[Senate Hearing 112-3]
[From the U.S. Government Publishing Office]



                                                      S. Hrg. 112-3
 
         AN OVERALL ASSESSMENT OF TARP AND FINANCIAL STABILITY

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

                                HEARING

                               before the

                     CONGRESSIONAL OVERSIGHT PANEL

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               ----------                              

                             MARCH 4, 2011

                               ----------                              

        Printed for the use of the Congressional Oversight Panel


         AN OVERALL ASSESSMENT OF TARP AND FINANCIAL STABILITY




                                                          S. Hrg. 112-3

         AN OVERALL ASSESSMENT OF TARP AND FINANCIAL STABILITY

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

                                HEARING

                               before the

                     CONGRESSIONAL OVERSIGHT PANEL

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 4, 2011

                               __________

        Printed for the use of the Congressional Oversight Panel


                     CONGRESSIONAL OVERSIGHT PANEL
                             Panel Members
                    The Honorable Ted Kaufman, Chair
                             Kenneth Troske
                           J. Mark McWatters
                           Richard H. Neiman
                             Damon Silvers



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                            C O N T E N T S

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                                                                   Page
    Opening Statement of Hon. Ted Kaufman, U.S. Senator from 
      Delaware...................................................     1
    Statement of J. Mark McWatters, Attorney and Certified Public 
      Accountant.................................................     6
    Statement of Damon Silvers, Director of Policy and Special 
      Counsel, AFL-CIO...........................................    16
    Statement of Kenneth Troske, William B. Sturgill Professor of 
      Economics, University of Kentucky..........................    20
    Statement of Richard Neiman, Superintendent of Banks, New 
      York State Banking Department..............................    24
    Statement of Timothy Massad, Acting Assistant Secretary for 
      Office of Financial Stability, U.S. Department of the 
      Treasury...................................................    28
    Statement of Jason Cave, Deputy Director for Complex 
      Financial Institutions Monitoring, Federal Deposit 
      Insurance Corporation......................................    60
    Statement of Patrick Lawler, Chief Economist and Head of the 
      Office of Policy Analysis and Research, Federal Housing 
      Finance Agency.............................................    74
    Statement of William R. Nelson, Deputy Director, Division of 
      Monetary Affairs, Federal Reserve System...................    89
    Statement of Joseph E. Stigliz, Nobel Laureate and University 
      Professor, Columbia Business School, Graduate School of 
      Arts and Sciences (Department of Economics) and the School 
      of International and Public Affairs........................   108
    Statement of Allan H. Meltzer, Allan H. Meltzer University 
      Professor of Political Economy at Carnegie Mellon 
      University.................................................   118
    Statement of Simon H. Johnson, Ronald A. Kurtz (1954) 
      Professor of Entrepreneurship, MIT Sloan School of 
      Management and Senior Fellow, Peterson Institute for 
      International Economics....................................   124
    Statement of Luigi Zingales, Robert C. McCormack Professor of 
      Entrepreneurship and Finance and the David G. Booth Faculty 
      Fellow, University of Chicago Booth School of Business.....   131


         AN OVERALL ASSESSMENT OF TARP AND FINANCIAL STABILITY



                         FRIDAY, MARCH 4, 2011

                                     U.S. Congress,
                             Congressional Oversight Panel,
                                                    Washington, DC.
    The panel met, pursuant to notice, at 10:00 a.m., in room 
D-538, Dirksen Senate Office Building, Senator Ted Kaufman, 
chairman of the panel, presiding.
    Present: Senator Ted Kaufman (presiding), Richard H. 
Neiman, Damon Silvers, J. Mark McWatters, and Kenneth R. 
Troske.

   OPENING STATEMENT OF HON. TED KAUFMAN, U.S. SENATOR FROM 
                            DELAWARE

    The Chairman. Good morning. As you can tell, this is our 
last hearing and we took the ceremonial picture.
    Good morning, Mr. Secretary. We appreciate your willingness 
to join the final hearing of the Troubled Asset Relief Program.
    There's no question our economy faces real challenges 
today, but let's take a moment at the start of today's hearing 
to imagine that those challenges could be far, far worse and 
were far, far worse. Let's imagine that the S&P 500, which is 
risen by nearly 20 percent in the last year, had instead fallen 
by 30 percent in the last month. Let's imagine that our 
economy, which has added over a million jobs in the last year, 
had instead lost that many jobs in just two months. Let's 
imagine that America's oldest and most highly regarded 
financial institutions were beginning to topple literally like 
dominos.
    I think it's fair to describe this scenario as dire, even 
apocalyptic. And yet that is precisely the scenario that faced 
our economy in late 2008 around the time Congress passed the 
TARP into law.
    Today the panic of 2008 is a slowly fading memory and the 
TARP played a role in turning the page on that grim chapter in 
American history. It did not rescue our economy on its own, nor 
were all of its programs successful, not by a long shot. Even 
so, I believe that any hearing on the TARP should begin by 
recognize its greatest success, that in a moment of financial 
panic, panic, it helped to pull our markets back from the 
abyss.
    Despite this accomplishment the TARP remains deeply 
despised among the Americans public. Most of the anger is 
eminently understandable, as the program is viewed as having 
done far more for Wall Street than for every day Americans. It 
is only fair to note that some of the TARP's unpopularity is 
due to misunderstandings about its track record. Disraeli said, 
``There's three kinds of lies, lies, damn lies and statistics'' 
and polls are the third kind, statistics. But a recent 
Bloomberg poll I think hits the point in terms of anecdotal 
evidence, is exactly what I've found. It revealed that 60 
percent of the Americans believe that most of the TARP money 
provided to banks will be lost and we will not get that back. 
Only 33 percent believe that most of the money will be 
recovered.
    Many of TARP's greatest skeptics, I am sure, recall the 
frightening price tag first associated with the program, $700 
billion, the amount the Treasury requested and Congress 
approved to bail out the financial system. What they may not 
know today is that the Congressional Budget Office estimates 
that the TARP will lose $25 billion. Let me clear, $25 billion 
is a vast sum of money, yet it is far less than anyone expected 
the TARP to cost when it was created.
    Yet the news, unfortunately, is not all good. Most starkly, 
the TARP has fallen far short in its effort to help owner--
homeowners stay in their homes. The President first announced 
the goal of leveraging the TARP to prevent 3 to 4 million 
foreclosures. Today the panel estimates it will prevent fewer 
than 800,000. It is no wonder then that many Americans view the 
TARP as a program designed and executed for the benefit of Wall 
Street CEOs rather than Main Street homeowners.
    Further, it would be grossly mistaken to account for the 
TARP solely by the number of taxpayer dollars lost. The program 
has a far greater and more noxious cost. Moral hazard. That 
lingering belief that America's biggest banks are Too Big to 
Fail and the rules that apply to everyone else in America do 
not apply to them. This belief continues to distort our 
financial markets, advantaging the largest banks on Wall 
Street, while disadvantaging every other bank in the country. 
The cost of moral hazard is not easily quantifiable, but is 
real and it's reprehensible.
    Today's hearing will consist of three panels of 
distinguished witnesses. First we are joined by Acting 
Assistant Secretary Timothy Massad who currently manages all 
the TARP programs for the Department of the Treasury. Mr. 
Secretary, Mr. Massad, I particularly hope that you will share 
with us your lessons learned from more than two years at work 
on the TARP.
    If you were creating the TARP today what would you have 
done differently? That's what we're focusing on, what would we 
have done differently. What can our nation learn from this ugly 
experience and how can we prevent it from ever happening again?
    Our second panel includes witnesses from FDIC, the FHFA and 
the Federal Reserve. These offices played critical roles in 
responding to the financial crisis, often acting in 
coordination with addition to TARP programs. I hope these 
witnesses will help us place the TARP in its proper context 
among the full range of crisis response programs.
    Finally, we'll be joined by four of this country's leading 
economists who will bring decades of experience and exceptional 
credentials to the task of scrutinizing TARP and its effects. I 
look forward to hearing their expert views on the financial 
crisis and its enduring impact.
    All of our witnesses' testimony will provide material and 
support for the panels 30th and final Oversight Hearing Report 
which will be issued to Congress and the public later this 
month.
    Before we proceed I'd like to hear from my colleagues. Mr. 
McWatters.

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 STATEMENT OF J. MARK McWATTERS, ATTORNEY AND CERTIFIED PUBLIC 
                           ACCOUNTANT

    Mr. McWatters. Thank you, Senator Kaufman.
    And welcome to our distinguished witnesses.
    Although the Congressional Budget Office has recently 
estimated that the subsidy cost of the TARP downward to only, 
only $25 billion, such metrics should not serve as the sole 
determinant of the success or failure of the program. We should 
remain mindful that the TARP's overall contribution to the 
rescue of the U.S. economy was relatively modest, when 
considered along with the multi-hundred billion dollar bailout 
of Fannie Mae and Freddie Mac, the multi-hundred trillion 
dollar intervention of the Federal Reserve and FDIC as well as 
the incalculable efforts of private sector capital market 
participants.
    It is particularly difficult to label the TARP, or any 
other government sponsored program aimed at securing financial 
stability, an unqualified successful when the unemployment rate 
hovers around 9 percent, the combined unemployment and under-
employment rate equals 16 percent and millions of American 
families are struggling to escape foreclosure. It is of cold 
comfort to these families that the two big to fail financial 
institutions, aided by the TARP and other generous, below 
market rate, government sponsored programs are recording near 
record earnings. That is, to this day that TARP carries a 
substantial stigma with the residents of Main Street should 
come as little surprise.
    Professor Troske and I noted in our additional views of the 
Panel's 2010 Oversight Report that the repayment by the TARP 
recipients of advances received under the program is a 
misleading measure of the effectiveness of the TARP and 
therefore should serve--should not serve as the standard by 
which the TARP is judged.
    The unlimited bailout of Fannie Mae and Freddie Mac, by 
Treasury, in the purchase of $1.25 trillion of GSE, guaranteed 
mortgage backed securities, in the secondary market by the 
Federal Reserve, under its quantitative--first quantitative 
easing program no doubt materially benefited the TARP 
recipients and other financial institutions. These institutions 
were not required, however, to share the costs incurred in the 
bailout of the GSEs.
    In effect, the bailout of Fannie Mae and Freddie Mac 
permitted the TARP recipients to monetize their GSE guaranteed 
MBS at prices above what they would have received without the 
GSE guarantees and use the proceeds to repay their obligations 
outstanding under the TARP, thereby, arguably shifting a 
greater portion of the TARP from the TARP recipients themselves 
to the taxpayers. Costs such as this should be thoughtfully 
considered when evaluating the TARP.
    After reflecting upon the analysis conducted by the panel, 
its individual members and panel staff over the past two years, 
it is all but clear that the success or failure of the TARP 
remains an open question in that neither a favorable adjustment 
to the CBO subsidy rate, nor the repayment of the TARP funds by 
some recipients tells the entire story. It is critical to note 
that although the TARP played a meaningful role in the rescue 
of the U.S. economy during the closing days of 2008, its 
enduring legacy may have been to all but codify the implicit 
guarantee of the ``Too Big to Fails'' notwithstanding the 
profound moral hazard risks arising from such action.
    The TARP, in essence, reinforced the bubble/bailout cycle 
as the government's preferred business model. Along these 
lines, the panel offered the following observations in its 
June, 2010 report on the AIG bailout. And I quote, ``The 
government's actions in rescuing AIG continue to have a 
poisonous effect on the marketplace. By providing a complete 
rescue that called for no shared sacrifice among AIG's 
creditors, the Federal Reserve and Treasury fundamentally 
changed the relationship between the government and the 
country's most sophisticated financial players. The AIG rescue 
demonstrated that Treasury and the Federal Reserve would commit 
taxpayers to pay any price and bear any burden to prevent the 
collapse of America's largest financial institutions and to 
ensure repayment to the creditors doing business with them. So 
long as this remains the worst effects of AIG's rescue on the 
marketplace will linger.''
    Likewise, in its January, 2011 report on the rescue of 
General Motors and Chrysler, the panel noted, and again I 
quote, ``Treasury is now on course to recover the majority of 
its automotive investments within the--within the next few 
years. But the impact of the actions will reverberate for much 
longer. Treasury's rescue suggested that any sufficiently large 
American corporation, even if not a bank, may be considered Too 
Big to Fail creating a risk that moral hazard will infect the 
economy far beyond the financial system. Further, the fact that 
the government helped absorb the consequences of GM's and 
Chrysler's failure, has put more competently managed 
institutions at a disadvantage. For these reasons, the effects 
of Treasury's interventions will linger long after the 
taxpayers have sold their last shares of stock of the 
automotive industry.''
    In closing, it is important to consider the reasons 
underlying the distinct unpopularity of and the stigma 
associated with the TARP, that the TARP helped to rescue the 
United States economy from financial collapse in the closing 
days of 2008 should not have served as a basis for the public 
outrage and scorn that shadows the program to this day. From my 
perspective the public rejected the program because hundreds of 
often profligate and ill-managed financial and other 
institutions, and their shareholders and officers receive 
taxpayer funded bailouts as well as other subsidies from the 
Treasury, the Federal Reserve and the FDIC on remarkably 
favorable terms. Many senior officers of these institutions 
retained their lucrative employment and although they generally 
suffered meaningful dilution, the shareholders and those TARP 
recipients were not wiped out.
    The publicly--public intuitively recognized that such 
policies were an anathema in a market economy when 
entrepreneurs and passive investors alike, retained their 
business investment profits without question, but are 
accordingly expected to bear their full losses with 
transparency and accountability and without subsidy.
    Main Street quickly realized that the TARP was heavily 
tilted in favor of Wall Street, while Main Street was stuck 
with dramatic rates of unemployment, neighborhoods decimated by 
foreclosure, banks that refused to lend and the general sense 
that the residents were left on their own.
    Thank you. And I look forward to our discussion.
    The Chairman. Mr. Silvers.

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  STATEMENT OF DAMON SILVERS, DIRECTOR OF POLICY AND SPECIAL 
                        COUNSEL, AFL-CIO

    Mr. Silvers. Thank you, Mr. Chairman.
    Good morning. This is the last hearing of the Congressional 
Oversight Panel. I would like to begin by expressing my 
gratitude to Senate Majority Leader Harry Reid and to House 
Minority Leader Nancy Pelosi for giving me this opportunity to 
serve my country.
    I would also like to express my profound gratitude to our 
chair and his predecessor, my dear friend, Elizabeth Warren, 
for their leadership of our panel.
    And also our--my gratitude to our staff, in particular our 
staff director, Naomi Baum, for all they have done over the 
last two and a half years to make our panel a success.
    Finally, I would like to thank my fellow panel members, 
Richard Neiman, Mark McWatters and Ken Troske. We have worked 
together as a team in a manner that is tragically rare in our 
national politics today and I'm honored to have been a part of 
that.
    Now today we hear from Acting Assistant Secretary Timothy 
Massad, from representatives of the key independent agencies 
that work together with Treasury on restoring financial 
stability and from some of the world's leading economists and 
experts on financial crises. While I'm grateful to all of our 
witnesses for joining us today, I want to note that we have, in 
many ways over the past two and a half years, benefited from 
the advice and assistance of Secretary Massad, of Professor 
Stiglitz and Professor Johnson. And it is fitting that they 
should be with us today.
    Before I conclude my opening remarks, I think it's 
appropriate for me to be clear what my final conclusions are 
about the TARP program. One, I believe TARP, through the 
initial investments in the large banks and in securitization 
markets primarily, was a substantial contributor to halting a 
global financial panic. It is, frankly, irresponsible, to 
suggest our nation would have been better off had we taken no 
action.
    Two, I believe, and there is overwhelming evidence to 
support my position in our February, 2009 report, that at the 
time these initial TARP investments were made, the public did 
not receive anything like full value for our money. However, 
over time the management of these assets and the execution of 
further transactions, by the team at Treasury managing TARP, 
became systematically fairer to the taxpayer. And the team at 
Treasury, Secretary Massad, his predecessor, deserve a great 
deal of credit for that.
    Three, the Paulson Treasury Department was not truthful 
with the public when it said that the Capital Purchase Program 
funds were only going to healthy institutions. And the Geithner 
Treasury Department has compounded this lack of candor by 
refusing to admit, in testimony before this panel, that 
Citigroup and Bank of America were on the verge of collapse 
when they received additional TARP funds in November, 2008 and 
January, 2009, respectively.
    Four, the failure to replace bank management, to do a 
rigorous evaluation of the state of bank assets and to 
restructure bank balance sheets accordingly has left the United 
States with weak major banks and a damaged sense of trust 
between the American public and our nation's elected leaders.
    Five, although more than half a million families have been 
helped by tarps foreclosure prevention programs, foreclosure 
prevention has been subordinated to the needs of the banks. The 
truth is that continued mass foreclosures of homeowners are a 
powerful source of systemic risk and downward pressure on our 
economy and on jobs.
    In December, 2008 this panel held its first hearing in 
Clark County, Nevada. We did so to make the point that the 
American people would judge TARP based not on the wealth of 
bankers but on the health of our communities. In December of 
2008 unemployment in Southern Nevada was 9.1 percent. Today it 
is 14.9 percent. In December, 2008, 6.58 percent of all home 
mortgages in Nevada were delinquent. Today 10.06 percent are.
    The most recent statement of the Federal Reserve's Open 
Market Committee states that quote, ``The economic recovery is 
continuing, though at a rate that has been insufficient to 
bring about a significant improvement in labor market 
conditions. Growth in household spending picked up late last 
year but remains constrained by high unemployment, modest 
income growth, lower housing wealth and tight credit.'' That is 
precisely the scenario that the majority of this panel warned 
in our April, 2009 report, would be the likely consequence of 
failing to restructure the major banks.
    Although this panel is going out of business, the task of 
managing TARP's remaining programs, of regulating the banks, of 
overseeing systemic risk goes on. The mass foreclosures 
tragically continue, but it is never to late to act to make 
change.
    Thank you.
    The Chairman. Dr. Troske.

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 STATEMENT OF KENNETH TROSKE, WILLIAM B. STURGILL PROFESSOR OF 
               ECONOMICS, UNIVERSITY OF KENTUCKY

    Dr. Troske. Thank you, Senator Kaufman.
    I would like to start by thanking the witnesses for 
appearing before the panel today. I recognize that all of you 
are very busy people with a number of other responsibilities, 
so I appreciate you taking time to come here and help us with 
our oversight responsibilities.
    Given the focus of this, our last Oversight Panel Hearing, 
it seems appropriate to comment on the overall impact of TARP 
and the financial rescue efforts in general. I was recently 
asked by a reporter whether my assessment of TARP would be 
different if TARP had ended up costing $356 billion, as was 
originally estimated, instead of the current estimate of $25 
billion, one of the more creative questions I've gotten from a 
reporter. I answered that any complete assessment of the 
success of TARP needed to take into account a number of 
factors, such as the role TARP played in preventing a financial 
collapse, the risk taxpayers were exposed to at the time TARP 
was enacted, the long run impact TARP had--has--will have on 
the market and TARP's effect on the likelihood of future 
financial crises.
    So while the actual cost of TARP is an important component, 
it is only one factor affecting ones evaluation of the success 
or failure of TARP. So my answer to the reporter was, ``Yes, I 
could still view TARP as a success even if the program had cost 
taxpayers $356 billion.''
    Throughout the financial crisis the government's actions 
were circumscribed by the expectations of the market that in 
the event of a financial crisis the government would bail out 
firms whose bankruptcy threatened to increase systemic risk. 
These expectations, of course, were based on past government 
bailouts of large financial firms. In fact, as I have argued 
previously, these expectations affected the severity of the 
financial crisis, since the market responded to these 
expectations by encouraging firms to grow until they became Too 
Big to Fail, thereby increasing the number and size of 
systemically risky firms in the economy and in turn increasing 
the amount of money needed to stem the financial crisis. Also, 
once they'd attained Too Big to Fail status, the bailout 
guarantee provided these firms gave them the incentive to 
increase their risky behavior, thus increasing the likelihood 
of a financial crisis.
    Ultimately, in my mind, the success or failure of TARP in 
particular and the overall financial rescue in general will 
hinge on whether we are able to eliminate the problem that 
caused the crisis, Too Big to Fail firms. Unfortunately, at 
least so far, it does not appear that we have taken the 
necessary steps to end Too Big to Fail.
    In my opinion, the first step in fixing the problem of Too 
Big to Fail firms is defining exactly what we mean by 
``systemically important firms'' or ``systemically important 
risks.'' That way the market has a clear understanding of which 
firms will receive support in the next financial crisis and 
which will not.
    Then the government needs to start charging market based 
fees to these firms for insurance provided to them, through 
substantially higher reserve requirements, which has been 
advocated by Professor Meltzer among others, by requiring firms 
to hold additional alternative reserves against their 
systemically risky holdings, as has been proposed by Professor 
Zingales, by charging firms by the bailout insurance along the 
lines proposed by the president of the Federal Reserve Bank of 
Minneapolis, or through some alternative mechanism which forces 
these firms to pay the cost of the insurance that is currently 
being paid for by the American taxpayers.
    Only by ending the taxpayer funded survival guarantee for 
large firms, both domestic and foreign, will we return basic 
market discipline to Wall Street and ensure that large 
financial firms face the same competitive pressures faced by 
firms operating on Main Street. In turn, this will ensure that 
future financial crises will be much less severe and the fixes 
to these crises will not involve putting trillions of taxpayer 
dollars at risk.
    Since this is our last hearing, there are some people I 
would like to note and thank for their work with the panel. 
First I would like to thank the panel staff and especially our 
executive director, Naomi Baum, for their work. Looking over 
the totality of the panel's reports, one realizes this work 
will become one of the definitive sources of information about 
the financial crisis and this is largely due to the hard work, 
patience and dedication of our staff.
    I would also like to thank my fellow panel member, Mark 
McWatters for help--for the help he has provided me in becoming 
familiar what the issues facing the panel. Mark was always 
available when I needed someone to bounce ideas off of, which 
helped me develop and formulate my ideas about TARP.
    I would like to thank Senator Kaufman for the leadership he 
has provided over the last several months. Senator Kaufman's 
guidance was important in helping the panel continue to build 
on the bipartisan spirit of cooperation we first developed 
under the leadership of former chair, Elizabeth Warren.
    Finally, I would like to offer a special thanks to the 
longest serving panel members, Richard Neiman and Damon 
Silvers. Richard has been part of 30 reports issued by the 
panel, while Damon has participated in 27. As someone who is 
exhausted after having participated in a mere 10, I can 
honestly say I don't know how they've done it reading over and 
offering comments on three drafts of each one of these reports. 
Based on my observations, both Richard and Damon have performed 
these tasks while recognizing the important responsibility they 
had to represent and protect the interests of the American 
taxpayers. So as one of these taxpayers, I would like to say 
thank you.
    And the--and I would also like, in conclusion, to thank the 
witnesses once again for joining us and helping us with our 
discussion today.
    The Chairman. Thank you.
    Superintendent Neiman.

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STATEMENT OF RICHARD NEIMAN, SUPERINTENDENT OF BANKS, NEW YORK 
                    STATE BANKING DEPARTMENT

    Mr. Neiman. Thank you.
    When the financial crisis hit in the fall of 2008, we had a 
Republican President and a Democratic Congress. This panel was 
created by that Congress to help hold the administration 
accountable in implementing the TARP program. There was no 
shortage of ideological objections from the Left and the Right 
when TARP was passed and there are no fewer today. But the 
American public's concern, it seems to me, has been far less 
ideological or partisan. Rather, they have retained the 
pragmatic focus asking the question, ``Is the investment of our 
money serving the public well?''
    It would have been difficult for this panel to assist with 
answering that question if we ourselves got distracted from it. 
Congress wisely placed both Democrats and Republicans on this 
panel to force us to be as pragmatic as the people we were 
appointed to serve. And our efforts toward that goal, over two 
years as the nation gained a new Democratic President and then 
gained a new Republican House of Representatives, remain the 
same.
    Our five different perspectives and backgrounds could have 
led to more disagreement than agreement and ultimately a 
failure to shed light and create accountability regarding the 
most complex financial issues of the day. But one of the things 
that I will personally take away from this experience of the 
last two years is a renewed optimism that people can still work 
together for the public good during increasingly partisan 
times.
    Even in the beginning, when ideology was at its height, 
prior panel members, Chair Warren, Congressman Hensarling and 
Senator Sununu who all had something important but different to 
contribute, found ways to come together. Elizabeth Warren 
deserves great credit for her leadership in the early days of 
this panel.
    We have not been perfect however, and our oversight was 
always finite. So if someone asked me, ``What is the single 
most important public service we were able to provide,'' I 
believe the answer could really only be one, I believe we 
helped empower the American public to fulfill their critical 
role as the true watchdogs of government. That's why we 
consistently called for more public data and more transparency. 
We demanded more information on TARP expenditures, HAMP 
mortgage modifications, non-HAMP mortgage modifications, bank 
health in lending and other TARP related areas. Our goal was to 
attain information on a systematic basis communicated as 
clearly as possible.
    With this, people can assess what is happening today and 
others in the future can, with the benefit of time, truly 
assess what happened back in the first global financial crisis 
of the 21st century.
    So our monthly reports and hearings come to a close this 
month, but the end of TARP oversight does not. I would humbly 
encourage our skillful fellow oversight body, SIGTARP and the 
GAO and the many reporters and bloggers who so often got the 
facts right, to continue to focus on ways to empower the public 
with clear information that provides opportunity to understand 
and have an impact.
    The fact is that free markets work, but the other fact is, 
they don't work as well as we would always like. The reason for 
this apparent inconsistency is often the lack of broadly 
available information that allows market participants and 
consumers to create fully functioning markets. We need 
continued light shedding oversight and reforms to make free 
markets work, it's simply good for the housing market, the 
financial market and the greater economy.
    I'd like to conclude by thanking today's witnesses for 
their past and current support of our work and by thanking all 
our earlier witnesses. I feel particularly compelled to express 
great gratitude to my colleagues, Ken, Mark, Chairman Kaufman 
and Vice-Chair Silvers for solidifying a belief that people 
with different philosophies can still work together for greater 
good in Washington, D.C.
    Thank you. I look forward to our questions.

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    [GRAPHIC] [TIFF OMITTED] T5276A.015
    
    The Chairman. Thank you. I'm pleased to welcome Timothy 
Massad, the acting assistant secretary of the Office of 
Financial Stability and thank him for joining us. He was here 
at the beginning. It's like bookends, it must be interesting to 
be at the beginning and the end.
    We ask that you keep your oral testimony to five minutes, 
that we will have adequate time for questions. Your complete 
written statement will be printed in the official record of the 
hearing.
    Please proceed with your testimony.

  STATEMENT OF TIMOTHY MASSAD, ACTING ASSISTANT SECRETARY FOR 
 OFFICE OF FINANCIAL STABILITY, U.S. DEPARTMENT OF THE TREASURY

    Mr. Massad. Thank you, Mr. Chairman.
    Chairman Kaufman, Members McWatters, Neiman, Silvers and 
Troske, thank you for the opportunity to testify today about 
the continued progress of the Troubled Asset Relief Program.
    As this is your last hearing, I want to begin by thanking 
you and your staff for your hard work in overseeing TARP. Your 
reports have provided useful insights and your suggestions and 
questions have helped us refine and strengthen our programs. 
TARP is a success story today, and it was made possible by the 
tireless efforts of countless people, not only at Treasury, but 
also at COP and the other oversight bodies.
    And as you noted, there is some irony or symmetry to this 
moment. I appear before you today as the Acting Assistant 
Secretary for Financial Stability, but I began my work on TARP 
with you in December, 2008, when I volunteered as your special 
legal advisory, to help prepare the first of your nearly 30 
reports. It has been an interesting journey for all of us and 
I'm--think we can fairly conclude that the journey, the 
program, was successful by any objective measure.
    First, TARP helped prevent a catastrophic collapse of our 
financial system and economy. In the fall of 2008 we were 
staring into the abyss, now we are on the road to recovery. 
TARP was not a solution to all of our economic problems, and 
there is still more work ahead. Unemployment remains 
unacceptably high and the housing market remains weak, but the 
worst of the storm has passed.
    Second, we accomplished all this using much less money than 
Congress originally provided and we are unwinding TARP faster 
than anyone thought possible. Congress authorized 700 billion, 
but we will spend no more than 475 billion and we have already 
recouped two-thirds of what we have spent.
    Third, the ultimate cost of TARP will be far less than 
anyone expected. The total cost was initially projected to be 
approximately 341 billion. According to the latest estimates, 
both from Treasury and the Congressional Budget Office, the 
overall cost of TARP will be between 25 and 50 billion and most 
of that will represent the money we spend to help responsible 
American families keep their homes.
    Finally, our financial system is in far better shape today 
than before the crisis. It is stronger and on a path to 
recovery and Congress has adopted the most sweeping overhaul of 
our regulatory structure in generations, which will give us 
tools we did not have in the fall of 2008. This work is not yet 
complete, but we have made great progress since this panel held 
its first hearing.
    TARP was a bipartisan success. The Bush Administration 
acted quickly and decisively to stop the panic and when this 
Administration took office we adopted a broad strategy to 
restore economic growth, free up credit and return private 
capital to the financial system. Today people no longer fear 
that our financial system is going to fail. Banks are much 
better capitalized and the weakest parts of our financial 
system no longer exist. The credit markets, on which small 
businesses and consumers depend, have reopened. Businesses are 
able to raise capital and mortgage rates are at historic lows.
    We have moved quickly to reduce the dependence of the 
financial system on emergency support. We have already 
recovered almost all of the funds invested in the banking 
system. And w this Administration provided funds to particular 
companies, we did so with tough conditions. Those companies are 
stronger today and have already--and we have already begun to 
recoup those investments.
    For example, the assistance we provided to AIG, one of the 
government's most controversial actions, was necessary because 
the failure of AIG, at that time, in those circumstances, would 
have been catastrophic to our financial system and our economy. 
Now barely two years later the company has been restructured 
and the taxpayers are in a position, potentially, to recover 
every dollar invested, an outcome that many thought impossible 
back then.
    Similarly, we've provided assistance to General Motors and 
Chrysler on the condition that they fundamentally restructure 
their businesses. Our actions helped prevent the loss of as 
many as one million jobs and have helped restore the companies 
and the industry to profitability. And we have completed a 
highly successful initial public offering of GM and we are 
working to exit our investments in Chrysler and Ally as well.
    Finally, I want to address our efforts to help 
responsibility but struggling American homeowners. By reducing 
mortgage rates and providing sensible incentives to prevent 
avoidable foreclosures, our policies have helped hundreds of 
thousands of families stay in their homes and have helped to 
change the mortgage servicing industry generally. We have not 
helped as many homeowners as we originally estimated, and much 
work remains to be done. But we remain committed to do so, to 
helping as many eligible homeowners as possible in a manner 
that safeguards taxpayer resources and we hope the panel will 
continue to support these efforts.
    Mr. Chairman and panel members, TARP succeeded in what it 
was designed to do. It brought stability to the financial 
system and it laid the foundation for economic recovery. Our 
comprehensive strategy and decisive action made our economy far 
stronger today than it was two years ago. We are proud of our 
actions and we appreciate all the help you've provided along 
the way.
    Thank you again for the opportunity to testimony and I 
welcome your questions.
    [The prepared statement of Mr. Massad follows:]

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    The Chairman. Thank you, Mr. Secretary. There's a lot of 
different reasons for this hearing and the last hearing and 
this report we're going to come out. And we're going to go back 
in history and what happened and the rest of it. What I'd like 
to focus today in my questions, as I said in my opening 
statement, is kind of what have we learned. What are the 
lessons learned? What--kind of--you know, we get in this kind 
of situation again, coming back, what did we learn?
    Now this is difficult to do because when TARP was 
originally set up, as I said in my opening statement, you--
everybody at Treasury, everybody at the Fed was under 
incredible pressure. I mean the place was going down and going 
down fast. A lot of decisions were made. And I'm--this is not--
I'm not here to be a Monday morning quarterback and go back and 
look at those decisions, although I'm sure other panel members 
will ask that and it will be in our report.
    But in term of lessons learned, going forward, if in fact 
you were summing up, we made some mistakes and things didn't 
turn out the way we wanted to, in the area of moral hazard, 
which everyone, I think, has referred to, what do you think? 
What does Treasury believe could have been done, would have 
been done or you would do differently if, in fact, you were 
faced with this problem again, to mitigate the moral hazard?
    Mr. Massad. Mr. Chairman, that's a very good question and 
something we've thought a lot about. I think the main lesson we 
learned is that we did not have the tools to deal with this 
crisis, at the time. And that is what, unfortunately, 
necessitated this program, which no one really wanted to have 
to do but we had to do it. We have now passed Dodd-Frank, the 
most comprehensive overhaul of our regulatory system, which I 
think gives us a variety of tools that should enable us to 
minimize and prevent these sorts of conditions again.
    Now, much work remains to implement that. But to me that is 
the principal lesson that we learned and that is the principal 
way we are trying to address the moral hazard issue, which many 
of you have, so rightly, noted.
    The Chairman. I mean just for the record, specifically what 
in Dodd-Frank do you think would reduce moral hazard?
    Mr. Massad. Well, I think the fact today that we have 
resolution authority, with respect to non-bank institutions, 
the fact that we have a manner for regulating systematic risk, 
the fact that we have the Office of Financial Research, 
Financial Stability Oversight Council, we have higher capital 
standards. All of those measures, I think, enable us to say 
that we now have the tools to try and prevent and minimize the 
effects of crises like this in the future. And therefore, 
render the sort of assistance we had to provide under TARP 
unnecessary.
    The Chairman. How about the method of the assistance?
    Mr. Massad. I'm sorry?
    The Chairman. How about the method of the assistance, how 
would that have changed with Dodd-Frank? How would you--would 
you have done it differently?
    Mr. Massad. Well, I think Dodd-Frank, for example, gives 
you the tools to dismember a non-bank financial firm. We didn't 
have that, that was one of the problems with the situation we 
confronted with AIG. So I think now we have that authority.
    The Chairman. And do you have any idea why most people 
believe, and you listen to economists talk about it of all 
parts and spectrum believe that we still have banks that are 
Too Big to Fail, that our major financial institutions that are 
Too Big to Fail?
    Mr. Massad. I think obviously the moral hazard issue is a 
very serious one and it's one we have to continue to look at 
and address. I think though, the focus should be now on 
implementing Dodd-Frank.
    The Chairman. No, I got that. I'm just--and I understand 
that, but I'm just trying to figure out what you learned, that 
specifically you would do. And you're saying essentially you 
have implemented--you have, in Dodd-Frank, all the things that 
Treasury would like to have had that could have helped them 
resolve this and eliminate----
    Mr. Massad. I don't know.
    The Chairman [continuing]. Eliminate moral hazard or 
mitigate moral hazard.
    Mr. Massad. Mr. Chairman, I guess I would say we have all 
the tools Congress decided to give us.
    The Chairman. Yeah. Well that's--this is your chance to 
tell--to say--this is your chance to lay out everything that 
wasn't included in that bill that you would have liked to have 
had, if in fact we were moving forward with this.
    Mr. Massad. Well, I don't know that I want to re-litigate 
the battle over Dodd-Frank. I think the main thing is that we 
did achieve, in a very short time, a dramatic overhaul and I 
think our focus should be on implementing that. Now, we may, at 
a future date, look at was that enough, do we need to do more. 
I think those are very good questions and we'll continue to 
address those.
    The Chairman. How about--you know, one of the--and again, I 
think most of the panelists mentioned this, there is a 
widespread perception, not perception, I think it's personally 
a reality, that Main Street did a lot worse than Wall Street on 
this. Are there some things that TARP, that Treasury could have 
done in the beginning of this program to kind of--more better 
balance between what was going to Main Street, the benefits 
would accrue to Main Street as opposed to Wall Street?
    Mr. Massad. I guess I would say this, Mr. Chairman. I think 
the main benefit to Main Street of this program was that we did 
stop the panic. And again, when I say ``this program'' I should 
say in conjunction with all the other actions that were taken, 
because it wasn't just TARP, but we did stop the panic and we 
did prevent a second Great Depression, which could have 
resulted, as many economists have estimated, of rates of 
unemployment of 16 percent, 20 percent possibly even higher. It 
also allowed us to start to get credit flowing again. Those are 
the main benefits to Main Street.
    Now obviously particular programs also had direct benefits. 
Under the Capital Purchase Program we invested in 400 to 500 
very small banks, banks that small businesses and communities 
depend on.
    I agree with you that the perception was that this program 
provided support to Wall Street and many people didn't think it 
did much for them. I understand that. This is still a very 
tough economy and people that are unemployed or in danger of 
losing their homes feel that way. We understand that and that's 
why I say there's still a lot of work to be done.
    The Chairman. I'll revisit this, but it's not a tough 
economy on Wall Street. It's a tough economy everywhere else, 
but it's not a tough economy on Wall Street.
    Mr. McWatters.
    Mr. McWatters. Thank you, Senator. And welcome again, Mr. 
Massad.
    Following up on Dodd-Frank, if I may quote and I hope I'm 
not quoting out of context, which is always a risk here, 
Professor Stiglitz's testimony. He says, ``Resolution authority 
has made little difference because few believe that the 
government will ever use the authority at its disposal with 
these Too Big to Fail banks.''
    So we have Dodd-Frank, we have a blueprint to take down not 
only financial institutions, which we had the authority under 
FDIC to do before, but now AIG and others. Will there be the 
courage in a time of panic to actually do this, to actually 
take them down, as opposed to just simply writing a check with 
another bailout?
    Mr. Massad. Mr. McWatters, I would certainly hope so. And I 
believe now that these tools are very good ones. But obviously 
it remains to execute on this, it remains to promulgate the 
regulations necessary and to act. And it will require 
regulation that is nimble. It will require regulation that is 
responsive to changes in the industry as we go forward. But I 
think we've come a long way and I think we should give these 
tools a chance to work before we judge.
    Mr. McWatters. And I know in one of the footnotes to my 
opening statement I make the observation that there was not the 
courage to take down some of the most insolvent financial 
institutions in early to mid 2009. I don't mean the last 
quarter of 2008 when the markets were frozen, okay, that might 
unto itself have sent a different message. But once the markets 
had stabilized in the last quarter of 2008, begun to stabilize 
more in 2009 and certain institutions came back and said, ``You 
know, oh by the way, we're still insolvent, we're still 
insolvent by the tune of many billions of dollars,'' at that 
point there were rules on the books of the FDIC to take down 
these institutions and they were not.
    So it really makes me question that now you have new rules 
for new institutions, when it comes right down to it will this 
happen or will simply more checks be written and as more 
questions are written, more moral hazard will be created. Any 
thoughts on that?
    Mr. Massad. Certainly. You refer to events in 2009, the 
Obama Administration did not provide a single dollar to a large 
bank. Most of the money provided to the banks was provided 
under the Bush Administration, decisions with which I agree. I 
think they made the right decisions under the circumstances, 
though I was not involved in those. The Obama Administration 
provided $11 billion in additional funds to banks, most of that 
went to small banks. Where we provided assistance to additional 
firms, we did so with tough conditions. I think if you look at 
what we did with the auto industry, we imposed some very tough 
conditions that required them to restructure. Those companies--
GM is now profitable, posted the first full year profit since 
2004. Chrysler has an operating profit.
    So I don't think there was a lack of courage. I think we 
acted very forcefully and decisively.
    Mr. McWatters. Yeah, but there were other actions going on 
underneath the surface, underneath TARP, which admittedly TARP 
was grabbing most of the headlines, that the FDIC was taking 
certain actions, the Federal Reserve was taking certain 
actions. Quantitative easing, one where the Federal Reserve 
purchased a trillion plus dollars of mortgage-backed 
securities, government-backed, mortgage-backed securities which 
would not have been purchased at a fair market value if Fannie 
and Freddie had been permitted to fail. So the bailout of 
Fannie and Freddie seems to me to have a direct correlation to 
the health of financial institutions and their ability to pay 
back the funds. So I mean there were a number of things going 
on here.
    Mr. Massad. Be happy to respond to that. You've raised a 
number of interesting points. First of all, I agree with you 
and with your opening comment that one must look at the cost of 
this, in terms of all the government programs, not simply TARP. 
But when you do that, the overall cost currently estimated is 
at about one percent of GDP, which is far less than the cost, 
for example, to resolve the S&L crisis.
    Secondly, you mentioned pricing of credit. In a crisis the 
government is acting because private capital isn't flowing. So 
we are pricing that under what the market would otherwise 
charge, because the market isn't stepping up. The trick is to 
still price it properly so that we don't encourage excessive 
reliance on it, number one, and to impose conditions so that we 
don't create a bigger moral hazard problem than is necessary. I 
agree that any government assistance comes with a moral hazard 
problem. But I think we did that and I think, again 
particularly when the Obama Administration launched the stress 
tests and provided the Capital Assistance Program, we said that 
is going to come with very tough conditions. No one took the 
money.
    Mr. McWatters. My time is about up, but I'll just leave it 
by saying that I think that there were some private market 
participants. Mr. Buffett and another--among others who, you 
know, cut better deals. So.
    The Chairman. Thank you.
    Mr. Silvers.
    Mr. Silvers. Mr. Secretary, first before I ask you any 
questions I wanted to just expand a moment on my opening 
remarks in respect to your work and the work of your 
predecessor.
    I think it's no secret that I have been critical of the 
economics of TARP transactions, but I want to, on the record, 
commend you and your predecessor for the work you've done since 
the spring of 2009 in managing--in a.) in managing TARP's--the 
TARP assets that you, so to speak, inherited and in the 
execution of the transactions that occurred since you and your 
predecessor came to work managing the TARP. I think 
particularly of the improvement in the economics from the 
public's perspective of the warrant repurchases and the way in 
which both Citi and AIG's investments have been managed, as 
purely as investment assets. So I want to make clear that I 
think you all have done a fine job in that respect and the 
overall cost numbers that you've been citing are substantially 
driven by that achievement.
    Now I want to turn to I think the exchange you just had 
with my colleague, Mr. McWatters, because I think that it's 
important in this final hearing to maybe shine a light on a 
couple of key moments in the history of the TARP. Do you agree 
that when the Obama Admin--I take your point and I've noted it 
for a long time, that under the Obama Administration there was 
not significant additional capital infused into large banks. Do 
you agree though, that there was a set of decisions made by the 
Obama Administration about what to do about the large banks and 
the government's investments in TARP in the early months of the 
Obama Administration?
    Mr. Massad. There were decisions made by Treasury and by 
the regulators. But as you note, with respect to the Obama 
Administration and Treasury in particular, under TARP, we 
inherited those investments and our focus was on managing those 
investments and exiting them. The regulators really had the 
primary responsibility to look at the health of those 
institutions and----
    Mr. Silvers. Mr. Secretary, that's not exactly what I was 
asking you.
    Mr. Massad. Okay.
    Mr. Silvers. The Treasury Department released a plan in the 
early spring of 2009, which included the stress tests, the 
stress tests were the centerpiece of that plan.
    Mr. Massad. Yes.
    Mr. Silvers. All right. The regulators executed that plan 
in substantial part, but it was an Administration and Treasury 
Department plan.
    Mr. Massad. Absolutely.
    Mr. Silvers. Is that correct?
    Mr. Massad. Yes, that's correct.
    Mr. Silvers. Now, that plan appears to me to represent a 
key strategic decision moment, right, for the Administration. 
Can you explain a little bit about--can you amplify that a 
little bit if you agree that that's true, about what those 
strategic decisions were that were made at that moment----
    Mr. Massad. Certainly.
    Mr. Silvers [continuing]. By the current president's 
administration?
    Mr. Massad. Certainly. It's a very good question. A central 
component of the financial stability plan was to recapitalize 
the financial system with private capital as efficiently as 
possible. And to do that we worked with the regulators to 
formulate the stress test for the largest 19 bank holding 
companies. And those tests were done with extraordinary and 
unprecedented transparency, because without those tests the 
market was not willing to reinvest in these institutions.
    I think the record of those stress tests and what followed 
is evidence of the success. Banks were able to raise a large 
amount of private capital following the results of those tests. 
So I think it was a very good strategy and executed 
successfully.
    Mr. Silvers. I would just observe that I think the nub of 
Mr. McWatters' dispute with you and perhaps another my--of my 
evaluation of TARP has to do with that moment and that set of 
decisions, in respect to the question of restructuring banks 
and the like. I don't want to spend what time we have arguing 
about that, but I want to make clear on the record that that, I 
think, is the key question.
    Can I just ask you, before my time has expired, what are 
your, going forward as this panel goes out of business, what 
are your greatest concerns? What worries you, both about TARP 
and about the issues TARP was designed to address, financial 
systemic stability?
    Mr. Massad. I'm very focused on our housing programs. We 
have not helped as many people as we would like. But I think 
the programs are very important and continuing to help tens of 
thousands, and I'm very concerned about efforts to eliminate 
those. I think without those programs many, many Americans who 
otherwise could be helped into an affordable mortgage will not 
have that opportunity to do so.
    Secondly, I'm very focused on managing and exiting our 
remaining investments as quickly as we can. I think it's very 
important to get the government out of the business of owning 
stakes in private companies. I think we've got a very good 
record there, we've made a lot of progress, but we still have 
more work to do. And in particular, with respect to our smaller 
banks, their path to recovery has been a little harder and we 
need to continue to work with them on that.
    Mr. Silvers. All right. Thank you. My time has expired.
    The Chairman. Dr. Troske.
    Dr. Troske. Thank you. I better turn on my mic. Thank you.
    I want to come back to one--hopefully come back to some of 
Damon's and Mark's questions about stress tests, but I wanted 
to start by talking more about TARP mandate.
    As you know, in addition to the core goal of restoring 
stability and liquidity to the financial system, the 
legislation directed Treasury to consider such goals as 
maximize overall returns and minimize the impact of the 
national debt, protect American jobs, savings and retirement 
security, help families keep their homes, stabilize 
communities, and on and on.
    Do you think that TARP, the mission of TARP was too broad? 
And do you think that this broad mandate clearly, I think a 
number of people have indicated, in terms of stemming the 
financial crisis, many people would agree that it would be a 
success. We are going to hear from some economists later. It's 
these other things that seem to be where the economy is still 
struggling. And by trying to throw all of that into a single 
piece of legislation, do you think that in some sense that 
doomed TARP to get the stigma that it has today?
    Mr. Massad. That's a very good question, Mr. Troske. We 
interpreted the considerations that you've referred to as 
things that we should take into account in how we went about 
executing the authorities we were given. The authorities we 
were given were narrower than that. The authorities we were 
given were to purchase troubled assets from financial 
institutions. We weren't given $700 billion and told--reduce 
the unemployment rate in any way you see fit. We were given a 
specific mandate to promote the stability and liquidity of the 
financial system. We were given the authority to do that 
through the purchase of troubled assets. And in doing so we 
were supposed to take those other considerations into account.
    I agree with you though, that because of the breadth of 
those, many people did feel it was up to TARP to resolve all of 
these economic problems, very important economic problems that 
we need to resolve. But I don't think it was the job of TARP to 
do that alone.
    Dr. Troske. And I guess, I mean do you think Treasury has 
done a good job of communicating its actions regarding TARP to 
the public? You know, are there areas or programs within TARP 
where Treasury--you feel Treasury could have done a better job 
articulating its objectives, similar to what you just said to 
me?
    Mr. Massad. Sure. Again, a very good question. I think we 
certainly could have done a better job explaining what we were 
doing, explaining why we were doing it. I think there is a 
tendency, where you're very focused on a crisis like this and 
taking action, to assume that people know a lot about what 
you're doing or know more than they may know. You know, I 
recognize most people in this country don't follow what goes on 
in Washington day by day the way many of us who live in 
Washington do. They're focused on their families, their homes, 
their jobs, keeping their homes, keeping their jobs, getting 
their kids through school. And yeah, we certainly could have 
done a better job communicating what we were doing.
    Dr. Troske. I want to return to the questions about the 
stress test. So I don't know whether you saw there was a column 
in Wednesday's New York Times alleging that banks supplied the 
measures that were used in the latest round of stress test, 
ensuring that they would look good and rendering the tests 
rather meaningless.
    I think part of this comes from the fact that these latest 
rounds of stress tests, the results have been kept somewhat 
private and were not as public as the first time around. And I 
guess I want you to maybe address why, and obviously this is 
the Fed's decision, not Treasury's, but whether Treasury pushed 
the Fed to make them public, what are the benefits and costs 
from making these results public and do you have any idea why 
the Fed has tended to think that the benefits were less than 
the costs in making the results public.
    Mr. Massad. Well as you know, the current round of stress 
tests is being conducted by the Fed. It was designed by the 
Fed. I had no involvement in it and Treasury generally did not, 
to my knowledge. So I can't really answer why the Fed 
structured it the way they have or their decisions about what 
they were going to publicize. Other than the fact that, I would 
note the following: Traditionally bank supervisory information 
and the testing that our regulators do, and they do it on an 
ongoing matter, is not made public. The exception was the 
stress tests of the spring of 2009. And we did that at that 
time, just given the gravity of the crisis.
    Dr. Troske. But as you noted, you attributed a lot of 
success to that. One would have thought we would want to follow 
up with that success.
    Mr. Massad. Well, I think again, one has to do 
extraordinary actions in a crisis and I think in the crisis it 
was appropriate to conduct those stress tests with the 
transparency with which we did.
    But I think there are good reasons why we have a model in 
this country of bank regulation and supervision in which a lot 
of the detailed information is not made public, but certain 
conclusions and other information is made public.
    Dr. Troske. I'll note that we--one of our later panelists 
is a Nobel Prize winning economists who won his Nobel Prize for 
his work on asymmetric information so I think it's going to be 
interesting to hear his take on keeping information secret.
    Mr. Massad. I look forward to that. Unfortunately I cannot 
stay, but I look forward to reading the transcript later, of 
both the panels that follow.
    The Chairman. We will send you the transcript.
    Superintendent Neiman.
    Mr. Neiman. Thank you.
    Mr. Massad, thank you very much for your role. I was here 
when you volunteered your work on the COP panel, which was very 
helpful at the time. I also very much appreciate the fact that 
you continued in that role when asked to serve by the Treasury 
Department. I also want to acknowledge the work of your 
predecessor, Herb Allison for his efforts and his coordination 
with this committee.
    I want to follow up with your answer to Damon's question 
about what worries you the most. The first point you mentioned 
was related to the housing programs and your concern that those 
could be eliminated.
    This is my area of interest because this week there were 
calls from lawmakers to eliminate Treasury's foreclosures 
mitigation programs. Some have referred to the approximately 
$50 billion set aside to American homeowners, as a waste of 
money. But few mention that very little of the money has 
actually been spent, and that lack of spending frustrates those 
of us who believe that effective government investment into the 
housing market is essential for further financial stability and 
economic recovery.
    But with only $1 billion spent on the HAMP so far, as 
estimated by the CBO and nearly 600,000 mortgages permanently 
modified, it's difficult to conclude that HAMP has been a waste 
of money. Even just as a back of the envelope estimate, that's 
around $2,000 per permanent mod and we know that there are 
certainly other more complicating factors, re-default rates and 
servicer incentives and the role that the GSEs have played.
    But, could you comment, from a cost benefit of analysis----
    Mr. Massad. Sure.
    Mr. Neiman [continuing]. As to the value of those dollars 
spent on those 600,000 permanent mods?
    Mr. Massad. Sure. I think it's been dollars very well 
spent. First of all, let me say that the money, as you know, is 
spent over time for once there is a permanent modification of a 
mortgage, the payments are made over time as long as the 
homeowner continues to make his or her payments. And you know, 
we estimate basically that over time a permanent modification 
will cost the government about $20,000. So we'll see that 
number go up and as long as we can continue to roll out the 
program we expect that, you know, more people will enter. We're 
getting 25,000 to 30,000 additional permanent modifications a 
month.
    Keep in mind also that we have reallocated some of that $50 
billion, it's actually $46 billion total, but we reallocated 
some of that to other programs, to the Hardest Hit Program, to 
the FHA Short Refinance Program and there are other subprograms 
within Making Home Affordable. So we're looking at the total 
cost that we think will be spent, it will be below the $46 
billion, but it will be significantly higher than where we are 
today, of course.
    Mr. Neiman. Could you talk to the benefits of those 
programs, both to the borrowers, I think----
    Mr. Massad. Sure.
    Mr. Neiman [continuing]. Which are more obvious, but also 
to the underlying economy?
    Mr. Massad. Certainly. Certainly. You know, this is the 
worst housing crisis that we've seen since the Great Depression 
and what we're trying to do through these programs is to help 
people modify their mortgage where it makes economic sense to 
do so. And by doing so you avert a lot of costs. A foreclosure, 
for any family that goes through it, is obviously a terrible 
economic loss, it's also a great social and--or great 
psychological and emotional loss. It's a loss to the community, 
the community suffers from it because neighboring house prices 
fall, particularly where you have a vacant home that can be 
then subject to vandalism, that hurts the community.
    So, you know, this situation is a drag on our economy as a 
whole. So the more that we can help people get into sustainable 
modifications, which is the focus of our program, it's not 
simply kicking the can down the road, as some people have 
alleged, we're helping people get into a sustainable situation, 
I think our country is much better off.
    Mr. Neiman. And before my time expires, could you comment 
on the impact of ending those programs would have on the 
economy?
    Mr. Massad. Certainly. I think it means that tens of 
thousands of people that could otherwise get help directly will 
not get that help. In fact more----
    Mr. Neiman. And what of the impact on non-HAMP mods? Do you 
see a direct correlation----
    Mr. Massad. Absolutely.
    Mr. Neiman [continuing]. If the HAMP program ended?
    Mr. Massad. I think--excuse me. Absolutely. I think one of 
the things that our program has done is it has set standards 
that have now been followed by the industry widely. There were 
no modifications getting done prior to the launch of this 
program. We've set standards, not only for how do you do a 
sustainable modification, what should be its terms, but also 
standards for borrower protection. Dual track, for example, the 
procedure where some of the servicers were talking to a 
homeowner about a modification at the same time that they were 
foreclosing. It's very, very confusing to the homeowner and 
very frustrating.
    Mr. Neiman. And the elimination of that program could 
certainly jeopardize the standardization, the focus on those?
    Mr. Massad. Absolutely. Absolutely.
    Mr. Neiman. Thank you. My time has expired.
    The Chairman. Thank you.
    Just to finish up on the moral hazard. I saw a quote, 
because as you--as everybody's pointed out, it's really a 
government problem. I saw a quote by Secretary Geithner and I 
just thought--right here in Financial Times, on January 14th, 
he said, ``In the future we may have to do exceptional things 
again if we face a shock that large. You just don't know the 
systemic, not until you know the nature of the shock.''
    Is this kind of backing away from the fact, no time, no 
way, no are we ever going to bail any bank out again?
    Mr. Massad. Chairman, it's a very good question. The 
Secretary--I've talked to the Secretary about that statement--
--
    The Chairman. Yeah.
    Mr. Massad. And he was referring to the use of the tools 
under Dodd-Frank. I think it's clear that we don't know what 
the next crisis will be. And as I said earlier, we believe that 
the tools that we now have under Dodd-Frank give us the ability 
to minimize the effects, but it requires, as I say, effective 
implementation and use of those tools.
    The Chairman. Is there any concern that--widespread belief 
that there still are banks Too Big to Fail. The market seems to 
indicate by the spreads that they give to the larger banks, 
that they're Too Big to Fail, that people all over the world 
are trying to figure out. I know there's a new study going to 
come out on resolution authority across borders, which has not 
been dealt with in Dodd-Frank and would be an incredible 
problem. Does any of that kind of concern you in terms of 
moving forward, with moral hazard?
    Mr. Massad. Certainly concerns me. I think the moral hazard 
issue is obviously a very, very significant one. And as you all 
have noted, it's a very significant issue in light of what we 
had to do under TARP. But, again I think it's up to us now to 
take the tools that Congress has given us and work to minimize 
that risk.
    The Chairman. One of the frustrations I think that people--
I mean not just people, everyone has, it's not just me, 
everyone, and that is the fact that, you know, we went in, we 
helped out the banks, we helped out the corporations and then 
the jobs just didn't come, the investment didn't come, the 
banks held on to the money, they're still not investing the 
money, the corporations didn't invest the money. Is there some 
way that TARP could have been structured to--I mean it sounds 
an awful lot like trickle down to a whole lot of people that 
didn't trickle.
    Mr. Massad. Um hmm.
    The Chairman. And so is there any way that you think, 
looking back on it, that TARP could have been structured so 
that it would be a better chance that we'd actually get 
economic growth and jobs for small business and for regular 
people?
    Mr. Massad. I think that the key thing was that TARP alone 
wasn't enough.
    The Chairman. No, I mean but again, we're just focusing on 
TARP.
    Mr. Massad. Um hmm.
    The Chairman. Could TARP have been structured, do you 
think, in some way so that we would have at least mitigated 
that if not eliminated it?
    Mr. Massad. Yeah. You know, I think policymakers, 
historians, probably this panel will explore that issue. I 
think it's one we should explore. Sitting here today, you know, 
I'm very focused on----
    The Chairman. Right, I got it.
    Mr. Massad [continuing]. Exiting the program and wrapping 
it up.
    The Chairman. One final thing. But one of the simple things 
was the panel I know right in the beginning said that there 
should be better support tracking of funds. And I know we've 
been concerned about the transparency of tracking where the 
funds went. Do you think, in retrospect, again the time, it was 
a tough time, everybody's running around. But now looking back 
in the calm of two years, two and a half years later, do you 
think maybe it would have been a better--good idea to track the 
funds better?
    Mr. Massad. Well, you know, we implemented the 
recommendations of SIGTARP in this regard. It was done, you 
know, later after a lot of the money went out the door.
    You know, on the lending point though, I would simply note, 
as I think this panel noted in a very excellent report, that 
the lending issue is not simply a supply of capital issue, it's 
also a demand issue, it's also a regulatory issue. In other 
words, the level of lending in this country and how you get 
that back up. And you're going to see that fall in a recession.
    So these are complex problems and while it may be that we 
could have done things differently under TARP, I think that, 
you know, the focus now should be to work with the tools we 
have and try to process----
    The Chairman. No, I have that. What I'm trying to get at is 
kind of a history so that if we go, start over again, god 
forbid anything like it should ever happen again, we're not 
starting without some of the best suggestions. So my question--
and you can think about that, maybe you want to get back to me 
on that, kind of what are some of the things that we could have 
done to have mitigated that.
    Mr. McWatters.
    Mr. McWatters. Thank you, Senator.
    If I may, I will go back to the written testimony of 
Professor Stiglitz, first page, and I'll read a quote and would 
like to hear your comments. Towards the bottom of the first 
paragraph Professor says, ``The normal laws of capitalism where 
investors must bear responsibility for their decisions, were 
abrogated. A system that socializes losses and privatize gains 
is neither fair nor efficient. Admittedly, the big banks were 
given money--were given many enormous gifts,''--and he uses the 
term gifts--``of which TARP was only one. The United States 
government provided money to the biggest of the banks in their 
times of need, in generous amounts and on generous terms but 
have been forcing ordinary Americans to fend for themselves.''
    Would you care to comment on that?
    Mr. Massad. Certainly. Well, first of all, I agree that we 
need to have a financial system where firms can fail, 
regardless of how big they are. The question is, when you were 
in the midst of the crisis that we faced, in the fall of 2008, 
what should we have done? And again I think the actions taken 
were appropriate in light of the situation that we confronted 
and the tools we had. But we obviously have to work toward a 
system where that never becomes necessary again and where firms 
do fail if they have taken excessive risks.
    Mr. McWatters. Okay. Moving to the testimony of Professor 
Zingales. Page 3, I read from the last full paragraph of the 
page, ``TARP was the largest welfare program for corporations 
of its--and their investors ever created in the history of 
humankind. That some of the crumbs have been donated to auto 
worker unions does not make it any better, it makes it worse. 
It shows that this redistribution was no accident, it was 
premeditated pillage of defenseless taxpayers by powerful 
lobbyists.''
    Do you agree with that or do you not agree with that?
    Mr. Massad. I don't agree with that.
    Mr. McWatters. Okay. On what basis?
    Mr. Massad. Again, I think that we were confronted with an 
extraordinary situation in the fall of 2008 and we took actions 
that were necessary to prevent the collapse of our financial 
system which would have had terrible effects for everyone in 
this country. And I think the actions we took succeeded in 
doing that.
    Mr. McWatters. You know, I don't think--my time is up, but 
I don't think either one of these gentlemen is saying that in 
October of 2008 the response by the United States Government 
was to do nothing. Okay? But it's more of a nuance issue as to, 
okay, once the meltdown threat is over, just a few months 
later, which from our recollection, then we need to be able to 
turn on a dime and maybe apply the rules somewhat differently.
    But, my time is up and I'll end there.
    The Chairman. Thank you. Mr. Silvers.
    Mr. Silvers. Mr. Secretary, we've had a lot of 
conversations in this room and privately with the Treasury 
Department which kind of end with the issue of, well, with the 
problem of, ``Well that would be a good idea to do but we don't 
have the power to do it.'' In that vein, as you look at the 
powers you have and don't have to manage TARP going forward 
after this committee disbands, and with the notion that 
Congress is listening, what powers would you like to have that 
you don't have?
    Mr. Massad. Well, I guess I've assumed we're not amending 
the TARP at this juncture
    Mr. Silvers I assume we're not either. I'm trying to build 
a record. [Laughter.]
    Mr. Massad. You know, I think the work that remains to be 
done, particularly in the area of housing, is obviously 
critical.
    Mr. Silvers. Yes.
    Mr. Massad. And as you know----
    Mr. Silvers. So let's take housing. I mean I think we--I 
think a lot of us agree on that and agree with, I think, the--I 
think the sentiments you expressed a few minutes ago, which I 
hope that you and your colleagues keep repeating.
    So let's take housing. You've got agreements, you've got a 
legal structure with the HAMP participants. If you could 
rewrite those agreements today, knowing what you know, what 
would you do?
    Mr. Massad. Well, if we were to rewrite the agreements, 
again within the framework of the powers we have, we would have 
simply----
    Mr. Silvers. Assume someone gives you a magic wand, what 
would you do with it? [Laughter.]
    Mr. Massad. You know, it's just difficult to answer the 
hypotheticals in terms of rerunning the history. In terms of 
going forward----
    Mr. Silvers. Going forward, yeah.
    Mr. Massad [continuing]. I think there, you know, I will 
leave it to the Congress. I don't mean to dodge the question, 
but I think there's a variety of things that have been 
considered. They range from the simple ones, which I know 
you've taken an interest in, that we concluded we couldn't even 
use TARP funds, for example, to pay for legal aid and broad 
counseling in the housing program, because----
    Mr. Silvers. But would it be a good idea to do that?
    Mr. Massad. Yes.
    Mr. Silvers [continuing]. I mean I'm not--I know that----
    Mr. Massad. We supported the legislation to do that. And it 
didn't go anywhere.
    Mr. Silvers. So that's one that's item one.
    Mr. Massad. That's a small one. That's a small one. You 
know, I think there are a range of things, such as cram down or 
reform of the bankruptcy codes so that, you know, people 
could--that judges could write down mortgages.
    Mr. Silvers. That would be item two then.
    Mr. Massad. That could be item two, but you know, I think 
we can certainly provide you potentially with others. I'm very 
focused, obviously, on just executing the authorities we have.
    Mr. Silvers. Okay. I don't know if I'm allowed to ask one 
more question?
    Several of the witnesses that we--in written testimony, 
have suggested that we ought to have sliding scale capital 
requirements for larger banks. That was in this panel's 
regulatory reform report at the beginning of our work. It is 
within the powers granted to the bank regulators and the 
systemic risk regulator. What is your view of that proposition?
    Mr. Massad. I will leave that one to the regulators and the 
Financial Stability Oversight Council. I think it's a very 
important question but I would note simply that, you know, we 
have raised the level of capital in the system significantly 
since where we were. Our banks are better capitalized, far 
better capitalized today. But as to the exact details of 
whether there should be a sliding scale and what that sliding 
scale should look like, I would defer to those who have that 
power.
    Mr. Silvers. Mr. Secretary, if the Treasury Department has 
a view on that question, I know I sort of caught you by 
surprise on that----
    Mr. Massad. Certainly.
    Mr. Silvers [continuing]. If the Treasury Department has a 
view in its role in the systemic risk process--management 
process, I think we'd appreciate that in writing.
    Secondly and finally, we've had--a number of us have had a 
back and forth with you about these fundamental strategic 
decisions that were made in early 2009. Our expert witnesses 
have a lot to say about that and a lot of it's quite critical. 
I would offer you the opportunity, in writing, to respond if 
you and the Treasury Department would wish, to make your view 
on those questions known.
    Mr. Massad. Thank you.
    The Chairman. Thank you.
    Dr. Troske.
    Dr. Troske. Thank you. I want to refer back to the quote 
that Chairman Kaufman referred to and I know it's always 
awkward to put someone in the position of criticizing their 
boss, but Secretary Geithner, Treasury Secretary Geithner did 
say, ``You just don't know what's systemic and what's not, 
until you know the nature of the shock.''
    The statement seems to be sort of in contrast to some of 
the calls by many economists, including some of our next panel 
and of course including myself in my opening statement, that 
the government needs to clearly define what they view as a 
systemically risky firm or systemic risk so that the market has 
a very clear understanding of what that means and what we view 
that--what we view is systemically risky.
    Could you sort of tell me why you don't think, or perhaps 
maybe you do think, we can--why aren't we defining what we mean 
by systemically risky?
    Mr. Massad. Well, I think there is a process going on to 
address that. I think what the Secretary was referring to is 
that it's not simply a quantitative determination or a simple 
determination, it's also going to be a determination that 
changes over time. But I think the Dodd-Frank legislation gives 
us the ability to do that. I think the initial work in that 
area has indicated that there will be a variety of criteria 
used that are both quantitative, qualitative, that involve 
looking at capital levels, leverage, interconnectedness and 
other factors.
    So I think the meaning of the Secretary's statement was 
simply that it is a complex determination.
    Dr. Troske. I mean--and I guess I want to push a little bit 
on that. Do you view that at some point there's going to be a 
clear statement to the markets, very transparent statement, 
``This I want we view as systemically risky,'' so that someone 
from outside looking in would come to approximately the same 
conclusion about which firms are systemically risky as say a 
future Treasury secretary?
    Mr. Massad. That is a subject that the Financial Stability 
Oversight Council and its various members will look at and 
consider, and I'm sure they'll have more to say about that in 
the future.
    Dr. Troske. Going back to the original TARP legislation, 
one in which was supposed to involve the purchasing of troubled 
assets, you know, toxic assets of the books of banks. That's 
not the way it was implemented and, I guess in my opinion, 
rightfully so. But I guess that--those troubled assets, 
presumably, are still sitting on banks' books. Do you have a 
sense of how big that--the problem is today? Do you have a 
sense of the--and whether the Federal Reserve's ultimate 
purchase of 1.2 trillion in residential mortgage-backed 
securities was, in addition to the other affects, a way of 
removing those troubled assets from banks' books and shifting 
them to the Feds books?
    Mr. Massad. Well, I would say a couple of things. It's a 
very good question. I think what we've seen is we have seen 
substantial write-offs by the industry, number one. Number two, 
I think we've seen asset quality generally improve. Number 
three, I think we've seen that the performance of the big banks 
at least has actually been better than what the stress tests 
predicted. The stress tests were designed to look at, you know, 
what was the riskiness of those assets in the bank situation.
    Is there more work to do? I would defer to the regulators 
on that, about the principal responsibility for overseeing 
those banks. We're obviously still on the road to recovery.
    Dr. Troske. Thank you.
    The Chairman. Superintendent Neiman.
    Mr. Neiman Thank you. I'd like to come back again to the 
foreclosure issues. And as I mentioned in my opening, I believe 
the best thing this panel can do is to establish a precedent 
and a process to get good information to the public. And that's 
why some of our, I think greatest frustrations around the HAMP 
program have been with respect to the release and obtaining of 
information.
    The first being really around non-HAMP modifications. I 
think in the defense of the HAMP program, you rightfully point 
to the fact that not only did you create a system for 
modifications, but also that it encouraged non-HAMP 
modifications outside of the HAMP program, and I think they 
probably exceed three to one the number of HAMP.
    But despite our continued calls for information--and it's 
been supported by the Secretary himself--when Secretary 
Geithner was here last December he acknowledged how important 
that kind of information was. He pledged to us, ``We are 
looking for ways we can get better information out there to 
assess these programs.'' What progress has been made since 
December in obtaining and publicly releasing this data, 
regarding proprietary bonds?
    Mr. Massad Thank you, Mr. Neiman. That's a very good 
question and I know it's been an issue that you've been very 
focused on. And I agree with you, we need more data on those 
non-HAMP modifications.
    As you know, those are outside of our program and therefore 
outside of the system, the reporting system that we set up. 
There was no reporting on any modifications in this country, 
prior to HAMP. And we set up----
    Mr. Neiman. Have servicers been asked to voluntarily submit 
that?
    Mr. Massad. We have suggested that to several of the 
servicers. I know you've raised it with HOPE NOW in your 
conversations with them and when they appeared before this 
panel. And I know the regulators are also looking at that 
issue.
    Mr. Neiman. So again, I think we would encourage you 
certainly to put a process in place. This is something that 
certainly, if not voluntarily submitted, should be a high 
priority to find a way to require that information to be 
submitted and publicly released.
    The other area has been around the web portal. And we've 
been talking about this web portal to allow not only housing 
counselors and borrowers to submit data directly through a web 
based system to their servicers, but even more importantly, to 
allow them to assess the status of their modification.
    Mr. Massad. Um hmm.
    Mr. Neiman. We continue to read and hear about the slow 
implementation and even the slow pick up on usage. Can you give 
us an update as to how frequently and the volume of usage on 
that system?
    Mr. Massad. Let me get back to you on that. I don't have 
those figures at my fingertips or the status of that. I know it 
has taken a lot of work to get to where we want to be. There 
are issues of, you know, making sure that it not only works, 
but that it protects privacy. But I'd be happy to get back to 
you on that.
    Mr. Neiman. Okay. And the last, if you bear with me, is 
something I've asked at our last hearing. I've asked Ms. 
Caldwell and I've asked the Secretary himself regarding the 
need for a national foreclosure database. And I've been given 
polite noncommittal responses each time. So I wouldn't want you 
to feel that you were left out today. [Laughter.]
    So, well what is it? What do you think would be the 
reluctance for starting a program that would provide mortgage 
performance data across the board, across state, across 
national, across all lines, for banks and nonbanks?
    Mr. Massad. Again, a very good question, Mr. Neiman. I 
think we're at a point in time where we're going to see very 
dramatic change, overall, in the mortgage servicing industry 
which will lead to things like national servicing standards and 
presumably a national database on a number of these issues. 
It's been clear throughout this crisis that we didn't have 
data, we didn't have standards and that's been a large part of 
the problem.
    So I think there is a lot of work going on on a number of 
fronts to look at those. I can't give you a specific prediction 
as to where we'll be when, but I think we will see some 
significant change there.
    Mr. Neiman Thank you. I look forward to your follow-up 
response on the web portal. Thank you.
    The Chairman. Thank you, Acting Assistant Secretary Massad. 
Thank you for being here today, but thank you so much for your 
public service.
    Mr. Massad. Thank you for having me.
    The Chairman. It's a real--it really is--appreciate it.
    One thing, one question I have is you said that you've 
raised bank capital requirements significantly. I don't want to 
ask that question now, if you could just submit in writing kind 
of what you did to raise bank capital requirements 
significantly.
    Mr. Massad. Yeah. Certainly. It wasn't us, but just 
generally what I meant was that bank capital levels have 
increased.
    The Chairman. Okay. I'd just like some details on that.
    Thank you very, very much.
    And the next panel come forward, please.
    Welcome. I am generally pleased to welcome our second 
panel. We're joined by Jason Cave, deputy director of the 
Office of Complex Financial Institutions Monitoring at the 
FDIC; Patrick Lawler, chief economist and associate director 
for Policy Analysis and Research at FHFA; and William R. 
Nelson, deputy director, Division of Monetary Affairs, Federal 
Reserve.
    Thank you all for joining us. Please keep your oral 
testimony to five minutes so that we will have ample time for 
questions. Your complete written statement will be printed in 
the official record of the hearing.
    We'll begin with Mr. Cave.

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STATEMENT OF JASON CAVE, DEPUTY DIRECTOR FOR COMPLEX FINANCIAL 
 INSTITUTIONS MONITORING, FEDERAL DEPOSIT INSURANCE CORPORATION

    Mr. Cave. Chairman Kaufman and members of the panel, I 
appreciate the opportunity to testify on behalf of the FDIC 
concerning the Temporary Liquidity Guarantee Program or TLGP.
    A significant contributor to the financial crisis was a 
disruption in credit markets, which significantly impaired the 
ability of even credit-worthy companies to refinance their 
commercial paper and long term debt.
    The FDIC's TLGP was one of several extraordinary measures 
taken by the U.S. Government, in the fall of 2008, to address 
the crisis in the financial markets and bolster public 
confidence. The FDIC TLGP helped to unlock the credit markets, 
calm market fears and encourage lending during these 
unprecedented disruptions.
    The TLGP provided a guarantee, for a limited period of 
time, for certain new senior unsecured debt issued by financial 
institutions. We designed this program to be as inclusive as 
necessary to ensure that credit--particularly between banks--
began to flow again. This calmed what was becoming ``the 
perfect storm,'' whereby creditors refused to roll their debt 
beyond weeks or even overnight and demanded more collateral at 
the exact time that banks needed these funds to continue to 
finance their operations.
    Additionally, the TLGP fully guaranteed certain non-
interest bearing transaction deposit accounts. This provided 
stability to insured banks, particularly smaller ones, enabling 
their commercial customers to continue to do business without 
disruption. The creation of this aspect of the program was 
necessary because we were seeing that smaller, healthy banks 
were losing these accounts to their much larger competitors 
because of uncertainties in the financial system.
    At its peak, the FDIC guaranteed almost $350 billion of 
debt outstanding. As of December 31, 2010 the total amount of 
remaining FDIC guaranteed debt was $267 billion. Of that 
amount, $100 billion, or 37 percent will mature in 2011, and 
the remaining $167 billion will mature in 2012.
    The TLGP has worked as it was intended to. Credit markets 
have returned to some level of normalcy, and private investors 
have resumed their roles as credit providers at market terms. 
Financial institutions are in the process of repairing their 
balance sheets, increasing cash positions and reducing their 
alliance upon short term debt.
    The FDIC as deposit insurer and as guarantor of TLGP 
supports these needed improvements. Given that $267 billion in 
TLGP remains outstanding, it is important that financial 
institutions continue to replace government guaranteed debt 
with private funds. The FDIC is closely monitoring the funding 
plans that institutions have developed to ensure that TLGP can 
be fully repaid through the private credit markets. The next 
two years will be important, given the significant amount of 
debt that is coming due.
    The financial system benefited from a prompt, coordinated 
response across regulatory agencies. The FDIC believes it is 
just as important to have that same level of coordination in 
evaluating the health of these large financial institutions 
coming out of the crisis.
    Currently we are working with the Federal Reserve to review 
the dividend plans at the large banking organizations. We 
believe that a comprehensive review of dividend and capital 
repayment plans across large firms is critical since these 
payments were a large drain on cash reserves prior to the 
crisis, leaving financial institutions more vulnerable to the 
disruptions that followed.
    This is why the dividend plan review and TLGP repayment 
plans are intertwined. The regulators should not approve 
dividend and capital repurchases which involve significant cash 
outlays by financial firms until we are all fully confident 
that these firms will have the financial resources, under both 
normal and stressed conditions, to repay debt guaranteed by the 
FDIC.
    In conclusion, while the measures taken by the FDIC and 
other governmental agencies to address the financial crisis 
were unprecedented in nature, these measures were successful at 
stabilizing the credit markets and creating an environment that 
allowed for economic recovery. Now we are actively working to 
ensure that the program winds down in an orderly fashion by the 
end of 2012.
    Thank you. I will be pleased to answer any questions from 
members of the panel.
    [The prepared statement of Mr. Cave follows:] 

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    The Chairman. Thank you.
    Mr. Lawler.

 STATEMENT OF PATRICK LAWLER, CHIEF ECONOMIST AND HEAD OF THE 
OFFICE OF POLICY ANALYSIS AND RESEARCH, FEDERAL HOUSING FINANCE 
                             AGENCY

    Mr. Lawler. Thank you. Chairman Kaufman, members of the 
panel, thank you for the invitation to present FHFA's 
perspective on the impact of TARP on the economy and the 
financial sector.
    I'm going to be referring to some charts in the back of my 
testimony, if you've got that handy.
    TARP was created when financial markets were in the midst 
of a crisis. Collectively, TARP programs made important 
contributions to reestablishing financial stability by 
increasing confidence and adding liquidity to financial 
markets. The oversight board, on which FHFA's director sits, 
concluded that without TARP the severity of the crisis and its 
impact on the economy would have been materially greater.
    Given the origins of the crisis and housing financial 
markets, the conservatorships of Fannie Mae and Freddie Mac 
were designed from the start to maintain access to funds for 
sound, new mortgages. To assist borrowers who were struggling 
to make payments on poorly structured and unaffordable loans, 
FHFA worked with the Treasury, HUD and others to develop a 
series of programs, including the Home Affordable Modification 
Program, which used TARP funds for non-GSE loans to enhance 
incentives for borrowers and servicers.
    In all cases, FHFA has been guided by its responsibilities 
as conservator of each enterprise to limit activities to those 
that make business sense, are safe and sound and are consistent 
with the enterprises' charters and the goals of 
conservatorship. These programs have benefited the enterprises 
by mitigating risks and reducing both direct losses on loans 
where foreclosure is avoided, and indirect losses on properties 
where housing markets are stabilized, which reduces defaults on 
other loans.
    As shown in Figure 1, with these and other programs, 
including notably the Federal Reserves large program for 
purchasing mortgage securities, the cost of mortgage borrowing 
declined, both absolutely and relative to yields on reference 
Treasury securities.
    In Figure 2, cheaper financing and foreclosure prevention 
programs helped stabilize house prices, as measured by FHFA, 
almost immediately and by other measures within a few months.
    In Figure 3, serious delinquencies continued to rise 
sharply in 2009 as the recession worsened, but they have since 
eased somewhat. Inventories of houses currently or potentially 
for sale are very high in portions of the country, so 
significant risks remain, despite recent price stability and 
lower delinquency rates.
    The enterprises have significant responsibilities with 
respect to TARP through their implementation of Making Home 
Affordable programs for mortgages on their own books as well as 
through their roles as Treasury's financial agents.
    Turning to Figure 4, in 2010 the enterprises completed 
nearly a million foreclosure prevention workouts. More than 
double 2009 total and nearly two and a half times the number of 
foreclosure sales in 2010. Most workouts are home retention 
actions intended to keep borrowers in their homes.
    While HAMP has not produced the volume of loan 
modifications the Treasury Department initially hoped for, we 
believe it has been instrumental in standardizing and 
streamlining the industry's modification process. And in that 
way it has contributed greatly to the sharp rise in non-HAMP 
modifications that has taken place over the past two years.
    The quality of the modifications also appears to have 
improved, as indicated in Figure 5. Although it is still too 
soon to judge how successful recent modifications will 
ultimately prove to be, re-defaults of loans modified by the 
enterprises have been much lower since the implementation of 
HAMP than previously.
    In addition to foreclosure prevention programs, the 
enterprises used the Home Affordable Refinance Program, HARP, 
to help homeowners whose property values has fallen to take 
advantage of historically low interest rates by refinancing 
their mortgages which can help them avoid future default. In 
Figure 6, the volume of HARP refinances has also been much less 
than Treasury--the Treasury Department anticipated, but 
refinances outside HARP, many with a similar streamlined 
structure, have been ten times as large with Fannie Mae and 
Freddie Mac mortgages.
    FHFA has worked closely with the Treasury Department on 
critical issues brought on by the housing crisis and general 
financial and economic disruptions over the past few years. The 
interactions have been frequent and professional, respectful of 
our differing roles and legal responsibilities but 
collaborative toward our common goal to bring stability and 
liquidity to housing markets and seek foreclosure alternatives 
whenever feasible.
    Thank you. I'll be happy to answer questions.
    [The prepared statement of Mr. Lawler follows:]

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    The Chairman. Thank you.
    Mr. Nelson.

 STATEMENT OF WILLIAM R. NELSON, DEPUTY DIRECTOR, DIVISION OF 
            MONETARY AFFAIRS, FEDERAL RESERVE SYSTEM

    Mr. Nelson. Chairman Kaufman and members of the 
Congressional Oversight Council. Thank you for the opportunity 
to testify about the Term Asset Backed Securities Loan 
Facility, TALF, which was established by the Federal Reserve 
and Treasury Department during the financial crisis to increase 
the availability of credit to households small businesses. 
Treasury provided credit protection for the TALF under the 
Troubled Asset Relief Program, TARP.
    When the financial crisis intensified in the fall of 2008 
investor demand for highly rated asset-backed securities, or 
ABS, evaporated. Spreads on ABS widened dramatically and 
issuance of new ABS dwindled to near zero. In response, lenders 
that relied on securitization for funding pulled back on the 
credit they provided to households and businesses contributing 
to the severe contraction in the economy that followed.
    Among the many actions taken by the Federal Reserve and the 
Treasury in response to these events, was the creation of the 
TALF, which was designed to encourage renewed issuance of ABS. 
Under the TALF the Federal Reserve Bank of New York provided 
loans to investors for the purchase of certain ABS backed by 
consumer and business loans. TALF loans had maturities ranging 
from three to five years. The interest rate spreads on TALF 
loans were set below spreads on highly rated ABS prevailing 
during the financial crisis, but well above spreads in more 
normal market conditions, providing investors an incentive to 
repay the loans as financial conditions normalized.
    To protect the Federal Reserve and the Treasury, several 
layers of risk controls were built into the TALF program and 
are detailed in my prepared remarks.
    The TALF contributed importantly to a revival of ABS 
markets and a renewed flow of credit to households and 
businesses. Issuance of non-mortgage ABS jumped to $35 billion 
over the first three months of TALF lending in 2009 after 
having slowed to less than $1 billion per month in 2008.
    During its initial months of operation the TALF financed 
about half of the issuance in the ABS market. Over the life of 
the program the TALF supported nearly 3 million auto loans, 
more than 1 million student loans, nearly 900,000 loans to 
small businesses, 150,000 other business loans and millions of 
credit card loans.
    When the program closed in June, 2010, $43 billion was 
outstanding. As a result, in July, 2010 the Federal Reserve 
Board and the Treasury agreed that it was appropriate for the 
Treasury to reduce the credit protection provided by the TALF 
under the TARP, from $20 billion, ten percent of the authorized 
size of the program, to $4.3 billion, ten percent of the loans 
outstanding when the program closed.
    As I noted, the TALF loan interest rates were set at 
spreads chosen to be well above those that prevailed in more 
normal financial conditions, yet below those at the height of 
the crisis. The TALF has earned nearly $600 million of net 
interest income to date. If there were to be any losses on TALF 
loans, the losses would first be absorbed by the accumulated 
net interest income. The TARP funds would absorb any losses 
that exceeded the accumulated net interest income, up to the 
commitment provided by the Treasury.
    The experience to date suggests that the multiple risk 
controls built into the TALF program have been effective and 
losses appear unlikely. Because market conditions have 
improved, TALF loans now appear expensive, as intended, and 
more than two-thirds of the loans have been repaid early. All 
the remaining TALF loans are current regarding payments of 
interest and principal. All of the collateral backing the 
outstanding loans have retained their AAA ratings and the 
market value of the collateral backing each of the loans has 
remained well above the loan amount.
    As a result, we see it as highly likely that the 
accumulated interest will be sufficient to cover any loan 
losses that may occur without drawing on the dedicated TARP 
funds.
    In conclusion, we believe that the TALF program represents 
a highly successful use of TARP funds. The TALF program helped 
restart the ABS markets at a critical time, thereby subording 
the provision of credit to millions of American households and 
businesses. Moreover, its careful design has protected the 
taxpayer and in the end the program almost certainly will remit 
a net profit to the Treasury.
    Thank you for the opportunity to discuss the TALF program 
today. I would be pleased to take any questions that you have.
    [The prepared statement of Mr. Nelson follows:]

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    The Chairman. Thank you very much.
    And we'll start--we'll have one round of questions.
    Mr. Cave, can you talk a little bit about the plans of 
the--that you mentioned in your testimony about plans for large 
banking organizations to increase dividends and how you think 
that works and why you think that works and what has to be done 
before that should go forward?
    Mr. Cave. Yes, thank you. I'd be happy to answer that 
question.
    The Federal Reserve is the lead agency with responsibility 
for administering the stress tests and the review of the 
dividend plans. We are involved as well. We think that this is 
a positive program. Before the crisis you had institutions that 
paid out significant amounts of cash in dividends and in 
capital repurchases, leaving them more vulnerable when the 
crisis did hit. So the process that's being used--before 
institutions can begin to increase dividends and capital 
repayments--is a programmatic approach that we view as an 
improvement over the past. And we are very much involved in 
that as well.
    The Chairman. Do you have any thoughts about the timing of 
this at this particular time?
    Mr. Cave. The staffs are working presently on this. It's a 
priority. There is interest in having responses to institutions 
for the first quarter of 2011, so this is a very important time 
where a lot of work is going into this as well.
    The Chairman. Mr. Nelson, do you have any comments on that, 
the dividends plans of large banks?
    Mr. Nelson. No, I do not.
    The Chairman. Okay. Mr. Lawler, what's your view about 
Fannie Mae and Freddie Mac having conflicts as their roles as 
investors in residential mortgages and their roles as Treasury 
agents with respect to HAMP?
    Mr. Lawler. I don't think it creates important conflicts. 
They are investors. They do have an interest in trying to 
reduce foreclosures to the maximum extent possible. I think 
it's very consistent with the Treasury Department's goals with 
these programs. They're working together to try and create 
programs that will work to keep people in homes and reduce 
costs to taxpayers.
    The Chairman. But the--one of the problems is, is there are 
conflicts involved throughout the whole process, with the 
servicers. Do you agree? And as Fannie Mae and Freddie Mac, you 
don't see they--where they have any conflict?
    Mr. Lawler. With servicers?
    The Chairman. Yeah.
    Mr. Lawler. Servicers have some conflicts in some parts of 
the process. For example, if they hold a second lien----
    The Chairman. Right.
    Mr. Lawler [continuing]. On a property where they're also 
servicing the first lien, that's a conflict and that's 
certainly an issue.
    The Chairman. Fine. Mr. Nelson, did TALF work, in your 
opinion?
    Mr. Nelson. Yes, sir, it was very effective. For example, 
in research that was just released on the Federal Reserve's 
website yesterday, my colleagues and I at the Federal Reserve 
have found that the TALF had a very consequential affect on 
lowering ABS spreads, both for consumer ABS and in commercial 
mortgage-backed securities.
    In other research, my colleagues have found a link between 
the issuance of TALF ABS and lower loan rates extended by the 
lenders that funded themselves with TALF ABS.
    And finally, I'd add that we talked to issuers when the 
program was in operation and in subsequent surveys and asked 
them what the effects of the program were for them and they 
indicated that the program helped them to lower rates and that 
without the program they would have lent less and there 
conceivably been a much more severe contraction of credit.
    The Chairman. Great. Follow on Dr. Troske's question, Mr. 
Cave. Are you concerned about how we get troubled assets off 
the balance sheets of banks?
    Mr. Cave. I think that what we are seeing are some 
improvements in troubled asset levels compared to what we saw 
during the crisis. Our latest review, the Quarterly Banking 
Profile that we released last week, showed that we're seeing 
some improvements in delinquencies and net charge-offs from the 
crisis levels. But again, levels are elevated compared to 
historical averages and there still remains work to be done to 
continue the process of balance sheet repair.
    The Chairman. Thank you very much.
    Mr. McWatters.
    Mr. McWatters. Thank you. Following up on that. Do these 
troubled assets, which are estimated at around a trillion 
dollars, as presently constituted, do they pose a systemic risk 
to the economy? Mr. Cave?
    Mr. Cave. Compared to where we were with troubled assets 
during the crisis, we are at a point where levels have receded. 
It is still very much something the FDIC monitors closely. 
Also, we look to ensure that institutions have proper reserves 
and capital and liquidity to be able to deal with their problem 
assets. Something that, again, we look at very closely.
    Mr. McWatters. Okay. And I'm putting words in your mouth 
and saying that sounds like a no to me. I mean it sounds like a 
no answer. It's not that these troubled assets, a trillion 
dollars on the books, do not pose a systemic risk today. Is 
that a fair statement or?
    Mr. Cave. I would need to get additional information to you 
on that.
    Mr. McWatters. Okay. Fair enough.
    Mr. Lawler or Mr. Nelson, do you have any thoughts on that?
    Mr. Nelson. No, sir.
    Mr. McWatters. Okay.
    Mr. Lawler. At Fannie Mae and Freddie Mac and the home loan 
banks there are troubled assets, but because Fannie Mae and 
Freddie Mac are currently under conservatorship and backed by 
the Treasury, they're not currently creating a systemic risk.
    Mr. McWatters. But if the bailout of Fannie Mae and Freddie 
Mac somehow went away, then the answer could be different?
    Mr. Lawler. Yeah, that's a hypothetical, so.
    Mr. McWatters. Okay. Okay.
    How about the robo-signing problems and the breech of 
representations that we read about a lot a couple months ago? 
Did those create a systemic risk in the opinion----
    Mr. Lawler. If the foreclosure process were to stop 
functioning entirely that would create some significant 
problems. Most of the--my understanding of those issues were 
that the processes were not followed correctly, but if they can 
be created, so that they do work properly, then that's not a 
systemic risk. If we simply were unable to foreclose on 
properties then that could create more serious problems.
    Mr. McWatters. Well, what about a systemic risk that could 
develop when financial institutions, the servicers, the 
originators, the securitizers are sued, particularly the 
financial institutions are sued and wearing any of those hats, 
perhaps multiple hats of the--being the securitizer and the 
originator? I mean there are claims now before the courts that 
investors were materially misled and they're asking for a 
significant amount of damages. I understand lawsuits, they 
happen all the time, but is the cumulative effect of these 
lawsuits, do they present a systemic risk to these financial 
institutions?
    Mr. Lawler. Again, not to Fannie Mae and Freddie Mac, 
because they're not----
    Mr. McWatters. Okay.
    Mr. Lawler [continuing]. The ones being sued.
    Mr. McWatters. Mr. Cave, what do you think?
    Mr. Cave. I think that in our view this is very much a 
question for the Financial Stability Oversight Council. As you 
have noted, this situation involves various financial market 
participants as well as regulators and we believe that this is 
something that should be a question for the FSOC.
    Mr. McWatters. Mr. Nelson, the Fed, what's the Fed's view 
of this?
    Mr. Nelson. I'm sorry, sir, this is not an area of my 
expertise.
    Mr. McWatters. Okay. Okay. Fair enough.
    So it sounds like no one is saying, well, with the 
exception of Mr. Lawler, because his client is--has an 
unlimited check from Treasury, that the answer is simply 
uncertain.
    Let me ask one final question in the few seconds I have. If 
you had to do this all over again and you were back in 2008 and 
you were gearing up, would you do anything differently? Would 
you have different programs? Would you have the programs that 
you have now but would you tweak them some way?
    Mr. Cave.
    Mr. Cave. Thank you for the question. From our perspective, 
the TLGP program, so far, has been a success and has done what 
it was intended to do, unlock the credit markets and allow 
institutions to extend their liabilities. We think that's very 
important. What was happening prior to the crisis was that 
institutions' balance sheet liabilities were getting shorter 
and funding was getting more complicated. So again, we think 
that the TLGP was successful in addressing that issue. There is 
still more time to go. We still have exposure and we are 
monitoring that very closely. So I think that is working as 
expected.
    The Dodd-Frank Act has provided us with greater authorities 
to do things that we could not do prior to the crisis. And we 
view, very much, the proper implementation of the Dodd-Frank 
Act as a key thing to do as we move forward.
    Mr. McWatters. Okay. Thank you, Mr. Cave.
    Mr. Lawler, Mr. Nelson, any thoughts?
    Mr. Lawler. Putting Fannie Mae and Freddie Mac into 
conservatorship was the right thing to do and that helped 
provide funding, continued funding for housing markets. We did 
not, at that time, appreciate, when we put them into--first put 
them into conservatorship, how serious the recession would be 
and how bad unemployment would be and what the implications 
would be for the housing market from that point forward.
    We did move with the Bush Administration to start the 
streamline mortgage modification program, but as we did that 
and as we moved into HAMP we learned a lot of lessons about how 
to institute such a program. We'd never done anything remotely 
like this before, trying to get all large servicers in the 
country working on a single program, doing things the same ways 
with systems that were entirely different. So we learned a lot 
as we implemented that and as we shifted from SMP to HAMP that 
had we gone through the experience before we would have been 
able to do faster.
    Mr. McWatters. Okay. Thank you. My time is up. Sorry.
    The Chairman. Mr. Silvers.
    Mr. Silvers. So this hearing and the wind up of our work is 
really focused, I think on two really major issues that I want 
to address with you all. One--and the relevance of your 
testimony to these two issues. One is the question of the 
stability, the health of the banking system and the other is 
the question of the housing market and the continuing 
foreclosure crisis.
    Let me start with the housing market. Mr. Lawler, let me 
make sure I have--I understand the GSE's position here 
correctly in terms of their exposure to the housing market and 
the foreclosure crisis. The GSEs have obligations to their--to 
the holders of GSE issued securities. And the GSEs bought some 
stuff during the run up to the financial collapse. It turns out 
probably to have been a mistake.
    Am I right in understanding that, and as a general matter, 
the more foreclosures there are, the more housing prices fall, 
the more the value--the more GSEs have difficulty meeting their 
obligations to their security holders and the lower the value 
of those assets they purchased fall, is that basically right?
    Mr. Lawler. Right. If they can prevent unnecessary 
foreclosures then that will help the market and makes their 
securities more valuable.
    Mr. Silvers. So if housing prices fall secularly across our 
economy, the losses the GSEs will suffer and that--the money 
that will be paid out per the guarantee Mr. McWatters was 
talking at, will increase, right?
    Mr. Lawler. Right.
    Mr. Silvers. So from the perspective of the interests of 
the GSEs as at least nominally independent firms, the fiduciary 
duties of the trusteeship over those entities, there seems like 
a compelling reason to try to do everything you can to keep 
housing prices from falling further. Is that right?
    Mr. Lawler. Right.
    Mr. Silvers. Okay. Now, the GSEs are today the, as far as I 
understand it, the really the only providers of a secondary 
market of any consequence, for mortgages in the United States. 
Is that true?
    Mr. Lawler. Conventional mortgages. Ginnie Mae handles----
    Mr. Silvers. Yes, there's Ginnie Mae and FHA, but there's 
not a private label mortgage market of any consequence today?
    Mr. Lawler. That's right.
    Mr. Silvers. Right? So you--so the GSEs really are--the 
GSEs have, shall we say, a fair amount of market power right 
now?
    Mr. Lawler. Okay.
    Mr. Silvers. Right? Would you agree that's true?
    Mr. Lawler. Yes.
    Mr. Silvers. All right. Does it make--isn't it--is it 
consistent with the GSEs business purposes, right and the 
duties owed to the GSEs by the governance of the GSEs, is it 
consistent with that to use that market power to ensure that 
the housing market doesn't fall further, all right, to--and to 
thus minimize the losses the GSEs are going to incur in the 
future? Does that make sense?
    Mr. Lawler. Well it does, except that the prices they 
charge directly affect what their earnings or losses are as 
well, so there's a balance that----
    Mr. Silvers. Right. No, I'm saying in totality the GSEs 
should be managing their business to minimize the losses 
they're going to incur. And this has everything to do with the 
broad movements of housing prices and stability in the housing 
market. Am I right?
    Mr. Lawler. That's right.
    Mr. Silvers. Okay. So would you agree then that to the--
that because foreclosures, as a general matter, all right, some 
foreclosures are unavoidable, but that foreclosures as a 
general matter contribute to falling housing prices and greater 
losses to the GSEs, as a pure business matter the GSEs ought to 
use every instrument and every power in their disposal to 
ensure that no unnecessary foreclosure occurs?
    Mr. Lawler. And ``unnecessary'' is an important word there.
    Mr. Silvers. But you agree with that, as a business matter?
    Mr. Lawler. Their program----
    Mr. Silvers. I said as a business matter----
    Mr. Lawler. Right.
    Mr. Silvers [continuing]. Not as a public policy matter, 
not as a matter of social do-gooderism, but as a pure business 
matter for the GSEs, you agree that that's true?
    Mr. Lawler. That's what their programs are designed to do.
    Mr. Silvers. Okay. Excellent. Thank you.
    Mr. Cave, your testimony, which I found very interesting 
expresses some concerns about dividends. And not surprisingly, 
the FDIC appears concerned that the--loans which the FDIC has 
guaranteed be paid first before any dividends get issued. I am 
concerned further beyond that about the quality of earnings at 
the large banks that are proposing paying dividends. Do you 
have--does the FDIC share my concern?
    Mr. Cave. Thank you. Based on our recent Quarterly Banking 
Profile report, the earnings and the state of the industry have 
improved. We saw 2010 as a turnaround year with stronger 
earnings. But, a portion of that was due to reductions in loan 
loss provisions, which had a benefit for earnings. Revenues did 
not see as much improvement. That's an area we are looking at 
very closely to ensure that those reductions in provisions are 
appropriate given the current risk of the assets. I think 
that's an area that----
    Mr. Silvers. Right.
    Mr. Cave [continuing]. Further work is needed. But we are 
looking at that very closely.
    Mr. Silvers. Now my time is expired, but if I can ask the 
Chairman's indulgence. I just want to clarify that for the non-
bank regulators who might be listening. What we're talking 
about here, and you tell me if I'm wrong, all right, is that a 
fair amount of the earnings of the large banks does not reflect 
actual cash that has gone into those banks. It reflects changes 
in assumptions about future losses. The dividends that would be 
paid would involve actual money, not assumptions or promises or 
other things, but actual money so that on the one hand you have 
no money coming in for that part of those earnings and on the 
other hand dividends would involve real money coming out. Is 
that, in a sort of simple-minded way, is that what we were just 
discussing?
    Mr. Cave. I think that would be a fair representation. 
Dividends would be cash coming out and there are various 
attributes of the earnings stream that have various levels of 
quality.
    Mr. Silvers. All right. I'm concerned about that. Thank 
you.
    The Chairman. Dr. Troske.
    Dr. Troske. Thank you. So I'll start with you, Mr. Nelson. 
In a recent paper Professor Zingales and a co-author estimated 
that the CPP program, along with the FDIC's Temporary Liquidity 
Guarantee Program increased the value of banks participating in 
these two programs by approximately $130 billion, of which 40 
billion represented a direct taxpayer subsidy to banks, it 
seems clear that many of the programs implemented by the 
Federal Reserve's including its purchase of mortgage-backed 
securities and the Primary Dealer Credit Facility also provided 
significant financial assistance to banks. Do you think the 
assistance from these other programs and other agencies enabled 
large banks to repay their TARP funds more quickly?
    I know that these efforts were coordinated between Treasury 
and the Fed and the FDIC. Was there some discussion about this 
and if so, do you think that these other programs allowed some 
of the shifts--some of the costs of TARP to be shifted to these 
other what I would call less scrutinized programs? Do you have 
any thoughts on that?
    Mr. Nelson. The Federal Reserve's response to the financial 
crisis could be divided up into two broad categories. One would 
be their provision of liquidity through the discount window, a 
traditional lender of last resort response, their liquidity 
facilities of which TALF was one. Those facilities were 
intended to increase the liquidity of financial markets and 
ultimately allow for greater credit to flow to consumers and 
businesses as I discussed.
    The purchases of agency mortgage-backed securities, 
something you mentioned before all of the Federal Reserve's 
purchases of securities were government guaranteed securities. 
Those were designed to act very much like traditional monetary 
policy, by lowering interest rates, encouraging spending, 
bringing down unemployment and achieving the macroeconomic 
objectives that the Congress gave to the FOMC.
    I don't know anything about any additional objectives along 
the lines of what you just described.
    Dr. Troske. But I mean it certainly is the case that they 
entered into a market in which the mortgage-backed security 
market was close to not functioning and they dumped $1.2 
trillion into that market. And I'm not arguing with--that that 
was not part of an active monetary policy and that that was not 
the right policy to adopt. But clearly that had to have some 
affect on the mortgages that were, you know, the liquidity that 
banks had with these mortgages and allowed them to move them 
off their balance sheets. Is that correct?
    Mr. Nelson. Well, Dr. Troske, I'd respectfully disagree. 
The government guaranteed mortgage-backed securities market 
functioned very well throughout the financial crisis. And the 
liquidity of those assets was very well maintained. They were 
government guaranteed assets. And during the financial crisis 
there was quite a bit of demand for the safety and security of 
government guaranteed assets.
    So it is true that by the nature of the actions, lowering 
interest rates raises the prices of securities, that's how it 
works. So, by lowering interest rates anyone who was holding 
those securities would have had an asset that went up in value, 
but that was not the objective of the programs.
    Dr. Troske. Mr. Cave, I guess I'd direct the same question 
to you. Do you think that the FDIC's actions sort of benefited 
large banks and in some sense allowed them or enabled them to 
be more quickly pay back their TARP funds? I mean and I'm not 
arguing that that was the main purpose but was that one of the 
consequences of this action?
    Mr. Cave. I don't believe that that was a consequence. The 
TLGP was very much a programmatic--systematic--approach that 
provided help to the markets, not just for large institutions.
    There were two parts to the program. It's important to know 
with the TLGP debt guarantee program that the main purpose 
there was to address the situation where money was coming due 
very quickly and debt was getting shorter. The TLGP allowed 
institutions to refinance as institutions were becoming less 
liquid. So it was very important.
    There was also the Transaction Account Guarantee program 
that benefited large banks, but also very much benefited small 
banks as well, because we were seeing issues there with these 
accounts. That provided some stability, not just to large 
institutions, but small institutions as well. We were taking a 
combined approach. These were broad programs with broad 
participation that provided the improvements to the situations 
that we were seeing at that time.
    Dr. Troske. Okay. And Mr. Nelson, let me ask you one more 
question. I guess throughout this crisis it seems as if, and 
perhaps rightfully so, there was a blurring in distinction of 
the Fed is traditionally the agency that conducts monetary 
policy, Treasury is traditionally the--one of the agencies that 
conducts fiscal policy. Many of the programs of the Fed looked 
a lot like fiscal policy, lending money to AIG, Primary Dealer 
Credit Facilities that I mentioned before. Financial stability 
program of the Treasury looked a lot like monetary policy, an 
effort to remove liquidity from the market to tamp down 
inflationary expectation.
    Does that concern you about this blurring of the 
distinction between who does monetary policy and who does 
fiscal policy? Perhaps it was necessary and I guess--do we 
think that at some point we can put the genie back in the 
bottle and get back to more traditional roles?
    Mr. Nelson. Dr. Troske, I agree. This is a very good 
question and it's very important that the independence of the 
Federal Reserve and the separation of monetary policy from 
fiscal policy be maintained. Being a lender of last resort is a 
very traditional role of a central bank and of the Federal 
Reserve. It's part of the reason why the Federal Reserve was 
created.
    You mentioned the Primary Dealer Credit Facility, that was 
a facility that was created using our emergency authority. But 
it looked like a traditional discount window facility rather 
than lending to depository institutions, in the case of the 
Primary Dealer Credit Facility, we lent to primary dealers who 
are generally large investment banks, for very short terms with 
very good collateral.
    And all of the Federal Reserve's interventions were against 
very good collateral. And all of the Federal Reserve's credit 
facility loans, apart from the TALF loans, which I've 
discussed, have all been repaid with no cost to taxpayers. So, 
I would argue that the Federal Reserve's actions during the 
crisis have been consistent with the traditional role of a 
central bank, as a lender of last resort, as a liquidity 
provider.
    In the case of the TARP and the TALF, which we're 
discussing today, that was a very important role of the TARP in 
allowing the Federal Reserve to participate in the TALF with 
the Treasury and yet maintain its position as a liquidity 
provider by having the credit protection provided by that 
program.
    Dr. Troske. Thank you.
    The Chairman. Superintendent Neiman.
    Mr. Neiman. Thank you.
    I'd like to shift to another area, probably one that you're 
not expecting, and that's the critical lesson that we learned 
from the financial crisis on the inextricable link between 
safety and soundness and consumer protection and the fact that 
loans that are made to individuals--either on onerous terms or 
loans that cannot be paid back--have a clear impact on 
financial stability.
    One of the most prominent steps to fix this problem, in 
Dodd-Frank, was the establishment of the Consumer Financial 
Protection Bureau. But regulators, particularly some of the 
witnesses here today, clearly are not off the hook when it 
comes to consumer protection. Certainly regular institutions 
below the $10 billion level continue to be reviewed for 
compliance by their existing federal regulators.
    But what I'm interested in, and maybe we could start with 
Mr. Cave as deputy director of the Complex Institution Unit at 
the FDIC, is how do you incorporate consumer protection into 
your risk assessment at these large institutions, particularly 
those over 10 billion, where you no longer have responsibility 
for direct consumer compliance examination that will be shifted 
to the CFPD?
    Mr. Cave. I'd be happy to answer that question. First off, 
at the FDIC we view safety and soundness and consumer 
protection as going hand-in-hand. We have made some changes in 
our structure at the FDIC recently, creating a new Division of 
Consumer Protection to continue to give that very much the 
focus that's necessary. That group will work very closely with 
our supervision group.
    But, it's a very important issue. I think that the recent 
foreclosure situation highlights the fact that what can happen 
on the consumer issues can have an impact for the large 
institutions. And it goes to show the importance of having the 
structures and controls in place to deal with those issues. 
Regulators very much look at those structures and controls to 
ensure that those are in place because consumer issues could 
create risks to these institutions.
    Mr. Neiman. So how will the actual supervision process 
change going forward? So I assume there will be a formal 
process for sharing exam information with the CFPB when they 
take on that responsibility. But the risk--you're still 
responsible for assessing risk within those institutions, 
assessment management. So how will you be able to assess 
management, assign ratings without having a clear understanding 
of the processes and controls around risk? Will it be beyond 
simply relying on the information from the CFPB?
    Mr. Cave. For the large institutions, our role will 
continue to be in a back up capacity. So we're used to being in 
that role, of having to work with other regulators to ensure 
that we have the information we need to assist. From that 
standpoint, for the large institutions, we have some experience 
there. We've made some improvements to where things weren't as 
enhanced, I think we would continue to work along those lines.
    Mr. Neiman. Thank you. I don't want to exclude other 
witnesses. And you know, when blame is assessed there's often 
fingers being pointed across the board with respect to 
institutions and credit rating agencies, and regulators are 
certainly not left out of that list. One of the issues that 
comes up frequently is the ability of regulators and 
examination personnel to stay current and have the expertise to 
understand the complexity of transactions at some of the 
largest most sophisticated financial institutions in the world.
    I'd like to get your sense of if this is an issue. How do 
you change or are you changing, either the incentives or the 
hiring? What are the issues around of being able to stay ahead 
and on top of these complex transactions at some of the most 
sophisticated institutions in the world?
    Mr. Lawler. We are indeed trying to develop a new program 
of examiner training, internally, to address just those kind of 
problems.
    Mr. Neiman. Mr. Cave.
    Mr. Cave. At FDIC we recently created the Office of Complex 
Financial Institutions. I'm the Deputy Director of the 
monitoring section. There's a few things going on there that 
are important to note. We'll have a group that is responsible 
for having onsite presence in the largest institutions. So we 
will have teams that will look at specific institutions and 
look at all of the risks associated with those. In addition, 
we'll be creating a systemic risk branch that will look at 
institutions horizontally--across institutions--to see where 
there might be outliers, where there might be areas of risk, 
and where there might be certain portfolios that require our 
onsite teams to devote more attention.
    So by covering the waterfront, both looking vertically at 
the institution and horizontally, we believe that we'll get a 
better picture of what's going on. And that will feed very much 
into our resolutions group that will also be part of the Office 
of Complex Financial Institutions and be responsible for the 
resolution plans. This will provide information to say, ``We're 
seeing some things here that concern us, I think we need to 
look further into the resolution plans, see how the 
institutions are dealing with it.'' So, we have that hand-in-
hand.
    The other area we have is an international section. 
Because, as it was noted in the earlier panel, having the 
coordination for these large institutions beyond the U.S. 
borders is essential to ensure that we will have plans that 
actually mean something when they're needed. So we will have a 
group that will be dedicated to working with the international 
regulators to make sure we're talking the same language.
    Mr. Neiman. Thank you. So there is no doubt, the fact that 
I am a current regulator, I am totally confident that 
regulators have the ability, that the types of people they are 
attracting have the ability and experience to stay current in 
order to provide that kind of oversight role. This is something 
that we should never lose sight of and though it will continue 
to be a challenge, it will certainly be a top priority.
    So thank you all.
    Mr. Lawler. And I should have added, as Jason and also the 
Fed and the FDIC and all of the regulators that are part of 
FSOC have developing units to address systemic risk issues that 
go across institutions.
    Mr. Neiman. Thank you.
    The Chairman. And thank you very much. Thank you for being 
witnesses. Thank you for your public service.
    I think as Superintendent Neiman said, it goes without 
saying that one of the features of our democracy is that we 
have regulators that have to work. And it only works because we 
have good people in regulatory agencies. And the sacrifices 
made by people in the regulatory agencies and people in public 
service and especially people in the federal service is 
something I've always been amazed at.
    So I just want to thank you again. And we'll bring up the 
next panel.
    I am very pleased now to welcome our third panel of 
distinguished economists. Joseph Stiglitz, a Nobel Laureate, 
University Professor at Columbia University; Allan Metzger--
Meltzer, the Allan H. Meltzer University Professor of Political 
Economy at Carnegie Mellon; Simon Johnson, the Ronald A. Kurtz 
Professor of Entrepreneurship at MIT Sloan School of Management 
and a senior fellow at the Peterson Institute for International 
Economics and Luigi Zingales, the Robert C. McCormack Professor 
of Entrepreneurship and Finance and the David G. Booth Faculty 
Fellow at the University of Chicago Booth School of Business. 
Thank you very much for coming. I want to thank you all.
    Please keep your oral testimony to five minutes so we can 
have ample time for questions. Your complete written statement 
will be printed in the record.
    We'll begin with Mr. Stiglitz.

 STATEMENT OF JOSEPH E. STIGLIZ, NOBEL LAUREATE AND UNIVERSITY 
 PROFESSOR, COLUMBIA BUSINESS SCHOOL, GRADUATE SCHOOL OF ARTS 
   AND SCIENCES (DEPARTMENT OF ECONOMICS) AND THE SCHOOL OF 
                INTERNATIONAL AND PUBLIC AFFAIRS

    Dr. Stiglitz. Well thank you very much for this opportunity 
to share with you my views about the success and failures of 
TARP.
    TARP and the recovery of troubled assets were not ends in 
themselves, but means to an end, namely the recovery of the 
economy. TARP was justified to the American people as necessary 
to maintain the flow of credit. It was hoped that it would 
provide--play a pivotal role in dealing with the flood of 
mortgage foreclosures and the collapse of the real estate 
market that led to the financial crisis.
    In these ultimate objectives TARP has been a dismal 
failure. Four years after the bursting of the real estate 
bubble and three years after the onset of recession, 
unemployment remains unacceptably high, foreclosures continue 
almost unabated and our economy is running far below its 
potential, a waste of resources in the trillions of dollars. 
Lending, especially to small- and medium-size enterprises, is 
still constrained. While the big banks were saved, large 
numbers of the smaller community and regional banks that are 
responsibility for much of the lending to SMEs are in trouble. 
The mortgage market is still on life support.
    But TARP has not just failed in its explicit objectives, I 
believe the way the program was managed has, in fact, 
contributed to the economy's problems. The normal laws of 
capitalism where investors must bear responsibility for their 
decisions were abrogated. A system that socializes losses and 
privatizes gains is neither fair nor efficient. TARP has led to 
a banking system that is even less competitive, where the 
problem of Too Big to Fail institutions is even worse.
    There were six critical failings of TARP. First, it did not 
demand anything in return for the provision of funds. It 
neither restrained the unconscionable bonuses or payouts and 
dividends, it put no demands that they lend the money that they 
were given to them, it didn't even restrain their predatory, 
speculative practices. Secondly, in giving money to the banks 
it should have demanded appropriate compensation for the risk 
borne. It is not good enough to say that we were repaid or we 
will be repaid or we will be almost repaid.
    If we had demanded arm's length terms, terms such as those 
that Warren Buffett got when he provided funds to Goldman 
Sachs, our national debt would be lower and our capacity to 
deal with the problems we had would be stronger. The fairness 
of the terms is to be judged ex ante, not ex post, taking into 
account the risks at the time.
    Thirdly, there was a lack of transparency. Fourthly, there 
was a lack of concern for what kind of financial sector should 
emerge after the crisis. There was no vision of what a 
financial sector should do. And not surprisingly, what has 
emerged has not been serving the economy well.
    Fifthly, from the very beginning TARP was based on a false 
premise, that the real estate markets were temporarily 
depressed. The reality was that there had been an enormous 
bubble for which the financial sector was largely responsible. 
It was inevitable that the breaking of that bubble, especially 
given the kinds of mortgages that had been issued, would have 
enormous consequences that had to be dealt with. Many of the 
false starts, both in asset recovery and homeowner programs, 
have been a result of building on that false premise.
    Particularly flawed was the PPIP, a joint public/private 
program designed to have the government bear a disproportionate 
share of the losses, the private sector, while putting up 
minimal money, would receive a disproportionate share of the 
gains. It was sold as helping the market re-price but the 
prices that were--that would emerge would be prices of options, 
not of underlying assets. The standard wisdom in such a 
situation is summarized in a single word, ``restructure.'' But 
TARP, combined with accounting rules changes, made things 
worse.
    The sixth critical failure of TARP was that some of the 
money went to restructuring securitization under the TALF 
program, without an understanding of the deeper reasons for the 
failure of mortgage securitization. These attempts to revive 
the market have failed, and to me this is not a surprise.
    There were alternative approaches, evident at the time of 
the crisis and even more so as time went on, that I describe 
more fully in my written testimony. These approaches, had they 
been taken, would have led not only to a strong economy today 
but would have led to our government being in a stronger fiscal 
position.
    We might say, ``Oh, this is water over the dam,'' but it's 
not. We have not repaired our banking system and indeed, with 
the enhanced moral hazard and concentration in the financial 
sector, the economy remains very much at risk, in spite of 
Dodd-Frank. Our economy is not back to health and will not be 
until and unless lending can be restored, especially to small- 
and medium-size enterprises. This means that we need a more 
competitive financial sector and one more focused on its core 
mission of lending.
    A wide--there is a wide array of important activities 
performed by the financial sector, but not all of them should 
be undertaken by government-insured banks. Banks won't focus on 
lending if they can continue to make more money by publicly 
underwritten speculation and trading or by exploiting market 
power in the credit and debit card markets. Moreover, Too Big 
to Fail institutions, whether they be mortgage companies, 
insurance houses or commercial investment banks, pose an 
ongoing risk to our economy and the soundness of government 
finances.
    I want to conclude with two more general comments. First, 
we should not forget the process by which TARP and this 
oversight panel were created. That political process does not 
represent one of the country's finest moments. At first a short 
three-page bill was presented giving enormous discretion to the 
Secretary of Treasury and without congressional oversight and 
judicial review. Given the lack of transparency and potential 
abuses to which I have already referred, which occurred even 
with full knowledge that there was to be oversight, one could 
only imagine what might have occurred had the original bill 
been passed.
    Fortunately, Congress decided that such a delegation of 
responsibility was incompatible with democratic processes. On 
the other hand, the political deals required to get TARP 
passed, with an estimated $150 billion in largely unjustified 
and unjustifiable tax breaks, do not speak well for our 
democracy. When we think of the cost of TARP, surely the price 
tag associated with those tax breaks should be included in the 
tally.
    Nor should we underestimate the damage of the correct 
perception that those who were responsible for creating the 
crisis were the recipients of the Government's munificence. And 
the lack of transparency that permeated this and other 
government rescue efforts has only reinforced public 
perceptions that something untoward has occurred.
    For these and the other failings of TARP, our economy and 
our society have paid and will continue to pay a very high 
price.
    [The prepared statement of Dr. Stiglitz follows:]

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    The Chairman. Thank you.
    Mr. Meltzer.

  STATEMENT OF ALLAN H. MELTZER, ALLAN H. MELTZER UNIVERSITY 
  PROFESSOR OF POLITICAL ECONOMY AT CARNEGIE MELLON UNIVERSITY

    Dr. Meltzer. Mr. Chairman, members, gentlemen.
    The invitation to this hearing, like most discussions of 
the TARP program asked whether TARP succeeded in preventing 
major financial failures. My answer is yes, TARP avoided a 
potential financial disaster.
    My concern is with a question. Congress should not start 
with a crisis that followed Lehman Brother's failure, instead 
it must ask and demand answers to some other questions. Why was 
it necessary to issue about a trillion dollars of public money 
to prevent financial collapse? What, if anything, has been done 
to reduce to insignificance the prospect that another TARP will 
follow at some unknown time in the future?
    Like many other bad decisions, the use of public funds to 
prevent failures began small. In the 1970's the Federal Reserve 
began the policy that became Too Big to Fail, by preventing the 
failure of First Pennsylvania Bank. That was followed by other 
bailouts. Soon bankers and financial firms recognized that 
becoming large was a way to reduce risk. Some recognized that 
they could take more risk. This is known as moral hazard.
    The process works like this. I've been present for some of 
these. Bankers and Treasury or Federal Reserve staff warn the 
principal policymaker that the failure invites a domestic or 
world financial crisis. Sometimes they say, ``Mr. Secretary, 
your name will be on that crisis in the history books.'' I've 
never found any way of overcoming that warning when the crisis 
occurs or seems imminent.
    It doesn't help to point out that on the few occasions when 
there was no bailout, financial failures occurred but no crisis 
followed. One example is the failure of Penn Central Railroad 
in June, 1970. Penn Central Railroad was a major issuer of 
commercial paper. The commercial paper market closed to most 
issuers. Federal Reserve Chairman Arthur Burns was anxious to 
protect the commercial paper market by bailing out Penn 
Central. Budget Director George Schultz opposed. President 
Nixon made the mistake of appointing an outside counsel from 
his old Nixon law firm. Congressional leaders, led by 
Congressman Wright Patman, viewed that as an effort to assist 
the Republican Party. That ended the bailout.
    The taxpayers were lucky that time, there was no crisis. 
The commercial paper market declined but borrowers got the 
accommodation at banks. No crisis occurred. After a few months 
the commercial paper revived--market revived.
    Drexel Burnham Lambert, the major issuer of non-investment 
grade debt at the time, went bankrupt. No bailout and no 
crisis. Other financial firms took over the business that 
Drexel had done and Drexel went into bankruptcy.
    The main reason that policymakers resort to Too Big to Fail 
in ever larger amounts is regulatory failure. Regulators do not 
require financial firms to hold enough capital. In the 1920's 
large banks had capital--held capital equal to 15 to 20 percent 
of their assets. Many small banks, but no large banks, failed. 
Even in the early years of the Great Depression, very few large 
banks failed. Stockholders, not the general public, bore those 
losses. That is as it should be, in my opinion.
    After the recent crisis Congress passed the Dodd-Frank 
bill. Dodd-Frank did nothing to increase capital requirements. 
The international regulators at Basel did better, but did not 
increase capital enough. Further, Dodd-Frank put the Secretary 
of the Treasury at the head of the committee to decide on Too 
Big to Fail. That decision embeds two errors in the law. First, 
the time to prevent bailouts is not when the crisis occurs, it 
has to be established policy, not a judgment made when failure 
threatens the international financial market. We profess to 
believe in the rule of law, we need a law that embeds a rule 
and a policy that applies it.
    Second, the Secretary of the Treasury is very often the 
principal person who favors Too Big to Fail. Nothing in Dodd-
Frank changes these incentives, it continues bailouts, it even 
provides money for them.
    I will repeat the proposal I've made in several previous 
hearings, that some minimum size to protect community banks, 
Congress should require banks to increase capital relative to 
their assets as asset size increases. Instead of subsidizing 
large banks we should make them pay for the cost that they 
impose. If a bank increases assets by ten percent, capital must 
increase by more than ten percent.
    The proposal has three major benefits. First, stockholders 
and managers bear the losses, not the taxpayers and the public. 
Second, the rule encourages prudence and eliminates the 
imprudent by replacing owners of failed banks. Third, Congress 
can eliminate many of the regulations included in Dodd-Frank. 
Regulation will not strengthen financial institutions, more 
capital will.
    In the most recent crisis Bear Stearns was the first big 
failure. Instead of letting it fail the Federal Reserve took 
some of the worst assets on to its balance sheet, shifting many 
losses to the public. The market read the decision as a sign 
that Too Big to Fail remained the policy. They got a big shock 
when without much warning, in the midst of a recession, Lehman 
Brothers was allowed to fail. This sudden policy change without 
warning in the midst of a recession created massive 
uncertainty. I believe Secretary Paulson and Chairman Bernanke 
were wrong to change policy without warning, but I praise the 
prompt response called TARP that provided liquidity to all 
parts of the market after making a huge error. TARP avoided 
compounding the error.
    Notice, however, what has happened. Chairman Bernanke told 
us that the top funds were short term, they would run off in 
due course, thereby shrinking the Federal Reserve balance 
sheet. But instead of shrinking the Fed, at the pressure from 
the Treasury, bought mortgages more than offsetting the 
original TARP funds. Again, Chairman Bernanke told us that the 
mortgages would start--would be repaid so the balance sheet 
would shrink. Again, that didn't happen. QE-2 purchased more 
than--purchases more than offset the reduction in mortgages.
    I don't believe that the Federal Reserve has a credible 
strategy to reduce its balance sheet. We face the prospect, in 
future years, of high inflation.
    Three last remarks. First, how can Congress continue to 
justify a system that makes the public pay for bankers' 
mistakes? Second, remember that capitalism without failure is 
like religion without sin, it doesn't work. Third, Congress 
should demand a detailed statement of how the Federal Reserve 
plans to shrink its balance sheet, including an estimate of how 
high market interest rates will have to rise.
    [The prepared statement of Dr. Meltzer follows:]

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    The Chairman. Thank you.
    Mr. Johnson.

STATEMENT OF SIMON H. JOHNSON, RONALD A. KURTZ (1954) PROFESSOR 
OF ENTREPRENEURSHIP, MIT SLOAN SCHOOL OF MANAGEMENT AND SENIOR 
     FELLOW, PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS

    Dr. Johnson. Thank you, Senator Kaufman.
    I completely agree with and would like to endorse the views 
of both Professor Stiglitz and Professor Meltzer. And let me 
frame my agreement in the form of the following question. Does 
anyone here think that Goldman Sachs could fail? If Goldman 
Sachs hits a rock, a hypothetical rock, I'm not saying they 
have and I'm not saying they will, but if they were to hit a 
rock, does anybody here believe that it would be allowed to 
collapse, fail, go bankrupt, unencumbered by any kind of 
bailout now or in the near future? I've asked this question 
around the country and across the world for the past two years, 
I've yet to find anyone who realistic thinks it could fail. I 
found some people who wish it could fail, but that's a 
different question.
    Goldman Sachs is too big. Goldman Sachs has a balance sheet 
around $900 billion in the latest data. It was a $1.1 trillion 
bank when it came close to failing in September 2008 and it was 
rescued by being allowed to convert into a bank holding 
company. It is too highly leveraged. Those debts are held in a 
complex manner around the world, including through its 
derivative positions. And it is too inherently cross border. 
We--I would remind you, and I would ask you to reinforce with 
everyone you meet, we do not have a cross border resolution 
authority. Whatever you think of Dodd-Frank, and I share many 
of the reservations already expressed, there is, there can be 
no cross border resolution authority in U.S. legislation. You 
need a cross border agreement.
    Among other things, I'm the former chief economist of the 
International Monetary Fund, I know well the technical people, 
the G20, the G10, various bodies responsible in the alphabet 
soup of international regulation and macro-prudential 
supervision, I know these people, I talk to them, there will 
not be a cross border resolution in our lifetimes. No 
mechanism, no authority. You cannot handle, in an orderly 
fashion, the failure of a bank like Goldman Sachs or JP Morgan 
Chase or Citigroup which operate in 50, 100, 120 countries. You 
can let them collapse but then you face another Lehman, or you 
can bail them out with some form of conservatorship where you 
protect the credit, and that's the key point, and then you have 
all of the complications Professor Stiglitz and Professor 
Meltzer put forward.
    Or it gets worse. You enter another phase of what the Bank 
of England now calls a ``doom loop'' where repeated boom, bust, 
bailout cycles lead you not just to some unfortunate situation 
where there's always a transfer from the public to the bankers, 
it leads you to fiscal ruin. And if you don't believe me look 
carefully at the experience of Ireland, where three big banks 
became two times the size of the Irish economy and they blew 
themselves up at enormous cost. That is where this leads. It 
leads to fiscal ruin.
    What we should have done along with TARP or in addition to 
it, quickly on its heels, is implement a form of size cap, a 
form of leverage cap relative to GDP, just as was proposed in 
the Brown-Kaufman Amendment to Dodd-Frank, which unfortunately 
failed on the floor of the Senate, I believe 33 to 61.
    We should also have implemented a cross border resolution 
framework, although as I said, that will always prove elusive. 
Given that those measures have failed and that water is now 
under the bridge, we should do exactly what Professor Meltzer 
and Professor Stiglitz have suggested. We should have much 
higher capital in these banks.
    It is astonishing, but unfortunately true, that Basel III 
supplemented with all the supplementary cushions and all of the 
implementation that we will see for systemically important 
financial institutions, the so-called SIFIs, will I believe 
leave us with a Tier I capital requirement below that which 
Lehman Brothers had the day before it failed. Lehman Brothers 
had 11.6 percent Tier 1 capital. We will end up between 10 and 
11 percent.
    How can this make any sense? The Swiss national bank is 
requiring 19 percent capital requirements, although I would 
suggest they go with pure equity for all 19 percent. The Bank 
of England is actively pursuing and trying to implement capital 
requirements closer to 20 percent.
    Raising capital requirements in this form is not socially 
costly. I know that the bankers claim vehemently to the 
contrary, but they are wrong. And if you don't believe me you 
should consult the research of Anat Admati and her colleagues 
at Stanford and other leading universities. These are the top 
people in finance who are not captured by the financial 
industry and they say we need more capital, it's not costly and 
we need a version, I would suggest, of exactly what Professor 
Meltzer just laid out for you most articulately. We are not 
going to do it.
    In conclusion, let me quote Larry Summers. His 2000 Ely 
Lecture to the American Economic Association where he reviewed 
the experience of financial crisis around the world to that 
point, particularly in the 1990s when he was at the U.S. 
Treasury. And Mr. Summers said, ``It is certain that a healthy 
financial system cannot be built on the expectation of 
bailouts.''
    [The prepared statement of Dr. Johnson follows:]

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    The Chairman. Mr. Zingales.

 STATEMENT OF LUIGI ZINGALES, ROBERT C. McCORMACK PROFESSOR OF 
  ENTREPRENEURSHIP AND FINANCE AND THE DAVID G. BOOTH FACULTY 
     FELLOW, UNIVERSITY OF CHICAGO BOOTH SCHOOL OF BUSINESS

    Dr. Zingales. Thank you, Chairman Kaufman and members of 
the Congressional Oversight Panel. Thank you for inviting me.
    In providing--TARP and the financial sector economy it's 
important to establish what is a counter factor, what will 
happen in the absence of TARP. Chairman Bernanke and then 
Treasury Secretary Paulson repeatedly presented their choice as 
an alternative between TARP and the collapse of the entire 
financial system. If the alternative was indeed the abyss, TARP 
is clearly an unqualified success. We have escaped the abyss.
    Even if the alternative was between TARP and some chance of 
falling into the abyss, we have to conclude that TARP was a 
success. The cost of TARP, however big, is small with 
comparison to the possibility of a second Great Depression.
    Pietro Veronesi and I estimated the bankruptcy of the ten 
largest banks would have wiped out 22 percent of their value 
for a total of 2.4 trillion, a number that doesn't consider the 
cost imposed on the rest of the U.S. economy which could be a 
multiple of that. The financial system was at risk and some 
intervention was needed. Yet, it is both false and misleading 
to say there were no other alternatives. False because there 
were feasible and in fact superior alternatives. Misleading 
because it made TARP appear inevitable forcing people not to 
question its cost.
    By stating clearly why an intervention was needed, ie. 
where the market failed, it would have been possible to design 
plans more effective and less expensive. This is not just 
hindsight. On September 19, 2008 I wrote a proposal to address 
the instability of the financial system through an emergency 
reform of the bankruptcy code that could have transformed the 
long term debt of shaking financial institutions into equity. 
The feasibility of this idea is proven by the fact that the 
Credit Suisse has not advanced a similar proposal to deal with 
future bailouts. The same is true for alternative plan to deal 
with home foreclosure and with the bankruptcy of GM and 
Chrysler.
    I didn't write a plan for AIG because I never understood 
what the real goal of bailing out AIG was, to save European 
banks, Goldman Sachs or the policyholder. We have to rely on 
Wall Street for claims that the failure would have completely 
roiled markets.
    If we agree that other feasible alternatives did exist, 
then we have to consider the cost and benefits of TARP, vis a 
vis these alternatives. Veronesi and I estimated that the 
capital purchase program increased the value of banks' debt by 
120 billion at a cost of 32 billion for the taxpayers. Though 
in spite of the enormous value created by the government 
intervention, taxpayers ended up with a large loss. In the auto 
companies' case, creditor were now the winner, the autoworkers 
union was with a gain of 16 billion. There is, however, a 
consistent lower, the taxpayers who lost 59 billion in the 
rescue.
    TARP was the largest welfare program for corporations and 
their investors ever created in the history of humankind. That 
some of the crumbs have been donated to the autoworkers unions 
doesn't make it any better. It makes it worse. It shows that 
that redistribution was no accident, it was a premeditated 
pillage of defenseless taxpayers by powerful lobbyists. TARP is 
not just a triumph of Wall Street over Main Street, it is the 
triumph of K Street over the rest of America.
    Yet, the worst long term effect of TARP is not the burden 
imposed on taxpayers but the distortion to incentives it 
generated. First, its excessively lenient terms of the bailout 
ensure that the legitimate assistance recapitalized in smaller 
banks and at market terms became more difficult.
    Second, the way subsidies were distributed under TARP show 
that the enormous return to lobby. A member of the Bush 
Treasury admitted that during the summer of 2008 any phone call 
from the 212 area code had one message, ``Have the government 
buy the toxic assets.'' Eventually this constant request became 
government policy.
    Third, the way the bailout was conducted destroyed the 
faith that the Americans have in the financial system and in 
the government. In a survey they conducted in 2008, 80 percent 
of the American people stated that the government intervention 
made them less confident to invest in the financial market.
    Last but not least, it entrenched the view the large 
financial institutions cannot fail and their creditors cannot 
lose. This expectation leads investors, such as a CFO I know, 
to invest their money in the banks most politically collected, 
not in the most financially sound.
    This is the end of the credit analysis and the beginning of 
political analysis.
    [The prepared statement of Dr. Zingales follows:]

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    The Chairman. Thank you.
    Now we'll begin the questions. And the first question I 
have is moral hazard. The panel, one of the things that has 
been incredible about the way this panel's functioned since 
I've been here is, and not because of me, because of the other 
panelists, is how bipartisan, non-partisan things have been. 
And I think moral hazard has been raised in every one of our 
discussions, just about everything that TARP's done and our 
concerns about that.
    Could each one kind of--this is kind of the history of 
TARP. Can each one kind of talk about how you think TARP 
impacted on moral hazard?
    Mr. Stiglitz.
    Dr. Stiglitz. You know, I think the point has been made by 
all four of us, and we didn't coordinate our testimony.
    The Chairman. Right.
    Dr. Stiglitz. And I think this is reflecting where the 
broad span of the economics profession is from a whole 
spectrum. We don't agree about a lot of things, but one of the 
things we do agree is, incentives matter. And that if you know 
that you're going to get bailed out no matter what your losses 
are, then you have an incentive to take on more risk. The 
market gets distorted because the Too Big to Fail banks get 
capital at a lower cost. So that money doesn't flow on the 
basis of efficiency, but on the basis of this connectedness, is 
the way Professor Zingales put it.
    So it's manifested in absolutely every way. It also gets 
manifested at a higher level, it's not quite moral hazard in 
the usual way, but the banks have gotten much higher returns 
out of their political investments than any other form of 
investment. And you might say, from the point of view of a firm 
obligated to maximize your returns to your shareholders, 
``Where is the best place to put your money? It's on K 
Street.''
    The Chairman. Mr. Meltzer.
    Dr. Meltzer. I agree completely with Joe. [Laughter.]
    He's absolutely right. There has to be incentive. Those 
incentives will never come if you say to the Secretary of the 
Treasury, ``Look, there's this crisis and we have to do 
something about it now. We have to do something about it 
before. We have to have capital in the banks. We have to give 
an incentive to the bankers to be prudent in the risks that 
they take.'' No set of regulations is going to do that.
    You know, I've given this talk to lots of places, including 
the Council on Foreign Relations, where I said regulations are 
made by bureaucrats and regulators and is circumvented by 
lawyers and markets. First question was a man got up and said, 
a large Wall Street audience, first question came from a man 
who said, ``I'm a Wall Street lawyer, who do you think shows 
them how to circumvent them?'' [Laughter.]
    We need to have capital so that the incentives are on the 
banker and stockholders to avoid TARP. We started small with 
First Pennsylvania. Before the 1970's we didn't bailout large 
banks. It's only something that has been growing and growing 
and growing. And it's time for Congress to put an end to it.
    The Chairman. Mr. Johnson.
    Dr. Johnson. Gene Farmer, the father of the efficient 
markets view of finance, said on CNBC recently, ``Too Big to 
Fail is not a market, it's a government subsidy scheme.'' And 
it's an abomination and it should end. The new GSEs, the 
government sponsored enterprises of today are--include, most 
prominently, the largest six bank holding companies in the 
country: Bank of America, JP Morgan Chase, Citigroup, Wells 
Fargo, Goldman Sachs and Morgan Stanley. These firms can borrow 
more cheaply because they are backed by the government.
    The estimates--responsible, realistic estimates are they 
have a funding advantage about 50 basis points, .5 of a 
percentage point. They can get bigger, they want to get bigger, 
they want to become more global. These are all exactly the 
things we can't deal with when they fail. It's all the things 
that make it harder for any secretary of the Treasury to refuse 
them a bailout.
    Gene Farmer suggests, and I actually agree with him, we 
should be looking at capital requirements closer to 40 or 50 
percent. This isn't--this is just the percent of their assets 
financed with equity. I know it's anathema to the modern 
bankers, because they're excessively focused on return on 
equity.
    And also they're not doing the analysis right. They're not 
following the principles of basic finance.
    And again, I refer you to the website of the analysis of 
Anat Admati and her colleagues who have written extensively 
about this for a broad audience and explained it to the 
newspapers repeatedly in op eds and letters. The technical 
people get this, the bankers refuse because they want to be 
paid on a risk--on a return on equity basis that's not risk 
adjusted. That way they can get a lot of cash out in the boom 
and they walk away a long time before society bears these 
horrible ultimate costs.
    The Chairman. Mr. Johnson, let me just follow up on that 
and then I'll get to Mr. Zingales.
    The plan of major banks to increase their dividends. How 
does that fit into capital requirements and stockholders' 
equity?
    Dr. Johnson. Senator Kaufman, it makes no sense at all. The 
Federal Reserve and the other responsible authorities have not 
yet determined--you know, so even within their own framework it 
makes no sense. They've not yet determined what a systemically 
important financial institution should hold. There are exactly 
the issues you were discussing with the previous panel, in 
terms of additional losses coming through from major lawsuits, 
various kinds of put-backs and so on. We don't know how much 
capital they're going to need to weather the next stage of the 
global cycle. And the Federal Reserve has not yet determined 
that. So why you would allow them to pay out any of this 
capital as dividends? This is just reducing their equity, it is 
allowing them to have more leverage in their business.
    The bankers, again, want it because they get paid on a 
return on equity basis. But this is just letting them leverage 
up. And there's a put option. We write the put option, we bear 
the cost of that. You're increasing the put option, which is 
not scored in anyone's budget, by allowing them to pay these 
dividends. It's unconscionable, it's irresponsible and the 
Federal Reserve should back off from allowing this increase in 
dividends, which is apparently where they're currently headed.
    The Chairman. Thank you. And I'll take this time off my 
next thing, Mr. Zingales, so we can have everyone comment.
    Dr. Zingales. Thank you.
    In terms of--I agree with most of--what everybody else has 
said. Let me point out one aspect of moral hazard that people 
generally don't think of, because they always think about sort 
of shareholders doing crazy stuff.
    But moral hazard arises also on the size of investors. What 
I was mentioning in my testimony is during the crisis I was 
talking with a CFO who had to park his liquidity, it was in 
Europe. And he had like very large liquidity in this company 
and was worried and he said, ``I need to invest in a safe 
place. Where is a safe place, and not the banks with more 
capital, other banks who are more politically connected.''
    And so this creates the incentives for lenders to actually 
lend more to the banks that are politically connected, 
independently of their safety. And bankers who find this--that 
extremely cheap, find it irresistible to take back. And 
sometimes they take back because they really sort of want to 
speculate, sometimes it's because they just don't see the end 
in sight. I think that in the case of Lehman, probably at the 
end, Dick Fuld was a fool, was not excited playing on some 
strategic risk taking, was simply not seeing that--the mistakes 
he was doing. But the credit market was not there to stop him 
because the credit market felt ensured by the Too Big to Fail 
policy.
    Let me add another couple things that are slightly 
different to my colleagues here. Number one, I would like, like 
Professor Meltzer, stop the Too Big to Fail by legislation. I 
don't think this is feasible. I think that it's like trying to 
stop a parent from saving a child when the child is in danger. 
I think that we should not bailout our children, it's not 
educationally good, but when their life is in danger we can't 
resist. And even if we promise before not to do it, eventually 
we're going to do it.
    So the very way to address sort of this problem is not by 
legislating out an intervention, it is by adding a system of 
intervention in place. Because the real problem of the 
regulator is they intervene too late. It's not that they don't 
have the instruments.
    Let's take a case where they did have the instrument, like 
in savings and loans or in the case of Washington Mutual, the 
regulator had the--all the instruments to intervene. You know 
when they intervene? When the credit default swap price was 
3,305. It means 33 percent spread over the risk free rate.
    And in spite of this, if you Googled Washington Mutual and 
shareholders, you find that there are some shareholders sued 
because the shareholders are complaining that the regulators 
are--intervene too early. I always say, if you are a turkey 
Thanksgiving always comes too early. And if you are sort of a 
shareholder of a bank that is really out of the money, the 
regulator always intervenes too early and you exert an enormous 
political pressure for them to intervene.
    So we need to have the market-based signal to force the 
regulator to intervene early on and give a choice, either you 
recapitalize or you are liquidated. And in a sense, what the 
gentleman earlier was saying, from the Treasury, the stress 
test was exactly that, was an out and out choice. Either you 
sort of recapitalize or we take you over. And all of a sudden 
all the problems in raising capital disappeared.
    The Chairman. Thank you very much. I just lost my second 
round.
    Mr. McWatters.
    Mr. McWatters. Thank you. That's a hard act to follow.
    When I read your testimony last evening, it was well after 
midnight, I'd just flow in and I was thumbing through the pages 
and I thought, ``Okay, there's four minds here thinking pretty 
much the same way.'' And I happen to agree with most everything 
I was reading, which was delightful.
    It raises a question though. If we go back to September of 
2008, okay, September, 2008 if President Bush and Secretary 
Paulson had called you and said, ``We're in a jam, we're in a 
really bad jam here. What should we do,'' what would you have 
said?
    Mr. Stiglitz.
    Dr. Stiglitz. Well, I think it is clear that there had to 
be some government action. I think it's also clear that we've 
all said the real mistake was letting things get to that 
position and also the case that given what we know now, the Fed 
knew that there was a lot of turmoil in the financial markets 
well before. Everybody knew; the Financial Inquiry Commission 
pointed this out, that after Bear Stearns it was known that 
Lehman Brothers was very likely--this argument that they didn't 
have authority is a little bit nonsense, because if they really 
believed that, they should have gone and asked for the 
authority. So they needed to do something.
    The real problem that I had, and I tried to emphasize in my 
remarks, was the way they gave money to the banks was wrong. 
Now, interesting, when TARP was passed, they said they were 
going to buy the troubled assets. Everybody pointed out that 
that was a flawed approach and to their credit Paulson changed 
the strategy after several weeks. And it would have been an 
even worse disaster had he not changed that strategy. But the 
way the money was put in, as I said before, without conditions, 
without thinking about the structure of where you wanted to go, 
and most importantly without thinking about the mortgage market 
which was the source of the--the underlying source of the 
problem. It seemed to me that they went in without any vision, 
without any understanding of how to get re-lending started, 
what to do with the mortgage market. And they'd had plenty of 
time to think about that. So it's not the intervention, it's 
how the intervention was done.
    Mr. McWatters. Okay. Mr. Meltzer.
    Dr. Meltzer. I'm in a good position to answer your 
question, Mr. McWatters, because I appeared on the Lehrer 
Program when the program was first announced and I said, ``I'm 
against it. He hasn't explained how it's going to work, he 
hasn't explained why it should work, he doesn't have a coherent 
plan. We need a coherent plan.''
    I've got--I've been on TV, such programs, many times. I 
received an overwhelming response from the public. Nobody that 
I knew, it went 149 to 1 on my side.
    I got a call from the Treasury, they said, not in so many 
words, but the message was clear, the message was, ``Okay, wise 
guy, what would you do?'' So I went to the Treasury and I told 
them what I would do. I said, ``Call the banks in, raise 
capital in the market. If you can raise--if you need $20 
billion, raise $10 billion in the marketplace and we'll give 
you $10 billion at subsidized rates. If they can't do that 
they're done.'' The Treasury eventually did something like 
that, close to that but at the time they didn't want to hear 
it.
    Capital, that's spelled in capital letters, is what 
protects the public and incentivizes the management and the 
stockholders.
    Mr. McWatters. Okay. Thank you.
    Mr. Johnson.
    Dr. Johnson. If you give me the choice between global 
calamity and unsavory bailout, I'm going to suggest unsavory 
bailout, along the lines of Mr. Meltzer recommending the 
capital injection, that is best practice if you find yourself 
with that choice.
    But I think all of the suggestions we're making are with 
regard to how do you learn the lesson and reduce the chance of 
a global calamity scenario going forward. And I completely 
agree, that given the options now on the table, capital is the 
answer. We need a lot more capital and it needs to be pure 
capital, real capital, not funky capital, not hybrid capital, 
not contingent capital. It needs to be real equity capital in 
our financial system.
    This is not costly, from a social point of view. The 
bankers don't want it. They hate it. They're fighting against 
it. All the arguments they brought forward against it are pure 
lobbying. They have no research on their side. They have no 
analysis on their side. It is complete public relations 
exercise. We need a lot more capital in the financial system 
here. And we need to persuade anybody who wants to do banking 
business or financial sector related business in the United 
States from another country needs to have, whatever they do in 
the United States be just as well capitalized as our financial 
institutions. And hopefully that will be a lot more capital 
than we have today.
    Dr. Zingales. Also in my case the question is not so 
hypothetical. I am a member of the Committee on Capital Market 
Regulation and while I didn't speak directly to Treasury, I did 
speak with the chairman of our committee who spoke with 
Paulson. And I had a very clear proposal that I articulated in 
two pieces that I reference in my testimony.
    One with a very subtle title, ``Why Paulson is Wrong'' and 
the second, ``Plan B'' where I would say it's very simple, you 
basically require a bank to do a debt for equity swap. There is 
enough long term debt that can absorb those losses. And if you 
think that this requirement is coercive, you give the option to 
shareholders to buy back their shares through a scheme that is 
known in the literature as a batch scheme, which is very fair.
    So it would not have been coercive at all, it would have 
been immediate. And even--the only objection that people could 
raise to the Meltzer idea, which is a very good idea, is the 
market is not ready to provide that capital. In that particular 
case there wasn't even that objection. So the plan was 
feasible.
    And, as I said in my testimony, now the Credit Suisse is 
proposing it as the law of the land in Switzerland. Why? 
Because banks in Switzerland know that they are too big to be 
saved. And so they are concerned about what is going to happen 
in the future. In the United States they're not concerned about 
that so they lobby in a different direction.
    Mr. McWatters. Okay. Thank you.
    I'll ask one more question. This will be my second round. 
If you fast forward to today and look at the other end of the 
bookend, March 4, 2011, you've all described problems we have 
now. The chair has described moral hazard and the like, we've 
all written and talked about moral hazard. What do you do 
today? I can anticipate your answers as I think you've given 
them, but just to make it very clear on the record, what would 
your recommendation be on March 4, 2011?
    Dr. Stiglitz. Okay, very briefly. You know, first I want to 
emphasize the two things that we've already said. One, that you 
need more capital and that you need--the magnitude of more--
increasing capital has to be commensurate with the size of the 
banks, the risk of the Too Big to Fail distortion has to be 
eliminated.
    But secondly, if you have a problem, I think Professor 
Zingales is right, you ought to play by the ordinary rules of 
capitalism which says when you go into bankruptcy you convert 
debt to equity. I mean it's really just a version of the 
standard rules of capitalism. And you look at the numbers, say 
back in Citibank, they had enough long-term capital that it was 
more than enough to manage them, it was actually more than we 
actually put in. So the answer, you know, that we need to have 
the resolution authority, ought to be nothing more than 
basically the rules of capitalism.
    But I do feel that because there are what we call agency 
problems, that the owners of the bank--the managers of the 
banks do not necessarily act in the interest of the owners. 
This is, you know, we have a kind of managerial capitalism, 
that you have to go beyond that to have regulations and 
restrictions on risk-taking. And in particular, for instance, 
that it should not be allowed for government-insured 
institutions or very large institutions to be writing these 
kinds of risky derivatives and under other very high risk 
activities.
    So I think we do need additional regulations and more 
transparency that would circumscribe excessive risk taking by 
either government insured institutions or large institutions, 
because they're implicitly government-insured, because I don't 
think the capital is enough, is a full solution.
    Mr. McWatters. Thank you.
    Dr. Meltzer. At the risk of sounding as though Simon 
Johnson and I collaborated, I would say, I'll change the word 
capital to equity and picking up what he had said. And what 
would I would do? I would raise the requirement to say that for 
every--that after a minimum size, to protect community banks, 
you start to phase in capital requirements which start at 10, 
10 percent and increase as the size of the bank increases so 
that it's 11, 12, 13 going up toward 20. So that the largest 
banks will be paying what they were paying in the 1920's.
    And I would phase that in beginning now, because the big 
banks are reporting substantial profits. And I would give them 
three years to get to the required capital.
    And as far as other regulation is concerned, I'm a believer 
that regulation only works when it incentivizes the regulated. 
That is, if you compare drug regulation where you say, ``Well, 
we'll give you a monopoly and you produce this drug,'' then you 
have someone who wants to protect his right. We have to go the 
same thing. Capital is one way to do it. There are other ways 
to incentivize the bankers. If we just give them prohibitions 
what we'll get, you can see it happening, you can see the 
number of lobbyists, bankers that are in Washington every day 
trying to write the rules that were passed in Dodd-Frank. That 
isn't the way we're going to restrict future risks.
    Mr. McWatters. Okay. Thank you.
    Dr. Johnson. Don't allow them to pay dividends today. 
Nobody knows--we're all agreeing you need more capital. Nobody 
knows how much capital is necessary. The--even the bankers will 
concede that the easiest way to increase equity in the business 
is to retain earnings. They have profits now. That money stays 
in the bank, it belongs to the shareholders.
    Paying out equity under these circumstances makes no sense 
in economic terms. It's irresponsible. It encourages risk 
taking of these banks, high leverage bets and it's completely 
contrary to the state of policy, both in the broad of the 
administration, Mr. Geithner says, ``We need capital, capital, 
capital,'' that's what he says all the time. But they're not 
pushing for enough capital.
    And it's completely against the process. The federal 
Reserve process stress test and the determination of how Basel 
III will apply to systemically important financial institutions 
is not done, so why would you let them pay capital under these 
circumstances? It makes no sense and they shouldn't do it.
    Mr. McWatters. Okay. Thank you.
    Dr. Zingales. I agree with most of what has been said, with 
one qualification. I think the definition of capital, 
especially if it is done in accounting terms, is not 
particularly useful because Washington Mutual did not violate 
any capital requirement before it failed. As was reminded 
earlier, Lehman at 11 percent of capital just the day before it 
went bust. So I don't think that this accounting based measure 
of capital are particularly useful.
    What we need to do is a market base. And Oliver Hart and I 
have a proposal based on credit default swap, you can have 
other proposals based on other indicators.
    But I think the notion is we don't want to treat everybody 
the same, because there are virtuous banks, there are sort of 
people who behaved properly. Why should they be subject to the 
same rules? I think that the rule should be if your CDS is 
above a certain level you cannot pay dividends and you cannot 
pay cash bonus. You have to transform all the bonus you want 
into equity and that will likely play a bigger role in 
recapitalizing banks than even stopping dividends.
    Mr. McWatters. Thank you gentlemen.
    The Chairman. Mr. Silvers.
    Mr. Silvers. Well, if I've learned one thing from this 
panel, it's not to ask all of you the same question. 
[Laughter.]
    Actually I have several questions I would like to get 
answered, and so although I enjoyed listening to you I'm going 
to be specific in whom I'm asking.
    First, when Secretary Massad spoke one of the things that I 
took away from his testimony was the argument that while we 
have a lot of problems in our economy, those problems aren't 
really related to TARP. Unemployment, foreclosures, so forth, 
that they didn't really--perhaps even in credit provision are 
not really the fault of TARP or shouldn't be--TARP shouldn't be 
held responsible for it.
    Professor Stiglitz, I think I take your testimony to be of 
the view that you don't agree with that. Can you explain what 
it is, in relation to those macroeconomic matters, that are 
related to TARP?
    Dr. Stiglitz. Well, they're related in the short run and in 
the long run. In the short run what I was trying to argue is 
that if you--they had given money to the banks in ways--in 
other ways, they could have induced more lending and induced 
more restructuring. So for instance, by the time we bailed out 
Citibank and Bank America, we were very large shareholders. We 
could have been even larger shareholders if we got shares----
    Mr. Silvers. If we got the value for the money, so to 
speak?
    Dr. Stiglitz. Yeah, if we had gotten voice relative to the 
money we put in. If we used that shareholder voice to say, you 
can't go make your profits out of speculation, you can't go 
paying these bonuses, this goes back to the point paying out 
bonuses and dividends is decapitalizing the banks and what was 
needed was recapitalization. And we allowed the 
decapitalization of the banks through the payouts of bonuses 
and dividends. We didn't put any pressure, any constraints on 
the behavior of the banks, so there were--including the 
restructuring of the mortgages.
    So given the amount of money that, you know you're putting 
in--if you're putting in hundreds of billions of dollars you 
should have some voice in what happens. And the result of that 
is that we didn't get what we wanted, which was a restarting of 
the economy.
    The long run are the more--are the even worse problems, 
because we have a more concentrated banking system, that means 
interest rates will be higher, spreads will be higher. And the 
result of that is not only are there the long risks that we've 
been talking about but in the short run the--because the market 
is less competitive the flow of money will, in the long run, 
not be what it should be.
    Mr. Silvers. Okay. Professor Johnson, Treasury seems 
convinced that the banks are healthy, sound or something like 
that. I wonder if you would comment on two things. One is, is 
that right? And two, how can anyone know that's right and given 
the state--we've talked a lot about the capital side of the 
balance sheet, the liability side, given the state of what we 
know or don't know about the asset side of the balance sheet.
    Dr. Johnson. Yes, that's exactly right. There's a great 
deal of uncertainty around asset values. And of course, the 
correct way to assess the state of any banks is to do the 
stress test. Now there needs to be tough stress tests, the 
downside scenario needs to be much more rigorous or negative, 
pessimistic than the one they used in 2009. And I fear that the 
stress tests that they're doing now, although they haven't 
disclosed anything really about them, I fear that those tests 
are even more gentle.
    So my answer is, we don't know. There's a lot of bad things 
that can happen. We're certainly not out of the recession, as 
my colleagues have mentioned, in many dimensions, and you have 
emphasized. So the sensible, prudent thing to do is to require 
that the banks retain the earnings and build up bigger equity 
buffers against potential future losses.
    And that's irrespective of whether or not you accept my 
view; Gene Farmer's view; Professor Meltzer's view and Admati's 
view that going forward we should have 20, 30, 40, Adair 
Turner's view from the UK, the FSA there, Financial 
Supervisors; Mervyn King's view, the head of the Bank of 
England; Philipp Hildebrand's view, the head of the Swiss 
National Bank, even if you don't agree with the views of those 
people, just today, and if you're just in learning Basel III 
the only thing that makes sense is to have them retain the 
earnings right now and not pay out dividends, given what we 
know and the many things we don't know, many things we fear 
about the economy going forward.
    Mr. Silvers. Professor Meltzer, your suggestion that we 
have size adjusted capital requirements is, as I noted in the 
prior panel, it was one of the recommendations of this panel, 
in our regulatory reform report to Congress.
    Dr. Meltzer. Good for you. [Laughter.]
    Mr. Silvers. Thank you.
    It seems to me, just the most sort of obvious idea and I'm 
heartened to see some one of your experience having recommended 
it.
    Dr. Meltzer. Senator Vitter introduced a bill to do it.
    Mr. Silvers. Now I've also been involved in the arguments 
on The Hill that essentially prevented it from being mandated 
in Dodd-Frank and I find that in general it is treated as 
though you were suggesting the creation of a perpetual motion 
machine or something of that nature in our politic processes. 
Can you explain to me why something so sort of straightforward 
can't seem to be taken seriously?
    Dr. Meltzer. Yes. The bankers don't want it and they come 
down with their lobbyists in hordes to tell them--tell the 
congressmen, you know, ``That's just disaster. You're facing 
disaster. There won't be loans for the public. There won't be 
capital to build industry,'' all that stuff.
    Mr. Silvers. Can I just ask and then I'm going to stop.
    Dr. Meltzer. We got through the 1920's with capital 
requirements.
    Mr. Silvers. But since we're talking about size-weighted 
capital requirements, would that not just mean that it would be 
a powerful incentive for institutions to be smaller and then 
they would lend more when they were smaller? I mean would not 
rational actors move to basically step away from the Too Big to 
Fail structures and the amount of credit provision would not be 
affected.
    Dr. Meltzer. We would remove the incentive which pushes 
them to be bigger and bigger all the time. And that would be 
good. I don't think they would be small, but I do think they 
were be small-er.
    Mr. Silvers. Smaller, right.
    Dr. Meltzer. There isn't any evidence that I know that says 
that there are economies of scale at that size which makes them 
want to be bigger.
    Mr. Silvers. Yeah.
    Dr. Meltzer. And I would like to add one other thing. In 
1991 I believe Congress passed FDICIA. Are you familiar with 
FDICIA? Yes. Did they use it at all? No, they didn't use it at 
all. What did it call for? It called for early intervention. 
Just completely ignored. And they gave reasons. They said it 
didn't apply to holding companies, such things as that. You 
know, given all the things that they were doing they could have 
made FDICIA work and closed them down early or make them raise 
more capital. They didn't do that. So we have to legislate it.
    Mr. Silvers. Thank you. I'm allowed to keep going, I'm 
told.
    Various people want to speak. Mr. Johnson?
    Dr. Johnson. My understanding of the literature, just to 
reinforce Professor Meltzer's point, is there's no economies--
no evidence for economies of scale or scope in banking over 
about $50 billion in total assets. You might see $100 billion 
dollars if you wanted to be generous. All the benefits above 
that are private benefits, not social benefits.
    Mr. Silvers. I guess one----
    Dr. Stiglitz. Can I just make one more point----
    Mr. Silvers. Yeah, sure.
    Dr. Stiglitz [continuing]. Just to emphasize the 
theoretical point here, that the requirements of leverage, 
there's a basic idea in economics called the Modigliani-Miller 
Theorem----
    Mr. Silvers. Yes.
    Dr. Stiglitz [continuing]. That says that leverage doesn't 
buy you anything except higher probabilities of default. And 
that--and so that the argument that they're making that it 
would interfere with the efficiency of the economy has no 
support in the economics profession.
    Mr. Silvers. But there is one more argument I'd like to 
dispose of, because there is this--there is the notion that--I 
mean you all suggested various levels of capital be required. 
But setting the question of how much capital should be required 
at any given size, just the notion of a sliding--the notion of 
a sliding scale, right, does not--is there any basis for the 
argument that a sliding scale would bring on a credit crunch?
    Dr. Meltzer. No.
    Dr. Stiglitz. No.
    Dr. Zingales. Can I dissent on this? I think that----
    Mr. Silvers. I've found a point of agreement. I feel proud. 
[Laughter.]
    Dr. Zingales. I have to say I have great respect for 
Professor Stiglitz. I think that since Modigliani and Miller we 
have a large literature in corporate finance saying that 
actually it's sort of--the level of that is not irrelevant. And 
actually he contributed in part to that literature. So I'm 
surprised to say--to see now that he says that it's completely 
irrelevant. I don't think it's irrelevant, I think that there 
are some costs of having too much or too little debt depending 
on the situation. And I think that in the current situation, if 
you were to dabble in the capital requirement to banks 
tomorrow, you will have a credit crunch. I think that it will 
definitely be a consequence.
    Why? Because the managers don't want to raise more equity, 
regardless of whether this is in the interest or not of the 
shareholders, but they don't want to raise more equity. And so 
the alternative of raising more equity is to lend less. So I 
think there will be consequences and I think that the argument 
they're going to use to say why the sliding scale is bad is 
that it's going to unfairly affect the large banks. I 
completely disagree with this argument. I think that now we 
unfairly favor large banks so the sliding scale will only bring 
sort of a level playing field, but that's how to argument they 
would make.
    Mr. Silvers. Right. Your point about the credit crunch is 
kind of an institutionalist argument.
    Dr. Meltzer. But, the main change would be----
    Dr. Zingales. Why institutional? I'm sorry.
    Dr. Meltzer [continuing]. You get more collective form of 
lending. That is if a bank--one argument that's made is that 
the corporations are so big that they need to have----
    Mr. Silvers. Big banks, right.
    Dr. Meltzer [continuing]. Big banks. But they can syndicate 
the loans, they've done that for hundreds of years. They can 
syndicate the loans and service the banks--the customers.
    Dr. Johnson. Sorry, I see a straw man slipping into the 
conversation. And no one is proposing that you immediately 
double capital requirements and tell them to hit that number 
tomorrow. Yes, the one way you could achieve that is by dumping 
assets or reducing loans as Luigi said. But, if you can look, 
for example, at the plans brought forward by or proposed by 
Jeremy Stein and David Scharfstein, for example, who are both 
very experienced, both worked in the Treasury under this 
administration, and now have proposals out there for ways in 
which you can time the shift in capital requirements to phase 
in these kinds of either a higher level overall or a step level 
as Professor Meltzer's suggesting. This, if implemented 
properly, would not be contractionary.
    Dr. Stiglitz. Let me just go back to----
    Mr. Silvers. I don't think--my chair has told me that this 
must come to an end. [Laughter.]
    The Chairman. Dr. Troske.
    Dr. Troske. Thank you. This has been a fascinating 
conversation and I'm certainly not going to try to compete with 
you on your field, so I'm going to pull you over to mine as a 
mere labor economist and start talking about executive 
compensation, which is--has received a certain amount of 
attention.
    But my own view of this issue and combined with the current 
crisis sort of has evolved over time and to one in which it 
seems to me that when you have a Too Big to Fail financial 
institution it's the case that shareholders very much value 
risk and are going to move towards more leverage. And they're 
actually going to compensate executives in a way that would 
have them shift the risk profile of the investments that they 
make out to a more risky environment. So you don't need to take 
a very strong stand, in terms of whether you think, you know, 
executive pay is set, you know, optimally or not, but in the 
presence of Too Big to Fail, both shareholders and executives 
are willing to move towards more risky forms of investment and 
are going to be compensated in that fashion.
    I guess I'd like your thoughts on my hypothesis. And I'll 
start with you, Professor Stiglitz.
    Dr. Stiglitz. Well, let me just say, the important point 
that you're emphasizing is that the decisions made by the banks 
are made by managers, not by the shareholders, and that there 
can often be misalignment of interest between the two. And 
that's why I remarked before, I think that there need to be 
regulations affecting shareholder compensation, regulations in 
general, including regulations affecting shareholder 
incentives. Because those incentive structures can lead them to 
want to undertake excessive risk and there may be limited 
ability of shareholders to constrain the ability of managers in 
that way.
    So--and there's a second problem in managerial compensation 
that you didn't mention that I think is important to realize. 
That when you get shareholder stock option kind of 
compensation, it provides an incentive for you to distort the 
information that you're providing. So it encourages 
nontransparent accounting and there's always going to be a lot 
of discretion. A lot of the issues that--we've ignored the 
mistakes that have been associated with the ability to not--to 
keep on bad mortgages at full value and that whole distortion 
in the assessing of the asset structure. But the point is that 
if you have compensation that is related to the seeming 
performance of the share market, you--sharers, you have an 
incentive to distort the information provided by the market and 
to the regulators.
    Dr. Troske. Does anybody have anything different to add?
    Dr. Johnson. Yes.
    Dr. Troske. Okay.
    Dr. Johnson. If I may. I agree with you that theoretically 
if the Too Big to Fail guarantee holds, then the interest of 
the investor and interest of management, in this regard, are--
can be aligned. So the investors want the management to 
leverage up, they want them to take a lot of risk. However, as 
a practical matter, I think the kinds of concerns Professor 
Stiglitz was mentioning come into play.
    And I would refer you to a paper by Sanjai Bhagat and Brian 
Bolton who went carefully through the compensation received by 
the top 14--by executives of the top 14 financial institutions 
in the United States between 2000 and 2008. They found that 
those executives took out, in cash bonus and through stock 
sales, $2.6 billion in cash. In fact the top five executives 
took out around $2 billion in cash. And the shareholders, at 
the same time, if you were a buy and hold shareholder over that 
period, you did pretty badly.
    So that suggests that as a practical matter, maybe it's 
because of misrepresentation, actually I think that's quite a 
plausible explanation, or maybe it's for some other reason, the 
shareholders do not do well when the managers leverage up, take 
a great deal of risk and get paid on a more or less immediate 
return basis, which is linked to your return on equity basis, 
not properly risk adjusted.
    Dr. Troske. Yeah. Thanks. Can I----
    Dr. Meltzer. Dr. Troske, I worried about this program a lot 
as a practical thing because I was a chairman of an audit and 
compensation committee for a Fortune 500 company. And so I 
faced the problem of how do you reward the chief executive and 
subsidiary executives. I don't think there's an easy answer to 
this problem. Dodd-Frank came up with a proposal which says 
that you have a nonbinding vote of the shareholders. So far I 
believe the evidence is the shareholders don't care much. That 
should be evidence that, leave it alone.
    Dr. Troske. Professor Zingales----
    Dr. Meltzer. Except in the case where you're failing.
    Dr. Troske [continuing]. I'd like to ask you a little, 
somewhat different question more related to your recent paper, 
``Paulson's Gift,'' and I like your title. I wish I were that 
creative, or editors let me be that creative in my titles.
    You estimate that TARP preferred equity infusions and the 
FDIC debt guarantee cost taxpayers between 21 and 44 billion. 
You talk about an alternative plan. The government could have 
charged more for both the equity infusion and the debt 
guarantee, as Warren Buffett did when he invested in Goldman 
Sachs three weeks before the Paulson plan. Could you kind of--
could you elaborate on the difference between private party 
transactions undertaken at the time of TARP on the one hand and 
the actual TARP transactions as well as the FDIC's extension of 
deposit insurance?
    Dr. Zingales. Yes. I think that there are two aspects. 
First of all, the capital infusion that was done was done, not 
in market terms by any stretch of the imagination, was 
definitely worse than the one that Warren Buffett got in terms 
of return. And the same is true for the debt guarantee. Now, 
what is interesting is we observe when this debt guarantee was 
the standard that the overall cost of insuring these 
institutions dropped.
    So--but even if we take the value of this cost after the 
announcement, so let's think about there is a systemic effect 
and there is an individual effect, even if we sort of take 
anyway the systemic effect, the cost of insuring this 
institution was too cheap and that was not really varying 
according to the type of institution. So for JP Morgan this was 
not very convenient, for Citigroup or Goldman was tremendously 
convenient.
    So what the accurate number you reported doesn't give a 
good sort of picture of is sort of the cross section. There was 
an important redistribution also within banks. JP Morgan was 
heavily penalized by the plan, probably because the market 
expected them to buy on the cheap the assets the other people 
were selling. And Citigroup was--Citigroup, Morgan Stanley and 
Goldman were tremendously helped by the plan.
    So there is sort of also this cross sectional aspect which 
I think is important because it distorts the market incentives. 
By treating everybody the same the good managers are not 
rewarded and the bad managers are not penalized.
    Dr. Troske. So let me ask one final question. As a 
profession we're often characterized as unable to reach 
consensus on any issue. And I would argue that the five 
independent PhD economists in the room, and I'm going to be 
arrogant enough to put myself in your group, agree about the 
importance of incentives and the effects that these distorted 
incentives had throughout this problem and continue to have 
today. This is a point I've made repeatedly since being on this 
panel.
    I can understand why folks ignore me, but I struggle to 
understand why they ignore you. And I guess I'm kind of curious 
on your thoughts, what are we doing wrong as a profession 
because I do think these issues are something that economists 
do agree about. And so I guess I'd like your thoughts on, you 
know, on--because I'm kind of tired of shouting into the wind. 
I don't know about you. [Laughter.]
    Professor Stiglitz, I'll let you lead off.
    Dr. Stiglitz. Okay. Well, I think the--what is interesting 
about this particular case is that there is a broad spectrum of 
support from the Left and the Right in the economics 
profession. But this goes back to the particular groups who are 
big beneficiaries of this particular system. And they have a 
lot of money to invest in both trying to shape public opinion 
and to get what they want.
    So I don't find it that mysterious in a way, that there is 
a lot of money at stake. I mean he's talked about some of it, 
but a lot of money and that the money on the other side of 
trying to create a more efficient, fairer system, the point 
that a number of people have always made, Becker, for instance, 
that those are lots of people. And you have concentrated 
beneficiaries and the alternatives are much more diffuse. It's 
very hard to get a fair battle when you have that--this much 
money at stake.
    Dr. Troske. Professor Meltzer, you've been doing this for a 
long time. What are your thoughts?
    Dr. Meltzer. Well, I'm a strong believer in what is now 
called ``political economy,'' that is making policy; the first 
four letters of policy and politics are the same and the money 
is very important. So you know, we're fighting a battle that 
I--well, I agree with my old friend, the late Milton Friedman 
who said, ``Our job as economists is to come up with proposals 
and when the crisis comes it will be better than the proposals 
that will occur at that time.'' And he and we have had a record 
of getting things done that way in crises.
    In the ordinary course of events you're fighting a tough 
political battle in which, as Joe just said, there's much at 
stake and there's a lot of money that goes into campaigns 
coming from Wall Street and that makes, you know, a big, big 
hurdle to get over. So when Senator Vitter introduced my bill 
to scale up the thing, you know, there just wasn't a lot of 
support in the Senate Banking Committee for it.
    Dr. Johnson. It's a fascinating question that the bankers, 
when confronted by these proposals in the United States say, 
``We're going to move to the UK,'' and when confronted by these 
proposals in the UK they say, ``Well, we're going to move to 
New York.'' You don't have to get the G20 together on this, you 
need to have the world's leading financials and New York and 
London would span most of it. And the Swiss are already 
pointing in exactly the same direction.
    And there are people within the Federal Reserve system, for 
example, Thomas Hoenig, within the other regulatory agencies, 
including Sheila Bair, who I think totally get this. I'm not 
saying that we convinced them, I think that they figured this 
out by themselves.
    There are other people, such as Treasury and important 
elements within the New York Fed and within the Board of 
Governors of the Fed who are absolutely adamantly opposed to 
applying the logic that we've been discussing here today. They 
say--well, I don't know what they say. They don't come out and 
discuss it enough and clearly enough and I think, you know, 
ultimately a lot of the reasons they put forward make no sense 
at all.
    And I think it was Mark Hanna, the legendary Republican 
Senator at the turn of the--beginning of the 20th century, the 
organizer of the Republican Party in the Senate around the 
country who said, ``There are two things that matter in 
American politics. The first is money and I don't remember what 
the second one is.''
    Dr. Troske. Mr. Zingales.
    Dr. Zingales. I think there are a couple of reasons. First 
of all, I think we know, as Stiglitz reminded, that there is a 
capture by the sort of people who are well organized and have a 
lot of money at stake. I actually believe in democracy enough 
that I think that on some topics this sort of strength can be 
overcome, but it requires that the topic is sufficiently 
interesting and sufficiently sort of easy to explain in the 
media that it generates sort of a public outrage.
    So I think that in terms of environmental issues, people 
are much more sensitive because you can explain that more 
easily to the ordinary human being. I think that excessive 
compensation really attracts the interest of voters. When it 
comes to how to properly regulate capital requirements, I think 
that would put asleep like 99.9 percent of the people. And so 
it's very hard to be successful in explaining or pushing on--
with the political agenda, against the entrenched interest.
    But I have to say that there is also a responsibility of 
the economic profession in that. I think that you preach to the 
choir and it says, here this is not a selected sample, I think 
there are people that have been actively engaged in public 
speaking and I don't think that you can say the thing about 
most economists. I think that most economists don't write in 
newspapers, don't sort of actively sort of take their 
positions, they're not public figures. It's not what you are 
awarded for academically. The type of policy advice you give is 
not sort of very strong in your vitae and I think that they 
don't care.
    Dr. Troske. Thank you.
    The Chairman. Thank you.
    Superintendent Neiman.
    Mr. Neiman. Thank you.
    The Chairman. We saved the best for last.
    Mr. Neiman. Oh, okay. Thank you.
    You know, in addition to the global calls and efforts to 
increase bank capital, we also know that liquidity is a driver 
to a firm's failure. Lehman is a good example with reference to 
the capital position at the time, the impact of short sellers, 
and of the fact that short term funding can dry up at any point 
in time.
    I'd be interested in your views on the relationship between 
capital and liquidity. And also your views on the proposals out 
there, particularly Basel III; the proposals with respect to 
increases in liquidity practices and requirements.
    Dr. Zingales. Can I start?
    Mr. Neiman. Sure.
    Dr. Zingales. I think that the risk that short term debt 
presents is very large because short term debt can run very 
quickly. If I lend somebody overnight, I don't want to take any 
risk that the counterparty will fail overnight. Whatever high 
interest rate you offer over a day is not large enough to 
compensate for the risk. And that's the reason why when the 
market sentiment shifts and when there is a fear that the 
counterparty is insolvent or--then the short term lenders stops 
lending.
    So that's the reason why I think it's important to have a 
cushion of long term debt. And so the Basel requirement for 
having a significant amount of long term debt I think is 
important. And paradoxically I think that part of what made the 
crisis worse are two pieces of--two facts. One is the Fed 
policy that kept sort of interest rates, especially short term 
on the curve, very low favored people--favored the short term 
borrowing by part of financial institutions, made it very 
convenient. And of course they don't internalize this 
externality of sort of the systemic aspect.
    The second paradoxically is sort of the bankruptcy reform 
done in 2005. By making sort of--by exempting derivative and 
repurchase agreements from bankruptcy, they made them much 
cheaper than everything else, basically inducing institutions 
to take more of it and then making them more fragile. So, I'm 
definitely in favor for some sort of requirement in terms of 
compositional liabilities.
    Mr. Neiman. Any other?
    Dr. Stiglitz. The--I think the issue that you raise focuses 
particularly on the question of the shadow banking system and 
that this is a really very serious problem that a lot of the 
discussion will be focusing on in the banking system. But you 
know, the point where Lehman Brothers really showed up was the 
collapse of reserve--the reserve fund. And people thought that 
they could use the shadow banking system as a substitute for 
the banking system.
    I think what we now know we have to regulate both the 
shadow and the regular banking system. We have to see them as 
an integrated whole and that we shouldn't view the shadow 
banking system as a way of circumventing the banking system. So 
I think that is one of the important aspects.
    I do want to agree with Professor Zingales that the 
incentive structures that are often built very subtly into the 
whole structure, like the bankruptcy provision, is really an 
example of something that's a major distortion that got very 
little attention at the time that it was adopted, but is 
obviously--it is an example of the kind of concern.
    Another example is when you have incentives where some of 
the things are--some of the CDSs are done in a transparent 
market and some are done over the counter. That is an incentive 
to move things into the dark areas and to engage in things 
where nobody--it's difficult to regulate.
    So, we are now, in the way we're going forward right now 
are creating new opportunities and new incentives to move 
things away from where we can see what's going on and to where 
we can't and where these kinds of liquidity issues become all 
the more important.
    Mr. Neiman. I'm glad you raised the issue of shadow banking 
because I did want to ask about the regulatory reform efforts 
about riskier activities, proprietary trading, swap activities 
and different proposals. For example, the Volcker Rule requires 
moving those activities, the proprietary trading, hedge fund 
activities out of the holding company all together as opposed 
to certain swap activities being moved out of the bank into the 
holding company.
    I'd be interested in your views as are you shifting those 
activities into a less regulated area or would you prefer to 
see them within the bank holding company structure with a 
higher level of oversight and capital requirement?
    Dr. Stiglitz. Well, my view, there are two separate issues. 
I think we have to deal with very strongly with the Too Big to 
Fail banks and financial institutions, whether they're banks or 
non-banks and with the Too Correlated. We haven't talked about 
the Too Correlated to Fail, because that's another set of 
problems that represent systemic risk. But--so that's one set 
of issues. And when you have them still connected in a holding 
company you haven't really solved the Too Big to Fail.
    But the other issue is, wherever they are there needs to be 
transparency. And the movements to allowing large segments of 
transactions to be in a nontransparent venue seems to me a real 
invitation to problems.
    Mr. Neiman. Any other?
    Dr. Meltzer. Yes. I'd like to say that on the money market 
funds, the biggest part of the off banking system, how did that 
crisis come about? Well, they got a rule, they had to mark 
their markets--their assets to market until they got to the 
point where they no longer could do that and pay a dollar or 
pay their face value. So they got the SEC to change the rule so 
they didn't have to mark their market--their assets to market. 
And when there was a run, after Lehman, that caused them. If 
they had been forced to mark their market--their assets to 
market that would have been the normal course of events. That 
was just a bad ruling.
    We ought to reverse that ruling and say that when your 
liabilities are only worth 95 cents, they're worth 95 cents.
    Mr. Neiman. Thank you, Mr. Meltzer.
    Dr. Meltzer. That was a mistake. I agree with a comment 
that you made quickly and I think it is a major problem that 
you have to think about. If we regulate too much, and we may 
well be doing that, we're just going to shift--somebody has to 
bear the risks of the forward movement of the American economy. 
If we shift those risks out of the banks, the most regulated 
part of the system, and into other agencies, perhaps some not 
yet born, that's not going to be in the public interest or in 
the long run interest of the country.
    So we have to be concerned with what we do to keep the 
risks where we can at least see them.
    Mr. Neiman. Well the most descriptive is to avoid playing 
``whack-a-mole'' I live near an amusement park and----
    Dr. Meltzer. Right. So that's another reason why capital 
requirements are much more desirable than regulation.
    Mr. Neiman. Appreciate that.
    Mr. Johnson.
    Dr. Johnson. I agree completely. The--many of these shadow 
structures were constructed as a way to get around capital 
requirements, to so called economize on capital which means to 
take more highly leveraged bets and to take on more risk. And 
while I recognize your points about liquidity, and I agree that 
we have constructed incentives for too much short term funding 
of longer term assets and assets that should be actually funded 
with equity, because of the nature of the risks there, I would 
emphasize we need high capital requirements across the board.
    We can't rely on the market to do this by itself, because 
as we've discussed it's an incentive for the management, for 
sure, and in many cases management and shareholders to get big 
enough so they can fail.
    And I would end by quoting somebody I know in the hedge 
fund sector, in a very large hedge fund, household name. He 
said to me, ``Simon, let's face it, on the Too Big to Fail 
debate you lost. And now our question is, or what we're working 
on in the hedge fund is, how do we become Too Big to Fail.''
    Dr. Zingales. Can I sort of endorse strongly what Professor 
Meltzer said? I think that the single most evil rule that is 
still in place is exactly that one of the SEC that provides an 
appearance of safety on money market funds and help them market 
themself as complete substantive deposits when they are not. 
And it's ironic that we had 2,000 pages of legislation and we 
could have changed that rule sort of very easily, I don't think 
it's subject to congressional approval, it's just a rule of the 
SEC, but nobody wants to do it and nobody even is discussing 
doing it.
    Mr. Neiman. All right. Thank you.
    The Chairman. Well, I've been around this place for almost 
40 years, I've never seen a panel and a group of witnesses more 
in agreement in my entire life. [Laughter.]
    So I--and let me tell you something, I know you know about 
the disparity in the political ideas of the witness, let me 
tell you, there's some pretty different views about just about 
everything up here on the panel, but I think there's one thing 
that we're all in agreement on and I think that Dr. Troske 
raised a good point, that I have felt the--I have the scars 
from, and that is the difficulty, of not just economists of 
trying to get some of these ideas that have been raised here 
that seem to be pretty simple, pretty straightforward and 
pretty widely held by people that have spent time thinking 
about it, to get it into legislation and get it into the 
Securities Exchange Commission and get it into CFTC.
    So anyway, I really, really want to thank you all for 
taking time out of your day to come down here and do this. We 
really do appreciate it.
    The record for the hearing will be kept open for one week 
so the panel may submit questions to the record of witnesses.
    I want to finally say, just thank some folks. And I want to 
thank my fellow panelists. I mean you know, I came into this 
late and the welcomeness, the ability, the--I've never seen a 
group that is so easy to get along with and are so interested 
in trying to come to a common ground, even though there are 
very basic differences on the issues. So I really want to help 
my fellow panelists.
    The other thing, having been a staff person, when you show 
up at this point with a staff that's in existence, you show up 
and you're a little scared because you know what you want in a 
staff and the rest of it. And I want to tell you, this has been 
a--absolutely--this COP staff is absolutely incredible and 
Naomi Baum does an incredible job to monitor the--Elizabeth and 
the whole group has just done an incredible job and I think the 
record shows that.
    So I want to thank everybody from here. And with that we 
will close the hearing.
    [Whereupon, at 1:44 p.m., the hearing was adjourned.]