[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
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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
U.S. GOVERNMENT PRINTING OFFICE
65-276 WASHINGTON : 2011
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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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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.]