 
technical people from they financial sector and people at 
central banks, people in the banking system themselves have 
impressed various points on me. I cannot find anything--I put 
this in the written testimony--that supports the idea that 
societies such as ours should have banks with total assets 
larger than around $100 billion in today's money.
    Now, if you were to impose a size cap of, say, 3 or 5 
percent of GDP, no bank can be larger than that size, that 
would return our biggest banks roughly to the position that 
they had in the early 1990s. Now, our financial system worked 
very well in the early 1990s. Goldman Sachs, as one example, 
was one of the world's top investment banks. I don't think 
anyone questioned the competitive sector. But since the early 
1990s, we have developed a lot more system risk focused on the 
existence of these very big banks.
    So, as Mr. Corrigan said, the essence of this crisis was 
lending, but it was lending that at the heart of it was based 
on the idea you could make nonrecourse loans to people who can 
walk away from their homes when the house value falls, leaving 
the bank with huge losses. How do people think this was a good 
idea? Why did they think that this would survive as a business 
model? Well, I think it was very much about the size of these 
banks and very much about the support they expected to receive 
when they are under duress.
    So in conclusion, I think the Volcker principles are 
exactly right. I think they are long overdue. I think you 
should--I hope that you will take them up and develop them 
further. I think the degree of unfair market competition, the 
degree to which the community banks are disadvantaged by the 
current situation, because they have to pay a lot more money--
they pay higher interest for funds, their cost of capital is 
higher--this is unfair. This dynamic will continue unless you 
put an effective cap on it. The biggest banks will become even 
larger and even more dangerous.
    Thank you very much.
    Chairman Dodd. Thank you very much.
    John, welcome again.


    Mr. Reed. Mr. Chairman, thank you very much for your kind 
welcome. Senator Shelby and everybody, I appreciate the 
opportunity to be with you. I had never anticipated as a 
retired citizen that I would find myself here, but I really am 
here to voice support for Mr. Volcker's suggestion, the Volcker 
    I do think that while details have to be worked out and so 
forth, I think that it is a good suggestion and one that is 
worthy of consideration by this Committee and the Congress in 
    I don't say this because I think the absence of that rule 
was central to the difficulties that we have just come through. 
I don't think that is the case. But I do say it from the point 
of view that if we were take a blank piece of paper and we were 
to say to ourselves, how can we design a financial system that 
would both serve the public and also be relatively safe and 
relatively unlikely to have a repeat of what we had, you would 
start out certainly with capital, which needs to be augmented.
    You would certainly look at the structure of the regulatory 
framework, which I believe this Committee is doing. But I would 
argue that you would also look to maybe compartmentalize the 
industry, not deny any function to the industry in general, but 
compartmentalize it so as to limit economic spillover.
    But as somebody who has run a large company in this 
industry for a long time, because of the impact that it has on 
the culture and the makeup of the various firms, dealing with 
the capital markets, proprietary trading, proprietary 
investing, hedge fund market, so forth and so on, each of these 
bring with them their own culture. These are cultures that have 
to exist for the particular purpose, but they have their own 
particular characteristics and there is no question in my mind 
but these cultures have an impact on the institution within 
which they are embedded.
    And if I were asked to design a system, I would not allow 
these kind of cultures and activities to be a part of large 
depository and traditional lending institutions. It is not that 
I feel these functions shouldn't exist. I would simply separate 
them from institutions that are the deposit takers and 
basically the traditional lenders for much of the economy. And 
I do this because I think the culture from the capital markets 
that rubs off has to do with risk taking. It certainly has to 
do with compensation, and it has to do with the nature of the 
human fabric of the various entities that we are talking about.
    So I believe as a part of a comprehensive reform that Mr. 
Volcker's idea with regard to separation of some of these 
functions makes a lot of sense, not because I am concerned 
about the economics, but because I am concerned of the nature 
of the impact that these various activities have on the players 
and the financial markets.
    With regard to size, I would differ a little bit with 
Professor Johnson. I think the antitrust laws are quite capable 
of dealing with size in the marketplace. The place where size 
is the problem has to do with the intra-industry transactions, 
the so-called ``counterparty risk.'' This is where the ``too 
big to fail'' comes into play. It isn't the balance sheet of 
the bank that is the problem on ``too big to fail.'' It is the 
interconnectedness of one financial institution with virtually 
all other financial institutions. And so this is where I 
believe we must be concerned about size.
    You could deal with size by having capital requirements 
that relate to the size of intra-industry activity, and 
obviously increasing capital as intra-industry activity goes 
up. You also, and this has been proposed and I think it is a 
good idea, can ask that certain instruments be traded through 
exchanges. This acts as a circuit breaker, the exchanges. It 
acts as a circuit breaker in the transmission of difficulties. 
And you could deal with size by simply putting limitations on 
counterparty risk, on the degree of leverage that can exist 
with regard to intra-industry trading.
    So the issue of size, I think, is also relevant, and so I 
think the two keys to Mr. Volcker's suggestion, that of 
segregation of function within the industry and particularly 
the protection of the large deposit-taking institutions and the 
idea of being concerned about size, have merit and deserve the 
consideration of this Committee.
    A final comment, if I could. I believe that one of the 
reasons that JPMorgan Chase did better than many others during 
this recent crisis is they did not have embedded in that 
institution a real money market activity, a trading house. 
JPMorgan Chase was the amalgam of about five commercial banks, 
but none of them had a big investment banking trading activity 
in it, and the absence of that kind of function turned out in 
the crisis to give them a relative strengthened position.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very, very much.
    Mr. Scott, welcome back to the Committee.


    Mr. Scott. Thank you. Thank you, Chairman Dodd, Ranking 
Member Shelby, and Members of the Committee for permitting me 
to testify before you today on the Volcker rules and related 
size limitations.
    Chairman Dodd. Mr. Scott, I am going to interrupt you for a 
minute if I can here. I rarely get a full quorum in the 
Committee, and we have got one here for at least a couple of 
minutes. We have some nominees that I am going to quickly try 
and take care of. I do not think they cause any controversy, 
but I will take a fair crack at it anyway.
    [Whereupon, at 11:04 a.m., the Committee proceeded to other 
business and reconvened at 11:05 a.m.]
    Chairman Dodd. The Committee will now turn to Professor 
Scott. How was that for speed? If I can just get financial 
reform through.
    Chairman Dodd. I was going to slip it in. Smuggle it in.
    Senator Shelby. Maybe you can.
    Mr. Scott. This Committee has been hard at work for several 
months on a broad range of issues of financial reform that are 
crucial to our Nation's future, including new resolution 
procedures to protect the taxpayers from loss, reduction of 
systemic risk through better capital requirements and central 
clearing for over-the-counter derivatives, and enhanced 
measures of consumer protection.
    Less than 2 weeks ago, the Administration announced the so-
called ``Volcker rules.'' Whatever one thinks of the merits of 
these new proposals, it is undeniable that they will take 
considerable time to develop and debate. Tuesday's hearing 
certainly underscored this point. These new proposals should 
not hold up action on the pressing fundamental issues much 
further down the track, and I encourage this Committee's 
continuing efforts to reach a bipartisan consensus on these 
    The asserted objective of the new proposed rules is to 
limit systemic risk. In my judgment, they fail to do so. If the 
limits on proprietary trading only apply where banking 
organizations take positions ``unrelated to serving 
customers,'' they will have little impact. For example, with 
respect to Wells Fargo and Bank of America, such activity 
represents around 1 percent of revenues. While this has been 
estimated to be 10 percent of the revenues of Goldman Sachs, 
Goldman could easily avoid the requirements by divesting itself 
of its banking operations since deposit-taking constitutes only 
5.19 percent of its liabilities.
    The real source of systemic risk in the banking system, as 
demonstrated by this crisis, is old-fashioned lending. It was 
mortgage lending that was at the heart of the financial crisis.
    I do not agree with Mr. Volcker that these traditional 
activities, by the way, are entitled to a safety net. Banks 
should not be bailed out, whatever the reason for their losses. 
Indeed, the focus should be, as it is in the pending 
legislation, to control risky activities of whatever kind.
    The Volcker rules would also prohibit banks from investing 
in, or sponsoring, private equity including venture capital 
funds. This would have little impact on the large banks whose 
investment in private equity accounted for less than 2 percent 
of their balance sheets.
    On the other hand, bank private equity investments are 
important to the private equity industry as a whole, accounting 
for $115 billion or 12 percent of private equity investment. 
Depriving the industry of this important source of funds could 
impede our economic recovery.
    Turning to the size limitation proposal, let me stress that 
this proposal does not purport to decrease the present size of 
any U.S. financial institution nor would it prevent any 
financial institution from increasing its size through internal 
growth. The proposal, as I understand it, would only limit the 
growth of nondeposit liabilities achieved through acquisition.
    Accordingly, if banks or other financial institutions are 
too big to fail, this proposal will have no impact on them. 
Indeed, it even permits them to get bigger.
    In thinking about size, our concern should be with the size 
of a bank or other financial institution's interconnected 
positions, not its total size, because it is the degree of 
interconnectedness that drives bailouts, and here I fully agree 
with what Mr. Reed said on this. I fail to see how market share 
of nondeposit liabilities could be a proxy for position size.
    Let me briefly turn to the international context. Without 
international consensus, adopting these proposals will only 
harm the competitive position of U.S. financial institutions. 
These proposals have not been agreed to, even in principle, by 
the G-20 or major market competitors, unlike most of the other 
proposals that the House has considered and that are presently 
before your Committee. While major market leaders and 
international organizations have been polite in welcoming these 
proposals, they have not endorsed them.
    In conclusion, do these proposals deserve further 
consideration and debate? Absolutely.
    But are they central to reform? In my view, they are not, 
and I would stress the fact that they should not in any event 
hold up action on the complex matters already before your 
    Thank you.
    Chairman Dodd. Thank you very, very much.
    Mr. Zubrow, welcome to the Committee again.


    Mr. Zubrow. Thank you very much, Chairman Dodd, Ranking 
Member Shelby, Members of the Committee. Thank you for giving 
us the opportunity to appear this morning.
    While the history of the financial crisis has yet to be 
written conclusively, we know enough about the causes to 
recognize that we need substantial regulatory reform. Our 
current framework was patched together over many decades. When 
it was tested, we saw its flaws all too clearly.
    Mr. Chairman, I want to assure you and the other Members of 
the Committee that we strongly support your efforts to craft 
and pass meaningful regulatory legislation. In our view, the 
markets and the economy reflect continued uncertainty about the 
regulatory environment. However, the details matter a great 
deal, and a bill that creates further uncertainty or undermines 
the competitiveness of the U.S. financial sector will not serve 
our goal of a strong, stable economy.
    At a minimum, we need a systemic regulator to monitor risk 
across our financial system. In addition, as we at JPMorgan 
Chase have stated repeatedly, no firm, including our own, 
should be too big to fail. Regulators need enhanced resolution 
authority to wind down failing firms, in a controlled way that 
does not put taxpayers' dollars at risk or the broader economy 
at risk.
    Other aspects of the regulatory system also need to be 
strengthened, including consumer protection, capital standards 
and the oversight of OTC derivatives. But I emphasize systemic 
risk regulation and resolution authority because they provide a 
useful framework for consideration of the most recent proposals 
from the Administration.
    Two weeks ago, the Administration proposed new restrictions 
on certain activities related to proprietary trading, hedge 
funds and private equity. The new proposals are a divergence 
from the hard work being done by legislators, central banks and 
regulators around the world to address the root causes of the 
financial crisis and to establish robust mechanisms to properly 
regulate systemically important financial institutions. While 
there may be valid reasons to examine these activities, there 
should be no misunderstanding. The activities the 
Administration proposes to restrict did not cause the financial 
    Further, regulators currently have the authority to ensure 
that these risks are adequately managed in the areas that the 
Administration proposes to restrict. We need to take the next 
logical step of extending these authorities to all systemically 
important firms regardless of their legal structure. If the 
last 2 years have taught us anything, it is that threats to our 
financial system can and do originate in nondepository 
    Thus, any new regulatory framework should reach all 
systemically important entities, including investment banks 
whether or not they have insured deposits. All systemically 
important institutions should be regulated to the same rigorous 
standards. If we leave some firms outside the scope of this 
regulation framework, we will be right back where we were 
before the crisis started. We cannot have two tiers of 
regulation for these systemically important, interconnected 
    As I noted at the outset, it is also very important that we 
get the details right. Thus far, the Administration has offered 
few details on what is meant about proprietary trading. Any 
individual trade taken in isolation might appear to be 
proprietary trading, but in fact is part of a mosaic of serving 
clients and properly managing the firm's risks. If defined 
improperly, this proposal could reduce the safety and soundness 
of our banking institutions, raise the cost of capital 
formation and restrict the availability of credit for 
businesses, large and small, all with no commensurate benefit 
to reducing systemic risk.
    Similarly, the Administration has yet to define what 
ownership or sponsorship of hedge funds and private equity 
activities means. Asset managers, including JPMorgan, serve a 
broad range of clients including individuals, universities and 
pensions, and need to offer these investors a broad range of 
investment opportunities across all types of asset classes. In 
each case, investments are designed to meet the needs of our 
clients. While we agree that the United States must show 
leadership in regulating financial firms, if we take an 
approach that is out of sync with other major countries, 
without any demonstrable risk reduction benefit, we will 
dramatically weaken our firms' ability to serve our clients in 
this Country.
    The Administration also proposed certain limits on the size 
of financial firms. If you consider the institutions that 
failed during the crisis, some of the largest and most 
consequential failures were standalone investment banks, 
mortgage companies, thrifts and insurance companies, not the 
diversified financial firms that appear to be the target of the 
Administration's proposals. It is not AIG's or Bear Stearns's 
size that led to their problems, but rather the interconnection 
of those firms that required the Government to step in.
    In fact, our capabilities, size and diversity were 
essential to both withstanding the impacts of the crisis and 
emerging as a stronger firm, but equally importantly putting us 
in a position to acquire Bear Stearns and Washington Mutual 
when the Government asked us to help.
    An artificial cap on liabilities will likely have 
significant negative consequences. Banks' liabilities and 
capital support the asset growth of their lending activities. 
By artificially capping liabilities, banks may be incented to 
reduce the growth of assets or the size of their existing 
balance sheets, which in turn would restrict our ability to 
make loans to consumers, to businesses, as well as to invest in 
Government securities.
    While numerical limits and strict rules may sound simple. 
There is great potential that they would undermine the goals of 
economic stability, growth and job creation. The better 
solution is modernization of our financial regulatory regime 
that gives regulators the authority and the resources needed to 
do the rigorous oversight involved in examining firms' balance 
sheets and lending practices.
    Let me conclude by just noting that it is vital that you as 
policymakers and those like us, with a stake in our financial 
system, work together to overhaul regulation thoughtfully and 
well. While the specific changes may seem arcane and technical, 
they are critical to the future of our economy. We look forward 
to working with the Committee to enact reforms that will 
position our financial industry and economy for sustained 
growth for decades to come.
    Thank you and I look forward to your questions.
    Chairman Dodd. Thank you very, very much.
    I will ask the clerk to put on, let's say, 6 minutes. So we 
will try and get through. We have a lot of good participation 
here this morning.
    Let me begin on the issue and ask all of you briefly to 
comment on it. There are a lot of issues surrounding this 
proposal, and I am going to focus on the issue of the 
proprietary trading side. I think some of you made a pretty 
good case, and I find myself sympathetic to the notion of the 
size question, that this is very difficult. It is the 
interconnectedness that I think makes a lot of sense to me.
    So, in my time, I want to focus on the other matter where 
there seems to be a little bit more of diversity of opinion, 
and the issue is the effective ability, in my view, to 
effectively draw that bright line between proprietary trading 
and these other activities.
    I know there was some interest. Bob Diamond, who is the CEO 
of Barclays, reportedly made a speech in this recent matter at 
a gathering in Switzerland. Let me tell you the quote. He said, 
and I am quoting here. This is the report of the quote: ``It is 
very, very difficult to think that we can differentiate between 
the risk bank's stake and the normal course of business for 
their clients and customers and proprietary trading.''
    Then another of his colleagues, apparently at the same 
setting, said the following: ``I can find a way to say that 
virtually any trade we make is somehow related to serving one 
of our clients. They can go ahead and impose the rule on 
Friday, and I can assure you that by Monday we will find a way 
around it. Nothing will change unless the definition is 
    Now I do not know who said that at that meeting, but that 
was the report of the meeting. And I have said that yesterday 
as well, that before even the ink dries on a proposal here, 
there will be very bright, young people who will sit and figure 
out some way to do a dodge. Is that your conclusion?
    Putting aside whether or not you agree whether we ought to 
do it or not, can we write such a thing here that would be 
ironclad, that would actually prohibit this kind of activities, 
and to such a degree?
    John, why do you not go ahead?
    Mr. Reed. Mr. Chairman, I believe you can. If you run a 
bank, you know what you are doing. You have to have limits for 
the various activities in your trading floor. There is no 
question that people can cheat and break rules. It happens all 
the time. Regulators, on the other hand, can catch them.
    If you say to a financial institution that proprietary 
trading is not an accepted practice, any well-managed financial 
institution knows how to run its business in such a way as not 
to be engaged in proprietary trading. And people who argue that 
you cannot find this out have not in fact run these 
    Chairman Dodd. Mr. Johnson.
    Mr. Johnson. Senator, I tend to agree with you completely 
on this question. You can. Within the banks, if the executives 
decide to shut down proprietary trading, they can do it. Sandy 
Weil, if I am not mistaken, closed the proprietary desk of 
Solomon Smith Barney in 1998 because he did not like the 
positions and the losses that they had incurred.
    But to come in from the outside and to say to legislators, 
or have regulators say, no more proprietary trading would I 
think lead to exactly the kind of evasion, evasive tactics you 
are talking about because there are many other ways to 
construct the same sort of risk return profile, which is what 
really they are going for with proprietary trading.
    They will not call it proprietary trading. It can 
disbursed. It can be put in different ways. So I agree with 
John Reed, that if the management really wants to do this, they 
will do it.
    But to impose it from the outside I think would be illusory 
at best and could lead to all kinds of dangerous distortions.
    Chairman Dodd. Gerry, in asking you to respond to the same 
question, tell us here what the impact would be on Goldman in 
terms of revenue and profits. Would it put a prohibition on 
hedge fund activity, private equity activity? As a practical 
matter, what happens at Goldman if we have an ironclad rule?
    Mr. Corrigan. The answer is not as much as some people tend 
to think.
    I think it is theoretically possible, Mr. Chairman, to 
construct a very tight regime for a very, very limited class of 
activities that you could call proprietary trading, where there 
is absolutely no interaction whatsoever between a group of 
proprietary traders and clients, and that activity is totally 
walled off within a given institution. But that would be a 
situation which I think would provide some liquidity to markets 
and price discovery, and that is fine.
    But to take the Goldman Sachs situation, if you took the 
net revenues associated with the best I can do to imagine a 
sensible definition, for example, of proprietary trading and 
hedge funds and private equity funds, we are, in net revenue 
terms, talking about something over the cycle in the broad 
order of magnitude of 10 percent of firmwide net revenues.
    Now I say over the cycle because in good years it could be 
a little higher, in bad years a little lower. But if you want a 
reference point, at least using Goldman Sachs as the example, 
that I think is as good as I can do right now since I do not 
know what the definitions that other people would have in mind 
when they talk about these alternative schemes.
    Chairman Dodd. Let me ask. Paul Volcker said he used, I 
believe it was Potter Stewart in his definition of pornography: 
You know it when you see it.
    I am hesitant to go down this road, but nonetheless since 
he used Paul Volcker talk, which gets to the point in a sense 
that Professor Johnson and John Reed were making, that if it is 
the bank institution looking at it, and they know it when they 
see it, that is one thing. When the regulator is looking at it, 
you could end up with two different people with a very 
different analysis of whether or not something is pornography. 
So the lack of clarity and the lack of certainty seem to be 
    So I have to look at this from the standpoint of not only 
the institution, what the effect is on the institution and the 
risk posed by it, but can you define it in a clear enough way 
so that a good regulator would be able to identify it and see 
it and respond do it. And that is really the prism I think 
through which we have to look at this--not to exclude how the 
institution looks at it, but more importantly I see it as how 
the regulator would look at it.
    Do you agree with that? And, if so, then I pose the 
question again. Can you do this?
    Mr. Zubrow. Mr. Chairman----
    Chairman Dodd. And put it this way, I really do not like 
it. But could you do it?
    Mr. Zubrow. I do think it is also important to remember 
that Justice Potter Stewart's remark also went on to say, with 
respect to pornography, that this is not it. And I think Mr. 
Volcker is also having the difficulty in saying that it is a 
very simple definition and it is very easy to see, but he seems 
to be having difficulty coming up with what that pure 
definition should be.
    I think that one of the significant issues that the 
Committee should is that proprietary trading not only means 
different things to different people, but in different contexts 
can mean different things. So, for instance, we obviously, in 
our regular market-making activities and client-facing 
activities, often take on positions from clients. We then need 
to hedge those risks. Now is that proprietary trading?
    Those risks have been given to us. They came out of client 
market-making activities, but now they are the bank's risks. 
So, if we want to go out and hedge those risks prior to being 
able to flatten those positions, that obviously could be 
interpreted by some as a form of proprietary trading.
    I would agree with Gerry's comment--if you take the 
extremely narrow definition and say that you put a group of 
traders in walled-off area, give them an amount of capital. 
That is not a business that we are in. That is not something 
that we find strategically attractive. Obviously, if we were to 
eliminate that type of activity, that would not have a 
particular impact on the firm.
    Chairman Dodd. Thank you.
    I have gone over my time, and I apologize to my colleagues. 
Senator Shelby.
    Senator Shelby. Mr. Corrigan, under existing authorities 
today, regulators are able to ensure the safety and soundness 
of an institution. I think that underlies everything here.
    Do you believe that regulators presently have the ability 
to restrict a firm's activities, including their proprietary 
trading, if they deem this not to be a safe and sound practice?
    Mr. Corrigan. I do not think there is any question at all, 
Senator, that they have the authorities. That is a no-brainer.
    One of the principles----
    Senator Shelby. If they have the authority, then it is a 
question of do they have the will to use their authority. Is 
that right?
    Mr. Corrigan. That is precisely the point, Senator. One of 
the principles that I articulated in the statement that I gave 
you is that going forward the official community has to conduct 
its affairs in such a way that what we call prompt corrective 
action becomes a reality rather than a slogan, and that I think 
is one of the great challenges that we face in the context of 
this whole effort of regulatory reform. I do think there have 
been some cases in the past where this notion of prompt 
corrective action works, but I think in the future we need to 
make it work better.
    Two elements, Senator, that go into that are a much, much 
more aggressive framework of stress testing. One of my favorite 
inventions that Mr. Zubrow knows about, reverse stress tests 
and extreme contingency analysis have to play a much bigger 
role in the future than they have in the past. If we can do 
that appropriately, which I think we can, I think that that is 
one of the absolute prerequisites for making resolution 
authority work.
    Senator Shelby. Speaking of that, Mr. Zubrow, Senator 
Corker and Senator Warner on this Committee have spent a lot of 
time on how do we find resolution authority here in our hopeful 
legislation, piece of legislation. If we basically all agree--
and I hope we do--that nothing is too big to fail, and if we 
have sound regulation, the power, that regulators have the 
tools to regulate and do their job, safety and soundness 
    What are a couple of things that you would suggest, and 
they may have covered already, these two Senators, in any 
resolution authority that would be deemed so important?
    Mr. Zubrow. Well, thank you very much, Senator for that 
question, and I agree with you. I think Senator Warner and 
Senator Corker are doing a terrific job leading the effort to 
really focus on what we mean by resolution authority.
    Senator Shelby. Absolutely.
    Mr. Zubrow. And I think that, first and foremost, it is 
very important that there be a clear regime in which firms can 
be allowed to fail. And part of that is obviously a recognition 
that when a firm gets into trouble, that they managements of 
those firms should be eliminated, the shareholders should be 
wiped out, and the creditors should be able to be dealt with 
through the existing regimes of the bankruptcy laws.
    Senator Shelby. Hopefully, the taxpayer will not have to 
step up, right?
    Mr. Zubrow. Absolutely. And if you eliminate the 
shareholders' equity, if you have the ability to eliminate 
unsecured debt to the extent that is needed, then obviously 
there should be more than enough resources in those 
circumstances, so that the taxpayers do not have to be involved 
in any way in a bailout of those firms.
    I think it is also very important that large, complex firms 
be prepared with their regulators for that potential 
eventuality. We have already begun discussions with our lead 
regulator, the Fed, about how would we think about how a 
regulator would step in, in a resolution regime, because I 
think it is very important that the regulator as well as the 
firms themselves think about the various steps that might 
happen under that situation.
    Senator Shelby. Is it in your mind very, very important 
that any legislation dealing with resolution authority be 
unambiguous that nothing is too big to fail, and if it bellies 
up we are going to close it down?
    Mr. Zubrow. I think that it is absolutely critical that 
that be clear in the legislation.
    Senator Shelby. Professor Johnson, you have a comment?
    Mr. Johnson. If I may, Senator, in the whole discussion of 
resolution authority, if I could just speak from the 
perspective of my previous job at the International Monetary 
Fund, that the hottest issue is the cross-border resolution. I 
think all the firms that are represented here and most of them 
sitting behind me are cross-border firms with massive, 
complicated international pressures. One thing we learned from 
the failure of Lehman is that regulators have just different 
statutory frameworks. There is a massive conflict over that.
    And the only way around that, at least on an interim basis, 
is to have a conservatorship, which is not exactly failing. 
That is the Government putting in money into AIG type 
situation. Unless you have cross-border authority----
    Senator Shelby. That is what these two Senators I mentioned 
have in mind, but they can speak for themselves.
    Mr. Johnson. My basic point from the perspective of the 
IMF, I would suggest, is that unless you have a cross-border 
resolution authority, which even the Europeans have struggled 
to establish within Europe, let alone U.S. to Europe, let alone 
U.S. to emerging markets, any resolution authority based just 
on the U.S. is not going to achieve the goals that you quite 
rightly are emphasizing.
    Senator Shelby. Professor Scott.
    Mr. Scott. To come back to what the ``too big to fail'' 
problem is, I think it is the degree of interconnectedness. So 
what you have to ask yourself, in addressing your question, is: 
Will we have the insolvency of a large institution which we 
have to rescue because it is too interconnected to let it fail? 
That might not be affected by the size of the total 
institution. It is a function of its positions with other 
    So, in answering the question, should a resolution 
authority not be permitted to bail out an institution, I think 
it would have to have a very high degree of confidence that you 
would not have a situation in which an institution failed that 
was highly interconnected because if you did not bail it out, 
then you risk a chain reaction of failures.
    So I think it is really important to understand the degree 
of interconnectedness of our institutions, and I think we have 
done a woeful job at uncovering that and that a lot more 
attention needs to be focused on what these connections are. 
For instance, I think we thought when AIG was rescued that it 
had to do with their counterparty positions. But then we are 
told by some of their counterparties, one of whom is sitting at 
this table, that they were totally protected in the event of an 
AIG failure.
    And I am not questioning that, but what I am questioning or 
asking is if you are going to design a resolution authority 
that says we will never rescue an institution, you have to have 
a high degree of confidence that you will never be in a 
position where these large connected positions could create a 
chain reaction of failures if you did not rescue the 
    Senator Shelby. Mr. Reed, do you believe that regulators 
lacked necessary authority and power to rein in reckless 
activities or do you think that regulators simply failed to use 
their available tools? And do you believe that regulators have 
been held accountable for their failure?
    Mr. Reed. Well, I agree with Gerry, the regulators clearly 
have the authority to rein in any practice. They have failed to 
do so for the human reason that they get captured and caught up 
with the current wisdom. It is very difficult to organize a 
structure that can systematically have a contrary view and 
divorce itself from current wisdom.
    The regulators have the authority. It is rare indeed that 
the regulators have anticipated and stopped problems.
    I do not think many people at all have been held 
accountable for what is going on. The regulators certainly have 
not been held accountable nor necessarily have the managements 
and boards of some of the financial institutions involved--so, 
in terms of who has been held accountable, not many.
    Can we rely solely on regulation, I do not believe so. You 
certainly need regulation. You need the right regulation. And 
you need a strong regulatory structure, but it is not in 
itself, I believe, sufficient.
    Senator Shelby. You got to have good management.
    Mr. Reed. And that is why I like this compartmentalization.
    Everybody is playing around with what is proprietary 
trading. That, with due respect, if you are running a company, 
you know if you are in the business or not. You do not hire the 
kind of people who want to be in that kind of business if you 
are not supposed to be in it.
    I believe that the nature, the human makeup of an 
institution is extremely important, and that is why I tend to 
favor Mr. Volcker's thought on regulating some of these types 
of activities that bring in a different kind of culture to big 
depository institutions.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you.
    Senator Johnson.
    Senator Johnson. Mr. Reed, would the Volcker Rules be 
difficult to implement? What challenges would it pose to the 
    Mr. Reed. Senator, I don't think they would be difficult to 
implement and I don't think it would be a regulatory issue. I 
think it would be a management issue. In other words, if there 
were rules with regard to the nature of businesses that certain 
entities could be engaged in, you could count on most good 
management to try to follow those rules. Regulators might well 
debate with the management whether certain practices are, in 
fact, OK or not. But those kind of debates are quite healthy 
and the regulators, if they insist, have the authority to have 
their views hold.
    When I was in the banking business, there were any number 
of activities that were not permitted of the banks that I was 
responsible for running at the time. We never had any problem 
knowing where the rules were and we didn't specialize in trying 
to get around the rules. The regulators are quite able to spot 
when a management is behaving differently than the rules call 
for and they certainly have the capacity to stop it. So I don't 
believe this is a real issue.
    Senator Johnson. Professor Scott, there are concerns that 
allowing commercial banks to engage in proprietary trading 
activities unrelated to serving customers creates unmanageable 
conflicts of interest. Can you provide some examples of these 
conflicts of interest in our marketplace?
    Mr. Scott. Not in the actual marketplace, Senator, but I 
think I could talk about the hypothetical marketplace.
    Senator Johnson. Yes.
    Mr. Scott. And I could see a situation in which a 
customer's interest was adverse to the interest of a 
proprietary trader. The customer would have a position that the 
trader was taking the opposite side of. It could hurt the 
customer's position. Now, my understanding is, of course, that 
these activities are walled off and that the proprietary 
trading desk is totally separate from the people who would be 
dealing with the customers and that that really handles the 
    I should say that commercial banking is full of potential 
conflicts. This is not the only conflict. And indeed, in the 
debate over Glass-Steagall, the emphasis was not on this. It 
was actually on underwriting, which nobody is attacking here, 
and the thought was that banks who took positions in 
underwriting, were potentially exposed to risk on underwriting, 
would not act in the interest of their customers and force them 
to buy something in order to protect the bank from risk. Again, 
we handled that situation by trying to isolate activities 
within the organization.
    So I don't think--if you are really worried about 
conflicts, this is a much bigger issue, and I wouldn't start 
with proprietary trading if I were worried about it.
    Senator Johnson. Mr. Zubrow, at Tuesday's hearing with 
Chairman Volcker and Secretary Wolin, there was much discussion 
about how to define proprietary trading. In your testimony, you 
echo those concerns. If you were trying to prevent or stop the 
riskiest types of proprietary trading activities at commercial 
banks, how would you define proprietary trading?
    Mr. Zubrow. Thank you, Senator. As I said, I think that it 
is very important to make sure that banks are able to continue 
to trade in ways that will allow them to hedge exposures that 
they take on. And so if I were to come up with a definition 
that was trying to wall off something that was pure proprietary 
trading, it would be utilizing the definition of taking a group 
of traders, putting them into a separate area, having the firm 
invest capital in that, and have that group not be engaged at 
all in any client or market making or other activities other 
than just trading of that particular capital.
    I do think, as I said before, that it is very important 
that firms like ours have the ability to continue to manage the 
various risks that we take on in our client-facing businesses 
and to not allow some broad definition to be enacted that would 
limit our ability to properly manage those risks.
    Senator Johnson. Professor Johnson, some preliminary 
analysis of the Volcker Rules contend that this proposal could 
have profound effects on the profits and business models of 
large U.S. financial firms, particularly those whose 
proprietary trading functions are fully integrated into the 
firm's global business. Do you agree with this statement?
    Mr. Johnson. Senator, the evidence that I have seen 
suggests it would have a relatively small impact on the 
profitability of these banks, with the possible exception of 
Goldman Sachs, as Mr. Corrigan emphasized. That 10 percent over 
the cycle of net revenues is probably an outlier for a bank 
holding company, and, of course, there is discussion about 
whether people who have bank licenses would be allowed to hand 
those licenses back and go off and become some independent 
structure not regulated by the Federal Reserve.
    If that were to be the outcome of the Volcker Rule, if that 
were permitted by the rules that you draw up and how they are 
implemented, that would be a complete disaster, because you 
can't have a situation where banks are very big doing banking 
activities not subject to comprehensive, tough regulation, 
which is, I hope, what we will get out of the regulatory 
structure that you create. You can't just go off and take those 
massive risks and then when you face a collapse say, oh, I 
would like my banking license back. And Goldman Sachs, I think, 
got a one-time-only pass--I hope--when they were allowed to go 
to bank holding company in September 2009--2008.
    Senator Johnson. My time has expired.
    Chairman Dodd. Senator Corker.
    Senator Corker. Mr. Chairman, thank you, and thank all of 
you for your testimony. I think the Volcker Rule is--I think 
the goal of it is one that all of us would like to achieve, and 
that is figuring out a way that institutions are not too big to 
fail. I think the abstract nature of it made it difficult.
    I want to agree with our Ranking Member. I think there is a 
lot of regulation in place, if regulators will just do what 
they are supposed to do to keep much of what has happened from 
happening. And I do think there ends up being a capturing of 
those regulatory. They are embedded in your institutions. They 
get to know you. They are having coffee with you every day. 
They are going to lunch. And the next thing you know, things 
happen. So I hope we can figure out a way to keep that from 
happening in the future.
    But Mr. Corrigan, I understand that in many ways, if the 
Volcker-like Rule was put in place, Goldman would be the Br'er 
Rabbit of this whole deal, that you drop your holding company 
situation and have less competition. I wonder if you might 
respond to that.
    Mr. Corrigan. Well, first of all, it is not entirely clear 
to me that that would be the result, but let me come back to 
that in a minute.
    Under the House bill, and I hope that under the Senate bill 
and the ultimate legislation, we would have a regime in which 
any systemically important institution would still be subject 
to consolidated supervision, presumably by the Fed.
    Senator Corker. Now, you are answering a question I didn't 
ask, so since it is my time, I am going to--so you can either 
go right to that question----
    Mr. Corrigan. But that is the starting point for your 
    Senator Corker. OK.
    Mr. Corrigan. So whether Goldman Sachs continued to be a 
bank holding company or not, it would still be subject to 
consolidated prudential supervision. I think that is the way it 
should be.
    Senator Corker. I was struck by your testimony regarding 
all institutions, that no institutions should be too big to 
fail, and then your solution was that if a company failed, they 
would go into temporary conservatorship. That is not much of a 
failure. So I am shocked by that and I wonder----
    Mr. Corrigan. Well, let me----
    Senator Corker. ----I think what we have all been talking 
about is that if you fail, you don't exist anymore and a 
temporary conservatorship is much like what we have just gone 
    Mr. Corrigan. Well, let me define terms a little bit better 
here, if I may. First of all, when I talk about temporary 
conservatorship, I have in mind that this feature of the 
process would exist only for a very short period of time, a 
matter of days or weeks. And I am not sure that conservatorship 
technically is the right legal word. But what I feel very 
strongly about is that we need to have a limited period of time 
after the institution in question has been taken over by the 
authorities--the shareholders are out, the managers are out, 
the board is out--we need a limited period of time to be able 
to put ourselves in a position where we can, in fact, execute a 
prompt, timely, orderly wind-down of an institution.
    Senator Corker. Or receivership.
    Mr. Corrigan. That is correct.
    Senator Corker. Let me move on. I appreciate very much your 
testimony. I would say that even under the Volcker Rule, if you 
had consolidated supervision but didn't have a bank holding 
company status, you would not be under the Volcker Rule. So 
consolidated supervision is not what is relevant.
    But let me move to Mr. Reed. I found your comments 
interesting, and certainly I respect each of you very, very 
much, as I do Mr. Volcker. But the comments about separating 
these, you were Chairman of Citigroup when all of this was put 
together. I think that is fascinating for all of us to know 
that you kind of put all this together and now are an advocate 
of separating, and I just wondered what you might share that 
you have learned since that time.
    And I would add another question, since I may run out of 
time. A lot of people think that Citigroup is one of those 
organizations--and I was watching the body language when we 
were talking about failure--that Citigroup is one of these 
companies, because of payment mechanisms that exist around the 
world with sovereign governments and others, that Citigroup 
cannot fail, OK, that they are so interconnected. And I think 
what all of us are seeking, even Chairman Volcker and others, 
is figuring out a way that regardless of the 
interconnectedness, there never will exist again in our country 
a financial institution that is too big to fail. We don't like 
that moral hazard. It goes against the American way.
    And yet there are people who come in, I think, and believe 
that a Citigroup, I am sorry, they are so interconnected, they 
have payment systems, and I wonder if guys like you and others 
laugh at us when we say that we want to create a regime that 
absolutely ends forever in the American vocabulary that any 
company is too big to fail. I think that is the goal of many 
people on this Committee, maybe not everybody, but I think many 
people. And I ask everything I have just asked with respect. I 
do find it fascinating, your position.
    And then, second, I wish you would respond to the issue of 
``too big to fail.''
    Mr. Reed. Senator, I learned a lot. There is no question 
that when we put Travelers and Citi together, we created a 
monster, and most of the difficulties we have had have stemmed 
from the Salomon Brothers side. Salomon had just been recently 
acquired by Travelers, but this is why I am so sensitive to the 
cultural impact.
    I am suggesting that it would be healthier for the system--
it may not be healthier for Citi's stockholders, but I am 
retired. I am free to speak as an individual citizen----
    Senator Corker. It is kind of like a Senator who is not 
running again.
    Mr. Reed. That is right.
    Mr. Reed. So my honest belief, having experienced it and 
having lived with it for years, is that the system would be 
stronger if we could provide for some separation where major 
depositories are not major actors in the capital markets. And 
you will notice that as I made my comments about these 
cultures, I didn't talk only about proprietary trading and 
proprietary investing. I talk about this interface with the 
capital markets.
    I believe that it is very difficult to manage these 
cultures. It is not impossible, but it is very difficult. They 
are hard to contain. They have big impacts on the risk taking 
sort of attitudes at the top of the company and the nature of 
the people who are working in the company. I think the system 
would be sounder if we had a couple major institutions that 
were a little pedestrian and that weren't occupied by all my 
colleagues from MIT who are pretty good at math.
    So I have come to the conclusion, having lived it, that the 
system would be better if we allowed for some 
compartmentalization. And as I said in my testimony, as I said 
in my written remarks, I would look at compartmentalization of 
culture as much as of economic function because it is the 
people within the company.
    So I have learned from my experience, and I think probably 
there wasn't a much more relevant experience around, and my 
conclusion is the system would be better. I am not speaking for 
the stockholders. The system would be better if we allowed for 
the type of separation that Mr. Volcker is talking about, and I 
think he probably comes at it from the same point of view. I 
saw him recently and he said, ``John, it is the first time you 
and I have ever agreed, isn't it,'' because we have had a 
number of issues where we didn't. But I think he saw it from 
the same point of view.
    Too big to fail, Senator, I am totally on your side. We 
have to come up with a mechanism that, regardless of the 
particular interconnectedness--Gerry is correct, we may need 
time to get this organized, but you have to be able to let 
institutions fail and I think you have to wipe the stockholders 
out. I think you have to wipe the board and the management out. 
And we have to have that mechanism.
    And it is true that Citi, in its current structure, would 
be very difficult to unwind, and the global issue would come up 
right away. And this global issue is real. There is no 
question. I forget the name of the British institution that 
failed in Singapore--Barings failed in Singapore. The Bank of 
England could not control the unwinding of this because the 
Singaporian authorities got into the middle of it and you had 
this cross-legal jurisdiction problem.
    So I do think Professor Johnson is correct in that regard, 
but I am on your side totally that we must come up with an 
architecture that allows us to say any person that gets in big 
trouble must be permitted to fail, and the bias has to be in 
that direction.
    The question, Senator, why did we save Long-Term Capital? 
It was alone. It could have been allowed to fail. But the 
instinct of regulators is to organize a rescue mission. And so 
I think you need a structure that sort of dampens that 
    Senator Corker. I would love to hear from everybody, and I 
don't want to be rude to my colleagues by asking another 
question, but I do hope in another setting we can, on the phone 
or by e-mail, talk more about the interconnectedness Professor 
Scott and many of you have brought up. I thank each of you for 
your testimony and I do hope we figure out a way to deal with 
the interconnectedness in a way that, through legislation or 
some other mechanism, regulation, that allows big companies to 
    I just want to say, it seems like every crisis we have had 
since I have been alive, and I am 57, has centered on real 
estate--just about--and somehow or another we still don't talk 
about that and we talk about all these other things, but that 
is a subject for another day.
    Thank you, Mr. Chairman. Thank you for your testimony.
    Chairman Dodd. Thank you, and let me just say again, I said 
at the outset in my remarks, having now just chaired this 
Committee in my third year, since January of 2007, the 
tremendous talent on this Committee. This is a hard subject 
matter and all of you have spent your lives involved in this. 
None of us claim to have lifetime experiences in all of these 
matters, but we have had tremendous contributions from Bob 
Corker and Mark Warner, Jack Reed, so many people on this 
Committee, delving into the various aspects of this, and it is 
hard work. It is difficult work.
    It is arcane work, in many ways, and we are all very 
sensitive to the notion that every good idea has an unintended 
consequence and trying to think through all the ripple effects 
of what you are suggesting. At one level, it can seem like the 
best idea in the world. And as you delve into it--I said the 
other day on these matters, I kind of regret we are not back 5 
or 6 years ago when we knew a lot less about all of this than 
we have learned. It was easier when you knew less in terms of 
the answers for things. So I thank the Senator from Tennessee. 
He has been tremendously valuable on this Committee, along with 
    Senator Reed.
    Senator Reed. Thank you, Mr. Chairman.
    Mr. Reed, I have been struck by what you have learned. I 
think we have learned something, too, and I think we have to 
carry it into the formulation of new regulations. First, we 
can't assume regulatory capacity adequate to the complexity of 
the financial markets. That is a function of funding and 
appropriations. It is a function of ideology. It is a function 
of personalities. But many of the discussions that we have 
heard, I think assume that, and I think that is an assumption 
that we have to question.
    The other aspect of this is managerial capacity, as you 
point out in your comments on culture. This would have been a 
different world if there had been different individuals at 
different institutions, but they were there. And I think also, 
too, in terms of who rises to the top of these complex 
institutions is a function not sometimes of who they are but 
what they do and how much money they make for the company. So I 
sense all of that.
    I think in that regard Chairman Volcker has raised the 
right sort of issue, but I think perhaps we have sort of taken 
the wrong path and we are now talking about proprietary trading 
and how to define it, et cetera. I think your approach is much 
more, I think, on target, which is what do we want? We want 
financial institutions, commercial banks, who focus on serving 
customers, who are businesses, consumers, basically, and we 
want them to be their core competency, et cetera.
    So one way to look at this is to say rather than you can't 
do proprietary trading, is that if your core business is just a 
fraction of what you do, then why should we allow you to get to 
the discount window? Why should we include you in Section 
13(3)? That is not our policy. Our policy is to support a 
vigorous commercial banking system. What about that approach, 
Mr. Reed?
    Mr. Reed. Senator, I agree with you. I think what we are 
striving is to have a healthy commercial banking sector. I 
think it is very important that there be a Goldman Sachs in the 
world and so forth and so on, and no one is suggesting that 
these activities be prohibited, simply that they not be in 
these big depository institutions.
    Commercial banks used to focus on customers and basically 
provide working capital finance. And if you needed to get into 
exotic instruments and so forth, the commercial banks didn't do 
    I think the recent crisis through which we are stumbling 
would have been much different had there been three or four 
large depository institutions that weren't in the center of it. 
I think one reason why JPMorgan Chase was able to play a 
positive role is that they did not have in the core of their 
business these kind of activities. They had some problem 
activities in terms of sourcing mortgages from third parties 
and so forth, but they played a positive role. The Bank of 
America, which absorbed Merrill Lynch, had the capacity because 
they didn't have these kind of problems. I think it served the 
country well to have some of these institutions that were not 
tainted by these kind of activities.
    But I don't think the solution is to now say we will let 
everybody do everything. I think we want our big depository 
institutions to focus on serving their customers, providing 
working capital, finance, deposits, consumer, and so forth.
    Mr. Reed. Mr. Johnson.
    Mr. Johnson. If I could just add to that, Goldman Sachs in 
1997 was about a $200 billion bank in terms of assets. It was 
about $270 billion in today's money. It peaked at about $1.1 
trillion. Now, I completely agree with Mr. Reed that having 
risk takers and risk-taking institutions in our economy is 
useful. I am a professor of entrepreneurship at MIT. I am 
completely supporting that. But if you let these risky 
enterprises become big relative to the system, when a crisis 
comes, even if you have a relatively stable core--and I do 
fully endorse what Mr. Reed is calling for here--you have this 
rather stable core and you have got very big other parts of the 
financial system that fail or are in danger of failing, then 
you let them into the discount window, which is what we did in 
September of 2008. So the size of these risk-taking parts 
matters, even if we are able to achieve a stable base, which is 
what Mr. Reed is rightly arguing for.
    Mr. Reed. Mr. Corrigan, I think you need to have a chance. 
You should turn on your microphone, because we want to hear 
    Mr. Corrigan. Today, the balance sheet side at Goldman 
Sachs is something in roughly $800 million-plus or something 
like that, so it has contracted in size relative to what it was 
a few years ago. But I would also observe that at least half, 
and perhaps more than half of the growth in Goldman Sachs over 
the past 10 or 12 years has been international, not in the 
United States but around the world, and I think that is an 
important factor, as well.
    But I really want to focus on these comments about discount 
windows and discount rates. I completely agree with what John 
Reed said a few minutes ago about discount window and discount 
rates. And as I am sure your staffs will note, in my 
    Senator Reed. I noted it directly.
    Mr. Corrigan. ----I had two things to say about discount 
window. One was that as the Fed winds down its heavy crisis 
intervention, in my judgment, we should go back to the old-days 
regime of the discount window, and under that old regime, even 
if you were a bank holding company, the bank itself had access 
to the discount window, but under the old rules, the bank could 
not take funds that it got through the discount window and 
cross-stream them to nonbank affiliates or to the holding 
company. Once we get this crisis behind us, that is what we 
should go back to.
    In addition to that, in my statement, I was very clear in 
saying that going forward, we need to modify the so-called 
``13(3) rules'' as they apply to the extreme emergency 
situations using the discount window, and what I personally 
have in mind is something along the lines of what I think is in 
the House bill, and I think, Senator Dodd, I think you have 
been contemplating this, as well, is that at a minimum, to use 
13(3) under any set of circumstances, the Federal Reserve would 
have to get the consent of the Treasury.
    So I am not by a long shot even close to a point of view 
about the discount window that is anything other than extremely 
conservative, both for so-called ``regular use'' of the 
discount window and emergency use. I think that, again, the 
traditional roles that said a bank in a bank holding company 
has access to the discount window, that is where we should get 
back to.
    Senator Reed. My time has expired, but I just raise the 
question--I think like Senator Corker, this will be an ongoing 
dialogue, but the crisis that we saw last year, getting the 
permission of the Secretary of Treasury to use 13(3) would not 
be too hard, because I would suspect he was begging the Federal 
Reserve to use 13(3). So we have to--and that, I think, is the 
ultimate. When we talk about ``too big to fail,'' we are 
basically saying there are some institutions that don't get 
13(3). I mean, that is when you cut it to the core.
    Mr. Corrigan. I agree with you on that, too, Senator Reed, 
but if I could, I would like to go back to this 
interconnectedness question and ``too big to fail'' and 
resolution authority, because I am convinced, absolutely 
convinced, that we have to get this resolution authority right. 
And in my statement, for example, I have laid out a bill of 
particulars that take the form of prerequisites that have to be 
in place for every large integrated financial intermediary that 
would make it possible for resolution authority to work the 
right way. Every one of these particulars deals in very 
specific terms with interconnectedness.
    I don't want to sound like--but I think that over the 
years, I probably have thought more about interconnectedness 
and the plumbing of the financial system, as I like to call it, 
than most everybody. But I think it is urgently important that 
the regulators, working with the major institutions, have to 
focus on these prerequisites, because I will tell you that in 
my judgment, if we don't get that right, we will not be able to 
close down ``too big to fail.''
    Senator Reed. My time has expired. I thank my colleagues 
for indulging.
    Chairman Dodd. Thank you, Jack.
    Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair, and thank 
you all for testifying today on these issues that are so 
important to our future economic health.
    Mr. Reed, you noted the question as to why do we rescue 
Long-Term Capital Management, and you noted that it stood 
alone, and I think you said, but there is an instinct in the 
system to save a major player. I want to turn back to that 
example to pursue that a little bit further.
    This was at the end of the 1990s and there were a lot of 
investments by major financial houses in Russian derivatives. 
If I recall right, Long-Term Capital Management, had it gone 
under, it would have been selling at fire sale prices. Many of 
these investments, which I believe we also had a number of 
large financial houses deeply invested in, including, I 
believe, Goldman and JPMorgan both had positions that were at 
risk, and so these other entities came together to help bail 
out Long-Term Capital Management to avoid at that point 
interconnections that were driven by market considerations. 
That is, one piece of the interconnectedness, if one firm fails 
and has to sell at fire sale prices, it drives down everybody 
else's asset portfolios. That is another form of 
interconnectedness or risk in the system.
    So could those of you who were involved in this or who have 
studied it share just a little bit more about the lessons to be 
learned from that setting, that form of risk, how that can be 
addressed? And it also certainly came up in mortgage-backed 
securities, the potential for them to be sold, and so forth.
    Mr. Reed. Well, Senator, I think you are absolutely correct 
as to what drove the rescue, that people felt that it was 
easier to rescue than to allow it to go broke. But this is why 
people are going to be very reluctant ever to say we are going 
to allow a given company to basically go bankrupt, because 
there is this level of interconnectedness.
    The lesson we should have derived from that is we didn't 
have enough capital. There wasn't enough capital in the system 
to take the risks that were there. And we didn't learn that. 
Had we learned that with Long-Term----
    Senator Merkley. Are you speaking of the issue of leverage? 
I remember at one point----
    Mr. Reed. There was a tremendous amount of leverage.
    Senator Merkley. ----101 or something like that.
    Senator Reed. Yes, it was tremendous leverage, and what we 
should have learned was that there wasn't enough capital to 
absorb the risks that were in the system, and therefore, when 
the risks manifest themselves, the human reaction is, let us 
gang together and we will see if we can take this together. 
Well, we had a situation there that was a one-institution 
version of what later happened to all of us and where basically 
the taxpayer had to step in because there wasn't enough capital 
in the private sector to cover the risks that were manifesting 
themselves in this crisis we have gone through.
    And so my question about Long-Term Capital was there was 
the anatomy of the problem that we are today wrestling with. It 
was alone that sat there. It was tremendously interconnected. 
As you say, it had counterparty lines. It had all sorts of 
assets which conceivably would have been liquidated at very 
distressed prices and so forth, which would have impacted the 
market. And yet as a system, we sort of ganged together, 
papered it over, and went on having learned nothing.
    Mr. Zubrow. Senator?
    Senator Merkley. Yes, Mr. Zubrow?
    Mr. Zubrow. Senator, if I could just add one point, which 
is that I also think that that is an example of how we allowed 
fundamental regulatory arbitrage to lead to a very difficult 
situation. And obviously, Long-Term Capital was outside of the 
regulatory regime. It wasn't subject to the same capital 
requirements or oversight as other institutions. And so I think 
that one of the lessons that we learned from that is that all 
firms that are systemically important need to come under the 
same umbrella of regulation, the same capital regimes, and the 
same oversight of regulators and not allow the form of 
ownership or the type of business they are in to allow those 
institutions to escape that type of comprehensive regulation.
    I would just comment that I, frankly, was somewhat 
surprised in Secretary Wolin's testimony last week, or on 
Tuesday, that he suggested that we could sort of allow certain 
institutions to be able to escape the regulatory situation if 
they were to divest their banks, and I think that it is very 
important that in that situation, all organizations that are 
systemically important be treated the same.
    Senator Merkley. I will ask both of you to be brief, 
because I am down to less than a minute. Mr. Scott.
    Mr. Scott. I think addressing Long-Term Capital Management, 
the first issue is protecting the institution from failing, 
capital. But then we come to, well, maybe we will not succeed 
at that, it is failing. Now we have to deal with 
interconnectedness. We have done all we can, it wasn't enough.
    If you look at the present world of interconnectedness, it 
is not about equity. Equity is not an interconnectedness 
problem. I do not think it is about debt. I do not think that 
we are worried particularly from an interconnected point of 
view who is holding the bank debt. We may have other issues 
about that. It is really counterparty. It is really 
derivatives, in my view. And the answer to this is 
    If you go back to the years when Mr. Corrigan was serving 
very adequately in the Federal Reserve Bank of New York, his 
major concern was the payment system, and particularly the 
clearinghouse interbank payment system, because if there was a 
default, you would have a systematic chain reaction of 
    What did we do about that? Well, we managed to figure out a 
way that that thing could function without causing that 
problem. It now settles continuously. You do not have end of 
the day large net positions that could endanger the system if 
there is a settlement failure.
    So we have to address the same problem now in the context 
of derivatives. And I think that needs to be the focus here, 
because that is, in my view, the interconnectedness problem 
    Senator Merkley. I am over my time. Shall I allow Mr. 
Johnson to respond, as well?
    Chairman Dodd. Sure.
    Mr. Johnson. I am afraid we haven't learned the lesson of 
LTCM, which is the capital that needs to be held with regard to 
derivative positions is still far too low. And that is where 
the regulatory arbitrage exists and it is still engaged in on a 
massive basis every day by the firms represented on this panel. 
We have not learned that lesson.
    In my written testimony, we have a very specific proposal 
about how you can change those capital requirements. But I 
think it is going to be hard to do because you are going to be 
fought every inch of the way by the people who make a lot of 
money on this regulatory arbitrage.
    Senator Merkley. Thank you.
    Chairman Dodd. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman. Let me thank all 
of our witnesses.
    As I approach this issue, I look at it as how do we strike 
the right balance, the appropriate regulations at the end of 
the day to make sure we don't have another taxpayer bailout, 
and at the same time the opportunity to make sure that growth 
can take place in our country.
    But I have to be honest with you. I was reading through the 
written testimonies and I get a sense that while we take--it is 
like a Texas two-step. We claim the veneer of saying that we 
understand and need reform. And then we have so many caveats to 
it that we, in essence, undermine the very essence of reform. 
And that just--that dog simply is not going to hunt because if, 
in fact, we have what we had in the past, we are destined to 
relive it again.
    And I hope the financial institutions, those that are here 
and others, understand that because they would be far better 
served in helping us strike the right balance on the pendulum 
than going ahead and just fighting us tooth and nail.
    I have got to be honest with you, when I walk the streets 
of New Jersey, the average person comes up to me and says you 
know what? When I make a mistake, I have to pay for my mistake. 
And when they--meaning some of our financial institutions--make 
a mistake, I also have to pay for their mistake. Something is 
wrong with that, Senator.
    And so I think sometimes my friends on the street have a 
disconnect with average Americans in this country, and it is a 
dangerous disconnect. It is a dangerous disconnect. I think 
everybody would be better served in honestly moving forward on 
    Let me ask you, Mr. Corrigan, I read your written statement 
and, you know, on page 10 you say that there is no question 
that the drive to shrink the size and activities of large and 
complex financial institutions is understandably driven by the 
political and public outrage about the use of taxpayer money to 
bail out institutions that were deemed too big to fail. And 
then you go on to say that because of that, observers believe 
that the easiest way to solve the problem is some combination 
of shrinking the size of these institutions and restricting 
their activities.
    But it is really more than the public and political 
outrage. You are not dismissing the fact that there is a need 
to actually do something here?
    Mr. Corrigan. Of course not, Senator.
    Senator Menendez. If you would put your microphone on, I 
would appreciate it.
    Mr. Corrigan. I am sorry. Of course not, Senator.
    Senator Menendez. The statement seems sort of like 
dismissive, in my mind.
    Mr. Corrigan. Then I did not do a very good job of drafting 
the statement, because if you look at the second section of 
that statement, it talks in very concrete detail of what I call 
the essential financial reform agenda going forward, and it is 
a line-by-line recitation of the things that I think must be 
done to get ourselves ahead of the curve for the next problem.
    I talk, for example, about the need for substantial 
increases in both capital and liquidity, the need to look at 
capital and liquidity as a singular integrated discipline. I 
talk about the enhancements we need to the financial 
infrastructure. I talk about the improvements we need in 
supervision and regulation.
    So again, if that is the interpretation, Senator, that you 
are drawing, I did not do a very good job of drafting that 
    Senator Menendez. Well, let me ask you, do you believe that 
there is any disconnect between entities like Goldman Sachs and 
the public at large?
    Mr. Corrigan. Unfortunately, I would have to agree that 
there is.
    Senator Menendez. You know, I think part of that 
disconnect, when I look at that Goldman has set aside an 
astronomical sum of $16.2 billion in compensation for 2009, 
that is 50 percent more than in 2008, and that is happening in 
a year in which the financial system nearly collapsed and 
Goldman Sachs received at least $24 billion in taxpayer 
assistance, including $14 billion from the bailout of AIG.
    And so I look at that and I look at that in the 
juxtaposition of what Goldman is trying to do, which I think is 
laudable, but definitely underfunded in terms of your small 
business project, where you are basically going to put out 
maybe $500 million, which is about 3 percent of the amount 
Goldman has allotted to compensation about 2 percent of the 
amount Goldman has received in taxpayer assistance, and I say, 
how is that being responsive to these times? Sixteen-billion 
dollars in compensation, $500 million to lend to small 
    Mr. Corrigan. Well, let me respond to that on two levels. 
First of all, as I said before, I do agree with you that there, 
unfortunately, is a disconnect here. But having said that, I 
would just make a couple of observations.
    First of all, I do think it is entirely accurate to say 
that the compensation framework at Goldman Sachs as it was 
amended further this year, I think is consistent to both the 
letter and the spirit of the various G-20 and other official 
guidelines on compensation. Now, that doesn't change the facts 
of the arithmetic, but I think that is a factually accurate 
    With regard to your comment on our small business 
initiative, I guess, again, I would make two or three 
observations. First of all, if that initiative turns out to be 
as successful as the earlier initiative we did on 10,000 women, 
it will be quite successful.
    Second, as that program begins to get legs, which is 
hopefully quite soon, I, for example, look forward personally 
myself, as being one of the mentors that will work with small 
business and small business leaders in the New York 
metropolitan area, and I am not suggesting you can put a price 
tag on that, but there will be hundreds, I suspect thousands of 
officials at Goldman Sachs that will be doing that as part of 
their personal contribution to the thing.
    And the last point I would make, Senator, is that in the 
general area of providing financial support to medium-sized 
businesses and to some extent small businesses, Goldman, as you 
know, essentially is a wholesale firm. But the fact of the 
matter is that we are in the process of stepping up our 
programs and one of our business units aimed at both debt and 
equity support for small and medium-sized companies. We are in 
the process also of putting into place in the Goldman Sachs 
Bank, which is quite small, another program that is 
specifically targeted and directed at small and medium-sized 
    So it is not as if I think we are perfect. We are not. But 
I think we are sensitive to the very issues that you have 
    Senator Menendez. Mr. Chairman, if I just may, one last 
    Chairman Dodd. [Nodding head.]
    Senator Menendez. You know, I appreciate what you are 
saying, but the numbers belie it and this is my concern. The 22 
banks that received the greatest amount of TARP funding have 
dropped their small business lending portfolio by $10 billion 
over the past 6 months. So as I said, your goal at Goldman is 
desirable, but you are significantly, in my view, underfunding 
it, especially when I look at the amount of money that is going 
to compensation. It is, like, 3 percent of that amount.
    And last, you know, this disconnect--I know people don't 
want to hear about it, but for a while, it just seems to me 
that the industry would be best served--the Times of London 
reported that your CEO is likely to receive even more money 
this year than his record $68 million a year. Is that true?
    Mr. Corrigan. That is nonsense.
    Senator Menendez. OK.
    Mr. Corrigan. Total and absolute nonsense.
    Senator Menendez. I am glad to hear that, because that is 
the type of challenge--I mean, $68 million, I am happy for----
    Mr. Corrigan. Trust me, it is not going to be that.
    Senator Menendez. ----to be able to get $68 million, but at 
the end of the day, if we see that type of reported increases--
    Mr. Corrigan. It is not going to happen.
    Senator Menendez. ----it just makes it very difficult----
    Mr. Corrigan. It is not going to happen.
    Senator Menendez. ----for people on Main Street to continue 
to understand why their taxpayer dollars should continue to 
fund institutions that, one, don't get it; two, fight financial 
reform; and three, ultimately have them holding the bag. And we 
need to change that if we want to strike the right balance 
    Thank you, Mr. Chairman.
    Mr. Corrigan. Senator, please. Personally, I have a great 
deal of sympathy for everything you have just said.
    Chairman Dodd. Very good. As I said earlier, we have a vote 
that will be occurring shortly, so I am going to ask a couple 
of quick questions, then I will turn to Senator Shelby and 
Senator Corker. We will stay on as long as we can before we 
have to leave for the vote. I am not bringing people back.
    Let me ask you to respond to--other Members to respond to 
what Professor Scott said earlier, and Senator Corker began 
that conversation, as well, and it is the interconnectedness 
issue, John, because I think we have wrestled with that in our 
conversations, as well. We clearly want--and there is a 
growing, I think almost unanimous consensus here, although I 
hesitate to say that until we actually get to the bill itself--
but a consensus about the ``too big to fail'' notion. And I 
think, again, you have all expressed your views on it, as well.
    Having said that, and in getting from Point A to Point B, 
where, again, the interconnectedness issue is not an irrelevant 
issue in today's economy and probably going to be a growing one 
in the global economic sense. So to what extent--what is the 
impact of that, potentially, on institutions' behavior? If we 
write in this matter here, what is likely to occur if we write 
this in a way that does make this about as, to use the word 
euthanasia that Paul Volcker used here, what are the 
implications of that for you?
    You have all agreed with this, but what if what Professor 
Scott raised is accurate and, in fact, you face a situation 
where one institution should fail. No one questions that at 
all. What they have engaged in is clearly behavior of their own 
making, their own fault. Shut them down. Put them in 
receivership. But a lot of these other healthy companies out 
there, good companies, operating well, but are connected with 
the failure of that institution. Is that a legitimate question 
Professor Scott raises, and if so, what are going to be the 
behavior changes that will occur institutionally, particularly 
in global markets? Gerry.
    Mr. Corrigan. This is really, Mr. Chairman, the crux of the 
issue. Let me give you, again, an example or two of the kinds 
of things we can be doing to make it much easier to deal with 
interconnectedness when we find ourselves in the very situation 
that you have described, the next train wreck.
    One example: Some institutions, certainly Goldman Sachs is 
one of them, have gone through--and I know about this because 
it was another one of my ideas--a very rigorous exercise that I 
call close-out stress test. It is very complicated. I am not 
going to bother you with the details. But what it is designed 
to do is to take hypothetical but very real world situations in 
which you say, just for the hell of it, let us assume that X 
and Y hit the tank. What do I do? How do I know what my 
exposures are? What do I do to manage those exposures? What 
approaches can I or can I not take in terms of closing out 
    Now, I have been arguing--and Barry Zubrow can be my 
witness--I have been arguing for years that one of the basic 
standards that should apply to all large integrated financial 
intermediaries is that those institutions should be able in a 
matter of a couple of hours to put together counterparty 
exposures across--to particular counterparties across all 
products, across all locations, across all markets, both gross 
and net, and to do that within a couple of hours, because that 
is how you begin to get your arms around interconnectedness.
    I, Barry, don't want to get myself too far out on a limb 
here, but I think I can probably say that the world is not full 
of institutions that even today can do that. Goldman Sachs can 
do that, and I suspect JPMorgan can do it, but I am not so sure 
how far that goes.
    So that is, again, a very concrete example of the things 
that we can and must do to put ourselves in a position to 
better deal with the interconnectedness. This list of 
prerequisites that is on the last page of my statement for 
winding down and closeout is another.
    So I am not ready to accept for 1 minute, and I don't 
think, Hal, you are, either, that we are hostage to a system 
that is so complicated that we can't deal with it. I just don't 
buy that. But I also say we have got a hell of a lot of work to 
do to get to that point.
    Chairman Dodd. Does anyone else want to comment on this? 
Mr. Johnson.
    Mr. Johnson. I think Professor Scott made a very deep point 
with regard to LTCM, certainly. It is the surprise 
interconnectedness. Now, maybe we can measure these. Maybe the 
regulator will catch up, to some degree, with the technology. 
But you are always going to be surprised in a big crisis.
    And then I think it comes down to two things. First, how 
big is this problem relative to the economy? Take CIT Group, 
for example, that failed last year. CIT Group had a balance 
sheet of $80 billion. There was a big debate, as you know, in 
Washington about whether they were too big to fail, and it was 
decided, rightly, despite their interconnections that were 
known and unknown, that they could fail--and did fail, have 
essentially failed--without disrupting the system. That is what 
we know. That is the biggest financial institution we have let 
fail and it hasn't had the systemic implications. Eighty-
billion, that is what we know.
    In addition to the size, it is about capital. It is about 
capital and derivative positions. I mean, that is the part that 
we know about, the part that Professor Scott and Mr. Reed have 
been emphasizing. These derivative positions with low capital 
requirements are asking for trouble. They are still there and 
they are not going away in the existing framework.
    Chairman Dodd. In fact, Barry raised the issue--I think it 
was he--do you see any deeper threats with banks that are 
creating over-the-counter derivatives, for instance. That kind 
of a matter poses some additional--when you start getting 
specific about the kind of proprietary trading that can occur, 
then you do begin to see some potential here for a larger 
question. Do you agree with that?
    Mr. Scott. Well, I think a lot of the derivatives business 
is client-based, and so--and hedged--so I am not sure it is a 
problem. But I think Mr. Corrigan has raised a very good point. 
As part of our arsenal of weapons against interconnectedness, 
perhaps there should be a requirement that every large or 
important financial institution stress test itself, supervised 
by the regulators, so that they could survive a failure of 
their major counterparties. This would be basically what 
Goldman Sachs is doing. I think this is something that every 
financial institution should do and the regulators should 
require it.
    Chairman Dodd. Yes, go ahead, quickly.
    Mr. Johnson. I have to ask the question, if Goldman Sachs 
is the gold standard of stress testing, why did they need to be 
rescued by being converted into a bank holding company in 
September of 2008? I don't understand. That is a disconnection.
    Mr. Corrigan. That is a gross overstatement.
    Mr. Johnson. Well, I am not sure if you had a chance to 
look at Mr. Paulson's book yet. I don't think he regards it as 
an overstatement.
    Mr. Corrigan. Well, I mean, clearly, and Goldman Sachs and 
Morgan Stanley were made bank holding companies at the height 
of the crisis, and I think that turned out to be a very good 
thing. As I say in my statement--I was very clear about this--
that we do benefit unquestionably from the intensity of the 
Federal Reserve's consolidated supervision of Goldman Sachs. 
But I don't think it follows from any or all of that that the 
mere fact--the mere fact of making Goldman Sachs a bank holding 
company constituted a bailout of Goldman Sachs. That is kind of 
pushing it.
    Chairman Dodd. Let me turn to Senator Shelby.
    Senator Shelby. A few observations. Professor Scott, on the 
Volcker Rule, in your judgment, the spirit of the Volcker Rule, 
I think, is a good idea. It is how you implement it and under 
what circumstances, how you do it, who would do it. Do 
regulators at the present time have the power to deal with 
that, or would we need to give the regulators some specific 
power outside of what they have, whoever winds up as the 
regulator--it might not be the Fed--and so forth. Do you have 
any documents?
    Mr. Scott. I think they have the power as part of their 
general safety and soundness responsibility, and examining 
institutions, if they find----
    Senator Shelby. But they have got to have the will, haven't 
they? They have got to have the will.
    Mr. Scott. Well, that is another question. You know, if I 
look at the Kanjorski Amendment, for instance, which is 
basically saying I want to give you this power, OK, to deal 
with large risks if banks are taking them, it is duplicating--
    Senator Shelby. They already have it, don't they?
    Mr. Scott. ----what powers are already there. But it is 
kind of underlining. Maybe there is a value to that, of just 
underlining the importance that the Congress sees in exercising 
that responsibility. But in terms of legally, yes, I think they 
have the power.
    Senator Shelby. And what about what Senator Dodd and 
Senator Corker have raised, and you have, too, on the panel, 
the problem of interconnectedness? That is in ``too big to 
    Mr. Scott. That is the absolute----
    Senator Shelby. Can the regulator deal with that now under 
the safety and soundness, in your judgment?
    Mr. Scott. Yes. I think if a regulator believed today that 
an institution that they were supervising were not able to 
survive the failure of their significant counterparties, they 
could do something about it. Now, that being said, the ability 
to understand that----
    Senator Shelby. That is right.
    Mr. Scott. ----that is hard.
    Senator Shelby. Professor Johnson.
    Mr. Johnson. I think that the evidence is very clear, that 
even the FDIC, which is actually pretty good, arguably even 
world class, at taking over relatively small- and medium-sized 
banks, even they come in too late. If the FDIC were doing its 
job properly, we would never need any taxpayer money. They 
would always come in while there was still enough capital 
    Senator Shelby. Prevent it, in other words?
    Mr. Johnson. Absolutely. Preventive action doesn't take 
place, even for the relatively less political ones. In terms of 
the point about the power and the caps here, let me remind you 
that under the Riegle-Neal Act, there is a cap on the size of 
our largest banks. That cap was waived every time the big banks 
asked for it. So JPMorgan Chase, Wells Fargo, and Bank of 
America all exceed the cap in that law, just because they asked 
for it. They were allowed to become bigger. So it is the same 
thing that would happen with all these other----
    Senator Shelby. And who waived it? The regulator. And who 
was the regulator? The Federal Reserve, right?
    Mr. Johnson. Absolutely.
    Senator Shelby. OK. Now, as we wrestle with this, we all 
know, and you know because you spend your life in this as 
either a professor or consultant or a banker, it is very 
complex, and as Senator Dodd said, there always--when we raise 
a question, then it begets another one to deal with. But do you 
know--do any of you know of any institution, financial 
institution, that has been well capitalized--we talked about 
capital here earlier--well capitalized, well managed, Mr. Reed, 
and well regulated that has failed? Do you?
    [Witnesses shaking heads.]
    Senator Shelby. I don't, either.
    Thank you, Mr. Chairman.
    Chairman Dodd. Jack.
    Senator Reed. Well, thank you very much.
    This issue of regulatory capacity, I think is important. 
Professor Scott, if someone called you up and said, the Fed is 
threatening me, shutting me down because they think my 
counterparties are unreliable, could you come up with some 
legal arguments why the Fed couldn't do that? Is it so clear 
they have that authority?
    Mr. Scott. No, I would not say they could shut you down, 
but what I think they could do is tell you to change your 
business to get rid of that problem.
    Senator Reed. Are there any examples where the Fed has 
actually gone in and told people to change their business?
    Mr. Scott. That happens every day to banks across the 
United States.
    Senator Reed. But apparently it didn't happen with respect 
to some critical issues.
    Mr. Reed, you look like you want to say something. Do you 
have some experience with this?
    Mr. Reed. I am just smiling because you are absolutely 
correct. It didn't happen with--I don't think there are many 
examples where regulatory structures have been able to 
anticipate these kind of problems. You know, it didn't happen 
in Germany, which has a very different structure. It didn't 
happen in England, which has a quite different structure. And 
it didn't happen in this country.
    Senator Reed. I want to get to an issue that we have been 
spending some time on, and that is derivatives. One argument 
that end users are making is that this would deny them sort of 
a great financial benefit which would cause them to retract in 
many different ways. But, Mr. Reed, you ran a major financial 
institution which presumably did derivatives, end user 
    Mr. Reed. Yes, sir.
    Senator Reed. Did you, when your people were selling these, 
did you reserve the margin that you needed to cover the risk 
and did the ultimate end user pay for that margin, or----
    Mr. Reed. Yes. No, I mean, we put caps on the size of the 
business within the total company. You know, you run these 
businesses with caps, and this is why I think this argument 
that you don't know what you are doing just doesn't make any 
sense. If a trading room has a certain limit to take to have 
open positions, you know what those limits are. So we did have 
a derivative function and it was global. In other words, we 
operated in the derivative markets around the world. But we had 
limits with regard to positions. We had limits with regard to 
counterparties. And you run the business so, hopefully, it 
can't produce a massive problem for the institution.
    Senator Reed. This is a very lucrative business with banks, 
and at least one could argue that in either a clearing platform 
or a trading situation, that this would be much more cost 
effective for end users. But there seems to be this willingness 
to pay significantly for these credit default swaps, these 
over-the-counter devices. What is your sense on that, if I----
    Mr. Reed. Well, I think what happened is that they didn't 
attract much capital and so it appeared that you were able to 
significantly augment your earnings. I mean, what happened is 
the banks were basically using capital both for their customer 
business and for their trading businesses and they were 
doubling up on it. Obviously, this causes your return on 
capital to go way up.
    I mean, the Deutsche Bank is a wonderful example. They 
announced publicly that they were going to get their return on 
capital up to 20 percent. Anybody who has done business in 
Germany knows that sort of a natural rate in the German market 
is maybe 7 or 8 percent. The only way they were able to do that 
was to build a significant trading and proprietary investing 
business on top of their banking business, and they did, in 
fact, achieve that result. They also ducked the great bulk of 
the problems that we are today confronting. They never did get 
any form of government assistance in Europe or elsewhere. So it 
can be done.
    But the point is, the attractiveness of this kind of 
activity is that it hasn't brought capital with it and 
therefore you are basically doubling up and you are able to 
earn better returns for your stockholders.
    Senator Reed. Mr. Johnson.
    Mr. Johnson. Senator, we also have to remember that the 
``too big to fail'' is a form of implicit subsidy from the 
taxpayer, which lowers the cost of funding for these derivative 
transactions. So one reason the massive banks were able to 
dominate this market is because they are viewed by the credit 
markets themselves as too big to fail. That gives them an 
unfair advantage that enables them to scale up and create even 
more risk for the taxpayer.
    The Bank of England financial stability people are calling 
this entire structure a ``doom loop'' because it is a repeated 
cycle of boom, bust, bailout, and we are just running through 
this again.
    Senator Reed. We have talked about interrelatedness, and I 
think that is a theme that everyone agrees to. But, Mr. 
Johnson, in terms of derivative trading, to what extent is that 
a key factor in this interrelatedness? I know there is no magic 
one thing, but it strikes me, given the notional size of 
derivative trading, given the fact that it inherently is 
staking your future to somebody else's future, would be one of 
the key drivers in some of these interrelated issues we have.
    Mr. Johnson. Absolutely, Senator. So Mr. Corrigan said a 
little while ago that the total balance sheet of Goldman Sachs 
right now is about $800 billion. But what is the balance sheet 
if you take into account derivative positions? That depends on 
risk models that they run that they report to other people. 
Perhaps the regulator has some independent ability to assess 
that. Perhaps the market has some ability to see through what 
they are doing. I actually don't think that they do.
    So derivatives are very important because that is the 
complexity and it is where a lot of the interconnectedness 
today is manifested in problems that will always be there, and 
it is where a great deal of problems occur whenever there is a 
crisis. We just don't know what is the true balance sheet, what 
are the true risks, what is the true capital of these financial 
institutions without relying on their own risk models, and 
those risk models failed dramatically and repeatedly in the 
run-up to September of 2008.
    And with respect to Mr. Corrigan and the idea that Goldman 
Sachs was not saved by becoming a bank holding company, what 
would have happened to Goldman Sachs if it had not become a 
bank holding company, particularly based on its derivative 
exposure and what had happened in and around AIG?
    Senator Reed. You should turn on your microphone, Mr. 
Corrigan, because we want to hear you.
    Mr. Corrigan. This is getting a little frustrating. In 
terms of derivatives, first of all, as a general matter, and I 
will come to Goldman Sachs in a minute, the fact of the matter 
is that over the past few years, there have been substantial 
improvements made in the entire infrastructure surrounding the 
way derivatives are traded, the practices for margining, the 
practices for collateral, the practices for closeout, and we 
are now, as you know, in the first stages of getting most 
derivatives through so-called ``CCPs,'' central clearing 
counterparty things, that clearly is a potentially huge 
reduction in systemic risk associated with derivatives 
activities in general. And that effort is still ongoing. I 
personally am very involved with that effort and Goldman Sachs 
certainly is one of the most enthusiastic supporters of all of 
those initiatives.
    Now, on the risk profile questions, as I think everyone 
knows, balance sheets are an imperfect indicator of financial 
profiles in general. But it is also true that in all of the 
risk metrics that organizations like Goldman Sachs and others 
use these days, in terms of all forms of stress tests and other 
contingent-type analyses that are done daily. All aspects of 
exposures, gross and net, margined, unmargined, et cetera, are 
taken into account in a context in which risk models in and of 
themselves are only one metric that is used in this process. 
And there are literally dozens of other metrics that are used 
to try to take account of the fact that risk models by their 
very nature are backward-looking, and as a result, are 
inherently flawed. We all know that and we try in the best ways 
that we can to take account of that in terms of how we think 
about risk.
    In addition to that, all of the stress tests and other 
things that are done in risk mitigation efforts are done and 
are looked at by the authorities, not just in the United States 
but around the world.
    So again, I am not Pollyanna-ish. I think I understand the 
risks associated with derivatives and most other things that 
you think about as well as anybody else. I spend a substantial 
part of my time trying to build and help the industry build 
better mousetraps to be able to deal with risk and risk 
    So again, I am sure I make mistakes. I am sure I don't get 
it right every time. But I also am sure that I have had as much 
experience over what is now 43 or 44 years in dealing with 
these questions and these issues on both sides of the street.
    Senator Reed. No, we appreciate that, Mr. Corrigan. Your 
leadership of the Federal Reserve Bank of New York was a great 
    Mr. Corrigan. Thank you.
    Senator Reed. I have this feeling, though, in terms of 
regulation that there is a 27-year-old----
    Mr. Corrigan. There is.
    Senator Reed. ----across the table from you talking about 
why your risk models are wrong, and I think you win that 
conversation every time, and that is one of the problems we 
have in terms of----
    Mr. Corrigan. I agree with that, Senator.
    Chairman Dodd. Jack added to the age. I said they were 22 
    Senator Reed. They spent some time in the Army.
    Chairman Dodd. There you go. That is a good thing to do.
    Senator Merkley, I am going to let you know we have got a 
couple of minutes left before the vote closes out, so why don't 
you go ahead and finish up.
    Senator Merkley. I have the same microphone problem. There 
we go.
    Mr. Corrigan, you seemed a little sensitive when it was 
suggested that Goldman Sachs was bailed out, if I caught your 
reaction right there. So to the----
    Mr. Corrigan. Let me just, if I could, be very clear on 
this. I was reacting more to the specific language that was 
used. Look, there is no question--none whatsoever--that when 
you look at the totality of the steps that were taken by 
central banks and governments, particularly in 2008, that 
Goldman Sachs was the beneficiary of this. There is no doubt 
whatsoever about that, as well as everybody else. I mean, that 
is what those extraordinary measures were all about.
    So again, I am not suggesting for 1 minute that Goldman 
Sachs was not a beneficiary of these initiatives. It was, 
    Chairman Dodd. Let me--Senator, we have a minute left on 
the vote on the floor. I will leave the record open, but I am 
afraid we are going to have to leave ourselves or else we will 
miss a vote, so we are going to have to terminate the hearing. 
I apologize.
    Senator Merkley. Thank you all very much.
    Chairman Dodd. And let me thank all of you very, very much. 
We could literally go on all day. You have been tremendously 
valuable, your testimony. We would like to follow up with you 
on some of these ideas and suggestions as we are trying to 
draft this legislation. I think we need further conversation.
    Gerry, we thank you for your long testimony you submitted. 
It is very valuable to have that, as well, as part of the 
    John Reed, good to see you again, as well.
    Hal, we love having you back here.
    Barry, you are always welcome at the Committee.
    And Professor Johnson, thank you for your presence here 
today, as well.
    The Committee will stand adjourned.
    [Whereupon, at 12:48 p.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]
    Thank you Mr. Chairman.
    On Tuesday, we heard from Paul Volcker, Chairman of the President's 
Economic Recovery Advisory Board, and from Treasury Deputy Secretary 
Wolin, about the Administration's most recent regulatory reform 
    I remain willing to consider any proposal that will strengthen our 
regulatory framework and help our economy.
    Before we do so, however, we must understand the objectives of any 
proposal, and how those objectives are to be met.
    The newest proposals are the so-called ``Volcker Rule'' to ban 
proprietary trading and hedge fund activities from firms with insured 
depositories, as well as limits on a bank's share of market 
    The stated objective of the Administration's newest proposals is to 
enhance the safety of the banking system. I certainly agree with that.
    Unfortunately, the manner in which the Administration's proposals 
will accomplish that objective remains elusive.
    With respect to placing limitations on the proprietary trading 
activities of banks, Chairman Volcker and Mr. Wolin seem conflicted on 
how regulators could, in practice, distinguish proprietary trades from 
trades made by banks to help fulfill customer needs.
    Chairman Volcker said that regulators should not be given the 
discretion to place restrictions on proprietary trading. Yet, when 
pressed for details on how the regulations would be implemented, Mr. 
Wolin stated: ``Like an awful lot of banking law and a lot of the 
proposals, lots will be left to the regulators to implement in a very 
detailed way.''
    When I asked about size limits, and how regulators would define 
``excessive growth,'' Chairman Volcker paraphrased the late Justice 
Potter Stewart: ``You know it when you see it.''
    Mr. Wolin failed to provide any more clarity when he said: ``We do 
not have the details of that fully nailed down.''
    As I stated on Tuesday, the manner in which the President 
introduced these new ideas is not conducive to developing thoughtful, 
comprehensive reform legislation.
    Chairman Dodd and I have made meaningful progress in our 
discussions on regulatory reform. It is my hope that we will continue 
to do so.
    Our overarching goal must remain eliminating taxpayer bailouts 
while establishing the strongest, most competitive, and economically 
efficient regulatory structure possible.
    Achieving this goal will involve consolidating our financial 
regulators, modernizing derivatives regulation, and strengthening 
consumer protection without undermining the safety and soundness of our 
financial institutions. In my view, these goals are not negotiable.
    We have a unique opportunity to make significant and necessary 
changes on a bipartisan basis. Whether we seize this opportunity 
remains to be seen.
    Thank you Mr. Chairman.
               Managing Director, Goldman, Sachs and Co.
                            February 4, 2010
    Chairman Dodd, Ranking Minority Member Shelby, and Members of the 
Committee, I am thankful for this opportunity to share with you my 
views on the urgently needed financial reform process in the wake of 
the financial crisis. As the Committee knows, in my earlier career at 
the Fed and in my current second career in the private sector, public 
policy issues relating to the quest for greater financial stability 
have been a subject of continuing interest to me.
    The views I will express today on financial reform are very much 
driven by what I consider to be in the best interest of long-term 
financial stability. Having said that, I cannot deny that there are 
instances in which my thinking about specific issues has been 
influenced by my tenure as an employee of Goldman Sachs and by what I 
have seen transpire during that period. To cite one clear example, in a 
sharp departure with my earlier thinking, I now recognize the value and 
importance of the so-called ``fair value'' or mark-to-market 
    At the center of the great debate about financial reform is the 
universal agreement that the ``Too Big to Fail'' problem must be 
forcefully resolved in order to provide comfort that future problems 
with failures of large and complex financial institutions will not be 
``bailed out'' with tax payer money. Achieving that goal will not be 
easy but it is not impossible.
    My formal statement contains four sections as follows:

    Section I: The Financial Reform Agenda

    Section II: Alternative Financial Structures in Perspective

    Section III: The Merits of Alternative Financial Structures

    Section IV: The Challenges Associated With Enhanced 
        Resolution Authority
Section I: The Financial Reform Agenda
    In looking to the future, almost everyone who has seriously studied 
the causes of the crisis agrees that certain basic reforms are a must. 
In summary form, those basic reforms include the following:

  1.  The creation of a so-called ``systemic regulator.'' Among other 
        things, the mission of the systemic regulator would include 
        oversight of all systemically important institutions and, 
        importantly, looking beyond individual institutions in order to 
        better anticipate potential sources of economic and financial 
        contagion risk including emerging asset price bubbles. 
        Anticipating future sources of contagion is difficult but not 

  2.  Higher and more rigorous capital and liquidity standards that 
        recognize the compelling reality that managing and supervising 
        capital adequacy and liquidity adequacy must be viewed as a 
        single discipline.

  3.  Substantial enhancement in risk monitoring and risk management 
        and more systematic prudential oversight of these activities.

  4.  The increased reliance by institutions and their supervisors on 
        (1) stress tests; (2) so-called ``reverse'' stress tests; and 
        (3) rigorous scenario analysis of truly extreme contingencies.

  5.  Efforts to intensify the never ending task of strengthening the 
        infrastructure of the global financial system.

  6.  The creation of a flexible and effective framework for the timely 
        and orderly wind-down of failing large and complex financial 
        institutions (the Enhanced Resolution Authority discussed in 
        Section IV).

  7.  Substantially enhanced cross-border cooperation and coordination 
        on a wide range of issues from accounting policy and practice 
        to more uniform prudential standards to better coordinated 
        macroeconomic policies.

    I believe that these measures--coupled with others that are in the 
House Bill such as tightening up the administration of Section 13 (3) 
of the Federal Reserve Act--will, over time, reduce the probability of 
future financial crises and materially help to limit or contain the 
damage caused by crises. Having said that, I want to underscore three 
key points: First; the execution challenges associated with this reform 
agenda are enormous. Second; the reforms are a ``package deal'' such 
that if we fail to achieve any one of these measures the prospects for 
success in the others will be compromised. Third; if we are successful 
in implementing the agenda over a reasonable period of time the case 
for wholesale restructuring of the financial system would hardly be 
Section II: Alternative Financial Structures in Perspective
    At the risk of considerable oversimplification, there are three 
somewhat overlapping suggestions on the table that are calling for a 
major restructuring of the core of the financial system both 
domestically and internationally. The more extreme of the three is the 
so-called ``Narrow Bank Model'' which, in effect, suggests that 
``banks'' should essentially take deposits and make loans. The second 
approach would limit the scope of activities in banks and in companies 
that own banks but would allow nonbank affiliates of bank holding 
companies to conduct certain other financial activities including the 
underwriting of debt and equity securities while sharply curtailing or 
prohibiting banks and bank holding companies from engaging in 
``proprietary'' trading and operating or sponsoring hedge funds and 
private equity funds.
    The third approach is the view that subject to a comprehensive and 
rigorous family of reforms as outlined in Section I, most large 
integrated financial institutions would be allowed to maintain much of 
their current configuration while being subject to much more demanding 
consolidated supervision.
    To many, the frame of reference surrounding the debate on these 
alternatives seems to be very much a matter of black and white. If we 
were starting with a clean slate, that might be the case. 
Unfortunately, we are not starting with a clean slate--far from it. 
Therefore, allow me to briefly focus on a few observations that--in my 
judgment--frame the perspective to be considered in shaping the debate 
on alternative financial structures.
    First; I have always believed that banks (whether stand alone or 
part of a Bank Holding Company) are special. Among other things, that 
is one of the reasons I agreed to take on the role of nonexecutive 
chairman of the Goldman Sachs Bank when Goldman became a Bank Holding 
Company in the fall of 2008.
    Second; under existing law and regulation there are now in place 
rigorous restrictions as to the activities that may be conducted in a 
bank that is part of a Bank Holding Company and even more rigorous 
standards limiting transactions that can occur between the bank, its 
holding company and its nonbank affiliates. Also, under precrisis rules 
regarding the administration of the discount window, access to the 
discount window applied only to the bank and such access did not 
extend, either directly or indirectly, to the Holding Company or the 
Bank's nonbank affiliates. As the Fed winds down its crisis driven 
extraordinary interventions, I believe we should return to the 
precrisis rules regarding access to the discount window so long as 
Section 13 (3) lending remains a possibility in extreme circumstances.
    Third; under existing law and regulation, the Federal Reserve, as 
the consolidated prudential supervisor of all U.S. Bank and Financial 
Services Holding Companies, already has broad discretionary authority 
to remove officers and directors, cut or eliminate dividends, shrink 
the balance sheet, etc. The Bill passed by the House in December would 
further strengthen this authority and extend it to systemically 
important financial institutions even if they do not own or control a 
    While on the subject of consolidated supervision, allow me to say a 
few words about the experience of Goldman Sachs since the Fed (working 
with other regulators) became its consolidated supervisor 16 months 
ago. First, and most importantly, I would describe that relationship as 
open, highly constructive, and very demanding. The Fed has now 
completed comprehensive full scale examinations of the Bank and the 
Group and reported the results of such examinations to both the Boards 
of the Group and the Bank. In addition, a large number of targeted 
exams and so-called ``discovery reviews'' have been completed or are in 
progress. In the case of major forward-looking supervisory initiatives 
on the part of the Fed in collaboration with other supervisory bodies--
both domestic and international--I personally have actively 
participated in all such discussions. Finally, and to put a little 
color on this subject, on more than a few occasions my high-level 
associates at Goldman Sachs have said to me something along the 
following lines: ``these guys (referring to the supervisors) ask damn 
good questions.''
    Fourth; given all that we have been through over the past 2 years, 
many observers are raising the perfectly natural question of whether 
society really needs large and complex financial institutions. Whatever 
else can be said about such large and complex financial institutions, 
financial services is one of the few sectors of the economy that make a 
consistent positive contribution to the U.S. balance of payments.
    Balance of payment issues aside, I strongly believe that well 
managed and supervised large integrated financial institutions play a 
constructive and necessary role in the financial intermediation process 
which is central to the public policy goals of economic growth, rising 
standards of living and job creation.
    While the business models of the relatively small number of large 
and complex financial institutions in the U.S. and abroad differ 
somewhat from one to another, as a broad generalization most are 
engaged to varying degrees in (1) traditional commercial banking; (2) 
securities underwriting; (3) a range of trading activities including at 
least some elements of ``proprietary'' trading; (4) financial advisory 
services; (5) asset management services including the management of so-
called ``alternative'' investments; (6) private banking; and (7) 
elements of principal investing.
    All of these large integrated financial groups are indeed large 
with balance sheets ranging from the high hundreds of billions to $2.0 
trillion or so. Among other things, it is their size that allows these 
institutions to meet the financing needs of large corporations--to say 
nothing of the financing needs of sovereign governments. The fact that 
so many of these large corporations operate on a global scale is one of 
the reasons why almost all large financial intermediaries also have a 
global footprint. As an entirely practical matter, it is very difficult 
to imagine how the vast financing needs of corporations and governments 
could be met on anything like today's terms and conditions absent the 
ability and willingness of these large intermediaries to place at risk 
very substantial amounts of their own capital in serving these 
companies and governments. One of the best examples of this phenomenon 
is the role large intermediaries have played in the recent past in 
raising badly needed capital for the financial sector itself.
    For example, over the past 2 years banking institutions in the U.S. 
and abroad have raised more than one-half trillion dollars in fresh 
private capital and the capital raising meter is still running. While 
there were some private placements, the overwhelming majority of such 
capital was raised in the capital markets and the associated 
underwriting, operational and reputational risks associated with such 
capital raising, were absorbed by various combinations of the small 
number of large integrated financial groups. Moreover, many of these 
transactions took the form of rights offerings which involve extended 
intervals of time between pricing and final settlement thus elevating 
underwriting risks. The ability and willingness of these large 
integrated financial groups to assume these risks depends crucially on 
large numbers of experienced investment bankers and highly skilled 
equity market specialists who are able to judge the tone and depth of 
the markets in helping clients shape the size, structure, and pricing 
for such transactions.
    More broadly, to a greater or lesser degree, most of these large 
integrated financial groups also act as day-to-day market makers across 
a broad range of financial instruments ranging from Treasury securities 
to OTC derivatives. The daily volume of such market activities is 
staggering and can be measured in hundreds of thousands--if not 
millions--of transactions. As market makers, these institutions stand 
ready to purchase or sell financial instruments in response to their 
institutional (and sometimes governmental) clients and counterparties. 
As such, market-making transactions--by their very nature--entail 
substantial capital commitments and risk-taking by the market maker. 
However, the capital that is provided in the market-making process is 
the primary source of the liquidity that is essential to the efficiency 
and price discovery traits of financial markets. Moreover, in today's 
financial environment, market makers are often approached by clients to 
enter into transactions that have notional amounts that are measured in 
hundreds of millions, if not billions, of dollars. Since transactions 
of these sizes cannot be quickly laid off or hedged, the market makers 
providing these services to institutional clients must have world-class 
risk management systems and robust amounts of capital and liquidity. 
Thus, only large and well capitalized institutions have the resources, 
the expertise and the very expensive technological and operating 
systems to manage these market-making activities. Having said that, it 
is also true that some of these activities are, indeed, high risk in 
nature. Thus, the case for greater managerial focus, heightened 
supervisory oversight and still larger capital and liquidity cushions 
for certain activities are all part of the postcrisis reform agenda.
    Fifth; in terms of both competition and regulatory arbitrage there 
is a critical international component to the outcome of the debate on 
alternative financial market structure in the U.S. That is, if the 
United States adopted a materially different and more restrictive 
statutory framework for banking and finance than, for example, Europe, 
the outcome could easily work to the competitive disadvantage of U.S. 
institutions. Similarly, such an outcome would, inevitably, introduce 
new pressures in the area of financial protectionism which, given the 
existing threats on the trade protection front, is one of the last 
things our country and the world need. Finally, if there are material 
international differences in financial structure and the ``rules of the 
road'' governing banking and finance, it is inevitable that one way or 
another, clever people, aided by highly sophisticated technology, will 
find ways to game the system.
    To summarize, even before approaching the very complex issue 
surrounding the pros and cons of alternative financial structures and 
effectively resolving the ``Too Big to Fail'' problem, we must 
recognize that even modest financial restructurings that would directly 
affect only a small number of institutions worldwide raise many 
questions about the laws of unintended consequences especially in the 
context of the larger agenda for reform discussed in Section I.
Section III: The Merits of Alternative Financial Structures
    There is no question that the drive to shrink the size and 
activities of large and complex financial institutions is 
understandably driven by the political and public outrage about the use 
of tax payer money to ``bail out'' institutions that were deemed to be 
``Too Big to Fail.'' Given that reality, it follows that many observers 
believe that the easiest way to solve the problem is via some 
combination of shrinking the size of these institutions, and/or 
restricting their activities in ways that will curtail risk and 
mitigate the conflicts of interest.
    Having said that, it is also true that while financial excesses 
were unquestionably one of the causes of the crisis, shortcomings in 
public policy were important contributing factors. Similarly, not all 
``banks'' that received direct tax payer support were large and complex 
institutions. Moreover, the largest single source of write-downs and 
losses in financial institutions--complex or not--occurred in 
traditional lending activities not trading activities. Regrettably, 
these lending driven losses and write-downs were magnified by certain 
classes of securitization especially very complex and highly leveraged 
instruments. Finally, it is also undeniable that all classes of 
financial institutions--big banks, small banks, investment banks 
(including Goldman Sachs) and so-called ``near banks''--to say nothing 
of businesses small and large--benefited substantially from the large 
scale extraordinary measures taken by governments and central banks to 
cushion the economic and financial fallout of the crisis.
    The most radical of the restructuring suggestions is the so-called 
``narrow bank'' which would essentially take deposits and make loans. 
As I see it, and with the exception of community banks, this approach 
is a nonstarter given the long history of credit problems over the 
business and credit cycle. In other words restricting diversification 
of risk and revenues is hardly a recipe for stability.
    A less extreme, but still transformational structural change has 
been suggested by Chairman Volcker and endorsed by President Obama. 
While the broad intent of the Volcker approach is quite clear there are 
a number of open definitional and important technical details that are 
yet to be clarified. One area of particular importance relates to the 
definition of proprietary trading and, in particular, the distinction 
between ``prop'' trading and market making. As I see it, client-driven 
market making and the hedging and risk management activities growing 
out of such market making are natural activities of banks and Bank 
Holding Companies. As such, these activities are subject to official 
supervision, including on site inspections, capital and liquidity 
standards and various forms of risk related stress tests.
    The Volcker plan would also prohibit ``banks'' and Bank and 
Financial Services Holding Companies from owning or sponsoring hedge 
funds and private equity funds. I believe that the financial risks 
associated with such ownership or sponsorship can be effectively 
managed and limited by means short of outright prohibition although 
bank owners or sponsors of such funds should not be permitted to inject 
fresh capital into an existing fund without regulatory approval.
    More generally, it should be noted that hedge funds and private 
equity funds are providing both equity and debt financing to small and 
medium sized businesses in such vital areas as alternative energy and 
technology ventures. Given the long term benefits of these activities, 
I also believe there is something to be said for the proposition that, 
subject to appropriate safeguards, regulated Bank Holding Company 
presence in the hedge fund and private equity fund space can help to 
better promote best industry practice.
    I am also mindful of the conflict of interest issue raised by 
Chairman Volcker. There is nothing new about potential conflicts in 
banking and finance. However, it cannot be denied that in the world of 
contemporary finance--with all of its complexities and applied 
technology--managing potential conflicts has become much more 
challenging. Reflecting that fact of life, so-called ``Chinese Walls'' 
segregating some business units from others is a necessary, but not 
sufficient, condition for managing potential conflicts. That is why at 
Goldman Sachs (and other large integrated intermediaries) conflict 
management policies and procedures are constantly evolving and 
    Goldman Sachs has established numerous committees and processes to 
help mitigate potential conflicts. We have a high level Firmwide 
Business Practices Committee which focuses on operational and 
reputational risk, including conflict management. We have a dedicated 
and independent high level worldwide Conflict Management team. We have 
a Firmwide Risk Committee which focuses on financial risk. The Firm's 
independent Legal and Compliance divisions, both of which have 
centralized teams of experts and high level officials who are embedded, 
but still independent, within all of the revenue producing business 
units, contribute to conflicts management. All of these committees and 
business areas are headed by senior officers who sit on the Management 
Committee. Side by side we have a Suitability Committee and a New 
Products Committee. In addition, our Capital Committee and Commitments 
Committee as well as all Division Heads share in the responsibility of 
helping to manage conflicts and reputational risk.
Section IV: The Challenges Associated With Enhanced Resolution 
    There is little doubt that a well designed and well executed 
framework of Enhanced Resolution Authority can address the Too Big to 
Fail problem and the related Moral Hazard problem. However, it is also 
true that a poorly designed and poorly executed approach to Enhanced 
Resolution Authority could produce renewed uncertainty and instability. 
Indeed, under the very best of circumstances, the timely and orderly 
wind-down of any systemically important financial institution--
especially one with an international footprint--is an extraordinarily 
complex task. That is why, at least to the best of my recollection, we 
have never experienced such an orderly wind-down anywhere in the world. 
In other words, even if we successfully implement all of the reforms 
outlined in Section I of this statement, that success by itself, will 
not ensure that Enhanced Resolution Authority can achieve its desired 
effects. Thus, great care must be used in the design of the approach to 
law and regulation for a system of Enhanced Resolution Authority.
    I, of course, have no monopoly on thoughts on how to best approach 
this task. On the other hand, as someone who has devoted much of my 
career to improving what I like to call the plumbing of the financial 
system I do have some suggestions as to (1) certain principles that I 
believe should guide the effort and (2) certain prerequisites that 
should be in place to guide the execution of a timely and orderly wind-
down or merger of a failing systemically important financial 
Guiding Principles
    First; the authorizing legislation and regulations must not be so 
rigid as to tie the hands of the governmental bodies that will 
administer those laws and regulations because it is literally 
impossible to anticipate the future circumstances in which the 
authorities will be required to act.
    Second; in my judgment, the authority and responsibility to carry 
out Enhanced Resolution Authority in a given situation should be vested 
in governmental bodies that have sufficient experience with the type of 
institution being resolved.
    Third; Enhanced Resolution Authority should be administered using 
the ongoing approach which probably means the troubled institution 
would be placed into temporary conservatorship or a similar vehicle 
allowing that institution to continue to perform and meet its 
contractual obligations for a limited period of time.
    As a precondition for conservatorship, one or more of the Executive 
Officers and the Board of the institution would be removed. The ongoing 
approach has many benefits including (1) preserving the value of assets 
that might be sold at a later date; (2) minimizing the dangerous and 
panic prone process of simultaneous close out by all counterparties and 
the need of such counterparties to then replace their side of many of 
the closed-out positions; and (3) reducing, but by no means 
eliminating, the very difficult and destabilizing cross-border events 
that could otherwise occur as witnessed in the Lehman episode. However, 
the ongoing approach is not without its problems, one of which is the 
sensitive question of how well an institution in conservatorship for a 
limited period of time can fund itself.
    Fourth: to the maximum extent possible, the rights of creditors and 
the sanctity of existing contractual rights and obligations need to be 
respected. Indeed, if the exercise of Enhanced Resolution Authority is 
seen to arbitrarily violate creditor rights or override existing 
contractual agreements between the troubled institution and its 
clients, its creditors, and its counterparties, the goal of orderly 
wind-down could easily be compromised and the resultant precedent could 
become a destabilizing source of ongoing uncertainty.
    Finally; the orderly wind-down of any large institution--
particularly such an institution having a global footprint--is a highly 
complex endeavor that will take patience, skill and effective 
communication and collaboration with creditors, counterparties and 
other interested parties. Shrinking a balance sheet or selling distinct 
businesses or classes of assets or liabilities may prove relatively 
simple but the winding down of trading positions, hedges, positions in 
financial ``utilities'' such as payments, clearance and settlement 
systems is quite another matter.
Prerequisites for Success:
    First; as a part of the reform of supervisory policy and practice, 
supervisory authorities responsible for systemically important 
institutions must work to insure that ``prompt corrective action'' 
becomes a reality not merely a slogan.
    Second; the official community must work with individual 
systemically important institutions to ensure that all such 
institutions have--or are developing--the systems and procedures to 
provide the following information in a timely fashion.

    Comprehensive data on all exposures to all major 
        counterparties and estimates of all such exposures of 
        counterparties to the failing institution

    Valuations consistent with prevailing market conditions 
        that are available across a substantially complete range of the 
        firm's asset classes (including derivative and securities 

    Accurate and comprehensive information on a firm's 
        liquidity and the profiles of its assets and liabilities

    Fully integrated, comprehensive risk management frameworks 
        capable of assessing the market, credit, and liquidity risks 
        associated with the troubled institution

    Legal agreements and transaction documents that are 
        available in an organized, accessible form

    Comprehensive information on the firm's positions with 
        exchanges, clearing houses, custodians and other institutions 
        that make up the financial system's infrastructure

    I am under no illusion that these guiding principles and 
prerequisites are anything close to the last word in seeking assurances 
that Enhanced Resolution Authority can deliver on the promise of a 
stability driven solution to the ``Too Big to Fail'' problem. On the 
other hand, I very much hope these suggestions will help to stimulate 
discussion and debate on this critically important subject.
    Ronald Kurtz Professor of Entrepreneurship, MIT Sloan School of 
                            Management; and
  Senior Fellow, Peterson Institute for International Economics; and 
                   Cofounder of BaselineScenario.com
                            February 4, 2010
A. General Principles \1\
     \1\ This testimony draws on joint work with James Kwak, including 
``13 Bankers'' (forthcoming, March 2010) and ``The Quiet Coup'' (The 
Atlantic, April, 2009), and Peter Boone, particularly ``The Next 
Financial Crisis: It's Coming and We Just Made It Worse'' (The New 
Republic, September 8, 2009). Underlined text indicates links to 
supplementary material; to see this, please access an electronic 
version of this document, e.g., at http://BaselineScenario.com, where 
we also provide daily updates and detailed policy assessments for the 
global economy.
    1) The broad principles behind the so-called ``Volcker Rules'' are 
sound. As articulated by President Obama at his press conference on 
January 21, the priority should be to limit the size of our largest 
banks and to reduce substantially the risks that can be taken by any 
financial entity that is backed, implicitly or explicitly, by the 
Federal Government.
    2) Perceptions that certain financial institutions were ``too big 
to fail'' played a role in encouraging reckless risk-taking in the run-
up to the financial crisis that broke in September 2008. Once the 
crisis broke, the Government took dramatic and unprecedented steps to 
save individual banks and nonbanks that were large relative to the 
financial system; at the same time, relatively small banks, hedge 
funds, and private equity and other investment funds were either 
intervened by the FDIC (for banks with guaranteed deposits) or just 
allowed to go out of business (including through bankruptcy).
    3) Looking forward, we face a major and undeniable problem with the 
``too big to fail'' institutions that became more powerful (in economic 
and political terms) as a result of the 2008-09 crisis and now dominate 
our financial system. Implementing the principles behind the Volcker 
Rules should be a top priority.
    4) As a result of the crisis and various Government rescue efforts, 
the largest 6 banks in our economy now have total assets in excess of 
63 percent of GDP (based on the latest available data; details of the 
calculation and related information are available in ``13 Bankers''). 
This is a significant increase from even 2006, when the same banks' 
assets were around 55 percent of GDP, and a complete transformation 
compared with the situation in the U.S. just 15 years ago--when the 6 
largest banks had combined assets of only around 17 percent of GDP.
    5) The credit markets are convinced that the biggest banks in the 
United States are so important to the real economy that, if any 
individual bank got into trouble, it would be rescued in such a way 
that creditors would be fully protected. As a result, the implied 
probability of default on debt issued by these mega-banks is very low--
as reflected, for example, in their current credit default swap 
    6) The consequent low cost of credit for mega-banks--significantly 
below what is paid by smaller banks that can fail (i.e., banks that can 
realistically be taken over through a FDIC intervention)--constitutes a 
form of unfair subsidy that enables the biggest banks to become even 
larger. Without a size cap on individual bank size, we will move toward 
the highly dangerous situation that prevails in some parts of Western 
Europe--where individual banks hold assets worth more (at least on 
paper, during a boom) than their home country's GDP.
    7) Just to take one example, the Royal Bank of Scotland (RBS) had 
assets--at their peak--worth roughly 125 percent of U.K. GDP. The 
mismanagement and effective collapse of RBS poses severe risks to the 
U.K. economy, and the rescue will cost the taxpayer dearly. Iceland is 
widely ridiculed for allowing banks to build up assets (and 
liabilities) worth between 11 and 13 times GDP, but the biggest four 
banks in the U.K. had bank assets worth over 3 times GDP (and total 
bank assets were substantially higher, by some estimates as much as 6 
times GDP)--and the two largest banks in Switzerland held assets that 
were worth over 8 times GDP. When there is an implicit Government 
subsidy to bank size and growing global opportunities to export 
(subsidized) financial services, market forces do not limit how large 
banks and nonbank financial institutions can become relative to the 
domestic economy. In fact, as financial globalization continues, we 
should expect the largest U.S. banks--left unchecked--to become even 
bigger in dollar terms and relative to the size of our economy.
    8) At the same time, under the current interpretation of our 
financial rules, a bank such as Goldman Sachs now has full access to 
the Fed's discount window (as a bank holding company)--yet also retains 
the ability to make risky investments of all kinds anywhere in the 
world (as it did when it was an investment bank, before September 
2008). In a very real sense, the U.S. Government is now backing the 
world's largest speculative investment funds--without any effective 
oversight mechanisms.
    9) Under the framework now in place, we are set up for another 
round of the boom-bailout-bust cycle that the head of financial 
stability at the Bank of England now terms a ``doom loop.'' The likely 
consequences range from terrible, in terms of pushing up our net 
Government debt by another 40 percentage points of GDP (or more), as we 
struggle again to prevent recession from becoming depression, to 
catastrophic--if we fail to prevent a Second Great Depression.
    10) In this context, reining in the size of our largest banks is 
not only an appealing proposition, it is also compelling. There is no 
evidence for economies of scale in banking over $100 billion of total 
assets (measured in today's dollars). As a result, the growth of our 
largest banks since the early 1990s has been entirely without social 
benefits. At the same time, the crisis of 2008-09 manifestly 
demonstrates the very real social costs: the revised data will likely 
show more than 8 million net jobs lost since December 2007--due to more 
than a decade of reckless risk-taking involving large financial 
    11) The Riegle-Neal Interstate Banking and Branching Efficiency Act 
of 1994 specified a size cap for banks: No single bank may hold more 
than 10 percent of total retail deposits. This cap was not related to 
antitrust concerns as 10 percent of a national market is too low to 
imply pricing power. Rather this was a sensible macroprudential 
preventive measure--don't put all your eggs in one basket. 
Unfortunately, since 1994 two limitations of Riegle-Neal have become 
clear, (1) the growth of big banks was not fueled by retail deposits 
but rather by various forms of ``wholesale'' financing, and (2) the cap 
was not enforced by lax regulators, so that Bank of America, JPMorgan 
Chase, and Wells Fargo all received waivers in recent years.
    12) While the U.S. financial system has a long tradition of 
functioning well with a relatively large number of banks and other 
intermediaries, in recent years it has become transformed into a highly 
concentrated system for key products. The big four have half of the 
market for mortgages and two-thirds of the market for credit cards. 
Five banks have over 95 percent of the market for over-the-counter 
derivatives. Three U.S. banks have over 40 percent of the global market 
for stock underwriting. This degree of market power is dangerous in 
many ways.
    13) These large banks are widely perceived--including by their own 
management, their creditors, and Government officials--as too big to 
fail. The executives who run these banks obviously have an obligation 
to make money for their shareholders. The best way to do this is to 
take risks that pay off when times are good and that result in 
bailouts--creating huge costs for taxpayers and all citizens--when 
times are bad. \2\
     \2\ For more analytical analysis and relevant data on this point, 
see ``Banking on the State'', by Andrew Haldane and Piergiorgio 
Alessandri, BIS Review 139/2009.
    14) This incentive system distorts market outcomes, encourages 
reckless risk-taking, and will lead to serious trouble. While reducing 
bank size is not a panacea and should be combined with other key 
measures that are not yet on the table--including a big increase in 
capital requirements--finding ways to effectively reduce and then limit 
the size of our largest banks is a necessary condition for a safer 
financial system.
B. Assessment of Bank Size
    1) The counterargument is that big banks provide benefits to the 
economy that cannot be provided by smaller banks. There are also claims 
that the global competitiveness of U.S. corporations requires American 
banks be at least as big as the banks in any other country. Another 
argument is that large financial institutions enjoy significant 
economies of scale and scope that make them more efficient, helping the 
economy as a whole. Finally, it is argued global banks are necessary to 
provide liquidity to far-flung capital markets, making them more 
efficient and benefiting companies that raise money in those markets.
    2) There is weak or no hard empirical evidence supporting any of 
these claims.
    3) Multinational corporations do have large, global financing 
needs, but there are currently no banks that can supply those needs 
alone; instead, corporations rely on syndicates of banks for major 
offerings of equity or debt. And even if there were a bank large enough 
to meet all of a large corporation's financial needs, it would not make 
sense for any nonfinancial corporation to restrict itself to a single 
source of financial services. It is much preferable to select banks 
based on their expertise in particular markets or geographies.
    4) In addition, U.S. corporations already benefit from competition 
between U.S. and foreign banks, which can provide identical financial 
products; there is no reason to believe that the global competitiveness 
of our nonfinancial sector depends on our having the world's largest 
    5) There is also very little evidence that large banks gain 
economies of scale beyond a low size threshold.
      a. Economies of scale vanish at some point below $10 billion in 
assets. \3\
     \3\ Dean Amel, Colleen Barnes, Fabio Panetta, and Carmelo Salleo, 
``Consolidation and Efficiency in the Financial Sector: A Review of the 
International Evidence'', Journal of Banking and Finance 28 (2004): 
2493-2519. See also Stephen A. Rhoades, ``A Summary of Merger 
Performance Studies in Banking, 1980-93, and an Assessment of 
the`'Operating Performance' and 'Event Study' Methodologies'', Federal 
Reserve Board Staff Studies 167, summarized in Federal Reserve Bulletin 
July 1994, complete paper available at http://www.federalreserve.gov/
Pubs/staffstudies/1990-99/ss167.pdf: ``In general, despite substantial 
diversity among the nineteen operating performance studies, the 
findings point strongly to a lack of improvement in efficiency or 
profitability as a result of bank mergers, and these findings are 
robust both within and across studies and over time.'' See also Allen 
N. Berger and David B. Humphrey, ``Bank Scale Economies, Mergers, 
Concentration, and Efficiency: The U.S. Experience'', Wharton Financial 
Institutions Center Working Paper 94-24, 1994, available at http://
      b. The 2007 Geneva Report on ``International Financial 
Stability'', coauthored by former Federal Reserve vice chair Roger 
Ferguson, found that the unprecedented consolidation in the financial 
sector over the previous decade had led to no significant efficiency 
gains, no economies of scale beyond a low threshold, and no evident 
economies of scope. \4\
     \4\ Roger W. Ferguson, Jr., Philipp Hartmann, Fabio Panetta, and 
Richard Portes, International Financial Stability (London: Centre for 
Economic Policy Research, 2007), 93-94.
      c. Since large banks exhibit constant returns to scale (they are 
no more or less efficient as they grow larger), and we know that large 
banks enjoy a subsidy due to being too big to fail, ``offsetting 
diseconomies must exist in the operation of large institutions''--that 
is, without the ``too big to fail'' subsidy, large banks would actually 
be less efficient than midsize banks. \5\
     \5\ Edward J. Kane, ``Extracting Nontransparent Safety Net 
Subsidies by Strategically Expanding and Contracting a Financial 
Institution's Accounting Balance Sheet'', Journal of Financial Services 
Research 36 (2009): 161-168.
      d. There is evidence for increased productivity in U.S. banking 
over time, but this is due to improved use of information technology--
not increasing size or scope. \6\
     \6\ Kevin J. Stiroh, ``Information Technology and the U.S. 
Productivity Revival: What Do the Industry Data Say?'' American 
Economic Review 92 (2002): 1559-1576.
    6) Large banks do dominate customized (over-the-counter) 
derivatives. But this is primarily because of the implicit taxpayer 
subsidy they receive--again, because they are regarded as too big to 
fail, their cost of funds is lower and this gives them an unfair 
advantage in the marketplace. There is no sense in which this market 
share is the outcome of free and fair competition.
    7) The fact that ``end-users'' of derivatives share in the implicit 
Government subsidy should not encourage the continuation of ``too big 
to fail'' arrangements. This is a huge and dangerous form of support 
for private interests at the expense of the taxpayer and--because of 
the apparent downside risks--of everyone who can lose a job or see 
their wealth evaporate in the face of an economic collapse.
    8) There are no proven social benefits to having banks larger than 
$100 billion in total assets. Vague claims regarding the social value 
of big banks are not backed up by data or reliable estimates. This 
should be weighed against the very obvious costs of having banks that 
are too big to fail.
C. Actions Needed
    1) While the general principles behind the Volcker Rules make sense 
and there is no case for keeping our largest banks anywhere near their 
current size, the specific proposals outlined so far by the 
Administration are less persuasive.
    2) Capping the size of our largest banks at their current level 
today does not make much sense. It is highly unlikely that, after 30 
years of excessive financial deregulation, the worst crisis since the 
Great Depression, and an extremely generous bailout that we found 
ourselves with the ``right'' size for big banks.
    3) Furthermore, limiting the size of individual banks relative to 
total nominal liabilities of the financial system does not make sense, 
as this would not be ``bubble proof''. For example, if housing prices 
were to increase ten-fold, the nominal assets and liabilities of the 
financial system would presumably also increase markedly relative to 
GDP. When the bubble bursts, it is the size of individual banks 
relative to GDP that is the more robust indicator of the damage caused 
when that bank fails--hence the degree to which it will be regarded as 
too big to fail.
    4) Also, splitting proprietary trading from integrated investment-
commercial banks would do little to reduce their overall size. The 
``too big to fail'' banks would find ways to take similar sized risks, 
in the sense that their upside during a boom would still be big and the 
downside in a bust would have dramatic negative effects on the 
economy--and force the Government into some sort of rescue to prevent 
further damage.
    5) The most straightforward and appealing application of the 
Volcker Principles is: Do not allow financial institutions to be too 
big to fail; put a size cap on existing large banks relative to GDP, 
forcing these entities to find sensible ways to break themselves up 
over a period of 3 years.
    6) CIT Group was not too big to fail in summer 2009; it then had 
around $80 billion in total assets. Goldman Sachs was too big to fail 
in fall 2008, with assets over $1 trillion. If Goldman Sachs were to 
break itself up into 10 or more independent companies, this would 
substantially increase the likelihood that one or more could fail 
without damaging the financial system. It would also greatly improve 
the incentives of Goldman management, from a social perspective, 
encouraging them to be much more careful.
    7) Addressing bank size is not a panacea. In addition, capital 
requirements need to be strengthened dramatically, back to the 20-25 
percent level that was common before 1913, i.e., before the creation of 
the Federal Reserve, when the Government effectively had no ability to 
bail out major banks. Capital needs to be risk-weighted, but in a broad 
manner that is not amenable to gaming (i.e., quite different from Basel 
II and related approaches).
    8) Such strengthening and simplifying of capital requirements would 
go substantially beyond what the Obama administration has proposed and 
what regulators around the world currently have in mind. In November 
2009, Morgan Stanley analysts predicted that new regulations would 
result in Tier 1 capital ratios of 7-11 percent for large banks--i.e., 
below the amount of capital that Lehman had immediately before it 
failed. \7\
     \7\ Research Report, Morgan Stanley, ``Banking--Large and Midcap 
Banks: Bid for Growth Caps Capital Ask'', November 17, 2009.
    9) The capital requirements for derivative positions also need to 
be simplified and strengthened substantially. For this purpose 
derivative holdings need to be converted according to the ``maximum 
loss'' principle, i.e., banks should calculate their total exposure as 
they would for a plain vanilla nonderivative position; they should then 
hold the same amount of capital as they would for this nonderivative 
equivalent. For example, if a bank sells protection on a bond as a 
derivative transaction, the maximum loss is the face value of the bond 
so insured. The capital requirement should be the same as when the bank 
simply holds that bond.
    10) A strengthened and streamlined bankruptcy procedure for nonbank 
financial institutions makes sense. This will help wind up smaller 
entities more efficiently.
    11) But improving the functioning of bankruptcy does not make ``too 
big to fail'' go away. When they are on the brink of failing, ``too big 
to fail'' banks are ``saved'' from an ordinary bankruptcy procedure 
because creditors and counterparties would be cut off from their money 
for months, which is exactly what causes broader economic damage. You 
can threaten all financial institutions with bankruptcy, but that 
threat is not credible for the biggest banks and nonbanks in our 
economy today. And if the Government did decide to make an example of a 
big bank and push it into bankruptcy, the result would likely be the 
kind of chaos--and bailouts--that followed the failure of Lehman in 
September 2008.
    12) A resolution authority as sought by the Obama administration 
could help under some circumstances but is far from a magic bullet in 
the global world of modern finance. Some of the most severe 
complications of the Lehman bankruptcy occurred not in the United 
States, but in other countries, each of which has its own laws for 
dealing with a failing financial institution. These laws are often 
mutually inconsistent and no progress is likely toward an integrated 
global framework for dealing with failing cross-border banks. When a 
bank with assets in different countries fails, it is in each country's 
immediate interest to have the strictest rules on freezing assets to 
pay off domestic creditors (and, in some jurisdictions, to protect 
local workers). No other G-20 country, for example, is likely to cede 
to the United States the right to run a resolution process for banking 
activities that are located outside the U.S.
    13) More broadly, solutions that depend on smarter, better 
regulatory supervision and corrective action ignore the political 
constraints on regulation and the political power of today's large 
banks. The idea that we can simply regulate huge banks more effectively 
assumes that regulators will have the incentive to do so, despite 
everything we know about regulatory capture and political constraints 
on regulation. It assumes that regulators will be able to identify the 
excess risks that banks are taking, overcome the banks' arguments that 
they have appropriate safety mechanisms in place, resist political 
pressure (from the Administration and Congress) to leave the banks 
alone for the sake of the economy, and impose controversial corrective 
measures that will be too complicated to defend in public. And, of 
course, it assumes that important regulatory agencies will not fall 
into the hands of people like Alan Greenspan, who believed that 
Government regulation was rendered largely unnecessary by the free 
    14) The ``rely on better regulation'' approach also assumes that 
political officials, up to and including the president, will have the 
backbone to crack down on large banks in the heat of a crisis, while 
the banks and the Administration's political opponents make accusations 
about socialism and the abuse of power. FDIC interventions (i.e., 
taking over and closing down banks) currently do not face this 
challenge because the banks involved are small and have little 
political power; the same cannot be said of JPMorgan Chase or Goldman 
    15) There are no perfect solutions to the problem we now face: a 
handful of banks and other financial institutions that are too big to 
fail. The Volcker Principles are sound--we should reduce the size of 
our largest banks and ensure that banks with implicit (and explicit) 
Government subsidies are not allowed to engage in risky 
undercapitalized activities.
    16) However, the proposed details in the Volcker Rules do not go 
far enough. We should put a hard size cap, as a percent of GDP, on our 
largest banks. A fair heuristic would be to return our biggest banks to 
where they were, relative to GDP, in the early 1990s--the financial 
system, while never perfect, functioned fine at that time and our banks 
were internationally competitive, and there is no evidence that our 
nonfinancial companies were constrained by lack of external funding. 
(More details on this proposal are available in ``13 Bankers''.)
    17) Much stronger capital requirements will reduce the chance that 
any individual financial institution fails. But financial failure is a 
characteristic of modern market economies that cannot be legislated out 
of existence. When banks and nonbank financial institutions fail, there 
is far less damage and much less danger if they are small.
                      Retired Chairman, Citigroup
                            February 4, 2010
    It is probably too early to fully assess the nature and causes of 
our recent financial meltdown but the conversation about potential 
remedies is well underway. Given that fact, a few thoughts could be 
    First, some ``framing.''
    One, the crisis was clearly ``man made,'' this was not the result 
of long standing and cumulative imbalances.
    Second, there seems to have been a key failure that none of us 
anticipated, namely, individual institutions which are thought to take 
steps and exercise judgments to ensure their self-preservation turned 
out ``not to have'' or been incapable of so doing. (This clearly means 
that in designing a robust system, we cannot count on that capacity.)
    Third, a financial system cannot be permitted to impact the real 
economy to the extent that it has.
    Fourth, while much has been made of the low interest rate 
environment that accompanied the build up to the crisis, one would not 
design a financial system that could not function in such an 
    Second, some casual factors that are worth noting.
    One, a dominant business philosophy focusing on ``shareholder 
    Two, almost frenetic activity in the creation and distribution of 
securitized products and derivatives. These turned out to be flawed as 
credits but further were not fully distributed to ``knowledgeable 
investors'' but to an incredible extent were inventoried on the balance 
sheet of ``intermediaries'' (e.g., Merrill Lynch, Citi).
    Third, the absolute failure of the rating agencies in the 
performance of their only mission.
    Fourth, the failure of supervision,

    In allowing the decapitalization of the sector.

    In ignoring the implications of ``low doc, no doc'' 

    In ignoring the levels of counterparty risk.

    In ``missing'' the fact that credit default swaps were 
        insurance products, requiring reserves and oversight.

    Fifth, the failure of policy in pushing the mortgage market through 
Freddie Mac and Fannie Mae to an uneconomic extent.
    Third, if the aim is to create rules and limits, which on the one 
hand would significantly reduce the likelihood of a repeat of our 
recent experience, and on the other would support a healthy and 
creative industry, what would the rules and limits be?
    First, capital should be significantly increased, maybe doubled. (I 
personally think the concept of Risk Adjusted Capital is flawed.)
    Second, the funding structure (liquidity) of each institution 
should be the subject of annual review (not just ``point in time'', 
averages and extremes over the year) and assessment by regulators and 
    Third, the industry should be compartmentalized so as to limit the 
propagation of failures and also to preserve cultural boundaries.
    Fourth, to the extent possible, traded products should flow through 
    Fifth, there is a good reason to create a Consumer Protection 
Agency with a clear and separate mandate.
  Nomura Professor of International Financial Systems at Harvard Law 
                              School; and
        Director of the Committee on Capital Markets Regulation
                            February 4, 2010
    Thank you, Chairman Dodd, Ranking Member Shelby, and Members of the 
Committee for permitting me to testify before you on the implications 
of the Volcker Rules for Financial Stability (Volcker Rules), as well 
as President Obama's proposed size limitations on banks. I am 
testifying today in my own capacity and do not purport to represent the 
views of the Committee on Capital Markets Regulation.
    Let me preface my testimony by stressing the urgent need for broad 
regulatory reform in light of the financial crisis on matters ranging 
from the structure of our regulatory system, to the reduction of 
systemic risk in the derivatives market, to improving resolution 
procedures for insolvent financial companies, to increasing consumer 
protection, and to revamping the GSEs. The Committee on Capital Markets 
Regulation dealt with these issues in its May 2009 Report titled ``The 
Global Financial Crisis: A Plan for Regulatory Reform''. \1\ These 
issues were also fully laid out in the Treasury Department's June 2009 
proposal on financial regulatory reform, \2\ and have been vigorously 
debated in public meetings, the press, and Congressional hearings for 
months. These efforts have so far culminated in the Wall Street Reform 
and Consumer Protection Act (H.R. 4173) as well as in Senator Dodd's 
thoughtful Discussion Draft. And I applaud the ongoing efforts of this 
Committee to reach bipartisan consensus on these issues. In my 
judgment, we should not hold up these important reforms while we debate 
activity and size limitations.
     \1\ This report contains 57 recommendations for making the U.S. 
financial regulatory structure more integrated, more effective and more 
protective of investors. Comm. on Capital Mkts. Reg., The Global 
Financial Crisis: A Plan For Regulatory Reform (May 2009).
     \2\ U.S. Dep't of the Treasury, Financial Regulatory Reform, A New 
Foundation: Rebuilding Financial Supervision And Regulation (June 2009) 
[hereinafter Treasury White Paper], http://www.financialstability.gov/
    The Volcker Rules would limit the ability of banks \3\ to own, 
invest in, or sponsor a hedge fund or private equity fund, or to engage 
in ``proprietary trading.'' The size limitation would limit the market 
share of all financial institution liabilities beyond the current 10 
percent market share cap applied to bank deposits.
     \3\ We use the term ``banks'' to refer generally to bank holding 
companies and their subsidiaries.
    At the outset, it is important to focus on the stated objective of 
these new proposals--to reduce bank risk so as to minimize the 
necessity of public rescue of banks that are ``Too Big to Fail.'' There 
is no question that we need to address the ``Too Big to Fail'' issue. 
We need to understand whether the conventional wisdom--that we cannot 
let large financial institutions fail, in the sense of imposing a full 
measure of losses on the private sector, whether they be equity or 
unsecured debt holders or counterparties--is actually true. The concern 
rests on an assumption that we cannot permit certain large and 
interconnected financial institutions to fail because such failure 
would trigger a chain reaction of other financial institution failures, 
with disruption to the entire economy.
    In the notable $85 billion Federal bailout of AIG, however, some 
question whether the asserted prospect of severe counterparty losses 
actually existed. Goldman Sachs, one of AIG's major counterparties, has 
stated that it had adequate cash collateral to survive an AIG default. 
\4\ We need to be careful that ``Too Big to Fail'' does not become a 
self-fulfilling prophecy.
     \4\ Transcript of F3Q09 Earnings Call (David Viniar, Chief Fin. 
Officer, Goldman Sachs Group, Inc.) (Oct. 15, 2009).
    Clearly, the absolute size of an institution is not the predicate 
for systemic risk; it is rather the size of its debt, its derivatives 
positions, and the scope and complexity of many other financial 
relationships running between the firm, other institutions, and the 
wider financial system. As Senator Schumer's example at Tuesday's 
hearing illustrates, 50 small but highly correlated hedge funds might 
combine to create systemic risk. In short, the proper focus is on a 
bank's interconnectedness with other financial institutions, and we 
have only a primitive understanding of the nature and extent of these 
connections. To the extent interconnectedness is a problem, the most 
fundamental way to attack it is to reduce the interconnections so that 
we can allow institutions to fail safely. This will also require that 
Federal regulators be given enhanced resolution authority, as set forth 
in H.R. 4173 and Senator Dodd's Discussion Draft. \5\ And as Secretary 
Geithner recently acknowledged, ``the Bankruptcy Code is not an 
effective tool for resolving the failure of a global financial services 
firm in times of severe economic stress.'' \6\
     \5\ H.R. 4173, 111th Cong. Subtitle G (2009); Restoring American 
Financial Stability Act, 111th Cong. Title II (2009) (mark by the 
Chairman of the S. Comm. on Banking, Housing and Urban Affairs).
     \6\ Systemic Regulation, Prudential Matters, Resolution Authority 
and Securitization: Hearing Before the H. Comm. On Financial Services, 
111th Cong. 2 (2009) (written testimony of Timothy F. Geithner).
    To address our ``Too Big to Fail Problem,'' we need to modernize 
financial regulation to address the problems of today, not of the past.
    Let me now turn in more depth to the Volcker Rules.
I. Proposed Restrictions on the Scope of Bank Operations
A. Proprietary Trading and ``Too Big to Fail''
    The Volcker Rules would prohibit banks and bank holding companies 
from engaging in proprietary trading ``unrelated to serving customers 
for [their] own profit,'' as well as from investing in or sponsoring 
hedge fund and private equity fund operations. \7\ Given that Mr. 
Volcker is the Chairman of the Trustees as well as the Chairman of the 
Steering Committee of the Group of 30 (G-30), it is worth noting that 
the Volcker Rules are significantly more aggressive than the G-30's 
recent proposal to merely limit proprietary trading by ``strict capital 
and liquidity requirements.'' \8\
     \7\ Press Release, The White House, Remarks by the President on 
Financial Reform (Jan. 21, 2010), available at http://
     \8\ Group of 30, Financial Reform: A Framework for Financial 
Stability 8 (Jan. 15, 2009), http://www.group30.org/pubs/
    The objective embodied in the Volcker Rules is to restrict banks 
that are ``Too Big to Fail'' from participating in nontraditional risky 
investment activity, thus minimizing the chance they might fail and 
have to be rescued to avoid endangering uninsured depositors or the 
FDIC insurance fund. This might have been the concern in the past but 
it misses the mark today. The reason for the rescues during the crisis, 
such as AIG, or the TARP injections to forestall failures, was not to 
protect depositors of banks or the FDIC insurance fund. The reason was 
rather to avoid a chain reaction of failures set off by 
interconnectedness. Furthermore, this need for rescue does not depend 
on what activity gives rise to the potential bank failure. We will have 
to rescue banks whose failure will endanger other banks even if these 
failing banks are engaging in traditional activities. Mr. Volcker seems 
to imply that it is acceptable to rescue banks engaging in traditional 
activities. I disagree. Quite frankly, I do not think a taxpayer would 
feel better about rescuing a bank that made risky loans than he would 
rescuing a bank that engaged in less traditional risky activity.
    As a solution to the problem of ``Too Big to Fail,'' the Volcker 
Rules are over-inclusive because not all banks, and not even all large 
banks, pose chain-reaction risks to the financial system. The Rules are 
also potentially under-inclusive, because many interconnected financial 
institutions which do pose systemic risks are not deposit-taking banks. 
Goldman Sachs--which is the only U.S. bank with significant revenue 
exposure to proprietary trading \9\--could avoid falling under the 
Volcker Rules by divesting itself of its small deposit-taking 
operations, which account for only 5.19 percent of its liabilities. 
\10\ Similarly, Morgan Stanley would lose only 8.70 percent of its 
liability base by giving up bank holding company status. \11\ None of 
the most prominent failures of the financial crisis--Fannie Mae, 
Freddie Mac, AIG, Bear Stearns, or Lehman Brothers--were deposit-taking 
     \9\ Goldman's management has stated that proprietary trading 
accounts for 10 percent of its total revenues. Transcript of F4Q09 
Earnings Call (David Viniar, Chief Fin. Officer, Goldman Sachs Group, 
Inc.) (Jan. 21, 2010). Citigroup reportedly maintains proprietary 
trading operations accounting for 5 percent of revenues. Jonathan 
Weisman, Damian Paletta and Robin Sidel, New Bank Rules Sink Stocks--
Obama Proposal Would Restrict Risk-Taking by Biggest Firms as Battle 
Looms, Wall St. J., Jan. 21, 2010, available at http://online.wsj.com/
article/SB10001424052748703699204575016983630045768.html; Citigroup 
Inc., Quarterly Report (Form 10-Q), at 88 (Nov. 7, 2009).
     \10\ See, Goldman Sachs Group, Inc., Quarterly Report (Form 10-Q), 
at 5 (Nov. 4, 2009).
     \11\ Morgan Stanley, Quarterly Report (Form 10-Q), at 2 (Nov. 9, 
    Furthermore, major U.S. banks that do have high levels of deposits 
relative to total liabilities derive only a marginal fraction of their 
revenues from walled off proprietary trading activities, if 
``proprietary trading'' is understood as trading activity carried out 
on internal trading desks purely for a bank's own account. Wells Fargo 
and Bank of America, two of the largest deposit-funded banks, report 
deposits accounting for approximately 72 percent and 49 percent of 
their total liabilities, respectively, but are both estimated to earn 
less than 1 percent of revenues from proprietary trading. \12\ These 
data show that U.S. banks with significant deposit bases assume little 
to no balance sheet risk from proprietary trading. Riskier institutions 
that do have exposure, if forced to choose between proprietary trading 
and deposits, may opt to ``de-bank.'' But because banks are highly 
regulated entities, regulators are in a good position to respond to 
bank failures. By encouraging banks to take themselves off the 
regulatory radar, the Volcker Rules could actually increase systemic 
risk. The regulatory and supervisory system is much better able to deal 
with controlling the risky activity of regulated banks than of 
unregulated investment banks, insurance companies, hedge funds, or 
commercial companies with large financial operations. The migration of 
risky bank activities to other large firms that may be ``Too Big to 
Fail'' would compound, rather than reduce, the systemic risk problem. 
The Administration's earlier proposals envision some level of 
regulation of systemically important institutions other than banks, but 
such regulation will be much less comprehensive than it is for banks.
     \12\ See, Bank of America Corp., Quarterly Report (Form 10-Q), at 
4 (Nov. 7, 2009); Wells Fargo and Co., Quarterly Report (Form 10-Q), at 
63 (Nov. 7, 2009); Brooke Masters, ``Alert Over Proprietary Trading 
Clamp'', Fin. Times, Jan. 28, 2010, available at http://www.ft.com/cms/
    The original proposal was somewhat ambiguous as to the level of the 
banking organization at which the Rules would apply. Unless the Rules 
limit the activities of bank holding companies and all holding company 
subsidiaries, banks could evade the restrictions by shifting hedge fund 
or private equity investments and proprietary trading activities to 
nonbank subsidiaries. This would, perhaps, protect bank depositors, but 
it would not solve the need to rescue bank holding companies to avoid 
the chain-reaction-of-failures problem. Because proprietary trading, 
hedge fund, and private equity investments could pose the same threat 
to other financial institutions because of connectedness, regardless of 
whether they occur in a bank or its holding company, the Volcker Rules 
only make sense if they apply to bank holding companies and all of 
their subsidiaries (including banks and nonbanks).
B. What Is Proprietary Trading?
    Mr. Volcker is confident that he as well as bankers know 
proprietary trading when they see it. Yet it is notable that neither 
Mr. Volcker nor the Treasury Department has presented a workable 
definition of this term. The suggestion that it can be measured by a 
pattern of large gains and losses is unclear. Hedges or positions taken 
for customers can exhibit the same pattern.
    Defining ``proprietary trading'' presents tremendous difficulties. 
Too narrow a definition, limited to discrete internal hedge fund and 
private equity activity undertaken by banks for their own accounts, is 
unlikely to lead to material reduction of risk, since these activities 
account for only a small fraction of most banks' operations. Defining 
proprietary trading too broadly, meanwhile, might seriously impair the 
basic function of modern banks as market-makers in Government and 
nongovernment securities, and as securitizers of consumer debt. Neither 
of these options is very attractive.
    1. Proprietary Trading as ``Internal Hedge Funds'' Is Insignificant 
to Banks.--Strictly construed, proprietary trading ``unrelated to 
serving customers'' encompasses any trading activity carried out on 
internal trading desks for a bank's own account, but not on behalf of 
clients. \13\ Writing in the New York Times on Sunday, Mr. Volcker 
echoed this definition, identifying proprietary trading as ``the search 
[for] speculative profit rather than in response to customer need.'' 
\14\ Generally speaking, there are at least two reasons why this narrow 
definition of the activity is unlikely to reduce systemic risk. First, 
in absolute terms, the scale of such internal, noncustomer, proprietary 
trading is too negligible to drastically impact banks that engage in 
it. As outlined above, most U.S. banks, with the exception of Goldman 
Sachs, report minimal proprietary trading activity so defined.
     \13\ Bernstein Research, Quick Take--Thoughts About Proposed 
Trading Constraints and Investment Prohibitions 1 (Jan. 22, 2010).
     \14\ Paul Volcker, ``Op-Ed, How To Reform Our Financial System'', 
N.Y. Times, Jan. 31, 2010, available at http://www.nytimes.com/2010/01/
31/opinion/31volcker.html?hp. (This article was attached to Mr. 
Volcker's testimony on Feb. 2, 2010.)
    Second, proprietary trading through internal hedge funds and other 
non-customer-related trading desks was not the source of the damaging 
losses that fatally impaired many of the banks at the center of the 
financial crisis. According to one Wall Street analyst's estimate, of 
the approximately $1.67 trillion of cumulative credit losses reported 
by U.S. banks, losses taken on trading activities and derivatives 
accounted for less than $33 billion, or 2 percent, of this total. \15\ 
And as Bernstein Research notes in a recently published analysis, a 
construction of the Volcker Rules confined exclusively to internal 
hedge fund activity would not, for example, have reached the 
significant mortgage positions and unsecuritized loans held by Lehman 
Brothers that plummeted in value as liquidity drained from the market 
during the crisis. These positions, while proprietary, were not trading 
positions assumed by an internal trading desk for Lehman's own account. 
\16\ Instead, they were accumulated as part of Lehman's mortgage-
underwriting and securitization businesses.
     \15\ Goldman Sachs Group, Inc., Goldman Investment Research, 
United States: Banks 6 (Nov. 30, 2009).
     \16\ Bernstein Research, supra note 13, at 1.
    2. Loan and Securitization Losses Were at the Heart of the 
Financial Crisis.--The losses at the center of the financial crisis 
mainly resulted from the credit, lending, and securitization functions 
of U.S. banks. To date, the vast majority of overall credit losses--
approximately 80 percent--have been linked to lending and 
securitization operations. \17\ Goldman Sachs estimates that 
approximately $577 billion, or 34 percent, of cumulative losses were 
incurred by banks on direct real-estate-related lending, including 
mortgages, commercial real-estate loans, and construction lending. An 
additional $338 billion of losses on non-real-estate loans accounted 
for 20 percent of cumulative losses. A further $519 billion, or 31 
percent, represented losses on indirect real-estate-backed 
securitizations, including RMBS, CMBS, and CDOs. The loss experiences 
of smaller regional banks, where poor-quality mortgage and construction 
loans drove the largest failures, confirm the centrality of credit and 
lending to bank losses. For example, option ARMs represented 65 percent 
of total loans at Downey Savings, 59 percent at BankUnited, 29 percent 
at Indymac, and 22 percent at Washington Mutual. Construction loans 
accounted for 88 percent of Corus Bank's loan book. \18\ At regional 
U.S. banks, just as at the national and global levels, under-priced 
credit risk embedded in loans and securitized debt, and not speculative 
internal hedge funds, generated the lion's share of the losses that led 
to financial collapse.
     \17\ Goldman Sachs Group, Inc., supra note 15.
     \18\ Id. at 7.
    To be clear, portfolios of securitized debt instruments held on- 
and off-balance sheet by banks were responsible for roughly one-third 
of total credit losses. Broadening the definition of ``proprietary 
trading'' to restrict banks from holding securitized debt instruments 
might address one of the central risks banks were exposed to in the 
financial crisis. But do we really want to prevent banks from investing 
in securitized debt altogether? The question is complicated by the fact 
that owning securitized assets typically serves several purposes for 
banks, including making markets in securitized assets and assuring 
clients that the banks that structured their deals will have ``skin in 
the game,'' particularly by holding junior tranches of securitized 
debt. \19\ Indeed, recently adopted legislation in the European Union 
requires banks to retain a 5 percent interest in securitizations. \20\ 
While it was also true that banks held securitized debt for speculative 
reasons, it would be difficult to separate such positions from those 
needed to engage in the securitization business. A blanket rule 
preventing banks from holding securitized debt might interfere with the 
revival of our already moribund securitized debt markets, \21\ since it 
would deprive banks of an important way of signaling the quality of 
issuances. Because restoring these markets is crucial to fueling new 
lending and economic growth \22\--Mr. Volcker himself, in his opinion 
piece, cited the ``large challenge in rebuilding an efficient, 
competitive private mortgage market, an area in which commercial bank 
participation is needed'' \23\--regulators must bear this risk in mind 
when implementing reforms.
     \19\ Morgan Stanley, Annual Report (Form 10-K), at 54 (Jan. 29, 
2008) (for a discussion of these different roles of VIEs/SPVs in owning 
securitized assets).
     \20\ Regulations in the European Union permit ``credit 
institutions'' to have securitization exposures only if the 
``originator, sponsor or original lender'' (a) retains no less than 5 
percent of the nominal value of each of the tranches sold or 
transferred; (b) in the case of securitization of revolving exposures, 
retains of the originator's interest no less than 5 percent of the 
nominal value of the securitized exposures; (c) retains randomly 
selected exposures, equivalent to less than 5 percent of the 
securitized exposures, where such exposures would otherwise have been 
securitized in the securitization, provided that the number of 
potentially securitized exposures is no less than 100 at origination; 
or (d) retains the first loss tranche, and if necessary, other tranches 
having the same or more severe risk profile than those transferred or 
sold to investors and not maturing any earlier than those transferred 
or sold to investors, so that retention equals in total no less than 5 
percent of the nominal value of the securitized exposures. European 
Parliament and Council Directive 2009/111/EC, Sept. 16, 2009, http://
     \21\ Data from the Securities Industry and Financial Markets 
Association show that there were approximately $146 billion of asset 
backed securities issued in the U.S. in 2009, as compared to about $754 
billion when issuance of asset backed securities was at its peak in 
2006. See, Sec. Indus. and Fin. Mkt. Ass'n, U.S. ABS Issuance, http://
     \22\ Int'l Monetary Fund, Global Financial Stability Report 78 
(Oct. 2009), available at http://www.imf.org/external/pubs/ft/gfsr/
     \23\ Volcker, supra note 14 (emphasis added).
    3. Market-Making in Securities Is a Core Function of Banks.--In its 
most expansive formulation, proprietary trading could include any 
activity that places principal at risk, including the longstanding role 
that banks have played in modern capital markets as market-makers in 
U.S. Government, agency, and nongovernment securities. A rule which 
restricts the scope of this function by classifying market-making as a 
form of proprietary trading would reduce liquidity and increase 
borrowing costs throughout a wide range of securities markets, 
including the market for GSE and U.S. Treasury securities. This 
activity cannot easily be performed by other institutions--it requires 
the large balance sheets of banks.
    According to Federal Reserve data cumulating securities ownership 
across all bank securities portfolios (including held-to-maturity, 
available for sale, and trading), over 60 percent of the securities 
held by banks are agency MBS and Treasuries. \24\ Forced reductions in 
this inventory under the Volcker Rules would drain liquidity from 
important Government funding markets and entail higher borrowing costs 
for the U.S. Government and its sponsored entities, negatively 
impacting economic recovery. \25\ Mr. Volcker likewise recognizes what 
he has called the ``essential intermediating function'' banks serve in 
meeting the ``need for reliable sources of credit for businesses, 
individuals, and governments.'' \26\ And Glass-Steagall itself 
recognized the linkage between liquidity in Government debt markets and 
proprietary trading by banks in Government securities, providing for an 
exception authorizing banks to deal in, underwrite, and purchase for 
their own account securities issued by the U.S. Government. \27\ So the 
area which comprises the largest portion of bank trading, U.S. 
Government securities, would have to be preserved.
     \24\ Fed. Res. Bd., Assets and Liabilities of Commercial Banks in 
the United States (Jan. 29, 2010), http://www.federalreserve.gov/
     \25\ These portfolio breakdowns illustrate how banks manage cash 
through treasury operations on an ongoing basis by investing it in U.S. 
Treasuries, GSE securities, and other fixed-income securities in order 
to manage risk and improve their financial position. While treasury 
operations are largely fungible with running an ``internal hedge 
fund,'' they are an inevitable part of running a bank. This suggests 
that trying to prevent banks from running internal hedge funds may be 
an exercise in futility.
     \26\ Volcker, supra note 14 (emphasis added).
     \27\ 12 U.S.C. 24 (Seventh) provides that ``[t]he limitations and 
restrictions herein contained as to dealing in, underwriting, and 
purchasing for its own account, investment securities shall not apply 
to obligations of the United States, or general obligations of any 
State or of any political subdivision thereof.''
    4. Proprietary Trading Is a Source of Diversification for Banks.--
Portfolio diversification reduces risk. All else being equal, more 
concentrated portfolios are more volatile than portfolios containing an 
array of uncorrelated earnings streams, even when parts of the 
uncorrelated income are volatile. As the breakdowns discussed earlier 
illustrate, a substantial portion of bank losses sustained in the 2007-
2008 financial crisis emanated from highly concentrated exposures to 
direct real-estate loans. And past financial crises, like the sovereign 
debt and thrift crises of the 1980s and the Asian crises of the 1990s, 
also involved lending operations. Proprietary trading (excluding 
securitization, as discussed earlier), which barely contributed to 
losses in these earlier periods, is a source of diversification that 
may help to mitigate, not aggravate, the risk profile of U.S. banks in 
the future. During the financial crisis, firms with significant 
proprietary trading operations like Goldman Sachs, or those that ran 
complex, interconnected books of business, including Goldman, Morgan 
Stanley, and JPMorgan, survived. Indeed, this diversification helped 
protect them in the crisis. By contrast, firms that concentrated their 
exposures in real-estate, like Lehman, or isolated these exposures in 
large, undercapitalized, off-balance sheet silos either did not 
survive, or needed Government capital injections to keep them afloat.
C. Limitations on Private Equity and Hedge Fund Investing by Banks
    The Volcker Rules, in addition to limiting proprietary trading 
activity, would also restrict banks from owning, investing in, or 
sponsoring private equity funds (including venture capital funds whose 
activity is crucial to small business) and hedge funds.
    Worldwide, banks and investment banks account for $115 billion, or 
12 percent, of the $1.1 trillion of investment by limited partners 
including coinvestments in private equity funds involved in corporate 
finance and buyouts. \28\ Indeed, banks are a larger source of capital 
as private equity limited partners than endowments or sovereign wealth 
funds. \29\ Historically, banks have also represented an important 
source of direct proprietary involvement in private equity as general 
partners, raising an estimated $80 billion in committed capital from 
investors over the past 5 years. \30\ Mandating the exit of banks from 
involvement in these activities could force the withdrawal of a 
substantial fraction of the private equity industry's available 
investment capital. This would deal a disruptive blow to the recovery 
of the private equity industry on the heels of serious setbacks in 
terms of both fundraising and transaction activity which the industry 
sustained from 2007 to 2008. U.S. and global private equity fundraising 
activity remains at or below 2004 levels, with less than $10 billion 
raised by U.S. funds in Q4 2009 as compared to an excess of $100 
billion raised in the same period in 2007. \31\ Nonetheless, private 
equity is still an important financing source for the U.S. economy, 
providing needed investment to undercapitalized or recapitalizing U.S. 
industries, including the financial sector. In Q4 2009, as investment 
activity began to recover, private equity funds invested $8 billion in 
U.S. buyouts (executing $48 billion in M and A transaction volume). 
\32\ At a moment when private equity activity is starting to rebound, 
rules that would force a withdrawal or reconfiguration of significant 
capital in the industry could chill investment in U.S. industry.
     \28\ Private Equity Council, Private Equity and Banks 1, Jan. 22, 
2010; see also Press Release, Preqin, Effects of Obama's Proposal on 
Alternatives Industry Significant (Jan. 22, 2010), http://
     \29\ Private Equity Council, supra note 28, at 1.
     \30\ Id.
     \31\ Private Equity Council, 2009 Year End Update 5-6, Jan. 4, 
     \32\ Id. at 2.
    These prospective costs to the economy might be acceptable if they 
were offset by a commensurate reduction in bank balance sheet risk. But 
while bank investment is an important source of capital to private 
equity, it is not a meaningful proportion of bank assets. \33\ As of 
September 30, 2009, investment in private equity accounted for less 
than 3 percent of the aggregate reported trading and/or ``other'' 
assets of the six largest U.S. banks. As a percentage of total bank 
assets, private equity investments accounted for less than 1 percent of 
the total consolidated balance sheet of Bank of America, JPMorgan, 
Wells Fargo, and Citigroup, and less than 2 percent of the total 
balance sheet assets of Goldman Sachs and Morgan Stanley. \34\ While 
relatively little bank capital is at risk in the private equity 
business, private equity nevertheless represents an important source of 
advisory, syndication, and underwriting revenues for banks which 
sponsor private equity funds. \35\ Mandating the spin-off or closure of 
these funds would not improve the composition of bank balance sheets or 
the profile of bank riskiness, but would terminate a lucrative source 
of earnings at a time when banks are focused on recapitalizing.
     \33\ Indeed, of the 10 largest private equity firms worldwide, 
only one--Goldman Sachs--is a U.S. bank. Bernstein Research, supra note 
13, at 3.
     \34\ Private Equity Council, supra note 28, at 1-8.
     \35\ Bernstein Research, supra note 13, at 3.

 Proprietary Investment in Private Equity as a Percentage of Trading and Other Assets (Q3 2009)\36\ ($ millions)
                                                              Proprietary                        PE Investment %
                                                             Investment in    Trading and Other   of Trading and
                                                             Private Equity         Assets         Other Assets
Bank of America..........................................            $13,500           $280,000             4.8%
Goldman Sachs............................................            $12,480           $381,000             3.3%
Morgan Stanley...........................................             $8,500           $340,000             2.5%
JPMorgan.................................................             $6,836           $351,000             1.9%
Wells Fargo..............................................             $2,771            $98,827             2.8%
Citigroup................................................               $359           $118,000             0.3%
    Total................................................            $44,446         $1,568,827             2.8%

    Although we have not been able to gather much data regarding bank 
exposure to the hedge fund industry, \37\ the information we do have 
suggests that eliminating these activities will not significantly 
reduce bank risk profiles either. Analysis by Preqin shows that banks 
directly invest only $10 billion (or 0.9 percent) of the total capital 
invested by U.S. investors in hedge funds. \38\ In addition, banks have 
fund-of-funds units that are responsible for channeling $180 billion 
(or 16 percent) of all U.S. capital flowing to hedge funds. \39\ It is 
unclear what percentage of this $180 billion represents banks' own 
capital. But even on the implausible assumption that all of $180 
billion comes from banks, it likely represents a negligible portion of 
bank risk. \40\ It is far more likely that a significant portion of the 
$180 billion is money that banks are managing on behalf of clients. 
Managing client funds (apart from the use of seed money) generally does 
not place bank capital at risk, and therefore does not implicate the 
underlying rationale of the Volcker Rules. \41\
     \36\ Private Equity Council, supra note 28.
     \37\ This is a distinct topic from what we referred to in section 
I.B.1 as ``internal hedge fund activity'' at banks. The focus there was 
on trading activity carried out on internal trading desks that are for 
a bank's own account. Here, the focus is investments banks make 
directly, as limited or general partners, or indirectly, through funds 
of funds products, to hedge funds established as distinct legal 
entities. Some such hedge funds are managed by third-parties, while 
others are managed by bank affiliates.
     \38\ Preqin, supra note 28.
     \39\ Id.
     \40\ To provide a very rough sense of scale, as of September 2009, 
Goldman Sachs and JPMorgan held assets worth approximately $882 billion 
and $2.04 trillion, respectively. Goldman Sachs Group, Inc., Quarterly 
Report (Form 10-Q) (Nov. 4, 2009); JPMorgan Chase and Co., Quarterly 
Report (Form 10-Q) (Nov. 10, 2009).
     \41\ Industry sources indicate that banks make small contributions 
of ``seed money'' to new funds to get them off the ground. Even if the 
Volcker Rules are enacted, the ability to make such contributions 
should be preserved through de minimus carveouts.
    In his written testimony, Deputy Secretary Wolin seemed to refer to 
Bear Stearns when he wrote that ``[m]ajor firms saw their hedge funds 
and proprietary trading operations suffer large losses in the financial 
crisis. Some of these firms `bailed out' their troubled hedge funds, 
depleting the firm's capital at precisely the moment it was most 
needed.'' \42\ Although Bear Stearns later pledged $3.2 billion to 
bailout Bear Stearns High-Grade Structured Credit Fund and Bear Stearns 
High-Grade Structured Enhanced Leverage Fund, Bear's original principal 
exposure was only $40 million. Clearly, Bear's real exposure, on a 
reputational basis, exceeded its investment. The same was true for many 
banks' SIVs and conduits. This problem is best addressed by FASB's new 
consolidation accounting rules, FAS 166 and 167, \43\ which effectively 
require banks to hold capital against these exposures. There is no need 
to ban these sponsorships entirely.
     \42\ Prohibiting Certain High-Risk Investment Activities by Banks 
and Bank Holding Companies: Hearing Before the S. Comm. on Banking, 
Housing and Urban Affairs, 111th Cong. 3 (Feb. 2, 2010) (statement of 
Neal S. Wolin, Deputy Secretary, U.S. Dep't of the Treasury) 
[hereinafter Wolin Testimony].
     \43\ Fin. Accounting Standards Bd., Statement of Financial 
Accounting Standard 166, Accounting for Transfers of Financial Assets, 
an Amendment of FASB Statement No. 140 and Fin. Accounting Standards 
Bd., Statement of Financial Accounting Standards No. 167, Amendments to 
FASB Interpretation No. 46(R).
    As the above analysis suggests, bank involvement with private 
equity and hedge funds can benefit bank customers in significant ways. 
Banks that sponsor or invest in private equity funds and hedge funds 
are better positioned to serve their global clients, who increasingly 
look to banks for ``one-stop shopping'' in financial products and 
services. Given the dramatic rise in assets under management in the 
private equity and hedge fund industry, \44\ it is fair to infer that 
clients are particularly interested in these offerings. In addition, to 
the extent that banks are permitted to continue managing funds or fund-
of-funds, allowing them to invest their own money alongside customers' 
is an important way to align interests.
     \44\ Private Equity Council, supra note 31, at 1-8; Hedge Funds 
2009 (Int'l Fin. Serv. London Research), Apr. 2009, http://
    Taking a more skeptical view of the implications for customers of 
bank involvement in proprietary trading as well as private equity funds 
and hedge funds, Mr. Volcker recently argued that these activities 
``present virtually insolvable conflicts of interest with customer 
relationships, conflicts that simply cannot be escaped by an 
elaboration of so-called `Chinese walls' between different divisions of 
an institution.'' \45\ Mr. Volcker elaborated on this point in his 
testimony before the Committee:
     \45\ Volcker, supra note 14.

        I want to note the strong conflicts of interest inherent in the 
        participation of commercial banking organizations in 
        proprietary or private investment activity. That is especially 
        evident for banks conducting substantial investment management 
        activities, in which they are acting explicitly or implicitly 
        in a fiduciary capacity. When the bank itself is a 
        ``customer'', i.e., it is trading for its own account, it will 
        almost inevitably find itself, consciously or inadvertently, 
        acting at cross purposes to the interests of an unrelated 
        commercial customer of a bank. ``Inside'' hedge funds and 
        equity funds with outside partners may generate generous fees 
        for the bank without the test of market pricing, and those same 
        ``inside'' funds may be favored over outside competition in 
        placing funds for clients. More generally, proprietary trading 
        activity should not be able to profit from knowledge of 
        customer trades. \46\
     \46\ Prohibiting Certain High-Risk Investment Activities by Banks 
and Bank Holding Companies: Hearing Before the S. Comm. on Banking, 
Housing and Urban Affairs, 111th Cong. (Feb. 2, 2010) (statement of 
Paul A. Volcker, Chairman, President's Economic Recovery Advisory 
Board) [hereinafter Volcker Testimony].

    If there is a sound justification for the Volcker Rules, it is that 
they would limit systemic risk, not that they would prevent conflicts 
of interest. Moreover, the issue of conflicts of interest was 
considered and rejected during the repeal of Glass-Steagall. If Mr. 
Volcker's contention were correct, it would be equally applicable to a 
much wider range of bank activities than proprietary trading and 
investment in hedge funds and private equity. It would extend to bank 
involvement in the underwriting of securities, for example, where the 
argument has long been made that a banker underwriting a faltering 
securities offering would encourage clients to invest in the 
securities. \47\ Given that there is no proposal to limit bank 
underwriting, or other securities services that raise potential 
conflicts, \48\ it is unclear why conflict of interest concerns justify 
restricting bank investments.
     \47\ Joseph Michael Heppt, ``An Alternative to Throwing Stones: A 
Proposal for the Reform of Glass-Steagall'', 52 Brook. L. Rev. 281, 289 
     \48\ In, Investment Company Institute v. Camp, 401 U.S. 617 
(1971), the Supreme Court discussed several additional conflicts that 
arise when commercial banking and securities services are combined. 
These include that banks involved in securities activities would: (a) 
lose the confidence of the public if their securities affiliates 
experienced business difficulties; (b) fail to act as ``impartial 
sources of credit,'' giving preference to their securities affiliates 
or to borrowers that use securities services; (c) make unsound loans to 
their securities affiliates or to borrowers who use their securities 
services; (d) become unable to act as disinterested advisors to their 
commercial banking clients; and (e) divert talent and resources to 
their securities businesses.
II. Proposed Restrictions on the Size of Banks and other Financial 
A. Proposed Limitations on the Size of Banks
    The actual operation of the size limitations is even less clear 
than the meaning of the Volcker Rules on bank activity. The 
Administration has referred to ``limits on the excessive growth of the 
market share of liabilities at the largest firms, to supplement 
existing caps on the market share of deposits.'' \49\ This appears to 
mean that the size limit would apply to banks' market share of 
nondeposit liabilities.
     \49\ The White House, supra note 7.
    Deputy Secretary Wolin's recent testimony that the ``size limit 
should not require existing firms to divest operations,'' but will 
instead ``serve as a constraint on future excessive consolidation among 
our major financial firms,'' would appear to be addressed to market 
concentration and antitrust concerns since they carry the striking 
implication that no firm is currently ``Too Big to Fail.'' \50\ If 
market concentration is the concern, we need to understand why existing 
antitrust law is not up to the task of dealing with this problem, while 
if systemic risk is the issue, it is puzzling why the size caps should 
apply only to firms that grow by acquisition. Presumably we should be 
concerned about the size (or the interconnectedness) of firms, whether 
the result of acquisition, organic growth, or otherwise.
     \50\ Wolin Testimony, supra note 42, at 4.
    To the extent systemic risk is the issue, the central questions 
are: (a) whether larger banks are more or less likely to fail than 
smaller banks; (b) whether the failure of large banks generates higher 
levels of systemic risk; and (c) whether the Administration's proposal 
to cap each banks' market share of liabilities is a plausible remedy 
for the problem.
    If larger banks are riskier than smaller ones, the differences are 
likely to be relatively minor. \51\ Studies have found that large banks 
hold more diversified portfolios and are engaged in a wider range of 
business, and that such diversification serves as a source of strength. 
\52\ Scholars have also found that size promotes stability since it is 
easier for large banks to obtain funding in the capital markets. \53\ 
On the other hand, larger banks tend to use size advantages to make 
riskier loans, conduct more off-balance sheet activities, and maintain 
more aggressive leverage ratios. \54\ As banks grow larger, they may 
take on additional risk by becoming reliant on noninterest income and 
nondeposit funding. \55\ On net, this combination of considerations may 
roughly balance out.
     \51\ Rebecca Demsetz and Philip Strahan, ``Historical Patterns and 
Recent Changes in the Relationship Between Bank Holding Company Size 
and Risk'', 1 Econ. Pol. Rev. 13 (July 1995); see also Rebecca Demsetz 
and Philip Strahan, ``Diversification, Size, and Risk at Bank Holding 
Companies'', 29 J. Money, Credit, and Banking 300, 308 (1997).
     \52\ See, e.g., Rebecca Demsetz and Philip Strahan, 
``Diversification, Size, and Risk at Bank Holding Companies'', 29 J. 
Money, Credit, and Banking 300 (1997).
     \53\ Jith Jayaratne and Donald P. Morgan, ``Capital Market 
Frictions and Deposit Constraints at Banks'', 32 J. Money, Credit, and 
Banking 74 (2000).
     \54\ See, e.g., Demsetz and Strahan, supra note 52, at 312.
     \55\ Asli Demirguc-Kunt and Harry Huizinga, ``Bank Activity and 
Funding Strategies: The Impact on Risk and Return'' 29 (European 
Banking Center Discussion Paper No. 2009-01, 2009).
    Turning to the second question, the surprising fact is that we do 
not know whether larger institutions pose greater systemic risk and, if 
so, whether that increase is significant. As discussed above, this 
question requires more data and discussion. The issue is whether larger 
banks are more interconnected in such a way that their failure would 
set off a chain reaction of failures. This should not be accepted on 
    To the extent that systemic risk does increase with ``size,'' it is 
unclear that broad-brush restrictions on nondeposit liabilities are the 
solution. First, the focus on liabilities ignores the fact that a 
bank's riskiness is determined in large part by the assets it holds. 
Some of the most prominent victims of the financial crisis failed 
because of the interactions between different parts of their balance 
sheets (e.g., funding risky assets with overnight loans). Second, a 
bank could comply with the general liability restrictions while 
maintaining risky assets. The Volcker Rules would not limit the ability 
of banks to make risky loans. Thus, the somewhat smaller bank, faced 
with Volcker Rules and size caps, may shift its activity to overall 
higher levels of risk in search of return. As Raghuram Rajan, Professor 
of Finance at the University of Chicago and author of a prescient paper 
anticipating the financial crisis, \56\ recently wrote:
     \56\ See, Raghuram G. Rajan, Fed. Res. Brd. of K.C., ``Has 
Financial Development Made The World Riskier?'' (2005), http://

        Crude asset size limits, for example, would probably ensure a 
        lot of financial activity is hidden from the regulator, only to 
        come back to light (and to the balance sheets) at the worst of 
        times. There are many legal ways to mask size. Banks can offer 
        guarantees to assets placed in off-balance sheet vehicles, much 
        like the conduits of the recent crisis. If, instead, capital is 
        the measure, then we will be pushing banks to economize on it 
        as much as possible, hardly a recipe for safety. \57\
     \57\ Raghuram Rajan, Op-Ed., ``A better way to reduce financial 
sector risk'', Fin. Times, Jan. 25, 2010.

    Finally, we should consider if overall size limitations are 
preferable to an approach targeted at individual institutions. It 
appears that, at most, only six banking institutions would be impacted. 
Assuming, for example, that a 10 percent of domestic wholesale funding 
market share ceiling is imposed on U.S. banks--analogous to the deposit 
market share limits already in place--Bank of America, Citigroup, 
Goldman Sachs, JPMorgan Chase, and Morgan Stanley are the only 
institutions that appear to approach this ceiling level. \58\ If a 
higher ceiling than 10 percent wholesale funding market share is 
imposed, it is possible that only the very largest domestic users of 
wholesale funding--Bank of America and JPMorgan Chase, the only two 
institutions with wholesale funding market shares significantly greater 
than 10 percent--would be impacted. We note that beyond these six 
institutions, the U.S. bank wholesale funding market is highly 
fragmented; no other institution has more than a 3 percent market 
share. Given that the size limitations might affect only a handful of 
banks, a better policy would be to address issues at those banks 
individually through better and more intense supervision.
     \58\ This judgment is subject to some measurement error due to the 
difficulty of determining the precise domicile of particular wholesale 
funding sources. Apart from defining what types of nondeposit 
liabilities count as wholesale funding, the specific data issue that 
arises in determining U.S. wholesale funding market shares relates to 
determining sources of wholesale funding. While the Federal Reserve 
reports wholesale funding data for the U.S. banking system as a whole 
(see, Bd. of Gov. of the Fed. Res., Assets and Liabilities of 
Commercial Banks in the United States (Jan. 29, 2010), available at 
individual banks with significant international operations (i.e., the 
six institutions mentioned above) generally do not disclose what 
portions of their nondeposit funding come from U.S. versus 
international sources. Thus determining the U.S.-only wholesale funding 
market shares for these institutions requires making some estimates 
about the proportion of wholesale funding that comes from the United 
    We must also take into account that size limitations on our biggest 
banks will negatively affect their global competitiveness. \59\ Size 
limitations could cause U.S. banks to lose the business of their 
largest and most important customers, who will prefer to work with 
banks that have the capacity to address their global needs. Larger 
banks and their customers also benefit from the economies of size and 
scope that exist when banks are large enough to offer a wider range of 
products, such as lending and derivatives. One study by an economist at 
the New York Federal Reserve found that bank productivity grew more 
than 0.4 percent per year during the bank merger wave of the early 
1990s, \60\ while Charles Calomiris of Columbia Business School 
suggests that the increasing size of banks has lowered underwriting 
costs associated with accessing public equity markets by as much as 20 
percent. \61\ As it is, as of the end of 2008, the United States only 
had two of the 10 largest banks in the world, Bank of America (6th) and 
JPMorgan Chase (9th). \62\ The world's five biggest banks are BNP 
Paribas (France), Royal Bank of Scotland (U.K.), Barclays (U.K.), 
Deutsche Bank (Germany), and HSBC (U.K.).
     \59\ Charles Calomiris, Op-Ed., ``In the World of Banks, Bigger 
Can Be Better'', Wall St. J., Oct. 19, 2009.
     \60\ Kevin J. Stiroh, ``How did bank holding companies prosper in 
the 1990s?'', 24 J. Banking and Fin. 1703 (Nov. 2000).
     \61\ Calomiris, supra note 59.
     \62\ Data from Capital IQ as reported in Damian Paletta and 
Alessandra Galloni, Europe, U.S. Spar on Cure for Banks, Wall St. J., 
Sept. 23, 2009, available at http://online.wsj.com/article/
    In this connection, it is worth recalling that a major motivation 
for the decision to repeal Glass-Steagall was the need to increase the 
competitiveness of U.S. financial institutions. \63\ At the time, 
Senator Proxmire noted that Glass Steagall's ``restrictions inhibit a 
U.S.-based firm from offering the entire range of financial services to 
both domestic and foreign customers in the United States.'' \64\ 
Therefore, many U.S. and foreign financial institutions were choosing 
to locate offshore, where they could provide such products to foreign 
clients. \65\ Furthermore, although U.S. banks had expertise as 
underwriters through offshore activity, they could not achieve the 
economies of scale attainable through underwriting domestically. \66\ 
Any limitation on U.S. bank activities that did not extend to foreign 
banks would be damaging to their future profitability.
     \63\ Comm. on Capital Mkts. Reg., supra note 1.
     \64\ 134 Cong. Rec. S3,382 (1988) (statement of Sen. Proxmire).
     \65\ Id. at S3,385 and S3,382.
     \66\ Id. at S3,382.
B. Proposed Limitations on the Size of Other Financial Institutions
    To the extent that the proposed rules regarding nondeposit 
liability market share addresses financial institutions other than bank 
holding companies, it is important to consider the potential impact on 
four additional groups. First, there are a number of U.S. wholesale-
funded lending businesses--most notably credit card lenders and nonbank 
commercial lenders--that are not typically grouped with banks in 
regulatory discussions. Many of the largest of these lending businesses 
are subsidiaries of bank holding companies. Of those that are not bank 
holding company subsidiaries, although some are large within the 
context of their narrowly defined business segments (credit carding 
lending, etc.), even the largest have modestly sized wholesale funding 
bases compared to the largest bank holding companies. In credit cards, 
for example, American Express and Capital One Financial (the largest 
pure-play card lenders by wholesale liabilities) have only 3 percent 
and 1 percent wholesale funding market shares, respectively. \67\ 
Similarly, GMAC and CIT, the largest wholesale-funded commercial 
lending businesses have only 4.5 percent and 2.2 percent nondeposit 
liability market shares, respectively. \68\ Though the precise details 
on the proposed wholesale funding limits are not yet available, it is 
hard to imagine that the market share ceiling would be set low enough 
to impact even the largest of these lenders.
     \67\ See, American Express, Financial Supplements (Q4 2009) and 
Capital One, Financial Supplements (Q4 2009).
     \68\ See, GMAC, Quarterly Report (Form 10-Q) (Nov. 4, 2009) and 
CIT, Quarterly Report (Form 10-Q) (Nov. 7, 2009). Note that even before 
its bankruptcy, at the end of 2008, CIT's nondeposit liability market 
share was only slightly higher, at 2.5 percent.
    Second, a number of U.S. insurance companies also have sizable 
balance sheets, with ostensibly sizable nondeposit liability bases. 
Although these large liability bases may seem to place insurers within 
the purview of the proposed liability size restrictions, the size caps 
are unlikely to apply to these institutions for two reasons: (1) 
insurers in general simply do not rely heavily on wholesale funding as 
part of their business models--the majority of the large funding bases 
of these institutions consists of expected future benefits or actuarial 
estimates of unpaid claims (classic insurance ``float'' funding that 
appears to fall outside the definition of the funding targets) \69\ and 
(2) as the last crisis has shown, the riskiest insurance institutions, 
like AIG, suffered primarily from underwriting risk--much of which was 
opaquely held in off-balance sheet vehicles--not from funding risk per 
     \69\ As examples, consider leading insurer Metlife's balance 
sheet--though its liability base is roughly 70 percent of Morgan 
Stanley's, its wholesale funding base is only 10 percent of Morgan 
Stanley's. Put differently, if Metlife were a bank holding company it 
would have a U.S. nondeposit liability funding market share of only 
about 2 percent. See, Metlife, Quarterly Report (Form 10-Q) (Nov. 4, 
2009) and Morgan Stanley, Financial Supplement (Q4 2009).
    Third, there are money market mutual funds that as of the week 
ended January 27, had assets totaling $3.218 trillion. \70\ The five 
largest money market fund families managed roughly 15 percent 
(Fidelity), 11 percent (JPMorgan), 8 percent (Federated), 7 percent 
(Blackrock) and 6 percent (Dreyfus) of this amount. \71\ Since even the 
largest money market fund family does not have a dominant share of the 
market, and there are numerous fund families with substantial levels of 
assets under management, the case for capping the size of money market 
mutual funds based purely on market concentration of liabilities 
appears weak.
     \70\ Inv. Co. Inst., Money Market Mutual Fund Assets (Jan. 28, 
2010), available at http://www.ici.org/research/stats/mmf/mm_01_28_10.
     \71\ Crane Data, Largest Money Fund Managers, Dec. 21, 2009, 
available at http://www.cranedata.us.
    Fourth, though GSEs are not bank holding companies, the largest 
GSEs use sufficient wholesale funding to make them worth discussing 
here. Freddie Mac and Fannie Mae each have roughly $800 billion in 
wholesale funding, an amount that dwarfs the domestic wholesale funding 
requirements of all bank holding companies, except that of Bank of 
America whose wholesale funding is slightly over $1 trillion. \72\ 
Given these very large nondeposit liability requirements--together 
these two GSEs use more wholesale funding than half of the entire U.S. 
bank holding company total--excluding them from any new size 
restrictions would seem highly inconsistent with the treatment of 
     \72\ See, Freddie Mac, Quarterly Report (Form 10-Q) (Nov. 6, 
2009); Fannie Mae, Quarterly Report (Form 10-Q) (Nov. 5, 2009); Bank of 
America Corp., Quarterly Report (Form 10-Q), at 4 (Nov. 7, 2009).
    In concluding the discussion of liability size restrictions, it is 
important to keep in mind that regardless of the liability size of any 
bank or nonbank financial institution, the proposed rules fail to 
address the more fundamental issue that nondeposit liability market 
share is not a good proxy for an institution's broader systemic risk. 
Even if a commercial lender or an insurer does not rely on systemically 
large amounts of wholesale funding, the interconnectedness of these and 
similar institutions could ultimately make them ``Too Big to Fail.'' 
Any set of new regulations designed to reduce systemic risk must focus 
not just on the size of institutions' wholesale liabilities, but also 
on institutions' connections with the broader financial system.
III. There Has Been a Lack of International Coordination in the Newest 
    Up to this point, the Obama administration wisely and appropriately 
has been careful to coordinate its regulatory reform recommendations 
with international efforts. In the Treasury White Paper, the 
Administration stressed the importance of international coordination 
stating, ``The United States is playing a strong leadership role in 
efforts to coordinate international financial policy through the G-20, 
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 . . . [U.S.] domestic 
regulatory reforms.'' \73\ Regrettably, this has not been the case with 
the Volcker Rules or size limitations.
     \73\ Treasury White Paper, supra note 2, at 80.
    Based on the initial reaction from international financial and 
regulatory bodies, we are far from reaching consensus on this issue. 
Speaking at the Davos economic summit, Dominique Strauss-Kahn--head of 
the International Monetary Fund--highlighted the lack of international 
cooperation behind President Obama's proposed banking reforms saying, 
``The question of coordinating the financial reform is key and I'm 
afraid we're not going in that direction.'' \74\ The Financial 
Stability Board says that the proposals are ``amongst the range of 
options and approaches under consideration'' and that a ``mix of 
approaches will be necessary to address the [`Too Big to Fail'] 
problem,'' \75\ hardly an endorsement. And earlier this week, the 
Deputy Director-General of the European Commission's internal market 
and services division, David Wright, said he was surprised the U.S. had 
taken a radical line on the structure of banking without first 
consulting European leaders--especially in light of U.S. discontent 
last year when the European Commission took the lead on securitization 
and credit rating agency reforms. \76\ Wright added that it might be 
difficult to find the right definition of ``proprietary trading'' to 
satisfy the Obama administration's goals without inflicting unintended 
consequences on the industry, emphasizing that Europe traditionally 
prefers to reform processes rather than change bank structure. \77\
     \74\ Simon Carswell, ``IMF Head Calls for Financial Reform'', 
Irish Times, Jan. 30, 2010, available at http://www.irishtimes.com/
     \75\ Press Release, Fin. Stability Bd., ``FSB Welcomes U.S. 
Proposals for Reducing Moral Hazard Risks'' (Jan. 22, 2010), http://
     \76\ Joel Clark, ``EC Says Obama Prop Trading Plans Would Be 
`Difficult' to Implement'', Risk Magazine, Feb. 1, 2010, available at 
     \77\ Id.
    National leaders have also emphasized the need for a coordinated 
approach. French President Nicolas Sarkozy stressed that all regulation 
concerning banks should be dealt with at an international level, 
coordinated by the G-20. \78\ Sarkozy called the current crisis a 
``crisis of globalization itself,'' urging broad coordination of 
regulation and accounting rules. \79\ In Germany, the Finance Ministry 
merely referred to the President's proposals as ``helpful 
suggestions,'' with Chancellor Angela Merkel stating that her 
Government will offer its own proposal to prevent G-20 banks from 
getting too big or interconnected. \80\
     \78\ Katrin Benhold, At Davos, Sarkozy Calls for Global Finance 
Rules, N.Y. Times, Jan. 27, 2010, available at http://www.nytimes.com/
     \79\ Id.
     \80\ Andrea Thomas, 2nd Update: Germany: Need International Review 
of Obama Plan, Wall St. J., Jan. 22, 2010, available at http://
    As Mr. Volcker asserted in his testimony before this Committee on 

        A strong international consensus on the proposed approach would 
        be appropriate, particularly across those few nations hosting 
        large multinational banks and active financial markets. The 
        needed consensus remains to be tested. However, judging from 
        what we know and read about the attitude of a number of 
        responsible officials and commentators, I believe there are 
        substantial grounds to anticipate success as the approach is 
        fully understood. \81\
     \81\ Volcker Testimony, supra note 46.

    In his appearance before the Committee, Mr. Volcker added that 
London was the other financial center whose acceptance of the Volcker 
Rules would be critical. Yet Prime Minister Gordon Brown of the United 
Kingdom, while welcoming the suggestion, stated the U.K. should 
consider similar rules only if there is an international agreement. 
\82\ The U.K.'s Chancellor of the Exchequer, Alistair Darling, 
expressed concerns that separating banks does not solve the problem 
posed by interconnectivity. \83\ To the extent there is a solution, he 
noted that ``everything we do has to be a global solution otherwise we 
will get arbitrage.'' \84\ Such comments are anything but an 
     \82\ Terence Roth and Laurence Norman, Europe Divided of U.S. Bank 
Proposal, Seeks global Pact, Wall St. J., Jan. 22, 2010, available at 
     \83\ Philip Aldrick, Alistair Darling Dismisses Obama's Plan to 
Break Up Banks as Ineffective, Telegraph, Jan. 28, 2010, available at 
     \84\ Id.
IV. The Perlmutter-Miller and Kanjorski Amendments Suggest a Preferable 
    If Congress were to conclude that bank activities and the size of 
financial companies were a problem, the Perlmutter-Miller and the 
Kanjorski Amendments to the House Bill are better solutions than the 
Volcker Rules and size limitations.
    The Perlmutter-Miller Amendment would allow the Federal Reserve 
Board (Board) to prohibit a systemically important financial holding 
company that is subject to stricter prudential supervision from 
engaging in all proprietary trading activities when the Board finds 
that trading activities threaten the safety and soundness of such 
company or of the U.S. financial system. \85\ The Amendment defines 
``proprietary trading'' broadly, as ``trading of stocks, bonds, 
options, commodities, derivatives, or other financial instruments with 
the company's own money and for the company's own account.'' \86\ 
However, the Board has the flexibility to ban certain forms of 
proprietary trading at a company without putting an end to all of 
company's proprietary trading activities. Instead, the Board can exempt 
proprietary trading activities that are ``ancillary to other operations 
of the company'' and do not pose a threat to the company or U.S. 
financial stability, provided they are carried on for the purpose of 
making a market in securities issued by the company, hedging or 
managing risk or other purposes permitted by the Board. \87\ While it 
would be preferable to extend this exemption to market making in a 
broader range of securities, allowing the Board to address proprietary 
trading at individual institutions and to distinguish between different 
trading activities is a better approach than the Volcker Rules.
     \85\ H.R. 4173, 111th Cong. 1117(a) (2009).
     \86\ Id. 1117(e).
     \87\ Id. 1117(b).
    If the Perlmutter-Miller Amendment is a better way of addressing 
proprietary trading, the Kanjorski Amendment is a better solution to 
the broader problem of all activities and size. \88\ The Kanjorski 
Amendment would allow a new Financial Services Oversight Council to 
require ``mitigatory actions'' whenever an individual firm that has 
been subject to stricter prudential supervision is deemed to pose a 
``grave threat to the financial stability or economy of the United 
States.'' \89\ The Amendment anticipates that such a threat could arise 
from a wide range of sources--including the amount and nature of a 
company's financial assets and liabilities, off-balance sheet 
exposures, reliance on leverage, interconnectedness with other firms, 
the company's importance as a source of credit for households and 
businesses and the scope of its activities. \90\ It considers a wide 
range of remedies: requiring the institutions to terminate one or more 
of its activities; restricting its ability to offer financial products; 
and requiring the firm to sell, divest or otherwise transfer business 
units, branches, assets or off balance sheet items. \91\ Firms that are 
subject to mitigatory actions have the right to a hearing \92\ and can 
seek judicial review if such actions are imposed on an arbitrary or 
capricious basis. \93\
     \88\ Id. 1105.
     \89\ Id. 1105(a).
     \90\ Id. 1105(c).
     \91\ Id. 1105(d)(1).
     \92\ Id. 1105(e)(1).
     \93\ Id. 1105(h).
    I am not endorsing these amendments but do believe they are 
preferable to the Volcker Rules and size limitations.
    Thank you and I look forward to your questions.
Chief Risk Officer and Executive Vice President, JPMorgan Chase and Co.
                            February 4, 2010
    Good morning Chairman Dodd, Ranking Member Shelby, Members of the 
Committee. My name is Barry Zubrow, and I am the Chief Risk Officer and 
Executive Vice President of JPMorgan Chase and Co. Thank you for the 
opportunity to appear before the Committee today to discuss the 
Administration's recent proposals to limit the size and scope of 
activities of financial firms.
    While the history of the financial crisis has yet to be written 
conclusively, we know enough about the causes--poor underwriting, too 
much leverage, weak risk management, excessive reliance on short-term 
funding, and regulatory gaps--to recognize that we need substantial 
reform and modernization of the regulatory structure for financial 
firms. Our current framework was patched together over many decades; 
when it was tested, we saw its flaws all too clearly.
    We at JPMorgan Chase strongly support your efforts to craft and 
pass meaningful regulatory reform legislation that will provide clear, 
consistent rules for our industry. It is our view that the markets and 
the economy reflect continued uncertainty about the regulatory 
environment. I believe that economic recovery would be fostered by 
passage of a bill that charts a course for strong, responsible economic 
leadership from U.S. financial institutions. However, the details 
matter a great deal, and a bill that creates uncertainty or undermines 
the competitiveness of the U.S. financial sector will not serve our 
shared goal of a strong, stable economy.
    At a minimum, reform should establish a systemic regulator 
responsible for monitoring risk across our financial system. Let me be 
clear that responsibility for a company's actions rests solely with the 
company's management. However, had a systemic regulator been in place 
and closely watching the mortgage industry, it might have identified 
the unregulated pieces of the mortgage industry as a critical point of 
failure. It might also have been in a position to recognize the one-
sided credit derivative exposures of AIG and the monoline insurers. 
While it may be unrealistic to believe that a systemic regulator could 
prevent future problems entirely, such a regulator may be able to 
mitigate the consequences of some failures and prevent them from 
collectively becoming catastrophic.
    As we at JPMorgan Chase have stated repeatedly, no firm--including 
our own--should be too big to fail. The goal is to regulate financial 
firms so they don't fail; but when they run into trouble, all firms 
should be allowed to fail, regardless of their size or interconnections 
to other firms.
    To ensure that this can happen--especially in times of crisis--
regulators need enhanced resolution authority to wind down failing 
firms in a controlled way that does not put taxpayers or the broader 
economy at risk. Such authority can be an effective mechanism that 
makes it absolutely clear that there is no financial safety net for 
managements or shareholders.
    Under such a system, a failed bank's shareholders should lose their 
investments; unsecured creditors should be at risk and, if necessary, 
wiped out. A regulator should be able to terminate management and 
boards and liquidate assets. Those who benefited from mismanaging risks 
or taking on inappropriate risk should feel the pain. Other aspects of 
the regulatory system also need to be strengthened--including consumer 
protection, capital standards and the oversight of the OTC derivatives 
market--but I emphasize systemic risk regulation and resolution 
authority specifically because they provide a useful framework for 
consideration of the most recent proposals from the Administration.
Restrictions on Proprietary Trading and Bank Ownership of Private 
        Equity and Hedge Funds
    Two weeks ago, the Administration proposed new restrictions on 
financial firms. The first would prohibit banks from ``owning, 
investing in or sponsoring a hedge fund or a private equity fund, or 
proprietary trading operations'' that are not related to serving 
customers. The new proposals are a divergence from the hard work being 
done by legislators, central banks and regulators around the world to 
address the root causes of the financial crisis and establish robust 
mechanisms to properly regulate systemically important financial 
    While there may be valid reasons to examine these activities, there 
should be no misunderstanding: the activities the Administration 
proposes to restrict did not cause the financial crisis. In no case 
were bank-held deposits threatened by any of these activities. Indeed, 
in many cases, those activities diversified financial institutions' 
revenue streams and served as a source of stability. The firms that 
failed did so largely as a result of traditional lending and real 
estate-related activities. The failures of Wachovia, Washington Mutual, 
Countrywide, and IndyMac were due to defaulting subprime mortgages. 
Bear Stearns, Lehman, and Merrill Lynch were all damaged by their 
excessive exposure to real estate credit risk.
    Further, regulators currently have the authority to ensure that 
risks are adequately managed in the areas the Administration proposes 
to restrict. Regulators and capital standards-setting bodies are 
empowered, and must utilize those powers, to ensure that financial 
companies of all types are appropriately capitalized at the holding 
company level (as we are at JPMorgan Chase).
    While bank holding companies may engage in proprietary trading and 
own hedge funds or private equity firms, comprehensive rules are in 
place that severely restrict the extent to which insured deposits may 
finance these activities. And regulators have the authority to examine 
all of these activities. Indeed, existing U.S. rules require that firms 
increase the amount of capital they hold as their private equity 
investments increase as a percentage of capital, effectively 
restraining their private equity portfolios.
    While regulators have the tools they need to address these 
activities in bank holding companies, we need to take the next logical 
step of extending these authorities to all systemically important firms 
regardless of their legal structure. If the last 2 years have taught us 
anything, it is that threats to our financial system can and do 
originate in nondepository institutions. Thus, any new regulatory 
framework should reach all systemically important entities--including 
investment banks--whether or not they have insured deposit-based 
business; all systemically important institutions should be regulated 
to the same rigorous standard. If we leave outside the scope of 
rigorous regulation those institutions that are interconnected and 
integral to the provision of credit, capital and liquidity in our 
system, we will be right back where we were before this crisis began. 
We will return to the same regime in which Bear Stearns and Lehman 
Brothers both failed and other systemically important institutions 
nearly brought the system to its knees. We cannot have two tiers of 
regulation for systemically important firms.
    As I noted at the outset, it is also very important that we get the 
details right. Thus far, the Administration has offered few details on 
what is meant by ``proprietary trading.'' Some traditional bank holding 
company activities, including real estate and corporate lending, expose 
these companies to risks that have to be managed by trading desks. Any 
individual trade, taken in isolation, might appear to be ``proprietary 
trading,'' but in fact is part of the mosaic of serving clients and 
properly managing the firm's risks. Restricting activities that could 
loosely be defined as proprietary trading would reduce the safety and 
soundness of our banking institutions, raise the cost of capital 
formation, and restrict the availability of credit for businesses, 
large and small--with no commensurate benefit in reduced systemic risk.
    Similarly, the Administration has yet to define ``ownership or 
sponsorship'' of hedge fund and private equity activities. Asset 
managers, including JPMorgan Chase, serve a broad range of clients, 
including individuals, universities, and pensions, and need to offer 
these investors a broad range of investment opportunities in all types 
of asset classes. In each case, investments are designed to meet the 
specific needs of the client.
    Our capital markets rely upon diversified financial firms equipped 
to meet a wide range of financing needs for companies of all sizes and 
at all stages of maturity, and the manner in which these firms are 
provided financing is continually evolving in response to market 
demand. Codifying strict statutory rules about which firms can 
participate will distort the market for these services--and result in 
more and more activities taking place outside the scope of regulatory 
scrutiny. Rather, Congress should mandate strong capital and liquidity 
standards, give regulators the authority they need to supervise these 
firms and activities, and conduct rigorous oversight to ensure 
    While we agree that the United States must show leadership in 
regulating financial firms, if we take an approach that is out of sync 
with other major countries around the world without demonstrable risk-
reduction benefits, we will dramatically weaken our financial 
institutions' ability to be competitive and serve the needs of our 
clients. Asset management firms (including hedge funds and private 
investment firms) play a very important role in today's capital 
markets, helping to allocate capital between providers and users. The 
concept of arbitrarily separating different elements of the capital 
formation process appears to be under consideration only in the U.S. 
Forcing our most competitive financial firms to divest themselves of 
these business lines will make them less competitive globally, allowing 
foreign firms to step in to attract the capital and talent now involved 
in these activities. Foreign banks will gain when U.S. banks cede the 
Concentration Limits
    The second of the recent Administration proposals would limit the 
size of financial firms by ``growth in market share of liabilities.'' 
Again, while the Administration has not provided much detail, the 
proposal appears to be based on the assumption that the size of 
financial firms or concentration within the financial sector 
contributed to the crisis.
    If you consider the institutions that failed during the crisis, 
some of the largest and most consequential failures were stand-alone 
investment banks, mortgage companies, thrifts, and insurance 
companies--not the diversified financial firms that presumably are the 
target of this proposal. It was not AIG's and Bear Stearns' size but 
their interconnection to other firms that prompted the Government to 
step in. In fact, JPMC's capabilities, size, and diversity were 
essential to our withstanding the crisis and emerging as a stronger 
firm--and put us in a position to acquire Bear Stearns and Washington 
Mutual when the Government asked us to. Had we not been able to 
purchase these companies, the crisis would have been far worse.
    With regard to concentration specifically, it is important to note 
that the U.S. financial system is much less concentrated than the 
systems of most other developed nations. Our system is the 2nd least 
concentrated among OECD countries, just behind Luxembourg; the top 3 
banks in the U.S. held 34 percent of banking assets in 2007 vs. an 
average for the rest of the OECD of 69 percent.
    An artificial cap on liabilities will likely have significant 
negative consequences. For the most part, banks' liabilities and 
capital support the asset growth of its loan and lending activities. By 
artificially capping liabilities, banks may be incented to reduce the 
growth of assets or the size of their existing balance sheet, which in 
turn would restrict their ability to make loans to consumers and 
businesses, as well as to invest in Government debt. Capping the scale 
and scope of healthy financial firms cedes competitive ground to 
foreign firms and to less regulated, nonbank financial firms--which 
will make it more difficult for regulators to monitor systemic risk. It 
would likely come at the expense of economic growth at home. No other 
country in the world has a Glass-Steagall regime or the constraints 
recently proposed by the Administration, nor does any country appear 
interested in adopting one. International bodies have long declined to 
embrace such constraints as an approach to regulatory reform.
    We have consistently endorsed the need for meaningful regulatory 
reform and have worked hard to provide the Committee and others with 
information and data to advance such reform. We agree that it is 
critically important to eliminate any implicit financial ``safety net'' 
by assuring appropriate capital standards, risk management and 
regulatory oversight on a consistent and cohesive basis for all 
financial firms, and, ultimately, having a robust regime that allows 
any firm to fail if it is mismanaged.
    While numerical limits and strict rules may sound simple, there is 
great potential that they would undermine the goals of economic 
stability, growth, and job creation that policymakers are trying to 
promote. The better solution is modernization of our financial 
regulatory regime that gives regulators the authority and resources 
they need to do the rigorous oversight involved in examining a firm's 
balance sheet and lending practices. Effective examination allows 
regulators to understand the risks institutions are taking and how 
those risks are likely to change under different economic scenarios.
    It is vital that policymakers and those with a stake in our 
financial system work together to overhaul our regulatory structure 
thoughtfully and well. Clearly such work needs to be done in harmony 
with other countries around the world. While the specific changes 
required by reform may seem arcane and technical, they are critical to 
the future of our whole economy. We look forward to working with the 
Committee to enact the reforms that will position our financial 
industry and economy as a whole for sustained growth for decades to 
    Thank you.